Severance Payment

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.