Supreme Court declares compensation paid to senior managers in case of withdrawal is tax exempt

On November 5, 2019, the Contentious-Administrative Chamber of the Supreme Court handed down a long-awaited judgment (appeal 2727/2017). This judgment upheld the Court of Appeal’s ruling and concluded that: in the case of termination of senior management contracts due to withdrawal by the company (unilateral termination by the company), cash compensation amounting to seven days’ salary per year of service, up to six monthly salary installments, qualifies as income exempt from personal income tax (IRPF).

This case law includes a new criterion, allowing senior managers that received termination compensation for withdrawal by the company to seek tax reimbursement from tax authorities for any tax year that has not been time barred.

The case related to the termination of a senior management contract subject to Royal Decree 1382/1985, of August 1, on senior management employment. The Supreme Court ruled on the termination of a senior management contract due to withdrawal by the company (unilateral termination by the company). The company paid compensation to the senior manager, and this compensation was exempt from IRPF.

The Contentious-Administrative Chamber embraced the Labor Chamber’s case law in its judgment of April 22, 2014, stating that at least some compensation must be paid to senior managers under their contract. Based on this, the Contentious-Administrative Chamber concluded that, in the case of termination due to withdrawal by the company, under article 11(1) of Royal Decree 1382/1985, senior managers have the right to compensation of at least seven days’ salary per year of service up to six monthly salary installments.

It is now Supreme Court established case law that (i) in the case of termination of senior management contracts due to withdrawal by the employer, senior managers must receive cash compensation of seven days’ salary per year of service, up to six monthly salary installments; and (ii) this compensation is exempt from IRPF under article 7(e) of the Personal Income Tax Act, up to a €180,000 limit.

The tax exemption only covers cash compensation amounting to seven days’ salary per year of service (excluding any remuneration in kind) or a maximum of six monthly salary installments. If the parties agree on higher compensation, which is standard practice in these contracts, any amount in excess will be subject to IRPF. It remains unclear whether this judgment applies to mandatory compensation payable in the case of senior managers’ dismissals on objective grounds or for cause due to misconduct if both dismissals are declared unfair and thus cash compensation amounts to 20 days’ salary per year of service up to 12 monthly salary installments (unless agreed otherwise).