Termination Payments in Hong Kong: Tax-Efficient Strategies & Compliance Guide
- Chloe Lau
- 3 days ago
- 5 min read
Author: Chloe Lau, Associate Solicitor
When an employment relationship comes to an end, it is common for employers to offer a termination package to employees. Some of these payments are taxable as Salaries Tax under Hong Kong laws, but some heads of payment may be treated as non-taxable if structured carefully. This article is a practical guide on simple steps that may be taken by both the employers and the employees to structure termination payment in a legal and compliant, yet tax-efficient manner. Read our case study on employment termination in Hong Kong for more information.
Category A: What is taxable under Salaries Tax in Hong Kong?
The following items are generally taxable under Salaries Tax in Hong Kong:
Salaries of the employee up to the last day of employment/termination date;
Compensation for untaken annual leave;
Bonuses, whether contractual or discretionary, awarded by the employer;
Payments in lieu of notice, if so, opted by either party, what is often overlooked when considering taxability of items contained in termination package.
The said items are often deemed as normal income of the employee and reported to the Inland Revenue Department ("IRD") by the employer.
Category B: What may not be taxable under Salaries Tax in Hong Kong?
On the other hand, some payments may not be taxable under Salaries Tax in Hong Kong, examples include:
Statutory severance (SP)/long service payment (LSP): these payments are usually tax-free up to the statutory cap of HK$390,000.
Termination payments for “loss of office”: Distinguished from SP/LSP, these are sums paid not for past or future services, but to compensate the employee for losing their position, waiving potential legal claims against the employer, or agreeing to post-employment restrictions such as non-competition clauses. If structured properly, such payments may be treated as non-taxable.
How to Separate Taxable and Non-Taxable Items?
In view of the above, it might be prudent to clearly distinct between the two categories of payment in the final payment calculation, or if the employment is one terminated by agreement, in the mutual separation agreement to be signed by both the employer and the employee. Examples of advisable titles include “payments up to the termination date” (which covers Category A payments) and “termination payment” (which covers Category B payments, which are potentially non-taxable). Without a proper distinction, there is a risk that both categories would be blurred into one, leading the IRD to treat all sums as taxable.
Best Practices for Structuring Termination Packages
Careful choice of titles of payments
In terms of technicality, the parties may consider avoid titling a Category B payment “remuneration” or linking it to the years of service of the employee, because a payment in recognition of past contribution of the employee may suggest taxable nature of the same. Instead, the payment may be described as a payment for the employee’s loss of office, waiver of claims against the employer, and/or compensation for abiding by any post-employment restrictive covenants.
Ensuring sufficient notice period to be served
Regardless of whether the termination is initiated by the employer or employee, the parties should ensure that the notice of termination is served in a timely manner, and that sufficient notice is served before the intended last day of employment. Otherwise, there is a risk that the IRD may regard Category B payment, whether in whole or in part, as “payment in lieu of notice” in disguise and hence taxable.
Liking post-employment restrictive covenants to termination payments
If a Category B payment arises due to post-employment restrictive covenants, this should be expressly and unequivocally, to emphasise the non-taxable nature of such payment. For instance, it may be a good practice to link termination payment (or part of it) and make specific references to a confidentiality or non-competition clause in the contract, which further strengthens the contention that the payment is one other than “normal income” of the employee.
Reporting obligations to authority
As may be aware, employers are, upon the departure of the employee, legally required to file a notification with the IRD to report final payments made to the employee (Form IR56F or IR56G). Notably, employers may consider reporting termination payments (Category B) separately as an appendix, together with a justification on reasons why the payment falls outside of “normal income” of the employee. For example, an explanation notes on the background of the payment, specifying that the payment is one for loss of office of the employee, may be attached to the notification. This may assist the IRD in understanding why the sum should not be subject to salaries tax.
Summary
It is crucial to identify which part(s) of the severance package represent(s) ordinary income of the employee, and which part(s) may potentially be non-taxable, which is an issue both the employer and the employee should remain mindful of. If structured and documented carefully and correctly, a tax-efficient solution which is well within the ambit of the laws may be achieved.
Want to make termination payments more tax-efficient? Read my full guide here. If you need tailored advice or assistance, contact us or reach out to Chloe directly.
FAQ: Tax-Efficient Termination Payments in Hong Kong
Are termination payments taxable?
Yes. Items such as final salary, untaken annual leave, bonuses, and payments in lieu of notice are generally subject to Salaries Tax.
Which payments are usually tax-free?
Statutory severance or long service payments are exempt up to HK$390,000. Certain “loss of office” payments may also be non-taxable if properly structured.
How can termination packages be structured to reduce tax?
Separate taxable and non-taxable items clearly, use accurate titles, link payments to loss of office or restrictive covenants, and ensure proper notice periods.
What should employers report to the IRD?
Most payments are reportable to the IRD by way of IR56F or IR56G, and employers may provide explanations for non-taxable payments, such as compensation for loss of office, to support compliance.
Why does documentation matter?
Clear agreements and supporting notes help prevent all payments being treated as taxable by the IRD.
Disclaimer: Whilst every effort has been made to ensure the accuracy of this article it is general in nature and does not constitute legal advice of any kind. You should seek your own personal legal advice before taking legal action. We accept no liability whatsoever for loss arising out of the use or misuse of this article.
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