The Spanish Personal Income Tax Law establishes an exemption for the severance payable on the termination of an employment relationship, but which can only be taken if a number of requirements are met. The first and most important requirement is that the termination must not be the result of a covenant, clause or agreement between the employer and the employee, i.e., it must originate in a unilateral decision by the employer.
If the first requirement is met, the exemption can be taken on severance deemed to be mandatory pursuant to the Workers’ Statute, to its implementing provisions or to the legislation regulating the enforcement of judgments. In other words, the exemption can be taken only on the amount that must be paid to the employee pursuant to labour legislation when the employer decides to terminate his/her contract, at all times subject to a maximum limit (applicable to dismissals taking place since August 1 2014) of €180,000.
Bearing this tax context in mind, it is important to note that labour legislation establishes mandatory severance for two cases of termination of a senior management relationship: (i) severance equal to seven days per year of service, with a limit of six monthly payments, in cases of withdrawal by the employer; and (ii) severance equal to 20 days per year of service, with a limit of 12 monthly payments, in cases of unjustified dismissal, in both cases provided that one requirement is met: that there is no severance clause to the contrary.
In this way, the labour legislation regulating the senior management relationship clearly provides that the employer and the senior manager may agree to specific severance that is higher or lower than what is stipulated in the legislation. However, if there is no such agreement, the employer is obliged to pay certain minimum amounts. Consequently, if the employer decides unilaterally to dismiss the senior manager, then the tax requirements for taking the exemption are met: (i) there is no agreement between the parties regarding the termination of the relationship and (ii) there is a mandatory minimum pursuant to labour legislation, with the particular feature (non-existent in an ordinary employment relationship) that a different amount of severance can be agreed in the contract.
Change in perspective
Now, despite what is stated in the legislation, the Spanish courts and tax authorities have been defending the view that, given the aforesaid possibility of an agreement regarding severance, all severance paid to the senior manager is voluntary and, accordingly, is not exempt from Personal Income Tax. This position was based on case law laid down by the Labour Chamber of the Supreme Court in the 1990s.
It is now this same Labour Chamber that, by changing its position, has enabled the Judicial Review Chamber (in charge of tax matters) of the Supreme Court to alter its case law.
In its judgment of April 22 2014, the Labour Chamber concluded that the lawmaker cannot permit the employer to agree to “zero severance” with the senior manager. The Court did not, however, rule on whether it was admissible to agree on an amount of severance other than “zero”.
Based on this judgment, the Judicial Review Chamber of the National Appellate Court took the view, in its judgment of March 8 2017, that in a case of withdrawal by the employer, the exemption could be taken on an amount of up to seven days per year of service (limited to six monthly payments), which implied that the Chamber considered this severance to constitute a mandatory minimum.
The Judicial Review Chamber of the Supreme Court upheld the ruling of the National Appellate Court in its recent judgment of November 5 2019, thus altering its former position. The Supreme Court categorically concludes that a clause stipulating a lower amount than that established in the legislation regulating the senior management relationship is invalid, which means that the exemption can be taken up to the statutory amount.
As we see it, two major conclusions can be drawn from this judgment: (i) although the Supreme Court judgment does not refer to a case of the senior manager’s unjustified dismissal, but rather to a case of withdrawal by the employer, it seems clear that its conclusions are extendable to the latter case, which may have a practical application of interest in tax inspections in which the inspectors deem that the employee dismissed by way of unjustified dismissal was a senior manager; and (ii) it is advisable to review the current severance clauses, because many of them may turn out to be null and void.
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