In this article Sharon Tayfield, Operations Director within the Global Payroll Services Senior Management Team at BDO talks us through how to process lump sums or terminal payments within South Africa.  Sharon, a registered tax practitioner in South Africa looks at the tax directive process; the different types of tax directive applications; what therefore can be classified as retrenchment or a severance benefit lump sum; and finally, how to how to submit a tax directive application.

The tax directive process in South Africa

In South Africa employers and fund, administrators are required to obtain a tax directive from the South African Revenue Services (SARS) in circumstances where the tax tables cannot be used for certain types of remuneration or for certain lump sum payments. SARS will use the information captured on the tax directive application form to determine the tax that should be withheld from the lump sum payment.

The different tax directive applications

There are various application forms to cover the wide range of lump sum payments. The table below outlines the current forms and the payments they cover.

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 for circumstance covered by paragraph 11 of the Fourth Schedule (hardship).
IRP3 (d) To determine the deemed remuneration to be used to deduct Employees’ Tax from as contemplated 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 where death occurs before retirement.
Form B Lump sums paid by a pension fund or provident fund on resignation or withdrawal from the fund. This would also cover the winding up of a fund or the transfer or payment as defined in Paragraph (eA) of the definition of gross income. The form would also cover the payment of any unclaimed benefit or payment made in terms of a divorce payment.
Form C Lump sum benefits paid by a Retirement Annuity Fund (RAF) to a member on death before retirement or on retirement due to ill health. The transfer from one RAF to another before retirement would also be processed via the form C.
Form E Lump sum benefits paid after retirement – for example on the death of the member.

 

The IRP3 (a) is the tax directive which is the most commonly used during payroll processing.  The IRP3 (a) is also the document which would be used in the case where a retrenchment/severance or redundancy lump sum payment is being made to an employee.

The question for payroll managers or anyone processing payroll is when does a tax directive need to be applied for and when does a payment get processed on the payroll using the normal tax tables? If an employee’s employment is terminated due to normal circumstances, that is the employee resigns, the lump sum paid to by an employer is treated as an annual payment. Leave pay that an employee is entitled to in terms of their employment contract would also be taxed as an annual payment in the cases where the employee resigns.

If an employee is retrenched or retirement payments or any payments are made as a result of the death of an employee, a tax directive is required to be obtained from SARS. It is the responsibility of SARS to ensure that they issue a directive which reflects the correct exemptions or tax relief. These payments will be reflected on the IRP5/IT3 (a) certificate under the correct tax code. (Normally 3901)

Tax relief on a retirement or severance lump sum is allocated once in a lifetime. Once the amount is utilized it cannot be used again which is why a tax directive (IRP3(a)) needs to be obtained from SARS. Currently, the lifetime tax relief is R500 000.

What therefore is classified as retrenchment (redundancy) or a severance benefit lump sum?

If an employee is retrenched in South Africa, normally a lump sum payment is made to compensate them as a result of their services being terminated. The 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.” (In terms of the definition in section 1(1))

For an employee to qualify for the special rate, the employer must have paid the lump sum as a result of terminating the employment relationship with the employee either as a result of the employer having stopped trading (or intending to stop trading), or due to a general reduction in headcount. An employee will also qualify for the special rate if they have attained the age of 55 years at the time they are retrenched or if they are retrenched as a result of becoming permanently incapable of employment. This could be due to for example sickness, accident or injury. An employee will not qualify if they have held more than 5% of the issued shares or member’s interest in the company paying the severance benefit. (As per SARS guidelines)

It is important to note that leave pay and any pro-rata bonuses that are paid to an employee at the time of the termination of employment, in terms of their employment contract, does not form part of the severance benefit and that these amounts are subject to normal rates of tax applicable to individuals. However any gratuitous payment, for example, leave pay that the employee is not entitled to on termination of their employment, is not classified as normal leave pay and could be included in a severance benefit amount.

How to submit a tax directive application

Tax directive application forms can be obtained from the SARS website (www.sars.gov.za), any SARS branch or via the online eFiling system. As employers will be using eFiling for processing the monthly PAYE this would be the option which would be used to submit the application. The application is normally processed within 24 hours.

Failure to classify payments correctly could result in the employee being undertaxed and could result in SARS holding the employer responsible for any shortfall in PAYE payments. It is therefore important to ensure that the application for the tax directive is correctly completed and that once it is received back from SARS that the tax according to the directive is processed via the payroll.

Conclusion

As mentioned above, care needs to be taken when completing the tax directive to ensure that any amounts paid to the employee are correctly categorised. In addition, care needs to be taken to ensure that the circumstances under which the payment is made complies with the tax legislation and guidelines issued by SARS. Failure in any of these areas could have a financial implication for the employer and the employee. Once an employee has received the final payment due to them, especially in retrenchment situations it is extremely difficult for the employer to recoup any taxes which may not have been withheld correctly from the payment.

About Sharon Tayfield

Sharon has over 25 years of outsourcing experience and has won Best Payroll Manager awards at the CIPP Awards, GPA Awards and The Rewards Awards in the last 12 months.  She has advised business owners and shareholders in the past and has led a strong payroll outsourcing team at BDO as well as in her native South Africa.  Sharon is a regular contributor to the GPA covering African legislation and compliance and as well as GPMI publications.