Taxation Treatment of Redundancy / Termination Payments

Introduction

The purpose of this article is to outline the taxation treatment of redundancy payments. It also highlights for practitioners the fact that specific prior Revenue approval is not required by employers when granting the basic exemption of ₤6,000 plus ₤500 for each complete year of service or, if higher, the alternative Standard Capital Superannuation Benefit exemption.

Types of Redundancy Payments

A composite redundancy lump sum might typically include the following elements:

• Statutory Redundancy Payments
• Ex-Gratia/Compensation Payments from Employers
• Company car transferred to employee
• Pension Scheme Refunds
• Pension Scheme Lump Sums (Commutation)

The tax treatment of the above sums varies and can be summarised as follows:

Statutory Redundancy Payments

Statutory redundancy payments made under the Redundancy Payments Acts 1967 to 1991 are exempt from income tax under Schedule E. They do not reduce in any way the exemptions which are available in respect of other redundancy payments

Ex-Gratia/Compensation Payments from Employer

Ex-gratia payments, that is, payments made by the employer over and above the statutory redundancy payment are taxable. However, there are a number of exemptions which reduce the amount charged to tax and a further relief which reduces the tax chargeable. These exemptions and reliefs are discussed later in the article.

Company Car

A common feature of a redundancy package is that an employee is allowed to retain a company car. The market value of the car is treated as part of the ex-gratia payment and is therefore taxable.

Pension Scheme Refund of Contributions

Any refund of contributions provided for under an approved superannuation scheme is not regarded as income in the hands of the employee and it does not reduce his/her entitlement to the various exemptions available in respect of other taxable lump sums.

However, a charge to tax of 25% is imposed on a pension scheme in respect of such refunds (including interest).

Pension Scheme Lump Sums (Commutation)

Some pension schemes have a facility whereby an individual can opt to take a lump sum and a reduced pension.

An employee who retires before reaching normal retirement date may take a lump sum and begin to receive his/her pension immediately if the retirement is due to incapacity, or takes place on or after the employee’s 50th birthday, subject, of course, to the benefit terms of individual schemes.

Although the pension scheme lump sum is itself tax free, it can have an effect on the exemptions available in respect of other lump sum payments.

Exemptions and Reliefs

Some payments are not taxable, for example, statutory redundancy payments, refunds of certain pension scheme contributions and certain pension scheme lump sums. All other payments are subject to tax but may be covered by the following exemptions:

Basic Exemption

The first ₤6,000 plus ₤500 for each complete year of service in the office or employment in respect of which the payment is made is exempt from tax. The figure of ₤500 cannot be apportioned to give additional relief for part of a year of service.

Increase up to ₤4,000 on the Basic Exemption

The basic tax-free exemption of ₤6,000 plus ₤500 for each complete year of service may be increased by a maximum figure of ₤4,000 if the following two conditions are satisfied:

• The employee has never previously claimed relief in excess of the basic tax-free exemption
  and
• The employee is not entitled to receive a tax-free lump sum from an approved pension scheme in excess of ₤4,000. Where an amount less than ₤4,000 is received or receivable from a pension scheme, the increase to the basic exemption will be ₤4,000 less that amount.

It should be noted that a pension scheme lump sum received or receivable can limit the entitlement to the increased exemption. Where the pension lump sum is receivable in the future, its actuarial value is taken into account. In practice, the administrator of the pension scheme provides details of the lump sum payable under the scheme or its actuarial value. Revenue approval must be sought for this increase in basic exemption.

Standard Capital Superannuation Benefit (SCSB)

The Standard Capital Superannuation Benefit is an alternative exemption which is available to all employees but is of benefit mainly to employees with high earnings and long service. This alternative exemption can give rise to a higher maximum exemption than the increased basic exemption.

The formula for calculating SCSB is as follows:

where:

A = Average annual emoluments, including benefits-in-kind, for the last three years of service to date of departure (or for the whole period of the service, if less than three years)

B = Number of complete years of service

C = Any lump sum pension entitlements i.e. any tax-free lump sum received or receivable under an approved superannuation scheme.

Amount Chargeable to Tax

The excess of any taxable lump sum over the relevant exemption figure is chargeable to tax as extra income earned in the year of assessment in which the termination of the employment occurs. If an employee is already paying tax at the top rate of 48%, all of the extra income will be charged to tax at 48%.

The taxable lump sum is not regarded as reckonable income for the purpose of PRSI but is liable for the Health Contribution (1%) and Employment and Training Levy (1.25%).

Top-Slicing Relief

The amount of the tax charged may also be reduced by what is known as “top-slicing relief”. There is a formula for calculating the relief, the effect of which is to reduce the tax rate on the lump sum payment to the individual’s average rate of tax for the previous five tax years. Where an employee feels that such relief is due he/she should contact the tax office. Top-slicing relief is not normally given until after the end of the year of assessment.

Procedures and Application of PAYE

The basic exemption of ₤6,000 plus ₤500 for each complete year of service or, if higher, the alternative Standard Capital Superannuation Benefit exemption may be allowed by the employer before applying PAYE to the lump sum payment - specific prior Revenue approval is not now required. Revenue approval is, however, required for an increase in ₤4,000 over the basic exemption. This will only arise when this increased exemption exceeds the SCSB.

Where a payment exceeds the basic exemption or SCSB exemption or such higher exemption figure approved by Revenue the employer is required to deduct and to account to Revenue for tax under PAYE and levies charged on the excess.

The employer is required to maintain satisfactory supporting records of redundancy/termination payments made.