From a Belgian income tax point of view, all payments made by a company as a result of the discontinuation of the work or the termination of an employment contract of an employee are characterized as “severance pay”.
In principle, such payments are taxed in accordance with the regime of article 171, 5°, a) of the Belgian Income Tax Code. Indeed, severance pay is subject to a separate taxation at the average tax rate of the last previous year in which the taxpayer exercised a normal professional activity. The purpose of this rather exceptional way of taxation is to temper the impact of the progressive income tax rates.
In the past, the notion of “the last previous year in which the taxpayer exercised a normal professional activity” was not always fully clear. Based on the case law of the Belgian Supreme Court, the relevant year was the last previous year in which the taxpayer had worked during 12 months. However, in practice, this was sometimes difficult to apply, especially if the taxpayer had not been working for 12 months during a previous year. From a pragmatic perspective, it was in such case in practice not uncommon to already take into account (periods with) unemployment income when determining the relevant ‘last previous year’.
Recent change in tax law
The law of 7 April 2019 (published in the Official Gazette on 3 May 2019) changed the wording of the Belgian Tax Code in this respect, retroactively as of 1 January 2018 (tax year 2019). The change directly relates to the year regarded as the ‘reference year’ for separate taxation of severance payments. Based on the new text of law, the reference year will be “the year in which the taxpayer has received taxable professional income during 12 months.” Consequently, even if – during the last previous year – the taxpayer actually only worked during 6 months and during the remaining 6 months received replacement income (such as unemployment or pension income, which is also taxable professional income), the whole year will be regarded as the relevant reference year. This legislative change certainly brings more clarity and legal certainty with respect to the applicable ‘reference year’.
Even with this recent change in the tax law, one can say that not all uncertainties (which previously existed under the old rule of law) are solved. Indeed, further practical difficulties will arise from time to time. In some cases there will strictly speaking not be a particular reference year, notably when the taxpayer has not had taxable income during 12 full months. This will for example be the case, for employees who take up a month of unpaid leave of absence every year. The same is true for employees who start working for the first time in one year and face a dismissal in the same year, or in the following year, with severance pay.
Furthermore, please note that in its decision of 24 September 2015, the Belgian Constitutional Court already indicated that article 171, 5°, a) of the Belgian Income Tax Code does not exclude that the average tax rate applies to other forms of discontinuation of work than that within the framework of an employment contract. Consequently, the separate taxation at an average tax rate would have to apply to severance pay, even if it is paid to a person who does work on a self-employed basis for a company, such as e.g. a self-employed director.