Severance Pay vs Redundancy Pay in Australia

Redundancy Pay: A Statutory Entitlement

Redundancy pay is a statutory entitlement enshrined in the National Employment Standards (NES), which are set out in Part 2-2, Division 11 of the Fair Work Act 2009 (Cth) (the Act). It applies when an employee's position is terminated because the employer no longer requires the job to be performed by anyone, or because of insolvency or bankruptcy, and this is not due to the ordinary and customary turnover of labour. The key element is that the job itself is gone, not merely the person performing it.

Eligibility for Redundancy Pay

To be eligible for NES redundancy pay, an employee must:

• Be covered by the NES (which generally includes all employees in the national workplace relations system, excluding certain high-income earners not covered by an award or agreement, or employees of small businesses in some circumstances).
• Have completed at least 12 months of continuous service with the employer.
• Be terminated due to genuine redundancy.

Employers are generally exempt from paying redundancy entitlements if:

• They are a small business employer (fewer than 15 employees at the time of redundancy).
• There is an industry-specific redundancy scheme that applies to the employee.
• Their enterprise agreement or modern award specifies different redundancy provisions (though these cannot be less favourable than the NES if the NES applies).
• The employee's employment is terminated because of serious misconduct.
• The employee is employed for a specified period, task, or season.
• The employee is a casual employee.
• The employer offers suitable alternative employment, and the employee unreasonably refuses it.

Calculating Redundancy Pay

The amount of redundancy pay is based on an employee’s continuous service with the employer. Section 119 of the Act outlines the scale:

• Less than 1 year: 0 weeks
• At least 1 year but less than 2 years: 4 weeks
• At least 2 years but less than 3 years: 6 weeks
• At least 3 years but less than 4 years: 7 weeks
• At least 4 years but less than 5 years: 8 weeks
• At least 5 years but less than 6 years: 10 weeks
• At least 6 years but less than 7 years: 11 weeks
• At least 7 years but less than 8 years: 13 weeks
• At least 8 years but less than 9 years: 14 weeks
• At least 9 years but less than 10 years: 16 weeks
• 10 years or more: 12 weeks (this reduction for long-serving employees has a historical basis and was subject to changes in 2009).

The calculation is based on the employee's base rate of pay for their ordinary hours of work. It does not include loadings, penalties, allowances, or superannuation.

The Fair Work Ombudsman (FWO) is the primary regulator responsible for enforcing the NES, including redundancy entitlements.

Severance Pay: A Broader Concept

'Severance pay' is not a legally defined term under Australian law. Instead, it is a colloquial term that describes any lump sum payment or package provided to an employee upon the termination of their employment, regardless of the reason for termination. It often encompasses several components that – depending on the circumstances – may or may not be legally mandated.

When parties refer to 'severance pay' or a 'severance package', they are usually referring to a comprehensive exit payment that can include both statutory entitlements and additional, discretionary payments.

Components of a Typical Severance Package

A comprehensive severance package can include:

1. Statutory Redundancy Pay: If the termination is a genuine redundancy and the employee is eligible under the NES, this forms a core part.
2. Payment in Lieu of Notice (PILON): Employers are generally required to provide a period of notice before terminating employment, or make a payment equivalent to that notice period. The minimum notice periods are set out in the NES (Section 117 of the Fair Work Act 2009), increasing with an employee's length of service. Modern awards, enterprise agreements, or employment service agreements may specify longer notice periods.
3. Accrued Annual Leave: All unused accrued annual leave must be paid out upon termination, regardless of the reason. This is a clear statutory entitlement under the NES.
4. Accrued Long Service Leave: Entitlements to long service leave are governed by state and territory legislation (e.g., the Long Service Leave Act 1955 (NSW)). Generally, an employee must have completed a minimum period of continuous service (e.g., 7 or 10 years) to be eligible for full or pro-rata payment of accrued long service leave upon termination, though this can vary depending on the reason for termination in some jurisdictions.
5. Ex-Gratia Payments / Additional Severance: This is the discretionary component. Employers may choose to offer an additional payment beyond statutory and contractual entitlements, for various reasons:
   • To encourage a smooth departure and avoid potential disputes.
   • To recognise loyalty and contribution, especially for long-serving employees not eligible for NES redundancy due to the small business exemption.
   • As part of a negotiated settlement for a contested termination (e.g., an unfair dismissal claim).
   • In exchange for the employee signing a Deed of Release, which typically waives their right to bring future claims against the employer.
6. Superannuation: Superannuation contributions cease with employment. Any superannuation guarantee contributions accrued up to the termination date must be paid. Superannuation is generally paid on most components of a severance package, including redundancy pay (up to the cap), PILON, and accrued leave, but not usually on true ex-gratia payments that are not part of "ordinary time earnings".
7. Other Entitlements: This might include payment of commissions, bonuses (if contractually owed), or the value of shares/options in accordance with relevant schemes.

Tax Treatment of Severance Payments

The tax treatment of components within a severance package is crucial and can significantly impact the net amount received by the employee. The Australian Taxation Office (ATO) applies different rules based on the nature of each payment.

Key tax categories include:

• Genuine Redundancy Payments: Payments that qualify as 'genuine redundancy payments' under Section 83-170 of the Income Tax Assessment Act 1997 (Cth) benefit from concessional tax treatment. A portion of a genuine redundancy payment is tax-free up to a certain limit (known as the tax-free threshold), which is indexed annually. Any amount above this threshold is taxed at a concessional rate, typically lower than ordinary marginal income tax rates. For a payment to be 'genuine', criteria include that the dismissal must result from the abolition of the employee's position, the employee must not have reached retirement age, and the payment must exceed the amount that would have been paid if the employee had voluntarily resigned or retired.
• Employment Termination Payments (ETPs): Certain lump sum payments made when employment is terminated are classified as ETPs. These include payment in lieu of notice, ex-gratia payments (unless they are genuine redundancy payments), and some unused sick leave. ETPs are taxed concessionally up to a cap, with different rates applying below and above the cap, and based on whether the employee has reached their preservation age.
• Unused Annual Leave and Long Service Leave: Payments for unused annual leave are generally taxed at the employee's marginal tax rate. Payments for unused long service leave accrued after 15 August 1978 are also taxed at the employee's marginal tax rate, while a concessional rate may apply to leave accrued before this date.
• Superannuation: Superannuation contributions are generally preserved until a condition of release is met (e.g., retirement and reaching preservation age). There are specific rules regarding the tax treatment of superannuation lump sum payments.

The interplay of these rules can be complex, and the final tax outcome depends on factors such as the employee's age, length of service, total income for the financial year, and the specific composition of the exit package. Employers must correctly categorise and report these payments to the ATO via Single Touch Payroll.

For both employers structuring exit packages and employees receiving them, obtaining professional advice from a legal and tax advisor is imperative to ensure compliance and maximise financial outcomes. Envision Legal frequently drafts deeds of release and advises on the tax-efficient structuring of exit packages.

This article contains general information only and does not constitute legal advice. Envision Legal accepts no liability for any loss arising from reliance on this content. You should seek independent legal advice tailored to your specific circumstances. For enquiries, contact Envision Legal.