Severance Pay After Leaving Canada: Tax on Final Pay and Bonus

How is severance taxed after you leave Canada?

Severance paid after you become a non-resident is usually a retiring allowance. The employer withholds 25% non-resident tax (Part XIII tax, a flat tax the payer takes off and sends to the CRA), unless a tax treaty with your new country lowers the rate, and reports it on an NR4 slip, the slip for amounts paid to non-residents (Income Tax Act s. 212(1)(j.1); CRA: retiring allowances). That withholding is generally your final Canadian tax on it. Part XIII does not reach the part that relates to service in years when you were never resident in Canada and not employed here, such as years with the same employer abroad before you moved to Canada; ask the employer to leave that part out (s. 212(1)(j.1)(i)).

Your last paycheque, bonus, vacation pay and pay in lieu of notice are different: they are employment income. A non-resident is taxed on employment income for duties performed in Canada, and for duties performed anywhere while still resident (s. 115(1)(a)(i)). That pay goes on a T4 and a Canadian return.

A case stops being simple when the settlement is large or lumps several payments together, when you have service before 1996, when stock awards are involved, or when your new country also taxes the payment. Gather:

• your termination letter and any settlement agreement, with the breakdown of each amount
• your departure date and proof of when you stopped being resident
• your service start date, and whether you belonged to the employer's pension plan
• your years of service before 1996 and 1989, and whether your pension or deferred profit sharing plan (DPSP) contributions had vested
• every payslip and slip for the final payments

Is severance taxed differently from my last paycheque?

Yes. Severance is a retiring allowance; your last paycheque is employment income, and Canada taxes the two through different systems once you are a non-resident.

The Income Tax Act defines a retiring allowance as an amount received on retirement in recognition of long service, or for the loss of an office or employment, even if paid as damages or under a court order. Wages earned for work you did are not part of it. The CRA lists salary, wages, bonuses, overtime, salary continuance, unused vacation pay and wages in lieu of termination notice as items that are not retiring allowances.

The label in your termination letter does not decide the tax. What the payment is for does.

Are pay in lieu of notice, vacation pay and a wrongful-dismissal settlement severance?

Pay in lieu of notice and vacation pay are not severance for tax purposes: they are employment income. Wrongful-dismissal damages generally are a retiring allowance.

The CRA treats a settlement this way:

• Split settlement: the part stated as wages in lieu of notice is employment income; the damages part is generally a retiring allowance.
• Lump sum with no breakdown: the full amount is generally a retiring allowance.
• Human-rights damages: amounts awarded under human rights legislation are not a retiring allowance, to the extent they are not taxable.

Because the split changes which slip you get and how much is withheld, read the settlement wording before you sign. Whether a particular payment is wages or damages can depend on the facts; the CRA uses the word "generally", not "always". Legal fees you paid to establish your right to the retiring allowance can be deducted only on a Canadian return, such as a section 217 return, up to the retiring allowance received less any part transferred to an RRSP or RPP, with unused fees carried forward up to seven years (s. 60(o.1)); fees to collect unpaid wages are a separate employment-expense claim (5013-G).

How much does Canada withhold on severance paid after I've left?

A retiring allowance paid to a non-resident is withheld at 25% under Part XIII, unless a tax treaty between Canada and your new country reduces the rate (CRA; s. 212(1)(j.1)).

Treaties differ, so check the one with your new country before assuming a lower rate. Give the employer your non-resident address before the payment and, if a treaty lowers the rate, a completed Form NR301, the treaty-eligibility declaration payers rely on.

Can I move severance into an RRSP to avoid the withholding?

Partly. The eligible part, based on service before 1996, can go straight to your RRSP or registered pension plan with no withholding. For a non-resident, the law exempts only that eligible part; the rest is withheld even if you have RRSP room (s. 212(1)(j.1)).

The amounts come from paragraph 60(j.1) and the CRA's transfer page. The eligible part cannot go to a spouse's or common-law partner's RRSP.

As a non-resident, the transfer must be direct from the employer to the plan, and you must complete Form NRTA1, Authorization for Non-Resident Tax Exemption, before it happens (T4058; 5013-G). Once the employer pays you the cash, the withholding is already taken.

Two traps:

• Severance does not create RRSP room, and once you are a non-resident, RRSP room does not shelter the non-eligible part from withholding.
• An RRSP you later withdraw from abroad faces its own non-resident withholding. See RRSP and pension income as a non-resident.

Can I get some of the severance withholding back?

Possibly. If the employer withheld more than the correct rate, for example by ignoring a treaty rate, you can ask the CRA for the excess back on Form NR7-R, generally within two years after the end of the year the tax was sent to the CRA (T4058).

Separately, a retiring allowance is one of the payments a non-resident can report on a Canadian return under a section 217 election, which may lower the tax if your other income is low. The return is due by June 30 after the tax year. How the election works and when it helps is covered in the section 217 guide.

My last pay, bonus or vacation pay arrived after I left: does Canada tax it?

Yes. Wages, a bonus and vacation pay for your Canadian work stay taxable in Canada however late they arrive, and pay in lieu of notice counts as pay for the work you did while employed (s. 6(3)), so it is employment income too. The employer issues a T4, and you report it on line 10100 of a Canadian return (T4058).

That pay is taxed at regular federal rates plus the rate of the province where you earned it, not at the flat non-resident rate; if you owe Quebec tax, you also file a Revenu Québec return. Income tax the employer deducted counts against the bill. If the payment arrives in the year after you left, you may need a non-resident return for that year: see the non-resident return guide. Your new country may tax the same pay too; any relief depends on its rules and the treaty.

Does the payment date change the tax?

Yes, for severance. What matters is whether you were a Canadian resident on the day it was paid, and your departure date depends on when you cut your residential ties, not just your flight date. Because resident severance is taxed at graduated rates with your other income and non-resident severance at a flat rate, the total can differ a lot; if the payment date is still open, compare both before you agree to it.

For wages, the date matters less: pay for duties performed while you were resident or working in Canada remains Canadian employment income. Your departure date and its proof are covered in the leaving Canada guide.

Which slip will I get: T4, T4A or NR4?

Employment income goes on a T4. Severance is not reported on a T4A. A retiring allowance paid to a resident also goes on a T4, with code 66 for the eligible part and code 67 for the non-eligible part. A retiring allowance paid to a non-resident goes on an NR4, with income code 36 (CRA: NR4 slip).

A trap: an employer that still has you on file as a resident may withhold at resident rates and put post-departure severance on a T4. The employer then owes the CRA the Part XIII tax it should have withheld and can recover it from you (s. 215(6)), so tell payroll before the payment and ask for the correct slip. For a slip that looks wrong, see Canadian slips after leaving Canada.

What should I ask the employer before the final payment?

Ask before the money is paid: the settlement wording and an RRSP transfer are hard to change afterwards.

1. Give your departure date and new address so the payroll records show you as a non-resident, and, if a treaty lowers the rate, a completed Form NR301.
2. Ask for a written breakdown: wages, vacation pay, pay in lieu of notice, bonus and retiring allowance, each separately.
3. Ask how many years of service before 1996, and before 1989, the employer counts for the eligible part.
4. If you want an RRSP transfer, ask for a direct transfer and complete Form NRTA1 before the payment date.
5. Ask which slips you will get and the address they will go to.

Example

These scenarios are illustrative, in Canadian dollars.

Laid off, then moved abroad

A Toronto employee is laid off in February and moves to Dubai in March. Severance of C$60,000 is paid in April, after departure. It is a retiring allowance: the employer withholds 25%, C$15,000, unless a treaty rate applies, and issues an NR4. Unused vacation pay of C$4,000 paid the same day is employment income: it goes on a T4 and a Canadian return.

Long service before 1996

An employee who started in 1990 receives C$50,000 of severance after leaving. Her eligible part covers 1990 to 1995, six years at C$2,000, so C$12,000. Using Form NRTA1, the employer transfers that C$12,000 directly to her RRSP with no withholding. The remaining C$38,000 is withheld at 25%, C$9,500, unless a treaty rate applies; her unused RRSP room does not change that for a non-resident.

Wrongful-dismissal settlement

A former employee settles a wrongful-dismissal claim for C$90,000, paid after departure. With no breakdown, the full C$90,000 is generally a retiring allowance on an NR4. If the settlement states C$30,000 as pay in lieu of notice, that C$30,000 is employment income on a T4, and the remaining C$60,000 is generally a retiring allowance.

Different for you?

• A large settlement, a split payment, service before 1996, a payment date still being negotiated, or your new country also taxes the payment: the wording and transfer choices are hard to undo after payment; get individual tax help before you sign.
• The severance was already paid at resident rates or on a T4: the slip, the withholding and possibly two years' returns need fixing; get individual tax help.
• You moved to the US, or your pay includes RSUs and a workday split: see stock awards and pay after a move; when two countries tax the same pay, get individual tax help.
• You hold stock options or RSUs and moved elsewhere: see departure tax on stock options and RSUs; when two countries tax the same pay, get individual tax help.
• You want some of the withholding back: see the section 217 return and refunds as a non-resident.
• You are still filing the departure-year return: see leaving Canada.
• The employer offers a commuted value from its pension plan: see workplace pensions when you move abroad.
• You keep working for the Canadian employer from abroad: see working for a Canadian employer from abroad.
• You missed Canadian returns for earlier years: see non-resident returns and catch-up and get individual tax help.