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

Example 1

An employee was made redundant upon closure of his employer’s business. The employer paid the employee a severance payment of $80,000 that he was entitled to under the Employment Ordinance.

The severance payment of $80,000 is not taxable.

Example 2

An employee was made redundant along with other employees upon closure of his employer’s business. Under a non-statutory redundancy scheme, the employer paid the employee a redundancy payment of $200,000, which was determined by reference to the employee’s annual salary and the number of years from cessation of his employment to his normal retirement age. The redundancy payment exceeded the amount of severance payment calculated in accordance with the Employment Ordinance (EO).

In view of the circumstantial facts (i.e. closure of the employer’s business, termination of employment of a number of employees and the existence of a non-statutory redundancy scheme), the redundancy payment of $200,000, though not paid under the EO, can be accepted as a non-taxable compensation made to the employee for the loss of his employment.

Example 3

The employment contract of an employee expired without being renewed. The employer paid the employee a long service payment of $100,000 that he was entitled to under the Employment Ordinance.

The long service payment of $100,000 is not taxable.

Example 4

The employment contract of an employee expired without being renewed. The employer paid the employee a sum of $120,000 based on his years of service, which exceeded his entitlement to the long service payment (LSP) of $100,000 under the Employment Ordinance (statutory amount).

Out of the payment, only the statutory amount of $100,000 is not taxable whilst the excess of $20,000 (i.e. $120,000 - $100,000) is taxable (section 9(1)(af) of the Inland Revenue Ordinance).

Example 5

An employee worked for the employer for 30 years before 1 May 2025 (Transition Date) and his employment was terminated after the Transition Date. Under the Employment Ordinance, the employee was entitled to a long service payment (LSP) of $390,000 (i.e. the maximum amount) based on his years of service before the Transition Date. The accrued benefit attributable to the mandatory contributions and voluntary contributions made by the employer in respect of the employee under the Mandatory Provident Fund (MPF) scheme were in the respective sums of $300,000 and $50,000 (a total of $350,000). The employer offset the LSP by the full amount of the accrued benefit and paid the balance of the LSP of $40,000 (i.e. $390,000 - $350,000) to the employee. The employee’s entire accrued benefit of $350,000 is retained in his account of the MPF scheme.

The LSP of $40,000 received by the employee is not taxable.

The accrued benefit of $300,000 attributable to the employer’s mandatory contributions, which is retained in the MPF scheme, is also not taxable.

Even though the accrued benefit of $50,000 attributable to the employer’s voluntary contributions is retained in the MPF scheme, the employee is taken to have received the accrued benefit from the MPF scheme on the date of termination of service (section 8(9) of the Inland Revenue Ordinance (IRO)). As the employee worked for the employer for 30 years (i.e. not less than 10 years), the accrued benefit of $50,000 attributable to the employer’s voluntary contributions is fully exempt (section 8(2)(cc), (4) and (5) of the IRO).

Example 6

Same facts as those of Example 5 except that the employer only offset the LSP with part of the accrued benefit of $200,000 and paid the balance of the LSP of $190,000 (i.e. $390,000 - $200,000) to the employee. The employee’s entire accrued benefit of $350,000 is retained in his account of the MPF scheme.

Similar to the answer in Example 5, both the LSP of $190,000 and the accrued benefit of $300,000 attributable to the employer’s mandatory contributions are not taxable. As the employee worked for the employer for not less than 10 years, the accrued benefit of $50,000 attributable to the employer’s voluntary contributions, which is taken to have been received by the employee on the date of termination of service, is also fully exempt.

Example 7

An employee worked for the employer for 7 years, with 4 years before 1 December 2025 (Transition Date) and 3 years starting from Transition Date. Under the Employment Ordinance, the employee was entitled to a long service payment (LSP) of $76,000 which was divided into 2 portions by the Transition Date, i.e. the pre-transition portion of $40,000 and post-transition portion of $36,000. The accrued benefit attributable to the mandatory contributions and voluntary contributions made by the employer in respect of the employee under the Mandatory Provident Fund (MPF) scheme are in the respective sums of $70,000 and $20,000 (a total of $90,000). The employer paid the employee the post-transition portion of $36,000. By virtue of section 12A(3) and (4) of the Mandatory Provident Fund Schemes Ordinance, the employee withdrew $40,000 (equal to the amount of the pre-transition portion) from his accrued benefit attributable to the employer’s mandatory contributions. The remaining balance of the employee’s accrued benefit attributable to the employer’s mandatory contributions and voluntary contributions in the respective sums of $30,000 (i.e. $70,000 – $40,000) and $20,000 (a total of $50,000) is retained in his account of the MPF scheme.

The post-transition portion of LSP of $36,000 received by the employee is not taxable.

The accrued benefit of $70,000 attributable to the employer’s mandatory contributions, whether withdrawn by the employee or retained in the MPF scheme, is also not taxable.

Even though the accrued benefit of $20,000 attributable to the employer’s voluntary is retained in the MPF scheme, the employee is taken to have received the accrued benefit from the MPF scheme on the date of termination of service (section 8(9) of the Inland Revenue Ordinance (IRO)). As the employee worked for the employer for 7 years (i.e. less than 10 years), the proportionate benefit rule applies to the accrued benefit attributable to the employer’s voluntary contributions. While the amount of proportionate benefit (i.e. $20,000 × 84/120 = $14,000) is exempt (section 8(2)(cc), (4) and (5) of the IRO), the excess of the accrued benefit over the proportionate benefit (i.e. $20,000 – $14,000 = $6,000) is taxable (section 9(1)(ae) of the IRO).

Example 8

Same facts as those of Example 7 except the employer paid the LSP of $76,000 to the employee and then withdrew $40,000 (equal to the pre-transition portion) from the employee’s accrued benefits attributable to the employer’s mandatory contributions by virtue of section 12A(1) and (2) of the Mandatory Provident Fund Schemes Ordinance. The remaining balance of the employee’s accrued benefit attributable to the employer’s mandatory contributions and voluntary contributions in the respective sums of $30,000 and $20,000 (a total of $50,000) is retained in his account of the MPF scheme.

The LSP of $76,000 received by the employee is not taxable.

The accrued benefit of $40,000 attributable to the employer’s mandatory contribution withdrawn by the employer from the MPF Scheme has no salaries tax implication on the employee because such benefit was not received by the employee.

The accrued benefit of $30,000 attributable to the employer’s mandatory contributions, which is retained in the MPF scheme, is also not taxable.

On the other hand, as the employee worked for the employer for less than 10 years, the accrued benefit of $20,000 attributable to the employer’s voluntary contributions, which is retained in the MPF scheme but is taken to have been received by the employee on the date of termination of service, is partly exempt to the extent of the proportionate benefit of $14,000 (i.e. $20,000 × 84/120) and the excess of $6,000 (i.e. $20,000 – $14,000) is taxable.

Example 9

Same facts as those of Example 7 except that the employer paid the LSP of $76,000 to the employee without offsetting the pre-transaction portion of $40,000 by the accrued benefit. The employee’s entire accrued benefit of $90,000 is retained in his account of the MPF scheme.

The LSP of $76,000 received by the employee is not taxable.

The accrued benefit of $70,000 attributable to the employer’s contributions retained in the MPF scheme is also not taxable.

On the other hand, as the employee worked for the employer for less than 10 years, the accrued benefit of $20,000 attributable to the employer’s voluntary contributions, which is retained in the MPF scheme but is taken to have been received by the employee on the date of termination of service, is partly exempt to the extent of the proportionate benefit of $14,000 (i.e. $20,000 × 84/120) and the excess of $6,000 (i.e. $20,000 – $14,000) is taxable.

Example 10

An employee was employed under 3 continuous contracts (each lasting 2 years) for a total of 6 years. His last contract expired without being renewed. After completing each of the 3 contracts, the employee was paid gratuities in the respective amounts of $25,000, $30,000 and $35,000 (a total of $90,000). Under the Employment Ordinance, the employee was entitled to a long service payment (LSP) of $90,000 based on the same years of service for which the gratuities were paid. The employer offset the LSP by the entire amount of the gratuities.

The gratuities in the total of $90,000 are income from employment chargeable to salaries tax.

Example 11

Same facts as those of Example 10 except the employee was paid gratuities in the respective amounts of $15,000, $25,000 and $30,000 (a total of $70,000) after completing each of the 3 contracts. The employer offset the LSP of $90,000 by the entire amount of the gratuities and paid the balance of the LSP of $20,000 (i.e. $90,000 - $70,000) to the employee.

The gratuities in the total of $70,000 are income from employment chargeable to salaries tax while the LSP of $20,000 is not taxable.

Example 12

Same facts as those of Example 10 except that the employer paid the LSP of $90,000 to the employee without offsetting any part of it with the gratuities.

The gratuities in the total of $90,000 are income from employment chargeable to salaries tax while the LSP of $90,000 is not taxable.