The clawback here applies to all employees, disgorging incentive payments made under inaccurate financial results with a two year look-back. Interestingly, the policy, adopted in 2010, includes instances of omission such as any failure to report or take action to stop misconduct of another employee that an employee knew, or ought to have known, about:
“New clawback provision for all employees
The board adopted a new clawback provision that allows it to recoup incentive compensation if an incidence of misconduct led to an overpayment of incentive compensation. This new provision is consistent with emerging competitive practice and regulatory principles.
Clawbacks
Our CEO and CFO are required by law to reimburse their incentive compensation if there is an incidence of misconduct and we need to restate our financial statements. In 2010 the board approved a new clawback policy, allowing it to demand that former or current employees pay back any or all of the incentive the compensation they received or realized in the previous 24 months if: employee was involved in misconduct (such as fraud, dishonesty, negligence or non-compliance with legal requirements or Sun Life Financial’s policies, any other act or omission that would justify termination of
employment for cause, and any failure to report or take action to stop misconduct of another employee that an employee knew, or ought to have known, about), and the
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misconduct directly or indirectly resulted in the employee receiving or realizing a higher amount of incentive or deferred compensation.”16
CANADIAN TAXATION
From the Canadian tax perspective, a clawback occurring in the same taxation year as the receipt of the compensation should pose no difficulty. The employer and employee can adjust the compensation and the related source deductions, prior to making the required tax filings in respect of the year. The difficulty arises when the clawback occurs in a subsequent year.
Limitations of Section 8 of the Income Tax Act
The difficulty stems from subsection 8(2) of the Income Tax Act, (Canada) (the “Act”) which reads as follows:
Except as permitted by this section, no deductions shall be made in computing a taxpayer’s income for a taxation year from an office or employment.
The balance of section 8 of the Act provides for a number of express deductions in computing income from employment, including deductions for:
• the reimbursement of amounts included in income for periods during which no services were rendered (8(1) (n)).
• amounts previously included in income but forfeited under a salary deferral arrangement; (8(1) (o)) and
• expenses incurred by employees engaged in the selling of property or negotiating of contracts, which deduction may provide relief in respect of a clawback in limited circumstances. (8(1) (f)). (See CRA Document 2004-0103391E5, where a commission salesperson was unable to make full
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use of the provision where amounts had to be repaid to his former employer.)
None of the deductions set out in section 8 expressly covers the scenario where a reimbursement or forfeiture of a bonus is required.
Accordingly, relief would have to be sought elsewhere.
Filing an Amended Tax Return
The taxpayer subject to a clawback could simply file an amended return for the year in which the bonus was received. However, there is no general, statutory right to file an amended return as established in Armstrong v. The Queen, 2006 DTC 6310 (FCA).
While the Act contains specific provisions that permit or mandate the filing of an amended return in specific circumstances, (See, for example, paragraph 164(6) (e), regarding the carry back of losses to a deceased’s terminal year.) No provision expressly permits an employee to do so in the case of a clawback.
Accordingly, relief would depend on the discretion of the Canada Revenue Agency (“CRA”) to assess on the basis of the amended return.
The Law of Mistake
A taxpayer may argue that the prior income inclusion ought to be reversed on the basis of a mistake of fact which rendered the agreement to pay the bonus void. A clawback would not seem to meet the Canadian definition of a mistake:
“If the parties base their contract on a fundamental error about the assumptions
supporting their agreement, and neither party agrees to bear the risk of the assumption turning out be false, the contact can be held void on the basis of the doctrine of
common-law mistake.”17
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Even if the clawback could meet the test of a mistake under Canadian law, which seems very unlikely, the taxpayer would have to navigate the procedural and jurisdictional hurdles.
In Fradette v. The Queen, [20] the taxpayer mistakenly received approximately $26,000 from a provincial pension commission over a period of years, which was included in the taxpayer’s income and subject to provincial and federal income tax. When the payer discovered the error years later, it required the taxpayer to repay the sums paid in error, which the taxpayer did.
While Revenue Quebec agreed to reimburse the taxpayer for the provincial tax paid on the repaid amount, the CRA did not so agree, and issued a nil assessment for the year of the final repayment. The taxpayer’s appeal to the Court was met with the Crown’s motion to dismiss on the basis that no appeal lies from a nil assessment. The Crown’s motion was successful. However, Mr. Justice Tardif made the following comments:
This is a very special case which causes one to have great sympathy for the appellant, who must bear unaided the consequences of a mistake in which he had no part.
Unfortunately, I have no jurisdiction to correct this injustice except that I would like to think that Parliament had such a situation in mind when it adopted the [Financial
Administration Act].
Remission
Remission orders are extraordinary measures that provide for complete or partial relief from taxes, interest or penalties. Remission orders are granted by the Governor General in Council, under the authority of subsection 23(2) of the Financial Administration Act:
The Governor in Council may, on the recommendation of the appropriate Minister, remit any tax or penalty, including any
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interest paid or payable thereon, where the Governor in Council considers that the collection of the tax or the
enforcement of the penalty is unreasonable or unjust or that it is otherwise in the public interest to remit the tax or
penalty.
A remission order must be sponsored internally by the CRA and the procedure is time-consuming. The CRA will generally require evidence of extreme hardship or incorrect action or advice from the CRA that led to additional tax. There is no public record of a remission order ever been provided in the case of a clawback.
Unjust Enrichment
Unjust enrichment is another remedy that might be considered. This equitable remedy requires an enrichment of one party, a corresponding deprivation of another, and the absence of any juristic reason for the enrichment. The remedy has been raised by taxpayers in a number of cases, with mixed results.
One difficulty in raising the remedy is that it will often conflict with the legislation on which the particular assessment is based. In the British Columbia Ferry Corp. v.
M.N.R., [2000] FCJ 227 F.C.T.D. in which the plaintiff sought a determination of whether it had overpaid taxes on fuel oil, the Court concluded that the Excise Tax Act constituted a complete code and excluded any equitable remedy that might otherwise have been available.
Another difficulty with the remedy in the case of a clawback is that there may arguably be a juristic reason for the enrichment and deprivation, namely the operation of the Act as it applies to the receipt of employment income in a particular taxation year.
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Rectification
Rectification is another equitable remedy that has been used by taxpayers in a number of tax cases. In H.F. Clarke Ltd. v. Thermidaire Corp. Ltd., [1937] 2 OR 57, at 64-65 (C.A.) the doctrine of rectification was described as follows:
In order for a party to succeed on a plea of rectification, he must satisfy the Court that the parties, all of them, were in complete agreement as to the terms of their contract but wrote them down incorrectly. It is not a question of the Court being asked to speculate about the parties’ intention, but rather to make an inquiry to determine whether the written agreement properly records the intention of the parties as clearly revealed in their prior agreement.
As rectification requires an error in the recording of an agreement, it would appear this would be of little use in the case of a clawback.
DESIGN
Based on the above, there does not appear to be a clear and certain way in which the negative tax impact of a clawback may be reversed. The following are some methods by which a clawback could be structured to take advantage of existing tax rules.