By OptiVal Editorial Desk
Letting a long-tenured employee go is one of the hardest things a business owner does, and the obligations do not end with the goodbye. If you have a remote employee in Ontario with five or more years of service, you may owe severance pay on top of termination pay, and plenty of small businesses have never heard of the rule. Severance pay in Ontario has a specific two-part test. Here is how the rule works, how to calculate what you owe, and the mistakes that catch employers out.
Severance pay vs termination pay: two different obligations
The terms get used interchangeably, but the Employment Standards Act treats them as separate obligations. Termination pay is pay in lieu of the notice the Act requires: one week of regular wages per completed year of service, up to 8 weeks, for employees with at least three months of service who are dismissed without cause. Severance pay is additional compensation for the loss of seniority and job-related benefits, owed only to employees with five or more years of service whose employer meets a size test. If an employee qualifies for both, you owe both, for a combined statutory maximum of 34 weeks. The ESA is the floor, not the ceiling: common-law reasonable notice can run much higher, up to 24 months in some cases.
Who qualifies for severance pay in Ontario
Two conditions must both be met, and the employment must have been “severed” as the Act defines it. First, the employee has worked for you for five or more years, continuous or not, active or not. Second, your business meets one of two size tests: your global payroll is at least $2.5 million, or you severed 50 or more employees within six months because all or part of the business permanently closed. The payroll test is global, not Ontario-only: a small Ontario branch of a larger business can qualify. “Severed” covers dismissal, constructive dismissal followed by resignation, a layoff of 35 weeks or more in any 52-week period, and permanent closure. Exemptions include the employee refusing reasonable alternative employment, retiring on a full pension, or wilful misconduct that is not trivial and was not condoned. Ontario’s guide to the Employment Standards Act sets out the full list.
How to calculate severance pay Ontario employers owe
Multiply the employee’s regular wages for a regular work week by the number of completed years of employment, plus the completed months in any partial final year divided by 12. The maximum is 26 weeks. Regular wages means the regular pay for the regular work week (salary divided by 52, or hourly rate times regular hours), excluding overtime, vacation pay, public holiday pay and premium pay.
Example: a remote bookkeeper on a $72,000 salary earns $1,384.62 per week. With seven years and nine months of service, that is 7.75 weeks of severance, for a total of $10,730.77, on top of any termination pay owed.
When and how it has to be paid
Severance pay must be paid by the later of two dates: seven days after the employment is severed, or the employee’s next regular payday. Two practices land employers in trouble here. The first is holding the statutory minimums until the employee signs a release: termination pay and severance pay are owed whether or not anything is signed, and waiting can draw damages. In Pohl v Hudson’s Bay Company (2022), the court awarded moral and punitive damages partly because the employer paid severance as salary continuance instead of on time. The second is switching unilaterally to salary continuance: unless the employee has agreed, that is a breach of the Act. Instalments are possible, but only with the employee’s written agreement (or the Director’s approval). The plan cannot run longer than three years, and if you miss a payment, the entire balance becomes due immediately.
The tax side: the CRA treats severance as a retiring allowance
For tax purposes, the CRA generally treats severance, termination pay and wrongful dismissal settlements as a retiring allowance, which changes how you withhold. You withhold income tax from the amount paid directly to a Canadian resident using the lump-sum rates: 10% up to and including $5,000, 20% on amounts over $5,000 up to and including $15,000, and 30% above $15,000. The rate is set by the total retiring allowances paid or expected in the calendar year, and it applies to the whole payment, not progressively like tax brackets. Our $10,730.77 example would have 20% withheld, or $2,146.15. No CPP and no EI are withheld from a retiring allowance. Report it on a T4 slip (code 66 for the eligible portion, code 67 for the non-eligible portion). The withholding is only an estimate: the full amount is taxed at the recipient’s marginal rate when they file. See the CRA’s guidance on retiring allowances for the payer rules.
If the employee has unused RRSP room, they can have the payment transferred directly to their RRSP, which avoids the withholding entirely.
The remote-employee wrinkles
The same rules apply to an Ontario employee whether they work from your office or their kitchen table. What changes is geography: if your remote employee works from another province, that province’s employment standards apply, and no other province mandates statutory severance pay the way Ontario does. A remote team spread across provinces needs province-by-province payroll handling.
ESA severance is owed to employees, not genuine independent contractors. If your “contractor” looks like an employee in practice, the ESA likely applies regardless of what the agreement says.
On Employment Insurance, Service Canada normally treats severance as earnings and allocates it across the weeks after termination, delaying benefits. A temporary federal measure currently waives that allocation for claims established or allocations starting between March 30, 2025 and October 9, 2027.
The mistakes that cost employers the most
- Treating remote staff as contractors by default and skipping ESA obligations entirely. If the working relationship is really employment, the severance obligation is real.
- Waiting for a signed release before paying the statutory minimums. Pay what the Act requires on time, then negotiate anything above it.
- Converting severance to salary continuance without the employee’s explicit agreement. That is a breach, and courts have awarded damages for it.
- Assuming the payroll test is Ontario-only and never checking the global figure.
- Forgetting that the ESA sets the floor. Common-law reasonable notice is usually the bigger number, so talk to an employment lawyer before finalising a departure for a long-tenured employee.
You will also need a Record of Employment filed on time with the right reason codes.
Ending an employment relationship cleanly takes careful payroll math: the severance calculation, the retiring-allowance withholding, the T4 codes and the timing rules all have to line up. Our payroll service ($29 per employee per month plus a $149 setup) handles the calculations and filings, and our bookkeeping plans from $199 per month keep your records straight. We are led by qualified professionals with more than 75 years of combined experience, PwC-trained, who have worked at world-leading multinationals in CFO-level positions. Book a free consultation and we will make sure the departure is handled properly. See our pricing for the full rate card.
