The economic news coming out of South Africa lately has been gloomy. While voluntary redundancies are the order of the day at oil and gas company Engen Petroleum, supermarket chain Pick n Pay has cut 10% of its staff, the equivalent of 3,500 jobs.
So as the threat of retrenchment continues to grow in certain sectors of the economy, it raises the question of how redundancy payments should be dealt with from a payroll perspective.
South Africa’s tax directive process
In South Africa, employers and fund administrators are required to obtain a so-called tax directive from the South African Revenue Services (SARS) if it is not possible to use tax tables for certain types of remuneration or lump sum payments. SARS uses the information captured on the tax directive application form to determine what tax should be withheld from the lump sum payment.
Different tax directive applications
There are various application forms that cover the wide range of lump sum payments currently available. The table below outlines existing forms and the payments they deal with:
|
Form name |
Remuneration covered by the directive/reason for the directive |
|
IRP3 (a) |
Gratuities that are paid to an employee on death, retirement, retirement due to ill health, retrenchment/severance or share options without obligations paid or other lump sums paid. |
|
IRP3 (b) |
In cases where employees’ tax will be deducted at a fixed percentage – for example, commission payments. |
|
IRP3 (c) |
Where employees’ tax will be deducted at a fixed amount – for example, an assessed loss carried forward and covered by paragraph 11 of the Fourth Schedule (hardship). |
|
IRP3 (d) |
To determine what remuneration figure should be used to deduct employees’ tax as understood by Paragraph 11 of the Fourth Schedule (hardship)/Paragraph 11C (1)(ii)(bb) of the Fourth Schedule. |
|
Form A & D |
Lump sum benefits paid by a pension and/or provident fund, for example, if death occurs before retirement. |
|
Form B |
Lump sums paid by a pension or provident fund following an employee’s resignation or withdrawal from the fund. The form likewise handles the winding up of a fund or the transfer of money or payment as defined in Paragraph (eA) of the definition of gross income. Also covered is the renumeration of any unclaimed benefit or payment made under the terms of a divorce payment. |
|
Form C |
Lump sum benefits paid by a Retirement Annuity Fund (RAF) to a member on their death either before they retire or following their retirement due to ill health. The transfer from one RAF to another before retirement would also be processed via Form C. |
|
Form E |
Lump sum benefits paid after retirement for example, on a fund member’s death. |
The IRP3(a) is the tax directive most commonly used during payroll processing. It would also be used if a retrenchment/severance or redundancy lump sum payment needed to be made to an employee.
But a key question for payroll managers or processors is when do they need to apply for a tax directive and when is the payment processed on the payroll using normal tax tables?
If a staff member resigns, the lump sum paid to them by their employer is treated as an annual payment. Holiday pay that they are entitled to under the terms of their employment contract would also be taxed as an annual payment in this instance.
But if an employee is retrenched, or retirement or any other payments are made following their death, a tax directive must be obtained from SARS. SARS is responsible for issuing a directive that reflects correct exemptions or tax relief. These payments will be included on the IRP5/IT3(a) certificate under the correct tax code (normally 3901).
Tax relief on a retirement or severance lump sum is allocated only once in any given individual’s lifetime. Once it is paid out, it cannot be claimed again, which is why a tax directive (IRP3(a)) must be obtained from SARS. Lifetime tax relief on these payments is currently R500,000 (US$36,675).
What is the difference between redundancy payments and severance benefit lump sums?
If an employee is made redundant in South Africa, a lump sum payment is normally made to compensate them because their services have been terminated. On the other hand, current tax legislation classifies a severance benefit as “any amount received or accrued to a person as a lump sum in respect of the relinquishment, termination, loss, repudiation, cancellation or variation of that person’s office/employment/appointment” (according to the definition in section 1(1)).
For an employee to qualify for a special rate, their employer must have paid them the lump sum due as a result of terminating the employment relationship either because they have stopped trading (or they are intending to do so) or because they have cut headcount.
Staff members also qualify for the special rate if they have reached the age of 55 at the time they are made redundant or if they are retrenched due to becoming permanently incapable of employment following sickness, accident, injury and the like. They do not qualify, however, if they hold more than 5% of the issued shares, or have a member’s interest, in the company that is paying them the severance benefit (as per SARS guidelines).
It is important to note that holiday pay and any pro-rata bonuses laid out in an employee’s employment contract when their employment is terminated do not form part of the severance benefit. These amounts are subject to the normal rates of tax that apply to individuals. But any gratuitous payment, for example, holiday pay that staff members are not entitled to on termination of their employment, is not classified as normal leave pay and could be included in severance benefit calculations.
How to submit a tax directive application
Tax directive application forms can be obtained from the SARS website, any SARS branch or via the online eFiling system. As employers will use eFiling for processing monthly Pay-As- You-Earn (PAYE) payments, this option would appear to make most sense when submitting your application. The application will normally be processed within 24 hours.
Bear in mind that failure to classify payments correctly could result in employees being undertaxed. It could also lead SARS to hold you responsible for any shortfall in PAYE payments. Therefore, it is important to ensure that the tax directive application is completed correctly and, after being received back from SARS, that the prescribed amount of tax is processed via payroll.
Conclusion
Care must be taken when completing the tax directive form to ensure that any amounts paid to employees are correctly categorised. It is also vital to ensure that payments comply with the tax legislation and other guidelines issued by SARS.
Problems in either of these areas could have financial implications for both employers and employees. Once a staff member has received their final payment, especially in retrenchment situations, it is extremely difficult for employers to recoup any taxes that may not have been withheld correctly.
After graduating with a degree majoring in taxation, accounting and managerial accounts and finance, Sharon gained considerable experience in the field of training, tax issues and financial/ICT management, including mergers and acquisitions. She started her career in education, but progressed to a position within the South African Revenue Services, before moving on to Anglo American Property Services. Here Sharon climbed the ranks to become group financial director, with ICT and payroll as part of her management portfolio. As Anglo American managed properties on behalf of their owners, she also gained experience of the outsourcing field. During this time, Sharon undertook further specialised studies focusing on property practice, financial markets and instruments.
She joined Praxima Payroll Systems in 2001, steering the company through the process of developing its own software and establishing them as a key provider of payroll services to some of the largest legal practices in South Africa. After relocating to the UK, Sharon continued in a consulting role with Praxima before joining global consolidator Celergo in 2012 as head of UK operations. She oversaw a right-sizing process and refined the company’s payroll processes to improve productivity. Sharon was asked to take on the chief operating officer role at Praxima Holdings in 2013 and assisted the firm in extending its footprint into Africa and beyond. In March 2017, she joined BDO as an account manager in its global outsourcing division.
The economic news coming out of South Africa lately has been gloomy. While voluntary redundancies are the order of the day at oil and gas company Engen Petroleum, supermarket chain Pick n Pay has cut 10% of its staff, the equivalent of 3,500 jobs.
So as the threat of retrenchment continues to grow in certain sectors of the economy, it raises the question of how redundancy payments should be dealt with from a payroll perspective.
South Africa’s tax directive process
In South Africa, employers and fund administrators are required to obtain a so-called tax directive from the South African Revenue Services (SARS) if it is not possible to use tax tables for certain types of remuneration or lump sum payments. SARS uses the information captured on the tax directive application form to determine what tax should be withheld from the lump sum payment.
Different tax directive applications
There are various application forms that cover the wide range of lump sum payments currently available. The table below outlines existing forms and the payments they deal with:
|
Form name |
Remuneration covered by the directive/reason for the directive |
|
IRP3 (a) |
Gratuities that are paid to an employee on death, retirement, retirement due to ill health, retrenchment/severance or share options without obligations paid or other lump sums paid. |
|
IRP3 (b) |
In cases where employees’ tax will be deducted at a fixed percentage – for example, commission payments. |
|
IRP3 (c) |
Where employees’ tax will be deducted at a fixed amount – for example, an assessed loss carried forward and covered by paragraph 11 of the Fourth Schedule (hardship). |
|
IRP3 (d) |
To determine what remuneration figure should be used to deduct employees’ tax as understood by Paragraph 11 of the Fourth Schedule (hardship)/Paragraph 11C (1)(ii)(bb) of the Fourth Schedule. |
|
Form A & D |
Lump sum benefits paid by a pension and/or provident fund, for example, if death occurs before retirement. |
|
Form B |
Lump sums paid by a pension or provident fund following an employee’s resignation or withdrawal from the fund. The form likewise handles the winding up of a fund or the transfer of money or payment as defined in Paragraph (eA) of the definition of gross income. Also covered is the renumeration of any unclaimed benefit or payment made under the terms of a divorce payment. |
|
Form C |
Lump sum benefits paid by a Retirement Annuity Fund (RAF) to a member on their death either before they retire or following their retirement due to ill health. The transfer from one RAF to another before retirement would also be processed via Form C. |
|
Form E |
Lump sum benefits paid after retirement for example, on a fund member’s death. |
The IRP3(a) is the tax directive most commonly used during payroll processing. It would also be used if a retrenchment/severance or redundancy lump sum payment needed to be made to an employee.
But a key question for payroll managers or processors is when do they need to apply for a tax directive and when is the payment processed on the payroll using normal tax tables?
If a staff member resigns, the lump sum paid to them by their employer is treated as an annual payment. Holiday pay that they are entitled to under the terms of their employment contract would also be taxed as an annual payment in this instance.
But if an employee is retrenched, or retirement or any other payments are made following their death, a tax directive must be obtained from SARS. SARS is responsible for issuing a directive that reflects correct exemptions or tax relief. These payments will be included on the IRP5/IT3(a) certificate under the correct tax code (normally 3901).
Tax relief on a retirement or severance lump sum is allocated only once in any given individual’s lifetime. Once it is paid out, it cannot be claimed again, which is why a tax directive (IRP3(a)) must be obtained from SARS. Lifetime tax relief on these payments is currently R500,000 (US$36,675).
What is the difference between redundancy payments and severance benefit lump sums?
If an employee is made redundant in South Africa, a lump sum payment is normally made to compensate them because their services have been terminated. On the other hand, current tax legislation classifies a severance benefit as “any amount received or accrued to a person as a lump sum in respect of the relinquishment, termination, loss, repudiation, cancellation or variation of that person’s office/employment/appointment” (according to the definition in section 1(1)).
For an employee to qualify for a special rate, their employer must have paid them the lump sum due as a result of terminating the employment relationship either because they have stopped trading (or they are intending to do so) or because they have cut headcount.
Staff members also qualify for the special rate if they have reached the age of 55 at the time they are made redundant or if they are retrenched due to becoming permanently incapable of employment following sickness, accident, injury and the like. They do not qualify, however, if they hold more than 5% of the issued shares, or have a member’s interest, in the company that is paying them the severance benefit (as per SARS guidelines).
It is important to note that holiday pay and any pro-rata bonuses laid out in an employee’s employment contract when their employment is terminated do not form part of the severance benefit. These amounts are subject to the normal rates of tax that apply to individuals. But any gratuitous payment, for example, holiday pay that staff members are not entitled to on termination of their employment, is not classified as normal leave pay and could be included in severance benefit calculations.
How to submit a tax directive application
Tax directive application forms can be obtained from the SARS website, any SARS branch or via the online eFiling system. As employers will use eFiling for processing monthly Pay-As- You-Earn (PAYE) payments, this option would appear to make most sense when submitting your application. The application will normally be processed within 24 hours.
Bear in mind that failure to classify payments correctly could result in employees being undertaxed. It could also lead SARS to hold you responsible for any shortfall in PAYE payments. Therefore, it is important to ensure that the tax directive application is completed correctly and, after being received back from SARS, that the prescribed amount of tax is processed via payroll.
Conclusion
Care must be taken when completing the tax directive form to ensure that any amounts paid to employees are correctly categorised. It is also vital to ensure that payments comply with the tax legislation and other guidelines issued by SARS.
Problems in either of these areas could have financial implications for both employers and employees. Once a staff member has received their final payment, especially in retrenchment situations, it is extremely difficult for employers to recoup any taxes that may not have been withheld correctly.
After graduating with a degree majoring in taxation, accounting and managerial accounts and finance, Sharon gained considerable experience in the field of training, tax issues and financial/ICT management, including mergers and acquisitions. She started her career in education, but progressed to a position within the South African Revenue Services, before moving on to Anglo American Property Services. Here Sharon climbed the ranks to become group financial director, with ICT and payroll as part of her management portfolio. As Anglo American managed properties on behalf of their owners, she also gained experience of the outsourcing field. During this time, Sharon undertook further specialised studies focusing on property practice, financial markets and instruments.
She joined Praxima Payroll Systems in 2001, steering the company through the process of developing its own software and establishing them as a key provider of payroll services to some of the largest legal practices in South Africa. After relocating to the UK, Sharon continued in a consulting role with Praxima before joining global consolidator Celergo in 2012 as head of UK operations. She oversaw a right-sizing process and refined the company’s payroll processes to improve productivity. Sharon was asked to take on the chief operating officer role at Praxima Holdings in 2013 and assisted the firm in extending its footprint into Africa and beyond. In March 2017, she joined BDO as an account manager in its global outsourcing division.
