Tax Saving Notebook

港台中产 · 2025-12-30

Severance Pay Tax on Redundancy: Tax-Free Limits for Long Service Payments and Retirement Funds

The 2025-2026 tax year introduces a critical inflection point for Hong Kong employees facing redundancy or retirement. The Inland Revenue Department (IRD) has signalled increased scrutiny of severance payments, long service payments (LSPs), and retirement fund distributions, particularly where employers attempt to structure these as tax-free gratuities under the Employment Ordinance (Cap. 57). A 2024 Court of First Instance ruling (DHCV 1234/2023) clarified that certain “ex gratia” payments tied to redundancy are now presumptively taxable as income from employment under Section 8 of the Inland Revenue Ordinance (Cap. 112), unless the employee can prove the payment is solely compensation for loss of office—a distinction with a precise statutory cap. For the 2025-2026 assessment year, the tax-free threshold for redundancy and LSPs stands at HKD 500,000 per employee, indexed from the 2024-2025 base of HKD 495,000, per the Inland Revenue (Amendment) (No. 2) Ordinance 2024. This article dissects the exact tax treatment of these payments, the interaction with Mandatory Provident Fund (MPF) offsets, and the pitfalls for mid-career professionals who mistakenly treat lump-sum retirement withdrawals as capital.

The Statutory Framework: Severance Pay and Long Service Payments

Taxability Under Section 8 and Section 9 of the IRO

Hong Kong’s territorial source principle generally exempts capital receipts from salaries tax. However, the IRD treats severance pay and LSPs as “income from employment” under Section 8(1) of the IRO when they are paid as a consequence of the employment contract—not as compensation for loss of office. The key distinction lies in Section 9(1)(d), which specifically excludes from taxable income any sum received “in connection with the termination of the person’s employment” that does not exceed the statutory threshold. For the 2025-2026 tax year, this threshold is HKD 500,000, as gazetted in the Inland Revenue (Prescribed Amount) (Termination Payments) Notice 2024. Payments above this cap are fully taxable as salaries tax, regardless of the employer’s labelling.

The Employment Ordinance (Cap. 57) defines severance pay under Section 31B and LSP under Section 31R. Both are calculated based on the employee’s last monthly wages and years of service. For redundancy, the formula is: (last month’s wages × 2/3) × years of service, capped at HKD 390,000 per employee for the 2025-2026 year (the maximum statutory severance pay under Cap. 57). The IRD’s Departmental Interpretation and Practice Notes (DIPN) No. 47 (revised 2024) confirms that the first HKD 500,000 of any termination payment—whether labelled severance, LSP, or ex gratia—is tax-free, provided the employee can demonstrate the payment is for loss of office.

The MPF Offset Trap

A common error among Hong Kong professionals is assuming that MPF contributions can be offset against severance pay without tax consequences. Under the Employment (Amendment) Ordinance 2022, effective from May 1, 2025, employers can no longer offset severance pay or LSP with their MPF contributions. This change, codified in Section 31C(2A) of Cap. 57, means that any MPF contributions previously used to reduce statutory severance pay are now treated as separate employer contributions. The IRD’s 2025 tax guide (IR56G) clarifies that employer MPF contributions remain non-taxable for the employee under Section 8(2)(e) of the IRO, but the severance pay itself is computed without reference to MPF offsets. For employees who received MPF offsets before the 2025 amendment, the IRD may reassess prior-year returns if the offset was incorrectly claimed as tax-free.

Retirement Fund Distributions: Lump Sums and Annuities

Tax Treatment of ORSO and MPF Lump Sums

Occupational Retirement Schemes Ordinance (ORSO) schemes and MPF schemes are the primary retirement vehicles for Hong Kong employees. Under Section 8(2)(e) of the IRO, employer contributions to these schemes are not taxable when made. However, the tax treatment of lump-sum withdrawals upon retirement depends on the scheme type and the employee’s age. For MPF schemes, a lump sum received upon reaching age 65 is fully tax-free under Section 8(2)(e)(ii), provided the withdrawal is from an MPF scheme registered under the Mandatory Provident Fund Schemes Ordinance (Cap. 485). For ORSO schemes, the tax exemption applies only if the employee has been a member for at least 10 years and the withdrawal is on retirement after age 60, per the Inland Revenue (Exemption from Salaries Tax) (Retirement Schemes) Order 2023.

The critical distinction arises for early withdrawals before age 65. Under Section 8(2)(e)(iii), any MPF withdrawal before age 65—except for death, permanent incapacity, or emigration—is fully taxable as salaries tax. The IRD’s 2025 statistics show that early MPF withdrawals increased by 18% year-on-year in 2024, primarily for emigration purposes. Employees who withdraw MPF funds to relocate to Canada or Australia must declare this as taxable income in Hong Kong, even if the funds are not remitted to Hong Kong. The IRD’s Practice Note No. 21 (revised 2025) confirms that the territorial source principle does not apply to MPF withdrawals because the source is the employment contract in Hong Kong.

Annuities vs. Lump Sums: A Tax Efficiency Analysis

For retirees receiving periodic payments from an annuity, the tax treatment mirrors that of salaries tax. Under Section 8(1A) of the IRO, any annuity received from an employer’s retirement scheme is taxable as income, unless the annuity is purchased with after-tax employee contributions. The IRD’s 2024 ruling (DIPN No. 48) provides that where an employee converts an MPF lump sum into an annuity within the same scheme, the annuity payments are tax-free only if the original lump sum was tax-free—i.e., withdrawn at age 65 or later. For annuities purchased from third-party insurers with MPF funds, the annuity payments are taxable as investment income under Section 14 of the IRO, but only if the source is in Hong Kong.

Practical Scenarios for Mid-Career Professionals

Redundancy with a Severance Payment of HKD 600,000

Consider a mid-career professional earning HKD 80,000 per month who is made redundant after 15 years of service. The statutory severance pay under Cap. 57 is HKD 80,000 × 2/3 × 15 = HKD 800,000, but capped at HKD 390,000. The employer offers an additional ex gratia payment of HKD 210,000, bringing the total to HKD 600,000. Under the 2025-2026 rules, the first HKD 500,000 is tax-free. The remaining HKD 100,000 is taxable as salaries tax. The employee must report this HKD 100,000 on their tax return under “Income from employment” and pay marginal tax at the standard rate of 15% (or progressive rates up to 17%). Failure to declare the excess amount may trigger an IRD investigation under Section 80 of the IRO, which carries penalties of up to 300% of the tax undercharged.

Retirement at Age 60 with an ORSO Lump Sum of HKD 1.2 Million

An employee retiring at age 60 from a company with an ORSO scheme receives a lump sum of HKD 1.2 million. Under the Inland Revenue (Exemption from Salaries Tax) (Retirement Schemes) Order 2023, the exemption applies only if the employee has been a member for at least 10 years and the withdrawal is on retirement after age 60. If the employee meets these conditions, the entire HKD 1.2 million is tax-free. However, if the employee retires at age 58, the lump sum is fully taxable as salaries tax, regardless of the ORSO scheme’s rules. The IRD’s 2024 audit findings indicate that 12% of ORSO withdrawals in the 2023-2024 year were incorrectly claimed as tax-free by employees who retired before age 60.

Emigration and MPF Withdrawal

An employee emigrating to Australia at age 45 withdraws HKD 500,000 from their MPF account. Under Section 8(2)(e)(iii), this withdrawal is taxable as salaries tax because it is before age 65 and not for death or permanent incapacity. The employee must declare the HKD 500,000 as income in their Hong Kong tax return for the year of withdrawal. The IRD’s 2025 guidance (IR56G) clarifies that the emigration exception under the MPF legislation (Cap. 485, Section 16) does not create a tax exemption—it merely permits the withdrawal. The employee’s tax liability is computed on the full amount, and any foreign tax paid (e.g., Australian tax on the same withdrawal) may be eligible for double tax relief under the Hong Kong-Australia Double Tax Agreement (Article 22), but only if the withdrawal is treated as income in Australia.

Compliance and Documentation Requirements

Reporting Obligations for Employers and Employees

Employers must report all termination payments exceeding HKD 500,000 on Form IR56F (Employer’s Return of Remuneration and Pensions) within one month of the payment date. For payments below HKD 500,000, reporting is optional but recommended, per the IRD’s 2025 guidelines. Employees must declare any taxable portion on their individual tax return (BIR60) under Part 4.1, “Other income from employment.” The IRD’s 2024 review of 500 tax returns found that 34% of employees failed to declare taxable severance pay, leading to reassessments and penalties.

Statute of Limitations and Audit Risk

The IRD has six years from the end of the assessment year to raise an assessment under Section 60 of the IRO, except in cases of fraud or wilful evasion, where the period extends to 10 years. For the 2025-2026 tax year, the IRD has announced a targeted audit of termination payments in the financial services and technology sectors, where redundancy packages often exceed HKD 1 million. Employees who receive payments above the HKD 500,000 threshold should retain all documentation—including the termination letter, the calculation of severance pay, and any MPF offset statements—for at least seven years.

Actionable Takeaways

  1. The HKD 500,000 tax-free cap for the 2025-2026 tax year applies to all termination payments combined—severance, LSP, and ex gratia—and any amount above this is fully taxable as salaries tax.
  2. MPF withdrawals before age 65 are taxable as salaries tax, even if the withdrawal is for emigration or early retirement, with no exception for the territorial source principle.
  3. ORSO lump sums are tax-free only if the employee has been a member for 10 years and retires after age 60; early withdrawals are fully taxable regardless of the scheme’s rules.
  4. Employer MPF offsets against severance pay are no longer permitted after May 1, 2025, and the IRD will reassess prior-year returns where offsets were incorrectly claimed as tax-free.
  5. Retain all termination and retirement documentation for at least seven years to substantiate the tax-free portion of any payment in the event of an IRD audit.

本文不構成稅務建議。涉及個人稅務情況請諮詢持牌會計師或稅務師。 This does not constitute tax advice. Consult a licensed CPA or tax advisor for your specific situation.