Backgrounder: Proposed Changes to the Treatment of Amounts Withheld on Salary Overpayments to Employees
Proposed Changes Will Help Employees Affected by Overpayments, Including Those Made Through the Phoenix Pay System
When an employer pays an employee, the employer is required to deduct a portion of the salary or wages and remit it to the Canada Revenue Agency (CRA). These deductions are made on behalf of employees to help cover their income tax and other obligations for the year in which they are paid.
This requirement can create difficulties when employees are accidentally overpaid, due to a system, administrative, or clerical error on the part of the employer. In these cases, employers still typically make deductions on overpaid amounts, and remit these to the CRA as they would for any payment of salary or wages.
Overpayments are sometimes not identified until after the calendar year in which the overpayments were made. When this happens, under existing rules, the employee is required to repay to the employer the gross (full) value of the overpayment, including the amount of income tax, Canada Pension Plan (CPP) contributions, and Employment Insurance (EI) premiums that had been deducted from the overpayment by the employer and remitted to the CRA. Because these deductions were remitted to the CRA on behalf of the employee, the onus is on the employee to recover the amount of these deductions from the CRA and provide them to the employer as part of the repayment.
This procedure may put an unfair burden on affected employees and may require them to make repayments that are larger than the amount they received from their employer, creating uncertainty and potential financial hardship.
To alleviate this burden and help affected employees, the Government of Canada is proposing changes that would—under certain conditions—permit an affected employee to repay to their employer only the net amount of the overpayment received in a previous year, rather than the gross amount (net amount plus income taxes, CPP, and EI). Under the proposed legislation, the CRA would be able to refund directly to the employer the income tax, CPP, and EI withheld on an overpayment (and remitted to the CRA on behalf of the affected employee) that occurred through a system, administrative, or clerical error. As a result, affected employees—who received overpayments through no fault of their own—would no longer be responsible for recovering these amounts from the CRA and repaying the gross amount to their employer.
These changes would apply to employees experiencing overpayments of salary or wages, including federal public servants affected by Phoenix pay system overpayments, and are applicable moving forward as a result of today's announcement. For example, they would apply to overpayments made during the 2018 tax year that have not already been processed under current rules.
These proposed changes are part of the Government of Canada's plan to address existing pay challenges and replace the Phoenix pay system with a system better aligned with the complex federal government pay structure.
To find out more, please visit the Government of Canada's Phoenix news and updates website.
Example of How the Proposed Changes Would Help Affected Employees
David received a regular annual salary of $50,000 for 2018, and received a gross overpayment of $3,000 in that year from his employer. From this amount, $700 was deducted by his employer for income tax, CPP and EI, leaving him with a net overpayment of $2,300. The error was identified in 2020, and he made an arrangement to repay his employer in that year.
Without the proposed changes, David would have to repay his employer the gross overpayment of $3,000, and would be refunded $700 from the CRA when his personal income tax return for 2018 is reassessed.
With the proposed changes in effect, the employer would be able to recover the $700 that was deducted from his overpayment directly from the CRA, and David would have to repay only $2,300 to his employer.
Technical Details on How the Proposed Changes Work
The employment income (T4) system is based on actual amounts paid and received in a calendar year. This means that the total amount paid to an employee by an employer in a year will be the amount reported on the T4 for that year, even if it is lower or higher than it should have been. The Income Tax Act, Canada Pension Plan, and Employment Insurance Act require employers to deduct, and remit to the Receiver General, appropriate withholdings on any salary and wages paid to an employee regardless of whether the amount was paid in error. These withheld amounts are considered to have been paid to the CRA by the employee, even if the employer made the remittance, and they go towards the employee's tax liability and other obligations for the calendar year in question.
When an employee receives an overpayment of salary (or wages) because of a system, administrative, or clerical error, this overpayment does not constitute salary if the employee repays the amount, or makes arrangements to repay the amount. As such, rules are in place to allow for the recovery of amounts deducted and remitted on such overpayments.
Repaying Net Salary
Employees can currently repay their employer the net amount of the salary overpayment (gross pay, less source deductions for income tax, CPP, and EI) if an error in pay is found before the end of the tax year. This procedure is available if the employee repays or arranges to repay the amount in the same year as the overpayment and the employer is able to reduce the next payroll remittance to the CRA by the CPP, EI or income tax sent in error before the last remittance for the year to the CRA.
In these situations, the overpayment and any CPP, EI, and income tax withheld on the overpaid amount are not included on the employee's T4 slip, and there are no income tax implications for the employee.
Repaying Gross Salary
Employees must currently repay their employer the gross amount of a salary overpayment if the amount paid in error and the repayment are in a different calendar year. In these situations, an employer prepares an amended T4 slip for the employee, reporting the corrected annual earnings for the year. However, any income tax, CPP, or EI withheld on the overpayment are still reported on the amended T4. In this situation, the employee pays back the gross amount to their employer and may be entitled to a refund of excess income tax, CPP, or EI withholdings on the overpayment, which would be provided through an assessment or reassessment of their personal income tax return for the year of the overpayment.
The draft legislative proposals released for public comment today would effectively extend the existing rules for overpayments repaid within the same year to overpayments repaid within three calendar years after that year (or where arrangements have been made within that three-year period to make such a repayment). This would allow employees, under certain conditions, to repay their employer the net amount of an overpayment (i.e., excluding income tax, CPP, and EI deductions), even where the salary paid in error and the repayment are in different years.
A public or private sector employer could elect to apply these new rules for any overpayment paid after 2015 as a result of a system, administrative, or clerical error as long as they have not previously issued a T4 correcting for this overpayment. For example, they could process overpayments made during the 2018 tax year under these new rules that have not already been processed under current rules.
For these new rules to apply, the employee must have repaid their employer (or made arrangements to repay) within three years following the end of the year in which the overpayment took place. Where these conditions are not met, the current rules would continue to apply.
In light of the joint federal and provincial management of the Canada Pension Plan, proposed amendments to the Plan would be subject to formal provincial consent, and would not be implemented until such time as this consent has been achieved.
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