Mutual Rescission/Termination (Ikale) of Employment Agreements
Mutual rescission or mutual termination agreement is an agreement that terminates the labor contract based on the mutual consent of the parties (ikale). Mutual rescission/termination agreement is not regulated under any specific law and in principle could be established in line with the freedom of contract principle and therefore the establishment and validity of the mutual rescission agreements are subject to the provisions of the Turkish Code of Obligations (“TCO”). Accordingly, when executing a mutual rescission/termination agreement, one of the parties shall explain to the other party its desire to terminate the labor contract, in other words, make an offer and the other party shall accept it. In Turkish law practice, mutual rescission/termination agreements are used for the termination of the employment contracts of employees who are eligible to the right of “reinstatement” within the scope of occupational safety regulations, and they are used to pay the compensatory rights subject to such possible reinstatement claims in advance.

Employment Termination Based Compensations in Mutual Rescission/Termination Agreements

Severance Compensation

The issue whether severance compensation could be received if the labor contract is terminated through mutual rescission/termination constitutes a pivotal point in terms of mutual rescission agreements. Severance compensation or payment is regulated in the sole remaining article of the now-abolished Labor Law No. 1475, that is still in force, the Article 14. The conditions for receiving severance compensation are determined in the Article 14 and except for subparagraph II of Article 25 of the (currently in force) Labor Law No. 4857, that is rightful termination, any other form of termination by the employer seems to be sufficient in case the employee has been working for such employer for more than one (1) year.

Again, in terms of entitlement to severance compensation, there is no distinction between fixed-term and indefinite-term employment contracts. However, in the case of a fixed-term labor contract that expires within the specified period, the precedent of the Court of Appeals General Assembly (dated May 30, 2014, No. 2014/22-391 E.) states that no severance compensation will be applicable. The Court stated that the contract is terminated automatically in such cases.

Since the compensation or payments to be received by the employee in cases of the termination of the labor contracts through mutual terminations or rescissions are not regulated in the law, the issue has been shaped by the precedent of the Court of Appeals and, the payment of severance compensations in cases of mutual termination/rescission agreements have become the practice in Turkey.

Notification Compensation

Although it can be claimed that the employee should not receive any notification compensation (paid for immediate termination without proper notice in regular terminations by either side) as well since the mutual rescission is in fact a joint termination statement by both parties immediately taking effect, notification compensation is also paid to the employees considering that there is a sudden/immediate termination in practice, and the Court of Appeals precedent supports such argument. In its decision (No. 2016/3269 E. and 2016/6967 K. dated March 23, 2016) the 7th Civil Chamber of the Court of Appeals, notes that the employer should pay severance and notification compensations to the employer in cases where the offer to execute a mutual rescission/termination agreement is made by the employee and the offer includes the demand of payment of his/her legal rights.

Reinstatement/Reemployment Compensation

Other compensations are also included in the terminations made by way of mutual rescission/termination of employment agreements. As stated above, in practice, mutual rescission is generally used for risk reduction within the scope of paying “reemployment/reinstatement” compensations in advance, and in this context, payments are made to replace “reemployment/reinstatement” compensations that may be awarded by Courts later through claims of terminated employees.

In order for the employee to file a reemployment lawsuit, the labor contract has to be terminated without a valid reason or without giving any reason, and the employee has to meet the criteria set forth in Article 18 of the Labor Law No. 4857, “The employer, who terminates the indefinite-term labor contract of an employee with at least six months seniority in workplaces employing thirty or more workers, has to rely on a valid reason arising from the competence or behavior of the employee or the requirements of the business, workplace or job”.

Consequences of invalid termination are regulated under Article 21 of the Labor Law No. 4857, which states that "When the employer has not been given a valid reason or the reason shown is not valid, and it is determined by the court or a special arbitrator that the termination is invalid, the employer has to start the employee within one month. If the employer does not start the employee within one month upon the employee’s application, the employer is obliged to pay the employee a compensation amounting to at least four months and at most eight months.”. Pursuant to Article 17 of the Labor Law, if the labor contract of the employees working with an indefinite-term labor agreement, which are outside the scope of Articles 18, 19, 20, 21 of the Labor Law, are terminated by abusing the right of termination, the employee is paid compensation in the amount of three times of the notification period. In practice, this compensation is called compensation for bad faith damages. Compensation for bad faith damages is subject to income tax as it is not counted in Article 25 of the Income Tax Law, which counts the compensations that are not subject to income tax.

In the event that the employee has not been allowed to return to work as a result of the labor contract terminated on the basis of invalid termination or without any reason, a compensation amounting to at least four and at most eight months' wages are envisaged. Whether this compensation is subject to taxation is regulated under Article 25 of the Income Tax Law No.193. According to Article 25/1 of the Income Tax Law, the compensations for not being allowed to return to work paid according to the Labor Law No. 4857 are not subject to income tax. Compensations for not starting work mentioned in Article 25/1 of Income Tax Law are explained in Article 9 of the Income Tax General Communiqué (Serial No: 306). Article 9 of the Income Tax General Communiqué (Serial No: 306) indicates that “(3)…  According to Article 21 of Law No. 4857, when it is determined by the court or a special arbitrator that the employer does not show a valid reason or the reason shown is not valid, and it is decided that the termination is invalid, if, upon the application of the employee, the employee does not start work within one month, the compensation paid to the employee for at least four months and at most eight months is within the scope of the exemption. (4) Pursuant to Article 21 of Law No. 4857, if the parties agree that the employee will not return to work as a result of the mediation activity, the compensation for not starting work, which is paid to the employees whose labor contract is terminated, in the amount of at most eight months' wages, is also within the scope of the exemption.”

Accordingly, various reinstatement/reemployment-based compensation amounts may be applicable. The Courts offer four (4) months’ worth of grossed up wages (gross in the sense to include any and all benefits provided to the employee in monetary terms, not simply income withholding tax-based gross and net salary) to the employees at the end of reinstatement claims for the time spent out of employment; also offer another four (4) months to eight (8) months’ worth of wages in cases where the employee is not taken back to employment by the employer following the Court order.

The question whether these reinstatement compensations are to be paid during a mutual termination agreement are again determined by the precedent of the Court of Appeals. According to the decision of the 9th Civil Chamber of the Court of Appeals (No. 2015/27647 E. dated March 30, 2016), if the mutual termination offer comes from the employee, then it might be deemed sufficient to pay only severance compensation, however, if the offer for mutual termination comes from the employer, in addition to the severance and notification compensations, an additional payment of at least four (4) months' worth of grossed up wages shall be made to the employee for the Court to deem the mutual termination agreement valid.

Taxation of Compensations Made Through Mutual Rescission/Termination Agreements

Since the employees are to receive compensations and/or wages in cases where the employment contract is terminated with the mutual rescission/termination agreement, the taxation application for such payments is an issue to consider.

This issue has been regulated with the amendments introduced by the Law No. 7103 on Amendments to Tax Laws and Certain Laws and Decrees with the Force of Law (“Law No. 7103”), published in the Official Gazette on March 27, 2018. According to Article 61 of the Income Tax Law No. 193, “Wage is the money given to employees in return for services attached to a particular workplace subject to the employer, and benefits that are provided by intangibles and can be represented by money” A 7th subclause has been added to Article 61st of the Law No. 7103 and the Income Tax Law No. 193 which lists the additional forms that count as wages. The added 7th subclause involves such statements “After the termination of the service agreement; payments and aids made under various names such as compensations paid under mutual termination agreement or mutual rescission agreement, compensation for job loss, compensation for termination of employment, compensation for job security”.

Therefore, it is stipulated that the compensation and payments paid as a result of the mutual rescission/termination agreement will clearly fall within the scope of wages.

Another amendment introduced with the Law No. 7103 was made in Article 25 of the Income Tax Law No. 193. Article 25 of the Income Tax Law lists the exemptions from income tax. With this amendment, the compensations paid as a result of the employment agreements terminated with the mutual rescission/termination agreements are also counted among these situations. According to the Law “…after the service agreement is terminated; payments and aids made under various names such as compensations paid under mutual termination agreement or mutual rescission agreement, compensation for job loss, compensation for termination of employment, compensation for job security” are exempt from income tax.

At this point, it should be noted that wages, overtime, premiums, unused annual leave, travel, meals and similar wages and benefits are not within the scope of Article 25/7 of the Income Tax Law and are subject to income tax.

Considering these amendments made to Articles 61 and 25 with the Law No. 7103, it is concluded that the compensation paid due to the mutual rescission/termination agreements are considered as a wage and will not be subject to income tax pursuant to Article 25/7-b. However, the Article 14 of the Abolished Labor Law No.1475 that is still in force shall also be noted. The said article indicates that in line with the Retirement Fund Law No. 5434, the annual amount of severance pay cannot exceed the highest retirement bonus to be paid for a year of service to the highest government official. The highest civil servant is the head of administrative affairs of the Presidency in accordance with the additional the additional Article 34 of the Decree Law No. 703. For 2021, this amount is TRY 8,284.51 as of July 1, 2021.

Accordingly, income tax will be applied to the amount of severance compensations that exceed the maximum retirement bonus to be paid to the highest civil servant for one year of service. Temporary Article 89 was added to the Income Tax Law No. 193 with the Law No. 7162 Amending Income Tax Law and Some Laws stipulate that “Compensations paid within the scope of mutual termination agreement or mutual rescission agreement before March 27, 2018, compensation for job loss, compensation for job termination, job security, income tax collected by withholding on payments and aids made under various names such as indemnities and benefits, is rejected and refunded in accordance with the provisions of the Tax Procedure Law No.213”. Therefore, the tax refund of the compensation payments given because of the mutual rescission agreement before the date of March 27, 2018, has been made possible.

Employment Terminations Through Mediation

According to the Law on Mediation in Civil Disputes No. 6325 (“LMCD”), mediation is “a solution proposal in case of failure of the parties to find a solution, which brings together the parties to discuss and negotiate by applying systematic techniques, establishes a communication process between them in order to enable them to understand each other and thus produce their own solutions. It refers to the dispute resolution method that is carried out voluntarily and with the participation of an impartial and independent third person who has specialized training.”

Article 3 of the Law on Labor Courts No. 7036 states that “in lawsuits filed with the demand of employee or employer receivables and compensation based on the Law, individual or collective labor agreement, and reemployment, it is mandatory to apply to a mediator.” In accordance with Article 3, application to a mediation process is mandatory before filing a reemployment/reinstatement lawsuit.

Accordingly, in case of a Court order or a mediation agreement following a mediation procedure (that also serves as a Court order), the reinstatement compensations awarded are not subject to income tax.

The status of the additional compensations given in cases of voluntary mediation procedures (with same results of a mandatory one) to agree on the termination conditions before the labor contract is terminated are explained in the Special Notice No. 64597866-120[25/1]-9209 of the Large Taxpayers Tax Office of the Revenue Administration, dated June 7, 2021. According to the Special Notice, “the additional compensation to be paid in case of applying to the voluntary mediation institution in order to agree on the termination conditions before the labor contract is terminated; Since it is not possible to evaluate it as compensation for not starting work paid according to Article 21 of the Labor Law No. 4857, it is not possible to exempt it within the scope of subparagraph (1) of the 1st  paragraph of Article 25 of the Income Tax Law. It should be evaluated within the scope of subparagraph (7)”. The explanation in the Special Notice and Article 9/5 of the General Communiqué of Income Tax Law (Serial No: 306) the additional compensations to be paid as a result of resorting to voluntary mediation before the labor contract is terminated are not included in the scope of not start to work. These compensations are within the scope of Income Tax Law 25/7.

Article 25 of the Income Tax Law regulates compensation and benefits that are exempt from income tax. According to Article 25/7-a “All severance pay to be paid according to the Labor Law No. 1475 dated August 25, 1971 , and the Maritime Labor Law No. 854, dated April 20, 1967 …” and pursuant to Article 25/7-b of the Income Tax Law, “after the end of the service agreement, provided that it is taken into account in the calculation of the exemption amount specified in sub-paragraph (a) of this clause, according to the legislation to which the service person is subject; Payments and aids made under various names such as compensations paid within the scope of mutual termination agreement or mutual rescission agreement, compensation for job loss, compensation for termination of employment, compensation for job security” are exempt from income tax.

The compensation paid as a result of voluntary mediation in order to agree on the termination conditions before the termination of the labor contract is within the scope of Article 25/7 of the Income Tax Law. Explanations on Article 25/7 of the Income Tax Law are in Article 11 of Income Tax General Communiqué (Serial No:303), which states that "(1) Payments such as compensations paid within the scope of mutual termination agreement or mutual rescission agreement, compensation for job loss, compensation for termination of employment, compensation for job security can be made to the persons who serve in the working life due to reasons such as leaving the job, retiring, not filing a lawsuit, etc. With the amendment made in sub-paragraph (b) of sub-paragraph (7) of the first paragraph of the Article 25 of the Law No. 193, it has been clarified that these payments should be taken into account in the calculation of the severance pay exemption amount according to the legislation to which the employee is subject. While the above-mentioned payments are included, an exemption will be applied over the total of the payments, and the amounts exceeding the exemption will be subject to income tax as a wage. (2) In of the event that an additional compensation payment listed in the first paragraph, other than the severance pay calculated as specified in Article 10 of this Communiqué pursuant to Laws No. 1475 and 854 made, this payment is the part of the sum of this amount and the severance pay amount, which does not exceed the maximum retirement bonus paid to the highest government official, will be subject to exception.”

Considering all these explanations, while all eight (8) months’ worth of wages, which is the highest possible amount of compensation for not getting the terminated employee back to work, paid in accordance with Article 21 of the Labor Law No. 4857 within the scope of compulsory mediation, are not subject to income tax, the compensations listed in Article 25/7 of the Income Tax Law including the compensations given within the scope of mediation (compensations paid under the mutual termination agreement or mutual rescission agreement for reasons such as leaving the job, retiring, not being sued, etc., compensation for job loss compensation, compensation for termination of employment, compensation for job security), the portion that does not exceed the maximum amount of retirement bonus paid to the highest civil servant  will be exempted from income tax.

In practice, it is possible to organize the voluntary mediation in a way that will result in the consequences of compulsory mediation (within the scope of the rightful termination of one party, the legal request of the other party and determination minutes).

Conclusion

In terms of taxation, compulsory (or optional/voluntary, including a rightful termination beforehand) mediation can be considered as to be quite more tax efficient compared to mutual rescission/termination agreements. According to Article 9 of the Communiqué No. 306, of the additional reemployment/reinstatement compensations paid within the scope of mediation, up to the amount of eight (8) months’ worth of grossed up wages will not be subject to income tax. Likewise, within the scope of the severance pay, the exception pursuant to Article 25/7 of the Income Tax Law still can be benefited from. However, in mutual rescission/termination agreements, only the exemption within the scope of Article 25/7 of the Income Tax Law can be benefited by considering the additional compensations and the entire severance pay.