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Taxation of Damages – What a Difference It Can Make
At the conclusion of a long litigation matter, two questions sure to arise – how much was awarded and whether or not that award is taxable. Everyone agrees that a tax-free award is most desirable to the plaintiff . Whether or not a particular award of damages is to be received on a tax-free basis depends upon the characteristics of the action, the pleadings, the methodology used by the trial judge and the actual calculation of the damages.
Lawyers and their clients would be well advised to consider the tax implications of the damages sought from the outset. In some instances, the nature of the action clearly determines whether the damages will be taxable by rule of law.
In other cases, there may be the possibility of framing the cause of action for tax purposes; whether the damages are deemed income and, if so, are they capital gains or income.
Damages Related to Personal Injury or Death
Th e characterization of damages awarded in the context of an injured individual is key to determining whether the award may be received on a tax-free basis. Damages awarded in respect to a personal injury or death are to be
received by the injured party, or by the dependant of a deceased party, on a tax-free basis as long as the damages are special damages, general damages or pre-judgment damages.
Special damages in the context of personal injury relate to compensation such as out-of-pocket expenses (for medical and/or hospital expenses) and accrued or future loss of earning. However, an amount which can reasonably be considered to be income from employment rather than an award of damages will not be excluded from income.
General damages in the context of personal injury relate to compensation for pain and suff ering, loss of amenities of life, loss of earning capacity, the shortened expectation of life and the loss of financial support caused by the death of the
supporting individual (a parent for example).
Furthermore, damages that are awarded to be paid over a period of time by periodic installments are also to be received on a taxfree basis by the injured party; notwithstanding that it appears to be an annuity. The CRA confi rmed in its IT Bulletin 365 that damages for personal injury or death that are ordered to be paid in periodic payments are not, despite such periodic payments, considered to be an annuity contract and the periodic payments themselves are not considered to be annuity payments.
An annuity contract purchased by a taxpayer or a taxpayer’s representative with proceeds of a lump sum award received for damages for personal injury or death will be considered an annuity contract and will likely be taxable, with
some limited exceptions.
Business Related Damages
Determining the characterization of damages awarded on business matters and the resulting tax treatment can be difficult. The general principle is that damages in lieu of receipts that would have been taxable as income remain taxable.
Determining whether those damages are deemed income or nontaxable receipts depends on the nature of the legal right at issue.
One must carefully review the facts and determine the purpose of the remedy; i.e., for what do the damages compensate?
If the damages awarded are for loss of income, then the general principle is that they will be considered business income and therefore taxable.
If the damages awarded relate to the loss of an income-producing asset, it will be considered to be a capital receipt and non-taxable. As one can imagine, the difference between loss of income and the loss of an income producing asset can be nuanced and there exists no bright-line test to diff erentiate the two; it is always a question of fact. Essentially, if the damages received are for the failure to receive a sum of money that would have been income had it been received, the
damages are likely deemed income receipt and taxable. Also, if the damages awarded are essentially a surrogatum for future profits surrendered, the damages will likely be treated as revenue receipts, not a capital receipt, and be taxable.
Employment Related Damages
In most instances, employment related damages are awarded as compensation for a loss of employment and are specifically dealt within the Income Tax Act as “retiring allowances.” Under the Income Tax Act, retiring allowances
are fully taxable as income.
As a result, damages for wrongful dismissal, damages for compensation for lost earnings or damages on account of a contractually agreed settlement (such as a signing bonus) will all be taxable in the hand of the recipient. Damages awarded by the Workers’ Compensation Board for illness, injury or death ought to be included as income but the recipient is entitled to a deduction which essentially off sets the inclusion by excluding the damages award.
Also, damages awarded in context of a human rights violation, personal injuries (e.g. defamation or harassment) or tortuous conduct by an employer are usually viewed as general damages unrelated to the loss of employment and are therefore non-taxable. Once again, the determination is a factual one.
Conclusion
Th e taxation of damages awarded will inevitably aff ect the ultimate cost of recovery or indemnity. In some instances, the Income Tax Act will clearly dictate whether the damages are taxable. In other cases, a proper determination can only be made sometime aft er the commencement of the litigation process.
Ultimately, the only certainty is that some damages are taxable while others are not, that the analysis is a factual one and that the framing of the cause of action and the pleadings may formulate the determination.
Tierney Stauff er LLP, you can be sure that lawyers litigate with their clients’ best interest in mind and that always includes making informed decisions with respect to taxation.
If you have any questions concerning the taxation of damages, please do not hesitate to contact me directly at 613.288.3220
This article is provided as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter referenced in this document before making decisions. Any use of this document does not constitute a lawyer-client relationship.
Taxation of Damages – What a Difference It Can Make
At the conclusion of a long litigation matter, two questions sure to arise are how much was awarded and whether or not that award is taxable. Everyone agrees that a tax-free award is most desirable to the plaintiff. However, whether or not a particular award of damages is to be received on a tax-free basis depends upon the characteristics of the action, the pleadings, the methodology used by the trial judge and the actual calculation of the damages.
Lawyers and their clients would be well advised to consider the tax implications of the damages sought from the outset. In some instances, the nature of the action clearly determines whether the damages will be taxable by rule of law. However, in other cases, there may be the possibility of framing the cause of action for tax purposes; whether the damages are deemed income and, if so, are they capital gains or income.
Damages Related to Personal Injury or Death
The characterization of damages awarded in the context of an injured individual is key to determining whether the award may be received on a tax-free basis.
Damages awarded in respect to a personal injury or death are to be received by the injured party, or by the dependant of a deceased party, on a tax-free basis as long as the damages are special damages, general damages or pre-judgment damages.
Special damages in the context of personal injury relate to compensation such as out-of-pocket expenses (for medical and/or hospital expenses) and accrued or future loss of earning. However, an amount which can reasonably be considered to be income from employment rather than an award of damages will not be excluded from income.
General damages in the context of personal injury relate to compensation for pain and suffering, loss of amenities of life, loss of earning capacity, the shortened expectation of life and the loss of financial support caused by the death of the supporting individual (a parent for example).
Furthermore, damages that are awarded to be paid over a period of time by periodic installments are also to be received on a tax-free basis by the injured party; notwithstanding that it appears to be an annuity. The CRA confirmed in its IT-Bulletin 365 that damages for personal injury or death that are ordered to be paid in periodic payments are not, despite such periodic payments, considered to be an annuity contract and the periodic payments themselves are not considered to be annuity payments. However, an annuity contract purchased by a taxpayer or a taxpayer’s representative with proceeds of a lump sum award received for damages for personal injury or death will be considered an annuity contract and will likely be taxable, with some limited exceptions.
Business Related Damages
Determining the characterization of damages awarded on business matters and the resulting tax treatment can be difficult. The general principle is that damages in lieu of receipts that would have been taxable as income remain taxable. However, determining whether those damages are deemed income or non-taxable receipts depends on the nature of the legal right at issue. One must carefully review the facts and determine the purpose of the remedy; i.e., for what do the damages compensate?
If the damages awarded are for loss of income, then the general principle is that they will be considered business income and therefore taxable. However, if the damages awarded relate to the loss of an income-producing asset, it will be considered to be a capital receipt and non-taxable. As one can imagine, the difference between loss of income and the loss of an income producing asset can be nuanced and there exists no bright-line test to differentiate the two; it is always a question of fact.
Essentially, if the damages received are for the failure to receive a sum of money that would have been income had it been received, the damages are likely deemed income receipt and taxable. Also, if the damages awarded are essentially a surrogatum for future profits surrendered, the damages will likely be treated as revenue receipts, not a capital receipt, and be taxable.
Employment Related Damages
In most instances, employment related damages are awarded as compensation for a loss of employment and are specifically dealt within the Income Tax Act as “retiring allowances.” Under the Income Tax Act, retiring allowances are fully taxable as income.
As a result, damages for wrongful dismissal, damages for compensation for lost earnings or damages on account of a contractually agreed settlement (such as a signing bonus) will all be taxable in the hand of the recipient.
Damages awarded by the Workers’ Compensation Board for illness, injury or death ought to be included as income but the recipient is entitled to a deduction which essentially offsets the inclusion by excluding the damages award.
Also, damages awarded in context of a human rights violation, personal injuries (e.g. defamation or harassment) or tortuous conduct by an employer are usually viewed as general damages unrelated to the loss of employment and are therefore non-taxable. Once again, the determination is a factual one.
Conclusion
The taxation of damages awarded will inevitably affect the ultimate cost of recovery or indemnity. In some instances, the Income Tax Act will clearly dictate whether the damages are taxable. In other cases, a proper determination can only be made sometime after the commencement of the litigation process. Ultimately, the only certainty is that some damages are taxable while others are not, that the analysis is a factual one and that the framing of the cause of action and the pleadings may formulate the determination.
If you have any questions concerning the taxation of damages, please do not hesitate to contact me directly at 613.288.3220
Sebastien Desmarais
Associate
Tierney Stauffer LLP
sdesmarais@tslawyers.ca
This article is provided as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter referenced in this document before making decisions.
Your Obigations When Terminating an Employee – Ontario
Non-unionized employees rights are not determined by a collective bargaining agreement. Employers of non-unionized employees require a firm understanding of their obligations when terminating an employee, failing which employers can be exposed to time-consuming and costly litigation.
The entitlements of non-unionized employees upon the termination of their employment arise through legislation such as the Employment Standards Act, 2000 (the “ESA”) and through the body of rules and principles resulting from the decisions of our courts known as the common law.
The ESA provides that an employee is entitled to notice prior to termination or payment in lieu (“notice pay”) in an amount equal to one week per year of service up to a maximum of eight weeks. An employee may also be entitled to severance pay if their length of service is five years or more and they meet one of the two following criteria: (a) they are one of fifty or more employees whose employment has been terminated by the employer within a six-month period, or (b) the employer has a payroll of $2.5 million or more.
The Supreme Court has ruled that employers have an implied obligation to provide employees with reasonable notice prior to the termination of their employment. This is a common law principle that binds all employers with non-unionized employees.
Unlike notice pay under the ESA, there is no grid applicable to determining common law reasonable notice. The period of reasonable notice applicable to an employee is determined on a case-by-case basis with regard to the employee’s age, health, length of service, training and experience, and the availability of similar employment. The period of reasonable notice is generally longer than the ESA entitlement, which is included within it.
The failure to provide notice prior to termination can be interpreted as a breach of contract upon which an employee can bring an action for wrongful dismissal. The damages payable to the employee consist of the amount of remuneration that the employee would have earned over the period of common law reasonable notice, including any payments such as commissions, bonuses, benefits and vacation pay. These damages are reduced by any income that the employee earns over that period through other sources, such as new employment.
There is no obligation on an employer to provide notice in cases where an employee is terminated for just cause. “Just cause” is a term with specific legal meanings. Not every act of misconduct or impropriety will qualify as just cause. Employers should be careful when asserting just cause, as the threshold of proof is high and employers bear the onus of proving that just cause exists.
Whether or not an employee’s behaviour warrants just cause is determined on a case-by-case basis. The court will look at the employee’s behaviour and determine if it is serious enough to be considered a breakdown in the employment relationship. Examples may include conduct which breaches a fundamental term of the employment relationship, which breaches the trust which exists in the employment relationship, or which is fundamentally or directly inconsistent with the employee’s obligations to his or her employer.
There are a variety of ways to structure an employment termination compensation package in order to fairly compensate the employee for lack of notice prior to termination. Packages can include working notice, a combination of working notice and an ESA notice payment, a salary continuation with an incentive for the employee to find new employment, or a lump sum payment. A release from the employee should be obtained in exchange for the payment.
Sabina Vltri
Lawyer, Litigation and Employment Law
Tierney Stauffer LLP
sveltri@tslawyers.ca
613-728-8057.
Am I Liable if my Guest Drinks and Drives?
A. This question refers to a Social Host’s Responsibility. The Supreme Court of Canada has said that as a general rule, a social host does not owe a duty of care to a person injured by a guest who has consumed alcohol.
What is responsibility as a social host?
One important consideration is whether the injuries suffered by those involved in the accident could have been reasonably foreseen by you as the social host. Where a host does not know – nor ought to know – that their guest is intoxicated, then it is not generally foreseeable that the guest may injure others while driving, and no legal duty will exist.
However, if a host does know that their guest is intoxicated, the host may be under a positive legal duty to prevent the guest from driving. Therefore, caution should be exercised if, as a party host, you know that a guest is intoxicated and intends to drive.
A legal duty may also exist, for example, if you continue to serve alcohol to a visibly intoxicated guest knowing that they would be driving home. This would be creation or enhancement of a risk sufficient to give rise to a duty of care on your part as the host.
– Cale Harrison, Lawyer
Tierney Stauffer LLP
charrison@tslawyers.ca
Ottawa Lawyer Q&A Blog 