Severance pay: formal requirements for exemption from personal income tax

Severance pay is only exempt from withholding when it is recognised by conciliation or by court decision, without the amount being entered in the dismissal letter being sufficient.

Withholdings on account of personal income tax indemnities for dismissal

The letter of dismissal of a worker states that the worker is inappropriate. And, faced with the doubt of whether in this case the compensation paid by the company is exempt from Personal Income Tax, the consultation is raised before the General Directorate of Taxes; who concludes:

1. That since the compensation has not been recognized in the act of conciliation before the SMAC or by judicial decision, the amount received for this concept is subject to and not exempt from Personal Income Tax. Consequently, it is appropriate for the undertaking to levy withholdingtax on the amount paid to the worker, which is considered to be work performance.
2. However, the compensation received may be applied to the reduction of 30% foreseen in cases of income obtained in a notoriously irregular way over time, provided that the number of years of service of the worker in the company has been greater than 2 (period considered to generate the yield), and the following are met conditions:
   • a) Within the period of the previous 5 tax periods, the worker-taxpayer cannot have applied this reduction on other income witha generation period of more than 2 years.
   • (b) The amount of thefull income on which the reduction is applied may not exceed €300,000 per year. In addition, when the amount is between 700,000.01 euros and 1,000,000 euros, the amount of income on which the reduction is applied may not exceed the amount resulting from a reduction of 300,000 euros in the difference between the amount of the yield and 700,000 euros. And when the amount is equal to or greater than 1,000,000 euros, the amount on which the reduction is applied is zero.

Summary of indemnities assessed for termination of contract

The following summary table shows, in a schematic way, the legal compensation provided in relation to the different causes of extinction, including the maximum ceilings established in some cases; in addition to the regulations by which they are governed.

Exemption Vs. No Clamping

The taxable event is the budget whose realization originates the birth of the tax obligation.

The law may:

• exclude from the taxable event certain cases, so that this, by legal will, does not occur: non-subjection; or
• prevent the tax liability from arising, even if the taxable event has occurred: exemption.

Deadlines

Calculation of retention

approach

Imagine that on November 1st your company dismisses a worker with a gross annual salary of 120,000 euros. The settlement corresponding to extra pay and holidays is 10,000 euros, and the compensation – calculated according to the limits established in the labor legislation – is 215,000 euros.

The part of compensation that exceeds the 180,000 euros established by law as the maximum limit (35,000 euros in this case) will be subject to Personal Income Tax, as well as the 10,000 euros corresponding to the settlement.

solution

To calculate the withholding to be practiced on the final payment, taking into account that until October 31 the worker has collected 94,286 euros and has endured a withholding of 32,350 euros (at the rate of 34.31%, according to the calculations made at the beginning of the year and in which it was considered that he had two children and that he presented an individual declaration) , the output would be as follows:

(1) The subject compensation is reduced by 30% if the affected person is more than two years old.

To determine the withholding to practice on the final payment, you can access the withholding calculation program on the AEATwebsite.

Retention allowance

If your company dismisses a worker and satisfies an indemnity above the legal limit or whose amount exceeds 180,000 euros, the excess will be taxed in personal income tax and will be subject to withholding.

Indemnification and settlement

If your company dismisses one of its workers, it must meet the following amounts:

The salary for the days worked in the month, the proportional part of extra pay and, where appropriate, the proportional part of holidays not enjoyed. eye! Because these perceptions are subject to retention.

Likewise, you must pay the compensation that corresponds to your seniority.

With retention

Although in most cases this compensation will be exempt from taxation in personal income tax and will not be withheld, in some cases the company must withhold. Specifically, this will occur if:

• If the compensation exceeds the amount established by law (in unfair dismissals, between 33 and 45 days of salary per year worked, depending on the seniority in the company). In this case, the excess will not be exempt, so you must practice the corresponding retention.
• Or if, not exceeding this legal amount, the compensation exceeds 180,000 euros. In that case, you must withhold on the amount that exceeds that amount.

Recalculation of retentions

If there are these excesses subject to withholding, there will be variations with respect to the amount that the company took into account at the beginning of the year to determine the type of withholding applicable to the worker’s payroll.

Therefore, you must recalculate the applicable withholding according to the final remuneration, and apply a “regularized” withholding rate on the last payment to be made to the worker.

In any case, if you have any questions about this type of calculations or about any labor issue of your company, you can contact us, and our team of advisors and consultants for companies will be in charge of helping you.