TAX ON VOLUNTARY SEVERANCE PACKAGES

By Patricia Williams,Karen Fulton Wednesday, January 17, 2018
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SARS has issued a Completion Guide for IRP3(a) and IRP3(s) Forms [an application for an income tax directive] in terms of which it introduces a new classification between a “Severance benefit – Voluntary retrenchment” and a “Severance benefit – Involuntary retrenchment” which must be used by an employer when indicating the reason for submitting a Tax Directive Application.

This new classification appears to reflect an interpretation by SARS that in the case of a voluntary severance package, the employee does not qualify for the more favourable tax treatment applicable to a “severance benefit” as set out in the definition of that term in the Income Tax Act. 

The Income Tax Act itself does not differentiate between voluntary and forced retrenchment packages.  The definition of a “severance benefit” in the Income Tax Act deals with amounts paid on retrenchment of an employee, and does not refer to terms “voluntary” or “involuntary”.  “Voluntary” retrenchment is in any event somewhat of a misnomer occurring as it does in the context of the employer wanting to terminate the services of employees due to an operational requirement.

Employees are unlikely to volunteer to be retrenched if they do not receive favourable tax treatment on their severance pay. On the other hand there are tax risks if the employer interprets the provisions of the Income Tax Act differently to SARS. The quandary for employers is how to ensure that “volunteers” receive the favourable tax treatment.

Various options are open to employers including applying to the High Court for a declaratory order, applying for a tax ruling or engaging SARS through the quarterly stakeholders meeting. Moreover, employers ought to also ensure that their communications during the consultation process and any subsequent agreements concluded with employees are in line with the requirements of the Income Tax Act.

Please contact Karen Fulton or Patricia Williams or any member of our Employment and Benefits Practice or Tax Practice for further information or advice.