How compensation for damages caused by the Phoenix pay system affects your personal income tax

On June 13, 2019, the Government of Canada and a number of public service unions finalized an agreement that will compensate current and former employees who were paid using the Phoenix pay system. Other agencies and unions have signed similar agreements.

The agreement provides for two types of compensation:

  1. General damages, and
  2. Damages for severe impacts and other demonstrable cases

The purpose of the compensation is to make current and former employees whole for the financial and non-financial damages caused by the implementation of the Phoenix pay system.

It is important that you understand the tax implications of the compensation you may receive as part of the agreement. Whether you are a current or former employee, the information provided below can help you better understand your situation.    

If you are a current employee who received compensation for general damages

The agreement provides that all current employees as of the date of signing of the agreement will have their annual leave banks credited 2 days of annual leave for the 2016-17 fiscal year (April 1- March 31) and 1 day of annual leave for each of the 2017-18, 2018-19 and 2019-20 fiscal years provided you are eligible under the agreement.

This compensation will be treated like any other type of paid leave that you take throughout a year. This compensation will be included in your T4 slip for the year you take the leave (as you will have been paid for the time off as part of your regular salary) or cash it out. It is also subject to income tax withholdings and, if applicable, CPP and EI.

If you are a former employee who is eligible for compensation for general damages

The agreement provides that all eligible former employees can submit a claim to receive a payment equivalent to the additional leave allocated to current employees. 

This compensation will be included in your income in the year the payment is received. It will be reported on your T4 slip for that year by your former employer and will be subject to income tax withholdings and, if applicable, CPP, and EI.

If you receive additional compensation for severe impacts or demonstrable cases

There are various types of claims for severe impacts or demonstrable cases outlined in the agreement. The following comments are general in nature. In most situations, the tax treatment of the compensation will be a question of fact depending on the specific case and the nature of the payment.

Additional compensation for financial damages

Amounts received for non-speculative investments losses are taxable. The tax treatment should be the same as the amount it is meant to replace. You must report the amount as either income from property or capital gains, depending on the underlying investment and whether it was held on account of income or capital, on your personal income tax return for the year in which the compensation is received. It is your responsibility to report this amount on your tax return as your employer (or former employer) is not required to issue you an information slip such as a T4.

Amounts received for non-speculative lost RRSP deferred taxation advantages, or the documented use of sick leave, and other paid or unpaid leave caused by illness, stemming from issues attributed to Phoenix are generally taxable as employment income. These amounts are subject to income tax withholdings. They are also subject to CPP and EI unless you are otherwise exempt. The amount must be included in your income in the year you take the leave or receive the payment. The amount will be reported on your T4 slip for that year by your employer (or former employer).

If you submitted a claim for out-of-pocket expenses such as interest charges or late fees you incurred on outstanding amounts on loans, mortgages, credit cards, or other debt instruments, the amount is not taxable. For more information, please see Question and Answer 6a of Frequently Asked Questions - 2018 Tax Implications of Phoenix payroll issues.

If you received interest on delayed severance pay, pension entitlements or missing pay, the amount received is taxable as interest income in the year you receive it. If the total interest paid is $50 or more your employer (or former employer) will provide you with a T5 slip.

The Employer has agreed to apply retroactively to February 2016, Annex A of the subsection of the Directive on Terms and Conditions of Employment (emergency replacement pay services or priority pay for individuals beginning disability insurance, maternity or parental leave).If you requested an emergency salary advance or a priority payment, please see Question and Answer 2 and Question and Answer 3 of Frequently Asked Questions - 2018 Tax Implications of Phoenix payroll issues.

Compensation for severe personal or financial hardship

Amounts received for damages for financial hardship (such as employees who resigned due to loss of income) are taxable. It will be a question of fact depending on the wording of the claim settlement as to whether the amount is included in income as a retiring allowance or employment income. Either way, the amount will be included in your income in the year you receive it. The amount will be reported on a T4 slip for the appropriate year unless it is a retiring allowance and you are a non-resident. A retiring allowance paid to a non-resident is reported on a NR4 slip. The withholding requirements will depend on whether the amount is a retiring allowance or employment income.

Whether amounts awarded for other damages such as lost occupational capacity, lost security clearance or bankruptcy are taxable or not is a question of fact. Each case will need to be reviewed separately. In part, the decision will depend on what the payment is intended to replace.

If the amount is taxable, it will be included in your income in the year you receive it. The amount will be reported on a T4 slip for the appropriate year unless it is a retiring allowance and you are a non-resident. A retiring allowance paid to a non-resident is reported on a NR4 slip. The withholding requirements will depend on whether the amount is a retiring allowance or employment income.

Amounts received with respect to claims for alleged discriminatory practice, or mental anguish or trauma are generally not taxable provided the amount paid is reasonable. The determination of what is a reasonable amount is influenced by the maximum amount that can be awarded under the applicable human rights legislation and the facts of each case. Amounts paid in excess of what is a reasonable amount will be taxable in the year the payment is received.

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