Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: Whether a lump-sum amount provided in connection with a non-competition agreement is taxable?
Position: Question of fact.
Reasons: See response.
Author: Baltkois, Thomas
Section: 5(1); 6(3); 6(3.1); 56(1)(a)(ii)
January 27, 2016
Re: Taxation of a lump-sum amount receivable from a former employer
We are writing in response to your correspondence of July 10, 2015, concerning whether a lump-sum amount receivable from your former employer would be taxable. In the situation you describe, the payment is to be provided based on a written agreement made with your former employer following the termination of your employment.
This technical interpretation provides general comments about the provisions of the Income Tax Act (Act) and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings and Technical Interpretations.
The tax treatment of a lump-sum amount received or receivable from an employer (or former employer) is dependent on the facts in each particular case. As discussed in paragraph 1 of Interpretation Bulletin IT-337R4 (Consolidated), Retiring Allowances, “an amount received by a former employee arising out of or in consequence of the cessation of employment is considered income from that employment under either subsection 5(1) alone or together with paragraph 6(3)(b) . . . or as a retiring allowance under subparagraph 56(1)(a)(ii).”
Payments from employer to employee
Generally, when an individual receives a payment based on a written or oral agreement made with his or her employer (or former employer) either immediately before, during, or immediately after employment, paragraph 6(3)(b) of the Act deems the amount to be employment income, unless it is reasonable to consider that the payment did not relate to:
* entering into the employment contract (e.g., inducement payments);
* services provided during employment; or
* a covenant as to what the employee is, or is not to do, before or after the end of employment (e.g., non-competition payments).
The determination as to when a particular agreement is made with an employer (or former employer) is a mixed question of fact and law. However, the greater the amount of time that passes between the end of an individual’s employment and the agreement, the less likely the agreement would be considered to have been made immediately after employment.
While payments of this nature are generally included in income when received, subsection 6(3.1) of the Act deems an amount receivable by an employee (in respect of a covenant granted more than 36 months before the end of a particular year), to have been received by the employee in that particular taxation year.
Subparagraph 56(1)(a)(ii) of the Act requires a taxpayer to include in computing income for a taxation year, the amount of a retiring allowance received by the taxpayer in the year. As noted in paragraph 5 of IT-337R4, a “retiring allowance” includes an amount received in respect of a loss of an office or employment.
In this context, the words “in respect of” have been held by the Courts to imply a connection between the loss of employment and the subsequent receipt, where the primary purpose of the receipt was compensation for the loss of employment. The Courts have set out two questions to determine whether a connection exists for purposes of a retiring allowance:
(1) But for the loss of employment would the amount have been received? and,
(2) Was the purpose of the payment to compensate a loss of employment?
Only if the answer to the first question is no and the answer to the second question is yes, will the amount received be considered a retiring allowance.
The tax treatment of a lump-sum amount received from an employer (or former employer) is generally based on the nature and purpose of the amount, which is a question of fact. Where an amount is received pursuant to a written agreement, the reasons or rationale outlined in the agreement generally provide the best indication as to why the amount was received.
According to the XXXXXXXXXX Agreement (dated XXXXXXXXXX), the lump-sum amount receivable from your former employer is for a covenant, outlining (among other things) what you could, or could not do, for a specified period after the termination of your employment. The lump-sum amount was calculated with reference to your investment in XXXXXXXXXX, and is equal to the loss incurred on the disposition of your XXXXXXXXXX.
While amounts of this nature (e.g., non-competition payments) are generally deemed by paragraph 6(3)(b) of the Act to be employment income under section 5 of the Act, this may not always be the case. As discussed in paragraph 13 of IT-337R4, an amount received pursuant to a contractual obligation with a former employer may be treated as a retiring allowance in circumstances where the amount received can also reasonably be regarded as compensation for a loss of employment.
Thus, where it is established that your XXXXXXXXXX were only sold because of your termination of employment (i.e., you would not have sold your XXXXXXXXXX otherwise), the amount receivable (equal to your loss on the disposition of XXXXXXXXXX) under the non-competition agreement could be reasonably regarded as compensation for your loss of employment. In such a case, the amount when received would be included in income as a retiring allowance under subparagraph 56(1)(a)(ii) of the Act.
The withholding requirements for the lump-sum amount will depend on whether the amount is deemed by paragraph 6(3)(b) of the Act to be employment income for purposes of section 5 of the Act, or is considered a retiring allowance and included in income under subparagraph 56(1)(a)(ii) of the Act. Please refer to Guide T4001, Employers’ Guide - Payroll Deductions and Remittances for more information.
We trust these comments will be of assistance to you.
Nerill Thomas-Wilkinson, CPA, CA
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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