In these challenging times companies are being forced to consider restructuring in a bid to have leaner cost structures and in some cases, to survive. Consequently the prospect of redundancy has, unfortunately, become a reality for many SMEs and their employees. This Information Bulletin seeks to outline the tax implications from both an employee and employer perspective.
Redundancy payments exempt from tax:
The main redundancy payments which are exempt from tax are statutory redundancy payments (e.g. what an employee is entitled to under employment legislation, where they meet the eligibility criteria) and any payment made on account of injury or disability. Ex gratia payments/ lump sums, made by an employer may qualify for potential tax relief depending on circumstances.
Redundancy payments not qualifying for relief from tax:
Where a lump sum payment is received on termination of contract and such a payment was provided for in the contract of employment, this payment is charageable to income tax, in full, in the normal way.
Tax on a lump sum is payable in the year the employee leaves the employment. The rate of tax chargeable depends on the income in the given year.
PRSI, Health Levy and Income tax Levy:
Certain lump sum payments made to employees when they leave their employment are not reckonable earnings for PRSI purposes. Examples of such payments are redundancy payments, gratuities or ex-gratia lump sum payments and payments in lieu of notice to an employee when they retire or leave their employment.
However, a Health Levy (Class K contribution), and also the income tax levy is payable on the taxable portion of the lump sum payment.
Pay in lieu of notice
Any payment in lieu of notice over and above the statutory entitlement whether in cash or in some other form will be taxable but may qualify for some relief.
Determining the taxable portion of a lump sum payment:
The amount of relief reduces the taxable portion of the lump sum received. For example if the lump sum received was €20k and the relief was €2k, the taxable portion of the lump sum after relief would be €18k.
There are 3 types of relief available. On receipt of a first redundancy payment the employee can avail of the highest of these three reliefs outlined below.
1. Basic Exemption
Employees are entitled to receive a tax free, ex gratia payment of €10,160 plus €765 for each full year of service with their employer. This is in addition to the statutory entitlement.
Joe has worked for his employer for 10 years. His employer has agreed to pay him an ex gratia payment of €50,000. He will be entitled to relief of €17,810(€10,160 + €765 x10).The remainder, €32,190 is taxed.
Part-time employees will effectively be treated as full time when calculating the period of service. Career breaks are excluded from the period of service.
2. Increased Exemption
In certain circumstances an employee will be entitled to an increased exemption over and above the Basic Exemption outlined above.
An increased exemption of €10,000 is available to employees who either are not a member of an occupational pension scheme or have given up the right (irrevocably) to receive a lump sum from the pension scheme, where no relief has been claimed in respect of a lump sum received in the previous ten years.
Where an employee is a member of an occupational pension scheme the tax increased exemption is reduced by either:
If such a payment is greater than €10,000 then no extra relief is available.
Taking the previous example, if Joe was entitled to a pension lump sum of €5,000, his increased exemption is €17,810 + (10,000 – 5,000) = €22,810.
3. Standard Capital Superannuation (SCSB)
This provides relief to the value of:
A B Value of any tax
_ x _ LESS free pension = Relief
3 15 lump sum
A = Total Emoluments* for the past 3 years
(*Income, BIK plus any other benefits)
B = Years of service
If Joe earned a total salary of €70,000 per annum and BIK of €5,000 per annum over the last three years his position is as follows
(70,000 + 5,000) x 3 10
____________ x _ = €50,000
Relief before deduction of pension €50,000
Less pension lump sum (€5,000)
Amount of relief €45,000
Additional Exemption for the employee: Retraining and Redundancy
An additional exemption of up to €5,000 may be available to an employee who has more than two years full time continuos service, where the employer bears the costs of retraining the employee, as part of a redundancy package. The training must be completed within six months of the employee being made redundant. The employee must avail of the training.
Restriction on basic exemption and SCSB
The Basic Exemption or the SCSB can only be given once against a lump sum from the same employer or associated employer.
Top Slicing Relief
The three reliefs discussed above determine the tax exempt portion of a lump sum received. Once the taxable portion of a lump sum has been determined, top slicing relief ensures that the rate of tax payable on the portion which is taxable is no greater than the average rate of tax paid for the 3 years prior to redundancy or retirement.
Taxable lump sum * (tax rate applied to lump sum – average tax rate paid for the previous 3 years) = amount of top slicing relief.
If Joe’s taxable lump sum is €20,000 he will be taxed in the current year on this at the marginal rate (say 41%, i.e. €8200. If his average rate of tax paid (taking into account tax credits etc) over the previous three years was say 30%, tax on the €20,000 will be restricted to €20,000 * 30% i.e.€6,000
Note: this relief is claimed at the end of a year and is paid as a rebate.
Revenue Approval (three reliefs):
In relation to the basic exemption, or if higher, the alternative SCSB exemption, specific prior Revenue approval is not required.
Revenue approval is, however, required for an increase in €10,000 over the basic exemption.
Refund of certain elements of Statutory Redundancy:
Employers who pay the statutory redundancy entitlement and give proper notice of redundancy (at least two weeks) are entitled to a 60% rebate from the Social Insurance Fund, into which they make regular payments themselves through P.R.S.I. contributions. The Redundancy Payments Section of the Department processes applications for these rebates (see Form RP50).
This rebate is available in respect of each redundant employee.
Redundancy payments are tax deductible as business expenses, provided the company is not being wound up.
Reporting requirements on Employers
Details of all lump sum payments made and treated by employers as exempt by reference to section 201 (2)(a) TCA 1997 and made after 25 March 2005 must be reported to the Revenue Commissioners not later than 46 days after the end of the year of assessment in which the payment was made.
The details to be forwarded to the appropriate tax district responsible for the income tax affairs of the employee / office holder are:
• The name and address of the person to whom the payment was made;
• That person’s personal public service number (PPS no.);
• The amount of the payment made; and
• The basis on which the payment is not subject to tax. In circumstances where the payment is on account of injury or disability, particulars of the injury or disability must also be indicated.
Section 19 Finance Act 2005 introduced a mandatory reporting requirement for employers in relation to such payments and is effective for all such payments made on or after the 25 March 2005.