On November 2, 2023, in response to certain controversy, the Canada Revenue Agency (“CRA”) sought to clarify the application of the new disclosure rules, in force since June 22, 2023. The CRA’s comments relate, in particular, to the impact of reporting obligations on severance agreements, a topic we initially covered a few weeks ago1. We believe it is appropriate to go over these clarifications. As a reminder, the disclosure rules generally apply to so-called avoidance transactions carried out to obtain a tax benefit and presenting one of the following three generic hallmarks: contingent fee arrangements, confidential protection or contractual protection. At first glance, the interpretation of these hallmarks suggests that severance agreements involving an employee’s undertaking to indemnify their employer are subject to reporting obligations. However, in response to questions from a number of legal experts, the CRA commented on the disclosure rules, specifying, in particular, that a tax indemnity granted under a severance agreement is not subject to the reporting obligation where it occurs in a business or financial context between persons dealing at arm’s length, and acting freely and prudently. In this regard, the CRA pointed out that the contractual protection included in such an agreement would not be considered a generic hallmark insofar as it does not cover a tax treatment giving rise to an unwarranted benefit. The CRA gave as an example a settlement reached between an employer and employee further to dismissal, harassment complaints or other employment-related recourses, providing for severance pay or warranted damages. Even if the employee were to undertake to reimburse the employer in the event of unexpected tax treatment, this type of agreement would not give rise to reporting obligations. Although the CRA’s clarifications were meant to clear things up, they did not definitively establish how the mandatory disclosure rules apply to severance agreements. A certain level of uncertainty remains with regard to severance agreements with no real legal basis awarding tax-free damages to an employee. In such a case, it would be difficult to argue that the business context warranted a favourable tax treatment for the employee. In the case of an agreement providing for the payment of unwarranted damages, and where contractual protection extends to the tax treatment of the amount paid, the avoidance transaction may, despite the CRA’s comments, require disclosure to the tax authorities. One thing is certain: tax indemnity clauses may well disappear from severance agreements. Ultimately, the new rules reinforce the principle that the granting of tax-free damages should be limited to circumstances that warrant it. Quebec case law has long established that the mere fact of losing one’s job does not give rise to damages, barring exceptional circumstances. In short, the CRA’s guidelines do not have the force of law, and may be amended or revoked at any time. Consequently, maintaining a cautious and conservative approach will be crucial when determining whether the new mandatory disclosure rules apply to severance agreements. Our team of employment law and tax professionals is available to answer your questions about these major changes and help you make informed decisions when negotiating severance agreements. Termination agreements: New reporting requirements apply!
Noémie Rochette Lawyer
- Québec, 2021
Noémie is a lawyer practising in the Business Law group and a member of the firm's tax law team. She specializes in all aspects of tax law, including tax planning for corporate reorganizations, estate planning and tax litigation.
Prior to joining Lavery, she began her career with the tax authorities, practising in the area of tax litigation and acting in cases involving income and commodity taxes.
- LL. M., Taxation, HEC Montréal, expected to graduate in 2023
- LL.B., Université de Montréal, 2020
Boards and Professional Affiliations
- Member of the Association de planification fiscale et financière (APFF)
On June 22, 2023, the federal government significantly expanded the reporting requirements for certain so-called avoidance transactions, in particular with respect to termination agreements.1 The new rules will make it easier for the Canada Revenue Agency (CRA) to detect certain avoidance schemes, conduct tax audits and issue notices of assessment and penalties more quickly when warranted. The reporting requirements now apply to reportable transactions defined as avoidance transactions, which are primarily aimed at obtaining a tax benefit. If these avoidance transactions involve one of the three markers set out by the Minister of Finance: contingent fee arrangement, confidential protection or contractual protection, they must be reported to the CRA in accordance with the rules in force. These enhanced rules cover a large number of transactions, in particular those which are part of agreements made specifically in the context of end-of-employment negotiations. In settlements between an employer and an employee following termination, harassment complaints or other employment-related disputes, damages may be awarded as part of the negotiation process. However, the award of these damages, which are normally granted in situations where the employee has suffered personal or moral harm, may not always have a strong legal foundation. In some cases, these damages may be part of a tax-driven strategy: while severance payments are taxable as employment income or as a retirement allowance, damages may be tax-exempt. This type of agreement allows the employer to pay less while maximizing the net amount for the recipient. An agreement providing for the payment of a tax-free amount for damages usually includes an undertaking by the employee to indemnify the employer when a tax audit concludes that the payment should be taxable. The new reporting requirements are likely to prevent these types of settlements in cases where it is reasonable to conclude that their main purpose is to obtain an unfair tax benefit. These avoidance transactions also exhibit the hallmark of contractual protection, which refers to a protection or guarantee against any failure of the transaction to produce a tax advantage. This is the case when the employee agrees to compensate the employer following a tax recalculation. Such contractual agreements now meet the new reporting criteria. In these transactions, the reporting obligation is incumbent on the employee (i.e., the person who obtains the tax benefit), the employer (i.e., the person who completes the transaction), and the advisor who obtains fees for setting up the transaction. They have 90 days from the time they entered into the transaction to submit Form RC312 to the CRA. Failure to do so will result in penalties and an extension of the normal reassessment period. As a result, it is inevitable that these updated rules will be taken into account when negotiating termination settlements, and it will be particularly important to review all agreements made since June 23, 2023. Our team of employment law and tax professionals is available to answer your questions about this major change and help you make informed decisions when negotiating termination agreements. Bill C-47: An Act to implement certain provisions of the budget tabled in Parliament on March 28, 2023
Lavery is pleased to welcome three new members to its Montréal office: Emma-Sophie Hall, François Pariseau and Noémie Rochette. Emma-Sophie Hall Emma-Sophie Hall is back in our Labour and Employment Law group. She assists employers with all aspects of labour and employment law, including labour standards, employment contracts and corporate policies. She is also called on to assist in preparing for the arbitration of grievances and proceedings before the civil courts of Quebec. "I am delighted to be back in such a stimulating work environment with exceptional mentors." Noémie Rochette Noémie joins our Business Law group and our firm's tax law team. She specializes in all aspects of tax law, including tax planning for corporate reorganizations, estate planning and tax litigation. "I am very enthusiastic about joining Lavery, a renowned organization with a corporate culture that values excellence and professional growth. I was won over by a friendly and dedicated team managing large-scale, diversified mandates and guiding junior lawyers in their development. I am looking forward to joining the team and furthering my career." François Pariseau François Pariseau is a member of the Administrative Law group. He focuses his practice primarily on administrative and constitutional law in many specialized areas, such as access to information, protection of privacy, and professional and disciplinary law. In this capacity, he regularly represents and advises public and private entities, including professional orders and public bodies on issues relating to constitutional law, judicial review, injunctions and disputes in administrative law. "I was genuinely impressed by how professional the people involved in the hiring process were when they contacted me. Every step of the way, the professionals I met showed interest in me and were very receptive during our conversations. At Lavery, I discovered a people-oriented team, a unique and powerful brand image and, above all, professionals committed to actively contributing to Quebec society."