Severance Pay in China
China’s employment termination law is stricter than most countries since the government places a great deal of focus on employee job security. Local and foreign companies that are preparing to establish a business in the country should be aware of the labor laws, including termination and issuance of severance payments. In this article we explain exactly how Severance pay works as well as what you need to know about severance pay in China.
How Does Severance Work in China
Severance pay in China aims to provide fair treatment to both employers and employees with respect to the agreed employment contract. In general, severance pay is obligatory, however, in exceptional cases, the payment of severance is not necessary if there is a valid reason.
Severance pay is a negotiable right of an employee and can be discussed with the employer. Employees must make sure that they have not committed any offense that may relieve the duty of the employer of any responsibility to pay severance.
Under the Labor Law of the PRC, severance pay in China is equivalent to one month’s full salary for each year of an employee’s service. An employment period between six months to one year is considered a full year. An employee working for nine months will still receive the equivalent of a full year’s worth of pay. Employment for a continuous period of less than six months is equivalent to half a month’s pay in severance.
Example: An employee who works for four years and four months will receive four and a half months’ worth of severance pay. Meanwhile, someone who worked for 10 years and eight months will receive 11 months’ worth of severance pay.
If the monthly salary of an employee exceeds three times the average monthly salary of employees in the area or municipality where the business is located, the calculation of the severance pay can be adjusted. Severance pay is to be paid at three times the average of the monthly salary in the area and only up to 12 years of work.
Is Severance Pay Mandatory in China?
According to Labor law in China, an employer is able to terminate an employee on the following grounds:
- Through mutual agreement between the parties
- On the grounds of misconduct or fault by an employee
- Termination without fault
- Wrongful termination
Besides cases of termination on mutual agreement, fault of the employee or termination without fault, any other type of unilateral termination is considered unlawful. Any unlawful termination is considered a violation of the labor laws in China and as a remedy the employee can request the contract be renewed or that he/she be reinstated.
In cases of wrongful termination, if the employee does not want to renew the contract or working under the same contract has become impossible, the employer must provide severance pay equivalent to twice the rate the employee used to be entitled to.
For instance, an employee working for 10 years will receive 20 months’ worth of severance pay if the employer breaches the labor laws and the termination was due to unfair dismissal. In case of reinstatement, the employer only has to work with the employee’s backpay.
When Severance Pay Must Be Made
Here are instances wherein employers can initiate terminations but have to provide severance pay to employees:
- Changes in the business circumstance
In case the company no longer needs the job for which they hired a new employee, they have the right to close the position and terminate the employment contract. Before termination, the company must try first to change the duties and responsibilities of the position to maintain the tenure of the hired employee.
- Health issues or injury renders an employee unable to work
When the contract has to be terminated because the employee cannot fulfill their duties due to injury or health reasons, the employer is obliged to give severance payment.
- Mass layoff
Severance payments are required to be made in cases of mass layoffs. Additionally, if the employer starts hiring again within six months after the layoff, the previously terminated employees should be given priority.
- Company dissolution
When the company shuts down, either through license revocation, bankruptcy, or an order to cease operation.
- Fixed-term employment contracts
Employers using fixed-term contracts have the right to not renew the contract in case they find the performance of the temporary employee unsatisfactory. However, they are required to pay severance to terminated employees.
While after the first fixed-term contact renewal is not mandatory, after the second fixed-term contract an employer is required to offer a renewal of the contract upon the request of an employee. An employer will also be required to provide severance for all consecutive fixed term periods. For example, if an employee’s employment contract is not renewed for a third time, the employer must pay a severance payment equal to two months’ salary.
Instances When Severance Pay Is Not Required
Here are the situations wherein the company is not required to pay severance to terminated employees:
- Probation period
In China, employers are allowed to set a probation period for new employees. When the employee fails to pass the job requirements or cannot fulfill the duties of the position, the employer is not obligated to pay severance.
- Mutual agreement on contract termination
There are cases where the employer and employee mutually agree to end the contract. In situations wherein the employer initiates the termination, severance pay should be given to the employee.
Sometimes, employers offer additional payment on top of the severance pay to get the consent of the employee to mutually end the contract.
This path is favorable to the employer because it prevents the termination from becoming costly. Alerting the local labor authorities for violations and settling disputes can be inconvenient for both parties. The employee can also benefit from the agreement, especially when the compensation is deemed reasonable.
- Termination due to prohibited behavior
- The employee commits a serious offense as stated in the company’s rules and regulations. When terminating using this reason, employers should provide evidence of the offense. The company’s guidelines should indicate that what the employee did was a grave offense and can be a ground for termination.
- The employee abandons their duties, resulting in a substantial loss for the company. However, the company must prove that the loss was directly caused by the employee’s negligence. The causality should be unambiguous for it to be valid.
- The employee fails to attend to their duties because they are also working for another employer. The employer can only terminate the contract after giving the employee an opportunity to cut off their contract with the other employer. If the employee refuses or does not comply, the employer can terminate the contract without paying severance.
- The employee is convicted of a crime while still employed or under contract. Employers should note that previous convictions and criminal records are not grounds for termination.
Taxes on Severance Pay in China
China’s State Administration of Taxation clarified that severance pay in China is considered as a wage or salary. As such, it is considered taxable income.
A one-time lump sum payment of severance is exempted from tax if it does not exceed three times the average monthly salary in the municipality during the previous year. However, if the severance pay exceeds this threshold, then the exceeding amount is subject to individual income tax. Tax exemption is only applicable to cases of abrupt termination of the contract.
Severance pay made after the expiration of the contract without renewal is subject to personal income tax. It is not exempted from tax because the termination of the contract is the result of a natural and legal process.
Getting Help With Employment in China
Local labor laws give preference and protection to employees over employers through the provisions on termination and severance pay. Learning the applicable national regulations on employment helps your business avoid basic mistakes in terminating employees that can result in violations and huge costs to the company.
As a business advisory that helps foreign companies overcome their challenges in China, our experts can help you navigate the employment laws in China. We have a comprehensive understanding of the business, legal and employment landscape in China and can provide you with the right advice to keep you fully compliant. For all your accounting, HR and company setup needs, get in touch with us today so we can assist you.
Disclaimer: all articles and its related content are the property of Moore Stephens Consulting Company Limited and may not be reproduced either in part or in full without prior consent.
Stay up-to-date with relevent issues in China.
Subscribe for the Moore - MS Advisory newsletter!