B Law & Tax
14 September 2023

Tax Advisor: The Supreme Court allows the deduction in the Personal Income Tax of the severance pay of senior managers who are administrators

The Supreme Court, in its ruling number 1092/2023, dated July 25, ECLI:ES:TS:2023:3589, has established as case law the following:

1) It is feasible to apply the reduction for irregular income as established in article 18.2 of the Personal Income Tax Law (LIRPF) to compensation received by senior executives who also hold the position of corporate directors at the end of their function, provided that the other requirements established in said precept are met.

2) In order to determine whether it is possible to apply the aforementioned reduction, linked to the irregularity in the receipt of the income, Article 18.2 of the LIRPF must be interpreted, which refers to total income other than that contemplated in Article 17.2 a), i.e., that which has a generation period of more than two years and which is not received on a regular or periodic basis.

3) The earned income corresponding to the compensation of directors and members of the Boards of Directors, as well as of the Boards acting in their stead and other members of representative bodies, being included in article 17.2.e) of the LIRPF, can benefit from the 40 percent reduction (subsequently 30 percent) provided that the other legal requirements are met, which has been met in this case.

4) The theory of the link has no relevance in this specific matter as to the inclusion or not of the compensation to the administrators we are dealing with in the objective scope of the reduction of total income established in article 18.2 of the LIRPF.

The ruling in question, issued by the Supreme Court, partially recognized that senior executives who also corporate directors areentitled to severance or termination pay, which is exempt from withholding in accordance with article 7.e) of the Personal Income Tax Law (LIRPF) of 2006, despite the fact that the Tax Inspection had denied it. However, the National Court denied the 40% reduction for irregular income for the part of the compensation that was not exempt, arguing that the employment relationship was overshadowed by the business relationship in the case of the administrators.

The theory of the link, in principle, holds that the special employment relationship cannot coexist with the mercantile relationship, since the latter prevails over the former, which would prevent the application of the exemption and the 40% reduction. However, the plaintiff argued that in this particular case, the coexistence of both employment relationships, the senior management and the common one, had not resulted in the absorption of the former due to the fact that the workers in question did not occupy particularly preponderant positions within the company.

The Supreme Court points out that the previously established case law recognizes the mercantile nature of the relationship of the corporate directors. However, it also mentions that, according to the case law of the Court of Justice of the European Union (CJEU), at the European Community level, the mercantile relationship is not allowed to prevail over the employment relationship when this is beneficial to the employee. Therefore, the maximalist position of the Audiencia Nacional infringes European Union law, since it places workers who are part of the management body in a disadvantageous position compared to those who are not.

In summary, the Supreme Court concludes that the theory of the link can be debated to determine whether the relationship between senior managers who are directors and the company is of a commercial nature. However, according to the case law of the CJEU, these employees cannot be treated less favorably than those who are not part of the management body or the companies that employ them and must be allowed to deduct the remuneration paid to them. In addition, it is emphasized that, from the perspective of Union law, the single bond theory cannot be accepted, i.e., they cannot be considered workers in some respects and not be considered workers in others.

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