The retrenchment procedure and tax implications of retrenchment packages:
With the third wave having just occurred, 2021 may very well be another gloomy year for some employees facing the harsh “barrel-reality” of possible retrenchments as businesses continue to feel the effect of the pandemic.
Section 189 of the Labour Relations Act (“LRA”) permits employers to dismiss employees for operational requirements based on the employer’s economic and structural needs. However, retrenchments must be both procedurally and substantively fair. Section 189(1) of the LRA asserts that, before retrenching, employers must consult with relevant stakeholders, including trade unions and workplace forums, relating to any collective agreement in force. In the absence of collective agreements, meetings should be held with all affected employees potentially to be retrenched. In such proceedings, the principle most relied on is ‘last in first out’, but is not the only consideration.
A notice to affected parties will serve as an invitation for parties to consult. The prime objectives being to either entirely avert the dismissals, change the timing of dismissal, review the selection criteria of employees facing dismissal or severance pay. On occurrence of the inevitable, section 189(3) of the LRA requires the employer to disclose in writing to employees or their trade unions all relevant information including but not limited to reasons for retrenchment, number of employees potentially affected, proposed selection criteria, possibility of future re-employment, etc. The employer must allow the affected employee the opportunity to make representations in relation to the proposed retrenchment, orally or in writing.
On concluding consultations, the employer must issue notices to employees selected for retrenchment. Section 41 of the Basic Conditions of Employment Act provides that an employer must pay retrenched employees a severance pay (at least 1 week’s pay of each completed year of ongoing service or any amount specified in any contract or policy, if such amount is greater in value), any outstanding leave and notice pay (either in terms of the BCEA or as per employment contract). No severance pay will be paid should the employee refuse alternative employment.
Additionally, a retrenched employee may be entitled to a pro rata payment of their annual bonus and balance of any pension or provident fund benefits. This is contingent on their employment contract. In the absence of a contract, one is entitled to notice pay as follows:
- If employed for 6months or less: 1 weeks’ notice pay.
- If employed for 6 months – 1 year: 2 weeks’ notice pay.
- If employed for more than a year: 4 weeks’ notice pay.
Tax issues for retrenchment benefits
Special tax rates are applicable to the severance benefit:
|Benefit||Rate of tax|
|R0 – R500 000||0% of benefit|
|R500 001 – R700 000||18% of benefit over R500k|
|R700 001 – R1 050 000||R36,000 + 27% of benefit over R700k|
|R1 050 001 and above||R130,500 + 36% of benefit over R1,050k|
If an employee has previously received other retirement fund or severance lump sum benefits these will be combined when determining the relevant tax bracket for the employee’s current severance package pay out. The timeline of these lump sum benefits is exceedingly vital as they impact on the tax table above.
The qualifying criteria for the special tax rates applicable to severance benefits due to retrenchment, is that an employer must have paid a lump sum as a result of employment being terminated or lost. Furthermore, employees also qualify for tax incentives if:
- they are 55 years at the time of retrenchment; or
- their retrenchment or loss of employment is attributed to a perpetual incapability of holding an office or employment due to sickness, accident or injury; or
- the employment has been terminated or lost because the employer stopped (or intending to stop) trading, or as a result of the employer embarking on a general reduction in personnel.
An employee will be disqualified from these tax incentives if at any time (s)he held more than 5% of issued shares in the company paying the severance benefit. Other exclusions from severance benefits include leave pay and pro-rata bonuses paid upon termination of employment as they are subject to tax at normal rates applicable to individuals.
Lastly, an employer will need to submit an application to SARS for a tax directive prior to paying out a lump sum amount so that SARS can calculate the withholding tax on the severance benefit. The employee will be required to declare the gross amount of the benefit in their income tax returns as reflected on IRP5 tax certificate.
Article prepared by: Tinashe Chipatiso (Tax and Corporate Consultant)
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