The difference between voluntary and involuntary retrenchment

There is no “voluntary” aspect to retrenchment, and this phase should not be used as it is unhelpful when considering the tax treatment of severance packages and retirement fund benefits, says Jenny Gordon, head of Alexander Forbes Retail Legal.

“Retrenchment is a form of dismissal due to no fault of the employee. It is a process where the employer reviews its business needs in order to increase profits or limit losses, which leads to reducing its employees.”

The Labour Relations Act permits employers to dismiss employees for operational requirements and provides that an employer must pay an employee dismissed for operational requirements “severance pay” equal to at least one week’s remuneration for each completed year of service with that employer.

In the first stage of a retrenchment process, it is acceptable for an employer to offer employees who might otherwise be selected by the employer, a sweetened retrenchment package to opt to be one of the selected employees to go first, said Gordon. This is in advance of the employer making the actual and difficult selection of the remaining employees.

“This is part of the retrenchment process and does not make this first stage of retrenchment into a resignation, which would be a voluntary act of terminating service. It is the first stage of the retrenchment process and qualifies as retrenchment.

“There is no difference in law between “voluntary retrenchment” and “involuntary retrenchment”. The employee has been retrenched.”

Alexander Forbes said that questions always arise in connection with the tax treatment of a severance benefit paid by an employer or a retirement fund upon retrenchment. “It is important to note that the Income Tax Act does not use the word “retrenchment” at all. The word “retrenchment” is a labour law term,” Gordon said.

Although there are no distinctions between “voluntary retrenchment” and “involuntary retrenchment”, the words “qualifying retrenchment” or “non-qualifying” retrenchment” in withdrawal claim forms do make a difference, the legal head stressed.

If the employee owns more than 5% of the member’s interest or share capital of the company, the employee will not qualify for the more favourable tax table.

The South African Revenue Service taxes retirement benefits on retrenchments as follows:

  1. Severance Benefit – a lump sum payment from a person’s employer received on termination of employment on: a) Such person reaching the age of 55; b) Sickness, accident, ill health or incapacity of body or mind; or c) the employer having ceased to carry on or intending to cease carrying on the trade in respect of which he or she was employed or appointed; or that person having become redundant in consequence of their employer having effected a general reduction in personnel.
  2. Retirement fund cash withdrawal benefits on retrenchment will be taxed on the more favourable “retirement table” and not on the “withdrawal table”.

“It is important for employers to understand the importance of ticking the correct blocks when completing tax and claim forms as the incorrect box can have a significant effect on the way the benefits are taxed.

“Retrenchment is a difficult time for employees and their families and it is important to be able to give clarity on the tax treatment of their hard earned benefits at this critical juncture in so many lives. The above are merely guidelines and it is best to consult with a qualified financial adviser who can help make decisions on the available options,” Gordon said.

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The difference between voluntary and involuntary retrenchment