Ruling of the National Court on the tax treatment of severance payments

On July 3, 2019, a ruling by the National Court was published introducing criteria to determine the correct application of the exemption on severance compensation

In general, the ruling denies the exemption to the compensation received by 15 employees as it understands that the dismissal is motivated by a voluntary extinctive agreement of the employment relationship between employee and employer, acknowledges the adverse financial circumstances in which the company was going through and, therefore, legitimates the cause of the dismissal.

The Court agrees that the tax law, specifically Article 7.e of the Income Tax Law regarding the exemption of tax on severance payment packages, is limited to the fact that the dismissal is effectively such and not the result of an extinctive voluntary agreement that allows the worker to link with the retirement benefit directly or to receive unemployment benefits until retirement.

Following the criteria of the Tax Inspection, the Court understands that an agreement is deemed to exist, at the present case, when the following circumstances are demonstrated in the dismissal:

  • The age of the employees at the time of dismissal was between 62 and 68.
  • Indemnifications accepted by employees were much lower than those that they were entitled to.
  • The seniority of the employees was not taken into account when determining the amount of severance.
  • Absence of elements of litigation in the dismissal process:
    • No dismissal letters.
    • All dismissals are verbal with no allegation of cause.
    • The documents contributed by the employees to the Conciliation Service are all identical.
    • All acts of conciliation ended with agreement between the parties without the intervention of the judicial authority.
    • All employees waived any subsequent conciliation or claim.

In view of the foregoing, the Court considers that the calculation of the severance was made not on the basis of years of service in the company but on the basis of the remaining years in order to reach retirement at the age of 70. For these reasons, the Court deems the existence of an agreement, not being the dismissal mandatory to the employee.

Few exemptions from the Personal Income Tax Law have aroused as much controversy as the exemption on severance payments. In this sense, we hope that the ruling commented on in this note clarifies the correct application.

It is necessary to infer from all this, an eventual risk of different interpretation by the tax authority when:

  • The compensation is lower than what the worker is entitled to;
  • The employee is approaching retirement age and
  • The conditions of dismissal are offered to the community of employees and they decide whether or not to accept them, for example, in the case of some collective dismissals or the dismissal is freely agreed with an employee.