Resolving the Vexed Issue in Hong Kong of Offsetting MPF Contributions against Long Service & Severance Pay Just Got (Potentially) Simpler

For many years, successive Hong Kong governments have struggled with the vexed issue of how to get rid of the statutory right of an employer to reduce the long service pay or severance pay (LSP or SP) to which an employee is otherwise entitled by the value of mandatory MPF contributions paid by the employer in respect of the employee. 

This "offset" right was part of the deal agreed with employers back in the mid-1990s when the MPF system was being introduced. However, for the past decade or so, trade unions and other bodies have contested in strident terms that this often results in employees losing their jobs through no fault of their own – and without the right to any kind of meaningful compensation. 

After several years of discussion, in 2018 the Government obtained broad approval from employer and employee groups for a gradual removal of the offsetting arrangement, on the basis that it would happen over a period of 25 years, during which the Government itself would bear a reducing proportion of the increased cost to employers. This was a major step forward. 

The 2018 proposal involved three distinct elements:

• the abolition of the offsetting arrangement, 
• requiring employers to fund their gradually increasing obligations by means of payment into a discrete account, and
• 25 years of subsidy from the Government. 

The first two elements were relatively simple to explain. However, the formula for determining the amount by which the Government would subsidise employers – and in what circumstances – was complicated, with employers arguing it did not give them sufficient confidence to be able to plan for their costs. 

More recently, therefore, the Government has proposed to the Legislative Council a revised manner of determining the subsidy arrangements.

This update explains the three elements in more detail; and in particular, the change to the subsidy arrangements.

Abolition of The Offsetting Arrangement

With effect from a date to be decided (expected to be in 2025), it will not be possible for an employer to use mandatory MPF contributions to offset LSP or SP earned after that date (the effective date).

It will, however, still be possible for an employer to use mandatory MPF contributions (even those paid after the effective date) to offset LSP or SP earned before the effective date.

In determining the LSP or SP earned before the effective date, an employee's salary immediately before the effective date is used (i.e. not the employee's salary on eventual cessation of employment). 

If an employer pays retirement scheme contributions in excess of the mandatory MPF contributions, or if the employer pays a gratuity in excess of such mandatory contributions, then the employer can continue to apply those excess contributions/gratuity to offset any part of the LSP or SP.

Creation of A Mandatory Funding Arrangement for Employers

Hand-in-hand with the abolition of the offsetting arrangement, the Government will introduce a mandatory system under which employers are required to save for their contingent LSP or SP obligations. 

Broadly speaking, every employer will be obliged to set up a Designated Savings Account (DSA) and contribute 1% of their employees' relevant income into it. 

When the value of an employer's DSA reaches 15% of its annual payroll, then it does not need to make further contributions. 

The balance on the DSA can only be applied in payment of the employer's LSP or SP obligations. 

The Subsidy Scheme

The Original Two-tier Subsidy Scheme

Under the original (2018) subsidy scheme, the Government agreed to pay a certain percentage of any LSP or SP due to employee. The percentage payable depended on when the employee became entitled to such LSP or SP (e.g. 50% subsidy within 1 to 3 years after the effective date; 45% subsidy in the 4th year after the effective date). This payment was known as the "first-tier subsidy". 

The DSA was then to be used to pay for the remaining liability. But if the DSA was insufficient, then the Government would contribute an additional subsidy, known as the "second-tier subsidy", determined as a percentage of the amount outstanding. Again, the percentage payable by the Government turned on when the LSP or SP was payable. 

All in all, this was considered to be overly complicated and impossible to plan for. As such it is now being ditched! 

The New "Refined" Subsidy Scheme

The new scheme adopts a different approach. 

The easiest way to consider this new scheme is that the employer will pay a percentage of any LSP or SP due after the effective date. Such percentage due by the employer increases from 50% to 95% over the 25 years following the effective date. The Government will pay the balance of between 50% and 5%, reducing over the same period. 

However, the above is a simplification because:

• the actual amount payable by an employer in respect of an employee in the first 9 years after the effective date is capped, and
• if an employer in any year pays over HK$500,000 in LSP or SP to its employees in aggregate, then the employer will have to pay an increased percentage of the excess over HK$500,000 in any year from the 10th year after the effective date.

Please refer to the Government’s Calculation Table describing the above at the end of this Legal Update. 

One point to highlight is that under this new arrangement, the amount of subsidy is entirely independent of the balance of an employer's DSA. As such, the DSA becomes a pure funding vehicle for the employer, rather than something which impacts the amount of subsidy potentially due from the Government. 

Comment

The new arrangement still takes some mental gymnastics to understand, but it is certainly simpler than the original proposal. It should also give employers some comfort, knowing that if they are diligent in maintaining their DSA, then this will be an adequate funding mechanism for payment of much of their LSP or SP. 

However, as with any major structural change of this type the "devil" will be in the "detail". When will the subsidy be paid by the Government? Will the employer have to front it initially and then reclaim from the Government? Or will the employee have to wait patiently for the Government machinery to calculate the subsidy before receiving the additional money? Time will tell. 

The cost to the Government is estimated to be just shy of HK$33 billion, not a trifling sum. So the Government should be applauded for putting its hands into its (admittedly deep) coffers to bring the respective groups together – finding a solution to this perennial aberration in Hong Kong's employee protection legislation. 

Table Describing The Amount of LSP or SP Payable by An Employer in Any Year After The Effective Date