If an employee files a lawsuit for compensation for unlawful termination of employment and enters into a settlement with his/her former employer under which a certain amount is paid to him/her, this amount is not exempt from personal income tax.

Such conclusions are drawn from the individual tax ruling by the Director of the National Tax Administration, ref. no. 0112-KDIL2-1.4011.475.2023.1.TR.

The authority held that when the amount of compensation is determined through negotiations and mutual concessions of the parties, it cannot be assumed that its amount or rules of determination were directly derived from the provisions of separate laws or from executive regulations, administrative acts or from the provisions of collective bargaining agreements or other collective agreements, regulations or articles of association. Therefore, the exemption provided for in Article 21(1)(3) of the PIT Act does not apply to it.

The authority further held that the compensation is intended to compensate the employee not for the actual damage to his/her property, but for the benefits lost as a result of the termination of the employment contract, i.e. unpaid wages. Therefore, the exemption referred to in Article 21(1)(3b) of the PIT Act also does not apply to the compensation.

Consequently, the compensation should be taxed as ordinary income from the employment relationship.
 

Find more in the PRO HR May 2024.