(TAX UPDATE) The Payment Voucher Trap: When a "Contractor" Is Really an Employee

Introduction

A typical Johor Bahru boss calls me. He has a team of "contractors" who have been with the business for many years. Every month he pays them in cash, on a payment voucher.

No EPF. No SOCSO. No annual leave. Yet each one reports to work from 9am to 5pm, and each one applies for medical leave from the company's approved panel of doctors.

This looks tidy. It is not. The day one of these arrangements ends, the boss expects it to close at zero. The real exposure can run well for a single long-serving "contractor".

The boss did everything he thought was clean.

The payment vouchers were real. The word "contractor" sat on every file. What he missed is that, in Malaysian employment law, the label does not decide the relationship. The substance does. And the 9am to 5pm attendance, the panel doctor and the years of service all point in one direction.

The statutory trap: Section 101C

The first source of the problem is Section 101C of the Employment Act 1955, inserted by the Employment (Amendment) Act 2022 (Act A1651) and in force since 1 January 2023.

Section 101C creates a presumption of employment. Where there is no written contract of service, the law presumes that an employment relationship exists, until the contrary is proved, once certain markers are present. Those markers include control over the manner and the hours of work, the provision of tools and equipment by the company, the integration of the person into the business, and the person working mainly for one principal.

A contractor agreement does not save you here. A "contract for services" is not a "contract of service", so the very document the boss is relying on does not switch off the presumption. It can switch it on.

Once the presumption operates, the burden shifts to the company. An invoice book and the word "contractor" on the first page do not discharge that burden.

The deeper principle: substance over form

Section 101C did not invent this idea. It codified something the courts have applied for thirty years.

The governing authority is Hoh Kiang Ngan v Mahkamah Perusahaan Malaysia & Anor [1995] 3 MLJ 369 (Federal Court), reported in parallel at [1995] 1 MELR 1. Gopal Sri Ram JCA held that the court is not bound by the name the parties give the arrangement. It looks at the degree of control exercised by the employer and the true nature of the engagement to decide whether the arrangement is a contract of service, which makes the person an employee, or a contract for services, which makes the person an independent contractor.

The Federal Court affirmed the test in Dr A Dutt v Assunta Hospital [1981] 1 MLJ 304 and overruled the contrary reasoning in Inchcape (Malaysia) Holdings Bhd v RB Gray. The message has been settled law ever since. You cannot contract your way out of an employment relationship by drafting around it.

What lands when the presumption operates

The consequences arrive together, not one at a time.

There are EPF arrears under the Employees Provident Fund Act 1991, with dividends and late payment charges. There are SOCSO and EIS arrears under the Employees' Social Security Act 1969 and the Employment Insurance System Act 2017.

There is the Monthly Tax Deduction, or PCB, that should have been operated under Section 107 of the Income Tax Act 1967 and the Income Tax (Deduction from Remuneration) Rules 1994. LHDN recovers the PCB that was never deducted from the employer, not from the worker, and failure to deduct or remit is an offence under Rule 17 of those Rules, with a fine of RM200 to RM20,000 and the unremitted amount treated as a debt due to the Government.

There is accrued statutory leave under the Employment Act 1955.

The misclassified worker can bring a representation for unlawful dismissal under Section 20 of the Industrial Relations Act 1967, and the company then has to justify both the reason and the manner of the dismissal. That is where the largest part of the exposure in our boss's case came from.

The audit every SME should run this week

This takes one afternoon. List everyone the company pays outside payroll, whether by invoice, payment voucher or cash. For each name, ask four questions.

Who controls the working hours.
Whose equipment and tools are used.
How integrated into the team is the person.
How many other genuine clients does the person actually serve.

Anyone who fails three of the four is, in substance, an employee wearing a contractor's label. Restructure those relationships deliberately, on a calm day, with proper documentation in whichever direction the facts support. A genuine contractor should look and operate like one. A genuine employee should be on payroll with EPF, SOCSO, EIS and statutory benefits in place.

KTP's View

The contractor label is a convenience, not a shield. Section 101C now puts the presumption against you, and Hoh Kiang Ngan has put substance over form since 1995. The cheap version of this exercise is a quiet internal review with your tax agent and your HR adviser. The expensive version is the one conducted by the Labour Court or the Industrial Court, with arrears, penalties and a dismissal claim attached.

If you are paying long-serving people outside payroll, review those arrangements before someone else reviews them for you.

Disclaimer: The contents of this article are for general information only and do not constitute professional advice. Legislation, regulatory guidelines, and market practice may change after the date of publication. KTP Group of Companies accepts no liability for reliance placed on this material. Please consult a qualified professional before acting on any matter discussed.

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