Emerging Damage and Loss of Earnings. The Revenue Agency Returns to the Taxation to be Applied.

With its response to question no. 185 of April 8, 2022, the Revenue Agency provided clarification about demotion and damages for loss of chance, stating that the sums awarded on an equitable basis by the Court, to compensate for the injury to the employee’s professional capacity, are to be considered non-taxable, in that they can be configured as consequential damages and, therefore, are not subject to withholding tax.

Before going into the merits of the Revenue Agency’s ruling, in terms of demotion, we can distinguish:

  • the pecuniary damage, deriving from the impoverishment of the professional capacity of the worker or from the failure to acquire greater capacity, with the related loss of chances, that is, of further possibilities of earning,
  • non-asset damage, including, inter alia, (i) damage to the worker’s psychological and physical integrity, (ii) existential damage, such as any prejudice that is not merely emotional and inner, but objectively ascertainable, that alters the worker’s habits and relational assets, inducing him/her to make different life choices as regards the expression and realization of his/her personality in the outside world, (iii) damage to the professional image and (iv) damage to the worker’s personal dignity.

The case that involved the tax authority originated from the request of a company that, having already paid to the Revenue Agency the withholding tax – operated on an amount awarded as compensation for damages to an employee – wanted to understand

  • whether the interest was intended to make up for the damage suffered and, therefore, was to be considered as having no relevance to income and improperly subjected to withholding tax or, differently, as being intended to make up for the loss of profit, with full relevance to income and, therefore, correctly subjected to withholding tax,
  • the procedures for recovering the withholding tax potentially considered to have been paid in error, assuming that this can be done when submitting the supplementary 770/2021 form, relating to the 2020 tax year.

In 2020 the petitioner had paid in two tranches to a former employee, the entire sum awarded as compensation for demotion by a sentence of the Court appealed by the same employee.

Specifically, a first instalment as an amount net of withholding tax, then, at the official request of the former employee, who had claimed the non-taxability of the sum in question, a second instalment by paying the difference between what was settled with the judgment and what was received.

In response to the question, the tax authorities point out that, based on Article 6, paragraph 2 TUIR, income earned in lieu of income and indemnities received, including in the form of insurance, as compensation for damages consisting in the loss of income, excluding those dependent on permanent disability or death, constitute income of the same category as that replaced or lost.

In this regard, in practice it has been specified that the indemnities paid by way of compensation must be taxed, provided that they have a replacement or supplementary function for the income of the recipient; in substance, the sums paid in order to replace lost earnings (so-called loss of profit), both present and future, of the person who receives them, are taxable.

On the other hand, the indemnities paid in order to restore the assets of the subject, or in order to compensate the economic loss suffered by the assets (so-called “emerging damage”) do not assume income relevance.

In view of the above, the Agency concludes that the sums settled on an equitable basis by the Court, following the injury to the professional capacity of the worker, are to be considered non-taxable, in that they can be configured as emerging damage and, therefore, aimed at compensating the economic loss suffered by the assets.

Therefore, as the petitioning company has already returned the withholding tax to the former employee, it may recover this amount by submitting the supplementary declaration for Form 770/2021 relating to tax year 2020.

With the response to the rulling , therefore, the Revenue Agency reiterates not only that, in terms of demotion and loss of chance, the sums settled on an equitable basis by the Court, following the impairment of the employee’s professional capacity, are to be considered non-taxable, but also that the chance represents a value that can be independently assessed from an economic point of view, making its loss a current and compensable damage.