Taxation Implications of Termination of Employees
Amounts you pay an employee when they stop working for you may be taxable. The tax being payroll tax under the Payroll Tax Act 2007 (NSW). How so and why?
Payroll tax is a state-based tax. It is a tax calculated on the wages employers pay their employees, both actual and deemed.
• self-assess their liability each month; and
• perform an annual reconciliation at the end
of each financial year.
If the total wages bill exceeds the relevant threshold, the employer must pay payroll tax.
In NSW payroll tax at the rate of 5.45% is paid on all the amount of wages over $750,000 per annum.
'Wages' includes most forms of remuneration, including
• superannuation contribution,
• directors' fees,
• most fringe benefits,
• share schemes and
• most termination-related payments.
Payments made to non-employee directors for terminating office and contractors who are deemed employees for payroll tax purposes for termination of service.
Payments to contractors will be deemed ‘wages’ and taxable in certain circumstances.
“Contractors” include sub-contractors, consultants and outworkers. A contractor can be a deemed employee regardless of whether the services by:
• a company,
• partnership or
• as a sole trader.
The distinction between employee and contractor isn’t always clear. The area is one that gets audited often. So make sure your ‘contractors’ really are contractors at law and not employees.
The general rule to apply is that all payments to contractors are liable for payroll tax. Several exemptions exist. If any exemption applies to a particular contract, the payments are not taxable.
Exemptions include any of the following reasons:
• The supply of labour is necessary to the supply of goods owned by the contractor (e.g. hiring a contractor to do work that involves the use of machinery owned by the contractor).
• The services are not ordinarily required, and the contractor provides the same services elsewhere to the public.
• A service is required by the business for fewer than 180 days in the financial year.
• Services are provided by an individual for less than 90 days in a financial year.
• The contractor delivers, transports or provides goods using their own vehicle.
• The service is related to providing insurance coverage.
• The contractor is selling door to door on behalf of a business purely for domestic purposes.
(If these first four exemptions don’t apply, the employer may apply for an exemption from the Commissioner.)
Contractors who engage two or more people to complete all or part of the work may also be exempt. Yet, it isn’t enough for the contractor to use more than two people. More than two people must be working for the employer.
Payroll tax treatment primarily follows the income tax treatment. If taxable for income tax purposes then generally subject to payroll tax.
For payroll tax purposes, the payment must be 'for or in relation to services performed by an employee'.
So, some payments may be taxable for income tax purposes but may not be 'for or in relation to services performed' for payroll tax purposes. An example: Restraint of trade payments are not normally 'for or in relation to services performed'
Similarly, other types of payments that are not 'for or in relation to services performed', are arguably compensation-type payments (unfair dismissal, damages for harassment, gardening leave outside the original employment contract).
At present there are no judicial precedents in this area.
Termination payments include:
• employment termination payments (ETPs) declarable as income under the Income Tax Assessment Act 1997 (Cth). The amount of the ETP that is liable is the amount paid by you less the income tax exempt component when received by your employee
• unused annual leave, sick leave, long-service leave, bonus, loading or other additional payments relating to that leave, no matter when it was accrued
• ex-gratia payments or ‘golden handshakes’
• payments instead of superannuation
• payments instead of notice
• income taxable component of approved redundancy or early retirement scheme payments.
The amount subject to payroll tax is the amount of an employment termination payment paid by the employer that would be income tax assessable income of the employee
A payment arising from the termination of employment may constitute either a genuine redundancy payment under section 83-175 of the Income Tax Assessment Act 1997 (‘ITAA’) or an early retirement scheme payment under section 83-180 of the ITAA. Such payments are exempt from payroll tax to the extent that they are exempt from income tax.
Even in terminating an employee an employer that must pay payroll tax must consider the tax implications. The last thing you want is to be liable to pay a large fine. If you have any doubts don’t hesitate to contact Etienne Lawyers.
by Steven Brown