Taxation of employment termination payments
When an employee is terminated, they usually receive a lump sum amount, this is called an employment termination payment or ETP. The amount may be taxed in a number of ways, depending on the employee’s age, years of service and type of payment. A single ETP may include a tax-free portion, a concession rated portion and a taxed portion.
For the employee to be eligible for certain concessions, the ETP must be paid within 12 months of the termination. If not, then the entire amount will be included in the assessable income and taxed at the marginal rate.
ETP’s may include the following:
- The “golden handshake” or gratuity
- A payment in lieu of notice period
- Compensation for loss of job or wrongful dismissal
- Payments for early retirement scheme or redundancy
- Unused rostered days off or sick days
Other payments made around the same time as an ETP can easily be confused as one, some of these include:
- Payments for unused annual leave
- Payments for long service leave
- Payment or compensation for injuries
- A loan payment or advance
- Salary or bonuses owed or leave already taken
- Payment for restraint of trade
- Any foreign payments received for termination
- Payments for an employee share scheme
These types of payments are generally taxed as per normal payroll and are not considered an ETP.
There are also certain concessional tax rates on specific types of lump sum payments at termination. Some of these payments include any unused leave, with the provision they are identified on the PAYG Summary specifically for the disclosure.
Tax caps and ETP’s
If the ETP is subject to a concessional rate, there are two types of caps you need consider, when calculating the tax.
This cap is indexed each year, for the 2015-2016 tax year the cap is $195,000. (For 2014-2014 it was $185,000)
The ETP cap refers to excluded ETP’s, including the following:
- Early retirement payments
- A genuine redundancy
- Invalid payments
Whole of income cap is set at $180,000, it is not indexed and only applies to non-excluded ETP’s like:
- Non-genuine redundancy payments
- The golden handshakes
- Payments for rostered days off and unused sick leave
- Gratuities or tips
Are ETP’s subject to superannuation guarantee?
You have to look at the purpose and the type of ETP to determine if it is subject to superannuation guarantee.
The superannuation guarantee is based on ordinary times earnings, so the specific termination payment must be categorised as that. If the ETP is in lieu of notice, then that amount is considered OTE, and would be treated as income they would have ordinarily earned if the work was performed.
If the ETP is part of a redundancy package, it is NOT OTE, and therefore would not be subject to SG.
Taxing genuine redundancy
This can be a confusing subject for employers. A genuine redundancy must meet four specific components to qualify for the concessional tax treatment. They are:
- The payment received must be in consequence of the termination
- The payment must involve the employee being dismissed from employment
- That dismissal must be caused by the redundancy of the position, and
- The payment must be made because of the redundancy.
Note that there are special circumstances where an employee may have dual capacity roles.
Contact this office if you have any questions about this or need any other business tax advice from our Caulfield accountants.
Hillyer Riches Management Pty Ltd is a Corporate Authorised Representative (No 466483) of Capstone Financial Planning Pty Ltd. ABN 24 093 733 969. AFSL / ACL No. 223135.This document contains general advice only and is not personal financial or investment advice. Also, changes in legislation may occur frequently. We recommend that our formal advice be obtained before acting on the basis of this information.