Are the benefits provided to departing employees under the separation agreement subject to salaries tax? And to what extent?

Generally speaking, only payments made “from employment” are subject to salaries tax. In this case, the Court of Appeal reaffirmed the interpretation of the term “arising out of employment” in the context of salaries tax and ruled that the payment of bonus shares to a former employee; and the daily allowance received by a former employee for post-employment assistance provided by the former employer, were not subject to profits tax.


Brian Zarin v Commissioner of Inland Revenue

The taxpayer in this tax case was employed by a bank and was entitled to participate in the bank’s discretionary bonus plan. In 2012, the bank granted the taxpayer restricted bonus shares under the plan, which vested in three tranches in 2013, 2014 and 2015. The restricted bonus shares also provide that the provisions of the above plan do not form part of the taxpayer’s employment contract.

The Bank terminated the taxpayer’s employment in January 2013 due to a reduction in force. After a series of negotiations regarding the severance agreement, the parties reached an agreement in June 2013.

The terms of the severance agreement included the following:

The taxpayer will be treated as a good leaver and the remaining bonus shares will vest on a date to be specified in the discretionary bonus plan in accordance with the terms of the termination agreement

The taxpayer agrees to perform various post-employment services (including, but not limited to, providing reasonable assistance in litigation involving the Bank)

Any bonus shares will be issued subject to the condition that the taxpayer does not breach any of the terms of the severance agreement

The Bank will pay the Taxpayer an allowance for each day that the Taxpayer assists in the litigation

The taxpayer also received two payments in 2014 and 2015, representing the last two tranches of bonus shares and the daily cash allowance respectively, after providing assistance to the litigation during the Singapore period and complying with the terms of the termination agreement. The IRS imposed tax on these two amounts. The taxpayer appealed. The Board of Review dismissed his appeal and the taxpayer appealed to the Court of First Instance.

The Court of First Instance allowed the taxpayer’s appeal and ruled that neither amount was subject to profits tax. The IRD appealed to the Court of Appeal against the ruling.


The Court had to clarify whether the daily allowance and bonus shares were “arising out of employment” and therefore whether they should be subject to salaries tax under sections 8(1) and 9(1) of the Inland Revenue Ordinance (Cap. 112).

The Court of Appeal’s decision

The Court of Appeal agreed in all respects with the Court of First Instance’s analysis that the primary purpose of the bonus certificates and per diem payments to the taxpayer was to induce him to provide potential long-term assistance in the litigation, rather than to reward him for services rendered during his employment with the bank. Both payments were also used to induce the taxpayer to agree to the terms and undertakings in the separation agreement. The Court of Appeal attached great importance to the clause in the scheme which provided that if a leaver entered into a severance agreement pursuant to his termination of employment, the bonus shares would not vest unless and until the taxpayer fulfilled his obligations under the agreement.

The Court of Appeal also took the opportunity to reiterate certain basic principles of salaries tax, including that for a payment to be “derived from employment” within the meaning of the IRO, it must have some causal connection to the relevant employment. The Court of Appeal rejected the IRD’s proposal to adopt an impressionistic or cursory approach. Not all payments made by an employer to an employee or former employee are taxable and are not sufficient to prove that the payment is in some sense related to employment or that it would not be payable if the recipient were not an employee.

The Court of Appeal therefore ruled that the payment of bonus stock to a former employee; and the daily allowance received by a former employee for post-employment assistance provided by the former employer, were not chargeable to profits tax.


As the Court of Appeal noted, matters relating to the taxability of employment income are sensitive and may involve difficult issues to be determined under a narrow definition. While the applicable legal principles are clear, their application remains challenging.

It is foreseeable that the taxation of severance payments will continue to be a controversial issue in Hong Kong. If you have any questions, please consult with a tax or legal professional.

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