Retrenchment and tax: all you need to know

Published on 18th July, 2022 at 03:19 pm

If you were one of the many people who were retrenched during the global pandemic, as employers reduced their full staff complement to stay afloat, there would’ve been a tax implication for your severance pay, annual leave payout and, if it applied to you, the savings in your employee retirement fund. So, when you file your tax this year, consider the following to ensure you don’t make any mistakes that could cost you in the long run.

Under the Basic Conditions of Employment Act (BCEA), workers should receive at least one week’s worth of remuneration for every full year they worked for a single employer. So, if you worked for a company for many years, it could likely have resulted in a good lump sum of severance pay.

However, if you were retrenched during the pandemic, it’s likely that this will affect your tax return for the year spanning March 2021 and February 2022. So, how does a tax return work if you’ve been retrenched? What do you need to include to make sure it’s accurate? And, importantly, what tax are you liable for?

Severance will be taxed like a retirement fund

Your severance pay is taxed in the same way that a retirement fund is taxed. “In other words, you get the first R500 000 taxed at 0%,” says Nicki Blignaut, senior financial planner and principal at 2one2 Bluestar Financial Advisory Services, authorised by Sanlam.

Tax applies to anything over R500 000 in the following way:

Source: TaxTim, correct as at 24 June 2022

It’s important to remember that everyone has a lifetime tax relief of R500 000. So, whether you hit this threshold through severance pay or through retirement funds, you need to bear in mind that anything over this R500 000 is taxable.

TaxTim highlights this as an example: if you received a severance lump sum of R300 000 two years ago, it would’ve been tax-free, as it fell below the R500 000 threshold. However, if you then received another R350 000 from your retirement fund, only R200 000 would be tax-free, and the balance of R150 000 would be taxed at 18%.

Use this free income tax calculator to work out the tax deductions you will pay for the current tax year.

Special tax rates

According to Nicci Courtney-Clarke, COO and Head of Tax at TaxTim, an online tax tool that makes eFiling a breeze, special tax rates apply to severance benefits due to retrenchment if your employer paid you a lump sum as a result of your employment having been, among other things, terminated or lost.

Courtney-Clarke says you can qualify for the tax incentive if the following applies:

• You have reached the age of 55 years when you were retrenched; or
• Your retrenchment or loss of employment is because you have become permanently incapable of holding an office or employment due to, for example, sickness, accident or injury; or
• Your employment has been terminated or lost due to your employer having stopped (or intending to stop) trading, or because your employer embarked on a general reduction in employees.

Clarke adds: “You will not qualify for the tax concession in respect of severance benefits if you at any time held more than 5% of the issued shares or member’s interest in the company paying you the severance benefit.”

Your annual leave payout

If you have any leave due to you and you choose to have that paid out instead, tax would be applied here, too. However, any leave pay and bonuses will not form part of your severance package and normal income tax rates (just like on your salary) will apply.

“Leave is taxed and often at a higher rate than your normal income. Because you are paid to take leave, if you take the money instead of the leave you will be taxed on it,” explains Blignaut.

What about the paperwork?

Your employer needs to apply to SARS for a tax directive on your severance benefit. This can be done on eFiling.

“SARS will then take any previous lump sums into account to calculate the tax that must be paid to SARS. Your employer should issue you an IRP5, which reflects the severance benefit on it with source code 3901, and the employee’s tax deducted should be reflected with source code 4115,” explains Clarke.

Get advice and preserve

You may be tempted to spend your retirement or severance on a holiday or to pay for other big expenses like home extensions, but think about your future, too. You can, after all, make a tax-free transfer into a preservation fund.

The paperwork and rules for retrenchment can be overwhelming, so if you still feel confused, consult an expert. “Speak to a financial planner or tax specialist before you sign anything. Make sure you understand how much you will end up with so that you can plan properly for the future,” says Blignaut.

As a Reality Health, Plus, Core or Club member, you can file your tax return for free using TaxTim, and online tax tool valued at up to R629 that files your tax return on your behalf, making it a breeze.