Be aware of correct tax treatment of severance benefits

The South African Revenue Service (Sars) relooked its policy on the tax treatment of voluntary severance packages, and whether they qualify as “severance benefits”. The conclusion was that they did. However, the form which is used to apply for a directive on the amount of tax that will be deducted on receiving severance benefits makes a distinction between voluntary and involuntary retrenchment.

The effect is that voluntary retrenchment benefits will be taxed like normal salary income.

The South African Institute of Tax Professionals (Sait) has made a submission to Sars stating that the concept of voluntary retrenchment – as opposed to forced retrenchment – exists in employment law. The courts have held that voluntary retrenchment agreements are valid and enforceable contracts.

Erika de Villiers, head of tax policy at the Sait, says in the latest guide – relating to the tax directive forms – Sars makes a distinction between voluntary retrenchment and involuntary retrenchment.

“The new classification appears to reflect an interpretation that in the case of a voluntary severance package, the employee does not qualify for the more favourable tax treatment applicable to a severance benefit,” she explains.

In terms of the tax tables for severance benefits, the first R500 000 is tax free and the remaining amounts are taxed at a sliding rate with 36% being the top rate.

Nikki Kennedy, owner of NK Accounting Services, says the voluntary retrenchment option is processed by Sars in the same way as normal taxable income and therefore at the normal tax tables applicable to individuals.

In terms of these tables, people who earned R700 000 or more will be taxed at 41% and those who received severance benefits of R1.5 million and more will be taxed at 45%.

The income source code that will reflect on the employee’s IRP5 certificate will not reflect that the amount received was a severance benefit and would merely be included in normal taxable income.

Kennedy says these changes to the form may lead to an employer being doubtful as to what particular option to choose from the list of severance benefits provided on the form.

She says on the new form Sars distinguishes between death, retirement (55 years and older), retirement due to ill health, involuntary retrenchment and voluntary retrenchment.

De Villiers says in their submission that the Income Tax Act does not differentiate between voluntary and forced retrenchment packages.

The definition of a “severance benefit” deals with amounts paid on retrenchment of an employee, and does not refer to the terms “voluntary” or “involuntary”.

She says Sait is of the view that the Sars Completion Guide for the forms should be updated in order not to differentiate between “voluntary” and “involuntary” retrenchment.

Sars said in its response to Sait that the operational tax directive guides and forms take some time to update, but they are in the process of being updated to reflect the change in policy.

“In the interim, Sars accepts that voluntary retrenchment packages should be disclosed under the involuntary retrenchment field on the tax directive application in order [in order to ensure] that they are treated correctly.”

Kennedy notes that it is common practice to negotiate a bit more in the case of favourable voluntary retrenchment in instances where the employer needs to reduce number of employees due to the closure of the business or for economic or restructuring reasons.

It does, however, still fall within the definition of severance benefits and fits the requirements to enable application of the separate tax tables for severance benefits.

She says since the change to the form her practice had to assist a few people with their tax affairs following retrenchment.

“We were able to identify that the ‘voluntary retrenchment’ option on the form would not provide the appropriate tax treatment of the severance lump sum payments to the affected employees,” she explains.

“We therefore opted for the ‘involuntary retrenchment’ option on the form, after having to cancel the previous applications that lead to incorrect tax treatment of the severance packages.”

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