Understanding the tax landscape of your golden handshake A guide to terminal benefits under IRA 2017 – By Suresh R. I. Perera

Understanding the tax landscape of your golden handshake A guide to terminal benefits under IRA 2017 – By Suresh R. I. Perera

Source : Sundayobserver.lk

Retirement marks a milestone in any professional’s life, representing the culmination of years of service and the transition to a new phase of financial independence.

In Sri Lanka, the “golden handshake” received at this stage, comprising gratuities, pensions, and provident fund balances is governed by a specific set of rules under the Inland Revenue Act (IRA), No. 24 of 2017 and amendments thereto.

For employers and employees, understanding how these terminal benefits are taxed is crucial to ensuring compliance and maximising the value of retirement savings.

Defining terminal benefits

Under the IRA 2017, terminal benefits are broadly categorised as “gains and profits from employment”. Specifically, Section 5 of the IRA includes payments for redundancy, loss or termination of employment, and retirement payments received in respect of employment within the scope of taxable income. Terminal benefits are characterised as “lump-sum” or “once-and-for-all” payments.

The law identifies several distinct types of terminal payments:

● Commutation of a pension: A lump-sum payment received in exchange for giving up a portion of a future pension.

● Retiring gratuity:A statutory or voluntary payment made by an employer in recognition of past service.

● Compensation for loss of office:Payments made under redundancy schemes or termination agreements, provided the scheme is uniformly applicable to all employees.

● Provident and Trust Fund withdrawals: Amounts paid at or after retirement from approved funds like the Employees’ Trust Fund (ETF) or Employees’ Provident Fund (EPF)

● Approved funds: The compliance prerequisite

One of the most critical distinctions in terminal benefit taxation is whether the payment originates from an “approved fund.” The Commissioner-General of Inland Revenue (CGIR) has the authority to approve pension, provident, and termination funds for tax purposes.Importantly, the EPF and ETF are statutorily considered approved funds for all purposes of the IRA 2017.

This status is vital because payments from approved funds are often subject to more favorable tax rates or specific exemptions compared to unapproved funds.

● Unapproved funds: Any sums payable from any provident fund, which has not been approved by the CGIR

● Other payment or benefits made in respect of retirement

The exemption shield: What is non-taxable?

Not every rupee received at retirement is subject to the taxman’s reach. The IRA provides several specific exemptions to protect the welfare of retirees:

● Compensation or gratuity – injury and death: Capital sums paid as compensation for death or personal injuries

● Government pensions and other payments upon retirement:Pensions received from the Sri Lankan Government or a government department

● Approved Provident Funds (EPF): Amounts paid from an approved provident fund (employer and employee contribution) areexempt at the point of receipt for the employee

● Any pension and ETF Investment Income: Any part of an ETF payment that represents investment income earned by the fund on or after April 1, 1987, is exempt from income tax

Tax calculation:

The “once-and-for-all” principle

Unlike regular monthly salaries, which are subject to standard progressive tax tables (ranging from 6% to 36%), terminal benefits, under certain circumstance are taxed using specialised rates to prevent a taxpayer from being pushed into an unfairly high tax bracket in a single year.

Terminal benefits that qualify for the concessionary rate (subject to rules) are as follows:

l amount received in commutation of a pension;

l amount received as a retiring gratuity;

l amount received as compensation for loss of office or employment under a scheme which the Commissioner General considers to be uniformly applicable to all individuals employed by the employer; and

l amount paid to a person at or after the time of retirement from employment from the Employees’ Trust Fund, established by the Employees’ Trust Fund Act, No. 46 of 1980.

From January 1, 2020: The threshold for taxation was increased. The threshold and rates applicable are as follows

Not exceeding Rs. 10,000,000 – 0%

Exceeding Rs. 10,000,000 but not exceeding Rs. 20,000,000 – 6% of the amount in excess of Rs.10,000,000

Exceeding Rs. 20,000,000 – Rs. 600,000 plus 12% of the amount in excess of Rs. 20,000,000

It is important thatany payment received other than mentioned above would be subject to tax at progressive rate applicable to such individual.

Withholding of tax on terminal benefits: the procedure for release. The Inland Revenue Department requires employers to withhold tax at source before releasing certain terminal benefits to employees.

Advance Personal Income (APIT) table 3 appliesfor deduction of Tax from Once-and-for-all Payments (Terminal Benefits – All Employees).

The withholding rates (APIT)

The APIT table provides two withholding rates, depending on the nature and quantum of the payment.

APIT at 12% Rate

Where the total terminal benefit payments made by an employer and/or the Employees’ Trust Fund (ETF) exceed Rs. 5,000,000, the employer and ETF must withhold 12% tax on the amount exceeding Rs. 5,000,000.

This applies to:

(a) commuted pension payments,

(b) retiring gratuities,

(c) compensation for loss of employment paid under a CGIR-approved uniform scheme, and

(d) ETF payments, excluding investment income earned after March 31, 1987.

Employers wishing to use an approved compensation scheme must obtain prior approval from the Commissioner General of Inland Revenue through the IRD’s Tax Policy and Legislation Unit.

APIT at 36% rate

A 36% APIT must be deducted from certain retirement-related payments and benefits by the employer, including:

(a) compensation for loss of employment under a scheme not approved by the Commissioner General of Inland Revenue (CGIR),

(b) payments from unapproved provident funds,

(c) any other retirement-related payments, and

(d) retirement non-cash benefits, valued at their market value

However, no APIT is required if the employee’s total taxable remuneration from the beginning of the year up to termination, together with these payments and benefits, does not exceed Rs. 1,800,000.

Retention and application for direction

Where tax has been deducted under APIT, the employer must retain the deducted amount and instruct the retiring employee to obtain a tax direction from the Clearance and Directions Unit of the Inland Revenue Department (IRD) within 90 days. Upon receiving the IRD’s direction, the employer must act according to those instructions. If no direction or advice is received within 90 days from the date of deduction, the employer must remit the APIT to the Commissioner General of Inland Revenue.

Understanding the tax treatment of terminal benefits is essential for employers and employees to ensure compliance with the IRA and to optimise retirement outcomes. While approved retirement payments such as gratuity, pension commutations, and ETF benefits enjoy concessionary tax treatment and exemptions, payments from unapproved schemes may attract higher tax rates. Proper application of APIT withholding procedures and timely engagement with the Inland Revenue Department are therefore critical to achieving a smooth and tax-efficient retirement transition.

The writer, an Attorney-at-Law (LLB), FCMA(UK), CGMA, FCMA, was awarded Tax Practice Leader of the Year 2024 (ASPAC) by International Tax Review (ITR) and was a top-four finalist for Tax Litigation and Disputes Practice Leader of the Year (ASPAC).