The Tax Reduction for Irregular Indemnity Paid to Corporate Directors due t

The Spanish Supreme Court (TS), in its ruling 3589/2023, July 25, gave judgement in favor of the company which applied for the reduction of irregular severance indemnities received by directors, that, in addition, were considered as senior managers. 

What is an irregular indemnity? What kind of remuneration are included? What is the link theory of "teoría del vínculo"? Which are the arguments used by the TS in its ruling? From Gentile Law, tax law experts, we tell you about the new judicial criterion in the field of reduction for irregular indemnity.

1. Which irregular indemnities are considered? 

Article 18.2 of the Personal Income Tax Law (IRPF) states the possibility to reduce by 30% the earned gross income when meeting certain requirement: (i) it is income provided by law; (ii) the income has been generated for more tan two years; and (iii) the income has not been obtained on a periodic or recurring basis. 

Therefore, this classifies irregular income. That is, earning that are not generated constantly over time or that are sporadic. 

2. What remunerations are included? 

In the context of the judgment, the TS discussed if severance indemnities received by directors were considered irregular income in order to apply for the tax reduction.

3. What is the link theory?

Another disputed matter in the judgement was to clarify if the title of director entails an employment relationship with the company. If not, the link theory would have to be applied. The link theory consists in a double link between a person and a company, whereby the same person has the condition of director an employee. 

In Spain this situation does not support major contradictions when the person holding the position of directors also holds a regular employee position. Nevertheless, the conflict arises when the same person has a commercial relationship as a director and special labor relationship as a senior officer. 

4. What was the controversy in the case of the TS judgment? 

The opposing party tried to argue that the special employment relationship, as a senior officer, was incompatible with the position of company director or member of the board of directors, since the condition of a director offsets that of the employee. This would make it impossible to benefit from the irregularity reduction. 

5. What arguments did the TS use in its judgement? 

The TS issued its judgement based on three arguments: 

1. It is appropriate to apply Article 18.2 IRPF which allows benefiting from the reduction for irregularity to all categories fo personal work income, among which are the reumenration to the directors.
2. Regardless of the existence or not of the link theory, the right of the directors remains intact in the sense that the object of the reduction is gross earned income and, in addition, the conditions for irregular income are fulfilled. 
3. The General Directorate of Taxes (DGT), in its binding consultation, was decisive in stating that in no case shall the type of relationship that exists between the employee and the company lead to the non-application of the reduction. 

6. What did the judgment state? 

The TS confirmed that the case law only allows such compatibility or double bond with respect to common or ordinary employment relationships in which the dependency regime predominates, and not thos of senior management. However, this does not preclude that the indemnity received by senior officers may apply the reduction for irregularity in its tax aspect. 

In addition, the DGT`s Binding Consultation (V2785-16, of June 21,2016) becomes relevant. This agency ruled in favor of the application of the reduction to a renumeration system designed to compensate senior officers of a company, which were mainly governed by a commercial relationship.

7. What are the practical consequences of this judgment? 

After the DGT`s consultation and the TS`s judgment, it is clear that even company directors or members of the board who are also senior executives will be able to apply the tax advantages of the reduction for irregular income if they receive severance indemnity. 

If you want to know more about these novelties, from Gentile Law, we help you to understand it.