Independent Contractor vs Employee: Classification & Tax

Introduction

You work for a company — but instead of a monthly salary, you are paid per project or assignment. Are you an employee or an independent contractor? The answer matters because it determines:

• the tax form you must use (Form EA/Form B);
• whether the employer withholds PCB;
• the expenses you can claim;
• your obligations to PERKESO.

This article explains the classification differences and their tax implications.

Employee (Contract of Service) — s.13 ITA

Under the Income Tax Act 1967 (ITA), the definitions of employee and employment (s.2) refer to a master-and-servant relationship that exists, or to the holder of an office/appointment with remuneration. Income received in the form of salary, wages, remuneration, fees, commissions, bonuses, gratuities, perquisites, allowances, benefits or compensation for loss of employment is gross employment income under s.13(1).

Common employee features: you work under the order and control of the employer, are provided tools/workplace, and do not bear the risk of business loss.

Independent Contractor (Contract for Services) — s.4(a) ITA

Profits from a business, trade, vocation or profession are taxed under s.3 and s.4(a) of the ITA. HASiL lists examples of business activities including acting, singing, product ambassadorship, product reviews, commissions, tuition classes, speaking, and taxi/e-hailing driving.

Independent contractors typically:

• decide for themselves how, when and where to work;
• provide their own tools and equipment;
• may hire others or send other workers;
• bear the risk of profit/loss;
• are paid by output, not a fixed salary.

Classification tests

There is no single definitive test listed in the statute. Courts use several tests — including the control test, the integration test and the economic reality test — to decide a person's status. HASiL's position is that each case is decided on its overall facts and circumstances, with the control relationship as the main determinant.

If you are an employee: tax implications

• The employer withholds PCB (Monthly Tax Deduction) from your salary.
• The employer reports your remuneration via Form EA to you and Form E to HASiL.
• Benefits and allowances received from the employer are generally taxable as employment income.
• Professional deductions for employees are limited to certain categories.

If you are an independent contractor: tax implications

• You are responsible under the self-assessment system: register for a TIN via e-Daftar, comply with CP500 notices (tax instalments) and notify changes in amounts.
• You need to prepare financial statements and report business income using Form B (e-B) before/on 30 June.
• Keep records and accounts for 7 years.
• You can claim allowable expenses under s.33 ITA (see perbelanjaan-perniagaan-kecil and perbelanjaan-tidak-boleh-ditolak).

Contract payments and s.107A withholding tax

Certain contract payments made to contractors are subject to withholding tax under s.107A ITA. If the payer fails to comply with s.107A, the deduction for those payments is denied under s.39(1)(i) ITA.

PERKESO and KWSP (non-tax context)

Employees under a contract of service are protected under the Employees' Social Security Act 1969 (Act 4). Self-employed persons, sole proprietors or partners are not protected under Act 4, but may contribute under the Self-Employment Social Security Scheme (SKSPS).

Summary

Aspect	Employee (s.13)	Independent contractor (s.4(a))
Relationship	Master-and-servant (contract of service)	Contract for services
Withholding	PCB by employer	CP500 (self-assessment)
Form	EA/E (employer)	Form B (e-B)
Deductions	Limited	s.33 expenses (subject to s.39)
PERKESO	Act 4	SKSPS (self-employed)

Your classification determines your tax and social security obligations. If you are unsure, check the details with HASiL or a qualified tax adviser.