The recent amendment to the Income Tax Law (118(I)/2002) by Amending Law 244(I)/2025 introduces significant provisions regarding the taxation of ex gratia payments made upon termination of employment. This article sets out the current legal framework and the practical implications for employees and employers.
1. Definition and Legal Basis for Taxation
The term “ex gratia payment” encompasses any payment made by an employer to an employee upon termination of employment that does not arise from a contractual obligation. Pursuant to Article 5(1)(b) of the Law, as amended, taxable income includes a gratuity granted as a gesture of goodwill upon retirement or early retirement, or upon the expiry or early termination of an employment contract or appointment to office. Furthermore, taxable income includes compensation for the termination of employment or appointment to office, the payment of which is not provided for in an employment contract, contract of appointment to office, collective agreement, regulations, or any other terms governing the employment or appointment to office.
In addition, sums receivable, including compensation, which are paid pursuant to a court order and relate to any of the above sub-paragraphs, are subject to tax under the relevant sub-paragraph and are taxed accordingly. Consequently, even ex gratia payments awarded by a court remain taxable.
2. New Article 20F — Special Tax Regime for Ex Gratia Payments
The key innovation of the recent amendment lies in the introduction of a special tax regime for ex gratia payments through the new Article 20F. Income of an individual falling within the provisions of sub-paragraphs (iv) to (vi) of paragraph (b) of subsection (1) of Article 5 and the provisions of sub-paragraphs (iv) to (vi) of paragraph (b) of subsection (2) of Article 5, which exceeds two hundred thousand euros (€200,000), is subject to tax at a rate of twenty per cent (20%). Furthermore, such income is not aggregated with any other income.
The above article applies to both residents and non-residents of the Republic, provided that the employment services were performed in Cyprus.
In practice, taxation is structured as follows:
- (i) Up to €200,000 — the amount is added to the individual’s other income and taxed at the progressive income tax rates.
- (ii) Above €200,000 — the amount is taxed separately at a flat rate of 20%, without being aggregated with other income.
3. Absence of a General Exemption for Termination of Employment
Crucially, the Law does not provide for a general exemption for ex gratia payments arising from termination of employment. The only relevant exemption is strictly limited to dissimilar circumstances: any lump-sum amount received as a gratuity on account of death, or as lump-sum compensation for death or bodily injury, is exempt from tax.
This exemption applies exclusively to cases of death or bodily injury and does not extend to ex gratia payments made upon termination of employment.
4. Non-Deductibility for the Employer
The current legislative framework, as amended, treats ex gratia payments uniformly from the employer’s perspective. Ex gratia payments to employees and officers falling within the provisions of sub-paragraphs (iv) to (vi) of paragraph (b) of subsection (1) of Article 5 and sub-paragraphs (iv) to (vi) of paragraph (b) of subsection (2) of Article 5 are not deductible in computing the employer’s taxable income.
This means that the ex gratia payment carries a double burden: it constitutes taxable income for the employee whilst simultaneously providing no tax relief to the employer.
5. Obligation to Withhold Tax
Notwithstanding anything contained in the Law, for each tax year, tax is levied on all remuneration for that year, and upon payment of remuneration or any sum in lieu of remuneration during the tax year, tax shall be withheld by the person paying the remuneration in accordance with Regulations made by the Council of Ministers.
For the purposes of the Law, the term “remuneration” means any income derived by an individual from profits or benefits as specifically defined in paragraph (b) of subsection (1) and paragraph (b) of subsection (2) of Article 5, and includes any pensions; thereby also covering ex gratia payments upon termination of employment.
The employer is obliged to withhold the corresponding tax at the time of payment and to remit it to the Commissioner of Taxation in accordance with the Withholding Tax on Remuneration Regulations.
6. Interpretive Issue: The Possible Legislative Intent for a €200,000 Tax-Free Threshold
Notwithstanding the above analysis, there is considerable interpretive disagreement in the market regarding the tax treatment of the portion of an ex gratia payment that does not exceed €200,000. Some tax advisors argue that this first portion remains tax-free.
This may indeed have been the legislator’s intention — an intention, however, that was not captured with sufficient clarity in the text of the Law. The arguments in favour of this interpretation may be drawn from the following:
Article 20ΣΤ(1) expressly provides that income “…which exceeds two hundred thousand euro (€200,000)” is subject to taxation at 20%.
If the intention had simply been to introduce a favourable 20% rate for amounts above €200,000, with the portion up to €200,000 remaining taxable under the normal tax bands, the correct legislative drafting would have been to expressly address the taxation of both portions. The Law’s silence as to the taxation of the portion up to €200,000 within Article 20ΣΤ could potentially be interpreted by some as a deliberate omission suggesting a tax-free threshold. The legislator chose to expressly set a minimum threshold of €200,000 (“which exceeds”), a fact that may arguably support the interpretation that the inclusion of this threshold was deliberate and implies a tax-free portion.
Article 20ΣΤ falls within Part IV of the Law, entitled “Special Modes of Taxation of Certain Types of Income,” which is introduced by Article 15, providing that “notwithstanding any provision of this Law, tax shall be determined in the specified cases as provided in this Part.” This precedence of the special Part IV over the general provisions may reinforce the interpretation that Article 20ΣΤ, as lex specialis, prevails over the general Article 5, fully replacing the method of taxing ex gratia payments.
The above, however, in our view runs up against Article 45A, which expressly provides that “any exemptions or deductions for the purpose of ascertaining a person’s taxable income shall be granted only in accordance with the provisions of this Law,” taken together with Article 8, which does not include in its list of exemptions any exemption for ex gratia payments made upon termination of employment.
Furthermore, Article 5(1)(b)(iv) and (vi) expressly classifies gratuities and termination compensation as taxable income, and there is no express exemption for the portion up to €200,000.
Accordingly, any interpretation producing a tax-free outcome without an express legislative reference raises serious interpretive difficulties.
7. Summary Conclusions
Under the current legislative framework, as shaped by the recent 2025 amendment, an ex gratia payment upon termination of employment is taxed as follows:
- A) Full taxation — there is no general exemption for amounts received upon termination of employment.
- B) Amounts up to €200,000, based on a literal reading of the Law, are subject to the standard progressive income tax scales and are aggregated with the individual’s other income. However, the legislative drafting of Article 20F leaves open the question of whether the legislator’s intention was for this portion to remain tax-free; an intention which, if it existed, was not captured with sufficient clarity in the text.
- C) Amounts exceeding €200,000 are taxed separately at a rate of 20% pursuant to the new Article 20F, without being combined with other income.
- D) The employer is not entitled to a tax deduction for such payments.
- E) The employer is obliged to withhold the corresponding tax at the time of payment.
- F) The interpretive gap regarding taxation of the portion up to €200,000 awaits official clarification from the Tax Department – either via Circular, or preferably through a legislative amendment by Parliament expressly stating that amounts below €200,000 are not taxable.
Author:
Konstantinos Kokkinoftas
Senior Partner