A guide to severance and termination pay in Canada

Letting an employee go is one of the toughest parts of running a business. It’s heavy. It’s complicated. And in Canada, it’s wrapped in layers of legal rules that can feel like a minefield. Getting it wrong doesn’t just feel bad; it can lead to costly legal disputes that pull you away from what you do best: building your dream. But what if you could handle terminations with confidence and clarity? What if you could transform this complex process into a clear, manageable path that protects your business and treats people fairly?

This guide is your resource for navigating the challenging landscape of termination and severance pay. We’re cutting through the jargon to give you the straight facts. We’ll cover the legal definitions, employee entitlements calculation methods and best practices to help you manage compliance and protect your business. Think of this as your partner in employment, ready to lend a hand.

What is in this guide?

This guide is designed to be your go-to resource for understanding the complexities of ending an employment relationship in Canada. It’s for the bold employers who are creating jobs and building our future. We know you need direct answers, not dense legal texts.

We will walk you through the crucial differences between termination pay and severance pay, explain when each is required and show you how they are calculated. More importantly, we’ll show you how to proactively manage these obligations, turning potential risks into structured, manageable processes. Let’s get you back to focusing on growth.

Termination pay vs. severance pay: Understanding the key difference

First things first: termination pay and severance pay are not the same thing. Many people use the terms interchangeably, but in the eyes of Canadian employment law, they are distinct concepts with different triggers and purposes. Getting this right is the foundation of a compliant and fair termination process.

Termination pay is compensation provided to an employee instead of the required notice period. When you terminate an employee without cause, you must either give them working notice of their last day or pay them what they would have earned during that notice period. This is a fundamental requirement under employment standards legislation across all provinces and territories.

Severance pay is different. It’s “money your employer pays you when you lose your job through no fault of your own (Canada Revenue Agency).” Think of it as compensation for loyalty and the challenges they will face in finding a similar role. Crucially, severance pay is only required in specific jurisdictions like Ontario and under the federal Canada Labour Code. An employee might be entitled to termination pay, severance pay, both or neither.

When is termination pay mandatory?

Termination pay is a widespread requirement. It applies when you terminate an employee “without cause” and choose not to provide them with the minimum amount of advance working notice. This is governed by the Employment Standards Act (ESA) in your province or territory or the Canada Labour Code for federally regulated industries.

“Without cause” simply means the termination is not due to serious misconduct. It could be for business reasons, like restructuring or because the employee is not the right fit for the role. In these common scenarios, you must provide notice or pay in lieu. This rule applies to most employees regardless of your company’s size or payroll.

Understanding severance pay requirements

Severance pay is a more specific obligation. Unlike termination pay, it doesn’t apply to every employee or in every province. It’s an additional layer of compensation reserved for long-tenured employees under specific conditions, primarily in Ontario and for federally regulated businesses. It’s designed to acknowledge a deeper loss than just the job itself.

Severance pay in Ontario

Ontario has a clear two-part test for determining whether an employer owes severance pay under its Employment Standards Act. Both conditions must be met:

1. The employer must have a global payroll of at least $2.5 million.
2. The employee must have worked for the company for at least five years.

If your business meets the payroll threshold and you terminate a five-year employee, severance is on the table. This is in addition to any termination pay they are owed.

Severance pay for federally regulated employers

For businesses under federal jurisdiction, like banks, airlines and telecommunications companies, the rules are different. The Canada Labour Code mandates severance pay for terminated employees who have completed at least 12 consecutive months of continuous employment. The employer’s payroll size does not matter. This makes severance a much more common reality for federally regulated employers.

Calculating termination and severance pay

Now for the math. Calculating these amounts requires understanding the difference between the statutory minimums and a much larger potential obligation known as common law.

How to calculate statutory termination and severance pay

The ESAs and the Canada Labour Code provide clear formulas for minimum payments. For termination pay, the rule of thumb is generally one week of pay for each year of service up to a statutory maximum, which is often around eight weeks.

Severance pay calculations are also formula-based. In Ontario, for example, it’s one week of regular wages for every year of completed service plus a prorated amount for partial years up to a maximum of 26 weeks. It’s a straightforward calculation based on the employee’s history with your company. Using robust payroll software can help ensure these calculations are accurate.

What is common law reasonable notice?

This is where things get much more complex and potentially more costly. Statutory minimums are just the floor. Canadian courts have established a principle called “common law reasonable notice.” This is a notice period (or pay in lieu) that a court would consider fair based on the employee’s specific circumstances.

Courts look at several factors often called the Bardal factors:

• The employee’s age
• Their length of service
• The character of their employment (e.g. a senior specialized role vs. an entry-level one)
• The availability of similar employment

Common law notice periods are almost always significantly longer than the statutory minimums, often measured in months, not weeks. An employee could be entitled to 12, 18 or even 24 months of notice or pay. This is the single biggest area of financial risk in termination, and the reason why proactive management is so critical. For complex situations, HR advisory services can provide essential guidance.

How enforceable employment contracts can limit severance costs

Here’s the game-changer: a professionally drafted employment contract. A well-written termination clause can legally limit an employee’s entitlements to the minimums set out in the ESA. This prevents them from suing for the much larger common law reasonable notice amounts.

But there’s a catch. Courts scrutinize these clauses intensely. If the wording is ambiguous or fails to meet the minimum legal standards in any way, a judge will throw it out. When that happens, the employee’s entitlement defaults back to the full common law reasonable notice. This isn’t a DIY task. Getting this clause right is one of the most powerful things you can do to protect your business.

Common employer questions about severance and termination pay

Let’s tackle some of the most frequent questions we hear from employers.

Do I owe severance if an employee is terminated ‘for cause’?

Generally no. If you terminate an employee for “just cause”—which means serious misconduct like theft, fraud or gross insubordination—you are typically not required to provide notice, termination pay or severance pay. However, the legal standard for proving just cause is extremely high. Poor performance or minor mistakes are rarely enough. You need to prove the misconduct was so severe that it fundamentally broke the employment relationship.

What is a constructive dismissal?

A constructive dismissal happens when you don’t fire an employee outright, but you make a significant negative change to their job without their consent. This could be a demotion, a major pay cut or a dramatic change in duties. The law sees this as a termination. The employee can resign and claim they were wrongfully dismissed, triggering your obligation to pay termination and potentially severance pay.

What happens if an employee files a claim with the Ministry of Labour?

If an employee believes they weren’t paid their statutory entitlements, they can file a claim with the Ministry of Labour in their province. The ministry will investigate to ensure you meet the ESA’s minimum requirements. It’s important to know this process only deals with statutory minimums, not common law claims. For a common law claim, an employee must file a civil lawsuit.

What are my payment options for severance?

You generally have two options: a lump-sum payment or salary continuance. A lump sum is a single payment of the full amount. Salary continuance means you keep the employee on your payroll for the duration of the notice period, paying them as usual. Each has its pros and cons regarding cash flow and benefits continuation. A managed payroll service can help process these payments correctly.

How is severance taxed in Canada?

Both termination and severance pay are considered taxable income. A lump-sum payment is taxed in the year it is received. With salary, continuance deductions are made just like a regular paycheque. Employees may have the option to roll a portion of a lump-sum payment into an RRSP to defer taxes. Navigating this is a key part of calculating payroll deductions in Canada.

Do I owe severance to an employee on long-term disability (LTD)?

This is a very high-risk area. Terminating an employee while they are on LTD can lead to severance obligations and human rights complaints for disability discrimination. The employment relationship is not automatically severed because an employee is on a protected leave. Always seek legal counsel before taking any action in this situation.

Protecting your business from costly severance disputes

You’ve built your business with passion and determination. The last thing you need is a legal battle that drains your resources and energy. Here are actionable strategies to shield your business.

Use clear, enforceable employment contracts

We’ve said it before, but it’s worth repeating. This is your number one line of defence. A termination clause drafted by an employment law expert is an investment that can save you tens or even hundreds of thousands of dollars down the road.

Document everything meticulously

From the moment you hire someone, create a paper trail. Document performance reviews, disciplinary actions and any conversations about workplace conduct. If you eventually have to terminate an employee, this documentation will provide crucial evidence to support your decision. Effective HR software can be a lifesaver here, creating a central, organized record.

Obtain a signed release

When offering a severance package that is more than the statutory minimums, it is standard practice to require the employee to sign a Full and Final Release. This legal document is a promise from the employee not to sue for any further money. In exchange for the enhanced package, they release the company from all future claims related to their employment and termination.

The final word on severance and termination pay

Navigating terminations is a journey every employer must take, but you don’t have to go it alone. It’s about more than just following rules; it’s about leading with confidence and building a resilient business. By understanding your obligations and implementing proactive strategies, you can handle even the most difficult employment decisions with clarity and integrity.

Take the guesswork out of severance and termination pay. Let Employment Hero help you stay compliant every time.