Severance pay: Holding corporate offices does not affect the tax treatment of amounts received in connection with the termination of an employment contract
A taxpayer who was hired as an employee of the television production company Endemol, in the capacity of director of development, had also been entrusted with the duties of a corporate officer at the company’s subsidiaries.
After terminating his employment and relieving him of all his duties, the company refused to pay him the €1.1 million severance payment provided for in a protocol attached to his employment contract in the event of termination not based on serious or gross misconduct. However, finding that the termination lacked a genuine and serious cause, the Paris Court of Appeals ruled in the labor case that the company must pay this contractual severance to the employee[1].
As a reminder, pursuant to the provisions of Article 80 duodecies of the General Tax Code, severance pay paid to employees is partially exempt from income tax, or even fully exempt in certain situations, such as a termination without real and serious cause. Conversely, severance payments made to corporate officers upon the termination of their duties are subject to a different tax regime in that they are, in principle, fully subject to income tax, except when the termination of duties is involuntary, in which case they may be exempt within certain limits.
However, in this specific case, the tax authorities had determined that the compensation received by the taxpayer should be taxed in full, subject to the applicable exemption limits, without distinguishing between the portion of the compensation resulting from the termination of the employment relationship and the portion related to the termination of his duties as a corporate officer. On appeal, the judges ruled in his favor.
For the first time, the Council of State was thus called upon to rule on the applicable tax treatment in the case of a one-time severance payment intended to compensate for the simultaneous loss of positions that differ both in nature and in tax treatment.
The High Court overturned the Court of Appeals’ decision on this point on the grounds of an error of law, holding that the lump-sum compensation paid by a company to an individual who serves as both an employee and a corporate officer cannot be subject in its entirety to the tax regime applicable to executives without determining whether, and to what extent, it was related to the termination of the employment contract. The compensation intended to remedy this harm must therefore be exempt from income tax.
[1]A contractual compensation payment was also provided for and upheld by the court to compensate for the harm resulting from the employee’s inability, due to his termination, to exercise stock options barely six months before their vesting date. The Council of State upheld its previous position (see CE November 5, 2014, No. 370845) that the purpose of this type of compensation is not to compensate for damages resulting from dismissal without real and serious cause, but rather a separate loss of opportunity, such that this portion of the compensation paid must be subject to income tax as wages, just as income from the exercise of options would have been if the individual had been able to exercise them.
