7.4 Compensation upon Termination of Employment

7.4.1 Accrued Vacation Pay

Calculating vacationable earnings for the purpose of paying out accrued vacation pay varies slightly between provinces and territories. However, the general approach involves calculating vacationable earnings based on the employee’s regular wages or salary (or according to the employment contract if the agreement exceeds the legislative requirements). The following is a general method used to calculate vacationable earnings:

1. Determine the period for which you are calculating vacationable earnings.
2. Exclude earnings that are not considered vacationable, such as overtime pay, bonuses, or commissions.
3. Include the employee’s regular wages or salary for the earnings period.
4. Include additional payments that are considered vacationable earnings. This might include certain allowances or shift differentials. Check with the provincial or territorial employment standards to determine which additional payments should be included.
5. Determine and apply the applicable vacation pay rate based on the provincial or territorial employment standards.
6. Calculate the accrued vacation pay by multiplying the total vacationable earnings by the applicable vacation pay rate to determine the accrued vacation pay owed to the employee.

7.4.2 Pay in Lieu of Notice

Pay in lieu of notice refers to the compensation provided by an employer to an employee when the employment relationship is terminated without cause and the employer chooses to end the employment immediately without providing the employee the required notice period (see the table “Individual Employee Termination Notice by Province and Territory” in section 7.3 Termination of Employment). When an employer provides pay in lieu of notice, it means that the employer pays the employee a lump sum equivalent to the wages they would have earned during the notice period instead of providing advance notice of termination. The amount of pay in lieu of notice is based on the employee’s length of service or employment contract. The applicable provincial or territorial employment standards legislation sets out the minimum notice periods in lieu of notice when terminating without cause.

7.4.3 Severance Pay

Severance pay is a form of compensation provided to employees when their employment is terminated, usually due to reasons beyond their control such as layoffs, company downsizing, or company restructuring. Severance pay is meant to provide financial assistance to employees and recognize their years of service.

Entitlement to severance pay varies depending on the employment standards legislation in the respective province or territory, length of service, and the terms of the employment contract. The employment contract may stipulate more than the employment standards legislation, but not less. Severance pay is not typically paid to employees who were terminated with just cause, and employees in a union may have severance pay provisions outlined in their collective agreement.

7.4.4 Retiring Allowance

Under the Income Tax Act, a retiring allowance is a payment made to an employee in recognition of long service or as compensation for the loss of employment. Although the term suggests the employee is retiring, an individual does not need to retire to receive a retiring allowance.

A retiring allowance is separate from legislated severance pay.

• Severance pay is a legal requirement under certain laws, such as the Canada Labour Code (for federally regulated employers) and the Ontario Employment Standards Act. It must be paid in addition to termination pay or wages in lieu of notice when eligibility criteria are met.

• Retiring allowances, by contrast, are discretionary or common-law payments made by employers to recognize long service or compensate for job loss above and beyond the minimum statutory entitlements.

According to the Government of Canada (2024), retiring allowances include:

• Payments for unused, uninsured sick-leave credits on termination.

• Amounts received upon loss of employment, including payments in settlement of wrongful dismissal or similar damages claims.

A retiring allowance may be paid in one lump sum or over multiple years, and it may be transferred directly to a registered retirement savings plan (RRSP) or registered pension plan (RPP). If transferred, the allowable amount cannot exceed the eligible portion of the retiring allowance minus any portion transferred in a prior year.

Certain severance payments may also qualify as a retiring allowance for tax purposes if the employee’s original hire date was before 1996, allowing for additional RRSP contribution room.

For tax and payroll purposes:

• Income tax must be deducted from any portion paid directly to the employee. Employers may use lump-sum withholding rates or apply regular annual tax rates if the employee requests.

• CPP, QPP, EI, and QPIP contributions are not deducted from retiring allowances because the employee is no longer in pensionable or insurable employment.

• In the Northwest Territories and Nunavut, the 2% payroll tax applies to all employment income, including retiring allowances.

7.4.5 Other Payments

There are potentially other payments due to an employee when employment is terminated. If an employee has incurred any work-related expenses not reimbursed, they may be entitled to be reimbursed for those expenses. If the employee participated in a pension or retirement plan, there may be obligations to continue making contributions or provide a payout. Lastly, if the employee holds stock options or equity in the company, there may be provisions regarding the option or equity upon termination, which may include cashing out the options.

Specific entitlements and payments upon termination of employment can vary depending on the province or territory of employment, the employment contract, or the collective agreement. Employers and employees are responsible for ensuring compliance with the specific requirements accordingly.

References

Canada Revenue Agency. (2024). Retiring allowances

Government of Canada. (2024). Transfer a retiring allowance. https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/payroll/completing-filing-information-returns/t4-information-employers/special-situations/transfer-a-retiring-allowance.html

Government of Canada. (2024). Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.)

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