Determining the Pay-As-You-Go Withholding (PAYGW) obligations for employers paying termination/redundancy packages to employees theoretically should be straightforward once employers determine (pursuant to Divisions 80 to 83 of the ITAA 1997):
- the extent to which the payment qualifies as a genuine redundancy payment (GRP), employment termination payment (ETP), unused annual leave or unused long service leave payment (as defined);
- whether any portion of the payment will be tax-free;
- the age of the employee; and
- the application of the caps to concessionally tax part/all of the payment.
However, a number of hidden intricacies in the law can add extra layers of complexity and can expose employers to potential penalties for failing to withhold the correct amount.
This article highlights some (but not all) of the more common issues employers should be aware of.
An employer’s PAYGW obligation applies to the total amount of the termination payment.
Accordingly, where employers provide termination/redundancy packages with cash and non-cash elements, the amount withheld must be referable to both the cash element and the market value of any property transferred to the employee (such as a car) and any payments made by the employer to third parties at the employee’s direction.
Additionally, employers will need to value the non-cash elements provided, particularly as book values may not be reflective of market values.
Genuine redundancy payments
Employers will often refer to termination packages as ‘redundancy’ packages. However, the package must qualify as a GRP for taxation purposes to access tax-free treatment of all/part of the package, as well as to determine how the caps may apply, if applicable (discussed further below).
For a payment to qualify as a GRP, a number of requirements must be satisfied.
The one that employers generally focus on is whether the redundancy is a ‘genuine redundancy’. This issue received substantial attention from the Commissioner of Taxation in Taxation Ruling TR 2009/2. Accordingly, this issue is not considered further.
However, employers often overlook the requirement that the amount paid must also exceed ‘the amount that could reasonably be expected to be received by the employee in consequence of the voluntary termination of his or her employment at the time of the dismissal’.
Accordingly, if the employee is entitled to an amount regardless of whether they resign or are made redundant, the amount will not qualify as a GRP for these purposes. In these circumstances, that portion of the package cannot receive GRP tax-free treatment, and will be taxed as an ETP.
By way of example, this will arise where an employee’s contract specifies that they are entitled to at least one week’s pay as a severance payment, regardless of whether they are terminated or resign
ETP concessional treatment and the caps
As employers would be aware, ETPs are taxed at concessional rates up to the amount of the relevant cap, with any excess taxed at the top marginal rate.
The application of the cap is often an area of consternation and frustration for employers as there are two caps that could apply:
- the ‘ETP cap’ [refer s. 82-10(4)(a) and (b) of the ITAA 1997] – a set amount that is indexed ($205,000 for the 2019 income year), adjusted for any ETPs paid earlier in the same income year or by any ETPs paid for the same termination; and
- the ‘whole-of-income cap’ [s. 82-10(4)(c)] – $180,000 (unindexed) less certain taxable payments received by the employee in the same income year (including unused leave payments paid on termination).
Which cap to use is determined by reference to the type of ETP paid:
- ‘Excluded’ ETPs, such as the taxable portion of a GRP (and certain other payments also listed in s. 82-10(6)), are only subject to the ETP cap.
- ‘Non-excluded’ ETPs, i.e. payments which are not listed in s. 82-10(6), such as golden handshakes not paid as part of a genuine redundancy, are subject to the lesser of:
- the ETP cap and
- the whole-of-income cap.
If the above was not sufficiently complex, additional complications arise where a single ETP with excluded and non-excluded payments is paid (in which case special ordering and calculation rules apply and employers will be required to issue two ETP payment summaries).
Note: unused annual and long service leave payments are not GRPs or ETPs and, therefore, the above caps have no application in relation to this portion of the payment. Instead, such unused leave payments are subject to taxation/withholding under Subdivisions 83-A and 83-B of the ITAA 1997.
Accordingly, careful consideration and classification of the type of termination payment being made is necessary, including how this impacts which relevant cap is to be applied.
The employee’s age
Employers can often overlook the impact the employee’s age can have on the taxation of termination packages.
For example, if the employee is aged 65 or over (or, if retirement age under the employment contract is a lesser age, that age) at the time of dismissal, the payment will not qualify as a GRP, even if all other requirements are satisfied. Instead the payment will be taxed as an ETP. However, in this specific instance, only the ETP cap will apply and, as the employee has reached preservation age, a lower concessional tax rate should apply.
As can be seen from the above, the taxation and withholding provisions relating to termination/redundancy payments can be more complex than initially thought. Employers should ensure they take due care when determining their PAYGW obligations to ensure that they do not open themselves to potential penalties or unintended consequences.