Tax privileged settlement in case of a consensual termination agreement

Tax privileged settlement in case of a consensual termination agreement

We continue our series about the particularities or the German tax law. Today we take a look at tax privileged settlements in case of consensual termination of employment

Compensation that is granted as replacement for missed income (either past or future) is part of the revenue liable to income tax.

Under specific circumstances compensations being an exceptional form of income are subject to a special (reduced) tax rate (the so called “Fünftelregelung” / fifth rule, § 34 para. 1 EStG).

Granting of a severance payment due of a termination of employment initiated by the employer is generally such a compensation. The settlement package is subject to a reduced tax rate in case of a concentration of income. We talk about a concentration of income, if due to a termination of employment an employee receives in total more money (including the compensation) for the relevant taxable period than if the employment had continued uninterrupted.

In the case which was decided by the fiscal court in the German city of Münster, the employment was terminated prematurely by a mutual / consensual settlement between employer and employee to avoid conflict. The court decided that the settlement package is subject to the reduced tax rate. The mutual / consensual severance agreement does not rule out a reduced tax rate.

A final ruling by the Federal Fiscal Court of Germany is outstanding in this matter.