Payroll Bulletin 12

TERMINATION PAY - the differences for payroll to get right

Author: David Jenkins, NZPPA CEO

Termination pay is one of the higher-risk areas of payroll processing. This is because termination pay can include several different types of payments not part of normal payroll processing while using various calculations that can impact other payments being made in the same pay.

I have written on several topics that will be covered in this article, but I wanted to link them up into a termination pay focus for this article (a one-stop shop as such). I will only cover some of the main points for each as some of these areas can have a range of alternative options, so as always, let’s keep it simple.

The areas for termination pay I will cover in this article are:

• 8% for leave termination (what’s included and excluded)

• Notice period worked and paid in lieu

• Redundancy compensation, if agreed to be paid

• Public holidays paid after termination

• Alternative holiday paid out on termination

• Personal grievance payment under Section 123 of the Employment Relations Act

• Payment made to the employee after they have been terminated

• Using your payroll system to best effect when doing a termination pay

As part of each section, the following will also be mentioned:

• Taxing termination payments as an extra pay (lump sum payment)

• What payments go into KiwiSaver on termination?

8% for leave termination

In any termination pay, you will always be dealing with the 8% accrual for holiday pay, whether this is for an employee who leaves before 12 months (start date to end date before 12 months, Section 23) or after 12 months (last entitlement date to end date after 12 months, Section 25). The 8% is based on the taxable gross less any annual holidays paid in advance. One extra point here is if the employer gave an employee an agreed extra week of annual leave (a 5th week), the 8% does not automatically change to 10%. As stated, the extra week was agreed, so the 10% would also have to be agreed, and if not, the 8% is law, and that is what is used.

Notice period worked and paid in lieu

Notice is an agreed term, so payroll should be clear on what notice periods are present within their business. The two main types of notice are when the employee works their notice and when notice is paid in lieu. When an employee works their notice, the termination pay is paid at the end of the notice period as part of the employee’s final pay, so this would include the payment of the notice period, outstanding leave (entitled and accrued (8%), along with any other agreed payments (as per the employee’s employment agreement).

Sometimes, the employer may decide they don't want the employee to work their notice. The choice to do this could be in the form of a clause in the employee's employment agreement or even by agreement with the employee at the time. Payment in lieu is a frequent question we get through to the NZPPA PayTech Adviceline, asking when the actual termination date is. So, think of payment in lieu as paying out the obligation of notice, so the notice is paid out on the date paid and does not extend forward. For example, the employee’s final day is a Friday, and they are not working notice of four weeks as the employer has advised it will be paid in lieu, so the employee’s final day is the Friday. In tax terms, notice worked is taxed as salary or wage, and notice paid in lieu is taxed as extra pay. Notice is included in the 8% on termination and the gross for KiwiSaver.

Redundancy compensation, if agreed to be paid

Nothing in current legislation provides redundancy compensation to an employee when made redundant. So, if this is seen, it is an agreed term. For payroll, you clearly need to understand what has been agreed (what calculation is being used over what period). Redundancy is one type of extra pay (lump sum payment) that no earner levy is included, so it is taxed at the flat tax rate. If the employee has a student loan, this is deducted but is not included in the gross for KiwiSaver or leave on termination (the 8%).

Public holidays paid after termination

One of the quirks with the Holidays Act is that when the employee does not use an outstanding annual holiday entitlement, it gets paid out on termination and will extend forward from the termination date (only entitlement extends forward, not accrual (8%). Think of it this way, the employee could have taken the entitlement as leave, but you cannot be on annual leave on a public holiday, so that is why the employee gets any public holidays in the period. The value of public holidays taken will also go into the 8% for leave and is taxed as extra pay and is included in the gross for KiwiSaver.

Alternative holiday paid-out holidays

An alternative holiday is earned when an employee works on a public holiday that is an otherwise working day.  On termination, if the employee has unused alternative holidays, it is based on the value of the employee’s final day of employment paid at RDP or if the day cannot be determined, ADP.  This is part of the 8% on termination, taxed as extra pay and is included in the gross for KiwiSaver.

Personal grievance payment under Section 123 of the Employment Relations Act

If a personal grievance has been settled that involves a termination payment, payroll may be involved in paying a range of payments depending on what has been settled, including final wages and salary, notice, any leave entitlement not used and the 8%.  The other common payment is a tax-free compensation payment under Section 123(1)(c) of the Employment Relations Act 2000.  As this payment is tax-free, it is not part of the 8% or KiwiSaver.  I regularly hear from payroll that they are not allowed to see the settlement agreement and are told what to pay, but what has been stated does not seem correct.  There is nothing confidential in a settlement agreement that payroll should not see (as with all the confidential information we see daily in payroll!).  It is also a document to put on file as IRD can investigate any tax-free payments made to an employee, including those made under Section 123(1)(c).

Payment made to the employee after they have been terminated

Once a termination pay has been made and the employee has left, there are occasions when an additional payment may need to be made to the now ex-employee, such as commission and bonus payments.  If this payment is made, it is taxed as extra pay, and it will still incur the 8% for leave and be part of the gross for KiwiSaver.  Payroll should contact the employee to get an ir330 (not revert to the one used while employed).  As the extra pay could be based on four weeks of zero, the employee can provide written confirmation if they want the extra pay to be taxed at a higher rate than the present rate that would be based on what threshold the payment was in to be taxed as an extra pay.

Source of information

NZPPA issue number 686 e-Payroll Newsletter, June 2023

If you have any questions or need further information, please don't hesitate to contact Olga at olga@topflight.co.nz