The request submitted to the PTA concerned a situation in which an employer proposed the termination of an employment contract by mutual agreement, through the payment of financial compensation and the establishment of a life insurance policy that would provide the employee with a monthly annuity for a period of twenty-four months.
First, the PTA clarifies that the tax regime set out in Article 2(4) of the Portuguese Personal Income Tax Code applies irrespective of the legal form of termination of the employment contract, including compensation paid under mutual termination agreements entered between employer and employee. Accordingly, provided that the statutory requirements are met, the compensation benefits from the partial tax exemption established under that provision.
Regarding the calculation of the tax-exempt amount, the PTA recalls that the exemption limit corresponds to the average amount of the employee’s regular remuneration subject to PIT received during the previous twelve months, multiplied by the number of years (or fraction thereof) of service with the employer.
For this purpose, only payments that constitute genuine consideration for the employee’s work, are mandatory under the employment relationship, are paid on a regular basis and are subject to PIT are considered.
Conversely, accrued employment entitlements, namely remuneration relating to work already performed, holiday pay and Christmas bonus, are excluded from this calculation pursuant to Article 2(6) of the Portuguese Personal Income Tax Code.
About annual bonuses, the PTA refrains from adopting a general position, emphasizing that their inclusion in the reference remuneration depends on the specific assessment of their remunerative nature and the regularity of their payment.
The Binding Ruling further clarifies that the portion of the compensation exceeding the statutory exemption threshold is fully taxable in the year in which it is paid or made available to the employee and is subject to the general withholding tax rules, with no deferral or spreading mechanism available over subsequent years.
Finally, concerning the life insurance policy taken out by the employer, the PTA states that premiums paid by the employer may qualify as employment income where they constitute vested and individualized rights of the employee.
The annuity payments subsequently received will, as a rule, be taxed as Category H – Pension Income. Where the insurance premiums have previously been taxed as employment income (Category A), the portion of the annuity corresponding to the repayment of capital may be excluded from taxation in accordance with the specific rules applicable to that category of income.
Comment
This Binding Ruling reinforces the Portuguese Tax Authority’s interpretation of the PIT regime applicable to employment termination compensation, confirming that the partial tax exemption provided for in Article 2(4) of the Portuguese Personal Income Tax Code does not depend on the legal form of termination of the employment relationship, but rather on compliance with the substantive legal requirements established by law.
The ruling is also particularly relevant in clarifying the criteria applicable to determining the regular remuneration used to calculate the tax-exempt amount, an issue that continues to raise practical questions, especially where variable remuneration components such as bonuses or incentive payments are involved.
Furthermore, the tax treatment of benefits arising from life insurance policies highlights the importance of carefully structuring employee benefit arrangements, since the tax treatment of the premiums paid by the employer may have a direct impact on the taxation of future benefits received by the employee.
This Binding Ruling therefore constitutes an important interpretative guideline for both employers and employees when structuring employment termination packages and employee benefit schemes, contributing to greater certainty in the application of the Portuguese Personal Income Tax Code.
At Belzuz Abogados, S.L.P., we can assist you in the planning and implementation of employment termination processes, ensuring that they are supported by a comprehensive legal and tax analysis to secure the correct application of the Portuguese Personal Income Tax regime and minimize potential tax risks for all parties involved.