Tax Tips For Employees Who Lost Their Jobs Or Get Retrenched
Last year also ended with the Malaysia’s unemployment rate rising to 4.8%. The nation hasn’t seen such a high rate of unemployment since 1993.
2020 was a year that most of us had never experienced before with the impact of the Covid-19 pandemic felt in every industry and job sector, and the after-effects will remain for years to come. Malaysian workers have also not been spared.
However, tax season still comes around every year. How do workers who have been retrenched or are facing retrenchment declare their annual income for last year (2020)? Read on to find out how your income should be declared in these unfortunate situations.
What is retrenchment?
It is a strategy adopted by companies or corporations to reduce the diversity or the overall size of its operations. This strategy is often used to cut expenses with the goal of becoming more financially stable.
Typically, the strategy involves withdrawing from certain markets or reducing manpower as part of a cost restructuring plan. In a retrenchment exercise, companies can lay off workers due to cost, business or operational factors. Due to the ongoing pandemic, retrenchment happened on an unprecedented scale in 2020.
According to the International Labour Organisation (ILO), 8.8 per cent of global working hours were lost in 2020 compared to the last quarter of 2019. This translates to a whopping 255 million full-time jobs losses. In fact, working-hour losses in 2020 were four times greater than during the global financial crisis in 2009.
This sudden loss or lack of income isn’t just a terrifying prospect, it also means an increase in non-performing loan (NPL) in the country, resulting in higher debts for individuals, especially for people with financial obligations such as a home loan or a car loan.
What happens when you get retrenched?
One of the first things to ask after you’ve been laid off is whether you are entitled to any termination benefits after the end of the employment relationship.
As an employee, your right to a termination benefit upon retrenchment depends on whether or not you are covered by the Employment Act (EA).
In general, an employee is only covered by the EA if their wages do not exceed RM2,000 a month, or if their occupation is a manual one, irrespective of how much they earn (applicable for workers in Peninsular Malaysia and Labuan only; Sabah and Sarawak have their own Labour Ordinances),
If an employee falls within the scope of the EA, he is entitled to termination benefits if he has been employed for at least 12 months. The termination benefits payable are as follows (or the amount in the employment contract if it is higher):
- 10 days’ wages for every year of employment if he has been employed for less than two years
- 15 days’ wages for every year of employment if he has been employed for two years or more but less than five years.
- 20 days’ wages for every year of employment if he has been employed for five years or more.
Meanwhile, an employee who is not covered by the EA is only entitled to termination benefits if it is provided in the employment contract. If it is not stipulated in the contract, then it is up to the employer’s discretion on how much termination benefits to pay, or whether or not to pay.
According to the Inland Revenue Board Malaysia (LHDN), when an employment ceases, the employer may make a lump sum payment to the employee. The lump sum payment may be described by the employer as compensation for loss of employment, ex-gratia, contractual payment, retrenchment payments or gratuity, etc.
However, one should note that gratuity is not the same as “loss of employment” in this context, SIMways Formulation’s consultant Choong Hui Yan points out.
For one, gratuity is normally referred to as a fixed amount that is presented in recognition of an employee’s services. As such, gratuity is normally paid upon an employee’s resignation or retirement after serving for a long period of time.
“It is to recognise the past services rendered by an employee,” said Choong.
Meanwhile, retrenchment is linked to a loss of employment as the employee is being laid off prior to the end of the contract of service, Choong added.
She explained, “Under Malaysia’s taxation system, gratuity would be taxed under s13(1)(a) while the loss of employment would be taxed under s13(1)(e) of the Income Tax Act 1967. Both come with different types of tax exemption. The Act was last revised in 2013.
In any case, the circumstances and nature of the payment must be reviewed to determine the real character of the payment. The amount paid on the termination of an employment may consist of the following two elements: (a) it is attributable to the loss of employment such as redundancy (compensation); and (b) it is attributable to the past services of the employee (gratuity).
The purpose of the lump sum payment has to be established in order to determine the tax treatment of the payment received by the employee.
However, it is important to note that some employers may carry out termination disguised as retrenchment as a way of dismissing unwanted employees. If you feel that you have been unfairly retrenched, you can bring a claim against the employer by making a complaint or claim to the Department of Industrial Relations Malaysia, Industrial Court, Civil Courts or Labour Court.
Meanwhile, employers who are carrying out retrenchment due to serious financial difficulties may be excused from paying retrenchment benefits.
How to file your taxes when you get retrenched?
According to LHDN on their website, compensation for the loss of employment is a payment made by an employer to his employee before or after the date of termination, and a certain amount of this payment is exempted from tax. The same applies to severance packages such as Voluntary Separation Schemes (VSS).
This compensation is exempted from tax if compensation received is due to ill health, and the other cases:
- Termination before July 1, 2008 – exemption of RM6,000 for every completed year of service with the same employer or with companies in the same group.
- Termination on or after July 1, 2008 – exemption of RM10,000 for every completed year of service with the same employer or with companies in the same group. This exemption was increased to RM20,000 for every completed year for the year of assessment 2020 and 2021.
Adam was working in his previous oil-and-gas company for five years, and was recently retrenched. He received RM150,000 in compensation in 2020.
Under local tax laws, he is entitled to RM20,000 exemption for each completed year of service. So if he serviced the company for five completed years, RM100,000 out of the RM60,000 he received is entitled for tax exemption (RM20,000 x 5).
However, this only applies for the year of assessment 2020 and 2021. In other years, he would only be able to claim exemption for RM50,000 (RM10,000 x 5).
However, compensation received by a director (not service director) of a Control Company is fully taxable.
Should complications occur when you get retrenched, SIMways Formulation’s consultant Choong Hui Yan advises you to collect ALL the documents that you can get your hands on to prove that the lump sum payment you receive is a compensation for loss of employment. For example, you will be required to show a letter of dismissal, contract, or even the description of the payment voucher, then discuss the matter with LHDN.
Further, you will be required to present your pay slip and EA form to prove that you have completed your said tenure of services to the LHDN.
“Sometimes, our interpretation of “termination benefits” may differ from the LHDN. Thus, should any complication occur, you must try to explain the issue with LHDN. If necessary, you may even need to engage a tax specialist to talk to LHDN,” advised Choong.
This article was first published in April 2016 and has been updated to include the latest changes on this topic.