Payroll’s termination role

When a worker is terminated, payroll needs to be kept in the loop

When it comes to employee terminations, most managers naturally turn to the HR department for information and advice. What they might not know is it’s just as important to check with payroll.

Payroll and HR must work together to ensure all aspects of a termination are properly covered. Unfortunately, there can be misconceptions about payroll’s responsibility when dealing with terminations. HR will often prepare the paperwork after having negotiated with the employee promises of a payment, how to treat the payment and when to process it without realizing the impact it has on payroll.

Sometimes, payroll can receive complex requests from the company that have not been included in the termination agreements. In other cases, the termination agreement information passed to payroll doesn’t include all the necessary information. This can cause headaches for payroll in a number of ways.

Why date of termination matters

One reason for concern is the need to comply with provincial and territorial employment and labour standards. Each province and territory has enacted legislation regarding the minimum amount of notice an employer must give an employee for an individual termination, a group termination and temporary layoffs.

The notice due an employee being terminated depends on the province in which the employee works and how long the employee has been with the company. The employer will either have the employee physically work the notice period or pay the employee wages in lieu. It’s important that managers are aware of the requirements.

Managers also need to let payroll know what is happening well in advance of the date of termination. Employment and labour standards in all jurisdictions specify time frames within which employers must pay all amounts due to an employee.

In Quebec, employers must pay wages in lieu of notice to employees at the time employment ends. In Ontario, all wages owing must be paid by the later of the next regular pay date or seven days after the employee’s last day of work. In Nova Scotia, all wages owing, except for vacation pay, must be paid at the end of the notice period. Any outstanding vacation pay must be paid within 10 days of the termination. To meet the deadlines, payroll must be aware of the actual date of the termination.

Payroll departments have to ensure the correct amounts for income tax, Canada/Quebec Pension Plan (C/QPP) and Employment Insurance (EI), as well as deductions for the Quebec Parental Insurance Plan, if applicable, are deducted from any amounts paid to a terminated employee.

Payroll is also responsible for reporting the payments and deductions to the Canada Revenue Agency (CRA) and Revenu Québec, if applicable, upon termination or at the time it prepares all of its year end reporting slips such as T4s, T4As, RL-1s and RL-2s.

Another important requirement for payroll is the issuing of records of employment (ROE) when employment ends. An ROE is a three-part document the federal government requires of all individuals who apply for EI benefits. Quebec also requires it for employees taking maternity, paternity, parental or adoption leaves and applying for benefits under the Quebec Parental Insurance Plan.

Employers are required to issue an ROE within five calendar days after an employee has an interruption of earnings. An interruption of earnings occurs when there is a dismissal, layoff or separation of employment that lasts seven consecutive calendar days during which the employee does not work and is not paid earnings considered insurable under EI.

Within the organization, if payroll is responsible for producing an ROE, it’s essential that a manager lets payroll know in advance of the termination in order to meet this critical deadline. There can be stiff penalties for employers who fail to meet the ROE deadline.

Why terminology matters

Another area where there can be a communication gap is in the type of termination package the employee is receiving. Employers offer many different types of termination packages. The terminology also varies greatly.

Lump-sum payments, gratuitous payments and termination money may all refer to the same type of payment, but, depending on the employer or manager, the wording may be different. Regardless of what the employer may call the payment, payroll has to determine what the payment represents in the eyes of the CRA or Revenu Québec in order to know how to process the payment correctly.

Also, depending on what the payment represents, the payroll requirements may differ. In addition to legislated wages in lieu of notice payment, the most common types of payments employees may receive upon termination are salary continuances and retiring allowances. If managers understand the differences between these two types of payments and use the correct terminology, it would help payroll better process the termination payments.

What’s a ‘salary continuance?’

A salary continuance occurs when the employment relationship between the employee and employer continues to exist after the person’s employment is considered terminated. The first indicator of a salary continuance is that the company pension is being maintained, which means the employee is entitled to accrue pensionable service under the company’s registered pension plan (RPP) or deferred profit sharing plan (DPSP).

If there is no RPP or DPSP in place, or the employee was never a member of the company’s RPP or DPSP, look next at the group benefits (medical and dental) being offered. If all of the employee’s benefits are maintained, a salary continuance situation exists. The individual is a “ghost” employee. Everything is maintained, except the employee is not physically reporting to work at the workplace.

Where a relationship continues to exist between the employer and employee, all money is considered employment income. It is subject to regular deductions at source for income tax, C/QPP, EI and the Quebec Parental Insurance Plan and is reported federally on a T4 and in Quebec on an RL-1. Since there is no interruption of earnings, the ROE is to be issued only at the end of the salary continuance period.

What’s a ‘retiring allowance?’

A retiring allowance is a sum of money paid, on or after termination of employment, in recognition of long service or as compensation for loss of the job. Court fees or damages awarded from a court settlement, unused accumulated sick pay credits and severance payments all qualify as a retiring allowance. In Quebec, under the Act Respecting Labour Standards, wages in lieu of notice are also considered a retiring allowance.

Payments can only be classified as a retiring allowance if the employee-employer relationship no longer exists. Either the employee has stopped being a member of the RPP or DPSP, or if no RPP or DPSP exists, then some, or all, of the group benefits have ceased.

A retiring allowance is usually a single payment, however, it may be paid in installments and still qualify. In either situation, continued participation in the employee benefit package will not necessarily disqualify the amount as a retiring allowance, unless the employee is allowed to accrue pension credits after termination. In that case, it’s a salary continuance.

Employers should examine the terms of their benefit plans (medical, dental and so on) to see if continued participation in the plans is limited to employees only. If so, the company needs to establish a plan specifically for non-employees such as retirees or terminated employees. Otherwise, if benefit coverage is continued after termination, the payments are disqualified as a retiring allowance.

Retiring allowances are not subject to C/QPP contributions or EI and, in Quebec, parental insurance plan deductions. The amount is taxable, using lump-sum tax rates, unless the employee transfers the retiring allowance tax-free to an RPP or a registered retirement savings plan.



3 common mistakes
When communication breaks down…

To better illustrate how problems can arise if there is a communication gap between HR (or the manager of the department involved in the termination) and payroll, here are three common scenarios in the termination process:

Scenario one: The employer decides to defer processing the employee’s final pay until the employee returns any company property in his possession such as credit cards, laptop, access card, uniforms or a vehicle. While the employer may have good reason to want to withhold the payments until the company property is brought back, this action could violate employment or labour standards requirements.

All employment and labour standards bodies in Canada require that final payments to employees be paid within a specific period of time. If the employer fails to pay the amounts when required, it could face penalties from employment or labour standards bodies.

Scenario two: The employer wants to process the employee’s wages in lieu of notice, vacation pay on termination and a lump sum, but stop all company benefits, including the pension plan deductions immediately.

In Ontario, this would not be possible, as the Employment Standards Act, 2000, clearly requires the employer to maintain all company benefits for the time equivalent of the wages in lieu of notice.

Scenario three: The employer decides to give the terminating employee a retiring allowance equivalent to six months’ salary, followed by a salary continuance for the next 18 months.

While this may seem perfectly reasonable to the employer, the payroll department cannot do this in the order requested. For a payment to be considered a retiring allowance, there must be a termination of the employment relationship. Yet, if there is to be a salary continuance at a later time, that implies that an employment relationship continues to exist. In such a case, payroll cannot treat the first payment as a retiring allowance.

The only solution would be to reverse the order of the payments so the salary continuance is paid for the first 18 months after termination and ensure that the employee continues to accrue pension credits and remains a member in all the employer’s benefit plans during that time. At the end of the 18 months, the relationship would be severed by at least discontinuing a pension or deferred profit sharing. At that time, the employer can pay the retiring allowance.

Annie Chong is manager of Payroll Consulting Group of Carswell, which publishes the Canadian Payroll Manual and operates the Carswell Payroll Hotline. She may be reached at (416) 298-5085 or at [email protected].

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