Wrongful Dismissal Damages: the Burden of Taxation
Total Page：16
File Type：pdf, Size：1020Kb
Wrongful Dismissal Damages: The Burden of Taxation When an employee is dismissed from their employment without cause, they are entitled to reasonable notice or pay in lieu of notice. In some circumstances, the reasonable period of notice awarded can range as high as 24 months (and in some provinces even higher in special circumstances). If a dismissed employee is paid for two years worth of compensation all in one lump sum, and therefore in a single tax year, then their tax burden will be substantially higher than it would have been if that employee had worked for those two years (since their compensation would have been paid gradually over two tax years). Through no fault of their own, a dismissed employee is therefore effectively compensated less if they are given pay in lieu of notice rather than working notice because their tax burden is significantly higher. Who, then, is responsible for the additional tax burden the employee will bear? Early Case Law – Fixation on Inapplicable Prior Law Generally, Courts have held that the impact of income tax on damages awards should not affect damages in wrongful dismissal cases: In dealing with this question, it is important to recognize that the action is one for damages for wrongful dismissal. There has, in effect, been a breach by the employer of the contract of employment. The employee may accept that repudiation and sue for damages. In R. v. Jennings, [1966] S.C.R. 532, 57 D.L.R. (2d) 644 [Ont.], the Supreme Count of Canada held that it was inappropriate to take account of the incidence of income tax on an award of damages for loss of earning capacity. In Harte v. Amfab Prod. Ltd. (1970), 73 W.W.R. 561(B.C.), Mr. Justice Ruttan applied the reasoning in R. v. Jennings, supra, in a case where damages for wrongful dismissal were sought. For those reasons, I would reject the plaintiff's submissions on the third issue.1 The decision in Harte, cited in the quotation above, relied on the decision of the Supreme Court of Canada [SCC] decision in Jennings that found that an injured individual’s damages should not be reduced by virtue of the fact that those damages were exempt from taxation. The insurance company in Jennings had tried to argue that since the damages they were to pay to the plaintiff were non-taxable, they should only have to pay the gross amount less the tax that would normally apply if taxes were actually applied to the damages award. The tax exemption, it was argued, resulted in the insurance company over-compensating the injured party. The SCC rejected this argument on the grounds that the government’s tax policy should not result in the defendant gaining a benefit.2 The Court in Harte then held that the same should also apply in wrongful dismissal cases. That is, an employer who wrongfully dismisses an employee should not be allowed to pay the damages amount less taxes to the dismissed employee, the employer must pay the gross amount. The case law relied on by the Court in Harte specifically stated that the defendant should not be able to benefit from a consequence of tax policy. In Antonacci, the Court dealt with the employer’s argument that because Workers’ Compensation Benefits (WCB) received during the notice period were deductible from the damages awarded for the dismissal, those WCB payments should be grossed up to account for the taxes that had been removed 1 Bower v J.M. Schneider Inc., [1987] BCWLD 134, 34 DLR (4th) 77 (BC CA) (WL) at paras 46-47. 2 The Queen v Jennings et al., 1966 CanLII 11 (SCC), [1966] SCR 532 when paid to the employee (thereby increasing the deductions made to the damages award in favour of the employer). If the WCB payments to be deducted from the damages award were not grossed up, the employer argued, then the employee would be overcompensated. Both the trial judge and the appellate court rejected the employer’s argument and held that: [19] The trial judge rejected a & P’s argument on the basis that the tax treatment of Workers’ Compensation Benefits rests on a tax policy of the federal government and any resulting benefit to the employee cannot be claimed by the employer. The matter is best left to the legislature. [20] I agree with the trial judge's conclusion. The result is consistent with the general approach adopted in personal injury cases whereby damages for loss of income are calculated on the basis of the before-tax income lost: Jennings v. Cronsberry (1966), 57 D.L.R. (2d) 644(S.C.C.). Much the same reasoning applies here. [21] Damages should restore Mr. antonacci to the position in which he would have stood but for a & P’s wrongdoing. However, what Mr. Antonacci would have done, or would have been required to do, with the employment income he would have received from a & P, in so far as a & P is concerned, is irrelevant. The “loss” resulting from any resulting overcompensation is to Revenue Canada, not to the employer. The rule against double recovery is not absolute. It admits of certain exceptions, particularly where there are competing policy considerations. In a case such as this one, it would be against public policy to make it more profitable for the employer to pay damages for the breach of contract than to perform the contract. Further, to require an assessment of the plaintiff’s liability to pay tax in every case where deductions are made from a damage award would give rise to considerable practical difficulties that would result in an unwarranted increase in the cost of litigation. Indeed, as the trial judge concluded, the tax treatment of Workers’ Compensation Benefits and any resulting benefit to the recipient is a question better left to the legislature.3 The cases discussed thus far, therefore, had essentially held that the party causing the harm was not entitled to gain a benefit from their wrongdoing by reducing the damages award, but they provide no comment on whether the employee should have the damages award increased due to the additional tax burden. In Peet, however, the Court of appeal for Ontario dealt with a situation in which the employee was terminated, elected early retirement under the employer’s pension plan, and sued for loss of pension benefits, requesting the difference he received under early retirement versus what he would have received if he retired at the end of the notice period. The Court of appeal in Peet held that courts should not treat pensions differently from awards for loss of salary with regard to tax implications in wrongful dismissal cases: The function of the court is simply to determine the commuted value of the pension loss and then to award a corresponding lump sum in damages. If the respondent wants to use the damages award to purchase an annuity, he is entitled to do so. However, the court is not entitled, for tax purposes, to treat a pension loss award any differently from an award for loss of salary… The 3 Antonacci v Great Atlantic & Pacific Co. of Canada, [2000] OJ No 40, 181 DLR (4th) 577 (ON CA) (WL) [Antonacci]. amounts received under the proposed annuity should be taxable in the hands of the annuitant, as would be the amounts received under the pension plan which it is intended to supplement.4 The court in Peet relied on the SCC decision in Red Deer College to state that an employee is only entitled to be put in as good of a position as s/he would have been in had there been proper notice.5 Because it is helpful to quote, the SCC in Red Deer College specifically stated, when discussing the duty to mitigate: The primary rule in breach of contract cases, that a wronged plaintiff is entitled to be put in as good a position as he would have been in if there had been proper performance by the defendant, is subject to the qualification that the defendant cannot be called upon to pay for avoidable losses which would result in an increase in the quantum of damages payable to the plaintiff.6 The comment in Red Deer College that the employee is entitled to be put in as good of a position as if there had been proper notice is a reframing of the classic test in Hadley v Baxendale and becomes an important part of this author’s argument later on. Further, Red Deer College only addressed the plaintiff’s avoidable losses. Surely, income tax is not an “avoidable” loss in the sense contemplated in Red Deer College. Modern Case Law – A Return to Fundamentals Rejecting the application of taxation to dismissal cases entirely can produce significant problems with the quantification of awards. If reasonable notice is found to be 24 months, then all financial gains from that employment, if working notice was provided, would have been received gradually over that 24-month period. This distributes the tax burden across at least 2 years (depending on the timing of the notice of dismissal). If notice is not given, pay in lieu of notice is required. Payment in lieu of notice provides the entirety of damages for that 24-month period in one lump sum all in one tax year. Because of this, an incredible tax burden is imposed upon the dismissed party which would not have been imposed had they been given working notice. As is standard in contract law, it is the breaching party that bears the costs of its breach.