The impact of abolishing Circular No. 481 on Chinese severance payments

The Ministry of Human Resources and Social Security invalidated a number of employer guidelines in China at the end of November 2017.

Among them was the ‘Measures on Severance Payment for Breaking or Terminating Labour Contracts’(Lao Bu Fa [1994] No. 481, also referred to as ‘Circular No. 481’. The Circular had been in effect for more than 20 years, acting as the legal basis for payroll professionals handling severance payments and  medical subsidies relating to recuperation periods.

What impact has the abolition of Circular No. 481 had on employers?

The impact of the move has been mixed and some legal implications remain unclear. While the guidelines set out in the Labour Contract Law generally take precedence over the now abolished Circular No. 481, in practice some facets can still be enforced in relation to employment contracts that predate the Law.

This means it is vital that employers review their internal procedures, particularly as some ambiguities still remain about how to handle employment contracts that pre-date 2008 and the provision of medical subsidies.

Employers that fail to comply increase the potential for labour disputes or possibly worse. Therefore, it is important to review any differences between severance payments and medical subsidies under Circular No. 481 and the current Labour Contract Law.

Calculating severance payments

The Labour Contract Law, which took effect in 2008, changed how severance payments were calculated. This calculation was previously stipulated in Circular No. 481.

Calculation period for severance payments

Circular No. 481 and the Labour Contract Law treat the period of employment used to calculate severance payments differently. The biggest difference relates to employees that have served less than six months.

According to the current Labour Contract Law, employers must still provide employees with a severance payment equivalent to one month of their salary for each full year of employment. Severance payment equivalent to a full year’s service is also due to those staff members who have served less than a year but more than six months.

But employees who have served less than a year are now entitled to half of their monthly salary. In the past, any period of employment less than a full year was considered to be a full year for the purposes of calculating severance payment. It amounted to one month’s salary for each year that an individual was employed.

Calculation base and severance payments

Under Circular No. 481, calculating severance payments was largely based on an employee’s average monthly wage in the 12 months before the employment contract was terminated. It was also partly affected by the reason behind their termination.

While this principle largely holds under the Labour Contract Law, the Law has both provided an upper ceiling on the payment and limited the impact of the reason behind why the staff member lost their job.

Under the current Labour Contract Law, the severance pay calculation is based on an employee’s average salary in the 12 months before their employment contract was terminated. If they worked for less than 12 months, their average monthly salary should be calculated according to the actual number of months worked.

If a worker’s average monthly salary ends up being lower than the local minimum wage if they take unpaid leave, for example, the local minimum wage should be used as the basis to calculate the severance payment.

For employees with an average salary that is three times higher than the local average monthly wage for the preceding year, the base should be capped at three times their average monthly salary. The calculation period should also be capped at 12 years.

If an employment contract was signed before the 2008 Labour Contract Law came into force, employers will need to follow the provisions that were active at that time. But there is some disagreement over whether Circular No. 481 guidelines for employment contracts executed prior to 2008 should be followed now that the Circular has been abolished.

While some analysts believe the Circular’s abolition means that it no longer applies, others maintain that, despite no longer being in force, it is still relevant for contracts pre-dating the Labour Contract Law.

At this time, it is difficult to ascertain which view will prevail in law, which means it makes sense to consult professional advisors to determine how best to calculate the standard base of a severance payment.

For ease of reference, the standard calculation base laid out in Circular No. 481 was an employee’s average monthly wage in the 12 months before their employment contract was terminated. If their employment was terminated due to illness or injury not caused by work, significant changes to their employer’s circumstances or layoffs, the calculation should be based on their average monthly wage or the organisation’s average monthly wage, whichever is larger.

Circular No. 481 also maintained that severance payments should not be provided for more than 12 months of an employee’s average monthly salary if their employer moved the termination date forward, and both the employer and employee subsequently terminated the contract through mutual agreement or because of the staff member’s performance at work.

Additional severance payments

Before Circular No. 481 was abolished, employers often faced a dilemma over whether to apply an additional severance payment. This situation took place because the terms for an additional payment were different under Circular No. 481 and the Labour Contract Law.

Following the abolition of Circular No. 481, the Labour Contract Law is now paramount in determining whether an employer needs to make an additional severance payment.

According to the Law, employers need to pay a 50% to 100% additional severance payment to employees under the following circumstances:

• Failure to pay wages in full;
• If paying wages that are lower than the local minimum wage;
• Failure to pay staff members for overtime, inclusive of extended work hours and work at weekends or during public holidays.

Notably, employers also need to make an additional severance payment if they failed to make the original payment in line with relevant regulations. This scenario underscores the importance of reviewing the Labour Contract Law and calculating severance payments correctly.

In contrast to Circular No. 481, the Law does not specify how medical subsidies should be paid if employees are terminated after a period of recuperation. Analysts are therefore split over whether employers should continue providing medical subsidies in the wake of Circular No. 481’s abolition.

Are employers now exempt from medical subsidy obligations?

It appears that Circular No. 481 can no longer serve as a reference for medical subsidies, but guidance can still be found in other legal documents such as Lao Bu Fa [1996] No. 354. As a result, employers should not assume there is no need to pay medical subsidies at all. Instead they should observe local practices and consult with professional advisors.

Circular No. 481 said medical subsidy amounts should not come to less than six months of an employee’s total wage. It further mandated that seriously ill staff were due an additional payment, amounting to not less than 50% of the medical subsidy. Similarly, employees with a fatal disease were due a subsidy not less than 100% of the medical one.

By Hazel Wang

This article was first published on China Briefing. 

Since its establishment in 1992, Dezan Shira & Associates has been guiding foreign clients through Asia’s complex regulatory environment and assisting them with all aspects of legal, accounting, tax, internal control, HR, payroll and audit matters. As a full-service consultancy with operational offices across China, Hong Kong, India and ASEAN, we are your reliable partner for business expansion in this region and beyond. For inquiries, please email us at info@dezshira.com. Further information about our firm can be found at: www.dezshira.com.

The Ministry of Human Resources and Social Security invalidated a number of employer guidelines in China at the end of November 2017.

Among them was the ‘Measures on Severance Payment for Breaking or Terminating Labour Contracts’(Lao Bu Fa [1994] No. 481, also referred to as ‘Circular No. 481’. The Circular had been in effect for more than 20 years, acting as the legal basis for payroll professionals handling severance payments and  medical subsidies relating to recuperation periods.

What impact has the abolition of Circular No. 481 had on employers?

The impact of the move has been mixed and some legal implications remain unclear. While the guidelines set out in the Labour Contract Law generally take precedence over the now abolished Circular No. 481, in practice some facets can still be enforced in relation to employment contracts that predate the Law.

This means it is vital that employers review their internal procedures, particularly as some ambiguities still remain about how to handle employment contracts that pre-date 2008 and the provision of medical subsidies.

Employers that fail to comply increase the potential for labour disputes or possibly worse. Therefore, it is important to review any differences between severance payments and medical subsidies under Circular No. 481 and the current Labour Contract Law.

Calculating severance payments

The Labour Contract Law, which took effect in 2008, changed how severance payments were calculated. This calculation was previously stipulated in Circular No. 481.

Calculation period for severance payments

Circular No. 481 and the Labour Contract Law treat the period of employment used to calculate severance payments differently. The biggest difference relates to employees that have served less than six months.

According to the current Labour Contract Law, employers must still provide employees with a severance payment equivalent to one month of their salary for each full year of employment. Severance payment equivalent to a full year’s service is also due to those staff members who have served less than a year but more than six months.

But employees who have served less than a year are now entitled to half of their monthly salary. In the past, any period of employment less than a full year was considered to be a full year for the purposes of calculating severance payment. It amounted to one month’s salary for each year that an individual was employed.

Calculation base and severance payments

Under Circular No. 481, calculating severance payments was largely based on an employee’s average monthly wage in the 12 months before the employment contract was terminated. It was also partly affected by the reason behind their termination.

While this principle largely holds under the Labour Contract Law, the Law has both provided an upper ceiling on the payment and limited the impact of the reason behind why the staff member lost their job.

Under the current Labour Contract Law, the severance pay calculation is based on an employee’s average salary in the 12 months before their employment contract was terminated. If they worked for less than 12 months, their average monthly salary should be calculated according to the actual number of months worked.

If a worker’s average monthly salary ends up being lower than the local minimum wage if they take unpaid leave, for example, the local minimum wage should be used as the basis to calculate the severance payment.

For employees with an average salary that is three times higher than the local average monthly wage for the preceding year, the base should be capped at three times their average monthly salary. The calculation period should also be capped at 12 years.

If an employment contract was signed before the 2008 Labour Contract Law came into force, employers will need to follow the provisions that were active at that time. But there is some disagreement over whether Circular No. 481 guidelines for employment contracts executed prior to 2008 should be followed now that the Circular has been abolished.

While some analysts believe the Circular’s abolition means that it no longer applies, others maintain that, despite no longer being in force, it is still relevant for contracts pre-dating the Labour Contract Law.

At this time, it is difficult to ascertain which view will prevail in law, which means it makes sense to consult professional advisors to determine how best to calculate the standard base of a severance payment.

For ease of reference, the standard calculation base laid out in Circular No. 481 was an employee’s average monthly wage in the 12 months before their employment contract was terminated. If their employment was terminated due to illness or injury not caused by work, significant changes to their employer’s circumstances or layoffs, the calculation should be based on their average monthly wage or the organisation’s average monthly wage, whichever is larger.

Circular No. 481 also maintained that severance payments should not be provided for more than 12 months of an employee’s average monthly salary if their employer moved the termination date forward, and both the employer and employee subsequently terminated the contract through mutual agreement or because of the staff member’s performance at work.

Additional severance payments

Before Circular No. 481 was abolished, employers often faced a dilemma over whether to apply an additional severance payment. This situation took place because the terms for an additional payment were different under Circular No. 481 and the Labour Contract Law.

Following the abolition of Circular No. 481, the Labour Contract Law is now paramount in determining whether an employer needs to make an additional severance payment.

According to the Law, employers need to pay a 50% to 100% additional severance payment to employees under the following circumstances:

• Failure to pay wages in full;
• If paying wages that are lower than the local minimum wage;
• Failure to pay staff members for overtime, inclusive of extended work hours and work at weekends or during public holidays.

Notably, employers also need to make an additional severance payment if they failed to make the original payment in line with relevant regulations. This scenario underscores the importance of reviewing the Labour Contract Law and calculating severance payments correctly.

In contrast to Circular No. 481, the Law does not specify how medical subsidies should be paid if employees are terminated after a period of recuperation. Analysts are therefore split over whether employers should continue providing medical subsidies in the wake of Circular No. 481’s abolition.

Are employers now exempt from medical subsidy obligations?

It appears that Circular No. 481 can no longer serve as a reference for medical subsidies, but guidance can still be found in other legal documents such as Lao Bu Fa [1996] No. 354. As a result, employers should not assume there is no need to pay medical subsidies at all. Instead they should observe local practices and consult with professional advisors.

Circular No. 481 said medical subsidy amounts should not come to less than six months of an employee’s total wage. It further mandated that seriously ill staff were due an additional payment, amounting to not less than 50% of the medical subsidy. Similarly, employees with a fatal disease were due a subsidy not less than 100% of the medical one.

By Hazel Wang

This article was first published on China Briefing. 

Since its establishment in 1992, Dezan Shira & Associates has been guiding foreign clients through Asia’s complex regulatory environment and assisting them with all aspects of legal, accounting, tax, internal control, HR, payroll and audit matters. As a full-service consultancy with operational offices across China, Hong Kong, India and ASEAN, we are your reliable partner for business expansion in this region and beyond. For inquiries, please email us at info@dezshira.com. Further information about our firm can be found at: www.dezshira.com.