The finance ministry has issued a decree on the conditions under which redundancy payments still rank for favourable tax treatment, despite continuing or additional benefits to ex-employees.
Redundancy payments to employees laid off are taxed on favourable terms, if the payment is not split over more than one tax year. A redundancy payment is seen as compensation for loss of future earnings rather than as consideration for past services rendered, so it would not be fair to charge it in full to tax at the top marginal rate in any one year. So at least the official explanation of the relief and the reason for not granting it when the payment is spread over more than one year. In practice, there are numerous borderline cases of payments or benefits inadvertently accruing in different years and so disentitling the redundant employee to the relief, if the provisions are taken literally. The ministry of finance has now published a collection of the more common examples of such events in a decree designed to give guidance to those negotiating lay-off schemes ("social plans"), so that an employee does not lose a significant tax benefit merely because a minor perk is forgotten. The decree makes the following points:
- Pension or benefits granted for life are current income as they accrue to the beneficiaries. They do not rank for the compensation payment relief, but neither do they destroy the entitlement in respect of other payments.
- The same applies to improvements to pension entitlements made as part of the lay-off settlement, including an earlier pension begin or accelerated vesting.
- On the other hand, fixed-term benefits (such as the right to a company flat for the next two years) can lead to loss of entitlement.
- Compensation payments qualify for relief if they exceed the "lost" earnings the taxpayer would have made during the rest of the year. Conversely, they do not qualify if they are less than these "lost" earnings and the employee earns no other income that he would not have had if he had kept his job.
- "Lost" income is to be based on the actual amounts earned in the prior year.
- The employer may apply the redundancy relief rules when calculating the "wages" tax to be deducted from a redundant employee's final salary, if he has the necessary information to do so. If he does not, the employee may claim the relief in his income tax return.
- Minor benefits that a redundant employee continues to enjoy after his departure, such as continued use of a company car or mobile phone, are not redundancy payments potentially harmful to the tax treatment, if they are regularly granted to other leavers or retirees of similar status.
- Additional benefits given after redundancy to preserve an ex-employee's social status - such as to help him find, or retrain for, another job - do not endanger the favourable tax treatment of the main payment if they are less than 20% thereof. A legal requirement to grant such benefits is irrelevant.
- Late payments to a former employee in a year following the redundancy count as part of the original redundancy payment if they merely correct an error in computation (but not a misinterpretation of the law) or if they are the direct result of a court case. In such instances, the employee must apply to his own tax office to have the redundancy year reopened. Failure to make this application will lead to the payment being treated as though it had been made in two separate years and therefore to loss in retrospect of the favourable treatment. [Note: a recently published Supreme Tax Court case - XI R 33/02 of January 21, 2004 - applied the same principle to a subsequent supplementary payment of 42.3% of the main payment made to put a volunteer for early redundancy on the same footing as his colleagues who waited for the mass lay-off.]
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.