Calculation and Payment of Economic Compensation (cont'd)

Is an employer in the PRC obliged to make a severance payment to its employee when the employment contract comes to an end due to the expiry of its agreed duration (rather than due to the employee being terminated)?

Yes, but only when:

  • a fixed-term employment contract expires (unless the employee refuses to renew the employment contract on no less favourable terms and conditions offered by the employer); or
  • the employer is declared bankrupt, has its business license revoked, is ordered to close down, or decides to dissolve the business.

Where economic compensation is payable, how is it calculated?

The PRC Labour Contract Law (which took effect on 1 January 2008) provides the statutory economic compensation formula to be "calculation base × service period". The application of this formula may vary from region to region.

What is the "Calculation Base", and is it capped?

The Calculation Base refers to the employee's average monthly salary in the last 12 months prior to the termination of employment. Any wages, bonus, allowance and other monetary income paid to the employee under the contract of employment during the relevant period is to be included.

In respect of the period after 1 January 2008, the PRC Labour Contract Law caps the Calculation Base at 300 percent of all the local employees' average monthly salary for the previous year (the "Local Average Monthly Salary"). The Local Average Monthly Salary is published by the government on a yearly basis. The pre-2008 rules do not impose any cap.

In practice however, we are aware of that in some areas (like Beijing) the court does sometimes impose a cap on the Calculation Base for the period before 2008. It is debatable whether this practise is legally justified and there is risk that it may not be adopted in all cases.

How is the "Service Period" defined?

As to the Service Period, the PRC Labour Contract Law requires that every full year of service with the employer must be counted as 1 year. Any period of more than 6 months but less than 1 year will be deemed to be 1 year, while a period of less than 6 months will be deemed as half a year. The Service Period will be capped at 12 years if the employee's Calculation Base exceeds 300 percent of the Local Average Monthly Salary.