Author: David Jenkins, NZPPA CEO

I have stated this before, but as a payroll professional, part of your role is to act as a gatekeeper for your business to ensure any payment of any type is correct, follows legislative requirements and is paid when it was agreed to be paid. Now in payroll, we act on instructions from management, HR, and external agencies or in response to various things from the employees we pay. But sometimes, payroll will come across instructions that conflict with what we know is right.

I get contacted regularly by payroll professionals that are being put in a position by management or HR that they know is wrong, wanting advice on what they can do. The bottom line is that all we can do in payroll is state what the law is and the consequences to the business and payroll if the law is not followed (and document what we have advised so that if issues occur in the future, payroll can show it was raised). Now, I am not talking about a criminal act (that’s a totally different ball game, and I am happy to say I have never come across that in payroll, except when theft involves “ghost employees”, etc.). I am talking about a situation such as where payroll is told to pay out all annual leave entitlement (the whole four weeks of current entitlement paid out at once because the employee is short of money instead of just the one week that the Holidays Act allows) or payroll is instructed to move payments into a different tax year to help the employee to pay less tax overall.

So, in this article, I will cover a situation I have seen several times to do with payroll becoming involved in paying a monetary compensation payment to an employee or ex-employee as part of a settlement agreement. As always, I will write in plain language for payroll, so if you are looking for a mixture of legal jargon and Latin to spice up the text, you’re out of luck!

When things go wrong at work for an employee

Sometimes an employee will feel that their employer has wronged them for a range of valid and occasionally invalid reasons (not up to payroll to judge or to be involved in that side of things). In the first instance, we would hope an employee can raise any issue with their employer, and both will be open to sitting down and working through a process to get an outcome resolving any problems that works for both parties. But sometimes, this cannot be done, and within the legislation, there is the ability for an employee (if they believe their employer has wronged them) to raise a personal grievance. Part of the employee’s personal grievance would be for them to state how the actions of the employer have caused them some form of harm, such as humiliation, loss of dignity, injury to their feelings and loss of any benefit, whether or not of a monetary kind that the employee might have reasonably expected. This is detailed under section 123 Remedies (1)(c) of the Employment Relations Act. The employee would also normally state what remedy or remedies they are looking for, which they believe would resolve the grievance from their point of view. The employer would use this as part of the discussion and at the other end (after discussion) to determine if an offer such as monetary compensation is made as part of the settlement (if at all). How much money is offered depends on various factors (again, out of payroll’s scope).

Is this payment taxable?

The whole purpose of a compensation payment made to an employee is to compensate the employee for what they raised in their grievance as part of a settlement to resolve their grievance and may form all or part of the remedies sought. So, this is not a taxable benefit that the employee is receiving and is not a reimbursement. It is a non-taxable payment.

Does this payment have to go through payroll?

The short answer is “No”. The usual reason I hear for this to go through payroll is that HR or management sees this as a confidential payment, and they don’t want a payment of this type in a more open financial system and reported in accounts etc.

What is the issue with compensation payments?

So, finally, I get to the reason for this article. Up to this point, I have talked about an employee raising a grievance and the employer potentially making a monetary compensation payment at the other end of that process. Now, this has been part of a process, and if the payment came from the outcome of that process, it would be an entirely valid payment, and the business would be secure in making it. What I have seen is a payment being put through to payroll as a tax-free compensation payment when the employee never raised a personal grievance, never raised anything about the harm they received from an action or actions of their employer or any remedies that the employee had asked for.

Here is an example I have often seen. An employee is told that their position is being made redundant. There was a redundancy process undertaken, but at no point did the employee raise a personal grievance. Now, when the employee is informed that they will be made redundant, they are also offered a redundancy compensation payment (from an agreed redundancy compensation clause included in their employment agreement) that could be changed to tax-free if they are willing to sign a settlement agreement. For the employee, a tax-free redundancy compensation payment looks even more attractive and would mean the payment will cover them for a longer period than a taxable payment would (as it would have been taxed as an extra pay with no earner levy deducted). They sign the settlement, and the payment is forwarded to payroll to pay.

Now, if this payment is made through payroll, payroll (as stated previously) is the gatekeeper and should be confirming that this payment actually meets the criteria to be paid as a tax-free payment, just like any other valid payment made through payroll is checked and verified. So, when checking the nature of the payment, payroll finds out that no personal grievance was made by the employee, no issues about harm have been raised by the employee or remedies sought. This should be a red flag for payroll to question further. Payroll then discovers no process was undertaken or associated paperwork exists and then finds the tax-free payment was offered as a way to exit the employee on better terms. This should be seen as not being a valid tax-free payment and must be highlighted to the business.

Another example is when an employer wants to basically get rid of an employee but does not want to go through the disciplinary, poor performance or redundancy options and calls the employee in for a meeting and offers an exit package stated as tax-free for the employee to leave (pretty much straight away). Again, the payment is offered tax-free to make it more appealing for the employee to take the offer. And once again, no personal grievance is raised or harm caused to the employee or remedies sought. This is all just framed in a settlement agreement and forwarded to be signed off by a mediator from MBIE. All the mediator will do is contact the parties detailed in the settlement agreement to confirm that they have agreed to the terms. They won’t question the background or the process that was or was not undertaken to get to a signed settlement agreement.

The bottom line is that these examples could be seen as the employer aiding in tax avoidance. The employer is leading that action as they are guiding the employee to accept it. And because the employer is promoting it, the employee thinks it is a valid alternative to having to pay tax on this payment.

What about the role of employer representatives and the advice they give?

You would expect that a representative hired to support an employer undertaking a personal grievance process would work in the employer’s best interest. However, I have seen a wide range of issues with services provided by lawyers, and especially by so-called HR consultants. In the example used above on the employee being made redundant, changing the redundancy compensation payment to a tax-free settlement payment was advised by an HR consultant working on behalf of the employer. When challenged on how it could be a tax-free payment without the employee’s personal grievance, all that was stated was, “I have made numerous payments of this type with no issues”. A true representative would understand the requirements to make a valid compensation payment as part of a settlement agreement with an employee. This representative has opened the door for the employer to be liable for tax in making this payment. Also do watch out for employee representatives that are in some cases no better than ambulance chasers that turn up and threaten the employer with over-the-top claims (taking them straight to the employment court, without first going to mediation or the ERA) with the aim to make a deal that usually is about a tax-free payment being made to the employee straight away so the problem goes away.  This type of representative just wants a quick win not for their client but their bank balance as they get their money from the employee.  Any suggestion made by this type of representative when the payment does not meet the criteria to make it a valid compensation payment should be met with a firm “No”.

Are there consequences for the employer if this invalid payment is allowed to be made?

A rather large “YES” on this one. If a payment that should have been taxed (PAYE) is made, the employer is liable for not taxing the payment correctly. IRD has every right to ask and investigate any payment made to an employee, even one made as compensation under section 123 Remedies. Here are just some of the questions that are included in an IRD questionnaire on this area:

1. Internal correspondence and documentation, including mail/letters/memos and submissions relating to personal grievances and/or S 123(1)(c)(i) payments.
2. Evidence that the employee lodged a personal grievance in accordance with the ERA.
3. Correspondence between the employer and former employee/employees (including correspondence between the parties’ solicitors/representatives) relating to personal grievances and/or S 123 (1)(c)(i) payments.
4. Any evidence of actual harm suffered by the employee. This could include third-party documentation (i.e. doctor’s records etc., setting out any harm suffered by the former employee/employees) relating to the personal grievance and/or the S 123(1)(c)(i) payment.
5. Documentation of any meeting between the employer and former employee/employees about the employment dispute. This would include file notes of any such meeting.
6. Documentation of any mediation meeting about the employment dispute. This would include file notes, proposals put forward leading up to and discussed in the meeting, and information on any settlement agreed upon.
7. Any settlement agreement entered into, including any draft settlement agreement or correspondence relating to a draft settlement agreement (from both parties and/or their legal advisers).

So, you could have IRD make its own assessment of the compensation payment made. When they see the employee raised no personal grievance, no precise details of the harm the employee believes they have endured, and little to no associated paperwork (such as meeting notes, letters etc.), you may find that IRD determines the compensation payment is taxable and that the employer is liable to pay the tax owed. You may ask why the employee is not paying taxes. Well, the employer is responsible for accounting and deducting taxes correctly when paying an employee, and there is also a settlement agreement that states all matters are full and final. The other thing that, to me, is even more dangerous for the business is if IRD finds that a compensation payment made is actually taxable. This would be a green light to go for a full audit of the business as it would be clear that the employer has not acted correctly in making a payment to an employee. Now, this is not an issue with IRD. This sits fully with the business and payroll to get right in the first instance.

I had a representative state that they could just write an additional clause in the settlement agreement that the employee would be responsible for any tax owed if the compensation payment were deemed taxable. This is just so wrong because it is basically saying you’re making a payment to an employee that is potentially dodgy and are covering yourself by roping the employee back in to become liable. I see this as being open to challenge and making a mockery of the purpose of personal grievance procedures to help resolve employment issues in a formal but mutually agreeable way.

So, in conclusion, and as stated right at the start, a true payroll professional acts as a gatekeeper for their business. If you become involved in making a compensation payment to an employee and believe it does not meet the criteria, and puts the business at risk, speak up and state what is wrong and the potential consequences for the business. If your view is not accepted, document it and be proud that you have done your job. That’s all we can do, but the key is that you did raise it and did not just let it through.

NZPPA supporting NZ payroll since 2007!