The tax treatment of payments made to employees by employers is dependent on the nature and character of the payments made.
The primary legislation governing the taxation of employees’ income is the Inland Revenue Ordinance (“IRO”). Broadly, salaries tax is charged for each year of assessment on every employee in respect of his income arising in or derived from Hong Kong from (a) any office or employment of profit and (b) any pension.
There is no exhaustive definition on what constitutes “income”. However s9 of the IRO provides that “income” would include wages, salary, leave pay, fee, commission, bonus, gratuity, perquisite & allowance and payments received by an employee before or after his employment ceases (such as a sign on bonus or termination payment or an end-of contract gratuity).
However, the Inland Revenue Department (“IRD”) does allow concessions on certain payments which are not chargeable to tax including:
- Severance payments made in accordance with the Employment Ordinance (“EO”);
- Long service payments made in accordance with the EO;
- Payments from a recognised provident fund upon termination of employment would be tax exempted up to a certain pre-determined limit;
- Disability pensions;
- Jury fees;
- Employee compensation arising from injury; and
- Depending on the circumstances, income derived by crew members of a ship or aircraft.
Severance or Compensatory Payment(s) over and above the statutory entitlement (“SSP”)
Whether or not an employee can claim a tax exemption on any SSP will depend on the facts and circumstances of why the employee is being paid an amount exceeding the statutory entitlement.
A persuasive factor for the payment to be treated as exempt from tax is if it could be established that the payment was not made for the employee’s past, present or future services, but as compensation for loss of office and/or abrogation of rights.
Compensation for loss of office would not normally be subject to salaries tax provided that the IRD is satisfied that the nature of the payment is to compensate the employee for the loss of certain rights or benefits that would have been enjoyed by the employee had the employment not been terminated. It is important to note that the IRD may also give consideration to how the level of compensation has been calculated. If the compensation payment is based on the actual loss or estimate of loss suffered by the employee, it is more likely that the IRD would accept that such a payment should not be taxable. However, if the payment is related to number of years of services, it will likely be treated as taxable.
Moreover, if the payment was made to compensate the employee complying with certain restrictions (for e.g. not to join any of the company’s direct competitors or not to engage in certain activities etc), it may be argued that such a payment does not arise from services and is compensation for future losses and therefore should be treated as non-taxable.
Payments in lieu of notice
Payments in lieu of notice are income from employment and are not compensatory in nature. Accordingly, they are generally subject to salaries tax.
Employer’s reporting obligations
Although the payment of salaries tax is solely the responsibility of the employee, it is important for employers to comply with their reporting obligations.
An employer is required to file a Form IR56B for all its employees annually, particularising:
- The employee’s details (including the name, HKID/Passport No., residential address/postal address);
- The employee’s income details (including the periods of employment and the particulars of income); and
- Whether a place of residence is provided to the employee.
In addition, an employer is required to notify the IRD before the employee’s employment is terminated by filing Form I.R.56F or Form I.R.56G where an employee intends to leave Hong Kong following termination.