Severance pay and final settlement are not the same
They are often confused, but they are different things. The final settlement must be paid whenever a contract ends, for whatever reason: it includes outstanding salary, the proportional part of extra payments and unused holiday days. It does not depend on who ends the relationship.
Severance pay is something else. It is only paid in certain cases, normally when the dismissal or termination of the contract is not the worker's fault. That is why the final settlement is a right in every end of contract and severance pay is compensation that only appears in specific cases.
When you are entitled to severance pay
The general rule is simple: if the company ends the contract without the worker having breached it, there is severance pay. Typical cases are unfair dismissal, dismissal for objective or economic reasons, collective dismissal (ERE) and termination of a temporary contract before the agreed date.
There can also be severance pay by mutual agreement, if the parties agree to it, or when working conditions change substantially and the employee decides to leave. What does not generate severance pay is voluntary resignation or not passing the probation period.
How it is calculated
The calculation is made in days of salary per year worked. In Spain, for example, unfair dismissal gives 33 days per year with a cap of 24 monthly payments, and objective dismissal gives 20 days per year with a cap of 12 monthly payments. The termination of a temporary contract is usually compensated with 12 days per year.
Those figures are the Spanish reference. Each country has its own formula, and they do not always coincide. In Portugal it is 12 days per year for objective dismissals, in Germany severance pay is more negotiated than calculated and in France one quarter of monthly salary per year is paid. If you are interested in the detail by market, you have it in the guide to dismissal in Europe.
What does not generate severance pay
If the worker leaves on their own (voluntary resignation), there is no severance pay to claim. Nor is there any if they do not pass the probation period, if the dismissal is disciplinary and is declared fair, or if the contract ends on the agreed date of a temporary contract.
It is worth being clear about this before hiring: severance pay is not an automatic cost of every termination, but a consequence of ending the relationship by company decision and without cause attributable to the employee.
Severance pay and taxation
In Spain, severance pay for unfair or objective dismissal is exempt from personal income tax up to a limit of 180,000 euros. Anything above that figure is taxed as employment income. Severance pay for agreed termination outside those cases does not enjoy the exemption.
In other countries, the tax treatment varies. If you manage payroll across several markets, check the local rules before running payroll, because an error in the exemption can end up in a tax adjustment.
