Hire in Malaysia with Confidence

Any business hiring in Malaysia should understand the important legal distinction between who classifies as an independent contractor and who can be hired as an employee. Fines or penalties may be issued to businesses that are hiring independent contractors under the guise of employment. 

Understanding the distinctions between employees and independent contractors is critical to compliantly engaging workers in Malaysia. It is important to work with a partner like Worksuite to ensure you put in place an engagement framework that accurately classifies freelancers as independent contractors for you and lets you know when freelance talent must be engaged as an independent contractor or employed directly.

This is critical to compliantly engaging workers in Malaysia and thereby avoiding severe legal, financial, and other penalties.

Under Malaysian law, an employee is defined as working under a contract of service, which is “any agreement whether oral or in writing and whether express or implied, whereby one person agrees to employ another as an employee and that other agrees to serve his employer as an employee and includes an apprenticeship contract.” In contrast, an independent contractor operates under a contract for service, which involves being compensated for services and/or outcomes delivered.

The key criteria in determining whether an individual is effectively working as an employee versus an independent contractor include the degree of control that the hiring company or client has over the individual. If the real substance of the company-contractor relationship proves to effectively be an employment relationship, the hiring company may suffer legal and financial penalties (including overdue payroll taxes). It is therefore important to leverage an employment service partner like Worksuite when hiring in Malaysia in order to ensure that independent contractors fall under the correct working relationship with your business.

• Who is an Independent Contractor?

As mentioned above, the key determinant of someone being an independent contractor rather than an employee is the level of control they work under. This includes considering the hiring company’s ability to make certain decisions on the individual’s behalf (such as their level of compensation), the authority to directly issue instructions to the individual, and the ability to legally enforce authority over them. However, in reality, a variety of factors are considered. In general, an individual will be considered an independent contractor if they:

• Are subject to relatively little control by the hiring company, which means they are free to decide when, where, and how they complete their tasks.
• Do not have fixed hours of work that are determined by the hiring company.
• Can choose the location from which to work.
• Provide their own equipment, rather than receive it from the hiring company.
• Can be (or are expected to be) dismissed once the contracted work is complete. 
• Are not integrated into the hiring company’s organizational structure.
• Are paid for a specific project or task rather than on a recurring basis.
• Can refuse to perform a task (unless that task is part of their contract).
• Are not entitled to a minimum amount of work or a minimum amount of pay.
• Are not listed on the hiring company’s normal payroll.
• Do not have their social security payments contributed by the hiring company
• Do not directly benefit from the hiring company’s business success
• Assume a level of business risk that is higher than what is expected from an employee

If a dispute about the status of an individual is brought before Malaysian courts, the burden of proof will automatically fall upon the hiring company to demonstrate that the individual qualifies as an independent contractor rather than an employee.

There are four main categories under which independent contractors can operate in Malaysia, with sole proprietorship being the most common.

• Sole proprietorship: Becoming a sole proprietor is a common route for many freelancers (especially in the ‘gig economy), entrepreneurs, and independent contractors, as it enables potential business benefits such as tax deductions and also has low administrative overheads. Contractors can register as a sole proprietor via Suruhanjaya Syarikat Malaysia (SSM) to obtain a business license, either using their personal name or creating a trade name. Sole proprietors pay 0-26% income tax.
• General partnership: A general partnership is not a legal entity, and is formed by 2-20 partners. The partners have unlimited liability for the business, including relating to their own personal assets. The partners pay from 0% to 26% income tax.
• Limited Liability Partnership (LLP): An LLP is a separate legal entity and is formed by two or more people, all of whom have a share in the profits and capital of the company. All partners also have joint, shared, and limited liability. LLPs pay 20% tax on the first MYR 500,000 [USD 106,576] of income and 25% thereafter. LLPs have “PLT” (Perkongsian Liabiliti Terhad) appended to their name.
• Company: A company is a separate legal entity that accepts its own liability and is managed by a board of directors. The company is owned by 1 to 50 shareholders. The Companies Act 2016 allowed companies to have a single director and shareholder who has limited liability and therefore offers an attractive model for some contractors. Companies pay 20% tax on the first MYR 500,000 [USD 106,576] of income and 25% thereafter. They have “Sdn Bhd” or “Bhd” appended to their name. 

There are two main types of contracting model for working with independent contractors in Malaysia.

A. Direct engagement of the contractor as self-employed or registered via their own company. Under this model, the hiring company engages directly with the independent contractor – as a sole proprietor, partnership, or company (see above) – and establishes a direct contract for the provision of services. The hiring company then pays the independent contractor directly, following the terms of the contract.

B. Third party. These companies come in two forms and both are specially designed to vet and engage freelancers compliantly as either contract employees or independent contractors on your behalf.

1. Temp/staffing agency: These are called Private Employment Agencies in Malaysia, and they are legally required to have “Agensi Pekerjaan” (Employment Agency) before their name. Under this model, the hiring company engages directly with the agency, which in turn supplies one of its own independent contractors to deliver the contracted services. The hiring company pays the agency directly, in accordance with the terms of the contract. The contract is, therefore, between the hiring company and the agency, while the agency pays the independent contractor through a separate contractual arrangement. 
2. Umbrella company: Independent contractors can also work through an umbrella company. This turns a ‘self-employed’ individual into a legal ‘employee’ of the umbrella company itself. The contractual relationship is between the umbrella company and the client, with the umbrella company running payroll and administration for the independent contractor. The umbrella company invoices the client directly, while paying the contractor via PAYE as a standard employee. Umbrella companies levy a fee on the contractor to cover their costs.
3. Hiring partner: The hiring company can also work with a hiring partner who helps them vet potential independent contractors, set up contracts, ensure the contractor is properly classified, onboard and manage contractors, and make payments to them. 

Companies hiring independent contractors in Malaysia should avoid making payments directly through their payroll system. Beyond these guidelines, there are no specific legal requirements related to paying contractors in Malaysia. The contract should stipulate the preferred payment method agreed upon by both parties.

Employees in Malaysia are subject to income tax, which is withheld at source. The personal income tax rates range from 1% (for incomes between 5,001-20,000 per year) to 30% (for incomes over MYR 2 million [USD 426,300] per year). However, all individuals who earn over MYR 34,000 [USD 7,247] per year must file their income taxes with the Inland Revenue Board (IRB) of Malaysia (Lembaga Hasil Dalam Negeri, LHDN) and this includes employees and contractors. The tax year runs from 1 January to 31 December, and the deadline for filing tax returns is 30 April (for the preceding tax year). Whereas employees need to file their taxes with payment being taken at source, independent contractors must both file and pay their own income taxes. 

Contractors operating as an individual without a registered company must file their income taxes using ‘Form BE’, while those running a registered company must file ‘Form B’. Both forms can be downloaded from the LHDN portal and filed electronically via the MyTax portal. Contractors can also pay their taxes electronically via the ByrHASIL portal.

There are two main security provisions schemes in Malaysia. The Employees Provident Fund (EPF) is mandatory for all Malaysian citizens and permanent residents working in the country. Employee contributions range from 0%-11% of salary depending on the age and income level, while employer contributions range from 4% to 13% of the employee’s salary. There is also an Employment Injury Insurance Scheme (EIIS) and the Invalidity Pension Scheme (IPS), which are managed by the Social Security Organization (SOCSO). 

Typically, the employer and employee contribute to both the EIIS and IPS, up to MYR 69.05 [USD 14.70] for the employer and MYR 19.75 [USD 4.20] for the employee. For employees who are not eligible for the IPS, the employer alone contributes to the EIIS up to MYR 49.40 [USD 10.53] per month. The type of employment and other contractual arrangements can also affect the levels of contributions. There is also a mandatory Employment Insurance Scheme (EIS), with contributions capped at MYR 7.90 [USD 1.68].

There are no payer tax and social security withholding requirements for independent contractors, who must arrange their own social security provisions. Independent contractors can, however, register for the voluntary Self-Employment Social Security Scheme (SESSS), along with the Voluntary Contribution with Retirement Incentive (i-Saraan). Contractors who also work as employees (although not for the same company) may not need to pay additional social security contributions where this is already covered by the employment deductions.