In Germany, severance payments (Abfindungen) can arise in two primary scenarios: either through a court settlement following a dismissal challenge or via a mutual termination agreement (Aufhebungsvertrag) between the employer and the employee. Understanding the legal framework and payroll implications of these payments is crucial for employers, especially when navigating complex employment disputes or restructuring processes.

1. Severance Payments Following Court Proceedings:

When an employee challenges a dismissal (Kündigung) in court, severance payments often become a negotiated outcome, especially when the court indicates that the dismissal may not hold up under legal scrutiny.

• Legal Basis: The legal framework for dismissal protection is outlined in the Kündigungsschutzgesetz (KSchG), particularly in § 1, which requires that a dismissal be socially justified. If the court deems the dismissal unjustified, it may propose reinstatement or, more commonly, a severance payment as an alternative.
• Amount of Severance: While there is no statutory formula for severance payments, courts often use a rule of thumb of 0.5 months’ salary per year of employment as a basis for negotiation. However, this can vary widely depending on the specifics of the case, such as the employee’s age, length of service, and the strength of the legal arguments.
• Payroll Considerations: Once agreed, the severance payment must be processed through payroll, ensuring that all applicable taxes and social security contributions are correctly calculated. Severance payments are generally subject to income tax, but they may benefit from favorable tax treatment under § 34 EStG (German Income Tax Act) as extraordinary income (außerordentliche Einkünfte), depending on the circumstances.

2. Severance Payments via Mutual Termination Agreements:

An Aufhebungsvertrag, or mutual termination agreement, is another common way for employers and employees to end an employment relationship, often involving a severance payment to the employee.

• Legal Framework: While a mutual termination agreement is a voluntary contract, it must comply with certain legal standards to be valid. This includes clear and unambiguous language, as well as consideration of the employee’s freedom of choice. The agreement should also include all relevant terms, such as the severance payment amount, the date of termination, and any other compensation.
• Consideration of Employment Office Penalties: If a mutual termination agreement is perceived as a way to avoid the consequences of a dismissal, the employee may face a blocking period (Sperrzeit) for unemployment benefits. Therefore, employers should carefully draft these agreements, taking into account the guidelines of the German Employment Agency (Bundesagentur für Arbeit) to minimize the risk of such penalties.
• Severance Calculation: Similar to court-negotiated severance, the amount is usually negotiated between the parties and often reflects the employee’s tenure and potential legal claims. A typical formula might still be 0.5 months’ salary per year of service, but this is negotiable.
• Payroll Implications: The severance must be reported and taxed correctly. As with court-ordered severance, it may qualify for preferential tax treatment under § 34 EStG, and the employer must ensure that this is reflected in the payroll processing.

3. Additional Legal and Payroll Considerations:

• Social Security Contributions: Severance payments are generally exempt from social security contributions if they are paid to compensate for the loss of future earnings rather than as compensation for work already performed. However, this must be carefully assessed to ensure compliance with § 14 SGB IV (Social Code IV).
• Documentation and Confidentiality: All severance agreements should be thoroughly documented, and payroll records must accurately reflect these payments. Maintaining confidentiality around the terms of severance agreements is also essential, particularly in sensitive cases involving high-level employees or potential reputational risks for the company.
• Impact on Future Employment: Employers should also consider whether to include a non-compete clause (Wettbewerbsverbot) in the severance agreement, as this might affect the severance amount or the employee’s entitlement to continued payments during the non-compete period, per §§ 74-75d HGB (Handelsgesetzbuch).

Conclusion:

Severance payments, whether resulting from court proceedings or mutual termination agreements, require careful legal and payroll management. Employers must navigate the legal requirements of the KSchG and EStG while ensuring that all payments are correctly processed and documented.

For further assistance in managing severance payments and ensuring compliance with German payroll regulations, please contact WW+KN, a Baker Tilly Company, at Info@payrollgermany.de.