When Your Employees Are A Little Too Taxing To Bear, It Might Lead To Termination – But What Does That Mean For The Taxable Consequences Of Their Payouts?

Posted on 19 October '21 by , under tax.

In the business world, employees can leave your business for various reasons. Sometimes as the employer, you may have to step in and terminate their employment (as a result of circumstances). At other times it could be a result of redundancy or resignation.

Regardless of the how or why employers who terminate their employee’s positions must be aware of a critical obligation that they must fulfil.

If you as an employee have your employment terminated, you may be eligible for employment termination payments (ETP). These payments form a part of your final payment, usually paid out as a lump sum or several lump sums. The tax treatment of ETPs will depend on the type of payment, how the employment was terminated and the age of the employee.

Only certain payments are eligible to be classified as ETPs, which receive concessional tax treatment. These can include:

  • Payment for unused rostered days off
  • Payment for unused sick leave
  • Payment in lieu of notice
  • Compensation for loss of a job or wrongful dismissal
  • Severance or gratuity packages
  • Redundancy payments or early retirement scheme payments which exceed the tax-free threshold
  • Invalidity payment, such as permanent disability.
  • Death benefits that are paid to another person as a result of the death of an employee.

For a payment to be classified as an ETP, there must be an official ‘termination of employment. Termination of employment can be as a result of the dismissal, redundancy, employee resignation, retirement, or unforeseen circumstances such as illness or disability.

The rate of tax that is paid on ETPs will depend on the type of payment that is received by the employee. If a part of the payment is for invalidity, it will have a tax-free component. However, the remainder of the ETP should be concessionally taxed, up to the concessional cap.

It is important to be aware of the special tax treatment and differing caps on concessional treatment of ETPs. For instance:

Whole-of-income cap: This is the tax payable on ETP, if an employee earns more income in the same financial year (eg, getting a new job) as their employment is terminated.

ETP cap: This cap applies to all ETP and has a threshold that is indexed annually. The ETP tax rate varies depending on the age of the employee. If over the preservation age, they are taxed at a maximum of 7%. If under the preservation age, they are taxed at a maximum of 32%.

If an ETP is received within 12 months of your termination, it is concessionally taxed. The rules around the concession caps for these kinds of contributions may differ according to the type of payment received.

Unused annual and long service leave may be paid out to employees on termination of their employment. This may be concessionally taxed based on:

  • How the employment was terminated
  • When the leave was accrued

However, these payments are not generally classified or determined as being a part of the ETP. This should be kept in mind when working out ETPs for your employees.

Employees may also request an employment separation certificate from their employer in the event that their employment is terminated. This can be presented to Centrelink when applying for unemployment benefits to assist them during their subsequent job-seeking process. Employers are legally required to issue these upon request – failure to do so may result in harsh penalties.

Employers should also provide an ETP payment summary as part of an employee’s final payment summary. This indicates how the payments were calculated, as well as any tax on these payments.

Have you been put into the position of having to terminate the employment of your employees? We can assist you with navigating employment termination payments, as well as the taxable concessions that those payments may be subject to. Come start the conversation with us.