Gratuity is a lump sum payment given by an employer to employees in recognition of their past service, which is paid when the employee leaves the company, either upon retirement or resignation. In other words, it is one of the retirement benefits offered by an employer to employees upon retirement or leaving a job. It serves as an appreciation for the employee’s loyalty and sustained contribution to the organization.    

Since it pertains to the employee’s service, this lump sum payment is taxable and taxed under employment income - section 13(1)(a) of the Income Tax Act (ITA). Additionally, it will be taxed in the year of assessment (YA) in which it is received. 

However, the Income Tax Act 1967 includes specific provisions that exempt gratuity payments, either partially or fully. In this article, we will look into the tax treatment of gratuity, along with the associated tax implications. 

Employees’ perspective   

Are you about to retire and looking forward to receiving your retirement gratuity? If you are nearing retirement, it is crucial to understand how gratuity is taxed. There are circumstances where gratuity may be partially or fully exempt from taxes. Here are some key points that you may consider. 

Full exemption  

According to the guideline, the full amount of retirement gratuity received is exempted if: 

• The retirement is due to ill health; or 
• Retirement on or after reaching the age of 55 years or on reaching the compulsory age of retirement, and has been in employment for more than 10 years of continuous service with the same employer or companies within the same group; or 
• Retirement upon reaching the compulsory age of retirement pursuant to an employment contract or collective agreement at the age of 50 but before 55, and has been in employment for 10 years of continuous service with the same employer or companies within the same group.  
   

Partial exemption  

If you fail to meet the exemption criteria mentioned above, you may still qualify for a partial exemption of RM1,000 for each completed year of service. if the employment is with companies in the same group, the partial exemption is only applicable to the gratuity attributable to the service with the last company in the group. The balance of gratuity after taking into account the partial exemption will be taxed in the year of receipt. 

Nevertheless, do note that when calculating completed years of service, 12 months constitute one completed year, rather than a calendar year. For example, if your service period begins on 10 April 2023, then 9 April 2024 would be considered one completed year of service.   

As an employee, gaining a thorough understanding of how gratuity is taxed, and the available exemptions can substantially reduce your tax burden.