Redundancy – Tips and traps

By Janet Manzanero- Caruana, Senior Technical Manager

The COVID-19 impact

The Australian Bureau of Statistics announced a record 932,000 jobs were lost between the March and June 2020 quarters in the wake of COVID-191. While the Government extended temporary economic assistance for most businesses until March 2021, its gradual phase out may result in many businesses downsizing, winding up or becoming bankrupt. This means it’s possible that more jobs may be lost in the coming months.

Redundancy is a significant event that may impact on a person’s career, family, mental health and financial wellbeing. For those who are ready to retire, termination payments are likely to be a welcome windfall. Those who don’t have retirement on the near horizon may find redundancy stressful, as it tends to happen during a downturn when it may be harder to find a new job.

The immediate issue clients need to address when they’re made redundant is whether there’s enough money to tide things over until the next job comes along.

To achieve the best outcome for a client who has been made redundant, the following issues need to be considered:

  • How will redundancy payments be taxed?
  • What other employee entitlements will be lost?
  • Will lump sum payments impact on entitlements to social security and family assistance?
  • How will payments be used?

This is a great opportunity to make a real difference to your client’s situation during a challenging time, and, if your client is the employer, you may be able to support them to achieve a better outcome for their employees.

1 Source: Labour Account Australia

Genuine redundancy payment (GRP)

Payments on termination due to redundancy attract more generous tax concessions than if the employee resigns.

A GRP must satisfy the following conditions:

  • The employer dismisses the employee because the employee’s position no longer exists.
  • There is no arrangement between the employer (or another entity such as a company associated with the employer) and employee to rehire the employee after dismissal.
  • Where the relationship between the employer and employee is non-arm’s length, the payment cannot be greater than the amount that would be reasonably expected if the relationship was at arm’s length.
  • The dismissal occurs at the earlier of the following:
    • before the employee attains Age Pension age, or
    • before the employee attains the age, or completes a period of employment, when employment would have terminated.

If these conditions are not met, the employee is ineligible for the tax concessions that apply to GRPs. For example, where redundancy occurs on or after Age Pension age, the employee is not eligible for a tax-free GRP.

Tip: If the employee will shortly reach Age Pension age, investigate the possibility of bringing forward the redundancy so that the employee meets the age requirement and qualifies to receive a portion of the GRP tax-free.

Payments on termination

Payments that may be received by an employee who is made redundant include:

  • salary and wages, overtime, bonuses and allowances
  • unused annual leave and long service leave
  • severance payments
  • a gratuity or ‘golden handshake’
  • genuine redundancy or early retirement scheme payments
  • non-genuine redundancy payments (eg redundancy occurs after employee reaches Age Pension age)
  • payments in lieu of notice
  • unused sick leave
  • unused rostered days off.

Taxation of payments

Payments on termination are categorised to determine how they are taxed. A client can plan ahead by asking their employer for an estimate of the payments they will receive including withholding tax amounts. They will be provided with an income statement at termination or they may also obtain this from the Australian Taxation Office (ATO).

The employer withholds tax from payments but the tax is not a final tax because taxable payments are included in the client’s assessable income which may be reduced by allowable deductions.

Payments eligible for concessional tax treatment attract tax offsets so that the tax paid does not exceed the concessional tax rate. Tax withheld by the employer reduces the final tax payable and if too much tax was withheld the excess is refunded to the employee.

The following is a guide to classifying payments and estimating the amount of tax payable:

Step 1 – Identify payments for earned income

Set aside earned income such as salary, wages, overtime pay, bonuses and allowances. These payments do not attract tax concessions and are taxed at the employee’s marginal tax rate after allowable deductions.

Step 2 – Calculate tax on unused annual or long service leave

Identify unused annual and long service leave. The tax on these payments is capped at lower rates when the termination is a genuine redundancy.

Type of leaveService periodAssessable incomeMaximum tax rate1
Annual leave Any service period 100% 30%
Long service leave Pre 16/08/78 5% Marginal
Post 15/08/78 100% 30%

1 Medicare levy and Medicare levy surcharge may be payable.

Step 3 – Work out the non-excluded employment termination payment (ETP), the tax-free genuine redundancy payment (GRP) and the excluded ETP

The remaining payments may comprise of the ETP and the tax-free GRP. What determines each category is outlined below:

1. Non-excluded ETP

Segregate amounts that would ordinarily be paid under the employment contract or relevant award if the employee voluntarily resigned (code O or P in the PAYG Payment Summary - ETP).

These payments are not excluded from the whole-of-income (WOI) cap.

Tip: If unused sick leave is paid on voluntary resignation it is a non-excluded ETP. However, if unused sick leave is paid only on redundancy it may be an excluded ETP. Other payments on termination such as a golden handshake may be classified as non-excluded if they would be paid on resignation.

2.Tax-free GRP

After segregating non-excluded ETPs, the remaining payments are GRP.
Calculate the tax-free GRP limit. GRP up to this limit is not an ETP. It is tax-free and not reported in the employee’s tax return. The tax-free GRP limit is calculated as:

Base amount* + (service amount* X years of service)

For 2020/21 this is:

Base amount = $10,989
Service amount = $5,496
Years of service = number of whole years in the period, or sum of periods of employment, to which the payment relates.

*The base amount and service amount is indexed annually.

The GRP may be less than, equal to or more than the tax-free GRP limit. Where GRP is less than or equal to the tax-free GRP limit, there is no excluded ETP.

3. Excluded ETP

The excluded ETP is any GRP that exceeds the tax-free GRP limit (code R in the income statement). Excluded ETPs are excluded from the WOI cap.

The diagram illustrates the categories:

excluded ETP

Step 4 - Apply the relevant caps for excluded and non-excluded ETPs

The taxable component of ETPs are concessionally taxed up to certain limits, called 'caps'. There are two caps:

  • The ETP cap is equal to $215,000 (2020/21), which is indexed annually and
  • The WOI cap.

Excluded ETPs are deemed to be received first and are subject to the lesser of the:

  • ETP cap less any excluded ETPs received earlier in the financial year, or
  • ETP cap less excluded ETPs received earlier in consequence of the same termination (in the same or earlier financial year).

Non-excluded ETPs are subject to the lesser of the:

  • ETP cap reduced by ETPs received earlier in the same financial year, or
  • ETP cap reduced by ETPs received earlier in consequence of the same termination (in the same or earlier financial year), or
  • WOI cap which is $180,000 (not indexed) less other taxable income (including the taxable component of any earlier ETPs) received in the same financial year.

The WOI cap generally applies to non-excluded ETPs (payments unrelated to redundancy) where it is substantially reduced by the employee’s other taxable income in the financial year payments are received. Total ETPs may not utilise the maximum ETP cap where the WOI cap applies, as shown in this diagram:

WOI cap

The maximum tax rate applicable to the taxable component of ETPs within the caps depends on the client’s age at the end of the financial year.

This table shows the maximum tax rates for ETPs:

Age at 30 June in a payment year

ETPs

Taxed at1

Under preservation age

Within ETP cap and/or WOI cap

Amount exceeding cap

Up to 30

45

Preservation age or above

Within ETP cap and/or WOI cap

Amount exceeding cap

Up to 15

45

1 Medicare levy and Medicare levy surcharge may be payable.

The 12-month rule

ETPs must be paid within 12 months of termination or payments are taxed at the person’s marginal tax rate. ETPs for the same termination may be paid in instalments. The employer may consider the impact of paying an ETP by instalments on their own financial and tax position.

Deferring ETP payments to the next financial year may benefit from the indexation of the ETP cap.

Example:

Gail was made redundant in 2019/20. She is entitled to:

  • $190,000 excluded ETP
  • $70,000 non-excluded ETP.

Her other taxable income averages $130,000 pa including the next financial year.

The excluded ETP reduces the ETP cap ($210,000 in FY 2019-20) to $20,000 ($210,000 - $190,000).

The non-excluded ETP is subject to the lesser of the:

  • WOI cap $50,000 ($180,000 - $130,000), and
  • ETP cap $20,000.

The ETP cap increases from $210,000 to $215,000 in 2020/21. If a non-excluded ETP is paid in 2020/21 an additional $5,000 may fall within the ETP cap.

Tip: Deferring some payments to the next financial year may reduce tax payable.

The 12-month period may be extended where the:

  • delay in payment is due to legal action that commenced within 12 months of termination
  • payment is made by a liquidator, receiver or bankruptcy trustee appointed within 12 months of the termination
  • payment is from a redundancy trust.

Applying concepts example

Frank is aged 65 (he will be Age Pension age on 15 January 2021). He started working for REFCO on 2 January 2012. He earns $130,000 pa as a base salary plus superannuation. REFCO’s turnover is reduced by half because of the impact of COVID-19 and Frank is notified by his employer that his position will be made redundant on 31 December 2020. The table below shows two scenarios for Frank:

Scenario 1: estimated current position.

Scenario 2: position when:

  • Frank and his employer agree to defer his termination to 2 January 2021, adding one year of service to increase the tax-free GRP and reducing the excluded ETP.
  • Frank prepays a year of deductible expenses and makes personal deductible contributions to reduce taxable income, thereby increasing the WOI cap to accommodate all of the non-excluded ETP.

Assuming Frank is not expecting any other income in the 2020/21 financial year, the following table outlines scenario 1 and 2.

Income/maximum tax rateIncome and deductions
Scenario 1
$
Estimated tax
Scenario 1
$
Income and deductions
Scenario 2
$
Estimated tax
Scenario 2
$
Year to date salary, bonuses, overtime/MTR4 75,161   75,6616 
Investment income/MTR4 48,000 23,0194 48,000 12,193
Unused annual leave/30%5 17,500 5,250 17,500 5,250
Unused long service leave/30%5 5,000 1,500 5,000 1,500
Non-excluded ETP1/15%5 57,339 8,601 60,000 9,000
Non-excluded ETP exceeding WOI1/45% 2,661 1,197   
Tax-free GRP3 54,957   60,453  
Excluded ETP2/15%5 35,043 5,256 29,547 4,432
Total assessable income 240,704  235,708  
Less deductions:    
Deductible expenses -16,000   -32,000  
Income protection premiums -7,000   -7,000  
Personal deductible contributions    -17,8127 
Total deductions-23,000 -56,812
Taxable income/tax payable 217,704 44,824 178,895 32,375
Medicare levy 4,354 3,578
Tax and Medicare levy 49,178 35,953

1 Non-excluded ETP subject to the lower of:
Unused ETP cap = $215,000 - $35,043 = $179,957
WOI cap = $180,000 – $122,661* = $57,339
* ($75,161 + $48,000 + $17,500 + $5,000) - $23,000 deductions

2 Excluded ETP subject to the ETP cap

3 Tax-free GRP = $10,989 + ($5,496 × years of service)

4 Salary, bonuses, overtime, investment income after deductions taxed at marginal tax rates

5 Tax offsets limit tax to concessional tax rate

6 $500 increase for one working day

7 $25,000 – (9.5% x $75,661)

Scenario 2 saves $10,553.20 in tax ($49,178 - $35,953 - $2,672 contributions tax) because:

  • tax-free GRP increased by $5,496 with the additional year of service
  • all non-excluded ETP was within the increased WOI cap.

If Frank’s redundancy happens on or after he attains Age Pension age, genuine redundancy requirements won’t be met. The tax-free GRP becomes an excluded ETP and leave payments will be taxed at Frank’s marginal tax rate.

Considerations

Some planning considerations for your client:

  • How the client’s immediate and ongoing expenses can be met and for how long.
  • Whether the client intends to retire or immediately find a job and how long it will take to find a job.
  • The financial resources available to them.
  • Their eligibility for social security payments and/or Family Tax Benefits.
  • Whether the client’s employer has the flexibility to ‘time’ the redundancy and termination payments to assist the client to achieve a better tax outcome.
  • Whether the WOI cap can be increased by deferring taxable income (for example deferring the sale of investments with capital gains implications) and bringing forward allowable deductions.
  • Their capacity to make personal deductible super contributions (including carried forward concessional contributions, if eligible).
  • Client’s expected taxable income next financial year.
  • Whether it is worth the employee taking leave (taxed at the marginal tax rate) prior to redundancy to attract additional SG and increase the years of service.
  • Client’s need to use or invest termination payments.

Social security and Family Tax Benefit entitlements

Clients who are less than Age Pension age may apply for the JobSeeker Payment but are subject to the liquid assets waiting period (LAWP) and income maintenance period (IMP) which run concurrently. The maximum LAWP is 13 weeks. As a rule of thumb, the IMP can be estimated as:

Total of termination and lump sum leave payments
Relevant weekly wage

Example:

Termination and lump sum leave payments = $172,500
Relevant weekly wage = $2,500
$172,500/$2,500 per week = 69 weeks

The IMP may result in the client receiving a reduced or no JobSeeker Payment during that period.

The LAWP and IMP does not apply to the Age Pension. However, payments left unspent are assessed for the pension means test. Superannuation contributions to a spouse who is under Age Pension age may be considered.

Family Tax Benefits may also be impacted by a change in the client’s adjusted taxable income.

Employee entitlements – key considerations

A redundancy also terminates other employee entitlements such as:

  • Insurance – premiums for insurance (in or outside superannuation) may have been funded by the employer so insurance cover may need to be replaced or reviewed. Consider how the client will meet any insurance premiums previously funded by their employer and whether the redundancy impacts on the required level of cover.
  • Employee share schemes – redundancy may be a taxing point for shares granted through an employee share scheme.
  • Fringe benefits such as novated leases and childcare.

Superannuation may need to be consolidated or transferred in cases such as when the employee is a member of a corporate super fund.

Bankrupt employer

If an employer becomes bankrupt, employees who are Australian citizens, permanent residents or special category visa holders may apply under the Government’s Fair Entitlements Guarantee (FEG) for certain entitlements not paid to them including unpaid wages, unpaid annual and long service leave, payments in lieu of notice and redundancy paid up to certain limits.

Conclusion

A redundancy may be beneficial for clients who are ready to retire but stressful for those who need to find a new job in a challenging economic environment. Some employers may be able to offer flexible payment arrangements on termination to facilitate a better tax outcome for the employee. Your role is key in considering both the impact of a redundancy on a client’s overall financial situation and in achieving the best payment outcome.

More information

If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.

Disclaimer
The information in this section of the website is intended for financial advisers only and is not to be distributed to clients. It has been prepared on behalf of Australian Executor Trustees Limited ABN 84 007 869 794 AFSL 240023, IOOF Investment Management Limited ABN 53 006 695 021 AFSL 230524, IOOF Investment Services Ltd ABN 80 007 350 405, AFSL 230703 and IOOF Ltd ABN 21 087 649 625 AFSL 230522 based on information that is believed to be accurate and reliable at the time of publication.