Lithuania: Evaluate the tax risks and tax optimization opportunities when terminating employment agreements.
The State Tax Inspectorate (STI) has published an explanation regarding taxation of severance and non-competition payments.
Companies paying severance and non-competition payments should note the following:
- Payments under non-competition agreements are more tax favourable compared to severance payments. Therefore, when considering the size of these payments, the tax effect should be evaluated separately.
- After conclusion of non-competition agreements it becomes vital to substantiate their benefits to the company. Therefore, non-competition agreements, despite other essential provisions, should contain provisions regarding their purposes and why they are needed in relation to company activities.
Although both severance and non-competition payments arise for the same reason – termination of employment – and are paid to the same individual, the taxation regime for these payments differs. The main reason for the difference is that they are regulated by two separate branches of the law, i.e. employment law and civil law.
For PIT purposes, severance payments are considered as employment related income and are taxed @ 15% PIT plus social security and health insurance contributions.
In contrast, non-competition payments are considered as unrelated to employment income and therefore are only taxed @ 15% PIT. For VAT purposes, neither payment is subject to VAT.
Severance payments are not subject to VAT since employment relations are treated as non-economic activities. Non-competition, although considered to be a service, is not subject to VAT since it is only considered as an incidental activity.
For CIT purposes both payments are eligible for tax deductible expenses, provided that both types of expenses are necessary for the taxpayer to earn their income or obtain economic benefit. However, according to the STI, a factor to take into consideration is that severance payments are eligible for tax deductible expenses at once, while non-competition payments require substantiation as to earning income and obtaining economic benefit.
Do you have questions regarding the severance and non-competition payments? Need assistance when concluding non-competition agreements? Feel free to contact us and we will be more than happy to assist.