Characterization of Wrongful Dismissal Awards for
Income Tax
Vern Krishna*
The recent decision of the Federal Court of Appeal in R. v. Atkins,’
confirming the decision of the Trial Division which had held damages
awarded for wrongful dismissal to be non-taxable, has brought to
the fore, here as in other areas of tax law, the difficult task involved
in the characterization of receipts as income or capital. Here, as in
the case of personal injury awards, taxpayers in receipt of damages
for wrongful dismissal as well as governmental agencies at the ju-
dicial, legislative and administrative levels, face the task of determin-
ing the tax treatment of such awards.
It is important to clarify at the outset the two stages at which tax
implications could have an impact on damages awarded -for wrong-
ful dismissal. In chronological sequence, a taxpayer (plaintiff) may
face the. issue of tax implications in the preliminary question as to
whether a judicial tribunal should take account of the plaintiff’s tax
status in assessing the quantum of the judgment which a defendant
would be required to pay. This aspect has been adequately discussed
elsewhere,2 and was the subject of discussion in the now famous
Jennings3 decision which decided that no deduction should be made
for any notional tax liability factor. This article will examine the
subsequent tax treatment of the judicial award or settlement, in the
context of the taxpayer vHi-&-vis the taxing authorities. This examina-
tion (including the problem of characterization) analyzes the concept
of income, the theoretical and pragmatic premises underlying damage
awards in this area, and the policy objectives of the tax structure,
* Assistant Professor, Faculty of Law, Dalhousie University. The author is
indebted to Professor Edwin C. Harris of the Dalhousie Law Faculty for
comments on an earlier draft.
(T.D.).
‘R. v. Atkins [1976] C.T.C. 497, 76 D.T.C. 6258 (F.CA.); [19751 C.T.C. 377
2 Dworkin, Damages and Tax – A Comparative Survey [1967] B.T.R. 315;
Fleming, Damages: Capital or Rent [1969] 19 U.of T.LJ. 295; Sheppard, The
Tax Element in Compensation since The Queen v. Jennings and Cronsberry,
19 Can.Tax J. 448; Bale, British Transport Commission v. Gourley,
(1971)
Reconsidered (1966) 44 Can.Bar Rev. 66.
3 The Queen v. Jennings (1966) 57 D.L.R. (2d) 644. See also Gehrmann v.
Lavoie [S.C.C.] October 7, 1975 as yet unreported; Ofstedahl v. Cam-Set
Mechanical Contractors Ltd [1974] 1 W.W.R. 329 (Alta CA.).
McGILL LAW JOURNAL
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with a view to suggesting an acceptable reconciliation of these various
aspects. For reasons which will become clear, this article does not
examine the alternative of whether damages for wrongful dismissal
are, or should be, taxable on a capital gains basis.
1. Tax policy objectives and the concept of income
Before attempting to characterize wrongful dismissal awards for
purposes of their tax treatment, it may serve some useful purpose
to provide a theoretical framework of tax policy objectives and the
foundation of the concept of income. These objectives include the
equitable distribution of tax burdens among the class of taxpayers
as a whole, and within that class equitable treatment of the tax-
payers inter se, and the avoidance of undesirable distortions in the
decision-making process of resource allocation. Further, economic
and social policy considerations play an important role in containing
or expanding aggregate demand in the battle against inflation and
the desire to promote full employment. Hence, equity, neutrality, and
economic and social policy, complemented by revenue collection, ad-
ministrative efficiency and tax simplicity, all play, with varying
degrees of impact, a role in the development of a tax structure.4
In evaluating the relative weight to be assigned to these various
tax objectives, one may observe at the outset that revenue collection
per se, assumes a secondary role. If revenue collection were viewed
as a primary objective of tax policy, any government would have
available several other alternatives which would be more efficient
in the promotion of this objective. Thus, a government might com-
mandeer resources, create money, or rely on property, sales or
consumption taxes. Each of these alternatives, while promoting
administrative efficiency, would, however, generate adverse con-
sequences. Commandeering resources would tend to be capricious;
the creation of money would, if unaccompanied by a commensurate
increase in national output, promote even greater inflation than that
which exists at the present time; property, sales and consumption
taxes if used as the primary source of revenue, would penalize a
limited segment of the population or place an uneven burden on
lower income levels who spend a proportionately larger percentage
of income on consumption.
That these consequences are undesirable is self evident. Thus
commencing with Adam Smith who stated that:
4 For an extensive discussion see Report of the Royal Commission on
Taxation, Ottawa: Queen’s Printer (1966-67), vol.2.
19771
“WRONGFUL DISMISSAL AWARDS
The subjects of every state ought to contribute towards the support of
the government, as nearly as possible, in proportion to their several
In the observation or neglect of this maxim consists the
abilities ….
equality or’ inequality of taxation…i
down to the Carter Commission which observed that:
… if the government had to choose one method to the exclusion of all
other methods, taxation would be preferable because it cath be more
equitable, can be less disruptive to the economy, and can give the govern-
ment more effective control over the total demand for goods and
services …6
equitable distribution of tax liabilities has been an important de-
terminant in the organization of a tax structure. It is submitted here
that equity should play -a pre-eminent role within any tax structure,
given that the very existence of any tax structure itself presupposes
the need for revenue generation.
The next step in implementation of the propounded concept of
equity, is the search for an appropriate vehicle. The choice often
made for this purpose is the allocation of the tax burden amongst
taxpayers in accordance with their relative economic well being or
taxpaying capacity. Economic well being and capacity in turn may
be measured by “income”, which reduces the immediate issue to one
of appropriately defining that term. The basic requirement of that
definition is given by the purpose to be served by the defined con-
that of providing a measure of the relative economic status
cept –
or well being of the taxpayer. For this purpose, therefore, the defini-
tion should be comprehensive and, subject to the demands of prag-
matic implementation, should include “the money value of the net
accretion to economic power between two points in time ….
7
,
This accretion concept endorsed by Fisher as “a flow of benefits
and Marshall who observed “for
during a period of time …
scientific purposes, it would be best if the word ‘income’ when oc-
curring alone should always mean total real income.. .”,9 was viewed
with favour by the Carter Commission in its formulation of a “com-
prehensive tax base”. Simons, arguing that income is a good tax
base, sought a definition of income which would provide the basis
for most nearly equitable levies.10 He stipulated the requirements of
objectivity and quantifiability and defined the accretion concept as
G Smith, The Synthetic Wealth of Nations, Graham (ed.) (1937), 282.
I Supra, note 4, 4.
7 Haig, The Concept of Income, The Federal Income Tax Act (1920), 7.
8 Fisher, Elementary Principles of Economics (1919), 34.
9 Marshall, Economics of Industry (1893), 51.
10 Simons, Personal Income Taxation (1938), 41.
McGILL LAW JOURNAL
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the algebraic sum of consumption expenditures and the change in
the taxpayer’s net worth over a specified period of time.
Given this accretion concept of income, the task of implementation
is viewed as one of maintaining the integrity of the concept without
creating insuperable administrative difficulties. It is only against
the backdrop of the conceptual definition of income, that administra-
tive efficiency should assume significance. Thus, the doctrine of
“realization” is not rationalized by the assertion that no income
has been generated in any conceptual sense, but rather because of the
difficulties involved in valuation without a market transaction, and
the attendant problems of liquidity. Similarly, the choice of a
calendar year as the yardstick in the computation of tax liability is
premised on an artificial but convenient time horizon, regardless
of whether the actual process of accretion accrues over a shorter or
longer period. Again, the exclusion of imputed income is supported,
not because of any rationale inherent in the definition of income, but
rather in deference to problems of valuation and administration.
Hence,’it is submitted that each concession or detraction from the
conceptual definition of income should be in response to a clearly
articulated and countervailing objective of tax policy, after a con-
sidered determination that the specific benefit derived by departure
from the concept of income clearly outweighs any corresponding
sacrifice in the purity of the concept itself and the objective of equity
in a tax structure. It is worthy of emphasis that the concept of in-
come is an economic concept, which has been modified by accoun-
tants and lawyers to meet the demands of specific requirements of
objectivity of market determination, convenience of tax administra-
tion, and the economic and social policy related to resource alloca-
tion.
2. Characterization of the award
Turning from the general theoretical framework of the concept
of income and the objectives of tax policy to the specific task of
characterization of wrongful dismissal awards, one should ask three
questions:
(1) Does the recipient of a wrongful dismissal award improve
his economic power or net worth, in a manner capable of objective
measurement and quantification? If the answer is in the affirmative,
then prima facie that portion of the award which contributes to the
economic net worth of the taxpayer should be included in income for
tax purposes, subject to two further questions.
(2)
Is it justifiable to treat the damages received for wrongful
dismissal in some special manner, owing to the existence of particular
1977]
WRONGFUL DISMISSAL AWARDS
circumstances surrounding such receipt which dictate its exclusion
from income?
(3) What is the price to be paid by the tax structure in the event
of exclusion of the damages for wrongful dismissal from income,
and with what corresponding benefits?
Addressing the first question requires a brief overview of the
basic objectives of damage awards for breach of contract, of which
wrongful dismissal is merely a sub-set, in order that the specific
issue may be placed in perspective.
The underlying principle of the theory of damages in breach of
contract actions has been explicitly enunciated on numerous occa-
sions. Nearly a century ago Lord Blackburn articulated the principle
in a classic statement; damages should represent “that sum of
money which will put the party who has been injured, or who has
suffered, in the same position as he would have been in if he had not
sustained the wrong for which he is now getting his compensation or
reparation”.” Specifically, in contract actions the successful plaintiff
is entitled to be placed, so far as money can do it, in the position
he would have occupied had the contract been performed, or
had his rights been observed. These sentiments have withstood the
test of time in various formulations. Thus, Viscount Dunedin stated
that “the Common law says that the damages due either for breach
of contract or for tort are damages which, so far as money can
compensate, will give the injured party reparation for the wrongful
act …. 12
This doctrine of compensation in contract damages has been
carried forth as entitling the successful plaintiff to the economic
“value” of the bargain or his expectational interest. In determining
the factual benefit implicit in the “expectation interest” the courts
take into account the certainty or uncertainty of the benefit.
Turning from the general theoretical premise of damages in con-
tract to the specific action for wrongful dismissal, one observes a
consistency of -approach in articulation of the principle. The prima
“Livingstone v. Rawyards Coal Co. (1880) 5 App.Cas. 25, 39. See Street,
Principles of the Law of Damages (1962), 3; Blain J. in Yetton v. Eastwoods
Froy Ltd [1967] 1 W.L.R. 104, 115; Ogus, The Law of Damages (1973), 17-21,
283-8.
12Admiralty Commissioners v. S.S. Susquehanna [1926] A.C. 655, 661. S5
also Victoria Laundry v. Newman [1949] 2.K.B. 528, 539 (CA.) per Asquith L..;
Robinson v. Harman (1848) 1 Ex. 850, 855; 154 Eng.Rep. 363, 365 per Parke B.
Czarnikow v. Koufos [1969] 1 A.C. 350, 400 per Lord Morris; British Westing-
house Co. v. Underground Ry Co. [19123 A.C. 673, 689 per Viscount Haldane
L.C.
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facie measure of damages is the contract price, which is all the
plaintiff need show. As McGregor suggests, the measure of damages
for wrongful dismissal “is prima facie the amount that the plaintiff
would have earned had the employment continued according to con-
tract subject to a deduction in respect of any amount accruing from
any other employment which the plaintiff, in minimizing damages,
either had obtained or should reasonably have obtained”.13
The central element in determination of quantum in wrongful
dismissal suits revolves around the question: what would the plain-
tiff have “earned”? The structural heads under which the quantum
is computed may, in the case of wrongful dismissal, be identified
from judicial decisions. Hence, it is clear that the salary or wages
which the defendant had agreed to pay for the services of the plain-
tiff would be included in determination of the factual benefit implicit
in the “expectation interest”. In so doing, the courts take into account
the certainty or uncertainty of the benefit. This rule is qualified,
however, in that where the realization of a benefit is dependent on the
discretion of the defendant promisor, then the plaintiff promisee
is entitled to no more than the defendant was legally bound to do
or convey.14
Specifically, where contracts are terminable on notice, damages
for lost earnings are restricted to those which would have been pay-
able during the period of notice.15 It is dubious whether a breach of
contract of employment will, ever give rise to an award of non-
pecuniary damages as part of the expectation interest. Thus, in Peso
Silver Mines Ltd v. Cropper,:’ the damages award was reduced from
$10,000 to $6,500 to reflect salary only, whereas the Trial Judge had
added $3,500 for loss of reputation in the mining community. Cart-
wright J. observed in this context that “the claim being founded on
breach of contract the damages cannot be increased by reason of
the circumstances of dismissal whether in respect of the respondent’s
wounded feelings or the prejudicial effect upon his reputation and
chances of finding other employment”. 17
13McGregor on Damages 13th ed. (1972), 594 (italics added).
14 Ogus, supra, note 11, 310.
25 British Guiana Credit Corporation v. Da Silva [1965] 1 W.L.R. 248, 259-60.
16 [1966] S.C.R. 673; (1966) 56 D.L.R. (2d) 117 (B.C. C.A.).
1 Ibid., 684. The decision in Jarvis v. Swans Tours Ltd [1973] 1 All E.R. 71
may reasonably be limited to fact situations other than employment contracts;
in that decision the award was increased from 31 to 125 for “loss of en-
tertainment and enjoyment” from being put in inferior facilities on vacation.
In a similar vein, compensation for injury to feelings was denied in Addis
v. Gramophone Company Ltd [1909] A.C. 488, 492-493, 501, 504.
So also in British Guiana Credit Corporation v. Da Silva [1965] 1 W.L.R.
19773
WRONGFUL DISMISSAL AWARDS
It is important, for the purpose of characterization of the damage
award, to bear in mind that damages for wrongful dismissal at com-
mon law are in lieu of notice, and that the plaintiff cannot-insist on
being employed by the employer- 8 The essence of the award then is
the “salary and other income which he [i.e. the plaintiff] would have
earned … less any amounts actually earned by him [i.e. the plain-
tiff] during the period”. 19 Hence, in Harte v. Amfab Products Ltd,2″
where an employee had been abruptly discharged, the Court found
that “the proper notice the plaintiff should have received upon
termination of employment was one year. The maximum award of
damages to’which he would therefore be entitled is one year’s salary
less any deductions that should reasonably be made for mitigation”.
The same principle was followed in Carter v. Bell & Sons,2′ where
the Court implied, as a term in the contract of hiring, an obligation
to give reasonable notice of an intention to terminate the employ-
ment. So also in Bardal v. The Globe & Mail Ltd2la where the
Court observed that “the contractual obligation is to give reasonable
notice and to continue the servant in his employment”.
Apart from the obvious inclusion of salary, the court may include
other forms of earnings where the circumstances warrant such -an
inclusion. Hence, in Lindsay v. Queens Hotel Co..’ Bray J. in as-
sessing the damages for wrongful dismissal ,of a domestic servant
was willing to include the value of board -and lodging, and included
these benefits -as a component of “the actual pecuniary loss which
has been sustained …
“. So also in Addis v. Gramophone Company
Ltd., Lord Loreburn L.C. included the value of commissions stating
that:
it signifies nothing … whether the claim is to be treated as for wrong-
ful dismissal or not. In any case there was a breach of contract… and
the damages are exactly the same in either view. They are, in my
opinion, the salary to which the plaintiff was entitled for the six months
… together with the commission which the jury think he would have
earned.. 3
248, the Privy Council refused, in an action for wrongful dismissal, to allow
damages under the head of “humiliation, embarrassment and loss of reputa-
tion”. See Lord Donovan at 259 D-E.
18Freedand, The Contract of Employment (1976), 250-252.
‘9 Wells v. Mack Maritime Ltd [1975] S.H. No. 04567 N.S.S.C. Trial Div. per
Cowan C.J.T.D. at p.10.
20 (1970) 73 W.W.R. 561 (B.C.S.C.) (italics added).
21 [1936] 2 D.L.R. 438, 439; [1936] O.R. 290, 297.
21a (1960) 24 D.L.R. (2d) 140, 143.
22 [1919] 1 K.B. 212-213.
23[1909] A.C. 488, 490.
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Similarly, tips and commissions were included in the determination
of quantum, where it was clearly within the contemplation of the
parties that the plaintiff would receive the tips. 24 In other situations,
the value of luncheon vouchers, 25 pension schemes,” and piece-
work’ r have been included in the assessment of damages. At the same
time, unemployment insurance receipts may be deducted and justi-
fied on the basis that the employer has contributed to the fund.28
Given the general enunciations above of the process of quantum
determination in actions for wrongful dismissal, the issue presented
here is whether the damage award received by a plaintiff in an action
for wrongful dismissal should be treated as income for purposes
of the Income Tax Act2Sa and therefore taxed, or as a capital receipt
thereby escaping taxation. Both views have received approval in the
past three years. In Quance v. The Queen,29 the taxpayer was wrong-
fully dismissed from his employment. At the outset the employer
offered six and one-half months salary, whereas the taxpayer de-
manded one year’s salary in lieu of notice. Eventually the employer
offered nine and one-half months salary in lieu of notice, which the
taxpayer did not agree to. The taxpayer consulted his lawyers, but
his demands went unheeded. Despite all protestations, the employer
continued to make semi-monthly payments to the plaintiff. In subse-
quent litigation with the Minister of National Revenue (MNR), the
Federal Court of Canada, Trial Division held that the amounts re-
ceived by the taxpayer were taxable as an income receipt, since the
money received by the plaintiff was in satisfaction of a contractual
obligation, and that “obligation was to give the plaintiff reasonable
notice of the termination of his employment and upon failing to do
so to pay him, in lieu thereof, the salary that would have been
earned during the period of notice” 30 (emphasis added). In adopting
this approach Cattanach J. followed an “in lieu” theory of income
and successfully harmonized the tax treatment of the award’with
the conceptual and pragmatic purpose of the award itself. He
analyzed that damages “for dismissal without notice are to replace
the income he was deprived of by not being given reasonable notice
24 Manubens v. Leon [1919] 1 K.B. 208, 211.
25 McGrath v. De Soissons (1962) 112 LJ. 60.
26Bold v. Brough, Nicholson & Hall [1964] 1 W.L.R. 201.
27 Devonald v. Rosser [1906] 2 K.B. 728; Bauman v. Hulton Press [1952] 2
All E.R. 1121.
28Parsons v. B.N.M. Laboratories [1964] 1 Q.B. 95 (C.A.).
28a S.C. 1970-71-72, c.63.
29 (1974) 74 D.T.C. 6210; [1974] C.T.C. 225.
-3oIbid., 6213 (italics added).
19771
WRONGFUL DISMISSAL AWARDS
… [and] … accordingly such -an award is imbued with the quality
of income.. .”P. A consequence of this reasoning was that substance
prevailed over form.
In contrast to the above approach is the decision of the Federal
Court of Canada, Trial Division in The Queen v. Atkins.32 Here the
taxpayer was abruptly dismissed from his employment, without
warning or explanation. Under threat of litigation, the taxpayer
managed to secure a settlement of $18,000 and some fringe benefits
and claimed the entire amount as tax-free damages. The Minister
contended inter alia, that the money represented approximately 42
weeks salary, and 42 weeks being a reasonable period of notice, the
stun involved was simply salary in lieu of notice 3 Collier J. rejected
the Minister’s contentions that the sum represented either salary,34
a benefit received by virtue of employment, 5 a retiring allowance 3
or a payment in satisfaction of an obligation contemplated in section
6(3) (b), and held the entire amount to be non-taxable.
In arriving at his conclusion Collier J. did not rejeot the Quance
decision; rather the Court approved of the result in the earlier de-
cision but distinguished it “on the particular facts”.1 The Court
accepted that there had been a breach of contract, that the employer
company had not given reasonable or any notice, -that the taxpayer
was entitled to damages for breach of contract, and that the general
principles of damages for breach of contract applied to cases of
wrongful dismissal.38 In characterizing the nature of the damages as
non-taxable, however, Collier J. was influenced by two considera-
tions:
(1) The fact that damages for wrongful dismissal may include
sums other than salary or wages, although salary or wages would
provide one component element; here the Court recognized that
older employees and executives might have -difficulty in obtaining
new employment “not because of lack of ability, but because of
their age and the disturbances which might be caused to existing
seniority stratas, and because of -the difficulties of injecting new
middle-aged (or older) persons into pension schemes” 9
31 Ibid., (italics added).
32 [1975] C.T.C. 377; (1975) 75 D.T.C. 5263.
33 Ibid., 383.
4 S.C. 1970-71-72, c.63, s.5(1).
-Ibid., s.601)(a).
36 Ibid., s.56(1) (a) (ii).
37 [1975] C.T.C. 377, 387.
s8 Ibid., 384.
39 Ibid., 386.
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(2) The absence of evidence as to the ingredient sums which
went into the computation of the $18,000 figure. In distinguishing
the facts from the Quance case, the Court specifically mentioned
that “[t]here is no evidence that the sum of $18,000 was intended
by the employer or by the defendant to represent salary purely and
simply, or that other factors deserving of compensation in damages
were not included …”.40 Collier J. rejected the suggested “strong
inference” of the Minister that the employer intended to compensate
only in respect of loss of salary:
The evidence is silent. No reasonable inference can be drawn that the
company and the defendant considered loss of salary as the sole matter
for compensation. Further, it is impossible to say what portion of the
$18,000 one, or either, party attributed to that aspect of the defendant’s
loss … there is … no evidence as to what the $18,000 covers, nor any
practical, realistic, or reasonable means of dissecting it to discover its
components 41
In light of the reasoning of the Trial Court in the Atkins decision,
(approved on appeal), several observations may be made. The first
consideration that the -award may contain elements other than salary,
and may be influenced by the age of the plaintiff, is not sufficient
rationale to metamorphose an income item into a capital receipt.
The difficulty which an ex-employee may encounter in obtaining
new employment by reason of -age or other factors may well be
accounted for in determining the period of reasonable notice required
to terminate the employment, and thereby indirectly influence the
quantum of the award or negotiated settlement. This was the
approach adopted in Bardal v. The Globe & Mail Ltd,4
‘ where McRuer
C.J.H.C. stated that the “reasonableness of the notice must be decided
with reference to each particular case, having regard to the character
of the employment, the length of service of the servant, the age of
the servant and the availability of similar employment, having regard
to the experience, training and qualifications of the servant”. The
second consideration that an award may contain elements other than
salary should merely be directed towards the evidentiary burden
of computation of the ingredient elements, which burden is usually
borne by the taxpayer. That this task of dissection is not impossible
for a taxing authority or tribunal may be evidenced by the fact that
the Tax Review Board, in the Atkins case, had managed to arrive at
two figures, viz. $12,000 as a taxable retiring allowance and $6,000 as
a non-taxable receipt.43
40 Ibid., 387.
41Ibid., 388-389.
42 (1960) 24 D.L.R. (2d) 140, 145; [1960] O.W.N. 253, 255.
4
3Unreported
decision of the Tax Review Board.
19771
WRONGFUL DISMISSAL AWARDS
In the Federal Court of Appeal, however, the Chief Justice
(Pratte 3. and MacKay D.J. concurring) went further and distin-
guished the situation where salary is paid as a benefit under the
contract or in respect of the contractual relationship, from the si-
tuation where the damage award is measured by reference to the
salary. While the former would be taxable under section 5(1) of
the Act, the Court held the latter to be a nontaxable receipt.
As a footnote to the Atkins litigation it is interesting to observe
that, whereas the Trial Division specifically decided that the payment
was not a “retiring ailowance 43a since the taxpayer was “fired”, and
the Minister did not advance or pursue the -retiring allowance ar-
gument on appeal, on August 23, 1976 (three months after reasons
for judgment were handed down in the appeal) Revenue Canada
issued an Interpretation Bulletin 43 b adopting the position that a
retiring allowance would include those situations where an employee
is dismissed prior to the normal date of retirement. In light of the
interval between the decision and issuance of the Bulletin, it is pre-
sumably the intention of Revenue Canada to restrict the application
of the retiring allowance provision to those situations wherein the
taxpayer accepts the monetary offer without threat of litigation,
etc., and does not intend to cover those situations in which such an
amount would be construed as damages.
The major difficulty of decisions in the area of wrongful dis-
missal has been two diametrically opposed -theories of the nature
of the receipt. On the one hand, there are those who suggest that a
wrongful dismissal award represents replacement of a loss of
earning capacity. This group may be categorized as, the “capital
asset” school, which favours non-taxation of any portion of the
damage award recovered by the plaintiff, on the premise that such
awards compensate for a loss of capacity or a capital asset. Brown
v. M.N.R.44 illustrates this line of thought. In that case, the Board
held the damages received by an ex-employee to be non-taxable,
stating that the “amount of damages awarded is not an income
receipt of the appellant equivalent to the income which he would
have received had he been permitted to continue in his employment,
but is a capital, receipt paid to him in respect of the destruction of
43 [1975] C.T.C. 377, 391.
48b I.T. 337, “Retiring Allowances”.
43c Ibid., para.4.
44 (1952) 52 D.T.C. 9 (I.T.A.B.).
McGILL LAW JOURNAL
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that right”.45 So also in Garneau v. M.N.R. 40 the Board, in finding
the damages of a wrongfully dismissed physician to be non-taxable
stated that the “capital of a profession is the right and privilege of
exercising it. To derogate from that right and privilege would impair
the capital it represents …
,,7
On the other hand, there are those who favour the view that such
an award received by the dismissed employee represents, in part at
least, a replacement of loss of earnings per se during the period of
reasonable notice required from the employer. This latter school,
epitomized by Quance, would argue that at least a portion of the
plaintiff’s damage award is granted “in lieu” of potential earnings
lost during the period of notice required, and should be subject to
tax.
Which of the above two theories is the more acceptable in the
context of wrongful dismissal awards? The answer should surely
depend and be formulated in the context of the theory and purpose
of damage awards, with an eye on the nature of income and the
pragmatic necessity of administering a tax system simply and
equitably in light of the objectives of taxation. If the “capital asset”
theory is accepted as the correct view, then it may be asked: What
is the value of the capital asset that is being replaced? The response
would call for valuation of a capital asset as being the equivalent
of the present value of future cash flows which are being com-
pensated in lieu of notice, at s6me specified rate of return. The fact
that, in wrongful dismissal situations, the period of reasonable notice
is usually short and rarely above one year does not detract from the
principle, but serves merely to alleviate the practical problem of
discounting. Thus, absence of discounting in the computational
process of quantum determination becomes an “acceptable” error
causing minimal distortion due to the brevity of the period involved.
Hence, it becomes readily apparent that the cash flow which is the
object being discounted (at least in theory) is the same cash flow
which is given in lieu of reasonable notice.
The traditional analysis based on conceptual distinctions of the
“capital asset” theory and the “in lieu” theory, useful as it is in tax
law, can, however, only be carried so far. When one gets to the
requirement, as an implicit assumption of the computation,. that
the plaintiff notionally erode his principal sum on a regular basis,
45 Ibid., 10 (italics added).
46 (1968) 68 D.T.C. 132 (T.A.B.) See also Wheatcroft, The Law of Income Tax,
Surtax and Profits Tax (1962), 1070-71.
4-1 Ibid., 136-37.
1977]
WRONGFUL DISMISSAL AWARDS
so that he is compensated and not enriched, the distinction between
capital asset and loss of earnings becomes obscure. Ultimately the
capital value of any property rights is the discounted present value
of expected future cash flows emanating from that property. Thus,
it is submitted that, shorn of all its verbal decorations, the tradi-
tional analysis of “capital asset” versus “in lieu” earnings is not
sufficient to provide a satisfactory solution. For every asset may be
viewed from two sides of the same coin. It may be conceived of as
the capitalized value of future cash flows, and classified as a sum
representing “capacity” or a “capital asset”; but this capital asset
represents no more than the substitution of discounted future
earnings. Hence, the two theories are essentially different sides of
the same equation. Viewed in this light, inconsistent tax treatment
of different sides of the same equation is premised on illusory and
non-existent distinctions, and reduces to an exercise in semantics,
with form prevailing over substance.
To escape from this tautological dilemma it is submitted that,
insofar as the primary purpose of a wrongful dismissal damage award
is compensation, pecuniary and other components represent substi-
tutional sums of money premised on the principle of restitutio in
integrum. The ‘damage award is computed by calculating an amount
in reference to the employee’s salary, with this calculated amount
being substituted for the salary. This same principle of substitution
should be extended in the subsequent tax treatment of the receipt.
Thus, substitutions for initially taxable components should remain
taxable. This category may include, in the context of wrongful dis-
missal, salary, wages, gratuities,4 8 or commissions,49 or the value of
board and lodging? In a similar vein, substitutions for initially non-
taxable components should continue to be excluded from taxation.
This approach would be similar to that suggested by Diplock L.J., in
the context of whether an award related to loss of prospective profits
or a capital receipt from business. He stated the principle thus:
Where, pursuant to a legal right, a trader receives from another person
compensation for the trader’s failure to receive a sum of money which, if
it had been received, would have been credited to the amount of profits
(if any) arising … from the trade carried on by him … , the compensation
is to be treated for income tax purposes in the same way as that *sum of
money would have been treated if it had been received instead of the
compensation.M’
4sManubens v. Leon, supra, note 24.
4) S.C. 1970-71-72, c.63, s.5(l); Addis v. Gramophone Company Limited [1909]
A.C. 488.
50 S.C. 1970-71-72, c.63, s.6(1) (a); Lindsay v. Queen’s Hotel Co. [1919] 1 K.B.
212.5 lLondon and Thames Oil Wharves Ltd v. Attwooll [1967] 2 All E.R. 124,
134 (CA.) leave to appeal denied.
McGILL LAW JOURNAL
[Vol. 23
The question then to be asked is: In substitution of what were
the wrongful dismissal damages awarded? The response suggested
in this paper is that the portion awarded to replace salary in lieu
of notice and other taxable components should be characterized
accordingly. Any portion awarded for non-taxable elements should
similarly be substitutionally characterized and totally exempt from
taxation.
On the basis of the preceding analysis, it is submitted that the
response to the earlier questions, as to whether the recipient of a
wrongful dismissal award improves his economic power or net
worth in a manner capable of objective measurement and quantifica-
tion, must be unequivocally affirmative. The improvement in net
worth is capable of objective measurement by valuing the substitu-
tional sum on which the damages are assessed. Based on this
accretion test, the amounts received should prima facie be cha-
racterized as an income receipt. Of equal importance, however, and
the central thrust of this paper, is the submission that given the
structure of the present Act, the damages awarded to Mr Atkins
should have been substitutionally characterized and the amount
received, or a part thereof, treated as income under the existing Act.
The above recommended substitutional characterization, and the
subsequent tax treatment in a manner similar to the treatment af-
forded the original elements, has several advantages at two levels,
conceptual and policy. Conceptually, three advantages may be ob-
served:
(1) This approach promotes the desired and oft-stated ob-
jective of compensation in the determination of damage awards.
(2)
It enhances the conceptual purity of income theory and
conforms to the accretion concept of wealth as enunciated earlier.
(3)
It promotes the tax objective of equity by providing for
similar treatment for -similar items, and avoids tax preferences which
are not founded on clearly articulated reasons.
Turning from the conceptual to the pragmatic, the suggested ap-
proach has a certain appeal:
(1)
It gives effect to the substance of the transaction rather
than the form of the negotiations and ultimate settlement documents.
In the Atkins decision itself, the Court alluded to the fact that a
clause of the termination document referred to “severance allow-
ance” and not to “salary”. 2 Thus, one author has suggested the
avoidance of particular terminology such as “retiring allowance”,
52R. v. Atkins [1975] C.T.C. 377, 387.
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WRONGFUL DISMISSAL AWARDS
“severance” or “salary”, which may tend to imbue the receipt with
the colour of income. 3
(2)
It will tend to promote settlements and avoid unnecessary
disputes or litigation. While some disputes and litigation are un-
avoidable given the usually hostile atmosphere surrounding a wrong-
ful dismissul, the suggested approach should have the effect of
confining such legal proceedings to “real” as opposed to “cosmetic”
confrontations. The present uncertain and somewhat variable tax
status of damages awards, dependent in part on the threat of litig-
ation, may be highlighted from two decisions.
‘In Larson v. M.N.R.,5 the taxpayer, who was a senior executive,
was suddenly informed that he was being “let go”, and was offered
two months salary. The taxpayer claimed one year’s salary ($20,000),
threatened legal action and settled for $10,000. The Board decided
that the award was not taxable and was influenced inter alia by
the fact that. the taxpayer did not accept the initial offer, stating that
“[h]ad he accepted this proposition the amount so received might
well be regarded as a retiring allowance in respect of -loss of off-ice
or employment”.P5 The opposite result was arrived at in Alexander v.
M.N.R.,r6 where the taxpayer’s resignation was demanded in return
for $30,000. The Board held the amount to be a retiring allowance
and therefore taxable because ” the payment received by the ap-
pellant was not the result or the final outcome of threatened litiga-
tion or protracted negotiations in that direction, but nothing more
than the first step towards the termination of an uncomfortable
situation”.57
Later the Board observed in the same decision -that “[t]he ap-
pellant made no attempt to negotiate for a larger amount or to
demand other concessions … ,.8 These decisions would thereby
suggest that the taxpayer may be well advised to have a good fight
first, and not to relent too readily once the fight has commenced.
(3)
It would avoid the present necessity for deliberate obfus-
cation both in the computation of the settlement amount and in
the drafting of the settlement agreement. Thus, in the interest of
tax minimization, there is at the present time a tendency to avoid
63McDonald, “Wrongful Dismissal: Tortious Breach of Contract” in Law
Society of Upper Canada, Special Lectures (1973), 477, 492.
(1967) 67 D.T.C. 81 (T.A.B.).
lM
5 Ibid., 83.
66Alexander v. M.N.R. (1971) 71 D.T.C. 664 (T.A.B.).
57 Ibid., 673.
68 Ibid.
McGILL LAW JOURNAL
[Vol. 23
express reference to “salary” or the salary period or mode of
payment, or any correlation between the amount paid as damages
with the period of reasonable notice. That this self-inflicted obscurity
is a response to the existing confusion with regard to the tax treat-
ment of wrongful dismissal awards is understandable.
(4) Finally, the approach suggested in this article would remedy
the peculiar and vulnerable position of the dismissed employee in
any settlement negotiations. While an employer may deduct the
damages payment as a business expense on the premise that the
liability was incurred as part of the operations by which the tax-
payer earned his income’ 0 the employee in negotiations is placed,
at least in part, in a disadvantaged position. If the employer, despite
the ex-employees protestations, continues to pay the salary equiv-
alent in regular amounts over the same salary period, e.g., weekly,
fortnightly or monthly, the ex-employee may find himself within
the scope of the Quance decision and subject to tax. This negotiating
leverage may well be used by an employer to induce the ex-em-
ployee to accept a settlement lower than that to which he might
otherwise be entitled. While negotiation in the settlement of legal
disputes is a function of numerous variables (including the talents
and knowledge of the negotiator) this leverage would appear un-
warranted, premised as it is on the mere form of payment without
any conceptual foundation.
In contrast to the benefits of inclusion of such awards in income,
the benefits of exclusion are minimal. It may be argued that exclusion
from income promotes simplicity within the tax structure by dis-
pensing with any necessity of allocation into taxable and non-taxable
components. The price paid, however, for this simplicity may well be
too high to warrant exclusion. Exclusion of damages would work
against the taxation policy of equitable distribution of tax liabilities;
at the same time it would have no corresponding beneficial impact
on the social and economic criteria of the tax structure.
Conclusion
This paper has endeavoured to analyze, in a narrow context, the
process of characterization of damage awards for tax purposes in
situations of wrongful dismissal. While the topic of damages for
wrongful dismissal may in itself be narrow, the task of characteriz-
ation of receipts and disbursements is one which is of wider import
59 Following the reasoning of Thorson J. in Imperial Oil Ltd v. M.N.R.
[1948] 1 D.L.R. 305.
19771
WRONGFUL DISMISSAL AWARDS
59
and familiar to those involved in legislative, judicial, administrative
is to be hoped that this process of
and advisory functions. It
characterization will be conducted in the wider context of income
theory and tax policy objectives and will be rationalized with other
spheres of legal and economic activity. The distinguishing charac-
teristics of the approach suggested in this article are its emphasis on
equity as being a desirable and the primary objective of a taxation
structure, and a broad inclusionary concept of income premised on
a theory of substitutional characterization of receipts. Further, ex-
tending this reasoning, it is submitted that characterization of
damages as a capital gain would merely blunt the thrust of the
inequity inherent in preferential treatment, without conceptual re-
conciliation of the underlying problem.
