ETPs are a crucial part of employment and involve various considerations from calculation to taxation. In this comprehensive guide, we’ll break down everything you need to know about ETP. Follow Workstem to explore now!
What is ETP?
The Employment Termination Payments (ETP) refer to a lump sum payment made to an employee when their employment comes to an end. Regardless of how or why an employee is terminated, this could be due to reasons such as resignation, retirement, redundancy, or other termination circumstances. One lump sum may be an employment termination payment (ETP).
When is ETP applicable?
ETPs come into play when an employment relationship concludes, regardless of whether it’s voluntary or involuntary. However, not all termination payments qualify as ETP, and it’s crucial to understand the criteria for eligibility.
A payment is considered an ETP when it is made to:
- an employee when the employment is terminated ( a ‘Life benefit’ ETP)
- an employee’s estate because their employment has been terminated due to death (a ‘Death benefit’ ETP)
- the payment is made within 12 months of termination
Note:
- A payment from a super fund is not an ETP.
- A payment made outside of 12 months is a delayed termination payment, unless it’s approved by ATO to be treated as an ETP.
What amounts should be included and excluded from an ETP?
Payments included in ETP:
- payments for unused sick leave or unused rostered days off
- payments in lieu of notice
- a gratuity or ‘golden handshake’
- an employee’s invalidity payment for permanent disability
- compensation for loss of job or wrongful dismissal
- genuine redundancy payments or early retirement scheme payments that exceed the tax-free limit
- certain payments made after the death of an employee
- the market value of the transfer of property (less any consideration given for the transfer of this property)
Payments not included in ETP:
- lump sum payments for unused annual or long service leave
- the tax-free part of a genuine redundancy payment or an early retirement scheme payment
- superannuation benefits (for example, a lump sum or income stream from a super fund)
- foreign termination payments
- salary, wages, allowances, bonuses and incentives an employee is entitled to
- restraint of trade payment
- genuine redundancy payments or early retirement scheme payments within the tax-free limit
- compensation payments for personal injury
How is ETP calculated?
There are several factors that influence the ETP calculation, such as the employee’s service period, weekends, public holidays, long service leave, etc. And you have yto always consider the tax-free and taxable components. Here are some components that make up an ETP:
- Termination reason: Death benefit terminations or life benefit terminations.
- Taxation rules: Whether have special taxation or not, such as unused annual leave, unused sick leave, golden handshakes or gratuities.
- In-lieu-of-notice: Should the employee remain employed until the culmination of the required notice period, the compensation in lieu of notice is determined using their complete pay rate. Apart from obtaining a payment in lieu of notice, the employee also retains the option to fulfil the notice period by working during that time.
- Unused annual leave and long service leave: Should be paid out, unless the employee has utilised their accrued leave ahead of time.
- Other payments: Whether the employee is entitled to other payments like overtime pay, public holiday pay, etc.
- Genuine redundancy payment: Whether the employee’s position is made redundant due to operational changes. There are tax concessions available for genuine redundancy payments up to a certain limit.
The tax treatment of ETPs can vary based on factors. Some ETP components might be subject to concessional tax rates, while others could be taxed at higher rates.
Tax on an ETP
Tax-free amount
ETPs are generally fully taxable although in some cases they may also contain a tax-free amount. A tax-free amount relates to:
- a pre-1983 component of employment
(ETP – invalidity segment) x (Number of days of employment before 1 July 1983 ÷ Total number of days of employment to which the ETP relates)
- an invalidity component
Amount of ETP × days to retirement ÷ (employment days + days to retirement)
- the tax-free element of a genuine redundancy
Taxable component
Taxable component of ETP = Total ETP – tax-free component of ETP
The taxable component of ETP will be concessionally taxed up to certain limits, known as ‘whole-of-income cap’ or ‘ETP cap’.
The type of termination payment will determine which cap applies and will fall into one of 2 payment categories:
- Excluded
- Non-excluded
Any amount in excess of the relevant cap will be taxed (top marginal rate of 45% plus medicare levy of 2%) of 47%.
*For the complete tax on an ETP, please refer to ATO.
Accrued leave
Accrued leave, such as annual leave and long service leave, forms a significant part of ETP.
- Annual leave accumulates from the first day of employment, and it accumulates gradually during the year and any unused annual leave will roll over from year to year.
- Most employees’ entitlement to long service leave comes from long service leave laws in each state or territory. It depends on how long an employee has to be working to get long service leave (for example, after 7 years) and how much long service leave the employee gets.
Annual leave and long service leave have yet to be used should be paid out unless the employee has used annual leave in advance. Even when an employee has been terminated due to serious misconduct, accrued leave must always be paid out.
Lump sum payments for unused annual leave and long service leave are not part of the employee’s ETP. They are separately recorded on either the employee’s:
- income statement at lump sum A or B
- PAYG payment summary – individual non-business.
These payments may be concessionally taxed. The tax rate depends on the type of termination, date of accrual and type of leave.
How can Workstem assist you?
Workstem, a world-class HR & payroll platform, can be a valuable partner in navigating the complexities of ETP. With features designed to handle payroll calculations, tax calculation, Workstem can streamline the ETP process, enables businesses to process leave cashing out, payments in lieu of notice, genuine redundancy pay and more, all in compliance with ATO regulations.
As the landscape of employment continues to evolve, partnering with reliable platforms like Workstem can simplify the process and enable you to navigate ETPs with confidence. Take control of your payroll issues today and experience the convenience of Workstem now!
