Salaries Tax Issues arising from Abolition of the Offsetting Arrangement under Recognized Retirement Schemes

Transition Date

The Employment and Retirement Schemes Legislation (Offsetting Arrangement) Ordinance 2022 has come into operation since 1 May 2025 (Transition Date) to abolish the offsetting arrangement under the Mandatory Provident Fund (MPF) schemes and recognized occupational retirement (ROR) schemes; and to make related amendments to certain other legislation concerning employment and retirement schemes. As for the Inland Revenue Ordinance (Cap. 112) (IRO), new sections 8(2)(cd), (ce) and (cf), 8(2B), 9(1)(af) and (ag) were introduced to provide for the tax treatment of severance payment (SP) and long service payment (LSP).

MPF scheme means a provident fund scheme registered under the Mandatory Provident Fund Schemes Ordinance (Cap. 485).

ROR scheme includes any occupational retirement scheme:

registered under the Occupational Retirement Schemes Ordinance (Cap. 426) or exempted from registration under that Ordinance;
operated by a foreign government or its non-profit making agency or undertaking; or
established under any other Ordinance.

Offsetting Arrangement before the Transition Date

Before the Transition Date, if an employee becomes entitled to SP/LSP under the Employment Ordinance (Cap. 57) (EO) and

gratuities based on length of service are payable or have been paid to the employee; or
benefits attributable to employers’ contributions under an ROR scheme are payable or have been paid to the employee; or
accrued benefit attributable to employer’s contributions is being held in an MPF scheme in respect of the employee, or has been paid to the employee,

the SP/LSP is to be offset against the aforementioned amount of gratuities and benefits to the extent that they relate to the employees’ years of service for which the SP/LSP is payable.

Abolition of the Offsetting Arrangement

After abolition of the offsetting arrangement (i.e. starting from the Transition Date):

Accrued benefit attributable to an employer’s mandatory contributions made under an MPF scheme in respect of an employee, or “carved-out benefits” attributable to an employer’s contributions made under an ROR scheme in respect of an employee, cannot be used to offset the employee’s SP/LSP entitlement under the EO in respect of his/her years of service starting from the Transition Date (post-transition portion of SP/LSP), but can continue to be used to offset the employee’s SP/LSP entitlement in respect of his/her years of services before the Transition Date (pre-transition portion of SP/LSP).
Accrued benefit attributable to an employer’s voluntary contributions made under an MPF scheme in respect of an employee, or “remaining benefits” attributable to an employer’s contributions made under an ROR scheme in respect of an employee, or gratuities based on length of service paid by an employer to an employee can continue to be used to offset the employee’s SP/LSP entitlement in respect of his/her years of service both before the Transition Date and starting from the Transition Date (i.e. both the pre-transition portion and post-transition portion of SP/LSP).
The SP/LSP is to be offset against the aforementioned amount of benefits and gratuities to the extent that they relate to the employees’ years of service for which the SP/LSP is payable.

“Carved-out-benefits” means:

Final average monthly relevant income ^[1]

Years of service with benefits from ROR scheme ^[2]

^[1]	Employee’s average monthly relevant income in the 12 months immediately preceding the termination of employment, subject to the current maximum relevant income of $30,000.
^[2]	Only years of service on or after 1 December 2000 will count.

“Remaining benefits” means:

Vested benefits from employer’s contributions under ROR scheme

―

“Carved-out benefits”

Salaries Tax Issues

SP

SP received by an employee on the dismissal or lay-off of the employee in the circumstances described in section 31B of the EO and calculated in accordance with section 31G of the EO is a compensation for loss of his/her employment or abrogation of rights under his/her employment contract. The newly added section 8(2)(cd) and (2B) of the IRO clearly provides that the aforesaid SP is not chargeable to salaries tax, even if any part of the SP that could be, but have not been, offset under the relevant offsetting arrangement.

If a payment is received by an employee in the aforesaid circumstances under a non-statutory redundancy scheme instead of under the EO and the payment is made as compensation for the loss of his/her employment or abrogation of rights under his/her employment contract, the entire amount of the payment is not chargeable to salaries tax (Henley v Murray [1950] 1 ALL ER 908, Mairs v Haughey [1994] 1 AC 303, Fuchs v Commissioner of Inland Revenue [2011] 2 HKC 422).

LSP

LSP received by an employee on his/her dismissal or termination of his/her contract of employment in the circumstances described in section 31R of the EO, or received in respect of an employee upon his/her death in the circumstances described in section 31RA of the EO, and calculated in accordance with section 31V of the EO (statutory amount of LSP), is a payment “in return for acting as or being an employee” or “as a reward for past services” and should be an income from employment chargeable to salaries tax (Fuchs v Commissioner of Inland Revenue [2011] 2 HKC 422). However, the newly added section 8(2)(ce), (cf) and (2B) of the IRO explicitly excludes the aforesaid statutory amount of LSP from being an income chargeable to salaries tax, even if any part of the LSP that could be, but have not been, offset under the relevant offsetting arrangement.

If a payment based on an employee’s years of service is received by the employee upon his/her dismissal or termination of his/her contract of employment in the circumstances described in section 31R of the EO, or received in respect of an employee upon his/her death in the circumstances described in section 31RA of the EO, and the payment exceeds the statutory amount of LSP, the newly added section 9(1)(af) and (ag) of the IRO clearly provides that the excess over the statutory amount is an income chargeable to salaries tax.

Retirement scheme benefits

Accrued benefit attributable to employer’s contributions (mandatory and voluntary) under an MPF scheme, or vested benefits (“carved-out benefits” and “remaining benefits”) attributable to employer’s contributions under an ROR scheme, received by an employee is assessed in accordance with the specific provisions under section 8(2)(c), (cb), (cc), (4) to (9) or section 9(1)(ab), (ad) or (ae) of the IRO (where applicable). For the Department’s assessing practices in relation to recognized retirement scheme benefits, please refer to the Departmental Interpretation and Practice Notes No. 23 (Revised) – Recognized Retirement Schemes.

Gratuity

Gratuity received or receivable by an employee from his/her employer based on length of service is a reward for his/her past services rendered. Such gratuity is an income from employment chargeable to salaries tax under sections 8(1)(a) and 9(1)(a) of the IRO.

Employee’s right to SP/LSP

Eligibility

Under the EO, an employee is eligible for SP/LSP subject to the following conditions:

Entitlement	SP (s.31B)	LSP (s.31R)
Qualifying period of employment	Not less than 24 months under a continuous contract	Not less than 5 years under a continuous contract
Conditions/ Requirements	The employee is dismissed by reason of redundancy*	The employee is dismissed but: he/she is not summarily dismissed due to his/her serious misconduct his/her dismissal is not by reason of redundancy
	Employment contract of a fixed term expires without being renewed by reason of redundancy* (s.31D)	Employment contract of a fixed term expires without being renewed** (s.31T)
	The employee is laid off	The employee dies (s.31RA)
		The employee resigns on ground of ill health (s.10(aa))
		The employee, aged 65 or above, resigns

*	If not less than 7 days before the date of dismissal or expiry of the fixed term contract, the employer has offered in writing to renew the contract of employment or re-engage the employee under a new contract but the employee has unreasonably refused the offer, the employee is not eligible for SP (s.31C(2)).
**	If not less than 7 days before the expiry of the fixed term contract, the employer has offered in writing to renew the contract of employment or re-engage the employee under a new contract but the employee has unreasonably refused the offer, the employee is not eligible for LSP (s.31S(3)).

An employee will not be simultaneously entitled to both SP and LSP.

Meaning of redundancy (s.31B(2))

An employee is taken to be dismissed by reason of redundancy if the dismissal is due to the fact that:

the employer closes or intends to close his business;
the employer has ceased, or intends to cease, the business in the place where the employee was employed; or
the requirement of the business for employees to carry out work of a particular kind, or for the employee to carry out work of a particular kind in the place where the employee was employed, ceases or diminishes or is expected to cease or diminish.

Meaning of lay-off (s.31E)

If an employee is employed on such terms and conditions that his/her remuneration depends on his/her being provided by the employer with work of the kind he is employed to do, the employee shall be taken to be laid off if the total number of days on which no work is provided or no wages is paid exceeds:

half of the total number of normal working days in any four consecutive weeks; or
one-third of the total number of normal working days in any 26 consecutive weeks.

The days of lock-out, rest days, annual leave and statutory holidays should not be counted as normal working days during the above periods.

Amount of SP (s.31G)/LSP (s.31V)

Where an employee’s employment did not straddle over the Transition Date (i.e. his/her employment was terminated before 1 May 2025 or commenced on or after 1 May 2025, or if the employee is not covered by the MPF scheme or the ROR scheme (e.g. domestic helpers, employees aged below 18 or employees who commenced employment at the age of 65 or above), section 31G (SP)/section 31V (LSP) of the EO applies and the following formula will be used to calculate the amount of SP/LSP for the whole period of employment:

Monthly-paid employee

(last full month wages* × 2/3)^#

reckonable years of service

Daily-rated/
piece-rated employee

(any 18 days’ wages chosen by the employee out of his/her last 30 normal working days**)^#

reckonable years of service

Where an employee’s employment straddled over the Transition Date (i.e. his/her employment commenced before 1 May 2025 and terminated on or after 1 May 2025), section 31ZEA of the EO applies and his/her entitlement to SP/SLP will be modified in accordance with Schedule 11 to the EO. According to section 2 (SP) or section 4 (LSP) of Schedule 11, the employee’s SP/LSP is divided into two portions by the Transition Date – the pre-transition portion (for years of service before the Transition Date) and post-transition portion (for years of service starting from the Transition Date). The calculations are as follows:

	Pre-transition portion	Post-transition portion
Monthly-paid employee	(last full month’s wages immediately preceding the Transition Date^ × 2/3)^# × reckonable years of service before the Transition Date	(last full month wages immediately preceding the termination of employment* × 2/3)^# × years of service starting from the Transition Date
Daily-rated/ piece-rated employee	(any 18 days’ wages chosen by the employee out of his/her last 30 normal working days immediately preceding the Transition Date^^)^# × reckonable years of service before the Transition Date	(any 18 days’ wages chosen by the employee out of his/her last 30 normal working days immediately preceding the termination of employment**)^# × years of service starting from the Transition Date

Service of an incomplete year should be calculated on a pro rata basis.

*	An employee may also elect to use his/her average monthly wages over the last 12 months immediately preceding the termination of employment for the calculation.

**	An employee may also elect to use 18 times of his/her average daily wages over the last 12 months immediately preceding the termination of employment for the calculation.

^	An employee may also elect to use his/her average monthly wages over the last 12 months immediately preceding the Transition Date for the calculation.

^^	An employee may also elect to use 18 times of his/her average daily wages over the last 12 months immediately preceding the Transition Date for the calculation.

^#	The sum should not exceed 2/3 of $22,500 (i.e. $15,000).

Reckonable years of service

For all manual employees and non-manual employees whose average monthly wages did not exceed $15,000 for the 12 months preceding 8 June 1990, if the relevant date of termination of employment occurs on or after 1 October 2004, the years of service should be reckoned in full.

For non-manual employees whose average monthly wages exceeded $15,000 for the 12 months preceding 8 June 1990, their years of service can be reckoned up to 1980.

Maximum amount

The maximum amount of SP/LSP is $390,000.

Where an employee has pre- and post-transition portions of SP/LSP, the sum of the two portions shall not exceed $390,000. The amount in excess should be deducted from the post-transition portion.

Further Information

More information about the salaries tax issues and other matters related to the abolition of the offsetting arrangement under the recognized retirement schemes is available through the following links: