Moore Stephens Tax Alert
Redundancies and Employee Termination Payments:
What you need to know to make the process run smoothly
Author: Varun Kumar, Manager - Tax and Business Services
Redundancies are, unfortunately, a part of doing business. Over the last year or so, there has been a lot of movement within the Western Australian job market with employments being terminated or being made redundant. As an employer, it is critical that you understand what your responsibilities are. To help you, we have undertaken various reviews of calculations for Employee Termination Payments (ETP) and genuine redundancies.
It is very important to calculate withholding tax correctly, especially to note the difference between a genuine redundancy and employee termination payment as the taxation of both differ significantly. If the withholding is incorrect, ex-employees may be subject to additional tax on lodgement of their tax returns. As an employer, you need to be aware that you may be liable for penalties if you fail to meet your PAYG withholding obligations on termination.
What are redundancies and what is the tax benefit of receiving a redundancy payout?
In a nutshell, redundancies occur when you make a position
within your organisation redundant i.e. terminate a person’s employment and not replacing the employee or rehiring that person in a similar capacity. Although from an employer’s point of view, there is little difference between paying out a redundancy or an ETP, there is a massive difference from an employee’s perspective. Genuine redundancies receive concessional tax treatment and the employee may be entitled to receive part of the payout tax free depending on the number of years of service. Any payment made in addition to this tax free component is thereon taxed as an ETP (whilst not tax free, still receives concessional treatment up to a certain cap).
What are the basic requirements for a redundancy?
As per TR 2009/2, there are four basic requirements:
- The payment being tested must be received in consequence of an employee's termination.
- That termination must involve the employee being dismissed from employment.
- That dismissal must be caused by the redundancy of the employee's position.
- The redundancy payment must be made genuinely because of a redundancy.
In addition to this, there are a few additional requirements that need to be met:
How much can an employee receive tax free as a result of a genuine redundancy?
- the dismissed employee is not older than 65 years old at the time of dismissal;
- the termination is not at the end of a fixed period of employment;
- the actual amount paid is not greater than the amount that could reasonably be expected had the parties been dealing at arm's length, in the event that the employer and employee are in fact not dealing at arm's length in relation to the dismissal;
- there is no arrangement entered into between the employer and the employee or the employer and another entity to employ the dismissed employee after the termination; and
- the payment is not in lieu of superannuation benefits.
To work out the tax-free amount of a Genuine Redundancy Payment use the following formula:
Base amount + (service amount × years of service)
Below is a table setting out the Base Rates and Service Limits for 2016-17:
||For each complete year of service
Any payment in excess of the tax-free limit is taxed as an ETP.
How are ETPs taxed?
A few years ago, the ATO introduced caps which apply to calculate the concessional treatment for tax purposes of ETPs.
Depending on the age of the employee and whether they are above the relevant caps, the tax rates are 17%, 32% and 49%. Therefore, it is very important as an employer that you apply the correct caps and withholding correctly.
Depending on the type of termination, two separate caps could apply:
What type of payments can fall within the concessional treatment for redundancy payments and ETPs?
- ETP cap – $195,000 (indexed annually) – this cap generally applies to genuine redundancies above the tax free limit, harassment, personal injury or permanent disability. Payments up to the ETP cap are taxed at 17% or 32% depending on age. Payments above the ETP cap are taxed at 49%.
- Whole of income cap – This cap applies to normal ETPs such a voluntary resignations etc. The cap is $180,000 less all taxable payments made to the employee during the year. For example, if you have paid $150,000 in salary and wages during the year, the whole of income cap is $30,000 ($180,000 - $150,000). Therefore only $30,000 receives concessional tax treatment at 17% or 32% depending on the person’s age. Any payment in excess of the whole of income cap is taxed at 49%.
Example of genuine redundancy payment include:
· payment in lieu of notice
· severance payment of a number of weeks' pay for each year of service
· a gratuity or 'golden handshake' – lump sum payment for professional financial advice may fall within this category.
The following payments are not included
in a genuine redundancy payment:
How much am I required to pay my employee as a result of termination or genuine redundancy?
- salary, wages or allowances owing to you for work done or leave already taken for work completed
- lump sum payments of unused annual leave or unused long service leave paid on termination of employment under a formal arrangement
- Payments made in lieu of superannuation benefits
It is important to be aware of your contractual obligations with your employee and the relevant awards or agreements in place which may cover your industry. If your employee is not covered by any industrial awards and there is no contractual obligation in the employee’s contract, you should check with Fair Works Australia. The National Employment Standards (NES) are the minimum requirements for an employer and there are requirements under NES on what an employer is required to pay on termination.
Does this affect my year end reporting for PAYG summaries?
Yes, it does. Redundancies are shown in different labels on the year end PAYG summary. If the payment is an ETP, separate ETP Payment Summaries are required.
No one likes to make employees redundant. It is a stressful time for employers, affected employees and the rest of your workforce. Ensuring that you are correctly calculating payments and tax can help to make this time less stressful for all.
If you have any queries or would like more information on this, please contact our Tax and Business Advisory Division on 9225 5355.
Varun Kumar is a Manager in the Tax and Business services division of Moore Stephens WA. He has extensive experience in indirect taxes and manages the WALGA tax service for local governments across Western Australia.