Payroll needs to know, follow the rules
Terminating an individual’s employment can be a minefield. There is the human element involved in telling an employee and dealing with their reaction.
There are also legal requirements under employment standards law. Payroll departments play an important role in helping organizations comply. Since payroll processes severance pay, it is important they understand the rules for calculating, paying and reporting it.
Severance pay is different from termination pay (or wages in lieu of notice). Severance pay is paid when employees retire to recognize their service or for the loss of their job. Termination pay is paid to an employee who does not receive the amount of written notice required. It is usually equal to the employee’s wages for a regular workweek for the number of weeks of notice to which the employee is entitled.
One of the first things payroll needs to know is whether an employer is required to pay severance pay and, if so, what rules apply. It is a legislated requirement in Ontario and under the Canada Labour Code for federally regulated employers and employees.
The code requires employers pay severance if they terminate an employee with at least 12 consecutive months of continuous service (except for dismissals for just cause). The amount of severance pay required is two days of regular wages (i.e., excluding overtime) for each completed year of employment. The minimum amount is five days’ wages.
The Ontario Employment Standards Act requires employers pay severance to an employee who has worked for a minimum of five years if the employer has a total annual payroll of at least $2.5 million or the employer is terminating the employment of 50 or more employees in a period of no more than six months because the employer is closing all or part of the business.
The province’s Labour Ministry considers an employment relationship severed if: the employer dismisses or stops employing an employee (including because the of bankruptcy or insolvency), constructively dismisses an employee, lays off an employee for 35 or more weeks in a consecutive 52-week period or lays off an employee because the business is permanently shutting down.
It also includes situations where an employee gets written notice of termination and the employee resigns after providing two weeks’ notice if the resignation takes effect during the notice period required.
Under Ontario law, employees are entitled to severance pay of one week of wages in a regular workweek for each year of employment (including partial years) to a maximum of 26 weeks.
Employers may still pay it as part of an employment contract, collective agreement, out of a spirit of goodwill or to avoid potential lawsuits.
When informed of a termination package with severance pay being prepared, payroll professionals should find out the date the employment relationship will end and what payments are included , says Kimberley Fiume, director of compliance/client services at the consulting firm LeadingEdge Payroll Group.
"Knowing the actual date that the relationship severs (is important) because that allows you to then separate the payments between employment income versus severance," she notes.
The end of the employment relationship is not always the employee’s last day at work, especially if the employer is continuing to provide benefits for a period of time.
If benefits are not mentioned, Fiume says payroll should make sure they ask to ensure there are no benefits being provided payroll does not know about.
"It becomes crucial to understand what the payment is and that we break it down appropriately with respect to here’s employment income versus anything else that may fall into the severance/retiring allowance category."
Payroll needs to know how much notice the employee is entitiled to and how much was provided or whether a combination of notice and wages in lieu was used.
Since wages in lieu of notice are required by law, payroll has to ensure the package has a sufficient amount to cover this.
In some organizations, the human resources department will break down the amounts for payroll and explain it in writing, says Fiume. In others, payroll is given an amount that needs to be paid to the departing employee.
"It becomes the payroll professional’s responsibility to ensure if they are just given a number, to follow up and say, ‘What is this number made up of?’" she says.
This is important because there are different source deduction withholdings. The Canada Revenue Agency (CRA) considers termination pay regular employment income, subject to Canada Pension Plan contributions, Employment Insurance premiums and income tax deductions.
The CRA views severance pay as a retiring allowance — not pensionable or insurable, but taxable at the federal government’s lump sum tax rates.
Revenu Québec has a different approach. It considers wages in lieu of notice payments to be severance pay and, therefore, to be a retiring allowance rather than employment income. As a result, Québec Pension Plan contributions do not apply to wages in lieu of notice. The payments are subject to premiums for the Québec Parental Insurance Plan and provincial income tax deductions, as well as to the employer contribution to the funding of the Commission des normes du travail.
Since severance pay is a retiring allowance, employees have the option of transferring some or all of the payment to a registered pension plan (RPP) or to a registered retirement savings plan (RRSP) in which they are the annuitant if they have years of service with their employer before 1996. The portion transferred is not subject to income tax deductions.
"Sometimes, because we’re getting into the dollars and cents and the payout of those funds, HR removes themselves and says, ‘the ball’s in your court payroll. You are the ones making these payments, so you need to communicate that to the employee.’"
If an employee decides to transfer, payroll is required to calculate the amount eligible for tax-free transfer. The CRA limits the tax-free amount to $2,000 for each year or partial year before 1996 that the employee worked for the employer, plus $1,500 for each year or part year before 1989 in which none of the employer’s RPP or DPSP contributions were vested in the employee when the employer paid the retiring allowance. The $1,500 amount can be prorated according to the percentage of vesting under the plan.
To make the transfer process easier, Fiume suggests payroll professionals have departing employees use the CRA’s old TD2 form.
When it comes to paying out the elements of the termination package, payroll professionals have to make sure they comply with the employment standards requirements in the jurisdiction in which the employee works. Payroll professionals should check the applicable legislation for the specific timeframes.
For severance pay, the Code requires employers to pay it within 30 days of an employee becoming entitled to it. In Ontario, employers have to pay no later than seven days after employment ends or on what would have been the next regular pay, whichever is later.
Ontario law does allow employers to pay in installments over a period of up to three years if the employer gets the employee’s written permission to do so or the director of Employment Standards approves it.
If the employer fails to make a payment on time, the amount still owing becomes immediately due.
Reporting severance pay on a T4, RL-1 and Record of Employment (ROE) should be straightforward if payroll properly separated termination pay from severance from the beginning, Fiume notes.
Since severance pay is not regular employment income, it is not reported in box 14 on a T4. Payroll should report it in the Other Information area on the T4, using code 66 for the amount of a retiring allowance eligible for tax-free transfer and code 67 for the non-eligible amount (or codes 68 and 69, respectively, for Status Indians with tax-exempt income). For Quebec, severance pay is reported in box O of an RL-1, using code RJ.
When it comes to the ROE, Fiume says it is important for payroll professionals to remember to include severance payments in block 17C on the form.
To help payroll departments keep track, Fiume says, "I recommend they follow a termination checklist if they don’t already have one." She adds a checklist is a valuable tool for all facets of employee termination.
Note: For severance pay in Ontario, the Ministry of Labour provides a tool explaining requirements and how to calculate payments on its website www.labour.gov.on.ca/english/es/tools/severance/index.php. For more info on retiring allowances, refer to the CRA’s websitewww.cra-arc.gc.ca/tx/bsnss/tpcs/pyrll/rtrns/t4/spcl/rtrng-eng.html.
Ontario ruling creates ambiguity
A recent ruling from Ontario’s Superior Court of Justice questions a long-held understanding that only an employer’s Ontario payroll should be included when calculating whether an employer meets the legislated $2.5-million threshold for paying severance pay. The ruling could have significant implications for multi-jurisdictional employers whose Ontario operations may not be large enough to meet the threshold, but if their outside-of-province payroll is included would be required to pay severance pay.
The Ontario Employment Standards Act requires employers pay severance pay if they terminate an employee who has worked for a minimum of five years if the employer has a total annual payroll of at least $2.5 million or the employer is terminating 50 or more employees within six months because of closing all or part of the business.
In Paquette c. Quadraspec Inc., Justice Paul Kane ruled in the spring the total wages paid to all employees inside and outside Ontario should be used to determine if the employer meets the $2.5-million threshold.
Claire Vachon, a partner in the labour, employment and human rights practise for the law firm Fasken Martineau in Ottawa, says the ruling creates "some ambiguity and some risk" for employers. She notes the decision contradicts a ruling from the Superior Court three years ago. In Altman v. Steve’s Music, the court ruled only an employer’s Ontario payroll could be included in the calculation. Vachon says the judge’s decision in the most recent case is based on a more thorough analysis as Kane looked at statements the provincial labour minister made in the Ontario Legislature when the threshold was implemented in 1987 and other provincial laws.
He determined if the intent was to limit an employer’s payroll to Ontario for calculating the threshold, it would have specifically referred to it in the employment standards legislation as in the province’s Pay Equity Act.
Vachon says she is waiting to see how the Ministry of Labour will respond. "They could decide to amend the legislation to clarify their view on whether payroll only in Ontario should be considered or not. Even if there’s no amendment to the legislation, it’s going to be interesting to see what position the Employment Standards office will take in their Interpretation Manual."
Currently, the manual advises using only Ontario payroll to calculate if they meet the threshold. The ministry’s online tool for calculating severance pay refers to Ontario payroll for the calculation. Vachon says employers should decide case-by-case on the best course of action.
"If I were to advise an employer tomorrow, I would have to tell the employer there’s a risk and depending on the amount (of severance pay) involved, they may decide they will just pay the amounts that are owed as severance even if the payroll in Ontario is less than $2.5-million because if it’s just one individual termination, it might not be a lot of money," Vachon says. "If I was advising an employer who, for example, is terminating a significant number of unionized employees and their sole entitlement is the entitlement under the ESA, depending on the amount involved,
"I’m not sure I would just tell them not to try to fight this issue," she says. "It could be a significant amount of money and I’m not sure that the last word has been written on this."