Special payments and the end of an employee's employment
Hello, my name is Nicolae and I am your presenter today.
Welcome to our webinar on special payments and the end of employment. This is the last of our three-part webinar series for this period that began in January 2017. Today's webinar is intended for you if you have a basic knowledge of payroll and would like to increase your knowledge of certain special payments to employees when they terminate their employment.
Today we will discuss the following subjects:
- termination of employment
- salary in lieu of termination notice
- retiring allowances
- record of employment, also known as an ROE
We will start by talking about termination of employment.
There are many reasons why an employee might leave their job. The reason can affect how we tax certain payments to employees on termination of employment.
Some of the most common reasons for an employee to leave their job are:
- layoff, or
If an employee leaves their job for one of these reasons, we suggest that the employer calculate the employee’s total annual remuneration up to the departure date and give the employee a T4 slip.
The employer must keep a copy of the T4 slip and attach it to the T4 Summary when sending it to the CRA on or before the last day of February of the following year, at the same time as all of the T4 slips for the year.
In addition to the employee’s regular salary, certain other amounts may be included on their T4 slip. We will be looking at these amounts in the next few slides.
In general, when an employee is dismissed, the employer must do certain things as set out in the employee’s contract of employment or in the federal, provincial or territorial employment labour standards.
For example, in the province of Quebec, the Commission des normes du travail [labour standards board] states:
- An employer must give the employee a written notice of termination of employment before terminating a contract of employment or laying off the employee for a period of more than six months.
- The length of time for giving the employee the notice vary according to the employee’s length of uninterrupted service. For example, an employee with one to five years of continuous service with an employer must receive a written notice of termination two weeks before the employment ends.
An employee’s contract of employment can also include various provisions specifically related to termination of employment. It is important that employers figure out which provisions apply to each situation.
Now, let’s discuss Wages in lieu of termination notice.
An employer and an employee may agree to forgo the specified timeframe and for the employee to leave immediately after being notified of their dismissal.
In this situation, the employer must pay the employee compensation equal to the salary the employee would normally have earned between the date the notice is scheduled to have been sent and the date their employment ends.
This compensation is known as “wages in lieu of termination notice” and is considered employment income. The employer then has to withhold the usual source deductions: CPP/QPP contributions, EI premiums and income tax.
These amounts are part of the employee’s regular income for the pay period. Let’s look at an example.
Luke was dismissed by his employer.
According to his employment contract, his employer has to give him three weeks’ termination notice.
When Luke was notified of his dismissal, he and his employer decided to end his employment immediately.
They agreed that Luke would receive an amount equal to three weeks’ salary and would be able to leave immediately.
Given that Luke’s employment contract said that his employer had to give him three weeks’ termination notice before ending his employment, Luke should have continued working for three weeks after being notified of his dismissal. But it was better for Luke to leave the employment immediately.
The amount that the employer pays to Luke is considered wages in lieu of termination notice and is part of the income he received during the year. This amount is reasonable under the circumstances because it represents the salary Luke would have received had he continued working.
The employer must take the standard source deductions from this amount and include the amount in box 14 of Luke’s T4 slip as employment income.
We will now look at retiring allowances.
Another amount that can be paid to an employee on termination of employment is a retiring allowance, also known as a severance benefit.
The employer pays this amount to an employee in the following two situations:
- on termination of the individual’s office or employment, even if the amount is received because of damages or following an order or a judgment of a tribunal; or
- in recognition of the individual’s long service on or after retirement from employment. Contracts of employment and collective agreements usually specify the payments an employee should receive on retirement.
In deciding whether an amount qualifies as a retiring allowance, the CRA considers a termination of employment for any reason as being retirement or loss of employment.
The CRA usually considers the term “long service” to mean the total number of years in an employee’s career with a particular employer or affiliated employers.
The amount can include many different types of payments, such as an amount for lost wages or moral damages. Each payment must be reviewed individually to determine if it can be considered a retiring allowance.
The retiring allowance is included in the annual income in the year it was received.
Let’s look at this in more detail.
For the amount to be considered a retiring allowance, an office or employment must be terminated, and the employment and benefits must end on a specific day.
However, not all payments the employer makes to the employee on termination of employment are considered retiring allowances.
Some payments may represent employment income while others may be non-taxable. This is based on the facts and circumstances surrounding the payment and on what the payments were intended to compensate for or replace.
Let’s look at a few types of payments to find out if they’re considered retiring allowances.
The two following amounts are considered retiring allowances:
- payments for unused sick leave credits on termination; and
- amounts individuals receive when their office or employment is terminated, even if the amount is for damages for wrongful dismissal when the employee does not return to work.
A payment for unused sick leave credits qualifies as a retiring allowance when the employee receives the payment on or after retirement in recognition of long service or for loss of employment. However, when the employee receives a payment for unused sick leave credits while still employed, the payment is considered employment income.
The next two slides list various types of payments that are not considered retiring allowances.
Retiring allowances do not include the following amounts:
- payments for accumulated vacation leave not taken before retirement
- salary continuance if there has been no interruption of leave or salary between when the duties ended and the payments began
- loss of employee wages, salary or benefits if the employee continues to work or returns to work. These amounts are considered employment income.
It is important not to confuse accumulated vacation with accumulated sick leave, which are part of retiring allowances, as we saw in the previous slide.
An employee’s salary can continue when a business closes and the employer continues to pay the employee’s salary even though the employee is no longer working. This constitutes compensation for loss of employment. Ongoing health insurance coverage or accrual of pensionable time show that the employer–employee relationship is continuing.
The following amounts are also not considered retiring allowances:
- wages in lieu of termination notice, which are considered employment income.
- amounts received in respect of damages for human rights violations. In this case, there must be clear evidence that an employee lost their job as a result of a breach in existing human rights legislation.
- payments for damages clearly proven to be unrelated to the loss of employment, for example, defamation.
A loss of office or employment usually means that a particular office or employment expired or was eliminated. However, it can also mean that an employee lost their source of income.
Examples include a business that is closing or downsizing or early retirement incentive plans.
In respect of loss of employment often leads to payments for injuries resulting from the loss. These payments may be made following an order or judgment for wrongful dismissal or an agreement between the parties in question.
The expression in respect of implies a connection between the loss of employment and the payment that results thereafter. In other words, the main purpose of the payment is to compensate the individual for the loss of employment. The courts have set out the two following questions to determine if such a connection exists:
- Would the employee have received the amount if the employee didn’t lose the employment?
- Was the purpose of the payment to compensate for a loss of employment?
Only if the answer to the first question is no and the answer to the second question is yes, then the amount received is considered a retiring allowance.
If the answer to the first question is yes, the payment is not a retiring allowance.
It’s important to know the answers to these questions because the deducting and reporting requirements differ based on the purpose of the payment.
The following list includes some of the payments that relate to a loss of employment and that can be considered a retiring allowance, as long as the employee does not return to their employment:
- any compensation on account of damages for loss of employment
- special damages
- general damages for:
- loss of self-respect
- mental anguish
- hurt feelings, etc.
To find out what type of payment the employee received, you have to review the relevant facts and documents of each particular case.
When an employee receives a payment in lieu of severance pay, the payment is considered employment income if the employee receives it while he or she is still working. This type of situation arises when severance benefits will no longer accumulate in the future.
For example, consider the case of employees covered by a collective agreement who accumulate severance benefits that will be paid on resignation or retirement. The benefit is equal to one week of pay for every year of service.
A new collective agreement is signed, which eliminates the accumulation of severance benefits as of a specific date. Severance benefits accumulated up to that date will be paid in accordance with the terms of the severance provision. Employees are given the choice of receiving an immediate lump-sum payment based on their current rate of pay in lieu of severance, or waiting to receive the severance payment on retirement.
If an employee chooses the immediate payment, it is considered employment income because the employee received the sum while he or she is still employed.
If an employee chooses to wait until retirement to receive the payment, the amount will be considered a retiring allowance because it was received on or after the employee’s retirement date.
Once you have decided that an amount is a retiring allowance, you can decide whether part of the amount is eligible to be transferred directly to an RRSP.
The eligible portion of a retiring allowance is based on the number of years of employment before 1996 with the employer who made the payment or the person related to the employer. The eligible portion can be transferred directly to an RPP or an RRSP under paragraph 60(j.1) of the Income Tax Act to defer its taxation.
Given that this situation is increasingly rare, we won’t spend much time on the subject. For more information, see Chapter 6 of guide T4001, Employers’ Guide – Payroll Deductions and Remittances.
The non-eligible portion of the payment can only be transferred to an RRSP if the employee has remaining RRSP contribution room. This type of transfer is more common. You will find all the necessary information on eligible and non-eligible amounts in Guide T4001.
Amounts paid as a retiring allowance are not considered pensionable or insurable income because they are not considered employment income. Do not deduct CPP/QPP contributions or EI premiums from these payments.
However, the employer must withhold the income tax because the income is taxable. To do so, use the rates for lump-sum payments in effect at the time the employee receives the payment.
If the retiring allowance will be paid in several instalments during the year, the employer must add all the lump-sum payments paid or intends to pay during the year to the employee to determine which rate to use.
We will look at an example to clarify this later in the presentation.
The following lump-sum withholding rates apply, as set out in the Income Tax Regulations:
- 10% on amounts up to and including $5,000 (5% for Quebec)
- 20% on amounts over $5,000 up to and including $15,000 (10% for Quebec)
- 30% on amounts over $15,000 (15% for Quebec)
The rates for lump-sum payments combine both federal and provincial rates, except for the Province of Quebec.
The 5, 10 and 15% rates for Quebec represent only the federal withholding rates. Employers must contact Revenu Québec to find out which provincial lump-sum withholding rates to use.
Here’s an example:
Braeden is retiring and his employment contract states that the employer will pay him an allowance in recognition of his long service when he retires. He is entitled to $40,000.
This amount will be paid in three instalments:
- the first in June for $20,000
- the second in September for $10,000
- the third in December, also for $10,000
The employer must now figure out the withholding rate to use for each payment. For this example, we will use the Province of Ontario.
As we saw before, Braeden’s employer must add all the lump-sum payments that have been or will be paid for the calendar year to determine which rate to use.
In our example, the total of the lump-sum payments for the year is $40,000. Given that the total amount is over $15,000, the employer has to use the 30% rate for each payment, even though two of the payments are less than $15,000.
For the June payment, the employer will deduct $6,000 ($20,000 × 30%).
For the September and December payments, the employer will deduct $3,000 ($10,000 × 30%).
The employer will withhold a total of $12,000 from the retiring allowance paid to Braeden during the year.
The tax deducted could be less than $12,000 if Braeden can transfer part of his retiring allowance into his RRSP. This depends on whether he still has contribution room in his RRSP and if the amount was transferred before he receives the payment, or if part of the amount was eligible for a direct transfer to an RPP or RRSP, because of the years he worked with the employer before 1996.
The employer must report the amount of the retiring allowance paid on the employee’s T4 slip for the year in which the payment was made.
If part of the retiring allowance is eligible for transfer to an RPP or RRSP, enter the amount in the other information box on the T4 slip using code 66, regardless of whether it has been transferred to an RPP or an RRSP in the annuitant’s name. Enter the non-eligible portion for transfer of the retiring allowance in the other information box on the T4 slip using code 67.
The “Other information” box appears at the bottom of the T4 slip.
Do not report any part of the retiring allowance in box 14 of the T4 slip.
We will now examine records of employment.
On termination of employment, regardless of the reason, the employer must fill out a record of employment generally in the five days that follow one of these events:
- the interruption of the employee’s earnings
- the day the employer becomes aware of the interruption
- the date the employee stops working for the employer
However, special rules may apply.
Service Canada is responsible for the record of employment. Contact them to find out more.
For more information on any of the items we talked about today, visit cra.gc.ca and go to our webpages for businesses.
If you have not already done so, you can subscribe to our payroll electronic mailing list at cra.gc.ca/lists. You’ll receive information about our upcoming webinars and much more.
The CRA website also has videos and recorded webinars for businesses at cra.gc.ca/videogallery, including a series on payroll for new small businesses and a series on payroll basics.
You can also listen to our payroll podcast at cra.gc.ca/socialmedia and follow us on Twitter at @CanRevAgency.
The CRA has many tools to help you understand your responsibilities for termination of employment and for other payroll obligations.
You can find them on the payroll deduction pages on our website. Guide T4001, Employers’ Guide – Payroll Deductions and Remittances, may especially be helpful.
That’s all the time we have. Thank you for joining me today. I hope this webinar helped you better understand special payments related to an employee’s termination of employment and how to handle a termination of employment.
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