For years, payroll administrators, tax consultants, accountants and human resource consultants have battled to get their heads around the tax treatment of tax directives pertaining to ‘voluntary’ retrenchments. There was a generally prevailing opinion that a ‘voluntary’ retrenchment did not qualify for the favourable tax treatment given to ‘involuntary’ retrenchments. The logic of this was that the employee had chosen to leave employment and that the termination was akin to a ‘mutual termination’. In reality though the concepts are far removed from each other from a tax treatment perspective. This article will focus on the concept of ‘retrenchment’ as a means of reducing the number of employees due to the closing of the business or for economic or restructuring reasons.
In a recent development the South African Institute of Tax Professionals (SAIT) 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 SAIT, says that in the latest guide relating to tax directive forms SARS clearly makes a distinction between voluntary retrenchment and involuntary retrenchment. This 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.
In terms of the tax tables for severance benefits, the first R 500 000 is tax free and the remaining amounts are taxed at a sliding rate, with 36% being the top rate. It is interesting to note that the voluntary retrenchment option is processed by SARS in the same way as normal taxable income, with the normal tax tables applicable to individuals being used. In such cases the IRP 5 source code used to report such income would be 3601 (normal taxable income).
The SAIT submission states that the Income Tax Act does not differentiate between voluntary and involuntary retrenchment packages. The definition of ‘severance benefit’ deals with amounts paid on retrenchment for an employee, and does not refer to the terms ‘voluntary’ or ‘involuntary’. Erika de Villiers says that 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 has been receptive to these comments and have stated that they will be amending their guides and forms in due course to reflect the change in policy. De Villiers says that in the interim SARS accepts that the voluntary retrenchment packages should be disclosed under the ‘involuntary’ retrenchment field on the application form, to ensure that the payment is treated correctly.
It is also important to note that should an employer negotiate a more favourable voluntary retrenchment package payable due to the operational reduction of staff, this payment will still fall within the definition of ‘severance benefits’ and qualify for the favourable severance benefit tables.
This certainly creates a complication for employers who have followed the policy currently in practice at SARS. Tax directives may need to be cancelled and new applications made. There is unfortunately only a small window of opportunity to do this before the 2018 tax year closes.