Where economic compensation is payable, how is it calculated?

Generally, the amount of the economic compensation payable is equal to one month’s salary (the “Calculation Basis”) for each year of service with the employer (the “Service Period”).

How to identify the “Calculation Basis”?

The Calculation Basis refers to the employee’s average monthly salary in the last 12 months prior to the termination of employment. Any bonus or allowance paid to the employee during the said period should be taken into consideration.

The PRC Labour Contract Law, which came into force on 1 January 2008, brings a cap to the Calculation Basis at 300% of all the local employees’ average monthly salary for the previous year (the “Local Average Monthly Salary”), while the pre-2008 rules do not have such a cap.

How to identify the “Service Period”?

As to the Service Period, under the Labour Contract Law any period of more than 6 months but less than 1 year will be deemed to be 1 year, and the period of less than 6 month will be deemed as 0.5 year. The Service Period will be capped at 12 years if the employee’s Calculation Basis exceeds 300% of the Local Average Monthly Salary.

Will the above calculation as provided under the PRC Labour Contract Law apply to the pre-2008 employment period?

No. The above calculation as provided under the PRC Labour Contract Law only applies to the post-2008 employment period.

Due to the difference between the Labour Contract Law and the relevant pre-2008 rules on calculation of severance pay (i.e., identification of Calculation Basis and Service Period), the severance payable to employees who joined the employer before 2008 may have to be calculated based on two periods (i.e. pre-2008 period and post-2008 period) separately, subject to the local rules of various localities.

We attach a case study explaining such manner of calculation.

Case Study 1: Mr. A joined Company X in Shanghai on 1 August 2006 and his existing employment contract with Company will expire on 30 October 2010. Assuming that Company X decides not to renew his employment upon the expiry of the above contract, if Mr. A’s average monthly salary during the last 12 months prior to the termination date of his employment is RMB15,000, how much severance pay is Mr. A entitled to?

Under the Shanghai pre-2008 rules, no severance is payable to the employee in case of any natural expiry of employment contract. Therefore, Mr. A is only entitled to the severance calculated based on his post-2008 Service Period.

As to the post-2008 period, a) the Calculation Basis shall be capped at 300% of the Local Average Monthly Salary in Shanghai, which is currently RMB3,566 × 3 = RMB10,698; and b) the actual years of service are 2 years and 10 months, which should be deemed as 3 years.

See details of the calculation in the table: click here to view

Case Study 2:

With all conditions mentioned in the above case remain unchanged, except that Mr. A agreed to terminate his employment with Company X prior to the expiry date of the existing employment contract, say, on 30 June 2010, how much severance pay is Mr. A entitled to?

For pre-2008 period, a) the Calculation Basis equals to Mr. A’s actual average monthly salary during the previous 12 months (i.e., without a cap); and b) the actual period of service of 1 year and 5 months can only be deemed as 1 year for the purpose of the Service Period (as under the Shanghai pre-2008 rules, any period of less than 6 months does not count for the calculation of severance pay).

As to the post-2008 period, a) the Calculation Basis shall be capped at 300% of the Local Average Monthly Salary in Shanghai (i.e., RMB10,698); and b) the actual years of service are 2 years and 6 months, which should be deemed as 3 years.