Retrenchment and taxes - creating best packages

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Understanding tax implications of retrenchment payments

To qualify for the special tax rates applicable to severance benefits due to retrenchment, an employer must have paid a lump sum to an employee because of their employment having been terminated or lost for the reasons listed below:

• Employment ended due to the employer having ceased trading or
  
• Employment ended due to a reduction in staff numbers

Employees over the age of 55 or who have lost their jobs due to the incapability to perform their work (such as sickness or disability) will also qualify for the severance benefits.

The second point of importance is that the first R500,000 of a severance package is not subject to tax, as a once in a lifetime benefit (meaning once this has been utilised, any subsequent lump sums will be taxable). Any amounts above the R500,000 will be taxed at special tax rates applicable to severance benefits.

Thirdly, it is very important to know that any pro-rata bonuses and leave pay paid at the time of retrenchment will not be considered to be part of the severance benefit and will be subject to normal tax rates.

Utilising special tax rates

To qualify for the special lump sum tax table, the employer needs to submit a tax directive to SARS. SARS will calculate the applicable tax rate, based on the tax directive, and the employer will pay out the nett amount to the employee. The employee needs to declare the severance pay on his/her income tax return.

An important point for retrenched employees to remember is that a severance benefit cannot be conserved in the employer’s retirement fund or in a preservation fund. If the employee wants to invest the retrenchment package, he or she can invest the after-tax amount in a retirement annuity fund.

Should the employee decide to transfer their retrenchment package to a retirement or preservation fund, it will cease to qualify as a severance benefit. Should they wish to access these funds before the age of 55, they will forfeit the tax-free benefit and will be taxed at the normal tax rates.

To ensure that retrenched employees get the best possible tax benefits on their retrenchment packages, employers are strongly advised to not only consult with HR and IR specialists when determining retrenchment packages but to also consult with a tax specialist.