Tax exemption for severance pay upon termination of employment contracts

Following the termination of an employment contract, employees may be entitled to payment of various types of compensation (compensation for unfair termination of the employment contract or severance pay agreed upon as part of a social plan, legal severance pay in the context of dismissal with notice, etc.). Those benefits are exempt from income tax in certain circumstances.

Who is concerned

The following benefits are income tax exempt:

  1. severance pay provided for by legislation pertaining to employment contracts, or in a collective agreement;
  2. compensation for unfair termination of an employment contract, as set by the labour tribunal;
  3. compensation for unfair termination of the employment contract as agreed upon in a settlement (an agreement reached between the employee and employer to end an existing dispute or to prevent a dispute from arising, allowing the parties to negotiate the consequences of the breaking of the employment contract through mutual concessions, entailing in particular, where the employee is concerned, agreeing not to take any legal action against the former employer for the dismissal in return for the payment of compensation beyond that provided for by law;
  4. voluntary severance pay in the case of termination of the employment contract by the employee, or termination by mutual consent of the parties;
  5. severance pay provided for in a redundancy plan;
  6. compensation provided for as part of a job protection plan, approved by the Labour Minister, the amount of which is equal to the severance pay provided for by legislation pertaining to employment contracts or in a collective agreement, in case of termination of the employment contract by the employer or by mutual agreement between the parties;
  7. voluntary severance pay allocated in case of total or partial closure of a company and in the framework of collective redundancy.

Amount of tax exemption

Only the legal or contractual severance pay (a) is entirely tax exempt.

All of the other aforementioned forms of compensation are only exempt up to an amount equal to 12 times the social minimum wage for unskilled workers.

If the compensation is to be split over a number of years, the monthly social minimum wage is that which is applicable on 1 January of the year in which the first instalment of the compensation is taxed.

Excluded from tax exemption

The following are excluded from tax exemption: compensation in categories a), b), c) and d) paid to people entitled either to an old-age pension or to an early old-age pension.

For employees aged 60 or over at the time of leaving employment or termination, who are entitled to neither a normal or an early old-age pension, and who normally received a salary, in each tax year, the taxable amount of which exceeds 150 % of the general taxation base limit for employees and pensioners, compensation in categories a), b), c) and d) are only exempt up to an amount equal to four times the monthly social minimum wage for unskilled workers.

How to proceed

Procedure for submitting an application

Depending on the type of compensation, the tax exemption may be awarded in the following ways:

  • compensation is categories a), b), c) and d), falling wholly under the responsibility of the Luxembourg Inland Revenue (Administration des contributions directes), are automatically tax exempt (art. 115-9 of the income tax law).
    However, it is up to the employer, the employee or their authorised representative to seek advice from the Luxembourg Inland Revenue regarding the deduction of the tax at source. To do so, the employer should send a letter to the relevant taxation bureau (RTS), to the section for tax deductions at source on wages and salaries.
    That letter should specify the name of the employee in question, the reason for dismissal, where applicable, and the total amount of the compensation to which the employee is entitled.
    It common practice to enclose the following documents with the letter when available – particularly in case of a signed compensation settlement agreement following a dismissal:
    • the worker's employment contract;
    • the letter of dismissal;
    • the letter requesting the reasons for the dismissal;
    • the letter specifying the reasons for the dismissal;
    • the letter disputing the reasons for dismissal;
    • the settlement agreement;
    • payslips retroactively covering a period of one year up to the notification of dismissal.

In response to that request, the section for tax deductions at source issues a notice setting out the exact amount of the tax-exempt payment the beneficiary will receive, depending on the relevant caps in place.

It is also important to note that in practice, the Luxembourg Inland Revenue can be contacted via e-mail.

For the persons concerned, the employer can apply the tax exemption without first seeking the advice of the RTS 1 bureau (Central Luxembourg), RTS Esch (South) or RTS Ettelbruck (North).
  • people wishing to take advantage of tax exemption on compensation under categories e), f) and g) must apply for it on a separate sheet of paper, submitting the application to the Economic Committee (Comité de conjoncture), which will issue an opinion. The Government in Council then rules on the application for tax exemption based on the opinion of the Economic Committee, and sends the file back to the Luxembourg Inland Revenue.
    Appeals to the Economic Committee may be made directly by those persons affected, or by businesses, and by their legal representatives (law firm, trustee, etc.).
    The appeal must include the following elements:
    • a list of the names of all the employees concerned, and their national identification numbers (13-digit social security number - matricule);
    • a copy of the social plan, the job protection plan or, failing that, the notification of collective redundancy lodged with the employment administration (Administration de l'emploi – ADEM).
These applications must be approved by the Economic Committee in order for the Luxembourg Inland Revenue to be able to apply the tax exemption.

Severance pay in the case of dismissal with notice

Any employee dismissed with notice is entitled to severance pay (as provided for by the Labour Code), provided they can prove at least 5 years of service at the company and are not yet eligible to receive a normal old-age pension. Nevertheless, an employee who is eligible for early old-age pension is entitled to severance pay.

An employee who applied for and obtained early retirement benefit cannot apply for severance pay.

Any collective agreement may provide for amounts and conditions of allocation of severance pay which are more favourable for the employees than the Labour Code.

In calculating the amount of severance pay, account is taken of the employee's length of service in the business at the end of the notice period, regardless of whether the worker has worked during the notice period or not.

For businesses with fewer than 20 employees, the employer has the following option:

  • either award severance pay;
  • or extend the dismissed employee's notice period.

The employer must state their choice in the letter of dismissal.

 

Severance pay based on length of service

Employee's length of service

Severance pay

Extended notice period
(substitution scheme for businesses with <20 employees)

less than 5 years

no severance pay

no severance pay

between 5 and 10 years

1 month

5 months

between 10 and 15 years

2 months

8 months

between 15 and 20 years

3 months

9 months

between 20 and 25 years

6 months

12 months

between 25 and 30 years

9 months

15 months

30 years or more

12 months

18 months

The severance pay is calculated on the basis of the gross salary or wages actually paid to the employee over the 12 months prior to the notification of termination of the employment contract.

Sickness benefits and standard incentives and extras are included in the salaries/wages used for calculating the severance pay. Overtime, bonuses and reimbursements for additional costs incurred are excluded.

Who to contact

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