Amendment of the cap on severance pay

1.    Background

The CPA Professional Association (“Consejo Profesional de Ciencias Económicas”) consulted the Federal Tax Authority (“AFIP”) for an opinion regarding the treatment to be given for Income Tax to the amounts paid as seniority severance pay in the event of dismissal. This comes as a result of the Supreme Court decision having found in re: "Vizzoti, Carlos Alberto vs. AMSA S.A." for the unconstitutionality of Article 245 of the Law of Employment Contract in relation to the system of caps on severance pay provided for in said law.

The request for an opinion was made in order to determine the criteria of the AFIP in relation to the amounts to be paid as "seniority severance pay in the event of dismissal" in excess of the amounts resulting from calculation of the "cap on severance pay", but within the limits resulting from the Supreme Court decisions according to which the restriction of the amount to be collected by the worker holds provided it does not imply a cut greater than 33% in the amounts that would have resulted in the event of discarding said cap.

2.    Analysis of the rules

Article 245 of the Law of Employment Contract provides that, in the event of dismissal without just cause, the employer is to pay the worker severance pay. In order to complete calculation of severance pay, the employer must take as a base the highest monthly, normal and customary remuneration paid during the last year or period of services rendered. This base, according to the provisions of the second paragraph of the article, "cannot exceed the equivalent of three times the monthly pay of the amount resulting from the average of all remunerations provided for in the collective bargaining agreement applicable to the worker at the time of dismissal ..."; this is what is generally known as the "cap on severance pay".

On the other hand, Article 20, subsection i) of the Income Tax Law provides that "seniority severance pay in the event of dismissal" is exempt, adding that the exemption covers those amounts due under the legislation.

Before the Supreme Court issued its decision on "Vizzoti", the AFIP held that severance pay in the event of dismissal was subject to the exemption provided for in Income Tax Law, provided it did not exceed the amounts established in Article 245 of the Law of Employment Contract, that is, considering the cap on severance pay. Those amounts paid on cessation of the employment relationship and exceeding those set out in Article 245, were, in fact, subject to income tax payment.

In the well-known decision in re: "Vizzoti", of September 14, 2004, the Supreme Court found for the unconstitutionality of the provision of Article 245 of the Law of Employment Contract, determining that the parameters to be considered for the base of calculation could not be less than 67% of the normal, monthly and customary remunerations collected.

This decision immediately led to concern regarding the fiscal situation of the amounts to be paid in the future by employers deciding to follow the Supreme Court decisions.

3.    Position of the Ministry of Economy

The AFIP chose to submit the case to the Ministry of Economy and "await the mood prevailing in the Ministry".

As a consequence the National Tax Department (Dirección Nacional de Impuestos) and the Department of Legislative and Fiscal Matters (Dirección de Asuntos Legislativos y Tributarios), expressed their opinion that the AFIP must adapt its criteria to the decision of the Supreme Court, and admitted that on the finding for the unconstitutionality of Article 245 of the Law of Employment Contract in relation to the system of caps on severance pay, the scope of what is to be exempt as provided by Article 20, subsection i) of the Income Tax Law, was extended.

After adding these opinions, the case was returned to the AFIP.

4.    Position of the AFIP

Consequently the AFIP adjusted its criteria to the proposal made by the Ministry of Economy and adopted the interpretation whereby in cases of dismissal, seniority severance pay is to be considered exempt of the payment of income tax, considered in correspondence with the Supreme Court decision in re: "Vizzoti".

5.    Conclusion

The AFIP’s interpretation may be understood in the sense that the exemption is applicable for the total amount of severance payment, considering the Supreme Court decision in re: “Vizzoti”. In that case, the Court stated that the application of the ceiling on severance payments is unconstitutional when it implies a reduction higher than 33% over the amount payable as severance payment, compared to the compensation that the employer should pay without the application of such ceiling.