Pandemic retrenchments and tax reform

Tax policymakers across the globe have been proactive to provide various tax reliefs to both companies and individuals to weather the cruelty of the pandemic – Pic by Shehan Gunasekara  

It is a fact that the COVID-19 pandemic has caused many organisations to make difficult decisions in relation to their employees. Organisations as a survival mechanism have focused on reducing employee-related costs such as staff welfare expenses, trainings, pay cuts and in certain instances, retrenchment of staff. 

Certain organisations have requested their employees to leave due to downsizing or closure while others have offered voluntary retirement schemes to their employees in order to navigate the difficult environment caused by economic hardships. This rings true in relation to companies outside Sri Lanka as well as those within the country. 

The practice of offering Voluntary Retirement Schemes (VRS) could be observed among multinational companies as well as small scale enterprises in Sri Lanka. These are challenging times for decision makers navigating the affairs of many companies. Voluntary Retirement Schemes, retrenchment schemes, termination or loss of employment be whatever the terminology that is, an employee that is severing ties with an employer more often is faced with the daunting task of financing not only his or her future but has to fend for the dependents of that person. Hence the quantum of the payment to be received from the employer at the time of the severance has a major impact in his or her hand. 

Provisioning of food, clothing, payment of utility bills, school fees of the children, health expenditure, rent and all other expenditure items falling due pursuant to severance have to be funded with the severance package to be received from the employer until such employee finds new employment or a new source finance to fend for him or herself and the dependents of the person. 

In the above context, it is certainly a welcome move that the Government introduced an amendment to the Gazette No. 1384/07 which was issued on 15 March 2005 which regulates the maximum quantum of payment to be made by an employer at the time of termination. The Gazette includes the formula to derive the payment of compensation. As per the new amendment by way of Gazette Number No. 2216/17, the ceiling which stood at Rs. 1.25 million has been doubled to Rs. 2.5 million. Although the Gazette was published on 25 February 2021, it has been signed by the Commissioner of Labour on 19 February 2021. There is no doubt this will provide much relief to employees that may lose employment opportunities at the time of termination of employment due to retrenchments caused by the pandemic. 

Whilst hailing the proactive movement by the policy makers to revise the rule entrenched in the Gazette issued under Termination of Employment of Workmen (Special Provisions) Act No. 45 of 1971 and double the quantum of the payment to be made at the time of termination of employment, the author wishes to draw attention to another policy move desired from the tax policy makers, in order to provide relief to both the employer and the employee concerned. 

As per the current rule embed in the Inland Revenue Act No. 24 of 2017 (IRA 2017) unless the compensation for loss of office or employment under a scheme is uniformly applicable to all the employees as approved by the Commissioner General of Inland Revenue (CGIR) the payment made is liable for tax in the hands of the employee at the standard personal Income tax rates. The concessionary rate of tax where the first Rs. 10 million will not be taxed, next 10 Mn at 6% and balance at the rate of 12% would only apply if the scheme is approved by the CGIR. 

Accordingly, the tax Act requires payment of tax from the payment received by an outgoing employee. If one thinks from the perspective of the outgoing employee, it is precious money that one has to rely on to fund his or her future requirements and the requirements of the dependents. From an employer’s perspective, unless it is a uniformly applicable scheme, they may not be able to secure the approval from the CGIR for the scheme. 

The Inland Revenue Act requires the employer to deduct tax from the payment made to an outgoing employee and remit the same to the office of the Commissioner General of Inland Revenue within 90 days of the retention. Meanwhile the employee has to obtain a Direction from the CGIR within 90 days of the deduction of tax by the employer, failing which the employer would remit the tax withheld. 

Furthermore, the current rule is such that, unless such a mandatory deduction is carried out by an employer, the employer loses the opportunity of obtaining a deduction for such payment in calculation of the tax liability of the company. 

Whilst the aforesaid tax rule is fair and justifiable under normal circumstances, it is certainly not so under the present circumstances, both to the outgoing employee who is a victim of the pandemic and the company that is battling to recover from the economic hardships caused by the circumstances. Hence the intervention of the tax policy makers is warranted to amend the current tax rule. Irrespective of the uniform applicability of the scheme, the payment to be made to an outgoing employee should be ideally free from the taxes if not at the very least qualify for the concessionary rate of tax and the company should be provided the right to deduct the payment in calculating its taxable income.

Tax policymakers across the globe have been proactive to provide various tax reliefs to both companies and individuals to weather the cruelty of the pandemic. The Sri Lankan tax policy makers too, have introduced tax reliefs to various stakeholders and selected taxpayers including waiver of taxes for the SME category, deferment of tax payment dates in addition to providing relief for statutory tax return furnishing dates. Perhaps the tax policy makers should consider at least for a temporary time period to reduce the tax burden at the hands of the outgoing employee on the payments received at the point of termination of employment. 

(The views expressed in this article are the author’s own and in her personal capacity.

Rifka Ziyard is the Director – Tax and Regulatory at KPMG. She is a Fellow Member of the Chartered Institute of Management Accountants, UK, Chartered Global Management Accountant (CGMA), Fellow member of the Sri Lanka Institute of Taxation, and holds an MBA from the University of Colombo and a Bachelor of Commerce from the same university.)