HW Legal
Is an employee entitled to compensation for a higher tax burden caused by a lump-sum payment of outstanding wages?
When an employer pays a large amount of outstanding wages in a single payment covering an extended period, the consequences may extend beyond employment law and have significant tax implications. A recent decision of the Czech Supreme Court demonstrates that these consequences can be both unexpected and substantial.
Lump-sum payment of outstanding wages and its consequences
How did the situation arise?
In the case decided by the Supreme Court, an employer failed to pay an employee's wages for approximately one and a half years.
After successfully pursuing a court claim for the unpaid wages, the employee eventually received all outstanding wages in a single payment approximately five years later. The employee also received statutory default interest that had accrued on the unpaid amount in the meantime.
When can such a situation occur?
Typically, it arises where an employer terminates an employee's employment relationship, stops assigning work, and ceases paying wages. The employee challenges the termination and brings legal proceedings. The court subsequently concludes that the termination was invalid.
We discuss invalid termination of employment in more detail here.
However, the lump-sum payment of the outstanding wages had an unexpected tax consequence. Because the employee received several years' worth of income in a single tax year, they became subject to a higher rate of personal income tax.
Loss caused by a higher tax liability
Why was the employee's tax liability higher?
Had the employee received the wages as they became due, the income would have been spread across several tax years and the higher tax rate would not have applied.
As a result of the lump-sum payment, however, the employee was required to pay a higher amount of personal income tax in the tax year in which the outstanding wages were finally paid. The reason was the significantly higher aggregate income received during that particular tax period.
The Supreme Court's decision
The employee is entitled to compensation
The Supreme Court held that the employer must compensate the employee for the loss resulting from the increased tax liability.
The Court reasoned that the loss would never have arisen had the employer paid the wages properly and on time as they became due.
Default interest does not compensate for this loss
Statutory default interest is not intended to compensate for an increased tax burden.
Its purpose is to compensate for the loss of the value of money over time during the period of delay. It also compensates the creditor for being unable to use the funds while they remain unpaid. In the meantime, the creditor may need to obtain financing elsewhere, potentially at commercial interest rates.
The Supreme Court therefore confirmed that the employer must compensate the employee for the tax-related loss in addition to paying statutory default interest.
Practical implications for employees and employers
For employers, this decision highlights another potential cost that should be considered when litigating disputes concerning the validity of an employment termination.
Where an employee successfully challenges a dismissal and the court declares the termination invalid, employers are often required to pay several years of outstanding wages at once. If that payment results in a higher tax liability for the employee, the employer may also be liable for the resulting tax loss.
From the employee's perspective, the judgment confirms that where a lump-sum payment of outstanding wages leads to a higher tax burden than would have arisen through regular monthly payments, the employee may successfully claim compensation for that additional tax from the employer.
Need advice on an employment dispute?
If you are an employer or an employee facing a similar situation, we recommend seeking advice from an employment law specialist.
We would be happy to assist you.