MALAYSIA was battered by the Covid crisis in 2020 and 2021 and the current headwinds blowing from the Russia-Ukraine war and the US-China conflict together with the recent upsurge in commodity prices is causing companies to downsize, rightsize or restructure their operations to stay afloat. The repercussions resulted in companies laying off employees.
In most situations, such employees were paid some money either in the form of compensation for loss of employment, or as gratuities. The terminology used to describe such payments is compensation for loss of employment, ex-gratia, contractual payment, retrenchment payments, gratuity.
HOW IS IT TAXED?
The starting point is all payments received in connection with your employment will be taxable. However, there are specific provisions in the Income Tax Act 1967 that exempt either partially or fully payments received in respect of compensation for loss of employment or retirement gratuities.
Retirement gratuities are fully exempt if you retire on the grounds of ill-health. The understanding of “ill-health” adopted by the Inland Revenue Board (IRB) requires a person to be certified unfit to continue working permanently. This can be an issue of dispute as to whether you have to be totally unfit to work before you fall within the words of “ill-health”. Similarly, sums received by way of death gratuities are exempt.
Retirement gratuities are also fully exempt if you retire on or after the age of 55 or compulsory age of retirement from an employment which has lasted 10 years with the same employer or with companies in the same group. This will also apply if you have a contract of employment or collective agreement which allows you to retire between 50 and 55 provided you meet the above 10-year requirement.
In case you don’t meet any of the above requirements, you are still entitled to claim a tax exemption of RM1,000 on for each completed year of service on the gratuities received.
Compensation for loss of employment
You are entitled to a full tax exemption if it is on the grounds of ill-health.
In all other cases, an exemption of RM10,000 is given for each completed year of service with the same employer or companies in the same group. This exemption is eligible to be exercised for payments received in respect of early termination of employment contracts under separation schemes such as voluntary or mutual separation schemes.
If you received the above payments for ceasing employment between Jan 1, 2020 but not later than Dec 31, 2021, the exemption is increased to RM20,000 per completed year of service.
Areas to watch out for
An area of common dispute is determining whether the payment is a gratuity payment or a compensation for loss of employment. This will depend on determining the true characteristics and the underlying nature of the payment as opposed to only looking at the legal document.
Generally, gratuity is a payment for the past services, while compensation for loss of employment is a payment received due to premature termination of employment where the employee has a prospect of continuing until retirement age.
If an employee receives the retirement gratuity at 55 after having met the 10-year rule, but continues his employment thereafter, the employee will not be entitled to the retirement gratuity tax exemption.
Please note that compensation payments made to non-service directors in a controlled company will not enjoy the tax exemption. A service director is someone who owns not more than 5% of the ordinary share capital of the company and is employed in a managerial or technical capacity.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director
SM Thanneermalai (www.thannees.com).