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This case concerns whether a lump sum payment received by each of the three appellants under a settlement package offered by their employer is payment for employment services (which is taxable) or represents damages for their employer's breach of statutory duty to grant statutory holidays and rest days pursuant to the Employment Ordinance (which is not taxable). The Board of Review's decision on 17 October 2008 held that the sums are income arising in or derived from Hong Kong from the appellants' employments and that the employments were the real effective cause for the payments. As such, the sums are subject to Hong Kong salaries tax.
The facts
The three appellants (all are medical staff) were required to work overtime and perform on-call duties on their rest days and on statutory holidays without any compensation under their employment contracts. Legal proceedings were initiated by some colleagues of the appellants against their employer in relation to overtime work and the provision of rest days and statutory holidays. They sought compensation for the extra work performed during overtime and on rest days and holidays in the form of time-off in lieu with pay. The High Court later upheld the rest day and statutory holiday claims but dismissed the overtime claim. The High Court considered the medical staff was required to work on their rest days and on statutory holidays and as such they should be compensated. The High Court rejected the claim for time-off in lieu with pay on the grounds that time-off in lieu as compensation would not account for the different values accorded to time and would be devastating to the public hospital and medical system in Hong Kong. For this reason, the High Court ruled that the compensation should be purely in monetary form.
As a result of the High Court ruling, the three appellants were offered a settlement package by their employer from which they received a lump sum as, among others, a full and final settlement of any claim, action, right, entitlement or proceedings that they might have against the employer arising out of or in connection with any rest days, statutory holidays or overtime work.
Salaries tax assessments were raised by the Inland Revenue Department ("IRD") on the sums received by the appellants.
The appellants' contention
Below are the two main arguments of the appellants:
- The payments made by the employer under its settlement package were damages paid for breach of its statutory duty to grant statutory holidays and rest days pursuant to the Employment Ordinance.
- The employments were not the source of the sums paid by the employer as their employments were not the causa causans (i.e. the real effective cause) but were merely the causa sine qua non (i.e. a preliminary event in the chain of causation) of the payments.
As such, the payments should not be subject to salaries tax.
The Board's decision
The Board dismissed the appeal and held that the sums were income arising in or derived from Hong Kong from the appellants' employments based on the following analyses:
- The appellants would not have been offered and paid the sums had they not rendered services by virtue of their employments on their rest days and statutory holidays.
- The sums were offered and paid to the appellants in return for their having acted as employees on their rest days, statutory holidays, public holidays and overtime.
- The sums were not paid as damages but were paid to compromise the appellants' claims and those claims were founded on the appellants having worked on their rest days, statutory holidays, public holidays and overtime.
- Even if the sums were paid as damages, the employment contracts were still the source of the payments because the statutory duty to grant statutory holidays and rest days arose only in cases of employment and a breach occurred because the appellants worked.
- In the Board's view, the appellants' employments were the causa causans of the payments.
- The fact that no overtime compensation was specifically included in the computation of the sums did not distract from the fact that the sums were offered and paid to compromise the appellants' claims which included overtime claims.
Our comment
The Board's decision in this case appears to follow the well-established principle that in determining whether a payment received is "income from employment" for Hong Kong salaries tax purposes, the test to be adopted (and which has been consistently adopted by the IRD) is whether the payment is made as "a reward for past, present or future services". That means not every payment made to an employee is necessarily income from employment and subject to tax. The taxability of a payment will depend on what is the real effective cause of such payment. In the present case, the Board is of the view that the real effective cause of the payments is the act of being an employee (in other words, the performance of services by the appellants as an employee) during their rest days and statutory holidays and therefore, the sums received are taxable.
It is also worth noting that the approach taken by the Board in the present case is to look beyond the legal form of the payments and to consider the context in which the payments were made. While the appellants argued that payment for work on rest day without consent and payment in lieu of the grant of a holiday are not allowed under the Employment Ordinance (so the payments should not be viewed as a reward for services rendered) and the High Court treated the payment as "damages for any lost rest days or lost holidays" in its judgement, the Board took the view that as the right to enjoy these rest days or holidays effectively arose from the rendering of services under the appellants' employments, they were considered as income from employment and therefore taxable. This contrasts with a payment for loss of right to make any claims against an employer for terminating an employment because such right does not arise from performance of services under an employment but from the employer's breach of the employment terms.
The IRD will always examine the context in which a payment is made as well as ask for the documentary evidence to support the intention or purpose of the payment. Hence as the starting point, if a given payment is not intended to be made to the employee for services rendered, the terms in the employment contract or settlement agreement will need to be carefully structured and phrased so as to reflect the intended purpose of the payment. |
