If you receive a monetary award for damages as the result of a personal injury, be it physical or mental, that award is generally tax-free. For example, a car accident victim may receive damages for personal injury including the reimbursement of various out-of-pocket expenses, such as uninsured medical and hospital expenses, as well as general damages compensating the injured party for pain and suffering, the loss of amenities of life, and loss of future earning capacity. The general rule is that damages for personal injury (or death) will be excluded from income regardless of the fact that the amount of such damages may have been determined with reference to the loss of earnings of the taxpayer for whom the damages were awarded.
There are other forms of damages which, when awarded, may be found to be taxable. Take, for example, the decisions issued this week in a trio of cases, heard together on common evidence, involving three taxpayers who went to Tax Court to argue that the monetary damage awards each of them received in 2017 should be considered tax-free.
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The case involved three Canada Revenue Agency employees, all experienced “team leads” in the Revenue Collections Division, who filed successful grievances to the Public Service Labour Relations and Employment Board. The employees’ grievances addressed an arbitrary overtime policy implemented by the incoming assistant director of the Calgary Tax Services Office in 2009. Apparently, from late 2010 to early 2012, overtime hours were only offered to team leads who were already in a particular section of Collections. Prior to the new assistant director being appointed, the policy was to offer available overtime to all Collections team leads regardless of their home section. The new policy effectively excluded the three taxpayers from overtime opportunities.
The taxpayers made multiple inquiries about the policy change and expressed their interest in working overtime on several occasions, without success. The taxpayer described the new assistant director’s behaviour toward them as “bullying, aggressive and harassing.” They subsequently filed grievances which were ultimately adjudicated before the board, asserting that their employer had breached a clause of their collective agreement which stated that among other things, the employer “shall make every reasonable effort to … offer overtime work on an equitable basis among readily available qualified employees.”
The board hearing took place in 2015, and in May 2016, the board allowed the grievances, concluding that the new assistant director changed the way in which overtime was distributed and in doing so, “the employer acted arbitrarily and violated the overtime provisions of the collective agreement.”
The taxpayers then sought monetary compensation for their losses resulting from the CRA’s violation of the collective agreement. The board agreed but left the matter in the parties’ hands to determine the appropriate amounts.
During the negotiations, the CRA advised at one point that the payments would be taxable as income. The taxpayers, however, wanted to insert wording into the settlement agreement that the payments represented general damages for personal injury “in order to best position the settlement as non-taxable damages rather than taxable income.” The question before the court, therefore, was whether the damages received were taxable, like employment income, or tax-free, like damages for personal injury.
Under the Income Tax Act, there is an exclusion from income for “income for the year from any property acquired by or on behalf of a person as an award of, or pursuant to an action for, damages in respect of physical or mental injury to that person.”
To determine whether the monetary awards the three taxpayers received fit within the definition of a personal injury award, the judge looked at what the payments were intended to replace. She turned to the seminal 2005 Supreme Court of Canada decision in a case involving disability payments. The Supreme Court found that to determine whether an amount is taxable, two fundamental questions must be answered. First, what was the settlement payment intended to replace and, second, would the replaced amount have been taxable to recipient?
Turning to the present case, the judge reasoned that if the taxpayers had accepted an offer to work overtime, they would have worked the additional hours and been paid for them. There may also have been times in which the employees may have declined the additional overtime hours. As the judge explained, “Since it was not possible to rewrite those past events, the compensation award was based on an agreed number of hours which might be more or less than what the (taxpayers) would actually have worked.”
The judge found that since the compensation award was based on an agreed number of hours and meant to replace the remuneration the taxpayers would have received had they been offered — and, in turn, accepted — the overtime work, those amounts would have been taxable as employment income. Even if the taxpayers had been compensated with additional time off in lieu of monetary payments, that additional vacation leave would likely also have been a taxable benefit.
The judge ruled that monetary awards that each taxpayer received were, indeed, taxable as employment income, concluding: “In order to characterize the nature of a compensation award for tax purposes, one must look at the particular facts. In the present case, there is an employment relationship … and an award arising from breach of a collective agreement.”