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- No matter the circumstances, saying goodbye to a member of your team rarely feels simple. And while sorting out the details of their final pay elements (while staying legislatively compliant, of course!) is just one of the many tasks on that particular to-do list, it can seem like a tricky one – at least, without the right knowledge and support.
Today, we’re providing an overview of pay in lieu and severance – the differences, the tax details, and how to easily process both within Payworks’ Payroll application.
First, some definitions…
Before we jump into the details, let’s first make sure we’re all speaking the same language!
“Notice”
To understand the difference between pay in lieu of notice and severance pay, you first need to understand the concept of “notice.” Per the federal government, the broad overview is:
“If you are an employer and choose to terminate the employment of an employee, you must provide the employee with a minimum of two weeks’ written notice. For an employee who has completed at least three years of service, the minimum notice requirement is equivalent to one week per completed year of employment, up to a maximum of eight weeks notice.”
A quick note about the length of notice periods: there are different employment standards in provinces and territories across Canada! For example, Ontario employees who’ve completed one year of service must receive a minimum-two-week notice period, whereas Alberta employees who’ve completed the same length of service must only receive a minimum-one-week notice period. So if you’re looking to get into the nitty-gritty, make sure to review the notice period requirements for the region in which your employee is located!
“Pay in Lieu of Notice”
When it comes to this notice period, there are a couple options for you as the employer: either your departing employee can continue working during that notice period, or you can issue “pay in lieu of notice” instead.
You would choose the latter option when it makes the most sense for a departing employee to stop working immediately or partway through the notice period (as opposed to continuing work until the end of it) – for example, if there’s a conflict of interest with their next employer, or you’re concerned that the employee’s presence will be disruptive to the business over the course of the notice period.
In these situations, the employee’s entitled to payment for the hours they would have otherwise worked during the notice period (if you’d allowed them to do so). This pay is taxed the same as normal earnings. If you’re curious to learn more, we outline some of the legislation surrounding pay in lieu here: https://blog.payworks.ca/what-is-pay-in-lieu.
Of course, there are some exceptions (because there always are!); for a deep dive into circumstances where notice and pay in lieu of notice aren’t required, as well as other details and parameters, please visit: https://www.canada.ca/en/services/jobs/workplace/federal-labour-standards/termination.html.
“Severance Pay”
“Severance pay” is different, as it refers to payment after the notice period (as opposed to during the notice period). Also, not all employees who are eligible to receive notice or pay in lieu of notice are eligible for severance. As the federal government explains, “As an employer, if you terminate the employment of an employee, you must provide the employee who has completed at least 12 consecutive months of continuous employment with severance pay.”
There are a few different ways to issue severance pay:
- As a lump sum payment. In this case, taxes are calculated the same as other lump sum payments:
- Lump sum payment of $5,000 or less: 10% combined federal/provincial tax (or 5% federal and 14% provincial tax in Québec).
- Lump sum payment of $5,001 to $15,000: 20% combined federal/provincial tax (or 10% federal and 19% provincial tax in Québec).
- Lump sum payment of $15,001 or more: 30% combined federal/provincial tax (or 15% federal and 19% provincial tax in Québec).
- As a salary continuance (which means the employee continues to receive their regular pay and benefits over the severance period). In this case, the severance payment is taxed the same as normal earnings.
- As deferred payments – delivered to the employee over several years. This is taxed the same as a salary continuance, but there are additional considerations given the extended time period; you can explore https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/payroll/payroll-deductions-contributions/special-payments/prescribed-salary-deferral-plans-arrangements.html for more information.
Again, there are also exceptions to severance pay eligibility; to explore severance in further detail, please visit: https://www.canada.ca/en/services/jobs/workplace/federal-labour-standards/termination.html.
How Payworks can help
“If one of my clients reaches out for help with processing pay in lieu or severance, the first thing I do is try to get a full understanding the circumstances of the employee’s departure,” says Client Service Representative Linda Azemi. “Every situation is different, and can also be influenced by factors as broad as regional legislation or as specific as the company’s own policies! There’s lots to consider – and that’s why we’re here and happy to help.”
Setting up the right Pay Element
The first step is to ensure that Pay in Lieu, Severance or both are available as a Pay Element. Payworks clients can access and set up Pay Elements through Company Setup (and can always lean on their dedicated Client Service Representative to answer any questions they might have about the process!).
When it comes to setting up Severance specifically, clients will need to determine whether to assign T4 box 66 (“Eligible Retiring Allowance”) or 67 (“Non-Eligible Retiring Allowance”) – both should be set up as separate Pay Elements per Canada Revenue Agency (CRA) requirements. This is reported to Revenu Québec (RQ) under Code RJ, but in the case of RQ doesn’t need to be separated. Learn more about the transfer of a retiring allowance here: https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/payroll/calculating-deductions/determining-tax-treatment/transfer-a-retiring-allowance.html.
Issuing Pay in Lieu
Now that Pay in Lieu is set up as an available Pay Element, Payroll clients can simply enter the information within the Pay Grid View (hint: you’ll find it under Employee Payroll Entries). Alternatively, you can use the individual employee’s Pay Profile, add the payment amount in the Pay in Lieu field, and save.
Payworks pro tip: If a Pay in Lieu column isn’t already visible with your Pay Grid View, all you need to do is click “Customize Grid” to add it, and then add in the payment amount. Easy peasy!
Issuing Severance
As mentioned above, there are a few different ways to pay severance. If you’re opting for salary continuance, you can simply process it the same as regular pay (since it’s taxed the same!). With deferred payments, it’s essentially the same as salary continuance, minus the differences outlined and linked above.
However, if you’re opting for a lump sum payment, you’re recommended to process it separately as its own payment (since the taxes are different from normal pay – no CPP/QPP, EI earnings or hours, or WCB, among other differences). To do so within our Payroll application:
- Enter the Extra Payments screen (found in the Employee Payroll Entries menu).
- Select the employee and the pay period ending date.
- Find “Severance” under Earnings and select “Federal Tax” under Stat Deductions (or “Federal Tax” and “Provincial Tax” for Québec, where they aren’t lumped together). Enter the tax amount based on the calculation parameters outlined above.
Yep, that’s it – seriously!
Staying compliant with complex payroll legislation can be tricky – but you’re not alone! Free to all Canadian businesses: Payworks’ Payroll Guide, which can help you stay informed on all the details you need to know to pay your employees accurately. Download your copy today: https://www.payworks.ca/landing-pages/campaigns/payroll-guide.
