Inland Revenue: clarifications on the taxation of sums paid following a settlement agreement

In its answer to question no. 344 of 23 June 2022, Inland Revenue ruled on the tax liability of amounts paid under a settlement agreement. In this case, the amount was compensation made by an employer to settle a long-standing dispute with several employees. This disbursement, which related to entitlements due for 2010, 2011, and 2012, was considered by the employer as subject to separate taxation and requested confirmation from the Inland Revenue.

The settlement and its effects

In its reply, the tax authority provided a civil law definition of the settlement as being “the contract by which the parties make mutual concessions, to put an end to a dispute that has begun or prevent a dispute from arising. Mutual concessions may create, modify or terminate relationships other than the one that was the subject of the parties’ claim and dispute” (see Art. 1965 of the Italian Civil Code).

In line with what was clarified by the Ministry of Finance in Circular no. 326/1997, Inland Revenue specified that “indemnities and sums or values received in lieu of employment income, including those arising from any settlement, are taxable as employment income.”

Employment income

After the question’s reply, appropriate considerations followed regarding the “comprehensive” nature of employment income, consisting of the “total taxability of everything the employee receives in connection with the employment relationship.” On this point, Article 49, paragraph 1, of the TUIR was cited, according to which:

• “employment income derives from relations having as their purpose the provision of work, with whatever qualification, in the employ and under the direction of others, including work from home when it is considered employment under labour legislation” and
• “employment income consists of sums and values in general, received during the tax period, including employment-related donations. ” Sums and values paid by employers before the 12th day of January of the tax period following the one to which they refer are considered as received during the tax period” (Art. 51, paragraph 1, of the TUIR).

Separate taxation and scope of application

The same Circular of the Ministry of Finance includes the separate taxation scope of application. The Circular clarified that “the sums and values received, net of legal fees incurred, even as compensation or as part of enforcement, following judicial orders or settlements relating to employment termination are subject to separate taxation”, under Article 17, paragraph 1, letter a), last part, of the TUIR.

It was stressed that separate taxation applies when there are “arrears in remuneration for employee services referable to previous years, received because of laws, collective agreements, rulings or administrative acts or other reasons beyond the parties’ control” under Article 17, paragraph 1, letter b) of the TUIR. This occurs if the sums in lieu of employment income relate to income that should have been received during a tax period, and are received in a later tax period, as a replacement.

As clarified in the above document, the sums and values received because of settlements, other than those relating to the employment termination, where none of the conditions set forth in Article 17, paragraph 1, letter b) apply, are subject to ordinary taxation.

Considering the regulatory and procedural framework described above, the Inland Revenue held that the sums paid by the applicant following the settlement agreement must be included in the employee taxable income for their full amount and subject to ordinary taxation. This is because their payment is not related to the employment termination, nor do any of the conditions set forth in Article 17, paragraph 1, letter b) of the TUIR apply.