What is an ETP payment according to the law?
For a payment to be classified as an ETP, there must be an official ‘termination of employment’. Termination of employment can be as a result of dismissal, redundancy, employee resignation, retirement, or unforeseen circumstances such as illness or disability.
Employment termination can also be by mutual agreement, otherwise known as a life benefit termination payment. In the event of the death of an employee, employers also need to pay a death benefit termination payment to a beneficiary. Both life benefit termination payments and death benefit termination payments are part of ETP but may be taxed differently.
Lastly, upon the termination of employment, employees may also request an employment separation certificate from their employer. This is in case they wish to apply to Centrelink for unemployment benefits. Employers are legally required to issue these upon request.
How is termination pay calculated?
According to the Income Tax Assessment Act 1997, employment termination payments are generally calculated based on an employee’s period of employment. This is known as their ‘service period’ with an employer.
The service period is the number of calendar days from the date an employee started working for an employer to the date employment was terminated. This includes work done in a part-time, casual or full-time basis. It also includes weekends, public holidays, and any periods of annual or long service leave. Typically, the service period doesn’t factor in any period of leave without pay.
When calculating ETP tax, it can be split into two parts: the taxable component and the tax-free component.
Every ETP has a taxable component. However, there is also a tax-free component for any invalidity payments or payments for employment that took place before 1 July 1983.
Invalidity payments are made to any employees who cannot work on medical grounds and need to take early retirement. This can include permanent disability or other cases of ill health. Invalidity payments represent the time between when employment was terminated, and the day an employee would have retired. As part of an invalidity payment, employers must fill out an invalidity segment worksheet and submit this to the Australian Taxation Office.
In addition to invalidity payments which are tax-free, employers should not tax ETP for any days of employment that occurred before 1 July 1983. In both cases, employers also cannot withhold from the tax-free component when paying any ETP.
Employers should also provide an ETP payment summary as part of an employee’s final payment summary. This indicates how the payments were calculated, as well as any tax on these payments.