Compensation for wrongful dismissal: what fiscal and social impacts?
When a dismissal is deemed unfair, the employer may be required to pay compensation to the employee. But is this compensation taxable? Should it be subject to social contributions? What are the rights and responsibilities of employers and employees?
This article, written by our partner CJE, Avocats, Conseillers d’Entreprises, guides you through the legal rules, tax and social implications, and points to clarify in your HR practices.
According to case law, a notice of termination is deemed to be unfair within the meaning of art. 336a CO according to:
- the manner in which the notice is given
- the fact that the notice typically contravenes the principle of good faith
- the fact that it is given by an employer who violates the employee’s personal rights
If the notice is deemed to be unfair, the employer may be required to pay the employee compensation.
The compensation paid by the employer to an employee in the event of unfair dismissal (art. 336a CO) is both:
- restorative
- punitive
The Swiss Federal Supreme Court (ATF 148 II 551) stresses that the purpose of compensation is to make up for the personal injury suffered by the employee as a result of his dismissal, and that this purpose cannot be sacrificed in favor of the punitive aspect of the compensation. It also stresses that the compensatory purpose of compensation is taken into account when determining the amount of compensation, which must take into account criteria such as the seriousness of the injury to the employee’s personality (recital 6.4).
Article 24 al. 1 let. g of the Federal Law on Direct Federal Taxation (hereafter: LFID) provides as follows:
The following are exempt from tax:
g. payments for moral damages ;
The payment of an indemnity as reparation for moral injury, although it should be considered as income (net increase in wealth), is therefore specifically mentioned as being subject to a tax exemption.
According to the case law, the exemption from s. 24 let. The LIFD concerning compensation for moral injury is explained by the fact that compensation for moral injury aims to repair a non-material harm and that the imposition of such compensation would be, for the State, to be enriched by the misfortune of its citizens (ATF 148 II 551 Cons. 5.2).
In the field of social insurance, although the allowance is paid to the employee by the employer following an employment relationship, it does not form part of the salary determining for AHV and is not subject to payment of social contributions, unlike severance pay. A coherence between social insurance law and tax law is moreover justified because the legislator does not require the judge to indicate what the purpose of the indemnity in art. 336a CO for moral injury, contrary to what is the case for severance pay (ATF 148 II 551 Cons. 6.1).
In the field of social insurance law, compensation for unfair dismissal is not subject to social charges because it has no legal link with work provision.
The severance pay obtained upon the cessation of an activity or the renunciation of the exercise thereof is taxable within the meaning of art. 23 let. c LIFD. In case of payment of such an allowance, the employer must indicate to the tax authority the purpose of the allowance.
Unlike the compensation for moral injury, the severance pay is therefore an amount taxable for tax purposes and subject to payment of social insurance contributions.
Conclusion
This decision of the Federal Supreme Court thus confirms the opinion of the majority of legal scholars, as well as the case law of certain cantons. The Federal Supreme Court has therefore settled the matter and confirmed the application of Art. 24 letter g of the Federal Direct Tax Act (LIFD) to the compensation for wrongful dismissal under Art. 336a of the Swiss Code of Obligations (CO).
Finally, let us note that, in the aforementioned decision, the Federal Supreme Court pointed out that, when ratifying the settlement before the Court, the employer did not make any reservation such as ‘without acknowledgment of liability,’ ‘at its discretion,’ or ‘for the sake of peace.
This article was written by our partner CJE, Avocats, Conseillers d’Entreprises.