Switzerland Update: Taxation of compensation for an unfair dismissal?

The Federal Supreme Court decides that compensation in the event of an abusive termination is regarded as satisfaction and is therefore tax-free.

1. Initial situation

After 16 years of service, Person A was terminated on January 27, 2016 to April 30, 2016. Since she was in psychiatric treatment for depressive disorders from that date, the end of the employment contract was postponed to March 31, 2017. On 20 June 2017, the employee filed a lawsuit against the former employer, believing that the reasons for her dismissal were abusive and requested compensation of CHF 30,000 plus interest. At the conciliation hearing, the employer and the employee agreed on a payment of CHF 25,000, which was slightly less than five months’ wages. The amount was correctly declared on the salary statement of the employees under section 3 “Irregular benefits” as “Non-imputed severance pay”.

In the 2017 tax return, the employee declared the amount as “non-taxable”. The tax administration of the canton of Vaud did not follow this assessment and offset the amount as taxable earned income.

2. Previous case-law

The cantonal jurisdictions differ and the doctrine is also divided on this topic. However, a majority of authors are of the opinion that, from a tax point of view, compensation paid by the former employer after an unfair dismissal should be treated entirely as payments to compensate for the non-material damage and are therefore tax-free.

Previous case law has made it clear that such payments have a dual purpose; on the one hand, reparation to the employee and, on the other hand, the punishment of the employer. With regard to the question of how much of one and how much of the other a payment contains, the prevailing doctrine must be followed, which assumes that the compensation serves primarily as satisfaction, since the damage caused to the employee as a result of the abusive dismissal is to be compensated. The second purpose, which is to punish the employer’s conduct, is not capable of covering up the first purpose. Thus, such compensation should be fully regarded as a satisfaction payment within the meaning of Art. 24 let. g DBG. In practice, it is in fact hardly possible to divide the compensation for these two purposes.

3. Decision

The Federal Court has never ruled on the question of whether severance payments incurred as compensation for an abusive dismissal within the meaning of Art. 336a CO, fall into the category of satisfaction payments and are therefore exempt from tax. In the case of social security, the court has clarified that compensation based on Art. 336a CO do not have to be taken into account in the relevant salary (BGE 123 V 5 of 17 April 1997).

With regard to taxes, it concludes in its decision that such payments are also to be regarded as tax-exempt for taxes (BGer 2C_546/2021 of 31 October 2022), thus dismissing the tax administration’s complaint.

By Vischer, Switzerland, a Transatlantic Law International Affiliated Firm.

For further information or for any assistance please contact switzerland@transatlanticlaw.com

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