Terminating Employees

The Chinese Labor Contract Law offers a high degree of protection to workers’ job security. Due to this, terminating an employee in China is difficult and expensive in comparison to other countries.   

Contributing Advisor

Donfil Huang

Manager, Business Advisory Services

In the table below, we discuss terminating fixed-term and non-fixed term contracts. Part-time contracts can be terminated at will by both parties. For job contracts, the same rules for termination apply as for fixed-term contracts.

Termination during the probation period

During the probation period, the employee can resign at will by giving three days’ notice. However, the employer can only terminate the employee with admissible grounds, such as:

• Employee doesn’t meet the job requirements stated in the job description;
• Employee is deemed to commit a serious violation of the company rules;
• The company suffers a serious loss that can be attributable to the conduct of the employee;
• Labor contract signed by employer under false assumptions or coercion from the employee;
• Employee is convicted of a criminal offence during the term of the labor contract;
• Employer’s interest is harmed due to the employee taking up a post at a separate entity;
• Employee is incompetent for the position, even after training or a job transfer; and
• Employee unable to work after sickness or injury.

The burden is on the company to prove that an employee has not been able to meet the requirements of the position they were hired to fill.

To terminate an employee on probation period, the company is not required by law to pay severance payment if the termination is based on the admissible grounds.

Termination during a fixed-term or non-fixed term contract

Upon completion of the probation period, the employee must give the employer one month’s notice if they intend to resign from the position.

During the term of a labor contract, the employment relationship can be terminated either by mutual agreement or by unilateral termination with lawful causes, the latter including immediate termination situations and termination with 30 days’ notice. The employee could also be terminated by:

• Mass-layoff;
• Automatic termination upon bankruptcy;
• Revocation, or
• Dissolution. 

Termination through mutual agreement

This type of termination occurs when the employer and employee mutually agree to terminate the relationship. If the termination is put forward by the employer, then the employee is entitled to severance payment. Often, the employer will provide additional money to the employee to obtain the employee’s consent on separation, and there is no mandatory limit to this additional money.

Immediate termination for inappropriate behavior of the employee

The employer can terminate its employee immediately for the employee’s inappropriate behavior. No severance payment is required in this case. However, the employer needs to inform the labor union in advance.

Immediate termination without compensation can only happen under five circumstances:

• The employee is deemed to commit a serious violation of the company rules;
• The company suffers a serious loss that can be attributable to the conduct of the employee;
• The employee is convicted of a criminal offence during the term of the labor contract;
• Labor contract signed by employer under false assumptions or coercion from the employee; and
• Employer’s interests harmed due to the employee taking up a post at a separate entity.

Termination with 30 days’ notice and compensation payment

An employer is allowed to terminate an employee unilaterally with 30 days’ notice or an additional month’s salary, when:

• Employee can no longer work after becoming sick or injured;
• Employee is incompetent for the position, even after training or a job transfer; and
• The objective situation on which the employment was originally based has changed considerably. As a result, the labor contract can no longer be fulfilled.

The terminated employee is also entitled to severance payment. The employer is required to inform the labor union in advance.

Mass layoff

Where an employer needs to reduce 20 or more employees or where the number of employees to be reduced is less than 20 but comprises 10 percent or more of the total number of employees, it is considered a mass layoff. The law imposes higher requirements and stricter procedures on mass layoffs.

Mass layoffs can be done under the following circumstances:

• The employer undergoes restructuring pursuant to the provisions of the PRC Enterprise Bankruptcy Law;
• The employer has serious production and business difficulties;
• The enterprise undergoes a change of production, significant technological reform, or change of mode of operation - upon variation of labor contracts, there is still a need for mass layoff; or
• The objective circumstances have undergone significant changes. As a result, the labor contract can no longer be performed.

The following personnel shall be given priority to be retained in a mass layoff:

• An employee who has entered into a fixed-term labor contract of a longer period with the employer;
• An employee who has entered into a non-fixed term labor contract with the employer; and
• An employee whose family members are not employed or who needs to support aged or under-aged family members.

If an employer that carried out a mass layoff is re-hiring employees within six months of the mass layoff, the dismissed employees need to be informed and shall be given priority for employment under the same conditions.

The detailed procedures of mass layoffs are subject to local variances. Companies are suggested to pay close attention to these procedures. If failing to fulfill these requirements, the company may be confronted with onerous labor disputes or even potential penalties from the labor bureau in charge.

Termination upon bankruptcy/license revoking/permanent dissolution of the company

The employment relationship can be terminated automatically, and the employer would have to pay severance payment to the affected employees, when:

• Employer is declared bankrupt pursuant to the law;
• Employer’s business license is revoked;
• Employer is ordered to close down; and
• Employer has decided to dissolve prematurely.

Termination at the end of a fixed-term contract

It is relatively straightforward for an employer to terminate an employee at this stage. The employer does not need to give the employee a reason for the company’s decision. However, employers should bear in mind the following points:

• If the employer does not provide a new contract to the employee by the end of the contract term, and the employee still works in the company after this point, the labor relationship effectively continues. The employer shall take liability for absence of the labor contract;
• If the employer decides not to renew the contract at the end of the period, the company must still pay severance payment to the employee; and
• If the employer offers the employee a renewed contract on equal or better terms to the expired contract but the employee refuses to accept it, the employer is not required to pay any compensation to the employee.

Upon expiration of the second fixed-term contract, where the employee raises the request to renew the employment contract, the employer will have to accept such a request depending on local regulations, unless the circumstances of ‘immediate termination’ or ‘termination with 30 days’ notice’ apply.

Employees not allowed to be terminated

Certain employees are specially protected, including:

• Who are suspected of having an occupational disease and waiting for diagnosis;
• Who have completely or partially lost labor capability due to occupational diseases or work-related injury;
• Who are still in the legal medical treatment period for non-work related illness/ injury;
• Who are pregnant, on maternity leave, or in nursing period; and
• Who have worked for the employer continuously for more than 15 years and are less than five years away from retirement.

These groups of employees mentioned above cannot be terminated for reasons listed under ‘termination with 30 days’ notice’ and ‘mass layoff’. Upon expiration of their labor contracts, they are not allowed to be terminated until the corresponding circumstances extinguish.

However, when an employee has completely or partly lost labor capability due to occupational diseases or work-related injury, they shall be terminated and treated in accordance with the provisions on work-related injury insurance.

Severance payment

An employer is required to make severance payment to employees for:

• Termination by mutual agreement and the proposal is put forward by the employer;
• Termination upon 30 days’ notice according to Article 40 of the Labor Contract Law;
• Termination upon bankruptcy/license revoking/permanent dissolution of the company;
• Termination in a mass layoff; and
• Termination upon the expiration of the labor contract, except where the employer offers the employee a renewed contract on equal or better terms to the expired contract, but the employee refuses to accept it.

Besides, the employee can get severance payment for termination put forward by themselves under the following circumstances:

• Where the employer fails to:
• provide labor protection or labor conditions pursuant to the provisions of the labor contract;
• promptly pay labor remuneration in full amount; and
• contribute social security premiums for the employee pursuant to the law.
• Where the rules and system of the employer violate the provisions of laws and regulations and are prejudicial to the employee’s rights and interests; and
• Where the labor contract is rendered void because it is concluded by use of fraudulent or coercive tactics or by taking advantage of employee’s unfavorable position thus against the real intention of the employee.

Calculation of severance payment

The formula of calculating the severance payment is:

SEVERANCE PAYMENT= AVERAGE MONTHLY SALARY x YEARS OF SERVICE

• For the average monthly salary: It is calculated as the employee’s average monthly salary during the last 12 months preceding the termination. If the employee worked for less than 12 months, the average monthly salary shall be calculated according to the actual work time.
• Three-time restriction: If the employee’s average monthly salary is more than three times the average monthly salary in the location of employment, the latter will be used to calculate severance pay. This rule does not apply to the period prior to the enactment of the PRC Labor Contract Law.
• For the counting of the years of service:

• Total amount restriction: For employee whose average monthly salary is more than three times the average monthly salary in the location of employment, the severance is limited to a maximum of 12 month’s average salary, even if they worked for a company for over 12 years.

The calculation method provided above is only the minimum amount an employer is required to pay by law. In practice, however, employers often pay a higher amount than the statutory minimum amount.

What’s the IIT implication on severance payment?

Under the IIT Law, for lump-sum compensation income derived by an individual for termination, the portion which falls within three times the annual average wage at the locality in the preceding year shall be exempted from IIT. The portion which exceeds three times the annual average wage at the locality in the preceding year shall be subject to IIT, but it won’t be included in the comprehensive income for that year, rather, it shall be taxed separately by applying to the IIT Rates Table for Comprehensive Income (Yearly).

If the employee pays any mandatory social security contributions when they receive the severance payment, the actual amount paid by the employee is deductible. Hence, the IIT calculation on severance payment should be as follows:

• Step 1: Decide on an amount for the total compensation package that will be provided to the employee;
• Step 2: Deduct an amount equal to 300 percent of the annual average wage at the locality in the preceding year from the total compensation package;
• Step 3: Deduct the mandatory social security contributions actually paid by the employee (if any);
• Step 4: Apply the tax rates and quick deductions provided in the IIT Rates Table for Comprehensive Income (Yearly), and then calculate the corresponding IIT.

This will be the IIT on severance payment for the employee. The employer is required to deduct any tax burden payable by the employee on money received as part of a termination package before paying the rest of the amount to the employee.