Can a payment before retirement be a retiring allowance?

Our company’s information line has received a string of similar inquiries from advisors in the same locality recently. The issue is the tax treatment of certain employment related payments.

A large employer in the area intends to make a current payment in lieu of what might otherwise be due upon retirement, with retirement itself still being a brief but undefined number of years away.

The rationale for the employer appears to be a desire to crystalize the liability and take it off the books. The question is whether under the Income Tax Act such a payment might constitute a “retiring allowance,” with its associated tax consequences.

Desirable tax treatment

The benefit of characterizing the payment as a retiring allowance is the recipient may direct a portion of the payment to her RRSP without having to reduce RRSP contribution room. The eligible amount for this purpose is:

  1. $2,000 for each year or part year of employment prior to 1996, plus
  2. $1,500 for each year or part year of employment prior to 1989 for which there were no vested or past-paid pension or deferred profit sharing plan benefits.

Payment on or after retirement

A retiring allowance is generally an amount that is received:

  1. on or after retirement of a taxpayer from an office or employment in recognition of the taxpayer’s long service, or
  2. in respect of a loss of 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.

Where the amount qualifies under the first arm of the rule, the payment must be “on or after retirement,” and may in fact be significantly later than the actual retirement date. In one case, the Canada Revenue Agency argued it could be as much as eight years later.

Payment prior to retirement

Keeping with that first arm of the qualification rule, CRA has acknowledged payment of unused sick leave could qualify as a retiring allowance. In one technical letter, however, the Agency opined that payment five months ahead was too far in advance to be contemporaneous with retirement.

Yet, the second arm of the rule does not stipulate when a payment must occur. In keeping with this, CRA’s administrative approach is to allow the possibility of a payment before retirement. To qualify, the termination should be certain to occur on a specific date, and the time frame must be reasonable.

Under either arm, it would appear to be a challenge to treat the payment as a retiring allowance. That remains for the client’s accountant or lawyer to advise on, based on a closer examination of the nature of the payment and surrounding circumstances.

Doug Carroll, JD, LLM (Tax), CFP, TEP is vice-president, tax and estate planning, Invesco Canada.