A common question we receive from clients concerns the tax treatment of different types of payments made upon an employee’s termination. Specifically, why is severance pay treated differently for tax purposes compared to the 13th cheque, leave payout and notice pay? Here is some clarity on the issue, based on a recent inquiry from one of our clients.
When an employee is retrenched, severance pay is considered compensation for the loss of employment. As such, SARS provides an exemption up to R550,000 on severance pay to support employees during this challenging time. The employer is required to apply for a tax directive for the severance payment and this tax directive information is processed through the payroll.
In contrast, payments like a 13th cheque, leave pay and notice pay are seen as remuneration for work done by the employee. These are taxed at the normal rates applicable to individuals under PAYE, as they are not considered part of the severance benefit.
Why this distinction matters
SARS is vigilant in ensuring that employers do not incorrectly include payments like leave pay, notice pay and pro-rata bonuses as part of severance pay. Doing so can lead to queries and require justification from the employer. This distinction is critical because it impacts how the payments are taxed and, consequently, the financial well-being of the employee post-termination.
For those looking for more detailed information, we recommend reading the SA Payroll Association’s How to Avoid Tax Issues When Leaving a Company which delves deeper into the nuances of this topic. In addition, you can visit the SARS website for more insights on the tax treatment of severance pay and other termination payments here.
It is essential to understand the different tax treatments for various payments made during employment termination to ensure compliance and to avoid unnecessary complications. If you have any further questions or need assistance, please do not hesitate to reach out to one of our team.