Court of Final Appeal decision on employee payments A look at why the benefits given to an employee were not for past services but were related to other matters
The case of Commissioner of Inland Revenue v. Poon Cho-ming John [FACV 1/2019] hinged on the fact that the payment for “something else” was essentially for the employee agreeing: not to take any course of action that might create unfavourable publicity for the employer; not to pursue threatened legal claims against the employer; and to simply “go away quietly.”
Brief facts Under an employment contract dated 20 October 1999 (the service agreement), the taxpayer was employed by a Bermuda company (the company), which was listed on the Stock Exchange of Hong Kong, as group chief financial officer (group CFO) and an executive director of the company. The service agreement was terminable by either party serving to the other a 6-month written notice. Circumstances leading to the immediate termination of the service agreement on 20 July 2008 On Friday afternoon, 18 July 2008, the chairman of the company informed the taxpayer that the company was going to terminate the service agreement immediately and remove him from his directorship positions of the group, including that of the company. The taxpayer was taken aback. His mood was combative, and he refused to go quietly. The taxpayer was of the view that even though the company could terminate his employment as group CFO, this was not the case with his position as executive director of the company and January 2020
other group companies. The taxpayer then threatened to take a two-pronged course of action. Firstly, he proposed to challenge the chairman’s plans to remove him from his directorships by taking the matter to the shareholders with a view to delay his departure from the board, contrary to the wishes of the chairman and a majority of the company’s board of directors. Secondly, the taxpayer was also prepared to take his claims to court, which would attract interest from the media, with consequential market reaction. Although the parties were in an acrimonious relationship, after a weekend of negotiations involving lawyers on both sides, they eventually agreed to the terms for the termination of the service agreement, by way of a separate written agreement (the separation agreement). Payments and benefits made to the taxpayer under the separation agreement Under the separation agreement, the taxpayer was to be paid, in addition to payment in lieu of six months’ notice and various other sums, a “payment in lieu of a discretionary bonus for the financial year ended 30 June 2008 – EUR 500,000” (sum D). Furthermore, the separation agreement also provided that the vesting dates in respect of three tranches of options in the shares of the company, which were granted to the taxpayer under his terms of employment, were accelerated to the date of the termination of the service agreement on 20 July 2008. These options were duly exercised
by the taxpayer resulting in notional gains of HK$43,250,400, calculated for tax purposes as being the difference between the market value of the shares on the date of exercise and the exercise price (the share option gain). The taxpayer accepted that the sums and benefits to be given to him under the separation agreement were in full and final settlement of all claims and rights of action (whether under statute, common law or otherwise).
Issue in dispute The Commissioner of the Inland Revenue (CIR) determined that sum D and the share option gain were “income from employment” chargeable to Salaries Tax in Hong Kong. On appeal, the tax tribunal of the Board of Review (BOR) and the Court of First Instance (CFI) upheld the CIR’s assessment of sum D and the share option gain. The Court of Appeal (CoA) however reversed the BOR’s and CFI’s decision and held that both sum D and the share option gain were not chargeable to Salaries Tax in Hong Kong. The CIR then appealed the CoA’s decision to the Court of Final Appeal (CFA).
Decision of the Court of Final Appeal Legal test for determining what constitutes “income from employment” In this regard, Mr. Justice Bokhary NPJ, delivering his judgement in this case, referred to an earlier decision of the CFA 2
