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Miriam Sánchez González. 

Irregular performance in the compensation of senior executives.

Are you a senior executive and you have been dismissed? If you are also a Director, you will be able to apply the reduction for irregular performance in your income tax return.

Recently the Supreme Court, in its ruling of July 25, 2023 (RCA 2334/2021) has determined that the reduction in the IRPF for irregular employment income is applicable to the severance pay of senior managers when they are also Administrators.

The Supreme Court now applies the jurisprudence of the Court of Justice of the European Union which establishes that the employment relationship does not vanish nor is it preserved by absorption of the commercial relationship in that which is favorable to the employee.


But, what does the reduction for irregular income consist of?

According to the IRPF regulations, a 30% reduction may be applied to income that is qualified as being obtained in a notoriously irregular manner over time, provided that it is attributable to a single tax period.


What did the Tax Administration say about this?

In the case at hand, the Tax Administration regularizes the tax situation of a company for the concept of withholdings on income from employment of the IRPF on the occasion of the severance pay paid to the senior management personnel.

On the other hand, the company subject to inspection maintains the application of the exemption of the severance payment, as well as the reduction for irregular income on the amount of the severance payment that exceeded the exempt amount.

The Tax Administration opposed this position based on the theory of the link, the effects of which make it impossible to apply, on the one hand, the aforementioned exemption and, on the other hand, the reduction for irregular income. According to the case law of the Supreme Court itself, the theory of the link admits the compatibility between the simultaneous performance of the position of director with the development of functions covered under an ordinary employment relationship, provided that the latter has as its object work that is classified as common or ordinary in which there is a relationship of dependence and that, unlike those of senior management, is not absorbed by the performance of functions that correspond to the condition of director.

In the subsequent instance, the Audiencia Nacional recognizes the applicability of the exemption to the compensation corresponding to the period of time corresponding to the senior management position. However, it rejects the right to the reduction for irregular performance with the argument that the labor relationship, common or senior management, is absorbed by the mercantile relationship in the case of administrators or members of the Board of Directors.

What does the Supreme Court say in this regard?

The Supreme Court rejects the assessment made by the administration, since the theory of the relationship in no way excludes the application of the reduction for irregular performance.

In the Court’s opinion, it makes no sense to leave outside the scope of said reduction the compensation received by the members of the board of directors given that neither the Law nor the Personal Income Tax Regulations make such exclusion.

On the one hand, the Law defines as employment income not only that derived from the employment or statutory relationship but also, and among others, the remuneration of the administrators and members of the Board of Directors. And, on the other hand, the reduction for irregular employment income is applicable to the compensation paid on the occasion of the termination of the directors as long as the rest of the requirements of the precept are met. For this purpose, it should be recalled that, in order to apply this reduction, according to its previous wording, it was essential that the full income received had a degeneration period of more than two years and that it was not obtained on a regular basis.

According to the Court “all earned income (including the remuneration paid to the directors or administrators of an entity) can be reduced by 40% (now 30%), when the other requirements of the Law are met, namely: a period of generation of more than two years and not being periodic or recurrent”.

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