Is the compensation for loss of employment taxable?

Tax Treatment of Compensation for Loss of Employment

Picture this scenario:
You have been happily employed at ABC Sdn. Bhd. for five years. However, the company has fallen on hard times due to the pandemic. As a consequence, your boss has decided to cease operations and close down the company. You were given a sum of money as compensation for this unfortunate circumstance and the termination of your employment.

|Is the monetary compensation that you received subject to tax?

What Is the Tax Treatment?

Generally, the compensation for loss of employment received by an employee is subject to tax under section(s.) 13(1)(e) of the Income Tax Act 1967 (ITA), which states that gross income of an employee in respect of gains or profits from an employment includes amount paid to an employee (whether before or after his employment ceases) as compensation for loss of the employment.

To put it simply, compensation for loss of employment which is specifically included in the gross income from an employment under s.13(1)(e) of the ITA encompasses:

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 such as redundancy payments, severance pay, etc. made to employees who have become redundant for reasons beyond their control; or
  • A payment in consideration of a covenant, arrangement 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.

Compensation vs Gratuity

Compensation refers to a lump sum payment received due to the premature termination of an employment which has the prospect of continuing up to the retirement age.

On the other hand, gratuity refers to a lump sum payment received due to a contract of employment is for a specific number of years and the employment ends at the specified time or the retirement age.

It is essential to determine whether the payment made to employee is in the nature of gratuity or compensation for loss of employment as different tax treatment applies for gratuity payments.


As stated in Paragraph 15 of Schedule 6 in the ITA, compensation for loss of employment can be exempted from income tax fully or partially under certain circumstances.

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