Are severance payments made to employees dismissed for reasons beyond their control subject to taxation and social security contributions?

Any entity employing at least 20 employees is subject to the provisions of the Act of 13 March 2003 on special rules for terminating employment relationships with employees for reasons not attributable to the employees (Journal of Laws No. 90, item 844, as amended). The provisions of this Act provide for severance payments to employees dismissed for reasons attributable to the employer. The amount of the severance pay depends on the length of service and amounts to one, two, or three months’ salary. The severance payment must be made to the employee on the last day of the employment relationship. In practice, employers often question whether social security contributions and income tax advances should be deducted from the severance payment.

According to § 2 section 1 point 3 of the Regulation of the Minister of Labour and Social Policy of 18 December 1998 on detailed rules for determining the basis for calculating contributions to pension and disability insurance, the following are excluded from the basis for calculating social security contributions:

– severance payments, compensations and reimbursements paid to employees due to the expiry or termination of the employment relationship, including termination for reasons attributable to the employer, unjustified or unlawful dismissal, dismissal without notice, shortening of the notice period, failure to issue or late or incorrect issuance of the work certificate.

The payments listed in this provision are exempt from social security and health insurance contributions regardless of their amount. The provision contains no limitations in this regard. Moreover, it is irrelevant whether the additional severance pay that a company intends to pay to dismissed employees is due to them under labour law or paid at the employer’s initiative. For the exemption from social security contributions under § 2 section 1 point 3 of the aforementioned regulation, a direct connection between the termination of employment and the severance payment is required. Severance payments made to employees dismissed for reasons not attributable to them (e.g. economic reasons) are exempt from contributions.

However, in the case of tax exemption, although Article 21 section 1 point 3 of the Personal Income Tax Act states that compensations or damages received are exempt from taxation if their amount or rules of calculation result directly from separate laws or executive regulations issued under those laws, severance payments made under the Act on special rules for terminating employment relationships for reasons not attributable to the employees are explicitly excluded as an exception in letter b) of this provision. This means that the discussed severance payment is subject to taxation. The severance payment paid to the dismissed employee constitutes income from employment, and the employer is obliged to withhold income tax advances when paying it.

In summary, severance payments made to employees dismissed under collective or individual redundancies based on the Act on special rules for terminating employment relationships for reasons not attributable to employees are exempt from social security contributions but are not exempt from taxation.