Taxation of lump-sum settlements on termination of employment with a pension character

• Private Clients
• SME
• Tax Law

Employer lump-sum payments to departing employees can be made for a variety of reasons. This is important for their taxation. If a contribution is made to the pension scheme, it is possible for the lump-sum settlement to be taxed separately and at a reduced rate like a pension benefit. Otherwise, the lump-sum settlement is part of normal income and is subject to full progressive taxation.

Lump-sum settlement for departing employees

When an employment relationship is terminated, the employer sometimes makes an additional one-off payment to the employee. Employees leaving the company in higher positions and at an advanced professional age can benefit from an extraordinary final payment, which can be substantial in some cases. Special circumstances such as a takeover of the company, differences in strategy, streamlining of management, reorganisation or restructuring give rise to this. However, payments from social plans to broad sections of early retirees also occur.

Taxation as ordinary income or as a pension benefit

Most income tax rates are progressive. This means that the higher the taxable income, the higher the tax burden on each additional franc of income earned. A lump-sum payment from the employer when the employee leaves the company constitutes taxable income. It is therefore generally added together with other income. This can result in a very high tax burden due to tax progression.

In certain cases, however, the Swiss tax system allows for a significant reduction in the tax burden if the employer’s payment has the character of a pension benefit. In this case, the payment is taxed separately from other income at the reduced pension rate, just like the payment of a lump-sum benefit from the pension fund. To this end, the lump-sum benefit must have been agreed or paid out primarily to cover a pension gap arising as a result of leaving the labour market. If the payment is made without the intention of providing for the future, but as compensation for recurring benefits, then at least taxation at the pension rate must be examined. Otherwise, taxation will take place with all other income at the ordinary rate.

Requirements for taxation as a pension benefit

Specifically, according to established practice, the following requirements must be met cumulatively:

The recipient must be over 55 years of age at the time of payment. The exact date of birth is decisive. This criterion offers few questions of interpretation and is therefore usually not open to interpretation.

The recipient must give up her main gainful employment; in fact, she must be in early retirement. A secondary occupation is still possible, but may only be of absolutely secondary importance. The practice in the tax authorities varies.

Leaving the pension fund must result in a pension gap, which is covered by the severance payment. This is the case if the early retirement ends the savings process in the occupational pension scheme (second pillar) and the pension provision in the pension fund cannot be continued until retirement age. In this context, only contribution payments that will cease in the future, but not purchase potential from the past, count as a shortfall. The necessary information must be obtained from the pension fund.

Recommendation

If the financial situation or life planning allows for an extensive withdrawal from gainful employment, the tax burden on the recipient of a lump-sum payment can be significantly reduced by the employer if the aforementioned conditions are met. A cancellation agreement or the design of a social plan that clearly expresses the precautionary purpose of the payment is highly recommended. The burden of proof for the pension purpose lies with the taxable recipient of the payment.