(TAX UPDATE) Employer-Borne Personal Tax: A Common Mistakes in Malaysian SMEs

(TAX UPDATE) Employer-Borne Personal Tax: A Common Mistake in Malaysian SMEs

A practical guide to Public Ruling No. 5/2019 (Perquisites from Employment), Public Ruling No. 3/2024 (Tax Borne by Employers), and the two mistakes that most often trigger IRBM penalties

Introduction

Many Sdn Bhds include directors' or employees' personal income tax in the remuneration package. Sometimes it is formally written into the contract. More often, it is a quiet annual practice. The intention is usually goodwill.

The tax treatment, however, is not optional, and it is one of the more frequently mishandled items the IRBM picks up on audit.

Two Public Rulings govern the position.

PR 5/2019 sets out the general framework for perquisites from employment, including the deduction available to the employer.

PR 2/2024 provides the specific computation for tax borne by an employer on behalf of an employee.

Read together, they tell employers exactly what is required. They also expose two errors that recur in owner-managed Sdn Bhds.

The legal characterisation: tax borne by employer is a perquisite

Under the Income Tax Act 1967, when an employer settles the personal income tax of a director or employee, the payment is not a neutral transfer. Paragraph 6.3.1 of PR 5/2019 treats the amount as a perquisite of the employee, forming part of gross income from employment under Section 13(1)(a).

The mechanics are well established. The employee receives a benefit equal to the tax paid on their behalf. That benefit is taxable in the year the actual amount of tax can be ascertained, which is the following basis year.

The benefit is itself subject to tax, which is why fully tax-borne arrangements require an iterative gross-up calculation. PR 11/2016 sets out the prescribed methodology.

A simple illustration.

A director draws an annual salary of RM200,000. The company also settles her personal tax bill of RM40,000 in respect of the previous year of assessment. The RM40,000 must appear on her EA form as a perquisite for the year of payment, and her BE or B form must reflect the grossed-up figure. Her taxable employment income is RM240,000, not RM200,000.

The employer's good intention does not change the character of the payment. What changes is whether the parties have reported and substantiated it correctly.

Mistake 1: Claiming the deduction without the documentation to support it

The one most taxpayers often misunderstood.

Paragraph 11 of PR 5/2019 states plainly that employers are eligible to claim a deduction for expenses in respect of employment, including all types of perquisites paid to employees, under Section 33(1) of the ITA, read together with the Income Tax (Deduction for Benefit and Gift From Employer to Employee) Rules 2009 [P.U.(A) 153/2009].

Tax borne by the employer falls squarely within that framework. As a general rule, the company can claim the deduction.

The problem is what happens when the recipient is a director or shareholder with control over the company, which describes the typical owner-managed Sdn Bhd. PR 5/2019 itself signals heightened scrutiny in this situation.

Paragraph 7.5 of the Ruling carves out persons with control from the exemptions otherwise available to ordinary employees, defining control by reference to shareholding, voting power, or rights conferred under the articles of association. The same posture carries through to the IRBM's audit approach on the deduction side.

In practice, when the IRBM looks at tax-borne payments for an owner-director, two questions follow:

First, is the payment genuinely "wholly and exclusively incurred in the production of gross income" under Section 33(1), or is it in substance a profit distribution dressed as remuneration? Where the director controls the dividend policy, the salary level, and the decision to pay the tax, the line between remuneration and proprietorial extraction is not always clear.

Second, is the payment specifically disallowed under Section 39 of the ITA, or otherwise outside the scope of an allowable employment expense?

The fix is not to abandon the deduction. It is to put in place the documentation that supports it: a written contract of service expressly treating tax-borne as part of the remuneration package, a board resolution approving the arrangement, MTD computed on the perquisite, and the perquisite reported on the EA form in the correct year.

Where all of these are in place, the deduction stands on the same footing as any other remuneration cost, consistent with PR 5/2019 paragraph 11. Where they are not, the deduction is exposed.

Mistake 2: Omitting the perquisite from the EA form

The second error is more straightforward and more common. The company settles the tax. The corresponding benefit never appears on the employee's EA form.

The consequences run in two directions.

For the employee, gross income is under-reported on the BE or B form. When the IRBM cross-checks employer records against individual returns, the shortfall is detected, an additional assessment is raised, and penalties under Section 113(2) apply on the individual.

For the employer, the EA form is incorrect. CP8D submissions and Form E filings that flow from inaccurate EA forms expose the employer to penalties under Section 120 of the ITA for failure to comply with reporting obligations.

This omission is especially common in owner-managed Sdn Bhds where the director who benefits from the arrangement is also the person signing off the EA forms. The shortcut feels harmless. It is not. It also undermines the deduction position in Mistake 1, because an unreported perquisite is almost impossible to defend as a legitimate employment expense at audit.

What employers and employees should each do

For employers. Maintain a clear, contemporaneous record of every tax payment made on behalf of directors and employees, identifying the individual, the year of assessment settled, and the date of payment.

Where the recipient is a director or controlling shareholder, ensure the contract of service expressly treats tax-borne as part of remuneration, and that a board resolution authorises the arrangement. Compute MTD on the perquisite. Reflect the perquisite on the correct EA form (the year the tax is paid, not the year it relates to). Reconcile EA, CP8D, and Form E annually before submission. Claim the Section 33(1) deduction on the strength of that documentation, not on the bare entry in the ledger.

For employees. Understand that any tax settled on your behalf is taxable income in your hands in the following year. Provide for the resulting tax liability; it is not a "free" benefit. Review the EA form before filing personal returns to confirm the perquisite is captured.

KTP's view

Tax-borne arrangements are legitimate. They are explicitly contemplated by the IRBM's own Public Rulings, and PR 5/2019 paragraph 11 expressly permits the employer's deduction. The exposure does not come from the arrangement itself. It comes from the gap between what the IRBM expects to see in support of the deduction and what most owner-managed Sdn Bhds actually have on file.

For ordinary employees, the deduction position is robust on its own terms. For directors and controlling shareholders, the deduction is technically claimable on the same Section 33(1) basis, but it needs to survive a different quality of scrutiny at audit. That scrutiny is documentary.

A contract of service, a board resolution, MTD treatment, and a correct EA form are not formalities. They are the difference between a deduction that holds and one that is reversed with a penalty attached.

If your company runs tax-borne arrangements for directors or senior staff, or is considering introducing them, the question to ask is not whether the deduction is available. It is whether the file would survive an IRBM officer asking to see the supporting documents. That is a quick review to do, and it is best done before the next EA cycle, not during a field audit.

This article is intended as general guidance and does not constitute formal tax advice. Specific arrangements should be reviewed against the facts of each case.

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