Alan M. Schwartz, Appellant, entered into a contract for employment with Dynacare Health Group at a salary of $250,000 together with stock options. However, after some time, Dynacare breached the contract and offered Mr. Schwartz $75,000 in return for the complete termination of the contract. Mr. Schwartz rejected the offer and thereafter entered into negotiations. The dispute was finally settled for $360,000 plus $40,000 in costs.
The Minister of National Revenue described the $360,000 as retiring allowance as per section 6(1)(a) of the Income Tax Act and contended that it is taxable. However, the Tax Court did not agree with the definition of retiring allowance and held that there was no payment of retiring allowance in order to receive any future income, but to compensate Mr. Schwartz for embarrassment, distress and inconvenience.
This decision was appealed, and in its judgment, the Federal Court of Appeal ruled that the Tax Court had erred in failing to take into account the correspondence between the lawyers representing Schwartz and Dynacare, and which showed that the settlement payment was essentially compensation for the loss of income and stock options. Accordingly, on this ground, the Court of Appeal held that most of the money was taxable.
In its judgment on appeal, the Supreme Court of Canada analyzed the issue of the standard of review and concluded that the Tax Court did not commit any palpable and overriding error in weighing the testimony of Mr. Schwartz more heavily than the correspondence between the lawyers. Ultimately, the Supreme Court determined that the trial court correctly determined that where no services were provided by an employee, there is no “retiring allowance”:
The damages received by the appellant cannot be considered a “retiring allowance” within the meaning of s. 248(1) of the Act — and therefore are not taxable under s. 56(1)(a)(ii) — because they were not received “in respect of a loss of … employment”. When one considers the ordinary meaning to be given to the words found in the definition of “employment” in s. 248(1), a distinction must be made between the start of the contractual relationship agreed upon by the employer and the employee and the moment, according to the terms of the contract, at which the employee is bound to start providing services to the employer. The statutory requirement that one must be “in the service” of another person to be characterized as an “employee” excludes any notion of prospective or intended employment. An employee is thus only “in the service” of his employer from the moment he becomes under obligation to provide services under the terms of the contract. It follows that “loss of employment” cannot occur before an employee becomes under obligation to provide services to his future employer because he cannot, before that moment, be “in the service” of that employer.
This decision would expand the range of payments that cannot be deemed to be “income” for tax purposes, permitting those who have been wronged by their employer or prospective employer to obtain compensation independent of the Income Tax Act.
Decided by the Supreme Court of Canada on February 22, 1996.
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