The compensation for unlawful dismissal is not exempt from taxation in the Personal Income Tax when there are clear indications of an agreement between the parties

The Spanish National High Court does not consider exempt the compensation for unlawful dismissal for seeing evidence of mutual agreement between the parties.

 The exemption, established in the Personal Income Tax Law, for which compensation for unfair dismissal is not taxed, requires that this compensation is not established by an agreement or contract and that the termination of the employment relationship does not come from a mutual agreement. The “Audiencia Nacional” has issued a judgment declining an exemption for unlawful dismissal because of the clear evidence that it was a dismissal by mutual agreement.

In this case, the appellant is an entity that dismisses 15 workers, who were satisfied with compensation for unlawful dismissal. In the Resolution of the Spanish Administration, it is considered that the amounts paid as compensation by the entity, are not exempt from taxation and therefore are subject to withholding tax by the entity. This resolution of the Administration was appealed to the “Tribunal Económico-Administrativo”, which dismissed it. The entity, finally, appealed before the Spanish National High Court “Audiencia Nacional” the Resolution of the “Tribunal Económico-Administrativo”.

The article 7, section e) of the Law on Personal Income Tax (PIT) provides for an exemption according to which compensation for unfair dismissal will not be taxed in the PIT, although with the limit of compensation of up to 180,000 euros, the part of the compensation that exceeds this amount will be taxable. For the exemption to be enforceable, as mentioned above, the dismissal must be unfair and without mutual agreement.

In this case, the entity argues that the dismissal was unlawful, however, the Court finds clear evidence that it was an agreed dismissal, such as:

  • The acceptance by the 15 employees of a lower compensation than the one that legally corresponded to them. The amount set as compensation did not correspond to the years of seniority (years worked) but to the years that each employee lacked to reach retirement.
  • The age of the workers at the time of termination of the contract was between 62 and 68 years.
  • The deficient formality of the dismissal process: no dismissal letters were made, they were all verbal dismissals without any cause, the allegation briefs of the 15 employees were identical and all of them resigned in the conciliation act to any later claim. This lack of formalization of the dismissals makes it clear that the employees did not have the intention to dispute the dismissal.

Thus, the Court dismisses the appeal considering that the requirements for the exemption from taxation of the compensation are not fulfilled, therefore, the entity should have withheld the corresponding part of the compensation from the employees.

In consequence, it is concluded that in order to apply the exemption of compensation for unlawful dismissal, the unfairness of the dismissal must not be only for formal purposes, if there is any evidence of an agreement between the parties, the exemption will not apply.


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Tags: irpf, severance pay, exemption