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It is not uncommon for dismissed employees and their former employers to disagree on the magnitude of the severance package offered. Of course, employers believe dismissed employees will find new employment quickly, while employees fear it will take them a long time to find something comparable. The point of this post is not to explore what might be fair in any given case, but to canvas how settlement dollars can be stretched to maximize the value of the severance package. The theme that runs through all of the options discussed below is tax avoidance.

Assuming the total number of dollars available to pay severance is constant, the primary goal should be to maximize the portion of the settlement that can be characterized as something other than income. The three most common ways to do this are:

  • Damages for breach of the Human Rights Code (i.e. discrimination based on age, gender, etc.)
  • Damages in tort for negligent misrepresentation (i.e. promises made by the employer that were untrue, especially with respect to job security)
  • Reputational damages (i.e. defamation, including libel and slander)

These types of damages suggest that the employer, or someone on behalf of the employer, did something wrong. Employers are therefore sometimes reticent to characterize a portion of the severance as damages. Nonetheless, if the dismissed employee has a reasonable claim, employers should seriously consider doing so in an effort to stretch the settlement dollars. Employers can protect themselves in the terms of the settlement and release documents by including a denial of liability clause and a robust confidentiality clause.

Legal costs associated with the negotiation of a severance package may also be eligible as a deduction from income. Such amounts may be claimed later when dismissed employees file their tax returns for the year, but it is better to obtain the deduction sooner.

It is also important to appreciate that the Canada Revenue Agency (“CRA”) may later audit the settlement and, if they do, will take a hard look at how the settlement funds were characterized. Employers would be well-advised to ensure they have the paperwork to back up the dismissed employee’s damages claim. In addition, employers can protect themselves by including an indemnity clause in the terms of settlement/release requiring the dismissed employee to satisfy a tax liability if CRA fully or partially denies the damages claim. Both sides should have appropriate legal and financial advice in this regard.

After minimizing the amount of “income” that is paid out in a severance settlement, the next consideration would be whether it is possible to have some of the income paid after the current taxation year, when the dismissed employee’s marginal rate may be lower. The simplest method for doing so is to have the employer agree to pay a portion of the settlement funds in the following year or years. This could also be appealing to an employer worried about cash flow. Of course, the dismissed employee would be taking a risk by assuming that the employer will continue to be financially sound in the future.

Pushing tax liability to a future taxation year can also be accomplished by a rollover to an RRSP. CRA permits this if all or a portion of the severance can be deemed a “retiring allowance” (typically, those amounts in excess of the statutory notice requirements). It is important to appreciate that there is no requirement that the employee be retiring from the workforce completely; “retirement” in this case simply refers to a departure from a particular job. CRA will allow such employees to use up their RRSP contribution room (as noted on the last Notice of Assessment from CRA) to achieve the rollover. Some long-standing employees may also have extra contribution room if they were employed by the same employer prior to 1996. Such employees may be entitled to $2000 or more of extra contribution room for their years of service before 1996.

For more information about retiring allowances and RRSP rollovers, you should consult your legal and financial advisors. More information is also available from CRA’s website here. Note that CRA sometimes uses language that is cryptic, even illogical, as noted above with the term “retiring allowance”. It is also helpful to know that CRA refers to an employee’s RRSP contribution room, as set out in their last notice of assessment, as an “ineligible amount” (emphasis added). To be clear, these amounts are, indeed, eligible for the rollover. CRA refers to the extra contribution room (for service before 1996) as an “eligible amount”.

While good faith, reasonableness and flexibility are typically required on both sides to achieve resolution of a severance package, employers and employees should also consider legitimate tax avoidance measures. In the right cases, these measures can help stretch the dollars available for settlement such that a resolution is achieved.


This content is not intended to provide legal advice or opinion as neither can be given without reference to specific events and situations. © 2021 Nelligan O’Brien Payne LLP.

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