Severance Payments in China: How the Abolition of Circular No. 481 Impacts Employers

By Hazel Wang
Editor: I-Ting Shelly Lin

On November 24, 2017, the Ministry of Human Resources and Social Security (MHRSS) invalidated a number of guidelines for employers in China.

Among them, the Measures on Severance Payment for Breaking or Terminating Labor Contracts (Lao Bu Fa [1994] No. 481) (referred to as “Circular No. 481”). Circular No. 481 had been in effect for over 20 years, serving human resource (HR) practitioners as the legal basis for severance payments and recuperation-period medical subsidies.

How did the abolition of Circular No. 481 impact employers?

The impact has been mixed, and some of the legal implications remain unclear. While the guidelines set in the Labor Contract Law should generally take precedence over the abolished Circular No. 481, facets of Circular No. 481 may still be enforced in practice for labor contracts that predate the Labor Contract Law.

This means employers and their HR teams need to review internal procedures. This is particularly the case because there remain some ambiguities about the treatment of labor contracts that pre-date 2008 and the provision of medical subsidies.

Employers that fail to bring their practice into compliance increase the potential for labor disputes or worse.  Accordingly, employers and their HR teams should review the differences in severance payments and medical subsidies under the old Circular No. 481 and the current Labor Contract Law, and ensure that their practices are compliant, ideally with experienced advisors.

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Calculating the severance payment

After the Labor Contract Law, which took effect in 2008, changed the method for calculating severance payment, which were previously stipulated in Circular No. 481.

Calculation period for severance payment

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

According to the current Labor Contract Law, employers still provide an employee with a severance payment equivalent to one-month of their salary for each full year of employment.

Further, employers should calculate a severance payment for employees that have served less than a year, but over six months, as a full year service.

Employers should now calculate a severance payment for employees that have served less than a year at half of the employee’s monthly salary.

Before, any period of employment that was less than a full year was considered a full year for the purposes of calculating severance payment. Severance payment was calculated as one month’s salary for each employed year.

Calculation base and severance payment bounds

Under the old Circular No. 481, the standard calculation base was largely based on the employee’s  average monthly wage in the 12 months before the labor contract was terminated, and partly impacted by the reason for the employee’s termination. While this principle largely holds under the Labor Contract Law, the Labor Contract Law has provided upper limit to the payment, and limited the effect of the reason for the employee’s termination.

Under the current Labor Contract Law, the calculation base is the employee’s average salary in the 12 months before the labor contract was terminated. When an employee worked for less than 12 months, the average monthly salary should be calculated according to the actual amount of months worked.

If the employee’s average monthly salary is lower than the local minimum wage, such as if the employee takes unpaid leave, the local minimum wage should be used as the base to calculate the severance payment. For employees that have an average salary three times higher than the local average monthly wage for the preceding year, the severance payment calculation base should be capped at three times the employee’s average monthly salary, and the calculation period should be capped at 12 years.

In the case that a labor contract was signed before the 2008 implementation of the Labor Contract Law, employers need to follow the prevailing provisions at that time. There is, however, some disagreement over whether employers should follow Circular No.481 guidelines for labor contracts executed prior to 2008 as it has now been abolished.

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Some analysts believe the abolishment of Circular No.481 means it is no longer applicable; however, other analysts maintain that while Circular No.481 is no longer in effect starting from the day it was abolished, it’s still relevant for contracts that pre-date the Labor Contract Law.

At this time, it’s difficult to ascertain which view will prevail in law. HR managers that need to manage a severance payment for a labor contract executed before 2008 need to engage professional advisors to determine how to calculate the standard base of the severance payment.

For ease of reference, the standard calculation base stated in Circular No. 481 was an employee’s average monthly wage in the 12 months before the labor contract was terminated. When an employee was terminated due to the employee’s illness or injury not caused by work, significant changes of the employer’s circumstances, or layoffs, the calculation base should be the employee’s average monthly wage or the enterprise’s average monthly wage, whichever is larger.

Circular No. 481 also maintained that severance payment should not be provided for over 12 months of the employee’s average monthly salary if the employer put the termination forward and the employer and employee subsequently terminated the contract through mutual agreement, or due to an employee’s work performance.

Additional severance payment

Before Circular No.481 was abolished, employers were often confronted with a dilemma over whether an additional severance payment should be applied. This was because the terms for an additional severance payment were different under Circular No.481 and the Labor Contract Law. Following the abolition of Circular No.481, the Labor Contract Law is now paramount in determining whether an employer needs to make an additional severance payment.

According to the Labor Contract Law, an employer needs to pay a 50 to 100 percent additional severance payment to an employee under the following conditions: failure to pay wages in full, a payment of wages lower than the local minimum wage, or failure to pay the employees’ overtime work (inclusive of extended work hours as well as work on weekends and public holiday).

Notably, employers also need to make the additional severance payment if they did not make the original severance payment according to relevant regulations. This underscores the importance of reviewing the Labor Contract Law and calculating the severance payment correctly.

International Payroll & HR Solutions from Dezan Shira & Associates

Medical subsidy

In contrast to Circular No. 481, the Labor Contract Law doesn’t specify how medical subsidy should be paid when an employee is terminated after a recuperation period. Analysts are therefore split over whether employers should continue providing medical subsidies after Circular No. 481 was abolished.

Are employers now exempted from the medical subsidy obligations?

Dezan Shira & Associates believes Circular No.481 will no longer serve as a reference for medical subsidy, but medical subsidy guidance can still be found in other existing legal documents, such as Lao Bu Fa [1996] No.354. Employers should therefore not assume that there is no need to pay medical subsidy at all; HR managers should closely observe the local practices and consult with professional advisors.

As reference, we note that Circular No. 481 said the amount of medical subsidy should not be less than six months of an employee’s total wage. Circular No. 481 further mandated that seriously ill employees were due an additional proportion, not less than 50 percent of the medical subsidy. Similarly, employees with a fatal disease were due a subsidy not less than 100 percent of the medical subsidy.

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