Introduction
Resolution No. 281 of April 2021 of the Italian Tax Authority has returned to the issue of the tax deductibility of the Employee Severance Indemnity (hereinafter “TFR”) for IAS adopters, finally providing guidance also for IRAP purposes.
It should be remembered that the International Accounting Standards (“IAS/IFRS”) were introduced by the national legislator to implement the process of harmonisation of EU accounting regulations, making their adoption compulsory in the annual and consolidated Financial Statements of listed companies and banks. The IAS/IFRS are inspired by the principle of “substance over form“, according to which the accounting representation of business events must be based on the economic substance of the transaction over the legal form of the contract.
The resolution, in addition to summarising the deductibility mechanism for IRES purposes provided for in the First Time Adoption (“FTA”), also focuses on the methods for determining the deduction of Labour costs provided for IRAP purposes.
In order to correctly determine the deductible amount, it is necessary to dwell on the accounting methods provided for by IAS19.
1. The “Severance Indemnity” according to International Accounting Principles
The TFR represents the liquidation indemnity of the worker, in case of termination of employment.
From a legal point of view, the TFR represents a real debt of the company accrued towards the employee; in this sense, reference is made to article 2120 of the Civil Code and to the specific agreements contained in the national collective contracts, even if from a strictly accounting point of view it is improperly referred to as a provision.
According to international accounting standards, the institution is not qualified as a debt, but as a provision for future charges and classified according to IAS19 as:
1) a defined Benefit plan for the employee severance indemnity accrued until 31 December 2006;
2) a defined Contribution plan for employee severance indemnity accrued from January 1, 2007.
The accrual made to the provision for termination indemnities expresses a value discounted at a certain discount rate, calculated through actuarial methods that take into account the demographic variable, such as employee mortality and staff turnover, and the financial variable, such as the future increase in employee salaries and the costs for employee medical assistance.
This value of the provision for severance indemnity is divided, at accounting level, into three components:
- Service cost: which represents the social security cost related to the services rendered by employees during the year;
- Interest cost: which represents the interest expense accrued during the year on the outstanding TFR debt;
- Actual gains or losses (“remeasurements”): representing the portion of actuarial gains or losses due to deviations from the actuarial assumptions used for previous years’ valuations.
The service cost and interest cost components are recognised in the income statement, while the actuarial gains/losses component is recognised in Other Comprehensive Income[1] (“OCI”).
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2. The Tax Deductibility of the TFR provision
Article 2 of Ministerial Decree no. 48 of 2009 (“IAS Implementation Decree”), recognised the full tax deductibility of the provision made on the basis of the provisions of 2120 of the Italian Civil Code.
In particular, it is necessary to consider the classification of IAS19 between TRF accrued from 1 January 2007 and TRF accrued until 31 December 2006.
While for the former, the above mentioned provision recognises the full fiscal relevance of the portion of TFR recognised in the income statement, the same cannot be said for the TFR accrued until 2006 and accounted as a “defined benefit plan”: in this case the IAS provision composed of service cost, interest cost and Actual gain or loss must be compared with the amount recognised on the basis of the statutory provisions (tax deductible limit).
If the IAS provision exceeds the tax limit, an increase will have to be made in the Tax return; if it is lower, no tax change will be made and this deductible “basket” can be used in the following year if the opposite situation occurs.
For IRAP purposes, the problem on the deductibility of the Employee Severance Indemnity arose in 2015, when the legislator introduced the additional deduction from the IRAP taxable base of the Residual personnel cost, consisting in the possibility to deduct the costs related to employees with an open-ended employment contract, net of what has already been deducted from the “Tax Wedge” (called “Cuneo Fiscale” in Italy) pursuant to Article 11 of Legislative Decree no. 446 of 15/12/1997.
Resolution No. 281 of 2021 of the Inland Revenue clarified that the rules set forth in the IAS implementing decree are also applicable to the above-mentioned deduction, with the consequence that the tax value of the TFR attributable to the civil rules must also be taken into account for IRAP purposes, using the same mechanism provided for IRES purposes of carrying forward the deductibility basket.
[1] This is a separate statement from the profit and loss account that includes revenue and cost items that are not recognised in profit or loss and are generally recognised directly in equity.