While the recession hasn’t “officially” arrived, Malaysians are still feeling the
heat with the rate of retrenchments and budget cuts due to the falling ringgit. If you are unfortunate enough to be laid off and receive the compensation, will this income be taxed?
In this article, we will
be covering the tax treatments on compensation for loss of employment received by these employees. But first, let’s catch you up with some key concepts
Key concepts:
Compensation for Loss of Employment
Lump sum payment is received due to the premature termination of employment which has the prospect of continuing up to the retirement age. (Taxed under Section 13(1)(e) of the Income Tax Act 1967 (“ITA”))
Gratuity
Lump sum payment is received due to a contract of employment for a specific number of years and the employment ends at the specified time or the retirement age.
(Taxed under Section 13(1)(a) of the ITA)
For example, compensation for loss of employment happens when an employer terminates an employee’s employment before retirement.
On the other hand, gratuity happens when an employee has served faithfully at a company and retires or resigns.
Why is differentiating between the two important? Well according to Section 13 Income Tax Act (ITA), both of these circumstances are taxed differently. We will first look into compensation for loss of employment and its tax treatments.
Compensation for Loss of Employment
What is included in the compensation?
- Salary or wages in lieu of notice
- Compensation for breach of a contract of service
- Payments to obtain release from a contingent liability (employer’s obligation) under a contract of service
- Ex-gratia or contractual payments – redundancy payments, severance pay etc made to employees who have become redundant for reasons beyond their control
- A payment in
consideration of a covenant, agreement 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
- Voluntary Separation Schemes (VSS) or Mutual Separation Scheme
Tax Treatment for Compensation for Loss of Employment
According to section 13(1)(e), the lump sum payment in the nature of compensation for loss of employment must be included in his/her assessable income. However, certain exemptions are given in Schedule 6 para 15.
There are two types of exemptions in this situation —full exemption, and partial exemption.
a) Full exemption - If the Director General is satisfied that the payment is made on account of loss of employment due to ill-health (required to be certified by a Medical Board); or
b) Partial exemption – An exemption of RM10,000 is given for each completed year of service with the same employer or with companies in the same group.
Want to learn more about gratuity?
