B Law & Tax
22 June 2023

Tax advisor: Compensation awarded to a senior executive due to an unfair dismissal

In relation to the possible application of the personal income tax (IRPF) exemption to severance compensation received by senior executives, the Supreme Court established in a ruling of November 5, 2019 a new interpretative criterion. In cases of termination of the senior management contract due to the employer’s retirement, the labor legislation recognized the right to a mandatory minimum compensation of 7 days’ salary per year of service, with a limit of six monthly payments (according to article 11.1 of Royal Decree 1382/1985). Therefore, that amount of compensation would be exempt from personal income tax.

Since the aforementioned ruling referred to a case of employer withdrawal, the question arose as to whether the criterion established by the Supreme Court could also be applied in cases where the severance payment was due to an unfair dismissal. The latter scenario was analyzed in a ruling of October 21, 2021 by the National Court, which also recognized the exemption in cases of wrongful dismissal in the amount recognized as mandatory minimum compensation in these cases (20 days’ salary per year worked, with a limit of twelve monthly payments).

The change in the tax treatment of compensation received by senior management employees in cases of retirement resulted from the Supreme Court ruling of April 22, 2014. This ruling was based on Article 11.1 of Royal Decree 1382/1985, which establishes a minimum compensation of seven days’ salary per year worked in the case of employer’s withdrawal. The Supreme Court argued that this article has a similar structure and wording to the second paragraph of the same article, which regulates compensation in cases of unfair dismissal, establishing that in the absence of a specific agreement, the compensation will be twenty days’ salary per year worked. Therefore, it was concluded that the tax exemption should also apply in the case of unfair dismissal, since there is an identity of reason to consider that the indemnity in this case has a minimum character. Consequently, the compensation paid to a senior manager for unfair dismissal is tax exempt in the amount corresponding to twenty days of salary per year worked, with a limit of twelve monthly payments.

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