OD FLASH | The tax judge clarifies the tax implications of settlement indemnities: an analysis of the factual circumstances of the termination.

Paris Administrative Court of Appeal, 17 January 2025, n°23PA04017

In a court ruling of 17 January 2025, the tax judge has stressed the importance of considering the factual circumstances of the termination to determine its nature and, consequently, to draw the tax implications for the treatment of settlement indemnities.

In the present case, a financial director who had been with the company for 16 years was terminated for personal reasons. In this context, the employee and his employer entered into a settlement agreement providing for the payment of an indemnity comprising three elements: a reminder of contractual termination indemnity, a compensatory indemnity for the loss of performance shares and damages in settlement.

When submitting his tax return, the taxpayer expressly indicated that the settlement indemnity was not subject to tax, on the basis of Article 80 duodecies-1 of the French Tax Code (hereinafter “FTC”), on the grounds that his wrongful dismissal does not have a real and serious cause. However, the tax authorities reintegrated these sums in his taxable income. In a ruling dated 13 July 2023, the Paris Administrative Court upheld the additional taxes payable by the taxpayer, who appealed against this decision.

Article 80 duodecies-1 of the FTC establishes the principle that all indemnities paid to employees when their employment contract is terminated are subject to income tax. However, there are a number of exceptions to this principle, allowing partial or total exemption of indemnities, in particular damages awarded by a judge in the event of unfair termination of an employment contract.

In this case, the Court of Appeal carefully assessed the circumstances of the termination after pointing out that the tax authorities and the tax judge must determine the true nature of the compensation paid, without being bound by the terminology used in the settlement.

The Court found that the reasons given in the letter of termination were insufficiently substantiated and unsupported by evidence, which, given the facts of the case, showed that there was no real and serious reason for the termination.

Based on this observation, the Court ruled that:

• The reminder of contractual termination indemnity, paid in addition to the indemnities already paid, exceeded the legal ceiling for exemption under Article 80 duodecies of the FTC and was therefore subject to income tax.

• The compensation for loss of performance shares was not intended to compensate for a loss linked to the dismissal, but to compensate for a loss of profit, which made it subject to tax.

• In the absence of a statement to the effect that they were intended to compensate for a loss distinct from the termination without real and serious cause, transactional damages should be exempt from personal taxation.