Exemption from Severance Pay and the Importance of Drafting the Settlement Agreement

Last week, the Nantes Administrative Court of Appeal issued two rulings that highlight the importance of the details included in settlement agreements when negotiating following a termination.

Article 80-12 of the General Tax Code provides that, in principle, severance pay is taxable income. However, it provides for exceptions. For example, severance pay received in the event of dismissal without just cause.

Thus, when an employee enters into a settlement agreement with their employer and receives a payment, in order to determine whether that payment is taxable, it is necessary to determine what the amounts granted under the agreement represent.

Two court decisions illustrate the importance of the wording of settlement agreements between an employee and their employer in determining the applicable tax regime.

A poorly drafted transaction (CAA Nantes, May 20, 2025, No. 24NT02243)

In the first case, an employee had been dismissed for poor performance and had received an initial severance payment. He then entered into negotiations with his employer and reached a settlement resulting in the payment of 100,000 euros. The Court then noted that the taxpayer“expressly acknowledges that the severance payment irrevocably and fully ‘settles’ all his rights, regardless of their nature, including those relating to wages, fringe benefits, overtime, benefits in kind, bonuses, any reimbursement of expenses, indemnities, and damages of any kind and on whatever grounds, and, furthermore, that the payment of this sum shall not constitute an acknowledgment, even implicit, of the employer’s liability regarding the performance and termination of the employment contract.”

The Court also notes that“given the terms of this protocol […] the applicant cannot be regarded as having demonstrated that the payment of the sum in question, even in part, constituted compensation for a loss other than loss of income.”

The taxpayer, who bore the burden of proof in this particular case, failed to provide evidence to quantify the extent to which the compensation did not correspond to a loss of income. The Court therefore ruled that the amount received was indeed taxable.

It is therefore important, at a minimum, to specify in these agreements exactly what the compensation payment covers, in order to avoid complications when the time comes to report this compensation to the tax authorities.

A transaction with room for improvement (CAA Nantes, May 20, 2025, No. 24NT02117)

The CEO of a bank, who had expressed reservations about the bank’s strategic direction and refused to participate in its implementation, was summoned for a pre-dismissal interview just five days after resigning from his position. He subsequently reached a settlement with his employer and argued that the severance pay was received in connection with a dismissal without real and serious cause, and was therefore not taxable.

administration challenged this classification, in part because the termination letter cited dismissal for“non-disciplinary personal reasons” and the settlement agreement did not specify the allegations against the former CEO.

The Administrative Court of Appeal will rule that the CEO could argue that his dismissal was without real and serious cause and that the severance pay he received was therefore indeed exempt from income tax.

It might have been advisable to include details in the settlement agreement regarding the nature of the compensation paid by the employer in order to clarify the situation foradministration .

This monitoring service is provided by Mispelon Avocat, a law firm specializing in tax compliance and litigation. You can stay updated by subscribing to the newsletter via this link.