South Africa is experiencing its biggest unemployment crisis in decades and retrenchments are bound to continue this year.
The tax dispensation on ‘severance benefits’ is purposefully lenient to assist those affected – but tax experts warn that employers who use the beneficial tax treatment of a retrenchment lump sum as a carrot to get rid of unwanted employees who receive a golden handshake, resign or are dismissed are committing tax fraud.
The tax treatment of a severance benefit is based on the retirement lump sum tax table, where the first R500 000 of the retrenchment lump sum is tax-free.
The maximum amount of tax payable is 36% compared to the top marginal personal income tax rate of 45% in the case of a resignation or termination.
A submission relating to the unfairness of the beneficial tax treatment in the case of a ‘voluntary retrenchment’ lump sum payment was met with surprise during a National Treasury workshop at the end of last year.
The submission was raised during discussions on technical tax proposals for possible inclusion in Annexure C of the 2022 Budget Review in February.
The technical matters relate to current tax legislation that require correction.
A participant in the workshop remarked that the difference between voluntary and involuntary retrenchment is the difference between jumping from a sinking ship, or being pushed.
“Nobody wakes up one morning and tells [their] employer [they] want to be retrenched,” he said.
Aneria Bouwer, senior consultant at Bowmans, says the test from a tax perspective (to qualify for the beneficial severance tax rates) is whether a person’s position has become redundant. There is no mention in the tax or labour laws of voluntary or involuntary retrenchment.
The retrenchment process in terms of the labour law is quite a formalistic process.
In the first phase the employer may consult with individuals who are selected for potential retrenchment on ways to mitigate the adverse effects of the retrenchment. The consultation may include a ‘sweetener’ in the form of a bigger lump sum if the employee elects to leave voluntarily.
In terms of the process the employer has to apply for a directive from the South African Revenue Service (Sars) to indicate that the lump sum payment on termination is a severance benefit.
The Sars application form differentiates between voluntary or involuntary retrenchment, and that is where the confusion may come in, says Bouwer.
Beatrie Gouws, head of strategic development and stakeholder management at the South African Institute of Taxation, says about five years ago some Sars officials started to adopt the approach that the first-phase retrenchments were voluntary, and therefore did not qualify for the severance benefit tax treatment.
For a while the workers who left voluntarily were taxed on the normal income tax rates for individuals as opposed to the beneficial tax rates received by workers who were involuntarily retrenched.
There was a huge outcry and Sars changed its view that all workers who were affected by a general reduction in personnel should receive the same tax treatment on their severance payments. It was not dependent on the phase of the retrenchment process.
Bouwer says the potential for abuse is wider in the case of voluntary terminations as the process is not as formalistic as with compulsory (involuntary) retrenchment.
Often when a termination is negotiated with an employee there is a temptation to treat it as a retrenchment because it is seen as a “win-win situation”.
The employee sees the lower tax cost and the employer sidesteps the formalistic termination of employment process.
Bouwer says employers must be able to show that the voluntary retrenchment payment qualifies as a severance benefit by reason of redundancy.
Where an employer and employee conclude a “mutual termination agreement” preceded by complaints regarding the employee’s performance or conduct it will not be considered a redundancy.
Gouws reminds employers and employees that leave pay and pro-rata bonuses do not form part of a severance benefit tax calculation. They are subject to tax at normal rates applicable to individuals.
Bouwer says the promise of the tax-free lump sum often appears to be a “quick fix” when a person stands to be retrenched, but:
“It is important to realise that when you have used the [tax-free] benefit, it is no longer available at a later stage – including in retirement.”
Employees who are retrenched for a second time must therefore consider what their first lump sum payment was. Only if it was less than R500 000 will it be taken into account in the severance pay tax calculation.