Taxation of compensation of Senior Managers

One of the main characteristics of the compensation set by the Workers’ Statute in cases of dismissal or contractual termination, it is that they are exempt from taxation and contribution</ strong>, as stated in art. 7.e) of the Personal Income Tax Law which states that:

“indemnities for dismissal or cessation of the worker, in the amount established on a mandatory basis in the Workers’ Statute, in its implementing regulations or, where appropriate , in the regulations governing the execution of sentences, without being able to consider as such the one established by virtue of an agreement, pact or contract.”

However, in the case of Senior Managers, we must remember that they are expressly excluded from the application of the Workers’ Statute in virtue of art. 2.1.a) of said standard, being regulated by Royal Decree 1382/1985, of August 1, which regulates the employment relationship of a special nature for Senior Management personnel.

In consequence of what has been previously stated, several questions arise to which we must answer.

Is the compensation set in the Royal Decree for Senior Managers considered minimum?

Art. 11.1 of the Royal Decree states that the Senior Manager has the right, in  case of termination of the contract by the will of the employer, to the indemnities agreed in the contract or, in the absence of an agreement, to the indemnity of seven days of salary in cash per year of service with the limit of six monthly payments.

Traditionally, this precept had been interpreted by the courts understanding that the parties had complete freedom of agreement when establishing compensation, and could even agree that there was no place for the same.

However, the Labor Chamber of the Supreme Court, in a judgment dated April 22, 2014, interpreted this rule as a necessary minimum right. In other words, such compensation must be applied as a minimum even in those cases in which the parties, although they have mutually agreed upon it, have established a lower compensation.

Is the compensation legally collected for Senior Managers of seven days a year with a limit of six monthly payments exempt from tax?

Traditionally, the Compensation of Senior Managers was fully subject to taxation. This was considered by both the General Directorate of Taxes (DGT) and the courts of justice.

They based their position on understanding that there was no minimum compensation to which the Senior Manager was entitled, but that it was only established for those cases in which the parties did not agree to anything.

However, with the Supreme Court Judgment of 2014, a radical turn was given to this conclusion, this amount being considered as an unavailable minimum right, despite the interpretation that the DGT has made of it, which has continued to maintain that said amount was subject to the understanding that this resolution continued to give the rule a subsidiary nature that was only applicable in the absence of an agreement.

The last endorsement of this new interpretation has been given by the National Court, which through its contentious-administrative chamber, following the resolution of the Supreme Court of 2014, in a judgment of March 8, 2017, concludes that the compensation paid to the senior manager is exempt from taxation up to the limit of 7 days of salary per year worked with a maximum of 6 monthly payments, on the understanding that it was a mandatory minimum compensation and therefore within the precept of the personal income tax law.

Here we review the most relevant aspects of this sentence:

SEVENTH.- (…) At this time, it is appropriate to analyze the incidence that the doctrine emanating from the Fourth Chamber of the Supreme Court in its STS of April 22, 2014, issued in the appeal for unification of doctrine no. 1197/2013.

Certainly, the position against recognizing severance pay for termination of the special senior management employment relationship as exempt income, even with the limits set forth, takes as its starting point the non-existence of a mandatory minimum compensation established by the applicable regulations.

So, if the Supreme Court interprets the art. 11.1, second paragraph, of RD 1382/1985, in the sense that the compensation provided therein (seven days of salary per year with a limit of six monthly payments) has Mandatory minimum character, even if the parties have agreed that there will be no compensation for termination, it is up to this jurisdiction to draw the precise consequences in matters under its jurisdiction, such as tax.< /strong>

This is required by the complementary nature of the legal system attributed by art. 1.6 of the Civil Code (EDL 1889/1) to the jurisprudence of the Supreme Court.

In effect, even when we are not in a prejudicial assumption in the strict sense, since there has not been a pronouncement of the social order regarding the nature of the labor relationship specifically analyzed In the present case, it cannot be ignored that the sentences handed down in cassation appeals for doctrine unification by the competent Supreme Court Chamber for reason of the matter have a particularly intense expansive force, derived from the very nature of the cassation appeal for unification of doctrine even without the binding effect of the sentences handed down in appeals in the interest of law -vid to important STC of March 19, 2012 -.

Well, reading the aforementioned Judgment of the Fourth Chamber of the Supreme Court, of April 22, 2014, (rec . 1197/2013) (EDJ 2014/119441), it follows that the compensation of seven days of salary per year worked, with a limit of six monthly payments, must be considered as mandatory minimum compensation for cases of withdrawal by the employer of a senior management worker, even in cases of express agreement that excludes any severance pay. Indeed, from this Judgment we must highlight, for the stated purposes, the following two passages:

… in the opinion of this Fourth Chamber, the most logical interpretation of art. 11.1, second paragraph of RD 1382/1985, considered in itself, is that it does not allow it. The precept in question is made up of three normative elements, which are the following: a) The legislator directly grants the senior manager an unconditional right to receive compensation when his contract is terminated by the unilateral will of the employer without the need for any just cause ( withdrawal, says the precept with all propriety): “The senior manager will have the right in these cases to compensation…” b) The legislator does not directly establish the amount of said compensation but refers to the amount agreed by the parties: “… agreed in the contract.”

c) The legislator establishes a subsidiary norm in the event that the parties have not agreed on said amount: “in the absence of an agreement, the compensation will be equivalent to seven days of Salary in cash per year of service with a limit of six monthly payments.”

Given that structure and that content of the precept, it does not seem logical to interpret that the legislator allows an agreement -as in the present case- whose content is not limited to fixing an amount different from that subsidiary but that consists, simply and simply, in eliminating all compensation. If this were the case, the legislator would incur in a glaring contradiction with what he himself establishes first and foremost: the senior manager “will have the right”. Therefore, various modulations of that right will fit, but not its complete ablation.

EIGHTH.- The consequence of the foregoing is that the compensation paid by the plaintiff to Ms. María Consuelo with cause in her dismissal as senior management personnel , is mandatory up to a limit of seven days of salary per year of work and with a maximum of six monthly payments and, as a mandatory minimum compensation, it would be exempt from taxation in this amount. Therefore, it is appropriate to estimate the resource at this point with the indicated scope.

Reduction of the tax rate on the compensation of Senior Executives

In addition to the previously mentioned exemption, we must take into account that a 30% reduction will also be applied to those earnings from work that have a generation period of more than two years and for which this reduction has not been applied within the five previous tax years, as well as those obtained notoriously irregularly over time.

This reduction that is included in art. 18.2 of the Personal Income Tax Law will therefore apply to the compensation amounts that are not exempt in accordance with the previously stated and within the limits established by the applicable legislation, for those Senior Managers who have more than two years of seniority in the company.