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Payments on Termination of Employment – Taxable or Not ?
1 July 2018

The question of whether payments or compensation made to employees on termination of employment are subject to salaries tax has often been the subject of litigation in Hong Kong and there has been various levels of judgment on the legal issue. Termination payments provided under an employment contract have in many cases been held by the courts as income or emolument arising from employment and therefore, taxable as salaries.

The decision in the recent Court of Appeal case of Poon Cho Ming John v Commissioner of Inland Revenue (CACV 94/2016) in June 2018 overturned the decisions of the Board of Review (“Board”) and the Court of First Instance and held that termination or separation payments are not taxable if they were paid wholly for the abrogation of the employee’s rights under an employment contract.

Facts of the Case

Pursuant to a Service Agreement, the Taxpayer was employed by a Hong Kong listed company (“Company”) as Group Chief Financial Officer and executive director. The Service Agreement provided for an employment term of 2 years and thereafter, until terminated by either party with 6 months’ notice. The Taxpayer commenced employment on 3 December 1999. The Service Agreement was subsequently terminated on 20 July 2008 and after a weekend of negotiations, the Taxpayer and the Company entered into a written agreement (“Separation Agreement”) to terminate the employment with immediate effect.

Under the Separation Agreement, in addition to payment in lieu of 6 months’ notice and other statutory entitlements, the Taxpayer was also paid :-

(i) payment in lieu of discretionary bonus for the financial year ended 30 June 2008 in the sum amounting to €500,000 (“Sum D”); and

(ii) acceleration of the vesting dates in respect of 3 tranches of share options to the date of termination of his employment. These options were duly exercised by the Taxpayer resulting in substantial gains (“Share Option Gain”).

Sum D and the Share Option Gain were, amongst other payments, assessed by the Inland Revenue Department (“IRD”) as taxable employment income. The Taxpayer appealed to the Board and then to the Court of First Instance. Both the Board and the Court of First Instance upheld the IRD’s decision that if a payment was made “in return for acting as or being an employee” or “as a reward for past services or as an inducement to enter into employment and provide future services”, it would be subject to salaries tax in Hong Kong. The Taxpayer then brought the case to the Court of Appeal.

Court of Appeal Judgment

The Court of Appeal decision reaffirmed that the relevant test to be applied is that set out in Fuchs v CIR (2011) 14 HKCFAR 74 i.e. whether the subject payment :-

(a) constitutes income “from” the taxpayer’s employment – which would make the payment chargeable to salaries tax, or

(b) was a payment “for something else” (or put another way, “for some other reason”) – which would not be chargeable.

In the judgment, the Court carefully analyzed the facts found by the Board and held that the Taxpayer had no contractual entitlement at the time of his termination either to Sum D or the Share Option Gain. These payments were paid as consideration for the Separation Agreement so that the Taxpayer would agree to leave the Company on good terms and without bringing any legal proceedings against the Company. The Court noted that the relationship between the Taxpayer and the Company at the time of termination was acrimonious.

Regarding Sum D, although the Taxpayer had an existing contractual right to be considered for a discretionary bonus, the process for determining whether the bonus should be paid to him in the relevant tax year in which his employment ceased has not commenced. Sum D did not derive from the employment contract, but was paid to the Taxpayer to prevent him from taking actions under the Service Agreement. In the absence of the Separation Agreement, the Taxpayer would not be entitled to Sum D given the termination of his employment.

The Share Option Gain the Taxpayer acquired was subject to a strict vesting schedule, which meant that unless the shares had vested at the time of termination, they would be forfeited. The Court was of the view that the Company’s decision to accelerate the vesting schedule was made not as a reward for past, present or future services given by the Taxpayer, but was consideration to induce him to enter into the Separation Agreement and to leave the employment quietly. If the Company did not agree to accelerate the vesting schedule, the Taxpayer would not have received the Share Option Gain. The fact that the Taxpayer got what he could have received under the Service Agreement (i.e. Sum D and Share Option Gain) pursuant to the Separation Agreement did not mean that these payments arose from a contract of employment or were paid for the Taxpayer’s services.


Based on the decision in the Court of Appeal and legal precedents including the case of Fuchs, in order to claim that a termination or separation payment is not employment income and “something else”, it must be supported by the terms of the employment contract and separation agreement. It must also be justified by the circumstances leading to the termination and the relationship of the employer and employee. It is obvious from the Court’s careful examination of the facts and background that labelling a payment as compensation for abrogation of rights in a termination agreement is not sufficient if in fact, there is no right to be abrogated by the employee in the circumstances of the employment termination.

It is therefore important that the employment contract be carefully drafted in the first place, and proper wording be used in the separation agreement to reflect the real bargain of the contracting parties and the true nature of termination payments in order to appropriately manage the potential tax exposure relating to such payments.

If you have any questions on the above case or employment law matters, experienced corporate and employment lawyers in our firm would be happy to assist you.

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