Understanding Terminations

When an employee is terminated by an employer, his pay out comprises a severance payment and a termination payment. Termination payments may also include pay in lieu of short notice and a payout to compensate for the employee's annual leave balance.

If an employer terminates an employee, then he has to pay the employee severance. If, however, the employee resigns, then no such payment is required. The monthly salary calculation would be company-specific. Some companies might use a base salary for calculation, while certain state-owned enterprises might include all the components of a salary while calculating the monthly salary. Severance pay is negotiable between the employer and employee. This payment can be calculated as:

  • A fixed monthly salary as decided by the employer or negotiated with the employee.

  • An actual average of the employee's salary, the average being calculated over a period of 12 months.

Tax calculation on severance pay is subject to the same taxation rules regardless of how it is calculated.

According to China Labor law, if an employer terminates an employee, then he has to pay the employee severance payment. This amount is taxable, but a specific tax calculation applies. If the employee resigns, however, then no severance payment is required.

The amount of severance pay depends on the years of service (YOS). Generally, for every year of service, one month's salary is paid. For the purpose of salary, the average salary of the last 12 months is used. Thus, the severance pay is calculated as:

Severance Pay = Average monthly salary from last 12 months × YOS

The YOS has a ceiling. For example, it can be a maximum of 12 years. Years of service are rounded up to the nearest integer.

This severance pay is further taxed per the taxation requirements, depending on the tax area. To determine severance pay tax amount, you initially determine the taxable income amount to obtain the tax rate and quick deduction amount to use.

Severance taxable income = (Severance Pay Amount – Severance Pay Exempted Amount (based on tax area)) ÷ Years Of Service

Using the Severance Taxable Income, you can determine the tax rate and quick deduction amount based on the employee's tax area. You can then calculate the actual amount of tax due on the severance payment in the following way:

Initial Severance Tax Amount = (Severance Taxable Income – Tax Exempt Amount) × Tax Rate – Quick Deduction Amount
Severance Tax Amount = Initial Severance Tax Amount × YOS

Severance Tax Amount is rounded off to jiao.

Termination payments are composed of:

  • Any breach of notice as established in the contractual agreement by either side (employee or employer). The party would pay the other in lieu of short notice period.

  • The compensation of accrued annual leave balance. Employers must pay out the leave balance.

Termination payments:

  • Are taxed along with the last month's salary of the employee. Not all companies have contractual agreements for the notice period.

  • Use one of two methods to determine the salary for the purpose of calculation:

    • A fixed monthly salary as decided or negotiated by the employer with employee.

    • The previous month's actual salary paid by the employer.

Leave Compensation for Annual Leave Balance

When an employee is terminated, if an outstanding statutory annual leave is accrued to his account, the company compensates the statutory annual leave. This amount is taxable along with normal earnings.

The amount paid in lieu of the balance statutory annual leave is calculated in the following way:

Statutory Annual Leave Payment = Daily Rate x Outstanding Statutory Annual Leaves x 300%

The calculation of daily rate is based on the type of the employee.

If the employee is a daily-rate employee, the same rate is used. If the employee works on a monthly rate, the daily rate is calculated as:

Daily rate = Average monthly salary of past 12 months ÷ Average working days in a month

The average working days in a month is regulated by the Ministry of Labor and Social Security (MOLSS) of China.

Pay In Lieu of Short Notice Period

If a breach of notice period occurs as detailed in the contractual agreement by either side, the party breaching the contract must pay the other in lieu of the short notice period. This amount is taxable along with normal earnings. Calculation of the notice period is:

Payment for Short Notice = Daily Rate × Days short of notice period

The Daily rate is calculated as:

Daily-Rate = Monthly Salary ÷ Average working days in a month

Payment in lieu of notice by the employer is a pretax earning for the employee. Payment in lieu of notice by the employee is a pretax deduction for the employee. As such, it would need to be taxed with the last month's salary.