Employees in the Netherlands, with an international employment history, will no longer be liable for full taxation by the Dutch revenue on severance pay. An expert reports on this new jurisprudence, which advises that careful planning is essential for the employee to reap any fiscal benefits across borders.

Cross-border employment is very common nowadays and severance pay is often due on termination of such employment. Severance pay should generally be regarded as compensation for future loss of income, and basically qualifies as salary. Therefore, it is subject to the normal progressive wage and/or income tax rates.

The taxation of severance pay is often a matter of debate between the Dutch tax inspector and the taxpayer in international relationships and such debates are regularly brought before the court. If an employee has worked in several countries, he or she will mostly take the position that the severance pay has to be allocated to all those different countries. In this way, the taxpayer is trying to achieve a more beneficial tax treatment of the severance pay by using low tax rates or a special exemption.

Recently, the Dutch Supreme court abandoned its steady case law on this issue and raised two unexpected decisions concerning the international allocation of severance pay, decisions which will have specific tax consequences and possible tax planning opportunities as follows.

General remarks

The part of the severance pay (not the pay of salary and/or expense allowances) that is awarded to the employee to compensate for defamation, loss of enjoyment of life or loss of the ability to work (such as injury as a result of an accident) is not subject to Dutch wage and income tax.

Such pay is called compensation for 'emotional damage'. In practice, the employee has to demonstrate that the compensation has been awarded as a compensation for emotional damage and is therefore free of tax. However, this position is not easily accepted in practice.

A severance pay will, in principle, qualify as regular employment income for an employee or as a director's fee for a company director. The below-mentioned jurisprudence only applies to the severance pay that qualifies as employment income/ director's fee.

However, if the severance pay reconciles the period from severance until pension, the severance pay will qualify as pension rather than an employment income/ director's fee.

A severance pay that is granted to an individual of 55 or more will, in general, qualify as income similar to pension (and not as employment income/director's fee). Generally speaking, pension payments (and similar remunerations) are subject to tax in the residency country of the individual concerned.

According to Dutch national law, the special expat regime called the 30 percent-ruling is not applicable to the severance pay.

Old jurisprudence: no international allocation

Based on the former jurisprudence, it is decisive where the employment activities are actually performed at the moment of the dismissal. If the activities were performed in the Netherlands at the time of dismissal, the Netherlands claimed the taxation on the full severance pay. According to this case law allocating any part of the severance pay to activities that were carried out outside the Netherlands was not allowed. It was claimed that no connection was available between the severance pay and the former employment activities abroad.

Recent court decisions allow international allocation

However, as mentioned earlier, the Dutch Supreme Court abandoned part of its previous case law in two decisions of 11 June 2004 and it now seems to be possible to allocate the severance pay to the former working countries. The rules of international allocation that should be taken into account are as follows:

• The severance pay can be allocated on a time-spent basis during a certain period.

• The period to be considered is the year of dismissal (1 January until date of redundancy) and the previous four calendar years.

• Allocation to the former working countries is possible, provided and to the extent that the severance pay is actually for the account of an entity in the former working country or is borne by a permanent establishment of the company in the former working country.

  If the costs of the severance pay are not for the account of an entity in the former working country, or if these costs are not borne by a permanent establishment of a company in the former working country the relation between the working history in that working state and the severance pay is deemed to be insufficient according to the Dutch Supreme Court.

Tax planning opportunity

According to these recent court decisions, it is possible to allocate the severance pay to the former working countries, if the severance pay is actually for the account of an entity in the former working state or is borne by a permanent establishment in the former working state.

Therefore, it now seems to be possible to influence the applicable tax regime of a certain country by making a cross-charge of costs to a former working country or to the head office which is not established in one of the former working countries, or by not making a cross-charge at all.

For instance, if a Dutch non-resident, who has carried out working activities in several countries during the last five years of his or her career, is receiving a severance pay for the termination of their Dutch employment, it seems to be possible that the severance pay may not be allocated to the Netherlands at all, provided the severance pay is not for the account of a Dutch entity or a Dutch permanent establishment.

Please keep in mind that making a cross-charge to a foreign entity or not will also have consequences for corporate income tax purposes, which should also be considered beforehand.

All in all, taxation of severance pay in an international context is very complex and is constantly changing. In addition, the foreign tax authorities involved might not follow the Dutch point of view concerning the international allocation of the severance pay. This could be advantageous, but might also lead to double taxation of the severance pay. Therefore, careful planning is of utmost importance since the fiscal treatment of such pay differs per country.

September 2004

Laura Luijten and Monique Disseldorp are tax lawyers with Deloitte, Human Capital Tax, Amsterdam. They can be reached at lluijten@deloitte.nl and mdisseldorp@deloitte.nl