Hong Kong: Termination payments not provided for in employment contract are held taxable

Jul 2016

The Court of First Instance (CFI) handed down its judgment in Poon Cho-ming, John v Commissioner of Inland Revenue on March 24, 2016. The CFI held that (1) payment in lieu of a discretionary bonus made to the taxpayer and (2) stock option gains derived by the taxpayer from the accelerated vesting of certain previously granted options upon termination of his employment are income from employment and subject to salaries tax. In this case, such payment and accelerated vesting were not provided for under the taxpayer’s employment contract.

Termination payments provided under an employment contract have been consistently held by the courts as income from employment and taxable. However, mixed outcomes have occurred in terms of the taxability of termination payments that are not stipulated in an employment contract.

Based on the decision in the present case and various legal precedents, any claim that a termination payment is not income from employment and therefore not taxable will not only need to be supported by the terms of the employment contract and termination agreement, but must also be justified by the circumstantial evidence. Merely labelling a payment as compensation for abrogation or abandonment of rights in a termination agreement is not sufficient if in fact, there is no right to be abrogated or abandoned by the employee given the circumstances of the employment termination.

Thorough upfront planning, careful drafting of the employment contract and proper wording in the separation agreement to show the true intent of the contracting parties are all equally important to substantiate the real nature of termination payments and to properly manage the potential tax exposure of such payments.

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