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There are a number of ways in which jobs are lost and these include mutual separation, retrenchment, dismissal, retirement among others. In the current hyperinflationary environment, retrenchment counts for the highest number of job losses as employers adopt cost rationalization strategies or close their businesses. Where an employee is dismissed through no fault of his or her own, an employer often pays a compensation known as severance pay. In practice severance pay and retrenchment package are used interchangeably. A retrenchment of at least five employees within a period of six months, requires the employer to file a notice of intention to retrenchment to the works or employment council and in the absence of these to the retrenchment board. This article unpacks the tax issues of severance pay from an employee perspective.
The starting point in taxing a severance pay is that it forms part of the employee’s taxable income because it arises from past services rendered. All amounts in respect of services rendered by an employee in the past, present or to be rendered in the future constitute gross income and may not be taxable if exemption for such amounts are provided for within the law. Meanwhile, the law provides for the exemption of the severance pay, gratuity or similar benefit arising on termination of employment due to retrenchment. The exemption is a third of the package or the first ZWL10,000, whichever is the greater amount. However the maximum exemption is ZWL20,000. This means that the employee will not be taxable on the said exempted amount. Any pension or cash in lieu of leave do not qualify for exemption relief notwithstanding they may also be paid upon retrenchment. These are taxable in full.
Similar benefits as contemplated above may include school fees, medical aid cover, disposal of a motor vehicle to an employee at a discount price or for no consideration, passage benefit among others. These should be aggregated as part of the severance pay for purposes of determining the exemption. However, benefits such as medical aid, passage benefit, disposal of a motor vehicle at a subsidised price or for no consideration to an old person etc have separate exemption provisions from the rest of the benefits contemplated above. Therefore employers should take care to ensure that these amounts are exempted under their provisions to maximise the employees’ after tax earnings. The discount or benefit on sale of motor vehicle to an employee who was 55 years or above on the date of sale of the motor vehicle to him or her is fully exempt in terms of the law. Passage benefit on termination of employment, any journey undertaken by an employee whose costs is borne by the employer is also fully exempt if it represents the first of its kind to be paid by the employer to the employee. The amount of any contributions paid to a medical aid society by an employer on behalf of his employee whether during or termination of employee’s employment is fully exempt from tax. The Income Tax Act defines a ‘medical aid society as any society or scheme which is approved by the Commissioner. This implies that medical contributions made to an unapproved medical aid society do not rank for exemption as aforesaid so is cash payment given to an employee in place of medical aid contributions.
Meanwhile, a separate exemption applies to amounts payable by way of commutation of a pension or annuity from the Consolidated Revenue Fund or a pension fund, other than a retirement annuity fund to an employee under the age of 55 years whose employment is terminated due to retrenchment. A third of the amount or ZWL10 000 whichever is the greater is exempted from tax provided that the maximum exemption shall be limited to ZWL 20 000. A commutation implies giving up part or all of the pension payable from retirement in exchange for an immediate lump sum payment. However, where a person is over the age of 55 years any pension granted to the employee is fully exempt.
The above severance pay and pension commutation exemption amounts were reviewed with effect from 1 January 2013 and converted from United States dollar to Zimbabwe dollar on a 1:1 basis through Statutory Instrument 33 of 2019. Whereas most statutory deductions, exemptions and credits were reviewed through the recently gazetted Finance (No.2) Act 2019, these exemptions were not reviewed. As a result, these have lost their economic value as reliefs to employees and we call upon the government to review these amounts in order to cushion the affected employees.
In order to process the payment of a retrenchment or other similar lump sum payments a directive from ZIMRA is required. The application for the directive must be made by the employer which includes benefit funds, pension funds, pension preservation funds, provident funds, provident preservation fund, and retirement annuity fund among others. The directive is applied by completing certain forms obtainable from the ZIMRA website. A directive is very important because it gives an opportunity to minimize the tax burden on the part of the employee especially those who were under the final deduction system (FDS). The employer will therefore be required to deduct the tax as per the ZIMRA directive opposed to determine the tax itself. The fact that pension commutation is payable by pension or retirement annuity fund, whilst termination benefits are payable by the employer implies there may be two or more tax directives for one employee. The law has not stated how this should be dealt with but there is need for synchronising these tax directives.
In conclusion employers should ensure they correctly exempt the severance pay and pension commutation in order to cushion their employees from the heavy tax burden that may arise on lump sum payment payable upon retrenchment. In every case it will be important to consider the mixture of the severance pay in order to maximize the after tax benefit to the employee. This implies that employers should identify the packages that are appropriate in line with the circumstances of the affected workers.