New Tax Law Amendments That May Affect Employers
September 2023 - 4 min read
Recent changes to the Income Tax Act may affect how employers approach settlement. Under these new amendments, any transaction that meets the updated definition of an “avoidance transaction” must be reported and filed with the Canada Revenue Agency. The proper characterization of a settlement payment, as well as indemnity clauses focused on tax implications, should be carefully considered and reviewed to ensure they are not unintentionally triggering the updated language, thus requiring the employer to report the transaction.
Settlement is a common and encouraged feature within our legal system. It offers certainty, is often confidential, is flexible to both parties’ needs and requests, can preserve ongoing relationships, is more efficient and cost-effective, and allows parties to move on. Settlements in employment disputes may include payments such as:
- Retiring allowance;
- RRSP contribution;
- Reimbursement of legal fees; and/or
- Non-taxable general damages
When it comes to hashing out the settlement details of an employment dispute, the allocation of the settlement payment is often a point of discussion. Indemnities, which are protection for a party from future claims, losses, or liabilities, are likely to be discussed as well. It is important for the settlement to include indemnities as they help the parties walk away confident that the matter is finished and that unintended consequences will not occur.
A common tax-related indemnity clause would be requiring the employee to be responsible for any tax amount owing, meaning that if the Canada Revenue Agency requested payment from the employer after the settlement agreement, they could then recover or seek the amount from the employee.
What Was Changed by the Federal Government?
In June 2023, the federal government passed Bill C-47, which amended the Income Tax Act. Employment dispute settlement agreements may now be considered “avoidance transactions,” which are defined as transactions where one of the main purposes is to obtain a tax benefit. The three key features in determining whether a transaction meets the new definition of an avoidance transaction are:
- Contingency fees;
- Confidential protection; or
- Contractual protection.
Under these new amendments, any transaction that meets the updated definition of an avoidance transaction must be reported and filed with the Canada Revenue Agency, outlining relevant and detailed information to the transaction. There are also enhanced reassessment and penalty clauses associated with the reporting requirements.
Impact on Employers
Sometimes the net is cast too wide in legislation, and the main concern is that employment settlements may be swept up in the net. Under these new amendments, a settlement payment characterized as non-taxable general damages, along with an indemnity drafted into the settlement, could result in the transaction being considered an avoidance transaction and would now need to be reported. However, it is unlikely that the new definition would be triggered as the indemnity usually applies to the employer, not the employee who is receiving the tax benefit, and there is no tax benefit to the employer.
Beyond this, another consideration is whether a payment as part of a settlement agreement would have a main purpose of obtaining a tax benefit. If damages are a proper recharacterization of a compensatory settlement, only the employee receives a tax benefit, while the employer only sees overall savings. It may be difficult to reasonably consider that tax savings is one of the main purposes for the employer.
While an employment settlement may not be captured in the wide net, the proper characterization of a settlement payment, as well as indemnity clauses focused on tax implications, should be carefully considered and reviewed to ensure that if necessary to the settlement, they are not unintentionally triggering the updated language within the Income Tax Act, thus requiring the employer to report the transaction.
As the legislation is new, it is important that your lawyer provides you with up-to-date information regarding potential triggering of the new definition of an avoidance transaction and subsequent mandatory reporting provisions within the Income Tax Act arising from a settlement agreement as an employer and when including indemnity clauses within the settlement agreement. Although settlement is highly frequent for clients, the specific facts and applicable law should be considered to ensure that there are no unexpected consequences.
If you are an employer seeking more information on how this change that could affect you and would like advice on what options are available, please contact Jason Kully in Edmonton, Steve Eichler in Calgary, or any member of Field Law’s Labour + Employment Group for guidance and assistance in this area. For tax-specific information, please contact Rob Worthington in our Tax Group.