What is Redundancy?
The term redundancy has been statutorily defined as an involuntary and permanent loss of employment caused by an excess of manpower[1]. The definition of the term has also received some judicial perspectives such as in Peugeot Automobile Nigeria V. Oje & Ors[2] and a retinue of other cases[3] where the Courts have agreed that redundancy is an involuntary loss of employment resulting from an excess of manpower.
Redundancy Payment and the Tax Regulatory Framework-
As with resignation and retirement which comes with some form of benefit upon the disengagement of the employee from the employer’s employment, an employee who has involuntarily lost his employment due to excess manpower (redundancy) is by law entitled to payments/compensation for the loss of his employment.
Generally, the Nigerian Legal and Regulatory Framework on the deduction of taxes from payments received or receivable by an employee for loss of employment is a subject of a legal ding-dong. While Paragraph 26 of the Third Schedule of the Personal Income Tax Act[4] (PITA) clearly exempts “any compensation for loss of employment” from taxation, Section 6 (1)(a) of the Capital Gains Tax Act[5] (CGTA) provides that “where any capital sum is derived by way of compensation for any loss of office or employment” such payments shall be “Capital Gains” which are chargeable to tax under the Act. Bad enough, the body of Nigerian Laws on taxation fails to give any statutory definition of what “compensation of loss of employment” means.
PITA OR CGTA?
In dealing with the legal conundrum presented by these two conflicting provisions of the law, tax administrators and regulatory bodies have generally devised a categorization model for the determination of which law would apply to payments received or receivable by an employee as compensation for loss of employment at any given time, depending on the facts of each case.
Under the model, payments for loss of employment are categorized either as “terminal benefit” or “termination benefit” for the purposes of tax treatment. While pre-arranged payments such as gratuities, payments in lieu of notice or pensions[6] which are all payments received or receivable upon the disengagement of the employee whether by satisfactory completion of the required years of service, voluntary resignation by the employee or by the exercise of the employer’s right of termination in accordance with the provisions of the Contract of Service are generally termed as terminal benefits, payments received or receivable upon premature and involuntary termination of employment, by way of redundancy for instance, are categorized as termination benefits. While terminal benefits are generally subjected to taxation as Personal Income Tax under PITA, termination benefits are subjected to taxation as Capital Gains Tax under CGTA.
The rationale behind this model is that terminal benefits usually form part of the pre-agreed payments under the Contract of Service which is akin to the regular remunerations in the course of employment and, therefore, chargeable as regular “income” or “revenue” under PITA. Termination benefits on the other hand are not predetermined, they are unexpected and are irregular lump sum payments accruing as compensation for sudden, involuntary loss of employment which by its very nature would qualify as “capital” and, therefore, chargeable under CGTA. It will then stand to reason that when payments for involuntary loss of employment were pre-agreed, they will be categorized as terminal benefits.
The import of all of the above is that generally, any lump sum received as compensation for loss of employment is subject to one taxation or the other, either as Personal Income Tax under PITA or as Capital Gains Tax under CGTA.
The belief that “compensation for loss of employment” is exempted from taxation is illusory as whatever is exempted under PITA is caught under CGTA and vice-versa. In the real sense, the only disengagement benefits that is exempted or truly immune from taxation is Pensions which are exempted under Section 10 of the Pensions Reform Act, 2014, subject to the conditions stated in the Act.
As has been mentioned earlier, the determinant of the tax-deductible from any payment is the categorization of that payment; either as a terminal benefit or as a termination benefit. Where the provisions of the Conditions of Service or the Contract of Employment on redundancy merely state the “how” and not the “how much” in terms of redundancy payments, then it can be argued that the sum payable has not been pre-agreed and the lump sum will be treated as “termination benefit” which will be chargeable under the CGTA as a capital gain.
As one may wonder, why should it matter which head of tax is applicable anyway? The difference is in the rate applicable and chargeable on each of the two heads of taxes. The current rate chargeable on taxable incomes as Personal Income Tax is a graduating percentage of between 7% at the minimum and 24% at the maximum. Meanwhile, the rate chargeable as Capital Gains Tax is constant at 10%.
EndNote: The new Finance Act, 2020 has no significant effect on the position highlighted above. The Act amends certain parts of seven (7) subsisting Laws on Taxation in Nigeria including PITA and CGTA[7]. However, the parts of PITA and CGTA amended by the Finance Act bear no direct effect on any part of the two Acts relevant to the subject under discussion in this document.[8]
*Ayodeji O.Olabiwonnu, Esq. (LL.B, B.L, LL.M) is the Managing Partner of the LEGALHUB PARTNERSHIP, a Lagos-based full-service Law Firm.
[1] Section 20 (3) of the Labour Act, Cap L1 LFN 2004
[2] (1997) 11 NWLR Pt. 530 Pg. 625
[3] Union Bank v. Salaudeen (2017) LPELR-43415 (CA); Adibuah v. Mobil Oil (Nig.) PLC (2015) LPELR-40987(CA); Obaleye v. Dunlop Ngerian Industries Ltd (1997) 11 NWLR (Pt. 530) 625.
[4] Cap P8 LFN 2004
[5] Cap C1 LFN 2004
[6] Total exemption status is granted to Pensions under Section 10 of the Pensions Reform Act, 2014 (PRA), although subject to certain conditions stated therein.
[7] Others are Companies Income Tax Act Cap C21; Stamp Duties Act Cap S8; Petroleum Profit Tac Act Cap P13; Value Added Tax Act Cap V1 and Customs And Excise Tariff, Etc (Consolidation) Act Cap C41.
Disclaimer: This article is for general information purposes only and should not be taken as a Legal Advice as the same does not constitute advice to the world. The LHP and the author shall bear or assume no responsibility and are hereby fully discharged and excluded from all liabilities or claims that may arise from the reliance on the content of this document by any person, body, or group of persons.
[1] Section 20 (3) of the Labour Act, Cap L1 LFN 2004
[2] (1997) 11 NWLR Pt. 530 Pg. 625
[3] Union Bank v. Salaudeen (2017) LPELR-43415 (CA); Adibuah v. Mobil Oil (Nig.) PLC (2015) LPELR-40987(CA); Obaleye v. Dunlop Ngerian Industries Ltd (1997) 11 NWLR (Pt. 530) 625.
[4] Cap P8 LFN 2004
[5] Cap C1 LFN 2004
[6] Total exemption status is granted to Pensions under Section 10 of the Pensions Reform Act, 2014 (PRA), although subject to certain conditions stated therein.
[7] Others are Companies Income Tax Act Cap C21; Stamp Duties Act Cap S8; Petroleum Profit Tac Act Cap P13; Value Added Tax Act Cap V1 and Customs And Excise Tariff, Etc (Consolidation) Act Cap C41.
Disclaimer: This article is for general information purposes only and should not be taken as a Legal Advice as the same does not constitute advice to the world. The LHP and the author shall bear or assume no responsibility and are hereby fully discharged and excluded from all liabilities or claims that may arise from the reliance on the content of this document by any person, body, or group of persons.