Redundancy pay tax in Australia explained

July 8, 2021

redundancy pay tax australia

Payroll laws in Australia are designed to protect employers and employees, but they can pose challenges to your business if you are unfamiliar with how they work.

Redundancy pay is one facet of employment that will likely come up if you have employees working in Australia. What is redundancy pay? Does redundancy pay get taxed in Australia? Read on to learn more.

What is redundancy pay?

When an employer no longer needs an existing employee to perform their role, that employee is considered redundant and is entitled to redundancy pay. This effectively plays the same role as severance pay in the United States, when employers provide employees with a sum of money and (sometimes) benefits following a lay-off or other termination.

In Australia, employees may be made redundant for a variety of reasons, including:

  • A slowdown in business
  • Mergers or takeovers
  • Business restructuring or reorganizing
  • Implementation of new technologies that replace current employees
  • Business relocation

Not every employee has an entitlement to a redundancy payment in Australia. Eligibility requirements and the actual amount paid depend on a variety of factors, including:

  • Length of employment
  • Employer’s business size
  • Employer’s ability to pay the amount owed
  • The exact wording in any employment contract, award or enterprise agreement

For employees that are eligible, the standard redundancy pay is equivalent to their ordinary rate—not including bonuses, commissions or overtime—and depends on the length of employment. For example, an employee that has worked with a company between one and two years will receive four weeks of pay at their regular rate. An employee that has worked at a company for at least 10 years will receive 12 weeks of pay.

When is redundancy pay not required?

Businesses with less than 15 employees—including the employer and the redundant employee—at the time of dismissal are not required to pay redundancy. There are some exceptions, like if an employment contract specifically notes a redundancy payment.

In other cases, an employer may offer an employee another job or position within the company. If the employee refuses, the employer may reduce the redundancy pay, sometimes even down to zero.

Redundancy payments are generally not required at the end of an agreed contract period for fixed-term contract positions. However, fixed-term contract redundancy rights in Australia may allow for some form of payment for early or unfair dismissals of fixed-term contracts.

Another exception is an employee that has worked at a company for less than a year. An employer is not required to pay redundancy for an employee of 12 months or less.

Employers that are unable to pay redundancy can also apply to the Fair Work Commission to have the amount reduced or waived entirely. However, employers that have gone bankrupt or entered liquidation may still have to pay employees unpaid entitlements, including redundancy payment.

Ownership changes

Ownership changes can come with unique challenges. If an employee’s role becomes redundant due to an ownership change, but the new owner hires the employee, that employee will not receive redundancy pay. In this situation, the employee is not considered to have been terminated from their previous position, even if they are technically employed by a new organization.

However, in some instances, the new employer can choose not to recognize an employee’s previous service period. This would require the previous employer to then provide redundancy pay.

Genuine vs. non-genuine redundancy payment

Taxes on redundancy payments rely on whether the payment was genuine or non-genuine. A genuine redundancy is payment provided to an employee whose position is abolished, resulting in termination. In order for a redundancy to be considered genuine, the employer must consult with the employee and determine eligibility based on the registered agreement terms.

Non-genuine redundancies vary, but can include:

  • Dismissals when an employee reaches retirement age
  • An employee leaving voluntarily
  • An employee leaving once their contract has completed
  • Dismissal for any disciplinary or inefficiency reasons

Furthermore, a redundancy is considered non-genuine if the employer terminates an employee but still needs that role to be filled by someone. If the employer could have reasonably given the employee another job at a different position in the business or associated entity, the redundancy is not considered genuine.

Determining whether the redundancy is genuine is important for tax reasons, but it’s also necessary to protect employers and employees. With a non-genuine redundancy, an employee may potentially succeed in an unfair dismissal claim, which can be even more costly and time-consuming for the employer.

Taxes on redundancy payments

Genuine redundancy payments are tax-free up to a certain limit that is determined by an employee’s years of employment. That limit is a flat dollar amount combined with an additional amount for each year of employment. The employer reports this tax-free amount as a lump sum payment on the employee’s income statement.

Above that tax limit, the payment summary can be concessionally taxed as an employment termination payment (ETP). For any redundancy amount above a certain cap, the payment is taxed at the employee’s typical marginal tax rate.

Non-genuine redundancy payments are not tax-free. They are taxed as part of an employee’s  ETP, but if the amount does not exceed certain caps, the payment is considered taxable income. Although, it receives a lower rate than normal.

Generally with concessional tax treatment, the payment is taxed at a much lower rate than an employee’s marginal tax rate. Redundancy payments are concessionally taxed if they are received within 12 months of the employee’s termination. Otherwise, the payment is considered part of the employee’s assessable income, which is then taxed at the normal, marginal rate.

If an employee receives an ETP, the employer is also required to pay out any unused annual leave. However, this payment is not included in the employee’s ETP and is separately recorded on their income statement. The lump sum payment for unused annual leave can be concessionally taxed.

Navigating tax and labor laws as an employer in Australia can be overwhelming and confusing, and the stakes are high as any misunderstanding of those laws can lead to litigation and costly proceedings.

Working with a global employer of record can take the pressure off of navigating foreign tax law by providing your organization with the resources and personnel necessary to manage international employment.

Learn more about how our employer of record service in Australia can support your employment compliance and tax needs.

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