It is part of economic life that employers sometimes have to retrench employees. Multinational groups often employ mobile employees, meaning employees who work in more than one country for their employer group. Where such mobile employees are retrenched, the payment of a termination package to the retrenched employee may trigger tax obligations for the employee and employer company in more than one country. A termination package typically includes one or more of the following components: a payment in lieu of notice, a bonus, and a severance payment.
Which country is entitled to claim the primary taxing rights in respect of a termination payment made to a mobile employee who worked in more than one country during the period of his employment? According to South African tax law, it is the country of source of the payment, but how is that determined?
The source of termination payments has not been expressly decided on by any South Africa court. Thus, the general common law principles apply, as set out in the leading case of CIR v Lever Brothers and Unilever Ltd1. In this judgment, Watermeyer CJ held that two factors are relevant to determine the source of an amount of income, namely:
If we apply the Lever Brothers principle to the above-mentioned components of a termination package, we submit that the originating cause of a bonus is the services rendered by the employee to earn the bonus and the originating cause of a payment in lieu of notice is the services to be rendered by the employee during his termination period. The source of the income must accordingly be located where the services were rendered (in the case of a bonus) and where the services are to be rendered ((in the case of a payment in lieu of notice) by the retrenched employee. If the services were rendered/are to be rendered in more than one source location (country), it should be apportioned among the difference source locations (countries) in accordance with the time spent in the different countries.
Where is the source of a severance payment located? In our view, a severance payment is compensation for the loss of employment / office and not for services rendered. This means that the originating cause of the severance payment is the termination of the employment relationship. Where should this be located? Our law does not provide any guidance on this point which makes this a surprisingly difficult question to answer.
If the severance payment is calculated with reference to past services, as it often is, we are of the view that the source must be apportioned among the different countries where such past services were rendered. If, however, the severance payment is calculated without reference to past services, it is an open question whether this approach is still correct. We understand that the South African Revenue Service (SARS) will continue to apportion the source between South African and non-South African services with reference to past periods of employment.
Another important consideration is the interplay of these domestic rules with any applicable double tax agreement, where the severance payment is taxable in two or more jurisdictions. The Organisation for Economic Co-operation and Development (OECD) Commentary on Article 15 of the OECD Model Tax Convention mentions that, since a severance payment is often, but not always, calculated with reference to the period of past employment with the employer, the source of such a severance payment should, absent facts and circumstances indicating otherwise, be allocated on a pro-rata basis to where the employment was exercised during the last 12 months of employment. We understand that SARS’ view on this is that it will continue to apportion the source of the severance payment between South African and non-South African services with reference to past periods of employment except if the severance payment is not calculated with reference to past services – in such latter event, SARS will apportion the source between South African and non-South African services with reference to where the employee has provided the services during the last 12 months of employment.
It must be noted that the above principles have not yet sedimented in our law and we therefore recommend that multi-national employers should consider consulting with an expert to discuss the tax implications of retrenching mobile employees.
1 1946 AD 441, 14 SATC 44