We Canadians all know too well that our income is taxable.
Money recovered in a wrongful dismissal action is mostly intended to approximate would-be income. Accordingly, with few exceptions, it too is taxable.
Therefore, employers usually withhold a certain proportion of amounts due for wrongful dismissal damages, and remit that amount to the Canada Revenue Agency for the employee’s tax account. The amount is a credit of tax paid by the employee for the relevant year.
There are certain techniques available to employees to minimize the legally required taxes which are payable at the time of termination of employment. Employees may be eligible to take advantage of a non-taxable retiring allowance for service before 1996, under a Canadian tax rule that applied until that time. This rule permits a certain amount of the retiring allowance attributable to years before 1996 to be paid into the employees’ RRSP, free of taxation at source. Some tax relief is also available in that legal expenses incurred to recover wrongful dismissal damages can be deducted from income, or paid directly by the employer, without withholding. Also, in some circumstances, it is possible to direct that some part of monies payable by way of wrongful dismissal damages be paid into the dismissed employee’s RRSP in respect of available “RRSP room” that exists because historically, maximum contributions have not been made. Finally, certain heads of damage advanced (such as punitive damages) are not subject to taxation at all, and accordingly a portion of the settlement in certain rare cases may be attributed to such heads of damage tax free.