[FAQ] Voluntary severance package & 10% shareholding

[FAQ] Voluntary severance package & 10% shareholding

• 08 February 2021
• Individuals Tax
• The Payroll Authors Group of South Africa

This article is based on tax law for the year ending 28 February 2021.

Background

A taxpayer, who is a director holding 10% shareholding in a company, also received a voluntary severance package.

Would the taxpayer be able to qualify for a tax directive on the retrenchment package as he held more than 5% shares in the company?

Answer

The Income Tax Act

References in this response to sections are to sections of the Income Tax Act, 1962 (the Act).

A “severance benefit” as defined in section 1(1) arises, once the general definition thereof has been met, in one of three instances:

(a) The person is at least 55 years old;

(b) The relinquishment, termination, loss, repudiation, cancellation or variation of employment has resulted from the person being permanently incapable of continuing with his or her employment due to, amongst others, sickness or incapacity; or

(c) The termination or loss of employment is due to the person’s employer having ceased or intending to cease carrying on a trade for which the person was employed, or due to the person having been made redundant by the employer, unless, where the person’s employer is a company, that person holds more than 5% of the shares or members’ interest in that company.

Note that the exclusion in reference to a person who holds more than 5% of the shares or members’ interest in that company, will only apply in respect of the provisions of paragraph (c) above. In other words, in the case of a person who is made redundant or whose termination or loss of employment was due to his or her employer ceasing trade, the lump sum received by or accrued to that person will not be regarded as a severance benefit as defined if the person (whether a director or any other employee) holds more than 5% of the shares or members’ interest in that employer company. The exclusion will, however, not apply in respect of the provisions of paragraphs (a) and (b) above, regardless of that person’s shareholding or members’ interest in the employer company.

In cases where the exclusion in paragraph (c) applies, the lump sum received by or accrued to the person in respect of the termination or loss of office or employment will not be a severance benefit as defined. However, the amount will still fall to be included in the person’s “gross income” under paragraph (d)(i) of that definition in section 1(1).

Accordingly, this amount is “remuneration” as defined in paragraph 1 of the Fourth Schedule to the Act (the Fourth Schedule) and will be subject to normal rates of tax applicable to natural persons. Paragraph 9(3)(a) of the Fourth Schedule further requires an employer to obtain a directive from SARS with respect to this lump sum in order to determine the employees’ tax to be deducted or withheld therefrom.

A severance benefit, although payable as a lump sum, is not a “lump sum benefit” as defined in section 1(1), since it is not paid by the person’s retirement fund under the Second Schedule to the Act. As such, the “Guide on the calculation of the tax payable on lump sum benefits” will not apply to the lump sum paid to the employee. Kindly refer to paragraphs 11 and 12.5 of the “Guide for Employers in respect of Employees’ Tax (2021 Tax Year)” for additional guidance in this regard.

Webinar Commentary

Further webinar commentary on An overview of retirement lump sum benefits can be accessed here.

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