Retrenchment is a form of dismissal due to no fault of the employee, based on the employer’s operational requirements. During this period, the employer must follow a fair procedure as set out in the Labour Relations Act, 66 of 1995, as failure to do so may result in the retrenchment being considered unfair. Operational requirements refer to the economic, technological or structural needs of the employer.
Voluntary retrenchment typically refers to the initial period of the employer’s retrenchment process where an employee can elect to take up an offer of a severance package, which is sometimes more favourable than an involuntary retrenchment. Taking up such an offer does not change the nature of the employee’s termination of employment to a resignation, as it is the employer that initiates the process due to its business requirements. This contrasts with involuntary retrenchment where the employer decides which employees are to be retrenched. From a tax perspective, however, it is irrelevant whether a retrenchment is voluntary or involuntary , and any severance benefit or retirement fund lump sum received as a result of a retrenchment will be treated the same.
Note that the South African Revenue Service’s (SARS’) Completion Guide for IRP3(a) and IRP3(s) Forms, and the actual IRP3(a) forms still differentiate between voluntary and involuntary retrenchment. However, SARS has confirmed that severance benefits due to voluntary and involuntary retrenchment should be treated the same from a tax perspective.
An employee is legally entitled to the amounts set out in the Basic Conditions of Employment Act, 75 of 1997, their employment contract (for example, a pro rata bonus) and applicable company policies.
In terms of this Act, the following benefits must be paid to an employee who is retrenched:
if the employee is not required to work the notice period; and
the minimum amount prescribed is one week’s salary for every completed year of continuous employment.
Furthermore, the employee may also elect to take their retirement fund benefit as a lump sum (subject to tax in terms of the retirement tax table), or transfer the benefit to an approved retirement fund on a tax-neutral basis.
A “severance benefit”, as defined in the Income Tax Act, 58 of 1962, is taxed in accordance with the retirement tax table, which currently allows up to R500 000 to be received tax free (if no previous applicable lump sums were received). Before 1 March 2011, section 10(1)(x) of the Income Tax Act provided that only the first R30 000 of a severance benefit was tax free.
A severance benefit is defined as an amount received by or accrued to a person as a lump sum, in respect of the relinquishment, termination, loss, repudiation, cancellation or variation of the person’s employment if:
unless, where the person’s employer is a company, the person at any time held more than five per cent of the issued shares or members’ interest in the company.
Leave pay and bonus pay are considered as payments for services rendered and are therefore not defined as severance benefits. Similarly, notice pay flows from the employee’s contract of employment and therefore also does not fall within the definition of severance benefits. These payments are taxed in accordance with the PAYE table, i.e. at the employee’s marginal rate.
Although a severance benefit is taxed in the same way as a retirement fund lump sum, it is not a retirement fund benefit. Therefore, the employee does not have the option of transferring the benefit to a retirement annuity or preservation fund on a tax-neutral basis. Such benefit can only be paid out in cash to the individual (although the after-tax funds can be invested in a retirement annuity in order to obtain further tax benefits).
In addition to receiving a severance benefit, the retrenched employee may also decide to take a lump sum benefit from their retirement fund. This lump sum will also be taxed in accordance with the retirement tax table, where the first R500,000 is tax free, provided that the tax-free portion has not already been utilised with the severance benefit (or any other retirement fund benefits previously received).
Alternatively, the retirement fund benefit can be transferred to an approved fund on a tax-neutral basis. However, should the retrenched employee transfer their retirement fund benefit to a preservation fund and opt to take a once-off withdrawal at a later stage, the benefit will then be taxed in accordance with the withdrawal tax table (taking into account any severance benefit received, as well as previous retirement fund benefits). The once-off withdrawal from the preservation fund will not be regarded as a retrenchment benefit.
The table overleaf compares the taxes payable when a retrenched employee decides to take a retirement fund lump sum on retrenchment (Scenario 1), versus the taxes payable if the individual opts to preserve their benefit in a preservation fund and subsequently does a once-off withdrawal (Scenario 2). For the purposes of these examples, we have assumed that the employee has taken no previous withdrawals from retirement funds or retirement lump sums.
Scenario 1 |
Scenario 2 |
|
| The employee receives a severance benefit of R300 000 and takes a lump sum of R1 200 000 from their retirement fund. | The employee receives a severance benefit and transfers their retirement fund benefit to a preservation fund. The individual subsequently takes a once-off withdrawal from the preservation fund. | |
| Severance benefit | R300 000 | R300 000 |
| Tax on severance benefit* | 0% of R300 000= R0 | 0% of R300 000 = R0 |
| After-tax severance benefit | R300 000 | R300 000 |
| Retirement fund benefit | There is a lump sum of R1 200 000 at the time of retrenchment. | The employee transfers their benefit of R1 200 000 to a preservation fund and thereafter takes the full benefit as once-off withdrawal. |
|
Tax on retirement fund lump sum* Step 1: Step 2: Step 3: |
Tax on retirement fund benefit** Step 1: Step 2: Step 3: |
|
| After-tax retirement fund lump sum | R9 000 000 – R6 000 000 = R3 000 000 |
R3 000 000 – R2 000 000 = R1 000 000 |
| Tax on taxable portion of lump sum benefit applying relevant tax table* | R907 500 | R862 500 |
| Total tax payable for severance benefit and retirement fund lump sum | R292 500 | R337 500 |
*Using retirement tax table.
**Using withdrawal tax table.
Please refer to Annexure A, for the applicable retirement/retrenchment tax tables, the withdrawal tax tables, and a summary of the steps to follow to calculate taxes payable in respect of a specific benefit.
Employees may also have to consider other benefits previously provided by the employer that may be lost as a result of retrenchment. In addition to their salary and future retirement fund contributions, retrenched employees also stand to lose the following benefits:
Most employee benefit providers offer employees the option to transfer their risk benefits and their medical aid to a private policy when their employment is terminated. Advisors should pay careful attention and obtain a full list of all the benefits the employee received while employed.
Advising an employee facing retrenchment can be complicated. It requires careful analysis of all the options available in respect of benefits payable, the tax implications of such options as well as consideration of the other benefits the employee may stand to lose.
Retirement fund withdrawal benefit
| Taxable income (R) | Tax |
|---|---|
| 0 – 25 000 | 0% of taxable income |
| 25 001 – 660 000 | 18% of taxable income above R25 000 |
| 660 001 – 990 000 | R114 300 + 27% of taxable income above R660 000 |
| 990 001+ | R203 400 + 36% of taxable income above R990 000 |
To calculate the tax in respect of a withdrawal lump sum:
Step 1 |
Add current lump sum to all previous lump sums* and apply current withdrawal tax tables. |
Step 2 |
Add all previous lump sums* and apply current withdrawal tax tables. |
Step 3 |
Answer in step 1 minus answer in step 2 = tax payable on current withdrawal lump sum. |
*Only retirement lump sums received or accrued on or after 1 October 2007, withdrawals received or accrued on or after 1 March 2009 and severance benefits received or accrued on or after 1 March 2011 must be taken into account.
Retirement lump sum or severance benefit
| Taxable income (R) | Tax |
|---|---|
| 0 – 500 000 | 0% of taxable income |
| 500 001 – 700 000 | 18% of taxable income above R500 000 |
| 700 001 – 1 050 000 | R36 000 + 27% of taxable income above R700 000 |
| 1 050 001+ | R130 500 + 36% of taxable income above R1 050 000 |
To calculate the tax in respect of a retirement lump sum:
Step 1 |
Add current lump sum to all previous lump sums* and apply current retirement tax tables. |
Step 2 |
Add all previous lump sums* and apply current retirement tax tables. |
Step 3 |
Answer in step 1 minus answer in step 2 = tax payable on current retirement lump sum. |
*Only retirement lump sums received or accrued on or after 1 October 2007, withdrawals received or accrued on or after 1 March 2009 and severance benefits received or accrued on or after 1 March 2011 must be taken into account.