The Tax Implications of Redundancy in Australia

Small Business Accountants Melbourne

Many businesses are currently into downsizing and staff cuts and it is possible you can find yourself on the wrong side of the axe. If you are facing an impending redundancy, you will need to familiarize yourself with the calculations to do with the leave entitlements. You have to also ensure that your redundancy is bona fide otherwise you are unlikely to get an Australian Taxation Office approval for any termination payments that you may be eligible for that are likely to attract concessional tax rates.

What makes redundancy packages attractive for some people that are voluntarily saying goodbye to the workplace is that these payments are huge and they carry certain tax concessions. However, to make the most of these benefits, the redundancy package must be well structured.

The Types of Redundancy Payouts

There are three types of payments that you can receive upon leaving employment. These include the redundancy payments, an employment termination payment (ETP) and an early retirement payment. But it can get a little more complicated than this. There are certain redundancy payments that are a mixture of any of these two types. The early retirement payments and redundancy payments get a similar tax treatment. However, the employment termination payments (ETP) are treated differently by the taxman. This is why it is imperative that you understand the type of payment that you are likely to receive upon leaving payment so as to help you optimize the various tax concessions that apply.

Redundancy Payments

A bona fide redundancy payment is made when you have been dismissed from your job because the position you were holding is no longer in existence or has been abolished. Redundancy payments are tax-free within certain limits and can be broadly classified into three categories:-

  • A golden handshake or gratuity
  • A severance payment that covers a number of weeks’ pay for every year when you were working.
  • A payment that is made in lieu of notice

A redundancy payment must be genuine. You can’t just claim it because you have just lost your job. For it to qualify as a redundancy, there are certain objective criteria that must be met. If it fails the cut, the payment will be taxed as an employment termination payment instead of a redundancy and that means you lose those generous tax concessions.

There are certain categories of payments that are not treated as redundancy payments or as ETPs and which will attract normal tax rates. These include the following:-

  • Any salaries, allowances or wages that are owing to you for work that has already been completed.
  • Any payments made by your employer in lieu of your super benefits.
  • Lump sum payments paid as compensation for unused long service leave which are disbursed after a formal termination of an employment.
  • A lump sum payment for an unused annual leave or a leave loading that is paid upon the termination of your employment.

If your redundancy payment is genuine, it will be taxed at a special concessional rate. There are certain parts of redundancy payments that can also be paid out tax-free. The two segments involved in the tax-free components include the base amount along with annual amount that is paid out for every year of service that you rendered. Any excess amount paid out over the tax-free limits is treated as an employment termination payment by the Australian Taxation Office.

Early Retirement

Approved early retirement schemes are put in place by employers to encourage certain categories or classes of their employees to take an early retirement.

However, an early retirement scheme will only be eligible for tax concessions if the process is open to all employees in the firm or to all employees that fall within a certain category in the firm. The scheme must also get the nod from the Commissioner of Taxation before the employer can begin issuing payments.

If it is genuine, the payments for an early retirement scheme are tax-free up to certain limit depending on the time duration the employee has spent with their employer. To qualify for tax concessions, the early retirement scheme must satisfy the following conditions:-

  • It must be done “early”, that is before the compulsory retirement age of 65.
  • There shouldn’t be an arrangement between the employee and the employer for a re-employment.
  • The payments issued must be at arm’s length values.

The tax-free limit for early retirement payments is similar to that of genuine redundancy payments. If there are amounts paid out above these limits, the Australian Taxation Office will treat it as an employment termination payment.

Employment Termination Payments (ETPs)

They are also widely common. Employment terminations occur on a daily basis. An employment termination payment refers to a lump sum payment that is made by the employment to an employee who ceases to work for them.

There are numerous types of employment termination payments:-

  • Contractual termination payments
  • Golden handshakes
  • Payments for unused sick leave
  • Payments for wrongful dismissal or compensation for a loss of employment

Genuine redundancy payments and early retirement schemes that are within the tax-free limits are given a different tax treatment from employment termination payments.

The ETPs will also be given a different tax treatment depending on whether termination is due to the death of the employee (death benefits) or whether it is a normal termination of employment (life benefits).

There are instances where part or all of the employment termination payments may be tax-free such as in the case of invalidity or if the person was employed before 1 July 1983. The more common scenario is usually a case of invalidity.

The taxable component of the life benefit ETP is taxed at a concessional rate of either 17% or 32% within a certain limit. The top rate applies for the amounts that are over the cap.

If you are facing a redundancy and need some help wrapping your fingers around the kinds of payments you are likely to get and the tax implications involved, you can contact an accountant Melbourne expert to help you make sense of this.

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