Taxation of termination benefits which include payment of redundancy Payment or loss or termination of employment is guided by section 7(4) of the Income Tax Act, 2004.

Employers who make such payments which are in most cases made in lump sum for compensation to employees for a loss or surrender of employment covering a number of years of service prior to termination should be aware that these payments are subject to income tax.

These payments should be spread back over a period of six years for cases where termination payments for the year of income relate to a year of income earlier than six years from the year when such payment is received or when services cease. No terminal payment will be assessed for tax purposes for the other prior years.

There is however a need to ensure that there is a genuine end of the original employment or cessation of services for the termination of employment tax treatment to be applied. This implies a requirement for the employee to relinquish the office without intension for resumption.

Compensation for the termination of specified term contract for unexpired period of service

Employees payments compensation for the termination of contract for unexpired period of a specified term of service are also taxed. The payment will be spread evenly in the unexpired period and subjected to tax. For unspecified term contract, the amount to be taxed should not be more than the amount which would have been received for the unexpired period of the contract.

Compensation for the termination of unspecified term contract for unexpired period of service

For termination compensation of unspecified term contract, the payment is assumed to have accrued immediately after such termination at a rate equal to the rate per annum of the gains from the employment contract received immediately before such termination.

Taxation of these payments shall be allocated to the period immediately after the termination using the annual rate of the income received for the contract immediately before the termination.

Compensation for a contract of unspecified term with no provision for compensation on termination

The compensation received will be assumed to have accrued in the period immediately after such termination at an amount equivalent to the gain of such contract received immediately before such termination. However, the taxed compensation amount should not exceed the three years remuneration.