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Different types of termination payments may be made either under the terms of the employment contract or the Employment Ordinance. Here you can learn about what you and your employer should report as taxable income when your employment has been terminated.

Payment in Lieu of Notice

In the years prior to the year of assessment 2012/13, payments in lieu of notice received from your employer and paid in accordance with the terms of your employment contract or the provisions of the Employment Ordinance were not assessed to tax. This is no longer the case because the Court of Final Appeal and Court of First Instance in their recent decisions have given clear guidance that payments in lieu of notice contractually agreed should be assessed to tax. Here you can learn about the tax treatment of "Payment in lieu of notice".

From 1 April 2012 onwards, any payment in lieu of notice that accrued to you from your employer, whether paid under an explicit contract term or under an implied contract term (e.g. section 7 of the Employment Ordinance) will be assessed to tax. Section 7 of the Employment Ordinance provides that either the employer or the employee may terminate a contract of employment by agreeing to make a payment in lieu of notice to the other party. The amount of payment necessary to terminate an employment contract is equal to the amount of wages which would have been accrued to the employee during the period of notice.

Your employer is required to report the payment in lieu of notice on the "Notification by an employer of an employee who is about to cease to be employed" (Form IR56F) or the "Notification by an employer of an employee who is about to depart from Hong Kong" (Form IR56G) and you have to report it on your Tax Return - Individuals (BIR60) from 1 April 2012 onwards. If you are given sufficient notice of termination and receive income during the notice period, your income during the notice period is a normal reward derived from your employment and should also be assessed to salaries tax.

An analysis of some common situations is provided below:

When the Employment is terminatedTax Liabilities
After working for 7 days7 days’ salary income is taxable.
After working for 1 month
-was paid 1 month’s salary and 7 days’ salary in lieu of notice (that is, the employment was terminated immediately and no notice period was given to the employee)Salary for 1 month and the 7 days’ payment in lieu of notice are taxable.
After working for 1 month and 7 days
-was paid salary for 1 month and 7 days (that is, the employee continued to work during the notice period)The salary for the entire 1 month and 7 days is taxable.
After working for 15 months
-was paid salary for 15 months and 1 month’s salary in lieu of notice (that is, the employment was terminated immediately and no notice period was given to the employee)The salary for 15 months and the 1 month's payment in lieu of notice are taxable.
After working for 21 years and 3 months
-was paid, apart from the normal monthly salary due, 6 months’ salary in lieu of notice in accordance with the employee’s terms of employmentThe 6 months’ salary in lieu of notice is taxable.

 More information on payment in lieu of notice and how such payment is taxable is available through the following link.

Payment in Lieu of Leave

Any salary you receive as an employee while you are on leave is part of your income and is taxable. This is called “leave pay”. However, if your employment is terminated and you have earned but not taken leave, your employer may wish to make a cash payment in lieu of leave to eliminate the accumulated leave balance. Cash in lieu of leave is similar to the salary paid when you take leave, and is thus taxable. Your employer must report it on Form IR56F or  56G and you must report it on BIR60.

Furthermore, as an employee you are entitled to annual leave upon completion of one year’s service. Sometimes for business reasons you may have to defer your leave. If your employment is terminated you may take the entitled leave before the cessation date. However, if your employer asks you to forego this option and tops up the payment for this earned but untaken leave with a cash payment as compensation, the topped-up payment is in nature similar to leave pay and should be reported by both you and your employer.

Employee Compensation Arising from Injury

If you suffer personal injury through an accident arising out of and in the course of your employment, the payments that you receive under the Employees’ Compensation Ordinance are not considered as income. Hence, your employer need not report such payments on Form IR56B, 56F or 56G, and you need not report them on BIR60.

Severance Payments and Long Service Payments

Sums paid to you as severance payments or long service payments strictly in accordance with the provisions of the Employment Ordinance (EO) are not assessable to salaries tax. The amount not assessable to salaries tax should be computed after deduction of :

(a)contract gratuities based on length of service;
(b)benefits attributable to employer’s contributions paid under an occupational retirement (OR) scheme; and
(c)
 
accrued benefits attributable to employer’s contributions held in a mandatory provident fund (MPF) scheme or which have been paid.

Your employer need not report the sums computed as above on Form IR56F or 56G and you need not report them on BIR60. However, you and your employer have to report sums that were paid in excess of your statutory entitlement.

Details of an employee's entitlement to severance payment or long service payment under EO are available on the website of Labour Department:

Computation of the Non-assessable Amount

No contract gratuity, OR scheme benefit or MPF scheme benefit to offset statutory entitlement

Non-assessable amount = Statutory entitlement calculated under EO

Example 1
An employee was made redundant. He was entitled to a severance payment of $80,000 under EO. His employer paid him $100,000.

If the employee was not entitled to any contract gratuities, OR scheme benefits or MPF benefits, the employee’s tax position would be as follows:

Non-assessable severance payment under EO$80,000
Assessable terminal award ($100,000 - $80,000)$20,000

Contract gratuities based on length of service to offset statutory entitlement

Non-assessable amount = Statutory entitlement calculated under EO – contract gratuities

Example 2
Same facts as in Example 1, except the employee was entitled to contract gratuities of $100,000 based on length of service.

As the contract gratuities exceeded the statutory entitlement under EO (i.e. $80,000), the employer strictly would not need to pay him any severance payment. The employee’s tax position would be as follows:

Assessable contract gratuities$100,000

All contract gratuities relating to the employee’s years of service for which the severance payment is payable should be taken into consideration.

The employee may apply for relating back in respect of the gratuities to reduce the tax liability. Further information is available through the following link:

OR scheme benefits (excluding any part attributable to employee’s contributions) paid to offset statutory entitlement
Non-assessable amount = Statutory entitlement calculated under EO – OR scheme benefits paid

Example 3
An employee was dismissed. He received OR scheme benefits of $150,000 attributable to employer’s contributions and was entitled to long service payment of $200,000 under EO. His employer reduced the long service payment by OR scheme benefits and paid him $50,000.

The employee’s tax position would be as follows:

Non-assessable long service payment under EO
($200,000 - $150,000)
$50,000

Regarding the OR scheme benefits, if the employee has worked for less than 10 years and the scheme is a recognized one, the amount attributable to contributions of the employer that exceeds the proportionate benefit (Note) would be assessable to salaries tax.

Where the employee has worked for 10 years or more, recognized OR scheme benefits of $150,000 would be exempt.

If the scheme is an unrecognized one, the amount $150,000 attributable to contributions of the employer would be assessable to salaries tax.

MPF scheme accrued benefits (excluding the part attributable to employee’s contributions) to offset statutory entitlement

Non-assessable amount = Statutory entitlement calculated under EO – MPF scheme accrued benefits

Example 4
An employee was made redundant.  Severance payment under EO was $200,000. Accrued benefits attributable to employer’s contributions (both mandatory and voluntary) held in the MPF scheme were $160,000. The employer reduced the severance payment of $200,000 by the accrued benefits of $160,000 and paid a sum of $40,000 to the employee.

The employee’s tax position would be as follows:

Non-assessable severance payment under EO
($200,000 - $160,000)
$40,000

Regarding the accrued benefits, the employee is taken to have received from the MPF scheme the accrued benefits attributable to voluntary contributions of the employer if the accrued benefits are retained within the MPF scheme or transferred to another MPF scheme.  

Where the employee has worked for less than 10 years, the amount attributable to voluntary contributions of the employer that exceeds the proportionate benefit (Note) would be assessable to salaries tax.  

Where the employee has worked for 10 years or more, accrued benefits of $160,000 would be exempt.

Note: More information on proportionate benefit is available through the following link:
 

Reporting of Termination Payments by Employer

Employers should report the following information on Form IR56F or 56G:

Nature of income"Particulars" under Item 13 of IR56F or Item 11 of IR56G
Salary from 1 April of the current year to the last date of employmentSalary/wages
Payment in lieu of leaveLeave pay
Payments in lieu of notice accrued on or after 1 April 2012 under the employment contract or in accordance with section 7 of the Employment OrdinancePayment in lieu of notice (will be assessed if accrued on or after 1 April 2012), Back pay, Terminal Awards or Gratuities
Any severance payment or long service payment in excess of the statutory entitlement as provided in the Employment Ordinance (refer "Severance Payments and Long Service Payments" for details of the statutory entitlement)Payment in lieu of notice (will be assessed if accrued on or after 1 April 2012), Back pay, Terminal Awards or Gratuities

 

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Last review date: April 2014

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