Retroactive pay increases should be taxed in the same way as a bonus. Therefore the account should be setup in the same way as a bonus.

But, most employees and employer’s object to the high tax rate applied to the amount, so they don’t do it. But, the high tax is correct. The employee will end up paying it in the long-run anyway – either through a lower refund or a higher tax payable when they file their return.

Here’s a link to T4001, Employers’ Guide – Payroll Deductions and Remittances:

http://www.cra-arc.gc.ca/E/pub/tg/t4001/README.html

See page 23 – “Bonuses and retroactive pay increases”. Just by the title you can see that they are treated identically for tax purposes.

Bob