Schwartz v. Canada

Schwartz v. Canada
Collection
Supreme Court Judgments
Date
1996-02-22
Report
[1996] 1 SCR 254
Case number
24093
Judges
La Forest, Gérard V.; L'Heureux-Dubé, Claire; Sopinka, John; Gonthier, Charles Doherty; McLachlin, Beverley; Iacobucci, Frank; Major, John C.
On appeal from
Federal Court of Appeal
Subjects
Courts
Taxation
Notes
SCC Case Information: 24093
Decision Content
Schwartz v. Canada, [1996] 1 S.C.R. 254
Alan M. Schwartz Appellant
v.
Her Majesty The Queen Respondent
Indexed as: Schwartz v. Canada
File No.: 24093.
1995: October 6; 1996: February 22.
Present: La Forest, L'Heureux‑Dubé, Sopinka, Gonthier, McLachlin, Iacobucci and Major JJ.
on appeal from the federal court of appeal
Taxation ‑‑ Income tax ‑‑ Computation of income ‑‑ Damages for cancellation of employment ‑‑ Employment contract cancelled by employer before employee obliged to provide services ‑‑ Whether damages received by employee taxable as income from unenumerated source or as retiring allowance ‑‑ Income Tax Act, R.S.C. 1952, c. 148, ss. 3(a), 56(1)(a)(ii).
Courts ‑‑ Appellate court ‑‑ Court of Appeal overturning trial judge's findings of fact with respect to apportionment of damages received by taxpayer for cancellation of employment contract ‑‑ Whether Court of Appeal justified in interfering with trial judge's findings of fact ‑‑ Principles to be followed by first and second appellate courts.
The appellant, a lawyer, accepted an offer of employment from a company in May 1988. The appellant was to receive a salary of $250,000 annually as well as the option to acquire non‑voting shares of the company. Both parties also agreed that he would start working upon completion of his assignment for the Government of Ontario. A few months later, the company informed the appellant that his services would not be required and offered him $75,000 in exchange for a full and final release. The appellant refused the offer. In January 1989, he withdrew from his law partnership and commenced a new employment. Following negotiations, the appellant reached a settlement with the company which agreed to pay him $360,000 as damages plus $40,000 on account of costs. The Minister of National Revenue assessed the damages as constituting a "retiring allowance" taxable under s. 56(1)(a)(ii) of the Income Tax Act. The Tax Court of Canada set aside the Minister's assessment. The trial judge held that the damages were not a "retiring allowance" within the meaning of s. 248(1) of the Act. He also held that the damages were not "income from employment" under s. 3(a) of the Act, finding that there was no evidence indicating any allocation of the settlement amount and that the damages had been received in a small part, if any, for loss of income for future services and to a larger part, according to the evidence, for embarrassment, anxiety and inconvenience. The Federal Court of Appeal agreed with the trial judge that the damages did not constitute a retiring allowance but overturned his findings of fact relating to apportionment because he had omitted to consider relevant documentary evidence ‑‑ two letters from the parties' solicitors ‑‑ which was contradictory to the testimonial evidence given by the appellant. The court preferred the documentary evidence over the appellant's testimony and held that, on a balance of probabilities, $75,000 had been allocated for loss of salary, $267,000 for loss of the stock options, and $18,000 for embarrassment, anxiety and inconvenience suffered by the appellant. The court held that compensation received by a person for the failure to receive a sum of money which, if it had been received, would have constituted income from employment, should be treated, for tax purposes, in the same way as if the sum of money had been received instead of the compensation. Accordingly, the court concluded that the damages relating to lost salary and stock options were taxable under s. 3(a) of the Act as income from employment.
Held: The appeal should be allowed.
Per La Forest, L'Heureux‑Dubé, Gonthier and McLachlin JJ.: A first appellate court can only intervene in a trial judge's findings of fact where it can be established that he made a palpable and overriding error which affected his assessment of the facts. A clear omission of evidence by the trier of fact is the kind of error that can and will justify a reassessment of the balance of probabilities taking into consideration the omitted elements by the appellate court. In order to disturb the trial judge's findings of fact, however, the first appellate court must come to the conclusion that the evidence in question and the error made by the trial judge in disregarding it were overriding and determinative in the assessment of the balance of probabilities with respect to that factual issue. When a second appellate court agrees with the ground upon which the first appellate court intervened, the second appellate court can substitute its own assessment of the evidence for the first appellate court's. The first appellate court is not in a more advantageous or privileged position than the second appellate court in assessing the evidence and thus there is no reason why a second appellate court should show deference towards the first appellate court's assessment of the balance of probabilities. If the ground upon which a first appellate court relies to intervene is, in the opinion of a second appellate court, ill‑founded, the trial judge's findings will be restored.
While the Minister should not have the burden of presenting, in every case where the apportionment of a general award is at issue, specific evidence amounting to an explicit expression of the parties' intention with respect to that question, there must be some evidence, in whatever form, from which the trial judge will be able to infer, on a balance of probabilities, which part of that general award was intended to compensate for specific types of damage. Here, the letters from the parties' solicitors, considered in the global evidentiary context of this case, are insufficient to serve as a basis for such an inference. These letters establish that in arriving at the final settlement amount, the parties considered losses of salary and stock options, but they do not constitute evidence as to what portion of the amount was allocated to such losses. The Federal Court of Appeal was thus wrong in concluding that the trial judge had failed to consider contradictory evidence and in interfering with his findings of fact regarding the apportionment. The court's conclusions as to the appellant's credibility ‑‑ as opposed to those arrived at by the trial judge ‑‑ also constitute in the present circumstances unjustified and inappropriate intervention by an appellate court on a matter which is at the core of a trial judge's duties. Since there is no evidence tending to establish specifically what portion of the amount was allocated to which head, the damages received by the appellant cannot, in whole or in part, be found to be taxable under s. 3(a) of the Income Tax Act as income from the employment contract.
Taxability in this case should be assessed pursuant to the retiring allowances provisions of the Act. While s. 3(a) of the Act contemplates the possibility that income arising from sources other than those enumerated in s. 3(a) and in Subdivision d of Division B of Part I of the Act may nonetheless be taxable, to find that the damages received by the appellant are taxable under the general provision of s. 3(a) would disregard the fact that Parliament, in amending the Income Tax Act in 1983, has chosen to deal with the taxability of such payments in the provisions relating to retiring allowances. Such an approach would amount to giving precedence to a general provision over the detailed provisions enacted by Parliament. This would be inconsistent with basic principles of interpretation.
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.
Per Sopinka, Iacobucci and Major JJ.: On a plain meaning, s. 56(1)(a)(ii) of the Income Tax Act does not provide for the taxation of settlements for loss of intended employment. As well, there was no factual foundation on which to argue that the settlement could be taxed under s. 3(a) of the Act as income from the employment contract. It is, however, unnecessary and undesirable in this case to answer the question of whether s. 3(a) permits taxation of unenumerated sources of income. If this Court intends to conclude that s. 3(a) should be applied literally, and permit taxation on income from any source, it should only do so in circumstances which warrant such a decision because such a result is of fundamental importance. Moreover, so deciding can be viewed as a marked departure from previous tax jurisprudence.
Cases Cited
By La Forest J.
Referred to: The Queen v. Atkins, 76 D.T.C. 6258, aff'g 75 D.T.C. 5263; The Queen v. Pollock, 84 D.T.C. 6370; Stein v. The Ship "Kathy K", [1976] 2 S.C.R. 802; London & Thames Haven Oil Wharves, Ltd. v. Attwooll, [1967] 2 All E.R. 124; The Queen v. Manley, [1985] 2 F.C. 208, leave to appeal refused, [1986] 1 S.C.R. xi; Krivy v. Minister of National Revenue, 79 D.T.C. 121; Girouard v. The Queen, 80 D.T.C. 6205; Beck v. Minister of National Revenue, 80 D.T.C. 1747; Grozelle v. Minister of National Revenue, 77 D.T.C. 310; Specht v. The Queen, [1975] F.C. 150; No. 45 v. Minister of National Revenue, 52 D.T.C. 72; Larson v. Minister of National Revenue, 67 D.T.C. 81; Jones v. Minister of National Revenue, 69 D.T.C. 4; Clarke v. Edinburgh and District Tramways Co., [1919] S.C. (H.L.) 35; Dorval v. Bouvier, [1968] S.C.R. 288; Beaudoin‑Daigneault v. Richard, [1984] 1 S.C.R. 2; Laurentide Motels Ltd. v. Beauport (City), [1989] 1 S.C.R. 705; Lapointe v. Hôpital Le Gardeur, [1992] 1 S.C.R. 351; Hodgkinson v. Simms, [1994] 3 S.C.R. 377; Fletcher v. Manitoba Public Insurance Co., [1990] 3 S.C.R. 191; Chartier v. Attorney General of Quebec, [1979] 2 S.C.R. 474; Demers v. Montreal Steam Laundry Co. (1897), 27 S.C.R. 537; Jack Cewe Ltd. v. Jorgenson, [1980] 1 S.C.R. 812; Curran v. Minister of National Revenue, [1959] S.C.R. 850, aff'g 57 D.T.C. 1270; Canada v. Fries, [1990] 2 S.C.R. 1322, rev'g [1989] 3 F.C. 362; The Queen v. Savage, [1983] 2 S.C.R. 428; Québec (Communauté urbaine) v. Corp. Notre‑Dame de Bon‑Secours, [1994] 3 S.C.R. 3; Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536; The Queen v. Golden, [1986] 1 S.C.R. 209; Johns‑Manville Canada Inc. v. The Queen, [1985] 2 S.C.R. 46; The Queen v. Imperial General Properties Ltd., [1985] 2 S.C.R. 288; Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32; McClurg v. Canada, [1990] 3 S.C.R. 1020; Friesen v. Canada, [1995] 3 S.C.R. 103; R. v. Zeolkowski, [1989] 1 S.C.R. 1378; Thomson v. Canada (Deputy Minister of Agriculture), [1992] 1 S.C.R. 385; Symes v. Canada, [1993] 4 S.C.R. 695; Thibaudeau v. Canada, [1995] 2 S.C.R. 627; Canada v. Antosko, [1994] 2 S.C.R. 312.
By Major J.
Referred to: The Queen v. Savage, [1983] 2 S.C.R. 428; Curran v. Minister of National Revenue, [1959] S.C.R. 850; Canada v. Fries, [1990] 2 S.C.R. 1322.
Statutes and Regulations Cited
Act to amend the statute law relating to income tax (No. 2), S.C. 1980‑81‑82‑83, c. 140.
Income Tax Act, R.S.C. 1952, c. 148 [am. 1970‑71‑72, c. 63] (now R.S.C., 1985, c. 1 (5th Supp .)), ss. 3(a), 5(1) , 6(1) (a) [am. 1980‑81‑82‑83, c. 140, s. 1(1)], (9) [rep. & sub. idem, s. 1(6) ], 12(1)(w) [rep. & sub. 1984, c. 45, s. 5(2)], 56(1)(a)(ii) [am. 1980‑81‑82‑83, c. 140, s. 26; am. 1987, c. 46, s. 15], (viii) [ad. 1979, c. 5, s. 15; rep. 1980‑81‑82‑83, c. 140, s. 26(3)], 80.4(1) [rep. & sub. idem, s. 44; am. 1984, c. 45, s. 25], 248(1) "employee", "employment", "retiring allowance" [rep. & sub. 1980‑81‑82‑83, c. 140, s. 128(10); am. 1990, c. 39, s. 54], "termination payment" [ad. 1979, c. 5, s. 66(8); rep. 1980‑81‑82‑83, c. 140, s. 128(13)].
Authors Cited
Arnold, Brian J., Tim Edgar and Jinyan Li, eds. Materials on Canadian Income Tax, 10th ed. Scarborough, Ont.: Carswell, 1993.
Canada. Minister of National Revenue. Taxation. Interpretation Bulletin IT‑337R. "Retiring Allowances", November 19, 1979.
Canada. Minister of National Revenue. Taxation. Interpretation Bulletin IT‑365. "Damages, Settlements, and Similar Receipts", March 21, 1977.
Canada. Minister of National Revenue. Taxation. Interpretation Bulletin IT‑365R. "Damages, Settlements, and Similar Receipts", March 9, 1981.
Collins, Lisa M. "The Terminated Employee: Minimizing the Tax Bite". In Canadian Tax Foundation, Report of Proceedings of the Forty‑Fifth Tax Conference. Toronto: Canadian Tax Foundation, 1994, 31.1.
Gibbens, R. D. "Appellate Review of Findings of Fact" (1992), 13 Adv. Q. 445.
Goodwin, Robert B. "Personal Damages". In Canadian Tax Foundation, Report of Proceedings of the Twenty‑Eighth Tax Conference. Toronto: Canadian Tax Foundation, 1977, 813.
Hansen, Brian G. "The Taxation of Employees". In Brian G. Hansen, Vern Krishna and James A. Rendall, contributing eds., Canadian Taxation. Toronto: Richard De Boo, 1981, 117.
Harris, Edwin C. Canadian Income Taxation. Toronto: Butterworths, 1979.
Harris, Edwin C. Canadian Income Taxation, 4th ed. Toronto: Butterworths, 1986.
Hogg, Peter W., and Joanne E. Magee. Principles of Canadian Income Tax Law. Scarborough, Ont.: Carswell, 1995.
Krishna, Vern. "Characterization of Wrongful Dismissal Awards for Income Tax" (1977), 23 McGill L.J. 43.
Krishna, Vern. The Fundamentals of Canadian Income Tax, 4th ed. Scarborough, Ont.: Carswell, 1992.
MacDonald, W. A., and G. E. Cronkwright, eds. Income Taxation in Canada, vol. 2. Scarborough, Ont.: Prentice‑Hall, 1977 (loose‑leaf).
Rendall, James A. "Defining the Tax Base". In Brian G. Hansen, Vern Krishna and James A. Rendall, contributing eds., Canadian Taxation. Toronto: Richard De Boo, 1981, 59.
Scace, Arthur R. A. The Income Tax Law of Canada, 4th ed. Toronto: Law Society of Upper Canada, 1979.
APPEAL from a judgment of the Federal Court of Appeal, [1994] 2 F.C. 720, [1994] 2 C.T.C. 99, 94 D.T.C. 6249, 167 N.R. 35, 2 C.C.P.B. 109, setting aside a judgment of the Tax Court of Canada, [1993] 2 C.T.C. 2125, 93 D.T.C. 555. Appeal allowed.
Benjamin Zarnett and Carrie Smit, for the appellant.
J. S. Gill, Q.C., Susan Van Der Hout and Elizabeth Chasson, for the respondent.
The judgment of La Forest, L'Heureux‑Dubé, Gonthier and McLachlin JJ. was delivered by
1 La Forest J. -- This appeal involves the issue whether compensation received by an "employee" from his "employer" pursuant to a settlement regarding liability for the employer's unilateral decision to cancel a contract of employment before the employee had become under obligation to provide services is taxable as income from an unenumerated source under the general provision of s. 3(a) of the Income Tax Act, R.S.C. 1952, c. 148 (now R.S.C., 1985, c. 1 (5th Supp .)), or, in the alternative, as a retiring allowance under s. 56(1)(a)(ii) of the Act.
I. Background
2 In the spring of 1988, Mr. Schwartz, a lawyer, received a verbal offer of employment from the Dynacare Health Group Inc.'s Chairman, Albert J. Latner. The appellant accepted on the basis that the employment would begin on completion of an assignment by the appellant for the Government of Ontario, which was expected in November. Later, in May 1988, Mr. Schwartz wrote Mr. Latner a letter outlining the terms of their agreement. Mr. Latner accepted the proposed terms and signed the letter. They agreed that the appellant was to receive a salary of $250,000 annually as well as the option to acquire 1.25 percent of the existing non-voting shares of Dynacare, calculated at the date of the agreement, for the price of $0.01 per share. The agreement provided that the shares would “vest in three equal amounts [on the date of commencement of the employment and on the first and second anniversary dates]”. They also agreed that every effort would be made to minimize taxes payable by both parties. Within days, the appellant notified his partners of his intention to withdraw from the partnership at the end of his assignment.
3 The contract was never carried out. In late September, Dynacare informed the appellant that his services would not be required. Later, the appellant received a letter dated October 6, 1988 from Dynacare's solicitors confirming the cancellation of the employment, recognizing Dynacare's contractual obligation towards the appellant and offering him $75,000 in exchange for a full and final release. The letter also made reference to the fact that the appellant had an obligation to mitigate his damages. The appellant refused the offer. He continued to practise law until he withdrew from the partnership on January 31, 1989, as he had agreed with his partners. He commenced employment with an investment firm the next day at an annual salary of $175,000.
4 Negotiations for settlement were conducted by the parties' lawyers during the course of which two letters, later filed at trial, were exchanged. The first, dated June 13, 1989, was from Dynacare's solicitors and was addressed to the appellant's solicitors. It dealt specifically with the value of Mr. Schwartz's stock options and concluded that Dynacare considered them to be worth $267,000 for the purposes of the settlement. Dynacare's solicitors also stated that their client was “prepared to be flexible around the range of $267,000”. The appellant's solicitors replied in a letter dated June 22, 1989, expressing disagreement with Dynacare's method of calculating the value of the stock options and stating that the appellant was owed $75,000 as lost salary. That letter contained an offer to settle the dispute for $400,000 plus costs.
5 A settlement was reached and a release was signed on August 21, 1989. Dynacare agreed to pay the appellant a lump sum of $360,000 as damages plus $40,000 on account of costs. At trial, Mr. Schwartz testified that in arriving at the amount of $360,000, losses on stock options, salary, embarrassment, anxiety and inconvenience resulting from the breach of the employment contract by Dynacare were considered, but no specific allocation among such losses was made.
6 The respondent Crown assessed the damages as constituting a “retiring allowance” taxable under s. 56(1)(a)(ii) of the Act. The appellant filed a notice of objection, but the respondent confirmed the assessment initially made. The appellant then appealed the assessment successfully to the Tax Court of Canada, [1993] 2 C.T.C. 2125, 93 D.T.C. 555, from whose decision the respondent appealed to the Federal Court of Appeal, which allowed the appeal, [1994] 2 F.C. 720, [1994] 2 C.T.C. 99, 94 D.T.C. 6249, 167 N.R. 35, 2 C.C.P.B. 109. This Court granted the appellant leave to appeal the latter decision on October 13, 1994, [1994] 3 S.C.R. xi.
II. Relevant Statutory Provisions
7 The provisions of the Act to which I will refer during the course of these reasons are the following:
3. The income of a taxpayer for a taxation year for the purposes of this Part is his income for the year determined by the following rules:
(a) determine the aggregate of amounts each of which is the taxpayer's income for the year (other than a taxable capital gain from the disposition of a property) from a source inside or outside Canada, including, without restricting the generality of the foregoing, his income for the year from each office, employment, business and property;
5. (1) Subject to this Part, a taxpayer's income for a taxation year from an office or employment is the salary, wages and other remuneration, including gratuities, received by him in the year.
6. (1) There shall be included in computing the income of a taxpayer for a taxation year as income from an office or employment such of the following amounts as are applicable:
(a) the value of board, lodging and other benefits of any kind whatever received or enjoyed by him in the year in respect of, in the course of, or by virtue of an office or employment, except any benefit . . . .
56. (1) Without restricting the generality of section 3, there shall be included in computing the income of a taxpayer for a taxation year,
(a) any amount received by the taxpayer in the year as, on account or in lieu of payment of, or in satisfaction of,
. . .
(ii) a retiring allowance, other than an amount received out of or under an employee benefit plan, a retirement compensation arrangement or a salary deferral arrangement . . . .
80.4 (1) Where a person or partnership received a loan or otherwise incurred a debt by virtue of the office or employment or intended office or employment of an individual, or by virtue of the services performed or to be performed by a corporation carrying on a personal services business (within the meaning assigned by paragraph 125(7)(d)), the individual or corporation, as the case may be, shall be deemed to have received a benefit in a taxation year equal to that amount, if any, by which the aggregate of
. . .
(b) the aggregate of all amounts each of which is an amount of interest that was paid or payable in respect of the year on such a loan or debt by
(i) a person or partnership (in this paragraph referred to as the “employer”) that employed or intended to employ the individual. . . .
248. (1) In this Act,
. . .
“employment” means the position of an individual in the service of some other person (including Her Majesty or a foreign state or sovereign) and “servant” or “employee” means a person holding such a position;
. . .
“retiring allowance” means an amount (other than a superannuation or pension benefit, an amount received as a consequence of the death of an employee or a benefit described in subparagraph 6(1)(a)(iv)) received
(a) upon or after retirement of a taxpayer from an office or employment in recognition of his long service, or
(b) in respect of a loss of an office or employment of a taxpayer, whether or not received as, on account or in lieu of payment of, damages or pursuant to an order or judgment of a competent tribunal
by the taxpayer or, after his death, by a dependant or a relation of the taxpayer or by the legal representative of the taxpayer;
III. Judgments Below
Tax Court of Canada, 93 D.T.C. 555
8 The Crown's principal contention before the Tax Court of Canada was that the settlement amount was taxable as a “retiring allowance”. In considering this contention, Rip J.T.C.C. relied heavily on the ordinary meaning of the words of the Act dealing with retiring allowances. In his view, the ordinary meaning of the words “employment”, “office”, “employee”, “officer”, “position” and “holding” ought not be altered. The definition of “retiring allowance”, he stated, does not refer to an “intended” or “prospective” employment, and one should not read into it words that are not present there. He confirmed that finding by considering English dictionary definitions of the word “position” and the French equivalent “poste” and found (at p. 560) that an officer is “one who holds, has possession of or fills a position which grants him a right to stipend or remuneration” and that an employee is one who “occupies a position in the service of another”.
9 The consideration of various factors led the trial judge to the conclusion that Mr. Schwartz was not an “employee” or in the “employment” of Dynacare when the cancellation of the employment agreement occurred. The appellant was still a partner in his law firm at the time. He was not performing any services for Dynacare, nor was he under any obligation to do so. He was not receiving any kind of remuneration and the directors of Dynacare had not yet appointed him. What the appellant lost when the contract was cancelled, Rip J.T.C.C. held, was not his employment or his position, but the legal right entitling him to employment in the future.
10 Rip J.T.C.C. rejected the respondent's submission that parliamentary documents and earlier cases supported its position by underlying the importance of the distinction to be made between termination of employment contracts occurring when employment had already commenced and those occurring before the employee had started providing any services to his employer. He therefore concluded that the damages were not a “retiring allowance” within the meaning of s. 248(1) of the Act.
11 The judge also rejected the respondent's first alternative argument that if the damages were not a retiring allowance, they had been received by the appellant as a benefit by virtue of an office or employment and therefore fell within the purview of s. 6(1)(a) of the Act. He followed the Federal Court of Appeal's decisions in The Queen v. Atkins, 76 D.T.C. 6258, and The Queen v. Pollock, 84 D.T.C. 6370, and found that the damages received by the appellant could not be regarded as “salary”, “wages” or “remuneration” or as a benefit “received or engaged [sic] by him . . . in respect of, in the course of, or by virtue of the office or employment” within the meaning of ss. 5(1) and 6(1)(a) of the Act. He added that the fact that the appellant had not commenced employment at the time the breach occurred made the reasoning even more persuasive.
12 Finally, Rip J.T.C.C. dealt with the respondent's argument that the damages were taxable under s. 3 as being “income from a source”, the source being the employment contract. He found that the amount received by the appellant could not be considered “income”, because the ordinary concept of income pertained to recurring receipts and did not extend to a lump sum received because a source of income had been taken away or destroyed. Consequently, in a case such as the one at bar, compensation for damages relating to future services was not to be considered “income”. He noted that in the present situation, the damages received by the appellant did not relate in any way to past services.
13 In the course of his reasons, Rip J.T.C.C. stated (at p. 557) that there was no evidence indicating any allocation of the settlement amount and made the following finding of fact, which was disturbed by the Federal Court of Appeal and which is at issue before our Court, at p. 562:
Schwartz suffered inconvenience and prejudice when he was informed his services would not be required. He had given notice of withdrawal to his law partnership. He had to begin to look for employment. Schwartz was never an employee or officer of the purported employer. The damages he received was [sic] in a small part, if any, for loss of income for future services and to a larger part, according to the evidence, for embarrassment, anxiety and inconvenience. [Emphasis added.]
Federal Court of Appeal (Mahoney, Stone and McDonald JJ.A.), [1994] 2 F.C. 720
14 The respondent did not argue that the damages constituted a retiring allowance before the Federal Court of Appeal. Mahoney J.A. for the court nonetheless held that he was in substantial agreement with Rip J.T.C.C.'s finding that the damages did not constitute a retiring allowance as contemplated by ss. 56(1)(a)(ii) and 248(1) of the Act.
15 The critical issue before the Federal Court of Appeal was the Tax Court of Canada's finding of fact relating to apportionment. After stating the guidelines laid down by our Court in Stein v. The Ship “Kathy K”, [1976] 2 S.C.R. 802, Mahoney J.A. concluded that the Federal Court of Appeal was justified in overturning Rip J.T.C.C.'s finding of fact because the latter had omitted to consider relevant documentary evidence. He found that the letters dated June 13, 1989 and June 22, 1989 from the parties' solicitors were contradictory to the oral evidence on the issue of allocation and he held that, on a balance of probabilities, $75,000 had been allocated for loss of salary and $267,000 for loss of the stock options, and that there was thus no reason not to conclude that $18,000 had been awarded for embarrassment, anxiety and inconvenience suffered by Mr. Schwartz. He preferred the documentary evidence over the appellant's testimony because paragraph 4 of the May 1988 agreement, which indicated concerns by both parties regarding taxes, and the self-serving nature Mr. Schwartz's testimony raised doubts as to his credibility.
16 The Federal Court of Appeal therefore held that the damages relating to lost salary and stock options ($342,000) were taxable under s. 3 of the Act as income from employment. It followed the English decision London & Thames Haven Oil Wharves, Ltd. v. Attwooll, [1967] 2 All E.R. 124 (C.A.), which was approved by the Federal Court of Appeal in The Queen v. Manley, [1985] 2 F.C. 208 (leave to appeal to this Court refused, [1986] 1 S.C.R. xi), and stated, at p. 732:
Where, pursuant to a legal right, a person receives from another compensation for the failure to receive a sum of money or benefit which, if it had been received, would have been income from an employment or office, the compensation is to be treated for income tax purposes in the same way as if the benefit or sum of money had been received instead of the compensation.
The Federal Court of Appeal held (at p. 732) that the source of the appellant's right was the contract of employment, “a source of income within the express contemplation of paragraph 3(a)”, and that the $342,000 was therefore taxable as income from employment.
IV. Analysis
17 Before this Court, the Crown argued that the damages received by the appellant were taxable in two ways. Its main contention was that the money received by Mr. Schwartz relating to lost salary and stock options was taxable as income from an unenumerated source under the general provision of s. 3(a) of the Act ‑- such unenumerated source being the employment contract terminated by Dynacare. The Crown also put forward an alternative argument, namely that the whole of the damages ($360,000) received by Mr. Schwartz were taxable under s. 56(1)(a)(ii) of the Act as a retiring allowance.
18 For the reasons that follow, I am of the opinion that the appeal should be allowed. To deal with the substance of the Minister of National Revenue's main argument, it is necessary to address the correctness of the Federal Court of Appeal's decision to overturn Rip J.T.C.C.'s finding of fact with respect to the allocation made by Dynacare and Mr. Schwartz of the compensation agreed upon. I conclude that the Federal Court of Appeal was wrong in doing so, a conclusion that is sufficient, technically, to dispose of the Crown's main argument in favour of the appellant. However, the substance of the Minister's main argument raises important questions that merit attention by this Court and it having been fully argued by the parties, I think it appropriate to deal with it on its merits. Regarding this issue, I have come to the conclusion that s. 3(a) of the Act does contemplate taxability of income arising from sources other than those specifically provided for in s. 3(a) and in Subdivision d of Division B of Part I of the Act. However, in the case at bar, an analysis of the way Parliament handled the taxability of payments such as the one received by Mr. Schwartz demonstrates that it is to the rules relating to retiring allowances that one should turn in assessing taxability. This brings us to a consideration of the Crown's alternative argument and, like the trial judge and the Federal Court of Appeal, I have come to the conclusion that the damages received by Mr. Schwartz do not constitute a retiring allowance.
19 Before dealing specifically with the issues raised in this appeal, however, I find it advisable to consider the manner in which Parliament has historically chosen to deal with the taxability of monies received by an employee from his ex-employer as a result of the latter's cancellation of the employment contract.
A. The Historical Background
20 The provisions on which the Crown relies in arguing that the amount received by Mr. Schwartz is taxable are all found in Part I of the Act, which is entitled “Income Tax”. Section 3 states the basic rules to be applied in determining a taxpayer's income for a given year and identifies, in para. (a), the five principal sources from which income can be generated: office, employment, business, property and capital gains. Subdivisions a, b and c of Division B of Part I contain specific provisions relating to the characterization of income as being from either office, employment, business, property or as constituting capital gains. Section 56(1)(a)(ii) ‑‑ which provides for the taxability of retiring allowances ‑‑ is found in Subdivision d of Division B of Part I, entitled “Other Sources of Income”. As noted by Professor V. Krishna, The Fundamentals of Canadian Income Tax (4th ed. 1992), at p. 525, these “other sources” relate to “certain types of income which cannot conveniently be identified as originating from, or relating to” the five sources enumerated in s. 3(a) of the Act.
21 Initially, damages received by an employee, from his ex-employer, as a result of the latter's cancellation of the employment contract, did not constitute income from office or employment taxable under s. 5(1); nor did they constitute a retiring allowance taxable under s. 56(1)(a)(ii).
22 On the first of these propositions, the Federal Court of Appeal, in Atkins, supra, stated that such payments did not constitute taxable income from an office or employment under s. 5(1). That was so because these amounts were not considered to be in the nature of income for tax purposes. Jackett C.J., confirming the decision rendered by Collier J. at trial (75 D.T.C. 5263), held, at pp. 6258-59:
Once it is conceded, as the appellant does, that the respondent was dismissed “without notice”, monies paid to him (pursuant to a subsequent agreement) “in lieu of notice of dismissal” cannot be regarded as “salary”, “wages” or “remuneration” or as a benefit “received or enjoyed by him . . . in respect of, in the course of, or by virtue of the office or employment”. Monies so paid (i.e., “in lieu of notice of dismissal”) are paid in respect of the “breach” of the contract of employment and are not paid as a benefit under the contract or in respect of the relationship that existed under the contract before that relationship was wrongfully terminated. The situation is not altered by the fact that such a payment is frequently referred to as so many months' “salary” in lieu of notice. Damages for breach of contract do not become “salary” because they are measured by reference to the salary that would have been payable if the relationship had not been terminated or because they are colloquially called “salary”. The situation might well be different if an employee was dismissed by a proper notice and paid “salary” for the period of the notice even if the dismissed employee was not required to perform the normal duties of his position during that period. Having regard to what I have said, it is clear, in my view, that the learned Trial Judge was correct in holding that the payment in question did not fall within section 5 of the Income Tax Act as applicable to the taxation year in question. [Emphasis added.]
The principle laid down in Atkins, which was decided by the Federal Court of Appeal in May of 1976, was therefore accepted as authoritative both by the courts and commentators (see Krivy v. Minister of National Revenue, 79 D.T.C. 121 (T.R.B.); Girouard v. The Queen, 80 D.T.C. 6205 (F.C.A.); Beck v. Minister of National Revenue, 80 D.T.C. 1747 (T.R.B.); Grozelle v. Minister of National Revenue, 77 D.T.C. 310 (T.R.B.); E. C. Harris, Canadian Income Taxation (1979), at p. 116; R. B. Goodwin, “Personal Damages”, in Canadian Tax Foundation, Report of Proceedings of the Twenty-Eighth Tax Conference (1977), 813, at pp. 820-21; also W. A. MacDonald and G. E. Cronkwright, eds., Income Taxation in Canada (1977 (loose-leaf)), vol. 2, at ¶17,521; and L. M. Collins, “The Terminated Employee: Minimizing the Tax Bite”, in Canadian Tax Foundation, Report of Proceedings of the Forty-Fifth Tax Conference (1994), 31.1, at pp. 31:18 and 31:19), although some questioned the correctness of the legal reasoning adopted by the Federal Court of Appeal at the time (see V. Krishna, “Characterization of Wrongful Dismissal Awards for Income Tax” (1977), 23 McGill L.J. 43). P. W. Hogg and J. E. Magee, in their recent textbook Principles of Canadian Income Tax Law (1995), at pp. 164-65, address this historical reality in these words:
Before 1978, if the departing employee sued the employer for wrongful dismissal and recovered damages, then the damages would be received free of tax. This was because an award of damages for breach of contract (or for a tort or other cause of action) is not income for tax purposes. This was so, even though the amount of a damages award for wrongful dismissal would be computed by reference to exactly the same considerations (that is, the amount of salary that would have been paid during a required period of notice) as would be applied to the computation of a consensual severance payment. Since court-awarded damages were free of tax, it was also held that an out-of-court settlement of a wrongful dismissal action also escaped tax.
23 The position taken by the courts towards such payments was clearly accepted by the Minister of National Revenue. In Interpretation Bulletin IT-365, dated March 21, 1977, and entitled “Damages, Settlements, and Similar Receipts”, it is stated:
Receipts in Respect of Termination of Employment
2. An amount that a taxpayer receives on the termination of his employment may consist of many components such as amounts in respect of salaries, accumulated leave credits, retiring allowances, compensation for loss of job opportunity or for lack of adequate or reasonable notice, or other similar amounts. That part of the amount that represents salary or wages that the taxpayer would have received under the contract is taxable pursuant to the provisions of section 5 of the Act. The portion of the amount that is damages for breach of contract or loss of future job opportunity is not taxable. It is a question of fact whether all or some portion of the amount received is on account of salary, retiring allowance, or an obligation arising out of an agreement. For example a taxpayer may be dismissed with proper notice and be paid “salary” (which would be taxable) for the period of notice even if the dismissed employee was not required to perform the normal duties of his position during that period. On the other hand, the fact that damages may be calculated by reference to salary that would have been payable if the relationship had not been terminated or because they are colloquially called “salary” does not alter the character of the payments to one of “salary”. [Emphasis added.]
24 It was also settled that such payments did not constitute retiring allowances as contemplated by the Act. The definition of “retiring allowance” was different th