Retrenchment 101

Due to the economic impact of the COVID-19 pandemic, many South Africans are facing retrenchment and must make some difficult decisions. With that in mind, we have compiled this guide to assist in explaining the different options available in respect of severance benefits and retirement fund benefits on retrenchment, as well as their tax implications.

What is retrenchment?
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.

Are voluntary and involuntary retrenchments subject to different benefits and tax treatments?
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.

What types of benefits may the retrenched employee receive?
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:

Accrued leave
Notice payif the employee is not required to work the notice period; and
A severance benefitthe 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.

Severance benefits
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:

such person has attained the age of 55 years; or
such relinquishment, termination, loss, repudiation, cancellation or variation is due to the person becoming permanently incapable of holding the person’s office or employment due to sickness, accident, injury or incapacity through infirmity of mind or body; or
such termination or loss is due tothe person’s employer having ceased to carry on or intending to cease carrying on the trade in respect of which the person was employed or appointed; or
the person having become redundant in consequence of a general reduction in personnel or a reduction in personnel of a particular class by the person’s employer,
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).

Find the full article: https://ninetyone.com/en/south-africa/how-we-think/insights/retrenchment-101 

July 06 2020 By Janine Langenhoven and Salome Young - Ninety One Personal Investing