In simple terms, and dealing with employees only, a “severance benefit” is defined in the Income Tax Act as a payment of a lump sum by an employer (i.e. not paid by a retirement fund or from the proceeds of an insurance policy) to an employee in respect of the relinquishment, termination, loss, or variation of the employee’s employment under circumstances where:
- The employer is 55 years of age or older
- The employee cannot continue working due to sickness, accident, injury or incapacity through infirmity of mind or body
- The employer discontinues the trade in which the employee was employed or makes the employee redundant by reducing staff.
Severance benefits are also described as ‘Voluntary Severance Packages’.
Severance benefits are taxed using the same tax table as used for retirement fund lump sums.
Table: Retirement Fund Lump Sum Table (including Severance Benefits):
|Taxable Income||Percentages and Brackets|
|0 – 500 000||R 0 + 0% of each R1|
|500 001 – 700 000||R 0 + 18% of the amount above R500 000|
|700 001 – 1 050 000||R 36 000 + 27% of the amount above R 700 000|
|1 050 001 and above||R 130 500 + 36% of the amount above R 1050 000|
This table must be applied on a cumulative basis by taking into account severance benefits and any retirement fund lump sums paid previously. Payrolls cannot apply this table because the payroll does not have a record of these prior lump amounts paid to the employee.
Only SARS have the records to be able to apply this table correctly and employers must apply for a tax directive from SARS to be able to withhold the correct employees’ tax amount.
Directive Rules – IRP3 (a)
SARS have confirmed the following directive application procedures for the taxation of a payment by an employer of a severance benefit.
Prior to September 2017, when an employer selected “Severance Benefit – Voluntary Retrenchment” on the IT3 (a) directive application, the normal income tax table was incorrectly used to determine the employees’ tax to be withheld from severance benefit lump sums. This was corrected by the final income tax calculation on assessment where the severance benefit tax table is used for severance benefits reported as code 3901 on the tax certificate.
From September 2017, the Tax Directive system was amended and the severance benefit tax table is now used to determine the employees’ tax amount stated on the tax directive if the reason “Severance Benefit – Voluntary Retrenchment” is selected.
If the employer used the reason “Other” and in the description field entered ‘Voluntary retrenchment’ instead of using the correct box (historically we saw people doing this because they were worried that under the old practice they would not get the R500,000 exemption), these directives must be cancelled and resubmitted with the reason “Severance Benefit – Voluntary Retrenchment” to ensure that the assessment calculation is correct.
The following ‘Reason’ options can be selected on the IRP3 (a) directive application form:
1. Severance benefit – Death
2. Severance benefit – Retirement (age of 55 or older)
3. Severance benefit – Retirement due to ill health
4. Severance benefit – Involuntary retrenchment
5. Severance benefit – Voluntary retrenchment
The following codes must be used to report the severance benefit amount and its related employees’ tax amount on tax certificates:
- Code 3901 (Gratuities / Severance Benefits (PAYE))
- Code 4115 (Tax on retirement lump sums and severance benefits).
If the employer has incorrectly used code 3907 for the severance benefit the amount will be treated as normal income and taxed using the income tax table on assessment without the R500 000 exemption allowed by the severance benefit tax table.
The employees’ tax withheld in accordance with the directive must be reported on the tax certificate as code 4115 and not as normal PAYE (code 4102).