Severance Pay vs Long Service Payment: Formula and Rules

At a glance

The cap, service periods and formula are as most recently published by the Labour Department and set out in the Employment Ordinance.

How do you tell them apart?

By the reason for leaving, not the amount.

Severance pay — dismissal by reason of redundancy. The role has gone, the company is shrinking, the business is closing — not something to do with the employee’s performance or conduct. The threshold is 24 months under a continuous contract.

Long service payment — 5 years’ employment, leaving in a specified circumstance (dismissed other than for redundancy, retirement on grounds of age, resignation on health grounds, or death of the employee).

For any one departure, an employee receives only one of the two.

What owners most often get wrong in practice is assuming that “dismissing someone always means severance pay”. It does not — an employee dismissed for performance who has more than 5 years’ service may be entitled to a long service payment; an employee with under 5 years’ service who is not being made redundant may be entitled to neither (though payment in lieu of notice still applies).

How is it calculated?

The formula:

(last month’s wages × 2/3) × reckonable years of service

The monthly wage figure is capped at HK$22,500. So HK$22,500 × 2/3 = a maximum of HK$15,000 per year of service.

Whether the employee earns HK$50,000 a month or HK$22,500, the annual figure works out the same.

Incomplete years are calculated pro rata.

Note that this is the statutory minimum. Where the employment contract or company policy provides something more generous, the contract governs.

When is payment due?

The two deadlines differ, and are widely confused:

Severance pay — the employee has to make a written claim, and the employer must pay within two months of receiving that notice. So it is not automatic; the employee has to ask. But once they do, you have a firm deadline.

Other termination payments (outstanding wages, payment for untaken annual leave, payment in lieu of notice) — payable within 7 days of the employment contract ending.

Seven days is tight, so do the arithmetic when you decide on the redundancy, not on the last day.

How does this relate to payment in lieu of notice?

These three get confused constantly. The simple division:

Payment in lieu of notice — you did not give the full notice period, so you pay for it instead. It can arise in any dismissal (except the statutory summary dismissal situations).

Severance pay / long service payment — compensation for length of service, unrelated to notice.

Which is to say that in a redundancy an employee may receive all at once: outstanding wages + payment for untaken annual leave + payment in lieu of notice + severance pay. Four separate amounts, each with its own calculation.

For the detail on notice and payment in lieu, see probation and notice periods.

How is it treated for tax?

Severance pay or a long service payment made as required by the Employment Ordinance is generally not chargeable income for the employee — only any amount above the statutory entitlement has to be reported.

So when you report a departing employee’s income on the IR56F, the statutory portion does not go into chargeable income; only anything extra you chose to pay does.

This box is easy to get wrong, and getting it wrong means the employee is over-taxed.

What does MPF have to do with it?

There used to be an MPF “offsetting” arrangement, allowing an employer to offset severance pay or a long service payment against the employer portion of MPF contributions. That arrangement has been abolished, and the transitional and calculation arrangements have their own rules.

The change directly affects how much cash you need to have ready. For how it actually calculates, rely on the current announcements and guidance from the MPFA and the Labour Department — this is the one item I would confirm again before finalising any redundancy.

Work out the numbers before deciding

The total cost of a redundancy is more than the severance pay — add payment in lieu, untaken annual leave and the final MPF contribution, and the figure is usually larger than the owner first assumed.

If the redundancy is part of closing down, there is a whole further set of steps; see what to settle before closing a company.

Want someone to work out what has to be ready and when? Talk to us.

This is general information and does not constitute legal advice. Caps, eligibility conditions and the MPF-related arrangements are as most recently published by the Labour Department and the MPFA; for a disputed case, consult a professional.