Tax Treatment on Compensation for Loss of Employment

Overview

Many economists and financial experts predict the global recession to start in 2023. The global recession has led the organisation to cut costs by laying off employees. Those employees will receive money either in the form of compensation for loss of employment or gratuity.

Do you know whether the incomes received by the employees from loss of employment are taxable or exempted in Malaysia?

Key takeaways:

You will understand:

1. What is included in compensation for loss of employment?

2. What is the difference between compensation and gratuity?

3. What are the tax treatments?

4. Circumstances not subject to tax exemption.

Summary of learning

1. What is included in compensation for loss of employment?

According to Paragraph 13(1)(e) of Income Tax Act 1967, it includes:

a) Salary or wages in lieu of notice;

b) Compensation for breach of a contract of service;

c) Payments to obtain release from a contingent liability (employer’s obligation) under a contract of service;

d) Ex-gratia or contractual payments such as redundancy payments, severance pay, etc. made to employees who have become redundant for reasons beyond their control;

e) A payment in consideration of a covenant, arrangement or similar agreement restricting the activities of an employee in respect of engaging in an employment of a similar kind after termination of his employment.

f) Voluntary Separation Scheme (VSS) or Mutual Separation Scheme

2. What is the difference between compensation and gratuity?

It is important to differentiate whether the payment made to an employee is compensation or gratuity, as there will have different tax treatment.

a) Compensation for loss of employment

- Compensation is a payment given to the employees when they are laid off before the end of the service contract.

b) Gratuity

- Gratuity is a payment given to the employees when they resign or retire after serving for a long period of time. It is a lump sum amount that is presented to recognise an employee’s past services.

3. What are the tax treatments?

The compensation for loss of employment received by an employee is given a full or partial exemption as follows:

a) Full Exemption

A full exemption will be given if the reason for loss of employment is due to ill health.

Criteria: The health condition of the employee is required to be certified in writing by a Medical Board.

b) Partial Exemption

An exemption of RM10,000 is given for each completed year of service.

Criteria: The employee must work with the same employer or companies within the same group during the period.

4. Circumstances Not Subject to Tax Exemption

a) Reemployment implied under separation schemes:

If the separation scheme offers the employees reemployment with the same employer or any other employer, the compensation under the scheme does not qualify for an exemption.

b) Compensation for loss of employment for non-service director:

Non-service director is a director employed in the service of the Company that owns more than 5% of the ordinary shares of the Company.

Payments made by controlled companies to non-service director is not eligible for any tax exemption.

Source:

Public Ruling No. 1/2012 – Compensation for loss of employment

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