Payments in Lieu of Notice Are Chargeable To Tax From Year of Assessment 2012/13 Onwards

Payments in Lieu of Notice accruing to employee on or after 1 April, 2012 in accordance with either the explicit term of employment contract or the provisions of the Employment Ordinance, will be regarded as income from employment and chargeable to Salaries Tax.

In the years prior to the year of assessment 2012/13, payments in lieu of notice received from employer were not assessed to tax by the Hong Kong Inland Revenue Department ("IRD").  However, the decision of the Hong Kong Court of Final Appeal ("CFA") in the Fuchs, Walter Alfred Heinz v. CIR ("Fuchs case") in February, 2011 has led to the IRD to change its assessing practice on payments in lieu of notice.  In the Fuchs case, the CFA adopted the key principle from the UK case law to determine whether the payment from the employer constitutes income from the taxpayer's employment.  This key principle is that if a payment is clearly an entitlement under the contract of employment in the event of early termination, such payment constitutes income from the taxpayer's employment.  The IRD then follows the judgment of the CFA and from the year of assessment 2012/13 onwards, payments in lieu of notice which accrue on or after 1 April, 2012 are assessable as income and chargeable to Salaries tax.

In this regard, the employer has to report the payments in lieu of notices accrue to the employee on or after 1 April, 2012 on the "Employer's return of remuneration and pensions" (Form IR56B).  Apart from this, the employer is also required to report to the IRD such payments in lieu of notice which accrue on or after 1 April, 2012 on the "Notification by an employer of an employee who is about to cease to be employed" (Form IR56F) or the "Notification by an employer of an employee who is about to depart from Hong Kong" (Form IR56G).  On the other hand, the employee has to report to the IRD the said payments in lieu of notice on his/her Tax returns-Individuals from the year of assessment 2012/13 onwards.  However, the amount accrues to the employee before 1 April, 2012 but received by him/her after 1 April, 2012 is not taxable and is not required to be reported to the IRD.

Tax implications on employment contracts regulated by foreign law
In Hong Kong, section 7 of the Employment Ordinance provides that either the employer or the employee may terminate a contract of employment by agreeing to make a payment in lieu of notice to the other party.  The amount of payment necessary to terminate an employment contract is equal to the amount of wages which have been accrued to the employee during the period of notice.  Therefore, for an employment contract governed by the Hong Kong law, the payment in lieu of notice received by an employee upon termination of employment will be regarded by the IRD as being paid by the employer under an implied term of employment contract even though such right has not been explicitly stated in the contract.  As a result, such payments will be assessable by the IRD as taxable income since the year of assessment 2012/13.  However, if a payment in lieu of notice is paid not in accordance with an explicit term of employment contract which is regulated by foreign law, the IRD will examine carefully the foreign law which regulates the employment, including the right to payments in lieu of notice.  The sum will be assessed to Salaries tax if it is concluded by the IRD as an income paid under the express or implied term of an employment contract.