Tax implications of severance pay

14 September 2020 | Business

Are you thinking of downscaling or closing down your business and have to retrench employees? Or are you close to your retirement age and expect severance pay to be paid out by your employer?

As employer and employee, you should consider the tax implications of these amounts paid/received.

As an employer you are obliged to withhold Pay-As-You-Earn (PAYE) on all remuneration paid to employees.

Amounts paid to employees for “relinquishment, termination, loss, repudiation, cancellation or variation of any office or employment or of any appointment” are specifically included in the definition of remuneration. This means that payments of this nature made by the employer are subject to PAYE.

Exemption

An exemption of N$300 000 will apply provided the following conditions are met:

· The employee is 55 years or older; or

· The employee was dismissed as a result of superannuation, ill-health or other infirmity; or

· The employee was retrenched due to his/her employer downsizing the business or closing the business.

The N$300 000 is for the employee’s lifetime and does not apply separately to consecutive retirements/retrenchments.

The employer should request and obtain a tax directive from Inland Revenue where they will indicate the amount of PAYE to be withheld on the payment to the employee.

On retrenchment payments, Inland Revenue also requires the office of the Labour Commissioner to confirm the employer’s retrenchment programme.

If the termination of the services of such employee is due to superannuation, ill-health or other infirmity and the amount received by the employee is more than N$300 000, the remaining amount may be taxed in three equal instalments in the year of payment and the two following years.

Tax deductibility of severance payments

Severance payments that are actually incurred, are deductible from the taxable income of your business.

The term “actually incurred” implies you either already paid the employee, or they have already been dismissed and you have an unconditional obligation to pay the severance pay.

A provision for possible future severance payments that might be incurred are conditional and these costs have not actually been incurred. As such, you will need to add back the severance pay provision in your tax calculation.

Johan Nel is a partner/director at PwC Namibia.

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