Retrenchment & Termination Benefits in Malaysia — How Much, and How They Are Taxed

The statutory amount: 10, 15 or 20 days per year

Statutory termination and lay-off benefits come from the Employment (Termination and Lay-Off Benefits) Regulations 1980, made under section 60J of the Employment Act 1955. To qualify you must have been continuously employed by that employer for at least twelve months before the termination date. Below twelve months there is no statutory entitlement at all.

The rate depends on length of service, and it is banded — not a smooth scale:

• Less than 2 years of service — 10 days' wages for each year of service.
• 2 years or more but less than 5 years — 15 days' wages for each year of service.
• 5 years or more — 20 days' wages for each year of service.
• An incomplete year is pro-rated to the nearest completed month, so 6 years 8 months counts as 6.67 years, not 6.

The RM4,000 ceiling most people miss

Since 1 January 2023 the Employment Act 1955 covers every employee under a contract of service regardless of salary — but coverage of the Act is not the same as coverage of every section in it. The First Schedule still carves out a short list of provisions for employees whose monthly wages exceed RM4,000, and section 60J — termination and lay-off benefits — is on that list.

The practical consequence: if you earn more than RM4,000 a month, you have no statutory retrenchment entitlement. What you receive is whatever your contract, employee handbook or collective agreement promises, or whatever the employer offers as an ex gratia sum. Many Malaysian employers voluntarily apply the 10/15/20 formula to everyone, and some pay a month per year of service, but above RM4,000 that is a commercial decision, not a legal floor. Read the contract before negotiating — a clause promising "benefits in accordance with the Regulations" makes the statutory formula contractual, and therefore enforceable, at any salary level.

Sabah and Sarawak operate under their own Labour Ordinances with separate (broadly similar) termination-benefit rules, so confirm the position locally if you are employed there.

Worked examples

For a monthly-rated employee the daily figure is the ordinary rate of pay — monthly wages divided by 26. Where wages vary month to month, the Regulations use the average over the twelve months preceding the termination.

When nothing is payable

The Regulations list situations that extinguish the entitlement even where the service requirement is met. You are not owed statutory termination benefits if you resign, if you are dismissed for misconduct after a due inquiry, or if you reach the retirement age stipulated in your contract.

Two further exclusions catch people out during a business sale or restructuring. If the employer offers to renew the contract, or the new owner of the business offers employment, on terms no less favourable than before, and you unreasonably refuse, the benefit is lost. "No less favourable" is judged on the whole package — pay, seniority, location and continuity of service — so a nominally equal offer that moves you interstate is arguable rather than automatic.

Payment is due quickly: the Regulations require the employer to pay termination benefits not later than seven days after the relevant date. Lay-off (as opposed to termination) triggers the same benefit if you are given no work and no pay for at least twelve normal working days within any four consecutive weeks.

Notice pay is separate — and is not a retrenchment benefit

Section 12 of the Employment Act sets minimum notice at four weeks for under two years of service, six weeks for two to under five years, and eight weeks for five years or more, unless the contract gives more. Notice runs alongside the retrenchment benefit; an employer terminating immediately must pay indemnity in lieu of notice on top of the benefit, not instead of it.

Unlike the retrenchment benefit, unpaid salary, accrued annual leave encashment and any earned bonus are ordinary employment income. They are fully taxable under section 13(1)(a) and get none of the exemption described below — which is exactly why the label on each line of the settlement matters.

The tax side: RM10,000 for each completed year of service

A retrenchment payment is compensation for loss of employment, taxed under section 13(1)(e) of the Income Tax Act 1967 — but Paragraph 15 of Schedule 6 exempts a large part of it.

• Ill health — if LHDN is satisfied the loss of employment was due to ill health, the compensation is fully exempt with no cap.
• Otherwise — RM10,000 is exempt for each completed year of service with the same employer, or with companies in the same group. Only completed years count; a part year adds nothing.
• Controlling directors — the exemption does not apply to a director of a controlled company who is able to control the company. A shareholder-director cannot retrench themselves into a tax-free lump sum.
• Retirement gratuity is a different relief entirely (Paragraph 25 of Schedule 6), broadly available on ill-health retirement or on retiring at the compulsory contractual age after ten years of continuous service with the same employer or group.

What the exemption is worth

Take the RM3,500 employee with 7 completed years above. The exemption is 7 × RM10,000 = RM70,000, comfortably more than the RM18,846 benefit, so nothing is taxable. That is the usual outcome for statutory-scale payouts, and it is why most retrenched employees at that level pay no tax on the lump sum.

The exemption bites at senior level. A manager on RM12,000 with 6 completed years, paid a contractual one month per year of service, receives RM72,000. The exempt portion is 6 × RM10,000 = RM60,000, leaving RM12,000 to be added to that year's chargeable income and taxed at the manager's marginal rate. If they had 7 completed years rather than 6, the whole RM72,000 would fall inside the exemption — so the exact commencement and cessation dates on the settlement letter are worth checking before signing.

Note that group service aggregates. Years spent at a subsidiary before an internal transfer normally count toward the same exemption, provided the companies are in the same group.

EPF, SOCSO and the CP22A tax clearance hold

Neither EPF nor SOCSO/EIS applies to a genuine termination benefit. The definitions of "wages" in the EPF Act 1991 and the Employees' Social Security Act 1969 both exclude gratuity payable on discharge or retirement and payment in lieu of notice, so these sums are paid gross of statutory deductions. Your final month's ordinary salary, of course, still carries the usual EPF, SOCSO, EIS and PCB.

The step that delays money is tax clearance. Your employer must notify LHDN of your cessation of employment on Form CP22A not less than thirty days before you leave, and must withhold monies otherwise payable to you until LHDN issues a clearance letter (SPC) or ninety days have passed from the notification, whichever comes first. Plan cash flow around that: a settlement agreed in principle is often not in your account for six to twelve weeks. Filing your own outstanding returns promptly is the fastest way to unstick it.

If you were retrenched rather than dismissed or resigned, apply separately to PERKESO for the EIS Job Search Allowance — it is a distinct benefit, unaffected by anything your employer pays you, and the wording of your termination letter decides eligibility.

Important caveats

This guide sets out the general statutory position and is information, not legal or tax advice. Whether a particular payment is compensation for loss of employment, a gratuity, or simply deferred remuneration is a question of substance that LHDN can and does re-characterise — an "ex gratia" label does not by itself secure the Paragraph 15 exemption. Confirm the current exemption figure and your own facts with LHDN or a tax agent before relying on the numbers here, and raise wage-claim disputes with the nearest Jabatan Tenaga Kerja (Labour Department) office. Use the calculator below to work out the take-home effect of any taxable balance on your income for the year.