Member Article

Factual background

The taxpayer, Dr Leung, was a medical doctor employed by the Hospital Authority (“HA”). Part of the conditions of his employment was that he was required to be ‘on call’ on certain days including Sundays and public holidays. When ‘on call’, he was obligated, among other things, to be within the physical proximity of the hospital, to be ready to render medical services if the need arose, and to abstain from drinking alcohol. Dr Leung brought a claim to the Labour Tribunal arguing that the ‘on call’ arrangements breached the terms of the Employment Ordinance (EO) by denying him the statutory rest days to which he was entitled under s.17 of the EO. A ‘rest day’ is defined in s.2 of the EO as a day on which the employee is entitled to abstain from working for his employer. The Court of Final Appeal (CFA) in Leung Ka Lau v Hospital Authority (2009) 12 HKCFAR 924 allowed Dr Leung’s appeal in that regard, holding that if he was ‘on call’, he logically could not be regarded as resting on that day because he was not entitled to abstain from work should the need for him to work arise; thus, the HA was found to be in breach of contract, and was ordered to pay Dr Leung substantial damages.

The tax dispute

The Hong Kong Inland Revenue Department (IRD) sought to charge the sums Dr Leung received from the HA pursuant to the CFA’s decision to salaries tax on the grounds that these constituted income from employment within the meaning of s.8 of the Inland Revenue Ordinance (IRO). The Board of Review agreed with the IRD, and dismissed Dr Leung’s appeal. Dr Leung appealed to the Court of First Instance (CFI), which allowed Dr Leung’s appeal and reversed the decision of the Board. The CFI applied (at [10] – [11]) the test in Fuchs v CIR (2011) 14 HKCFAR 74: if payments are made in return for acting as or being an employee, they are chargeable to salaries tax; if they are paid for anything else, they are not. On that basis, the CFI held that the sums Dr Leung received were not from his employment in a technical sense (i.e., a reward for services he rendered as an employee), but rather they constituted compensation for a breach of his employment contract. The obligation to provide rest days was an implied term of an employment contract and, it followed, the damages awarded by the CFA to Dr Leung flowed from the breach of contract itself, and not from Dr Leung’s past, present, or future services as an employee of the HA. Dr Leung was not paid for rendering services as an employee since being ‘on call’ did not itself necessarily entail Dr Leung working that day, but to compensate him for a contractual default caused by his employer.

Analysis

As a prior matter, it is important to bear in mind that this decision does not apply to leave pay of any description, including maternity or paternity leave, or annual leave. That is because leave pay is expressly treated as chargeable to salaries tax under ss.8(1A)(a) and 9(1)(a) of the IRO. The taxable status of such leave pay is therefore wholly unaffected by the CFI’s decision, which is authority for a much narrower point: damages for breach of an employment contract, where such damages do not comprise an amount that was contractually due to the employee under his contract of employment, are not chargeable to salaries tax.

The CFI’s decision, however, is not entirely free from problems.

First, the analogy proffered by Chan J (at [14] – [16]) between, on the one hand, a medical doctor being ‘on call’ and, on the other, an employee being required to attend a charity football game on a Sunday by his employer is, at best, strained. A person who contractually agrees with his employer to work overtime on a Sunday should in the ordinary course be chargeable to salaries tax on the overtime pay he receives, and the same logic should apply if his employer decided to pay him to attend a football match instead to the extent such attendance was in the course of the employee rendering services in employment.

Second, the IRD accepted that if Dr Leung had been offered days off in lieu as compensation for forfeiting his rest days, such a benefit in kind would not have been chargeable to salaries tax. The CFI thought this to be inconsistent with the IRD’s principal argument that the cash payment he had received was so taxable (at [19] – [21]). The IRD’s position on that point, however, likely arose from s.9(2A)(a)(ii) of the IRO, which in essence provides that a benefit in kind provided by an employer to an employee is not chargeable to salaries tax to the extent that it is not convertible into money. Thus, the grant of a day in lieu, with not option to liquidate this for a cash payment instead, would have been statutorily exempt from salaries tax.

How we can help

The IRD has become increasingly assertive in assessing salaries tax on compensatory and terminal payments, and the relevant case law is therefore constantly evolving. We are highly experienced in advising in both non-contentious and contentious employment law and employment tax matters and we stand ready to assist.