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Allocating Payments in a Wrongful Dismissal Action
Employment Law

Allocating Payments in a Wrongful Dismissal Action

As some regular readers may know, an overwhelming majority of wrongful dismissal claims never end up proceeding to trial. Instead, they settle out of court without ever being adjudicated. When considering the vast resources, time, energy and stress involved with litigating a claim, settlement often makes the most sense. Were a matter to proceed to trial, it means that the dispute would end up on the public record. Very seldomly will a party wish for its dirty laundry to be aired out in the public forum, especially where claims of bad faith are made, or where the employee was fired for cause.

Accordingly, one of the most important aspects of wrongful dismissal negotiations leading up to settlement is the apportionment of the employee’s damages. Since parties are negotiating, such arrangements may be mutually beneficial.

Salary Continuance – EI and CPP Deductions

Payments that are allocated as salary continuance will be subject to the same source deductions that applied during the employee’s tenure with the employer. These withholdings include CPP contributions and EI premiums, and are typically 20% of the employee’s gross salary. Some employees may prefer the steady cash flow that salary continuance arrangements provide for, rather than lump sum payments and their associated financial risks.

Retiring Allowance and Lump Sum Payments

Where cases do eventually proceed to trial, and the dismissed employee is successful, the damage award is categorized as a retiring allowance (also called severance pay). Retiring allowances may qualify for special tax treatment under Canada’s Income Tax Act. Most importantly, an eligible retiring allowance may be paid to the employee in whole or in part, directly or transferred to their RRSP. If transferred directly to an RRSP, the amount can be deposited directly into the account without deductions, as the employer is not required to withhold tax on the payment.

If the amount is paid to the employee as a lump sum, the payment will be subject to the following withholdings for each respective payment amount:

  • 10% (5% for Quebec) on amounts up to and including $5,000
  • 20% (10% for Quebec) on amounts over $5,000 up to and including $15,000
  • 30% (15% for Quebec) on amounts over $15,000

Further, retiring allowances are not subject to Canada Pension Plan contribution or Employment Insurance premium deductions. Recipients may have to pay extra tax on these amounts when they file their income taxes.

General Damages

This allocation is the most favourable type of payment allocation from an employee’s perspective since it is tax-exempt. Employers will have various reasons for avoiding paying out a settlement as general damages. These include financial and accounting considerations, as well as legal considerations respecting admission of liability. Allocating general damages is often perceived as an admission that the employer conducted itself in bad faith.

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