The fine tax line during retrenchments

share trends 4Author: Amanda Visser (IOL).

The different tax treatment of lump sum withdrawals following retrenchment seems at odds with efforts to give relief in difficult times.

In March 2011 the Income Tax Act was changed, treating severance benefits similar to lump sum payments from pension or provident funds. However, it appears as if policy is not taking heed of the dire employment situation in the country.

Deloitte Tax Associate Director Jaco la Grange says, someone who has been retrenched and needs to access his pension or provident fund to survive, receives harsh tax treatment.

Retirement funds can, in fact, be accessed in full for use by the retrenched person. However, the tax-free benefit is only R25 000 for this lump sum (as opposed to the normal R500 000 tax-free amount upon retirement).

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Someone who takes a lump sum on a portion of his pension or provident fund, and preserves the remaining savings in a preservation provident, or preservation pension fund will receive the first R500 000 tax free.

“The unemployed individual withdrawing retirement savings will be taxed as if he resigned from the pension or provident fund, although the reason for accessing the funds is because he was retrenched. The underlying principle behind this is that government wants to encourage people to preserve some of their pension for later,” says La Grange, also the personal income tax committee chair of the SA Institute of Tax Professionals (SAIT).

Hence, these pre-retirement withdrawals reduce the R500 000 tax-free amount upon retirement, even though these pre-retirement withdrawals are largely taxable.

Marty Santana, senior manager in the expatriates division of SizweNtsalubaGobodo, says the tax-free amount is cumulative, with pre-retirement withdrawals working against retirement withdrawal.

“If you are retrenched more than once in your career, it is possible that you do not have a tax free amount available by the time you get to retirement,” she says.

La Grange says the counter argument is that these are abnormal circumstances.

The act actually provides for pre-retirement severance benefits to be tax-free up to R500 000, and forced retirement withdrawals should arguably be treated the same.

Santana also refers to employees who take voluntary retrenchment packages as part of an informal reduction of staff.

These retrenchments do not appear to be generally covered by the relief that came into effect in 2011.

“If an employee takes a voluntary retrenchment package, the lump sum is treated as normal income and the individual is taxed at the maximum rate,” says Santana.

The South African Revenue Service says, for an individual to qualify for the beneficial tax treatment, employment must have been lost due to the employer having stopped trading, or the employer is embarking on a general reduction of personnel.

Santana says, if one takes voluntary retrenchment or early retirement, it is not seen as part of the beneficial regime.

“It is a very fine line. If you go voluntarily, you are not being relinquished and you could have stayed on. That is the fine line.”

This issue was addressed during a personal income tax workshop between tax consultants and the National Treasury in December last year.

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