Severance Pay Is Excluded from Income Tax

Labor Courts have confirmed the prevailing rule in re Negri, whereby the Supreme Court found that the amounts paid to employees in excess of the statutory severance pay under the Employment Contract Act [Ley de Contrato de Trabajo] were not subject to Income Tax and in this particular case, ordered the Employer to return the withheld amount plus interests and court costs. The Company will now have to seek refund from the Tax Authority [AFIP], who collected the withholding at the time.

Published in El Cronista on March 12, 2019
Remember that in previous cases the Defendant used to be the Tax Authority, who was sued to recover withholdings made by the Employer. In this case, the Employer was sued by the Employee, and the Court did not accept to summon the Tax Authority as a third party.

As a matter of fact, in the case of Bogado, Ricardo Enrique v Citibank N.A. on salary discrepancies (December 21, 2018), the Court has ruled that severance payment does not meet the requirements of a regular payment and a permanent source of income contained in the definition of “income” or “gains” under the terms of the Income Tax Act [Ley de Impuesto a las Ganancias]. The amount withheld for income tax at the time of calculating the Plaintiff’s final pay is part of his severance package, which should be excluded from Income Tax as a “tax exclusion” because lawmakers have not considered it as taxable income when defining “taxable event” under Section 2 of Act No. 20628 (National Labor Court of Appeals, Panel VII, December 21, 2018, Bogado, Ricardo Enrique v Citibank N.A. on salary discrepancies, La Ley Online AR/JUR/75792/2018).

In this context it has been established that the income tax withholding for the Plaintiff did not meet the statutory definition of taxable income because even after the 2017 reform lawmakers did not deem it to be taxable income when defining “taxable event” under Section 2 of Act No. 20628 (as amended by Act No. 25414).

This has been the standard for interpretation imposed by the Highest Court in the case of De Lorenzo, Amelia B. v DGI (judgment dated June 17, 2009) and sustained by the Supreme Court of Justice in re Negri, Fernando Horacio v PEN-AFIP DGI (dated July 15, 2014), whereby it has been found that severance pay does not meet the requirements of a regular payment and a permanent source of income that are necessary to be subject to income tax under the terms of Subsection 1 of Section 2 of the relevant Act.

Finally, on August 12, 2016 based on the Highest Court’s ruling on the Negri case, the Tax Authority issued Circular No. 4/16 establishing that severance payment as a result of an employment termination by mutual agreement under the terms of Section 241 of the Employment Contract Act is not subject to income tax.

Even though no judgment has been passed yet to cover top-level executives, who as a result of the latest reform are directly affected by an exception that is overtly unconstitutional, this new precedent leads to the application of the concept of taxable income under Section 2 of the Income Tax Act determining that severance pay does not meet the requirements for income tax withholding even in excess of the calculation formula under Section 245 of the Employment Contract Act because it is paid when the permanent source of income has ended and naturally regular payments have ended as well, when the notice of termination is served or in the case of a termination by mutual consent, when termination is agreed (Section 241 of the Employment Contract Act).

Remember that with the latest reform of the Income Tax Act, any amount in excess of the statutory severance pay under the Employment Contract Act was taxable, either in the case of a direct termination or a termination agreement (Section 241 of the Employment Contract Act), and its regulation allegedly extended it beyond the law. Both rules are unconstitutional because they breach Section 2 of the very same substantive law (Act No. 20628), which remains unchanged, and go against the principle of tax equity, equal treatment and property rights because they become confiscatory.

We think that the prevailing rule in re Negri will be ratified soon for top-level officers, who are now arbitrarily included in the reform of the Income Tax Act.

By Julian A. de Diego
Director of the postgraduate course on Human Resources at the School of Business at UCA.