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Jul 2007
This case concerns an appeal by the taxpayer against the Acting Deputy CIR's determination where an amount received by the taxpayer on termination of her employment was treated as assessable income for Hong Kong salaries tax purposes.
The facts
- The taxpayer signed the Employment Letter and subsequently the Supplementary Provisions to the Terms of Employment Agreed ("the service agreements") with her employer for a 2-year period employment starting from April 1994.
- Based on the terms of the service agreements, the employment can be terminated by giving six months' notice and in case of a premature discharge under notice, the employer has the right to pay in cash for perquisites of any kind to which the taxpayer may be entitled until expiration of the contract period.
- Subsequently, the taxpayer's employment was terminated in October 1995. By the Termination Agreement entered into between the taxpayer and the employer, the taxpayer would receive payment of salary up to 6 months, house allowance for a month and a payment for losses on exchange rates, etc. The Termination Agreement states that this settlement was being offered to the taxpayer on the understanding that she would adhere to the terms of the agreement and refrain from taking any action prejudicial to the group.
- By the Supplemental Termination Agreement entered into between the taxpayer and the employer, both parties further confirmed that the company had made a capital payment to the taxpayer which eliminates all contractual obligations of both parties.
The taxpayer's case
The taxpayer's case is that the capital payment made to her upon termination of her employment is not chargeable to salaries tax.
The Board's decision
The Board allowed the taxpayer's appeal and held that the sum is not chargeable to salaries tax. Below is a summary of the Board's analysis.
- Based on the case law, the tests were whether the payment was made in return of acting as or being an employee and whether the payment was a reward for past services, in either case the amount will be taxable.
- In the Board's view, the amount was not paid in reference to the services of the taxpayer rendered by virtue of her office. Nor was it paid in return of acting as or being an employee. Nor the service agreements was the causa causans (the real effective cause) and not merely the causa sine qua non (a preliminary event in the chain of causation) of the receipt of the payment.
- By the Termination Agreement and the Supplemental Termination Agreement, all contractual obligations under the service agreements were eliminated. The sum was paid for the consideration of total abandonment of all contractual rights which the taxpayer had under the service agreements.
- On the facts of this case, the sum was paid in the nature of a sum paid in consideration of the surrender by the taxpayer of her rights in respect of the office.
Comments
The taxability of payment on termination of an employment has long been a disputed area in the Hong Kong salaries tax regime. In recent years, there have been two court cases in this area i.e. the CIR v Yung Tse Kwong case in 2004 and the CIR v Elliott, Stewart William George case in 2006. In both cases, the court ruled that a major portion of the payment received by the taxpayer is non-taxable. In the present case, the Board also ruled in favour of the taxpayer and concluded that the whole sum paid to the taxpayer is not taxable.
Naturally, the key question on determining the taxability of a termination payment remains "what the sum is paid for". In answering this question, the terms stated in the employment contract and the termination agreement will no doubt carry significant weight. For example, in the Yung Tse Kwong case, the court concluded that 10% of the payment was an inducement to the taxpayer entering into the employment and therefore was taxable because the employment letter provided that as an "insurance policy for peace-of-mind", the taxpayer would be entitled to a severance pay for 12 months equal to his base salary at that time. The taxpayer and her employer in the present case probably understand the importance of such documentation as can be told from the fact that the termination agreements specifically stated the settlement was made for eliminating all contractual obligations of both parties under the service agreements. |
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