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Commissioner of Inland Revenue v Poon Cho-ming, John [FACV 1/2019]

Background of the case

The taxpayer has been employed as the Group CFO and executive director of a Hong Kong listed company since 1999. In 2008, his contract was terminated by his employer with immediate effect. The taxpayer refused to accept the termination and planned to take legal actions. After hard negotiations, both parties agreed on the termination terms under a “Separation Agreement”.

Under the “Separation Agreement”, a total of six sums would be made by the employer to the taxpayer, out of which the taxability of the following two sums was submitted to courts for determination

Payment in lieu of a discretionary bonus (“Bonus”); and
A notional share option gain, which was derived from early exercise of share option which was not supposed to be vested as at the employment termination date (“Share Option Gain”).


Held in favour of

Board of Review (“BoR”)

Court of First Instance (“CFI”)

Court of Appeal (“COA”)

Court of Final Appeal (“CFA”)

The judges of both BoR and CFI held in favour of the CIR on the basis that the termination payment were related to the employment services of the taxpayers. However, the decisions were overturned by COA and further confirmed by CFA because of the payments were made “for something else”.

It is considered that the payments were made due to the legal actions proposed by the taxpayer and were made to let the taxpayer “go away quietly”. From our perspective, the timing of payment agreement was of paramount importance. As the payment was negotiated and concluded after the termination decision was held, it was not related to the past employment of the taxpayer.

Lastly, the CFA considered the below arguments are also relevant:

Bonus: The amount was determined arbitrarily and there was no evidence to support that it was related to the employment performance. The bonus review process was after the termination date;

Share Option Gain: The acceleration of vesting was obviously not for the employment performance of the taxpayer, but an incentive for the taxpayer to “go away quietly”.  

POINTS TO NOTE
We consider that the facts that the employer is a listed entity and the important role undertaken by the taxpayer are two exceptional factors giving rise to the favourable decisions by the CFA.

Having said that, taxability of termination payments are often controversial which implies room for tax planning. While the “substance-over-form” principle has been used in this court case, the way in which the employment contract and other relevant agreements are drafted are usually the first reference point of the Inland Revenue Department (“IRD”).

On the other hand, besides the payments highlighted in this case, some other termination payments like payment for non-competition after the employment contracts are usually treated as capital in nature and thus non-taxable. The court decision has explicitly pointed those payments “for something else” should not be subject to Hong Kong Salaries Tax, while the employer may still pursue tax deduction on such termination payments.

In view of the above, it is recommended that, taxpayers should ensure that accurate wordings and all the relevant details should be in place when the employment contracts and termination agreements are drafted. Otherwise, the potential non-taxable claim of termination payments would be missed out. You are advised to consult with your tax advisors if necessary.

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