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Avvocato Arlo Canella
In a recent case of demotion, the Italian Supreme Court took the opportunity to clarify the taxability of compensation amounts, distinguishing between different types of compensable damages and their proper taxation regime. In this article:
The case at hand concerns an employee who, as part of a dispute over alleged demotion, had reached an out-of-court settlement with her employer and, within that settlement, was given “moral, professional and biological damages,” without further specification.
The employee had requested the reimbursement of the IRPEF deductions from the compensation received by the employer, and a dispute with the Internal Revenue Agency ensued regarding the taxability or non-taxability of the sums received as compensation, and the case came before the Italian Supreme Court.
Order No. 8615/2023 of the Italian Supreme Court ends up dealing with a relevant issue: the taxability or otherwise of sums received as compensation in cases of demotion. The decision provides an important clarification regarding the taxation of these sums: “The sums paid to the employee as compensation for the unlawful deprivation of employment are also considered income from employment.” However, the Italian Supreme Court’s ruling, also takes the opportunity to provide some further clarifications on the interpretation of Article 6(2) of the TUIR. Let’s see which ones.
The Italian Supreme Court has clearly established that, in the case of demotion, it is necessary to distinguish between damages resulting from loss of income (taxable) and those resulting from the depletion of professional capacity, with associated loss of chances, biological, medically ascertainable, existential, moral, and to professional image and personal dignity (not taxable). Let’s examine them one by one:
Damage resulting from loss of income: This type of damage refers to the decrease in income suffered by the employee due to demotion. The Italian Supreme Court has ruled that these amounts are taxable since they are considered employee income under Article 6(2) of the TUIR.
Damage resulting from the depletion of professional capacity and related loss of opportunities: This is the damage suffered by the employee in terms of the reduction of his or her professional skills and opportunities as a result of demotion. The Court has ruled that these amounts are not taxable.
Biological damage, medically ascertainable: This represents the injury to the employee’s physical health resulting from the demotion, and must be substantiated by appropriate medical documentation. This type of damage is also considered nontaxable.
Existential damage: This refers to the injury of a non-mere emotional and internal nature that alters the employee’s habits and relational arrangements due to the demotion. The Italian Supreme Court has ruled that this damage is not taxable.
Moral damage: This concerns the inner suffering and psychological consequences suffered by the employee as a result of the demotion. Again, the Court has ruled that moral damage is not taxable.
Damage to professional image and personal dignity: This type of damage refers to the injury suffered by the employee in terms of professional reputation and respect for his or her personal dignity due to demotion. The Italian Supreme Court has made it clear that these amounts are not taxable.
However, the onus is on the taxpayer to prove the existence of the prerequisites for the exempt types of damages. In the case at hand, the Court held that the ruling of appeal had entrusted the existence of the prerequisites for exemption from taxation to the mere declaration of the parties (contained in the conciliation), without having examined any evidence, the burden of which rested on the taxpayer in any case. The Court then expressed the following principle of law (excerpted from the order): “In application of the rule drawn from Article 6, paragraph 2, TUIR, […] on the subject of demotion, it is necessary to distinguish between damages arising from loss of income, which is certainly taxable, and damages arising from the depletion of professional capacity, with the associated loss of chances, biological, medically ascertainable, existential, that is, the injury of a nature that is not merely emotional and interior, which alters the habits and relational arrangements, moral, from inner suffering, and finally to the professional image and personal dignity, which are not taxable”.
The Italian Supreme Court ruling emphasizes the importance of distinguishing, even in the case of a settlement, between different types of compensable damages.
This ruling provides an indication to employees, employers, and attorneys active in the field of the need to specify precisely the nature of compensable damages in out-of-court settlements and to provide adequate documentation to support compensation claims for non-taxable damages.
By virtue of this ruling, experienced lawyers should pay special attention to the drafting of settlement agreements, seeking to detail individual items of compensation and precisely identify those related to non-economic damages, which are exempt from taxation.
In addition, it is advisable to collect and preserve all evidence necessary to prove the existence of non-taxable damages (e.g., medical records and other relevant certification) in order to avoid possible disputes with the Internal Revenue Service.
Ultimately, it is important to keep in mind that the burden of proof in these cases always lies with the taxpayer, and therefore it is crucial to be diligent in both the handling of disputes regarding damages and the qualification of the same at the settlement stage. Following the principles laid out by the Italian Supreme Court in this order can help you move with greater confidence, preserving your client’s interests even from an excessive and unjustified tax levy.
Avvocato Arlo Canella
