How The Income Tax Act Treats Settlements And Damage Awards For Wrongful Dismissals

• Published date: 15 July 2025
• Subject Matter: Employment and HR, Tax, Unfair/ Wrongful Dismissal, Income Tax, Capital Gains Tax
• Law Firm: Rotfleisch & Samulovitch P.C.
• Author: Mr David Rotfleisch

General Principle - Income Must Come From a Source

The general principle under the Income Tax Act (the "Tax Act") is that for an amount to be considered income, it must belong to a source in section 3. These sources are: office, employment, business, and property. Amounts that are received that cannot be characterized under any of these sources may not be taxable. For example, windfalls from gambling or a damage award received for personal injury have been found not to be taxable income.

When someone is wrongfully terminated from their employment, he or she may be entitled to payment for an order from a Court, tribunal or through a settlement. These amounts may not fit squarely in the definition of the sources of income. A question that arises is whether an award received for compensating wrongful dismissal is taxable income.

Are Damages for Wrongful Dismissal Fully Included in Income?

Subparagraph 56(1)(a)(ii) of the Tax Act provides for the taxation of wrongful dismissal types of payments. In general, section 56 provides for the addition of amounts in a taxpayer's income that would not otherwise be captured by the sources in section 3. Specifically, subparagraph 56(1)(a)(ii) will operate to include a retiring allowance as income, other than an amount received out of or under an employee benefit plan, a retirement compensation arrangement or a salary deferral arrangement.

A "retiring allowance" is defined as an amount received in respect...