In this blog we will thoroughly discuss and analyze the judgement for different tax cases to draw a clear line of distinguishing between circumstances under which income received by a person is exempted from salaries tax or chargeable to income tax. These incomes can be from different source like compensation of loss of rights, benefits in kind or apportionment from company setup in Hong Kong.
In Fuchs, case of CIR (2011), a bank employed a person named as T. The contract between person and bank was of 3 years and it started from 1 January 2004. In the contract between bank and employee it was mentioned that following compensation would be given to employee T in case of termination of job:
After exact 2 years on 31 December 2005 the job of T was terminated by him. And according to as mentioned in his employment agreement, he was paid a sum that was consisting of following benefits:
The stance of T’s counsel before CFA was that the termination agreement superseded the rights under the contract. As same was in the case of Elliot. In that case the incentives that an employer may get as a result of incentive compensation plan due to cancellation of all his rights under some units that consisted of part of package of his remuneration was held to be chargeable by Court of Appeal. As sum B and sum C were not paid for cancellation of any rights so it was disagreed by Court of Appeal that the Elliot was applicable to case of employee T. T’s sum was subjectable to Hong Kong tax law as it was not accidental.
But it was also accepted by the Court of Appeal that variety of payment among sum B and sum C may fall outside the scope of tax charges such as:
While on other side it was also pointed out by Court of Appeal that, in the event of early cancellation of employment contract of an employee, the sum demanded in the contract of employment that is to be payable in case of this early cancellation of contract is simply a claim under the contract of employment. This sum is basically a payment instead of notice paid in accordance with a clause in the contract of employment and also a compensation paid pursuant to the articles of association to both directors (Henry case).
So by having the reference under Section 8 (1) of Hong Kong tax law it was ruled out by Court of Appeal that sum B and sum C of employee from employment of company incorporation Hong Kong are taxable. It was asked by T to divide and share sum C by worthiness of Section 8 (1A) of Hong Kong tax law on such ground that, this sum C is defined as compensation payable under German law in accordance with his 29 years of service for bank. And most of his services among these were outside Hong Kong. This of his stance was as a fallback position.
But this of his argument was also rejected, as according to Court of appeal it was mentioned now where in his contract that, his employment contract said nothing about his 27 years of services rendered outside the Hong Kong before commencement date of his new contract. And contract also said nothing that this contract was governed by laws of Hong Kong. So in a nutshell the appeal of T was dismissed by Court of Appeal.
By having view on Mike M case, of Mrs. Murad and others it was observed that the person ‘T’ was nominated by late Mr. Murad to carry out the instruction of will. He entered in service agreement on 1999 with a bank in Hong Kong. According to the contract between employee T and bank it was mentioned that T would be entitled to a number of upon early cancellation of his employment. And according to agreement these payments would include cost of airfare, total basic annual salary, expenses of removal and shipping, fixed payment of bonus etc. these payments collectively are called ‘the taxed sums’. As employment status of T was terminated due to restructuring and addition of corporate. Then a separate agreement was made between T and Bank. The claim of employee ‘T’ for taxed sums in service agreement was specifically referred by the separation agreement. According to CIR the assessable income from employment is called taxed sums. As claim of ‘T’ for those sums arose due to the service agreement and these sums are associated with terms of his employment.
It was stance of ’T’ that taxed sums were not taxable as these were the compensation of loss of office. As a result of direct appeal of ‘T’ to CFI, the response of CFI was that:
The sum would not be considered as taxable in the case if it is specified for not being services provided or to be provided and only considered as being consideration for something. For example, a consideration with certain prohibited contracts, such as not to sell or provide the information of an employee to any third party and not to compete against employer. The reference for this statement is taken from Yung Tse-kwong case (2004), Beak case (1943).
It was the common practice of Inland Revenue department, not to assess the payments instead of notice. But after following the decision of Court of Appeal as from assessment year 2012 to 2013 onwards the inland revenue department will charge to salary tax payment instead of notice and it will applicable on or after 1 April 2012. And under the Section 7 of Employment Ordinance the payment instead of notice that was enforced by contract include sums that were made to employee by employers of Hong Kong company incorporation services. Also there are concession by Inland Revenue department on the extra payments and award for long services that were payable due to integrity of Employment Ordinance as these are not chargeable to tax.
Given in Yung Tse-kwong case, the sum can be divided in the case if it is considered for services provided partly and partly for loss or rights.
Compensation by Virtue of Employment Ordinance for Loss of Rights
In the proceeding of Elliott case, it was observed that Inducement Compensation Scheme was included in package for employment of taxpayer. And by virtue of this scheme he was having the right to five million units upon beginning of employment. These five million units include the existing unit. And had entitlement of further units in future. Due to these units he was entitled of sharing the income of his employer. But after sometime his contract was ended. After the termination of contract, he was entered into termination agreement and according to that agreement these units were cancelled in deliberation for USD 11 million. It was ruled out by board Inland Revenue that the compensation that was applicable on existing five million units was taxable as an incentive for taxpayer to provide his future services while the part caused by to the future units was not chargeable to tax. As taxpayer received the USD 11 million as compensation of rights due to cancellation of agreement so it was exempted. This compensation also named as loss of right in order to receive the share of income of company in future.
In D 17/06, the demotion and reduction in the salary of an employee of a university was observed. The compensation he received as a result of demotion of his salary and family hardship was not allowed to be chargeable.
Benefits given on termination of Employment
It was seen in several cases that taxpayers, upon the completion of their employment contracts with employers were qualified to gratuities under their contracts of employment. It was argued by them that these gratuities were severance payments according to Employment Ordinance so these should be exempted from salaries tax. And according to judgement of D 19/06 and D 16/06 these of their arguments were rejected.
While discussing Tsai Ge case, it was order of CA that part of gratuity in dispute which was paid upon the cancellation of agreement of employee T’s employment for company incorporation Hong Kong should not be exempted. T had received the benefits or gratuities so that the long service payment (LYP) before the cancellation of his agreement was already fully set-off. As described in the Section 31 Y of Employment Ordinance. So this sum was not considered as neither compensation payment nor Long Service Payment. Then it was observed by court later that, there may an irregular situation arise such that a taxpayer may have his gratuity exempted from tax if Long Service Payment as provided by employment contract is payable before gratuity. But if an employee is unable to arrange his/her employment contract in such a way that Long Service Payment is payable before gratuity then he/she need to pay full tax on termination payment.
Extra Payments in addition to Wages
In Section 9 of law, following extra payments in addition to wages are considered as income from office or employment: