Executive Severance Rules · Executive Severance Pay Policy and Shareholder Resolutions
Executive Severance Pay Rules
What is an executive severance policy?
- Executives fall outside statutory severance; company policy is the basis
- Requires a provision in the articles of incorporation or a shareholder resolution
- Amounts above the tax-law limit are taxed as earned income
Whether a company has an executive severance policy changes what the same money is called. Registered executives are not employees, so the severance system under the Employee Retirement Benefit Security Act does not apply to them. To pay an executive severance, a company must set a policy either directly in its articles of incorporation or through a shareholder resolution the articles delegate to. Money paid without this basis is treated as a bonus for tax purposes, so it is not deductible for the company and is taxed as earned income for the executive. The starting point is that an executive severance policy is a document that establishes the basis for payment, not an employee benefit.
The policy should cover who is eligible, how length of service is calculated, the payment multiplier, payment timing, and how mid-term departures are handled. A common method multiplies the average pay over a set period before departure by years of service and a multiplier by position. The higher the multiplier, the bigger the gap against the amount recognized as retirement income. Tax law sets a separate limit on executive retirement income and taxes the excess as earned income. Because the limit formula and its effective dates have been amended over time, check the current limit against the latest Income Tax Act and National Tax Service guidance. Unregistered executives who are in substance employees are entitled to statutory severance pay, so retirement benefits must be paid to them regardless of the policy.
In the December–January executive reshuffle season, HR and training managers face one practical issue: 'the moment an employee is promoted to executive.' When employee status ends, severance for the employee years must be settled and retirement pension membership closed out. At many companies, the session that explains severance settlement and changes to the four major social insurances for newly promoted executives becomes the first session of new-executive training. If settlement is put off, the employee and executive periods get mixed together at retirement, and disputes over the calculation follow.
Where practice goes wrong is paying on the sole decision of the CEO with no policy. Even in a company with one shareholder, a missing shareholder meeting record means the deduction is denied in a tax audit. Another problem is raising the multiplier after the fact. If the policy is amended just before a departure to raise the multiplier, it may be seen as a measure for one person and not be recognized in the limit calculation. Disputes at retirement are also common when a company runs without deciding whether to include or exclude people whose status is ambiguous, such as employees who also serve as executives, outside directors, and non-executive directors.
Inwoo LeeLeadership, communication & performance management expert
Anna ChoOrganizational culture, coaching, emotion management & CS consulting expertThe Commercial Act requires directors' compensation to be set in the articles of incorporation or, failing that, by shareholder resolution, and courts have held that severance pay counts as part of this compensation. Tax law sets its own conditions for deducting executive severance and its own limit on retirement income, and it requires 'payment under a policy,' so in practice a severance provision in the articles or a shareholder resolution is essential.
Consider a hypothetical case. Company A is a building-materials manufacturer with KRW 120 billion (≈ US$89,780,000) in revenue and 380 employees, including 4 registered executives and 7 unregistered executives. In next January's personnel moves, 2 department heads will be promoted to unregistered managing director and 1 registered executive will step down. The executive severance policy was a single line in the articles of incorporation from 10 years ago, so the finance and HR teams disagreed over the payment standard.
- The finance head consulted the tax accountant and was told that the article from 10 years ago, with no multiplier or calculation period, would make deductibility hard to defend. On hearing that 'paying without a policy gets booked as a bonus,' the CEO immediately ordered the policy to be put in order.
- The HR head drafted a policy covering multipliers by position, the averaging period for pay, handling of mid-term departures, and exclusion of non-executive and outside directors. The tax accountant advised adjusting the multipliers after comparing them with the current tax-law limit.
- For the registered executive due to step down, the company explained that the policy amendment came just before their departure. So that it would not look like a change made for one person, it set a standard that applies to all executives and had the minutes of the extraordinary shareholder meeting notarized.
- For the 2 department heads being promoted, the first session of the new-executive training explained how their employee severance would be settled as of the day before promotion and how their DC retirement pension would be moved to an IRP. One of them said, 'I didn't know my severance pay would stop.'
- After the overhaul, the departing executive's severance of KRW 210 million (≈ US$157,100) was paid under the policy and fully deducted as an expense. Severance for the 2 promoted executives’ time as employees was settled within 14 days of their promotion.