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While the Government is considering capping judicial redundancy payments, the Conseil d’Etat has just ruled that a settlement payment may be fully exempt from tax. This is the first positive application of the reservation made by the French Constitutional Council in 2013, according to which the tax treatment of redundancy payments cannot be determined by the way in which they are awarded (judgment, arbitration award or settlement). This is an opportunity to take stock of the tax regime applicable to redundancy payments, which now depends on the tax judge’s assessment of situations hitherto known only to the employment contract judge.

Although the principle is not self-evident, it is clear: all compensation paid to an employee on termination of their employment contract is taxable as salary¹. The same applies to directors who are treated as employees for tax purposes when they cease to hold office². Why is this principle not self-evident? Because it contributes to ‘dilating’³ the concept of taxable gain. This concept, inspired by the concept of fruit in civil law, originally referred to a gain likely to be renewed (a salary, rent, etc.). It was then extended to any enrichment, regardless of whether it was renewable (capital gains, etc.). Redundancy pay is not intended to be renewable. It compensates for a loss and, to the extent of that loss, does not give rise to any enrichment. Despite this, the law declares it to be taxable as a matter of principle. There are, however, so many exceptions to this principle that, in practice, full taxation of redundancy payments is the exception rather than the rule.

The general case of partial exemption for redundancy payments.

This partial exemption applies to redundancy payments that are not paid as part of a plan to safeguard employment or that do not sanction unlawful or unfair dismissal. Therefore, apart from these two cases, all termination payments for permanent contracts initiated by the employer are exempt from income tax up to the highest of the following three amounts⁴ :

Amount of redundancy pay provided for by the branch collective agreement, by the professional and interprofessional agreement or by law;
Half of the redundancy payment received ;
Twice the gross annual remuneration received by the employee during the calendar year preceding the termination of his employment contract.

However, the exempt fraction resulting from the application of either of the last two limits⁵ may not exceed six times the annual social security ceiling in force at the time of payment of the compensation⁶.

The benefit of this partial exemption poses little difficulty in practice as it is in no way conditioned by the terms on which the compensation is obtained (judgment, arbitration, settlement): a taxpayer who would not be entitled to statutory or contractual compensation (because of his seniority of less than two years or because of the commission of serious or gross misconduct) but has nevertheless entered into a settlement with his employer benefits from it⁷.

Special cases of total exemption

The first case of total exemption⁸ concerns redundancy payments (or voluntary redundancy payments) made as part of an employment protection plan⁹. In practice, this concerns redundancies for economic reasons, envisaged for a reason unrelated to the person of the employees concerned, and involving at least ten employees within the same thirty-day period.

The second case of total exemption is more problematic: it concerns compensation for unlawful or unfair dismissal, i.e. dismissal without a real and serious reason or in breach of the procedural rules laid down in the Labour Code. As this is an exception to the principle of taxation, this case of total exemption must be interpreted strictly. This is, moreover, the traditional position of the Conseil d’Etat, which has held that compensation for unjustified early termination of a fixed-term employment contract is not covered by this exemption¹⁰. Similarly, the Conseil d’Etat was able to rule that compensation for dismissal without real and serious cause awarded by arbitration is fully exempt if – and only if¹¹ – the arbitrator did not intervene as amiable compositeur but ruled in accordance with the rules laid down by the Labour Code¹².

The Constitutional Council’s reservation of interpretation

This principle of strict interpretation meant that settlement redundancy payments were excluded from the total exemption, even though if the taxpayer had pursued the dispute before the industrial tribunal, any compensation awarded to him by judgment could have been exempted in full. However, in both cases (settlement or legal indemnity), the indemnity compensates both a loss resulting from a loss of salary and a loss of another kind. Faced with this difficulty, the Conseil d’Etat referred the question to the Conseil constitutionnel¹³.

The judges of the rue Montpensier ruled that the law as interpreted by the tax judge should not result in the benefit of the exemptions varying depending on whether the compensation is awarded by a judgment or a settlement¹⁴. It is the classification of the compensation that justifies the income tax exemption and not the way in which it is determined. As a result, a transactional indemnity cannot be refused a priori the benefit of an income tax exemption. It is up to the tax authorities, under the supervision of the courts, to determine the exact classification to be given to the compensation paid. In doing so, interpreting Article 80 duodecies in accordance with the Constitution requires an examination – necessarily subjective – of the conditions (lawful or unfair) under which the employment contract was terminated.

Recent decisions by the Conseil d’État

The judges of the Palais Royal did not have to wait long to apply this new interpretation. In a first case, the Conseil d’Etat accepted that the compensation received by an employee who had resigned could benefit from total exemption if the resignation, due to the conditions under which it was given, had the character of a dismissal¹⁵. However, this was not the case in the judged case: without venturing to list the criteria to be taken into consideration, the Council validates the qualification of the facts by the trial judges who, having regard to a bundle of indications, had found that the resignation was free and not forced.

The first positive application of this reservation of interpretation came quickly: the Conseil d’Etat has just annulled an appeal decision on the grounds that the lower courts had not examined whether an employee who had taken notice of the termination of his employment contract provided proof that this notice was comparable to a dismissal without real and serious cause due to facts likely to justify the termination of the contract to the detriment of the employer¹⁶. It should be noted that by leaving it to the lower courts to determine whether the grievances raised by the employee against his employer justified the termination of the contract to the latter’s detriment, the Conseil d’Etat endorsed the reasoning of the Cour de cassation in this regard¹⁷. It is now to be hoped that the other judges of the administrative order will arrive at solutions in line with those of the judicial judge when dealing with the same facts.

Some practical considerations

The Conseil d’Etat has had to deal with two applications of the Constitutional Council’s reservation: settlements following resignation and settlements following termination of the employment contract. In both cases, the tax treatment of the compensation is black and white: total exemption if the resignation is forced or if the termination is justified, otherwise full taxation.

The conclusion will be less clear-cut in a third case, which is much more frequent in practice: settlement after dismissal. In this case, the reality of the termination at the employer’s initiative is not debatable and the employee will benefit from a partial tax exemption where applicable. Although fixed by the parties and not by the judge, it should be possible to claim total exemption if the dismissal is unfair or unlawful.

If the taxpayer wishes to benefit from a total exemption, the settlement must set out the factual elements that justify the unlawful or unfair nature of the dismissal. Prudence would dictate that all the elements that could be raised in a classic industrial tribunal dispute should be included in the settlement. The mere fact that the employer acknowledges the unfair or unlawful nature of the dismissal on which he is settling should not be enough to convince the authorities. Ultimately, it will be the tax judge who will have to take the place of the employment contract judge in assessing whether the dismissal is unfair or unlawful. Here again, the emergence of administrative jurisprudence that competes with – or even differs from – judicial jurisprudence in this area cannot, unfortunately, be ruled out.

Until 1999, the tax treatment of redundancy payments was largely unpredictable, since it was based on a purely subjective assessment of the nature of the loss compensated by the payment. Was the compensation for loss of earnings taxable? It was taxable. Did the compensation compensate for a distinct loss, particularly of a moral or professional nature? It was exempt. To distinguish the wheat from the chaff, the judge took into account various criteria: the taxpayer’s age, seniority, level of training, or the conditions under which the termination of his or her duties had occurred, etc. It was to put an end to this legal uncertainty that the legislator intervened in 1999¹⁸ and established an objective system, as far removed as possible from all these contingencies. Constitutional and administrative case law, which now requires a casuistic examination of the conditions under which the termination took place to determine whether the compensation is taxable or exempt, gives credence to Horace’s saying: ‘Chase the natural with pitchforks, it will always return’¹⁹.

1 – CGI, art. 80 duodecies, 1

2 – In practice, the following are concerned: the chairman of the board of directors, the chief executive officer, the deputy chief executive officers, the provisional managing director and the members of the management board of a société anonyme; the statutory managers of a société par actions simplifiées; the non-majority manager of a société à responsabilité limitée.

3 – In the words of Claire Legras, public rapporteur, in her conclusions under CE, 24 June 2013, no. 365253: Dr. fisc. 2013, comm. n° 402, n° 36).

4 – CGI, art. 80 duodecies, 1-1° and 3°.

5 – These last two limits also apply to forced termination payments made to corporate officers and directors (CGI, art. 80 duodecies, 2).

6 – i.e. €228,240 for compensation received in 2015.

7 – BOFIP, BOI-RSA-CHAMP-20-40-10-30-20140307, no. 40.

8 – CGI, art. 80 duodecies, 1-2°.

9 – Within the meaning of C. trav. L. 1233-32 and L. 1233-61 to L. 1233-64.

10 – CE, 5 May 2010, no. 309803: RJF no. 7/10, no. 677, BDCF 2010, no. 77, concl. P. Collin.

11 – BDCF 2012, no. 113, concl. V. Daumas.

12 – CE, 20 June 2012, no. 345120: RJF no. 10/12, no. 914. In the same vein: CAA Paris, 25 Oct. 2011, no. 10PA04698: RJF no. 4/12, no. 358.

13 – CE, 24 June 2013, no. 365253: RJF no. 10/13, no. 963.

14 – Cons. const. 20 Sept. 2013, n° 2013-340 QPC : RJF n° 12/13, n° 1162.

15 – CE, 24 Jan. 2014, no. 352949: RJF no. 4/14, no. 335; BDCF 2014, no. 4, concl. C. Legras.

16 – CE, 1 Apr 2015, no. 365253: RJF no. 01/15, no. 487; BDCF 2015, no. 69, concl. M.-A. Nicolazo de Barmon. Note that this was the case that gave rise to the Constitutional Council’s decision.

17 – Cass. soc. 25 June 2003, n° 01-42335 – Cass. soc. 25 June 2003, n° 01-42679 – Cass. soc. 25 June 2003, n° 01-43578 : RJS n° 8-9/03, n° 994, with chronicle J.-Y. Frouin, p. 647.

18 – L. n° 99-1172, 30 déc. 1999, art. 3 : JO 31 déc. 1999, p. 19914.

19 – ‘Naturam expelles furca, tamen usque recurret’, Horace, Epistles, 1, 10, 24.

Bertrand Lacombe

Lawyer at the Court, Lacombe Avocats

Experts de premier plan en droit fiscal