Treatment of Pay In Lieu of Notice (Termination Pay) for SR&ED
We are often asked by our clients about other costs that can be included under SR&ED. In this article, we will examine an unfortunate expenditure that is increasing in frequency – termination pay (pay in lieu of notice).
What are Salaries & Wages?
When requesting the salary/wages of an employee, the CRA is looking for:
Income from an office or employment. (…) generally includes any expenditure made in respect of a benefit that would be taxable to the employee under section 6 of the Act (see section 3.0) as well as vacation pay, statutory holiday pay, sick leave pay, pay in lieu of termination notice, bonuses (see section 4.0), tips and gratuities, honorariums, director’s fees, management fees and commissions. These amounts must be paid to or incurred for the employees in the year (see section 2.2).” 1
To clarify, when the CRA asks for the salary or wages that you have paid to an employee, they are asking for the salaries or wages that you’ve paid to an employee for that is “incurred on or in respect of SR&ED” and directly attributable to their SR&ED eligible work. 2
Pay In Lieu Of Termination Notice (Termination Pay)
“Pay in Lieu of Notice” (PILON) is a payment made to an employee when their employment contract is terminated, typically without any requirement for the employer to provide the employee with a certain period of notice. This can be paid as a lump sum or a series of payments.
In some contracts, employees are entitled to pay in lieu of notice if they are dismissed by their employer without giving them the specified notice period. The payment is usually calculated based on the employee’s contractual salary and is intended to compensate for the loss of income during the notice period that would have been earned had the employee remained employed.
Here are some key aspects of PILON:
- Contractual requirement: Pay in Lieu of Notice is typically specified in an employment contract, and its terms may vary depending on the agreement between the employer and the employee.
- Calculation: The payment is usually calculated based on the employee’s contractual salary for the notice period.
- Tax implications: PILON payments are subject to income tax and other source deductions.
- Payment structure: Employers can choose often choose between a lump sum or a series of payments, which may be weekly or monthly.
PILON is often used in employment contracts as an alternative to providing notice periods, allowing employers more flexibility in managing staff changes while still fulfilling their contractual obligations.
Here are some scenarios where PILON might be applied:
- Redundancy: When an employee’s role is made redundant, and they receive a payment in lieu of notice.
- Dismissal without notice: When an employer terminates an employee’s contract without giving the required notice period, and instead offers a PILON payment.
It’s worth noting that some contracts may specify different terms for PILON payments, such as a fixed amount or a percentage of the employee’s salary.
PILON and SR&ED
The logic is such that if an employee was working 80% on SR&ED, they likely would have continued to work on SR&ED activities if employment had continued. Therefore, termination pay (in lieu of) can and should be identified and included in SR&ED Salary & Wages calculations.
Is Termination Pay the Same As Retiring Allowances?
No. Although termination pay is also mentioned in 5.4 Retiring Allowances, there are some key differences:
A retiring allowance is included in the income of the recipient. However, a retiring allowance is not considered to be salary or wages by definition. As a result, a retiring allowance cannot be allowed as salary or wages under either the traditional method or the proxy method.A claimant may be able to treat a retiring allowance (which may include a payment described as termination or severance pay) as overhead and other expenditures on line 360 of Form T661 under the traditional method. For more information on retiring allowances as SR&ED overhead and other expenditures, please refer to the SR&ED Overhead and Other Expenditures Policy.”3
Conclusion
Termination is unfortunate for all parties. With recent economic changes, it’s important for firms to recapture costs where possible, including pay in lieu of for employees that otherwise would have been performing SR&ED-related activities. Please speak with your SR&ED consultant or tax professional if you have questions about these costs.
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