Details of Employee’s Severance Package in China
If an employee is about to be terminated from a position involuntarily and through no fault, the employee will be eligible for severance pay. From an employer’s perspective, it does not only mean you will offer the employee a nice sum of money and request the employee to waive the right to sue you, you also need to pay attention to the details of severance package to plan your operational budget and avoid illegal termination lawsuit.
Most severance packages include the following things
Severance Compensation: Standard and Base for Calculation
When employers dissolve labor contracts with employees, the calculation standard for severance compensation is divided based on length of time served. Workers in service for more than one year should be paid one-month wages per year of service. Those who have worked more than six months but less than a year should be paid one-month wage and those working less than six months should be paid half a month’s wages. The base for calculating severance compensation is the average monthly wage of the 12 months’ preceding discharge or termination of the labor contract. The maximum total severance pay required in China is three times the local average monthly wage times 12 years worked.
Length of Service in the Calculation of Severance Compensation
The length of service of an employee in an enterprise should be calculated from the first day that the employee serves the enterprise. If a labor contract is not duly signed between the employee and enterprise due to certain reasons, it should not affect the calculation of his length of service. If the employee serves the enterprise continuously under several labor contracts, the length of service should be calculated continuously. If the employee serves the enterprise for several years but with a period of interruption under several labor contracts, in principle, the length of service should be calculated continuously, with the period which financial compensation has been paid excepted. In case of changes in the enterprise due to merger, annexation, joint venture, or changes in nature and name of the enterprise, the working term before the changes should be included in the length of service.
Meanwhile, if the terminated employee started his or her employment before Jan. 1, 2008, the effective date of the LCL, two service periods must be considered when calculating severance: (i) length of service before the effective date of the LCL (applying the old rules), and (ii) length of service after the effective date (applying the LCL). In other words, their total severance consists of severance before the effective date (calculated under the old rules) and severance after the effective date (calculated under the LCL).
Unused Annual Leave
All Chinese employees covered by annual leave laws are entitled to receive a lump sum payment for accrued annual leave when being terminated. It should be included in the severance package, as the Chinese law requires payment for this time.
After the employer terminates the labor relationship with the employee, it should inform the employee about their entitlement to the unemployment insurance according to law, and complete the termination procedures with local employment service institution of the place where the employer is located within 15 days. At present in Shanghai, the maximum unemployment insurance is RMB 482 per month and the minimum is RMB 360 per month.
If there is any other insurances paid by the employer for the employees to be terminated, such as health insurance, disability insurance, life insurance ends or other insurances. The employer should negotiate with the employee to buy their own policy or terminate the issuance.
Typically, the employer should pay all at once, or a lump sum in addition to the non-compete compensation which should be paid on monthly basis within the non-compete period after termination according to law.
If there is a non-compete obligation on the employee after the termination, the compensation for the non-compete shall be included in severance packages. Generally, the non-compete obligation is to bar the employee from working for a business or company that competes directly with the old employer. They can also stop the employee from opening his/her own business and competing with the employer.
Lump sum severance pay made to individuals as a result of termination of their employment contracts is treated as wages and salaries for China tax purpose. Severance pay to the extent the amount exceeding three times the previous year’s average salary of the concerned locality is taxable. The formula to calculate IIT on severance payments is as follows:
(Severance Payment – 3x the Previous Local Annual Average Salary) x the Applicable Tax Rate
In addition to the above mentioned matters included in the severance package, if the employer is ruled illegal termination of employee by the labor dispute arbitration tribunal or court, the employer shall make Compensation for Illegal Dissolution or Termination of a Labor Contract. In this case, three points should be clearly understood:
According to Article 87 of the Labor Contract Law, the compensation standard should be twice the severance compensation as prescribed in Article 47 of the Law.
The period for payment of compensation should start from the commencement of employment, which should not be calculated with different rates for periods before and after enforcement of the Labor Contract Law or starting from Jan. 2008;
After the compensation is paid at the rate of double severance compensation, the employer needs not pay severance compensation for dissolving or terminating the labor contract.