Terminating Employees in Malaysia

Malaysia's employment law is primarily governed by two foundational statutes: the Employment Act 1955 and the Industrial Relations Act 1967. These laws work in tandem, with the Employment Act establishing statutory minimum benefits and procedures, while the Industrial Relations Act provides mechanisms for dispute resolution and protection against unfair dismissal. A critical principle underlying Malaysian employment law is that employers cannot simply terminate "at will" merely by invoking a contractual termination clause. Instead, both substantive justification and procedural fairness are mandatory—a principle reinforced by case law establishing that "termination simpliciter" (termination by notice alone without just cause) is not recognized.​

Contributing Advisor

Marco Förster

Director, Operations

Types of employee termination under Malaysian Law

While these terms are often used interchangeably in casual conversation, Malaysian employment law makes a critical distinction that directly affects legal rights and remedies.

What is "dismissal" under Malaysian Law

Dismissal refers to employer-initiated termination of employment, whether for cause or without cause, and is the only form of termination subject to the “just cause or excuse” test under Section 20 of the Industrial Relations Act, allowing employees to challenge unfair dismissals in the Industrial Court. It may occur through direct dismissal, where termination is expressly communicated, or constructive dismissal, where the employer creates intolerable working conditions that force the employee to resign, with such resignation treated in law as a dismissal and preserving the employee’s right to seek redress.

Termination

Termination with cause

When an employer terminates employment due to employee misconduct—such as dishonesty, theft, insubordination, gross negligence, or serious policy violations—the employer may exercise the right to dismiss with or without notice. However, procedural safeguards remain mandatory.

Section 14(1) of the Employment Act requires that before dismissing for misconduct, the employer must conduct a "due inquiry" (also called a "domestic inquiry"), allowing the employee opportunity to respond to allegations and defend themselves. Summary dismissal (immediate termination without notice) is permitted only for gross misconduct of such severity that continued employment is impossible. The employer bears the burden of proving the misconduct justified dismissal.​

Termination without cause

When positions become redundant due to business reorganization, technological change, reduced workforce needs, or company closure, employers may terminate employment without this being attributed to employee fault.

However, termination without cause still requires proper notice (typically 4-8 weeks depending on service length) and entitles the employee to severance pay calculated according to statutory formulas. These terminations must still comply with fair procedure: the employer should follow the "Last In, First Out" (LIFO) principle in selecting employees for retrenchment, notify workers adequately, and document the genuine business necessity for redundancy.​

When is a termination considered lawful or unfair

A termination is lawful when it satisfies both elements:

• The employer can demonstrate substantive justification (misconduct, poor performance, redundancy, business closure, or other legitimate cause), and
• The employer followed proper procedural steps before finalizing the termination, giving the employee opportunity to respond and defend themselves.​

A termination is unfair when:

• The employer cannot establish just cause or excuse;
• Proper disciplinary procedures were not followed;
• The dismissal constitutes retaliation for protected activities (union membership, health complaints, maternity leave);
• Dismissal involves unlawful discrimination; or the employer acted in bad faith.

Termination due to misconduct

Malaysian employment law traditionally identifies four primary grounds justifying summary (immediate) dismissal for gross misconduct:​

• Dishonesty or fraud: Falsifying records, making false claims, fraudulent misrepresentation, or deception affecting employment relationship. Includes falsifying timesheets, inflating expense claims, or false qualification claims.​
• Willful disobedience or insubordination: Deliberate, conscious refusal to obey lawful employer instructions or breach of important employment terms. Isolated instances or good-faith disagreements typically do not qualify; the disobedience must be deliberate and material.​
• Conduct incompatible with position or prejudicial to business: Theft of company or customer property, breach of confidentiality, conflict of interest, criminal conduct affecting work or employer reputation. Examples include security guards stealing inventory, sales staff accepting competitor bribes, or managers embezzling funds.​
• Gross negligence: Reckless failure to perform duties resulting in harm—not mere negligence (reasonable mistakes) but gross negligence demonstrating fundamental disregard for responsibilities. Examples include security staff sleeping during shifts, causing workplace injuries through intentional non-compliance with safety procedures.​

These categories are illustrative rather than exhaustive; courts assess whether conduct is so serious that continued employment is impossible.

Before misconduct dismissal, the employer must issue a written show-cause letter to the employee, clearly stating alleged misconduct, providing supporting evidence, and requesting the employee's response within a specified period (typically 7-14 days). This gives the employee fair notice and opportunity to respond before escalation to inquiry.​

If the show-cause response does not resolve the matter, or for serious allegations, an internal domestic inquiry is conducted. This is a formal but non-court hearing where:​

• An impartial panel (typically 2-3 representatives) hears the case.
• Evidence is presented by employer representatives.
• The employee has opportunity to present defense, call witnesses, and cross-examine.
• Proceedings are documented (minutes, attendance records).
• Both sides are afforded natural justice and fairness.
• The panel determines findings and makes recommendations.

Impartiality of decision-makers, clear evidence presentation, employee fair opportunity to respond, proper documentation, reasonable duration, and proportionate outcome aligned with misconduct severity.​

Termination due to poor performance

Poor performance—the employee's inability or unwillingness to meet reasonable job performance standards—is distinct from misconduct and requires different procedural handling. Unlike misconduct requiring domestic inquiry, poor performance termination typically involves a progressive discipline approach: identifying performance gaps, providing feedback and support, offering training or performance improvement plans, and allowing reasonable time for improvement before termination.​

• The employer should document specific performance failures (missed targets, quality issues, incomplete work);
• Communicate performance concerns to the employee; provide reasonable opportunity for improvement (typically 30-90 days with support);
• Evaluate whether performance improved; and,
• If not, provide warning and opportunity for response before final termination.

This process demonstrates that termination was truly performance-based rather than pretextual.​

The employer must prove the employee was aware of performance expectations and failed to meet reasonable standards, as evidenced by performance reviews, target documentation, and communication records.

Termination due to redundancy or retrenchment

Redundancy exists when an employee or position is no longer required due to organizational changes, business downturn, technological replacement, or restructuring.

Retrenchment—the termination resulting from redundancy—requires not only just cause but compliance with specific procedures reflecting the principle that employers reorganizing their workforce must act in good faith and select employees fairly.​

Three Prerequisites for Valid Retrenchment (Established in Case Law):

• Genuine Redundancy: The employer must prove that circumstances necessitate workforce reduction—actual business need, not pretext for removing unwanted employees.
• Correct Selection: The employee selected must have been properly chosen using fair, objective criteria.
• Fair Procedure: The employer should follow established retrenchment principles, primarily the LIFO principle, and notify affected workers adequately.​

The “Last In, First Out” (LIFO) principle provides that, in a redundancy exercise within the same job category, the most junior employees should be retrenched before senior employees. While not legally mandatory, LIFO is the accepted benchmark of procedural fairness, and any departure must be supported by clear, objective justification. Employees retrenched due to genuine redundancy are entitled to statutory severance benefits and notice pay, as redundancy is not fault-based regardless of individual performance issues.

Termination due to resignation or mutual agreement

Resignation is employee-initiated termination. The employee provides notice (typically per employment contract or statutory minimum) and voluntarily ends employment. Resignation is not dismissal; employees who resign voluntarily have no unfair dismissal recourse unless they can prove constructive dismissal (employer actions forced the resignation).​

Mutual Agreement occurs when employer and employee consensually agree to end employment, often on enhanced terms. Voluntary Separation Schemes (VSS) represent formalized mutual separation, typically offering more generous severance than statutory minimums in exchange for employee waiver of future claims.​

Contract expiration or closure of business

• Contract Expiration: When a fixed-term contract expires naturally or a project-based contract concludes, the employment ends automatically—no dismissal occurs, so no unfair dismissal claim is available (except if the employee proves the "fixed-term" classification was a pretext).​
• Business Closure: When a company ceases operations, all employment contracts terminate. Employees are entitled to full notice (or payment in lieu) and severance benefits calculated through termination date, though in insolvency proceedings, statutory benefits may compete with other creditors.​

Employee classification and legal coverage

The Employment Act 1955 now extends baseline protections to all employees under a contract of service, regardless of salary. However, the scope of protection varies based on a RM 4,000 (USD 960) monthly salary threshold established by amendment effective January 1, 2023.​

Non-EA employees

Non-EA employees are not exempt from employment law; rather, they operate under a different legal framework where the employment contract assumes primary importance for most terms. These employees retain protection under the Industrial Relations Act against unfair dismissal and maintain statutory leave entitlements, but lose the detailed procedural protections and benefit formulas of the Employment Act.​

Non-EA employment contracts typically include negotiated notice periods (often 1-3 months), specified severance arrangements, and detailed termination conditions. Since statutory formulas do not apply, non-EA termination agreements often provide more generous packages negotiated during hiring. However, these employees are not free from legal constraints—their contracts cannot legally eliminate unfair dismissal protection, discriminate unlawfully, or provide notice periods less favorable than statutory minimums in certain circumstances.

Probationary employees

A critical misconception persists that probationary employees can be terminated at the employer's discretion without procedural safeguards. Malaysian law firmly rejects this. The Court of Appeal's landmark decision in Khaliah Abbas v. Pesaka Capital Corporation Sdn Bhd established that probationary employees are workers under the Industrial Relations Act 1967 and cannot be terminated without just cause or excuse, regardless of probationary status.​

Fixed-Term vs Permanent Contracts

Fixed-term contracts

A genuine fixed-term contract specifies a definite beginning and end date with no expectation of renewal. When the contract term expires, it terminates automatically—there is no dismissal or resignation in the legal sense. At common law, "when a contract for a fixed term expires, it terminates of itself: it has not been 'terminated' by either party." Therefore, if an employer declines to renew a genuine fixed-term contract upon expiry, the employee generally has no recourse for unfair dismissal because no dismissal occurred—the contract simply ended as agreed.​

However, the critical word is genuine. Courts will examine whether both parties genuinely understood the contract was truly fixed term with no renewal expectation. If a contract is portrayed as fixed term but the parties' conduct (repeated renewals, employer discretion regarding renewals, practical permanence) suggests otherwise, courts may treat it as a permanent contract in disguise. An employee terminated before contract expiry, conversely, can claim unfair dismissal because the contract was breached.​

Fixed-term contracts for expatriates present a special case: employment passes have fixed validity periods, so tying employment contracts to pass expiration dates creates a more defensible fixed-term structure, provided the contract clearly states this connection and the pass genuinely expires.​

Limitation on fixed-term compensation

In an important High Court decision, when an employee challenges a fixed-term dismissal as unfair, compensation is limited to the unexpired contract period rather than extending beyond it. If an employee was employed on a 12-month fixed-term contract with 5 months remaining and was dismissed, compensation is capped at 5 months' back wages, not 12 months, because the contract would have expired regardless.​

Permanent contracts

Permanent contracts have no specified end date and continue indefinitely until terminated by either party with proper notice. Employees in permanent positions have full statutory protections and cannot be dismissed without just cause and fair procedure.

Notice period and payment in lieu

The Employment Act 1955 Section 12 establishes statutory minimum notice periods that apply to all EA employees and constitute the baseline for non-EA employees, though non-EA contracts may specify longer periods.​

Notice Periods Based on Service Length (Section 12(2), Employment Act 1955):

These periods represent the minimum requirement. Employment contracts frequently specify longer notice periods (3 months, 6 months) for senior roles, which must be honored. Both employers and employees are bound by identical notice periods—symmetrical obligations ensuring fairness.​

When payment in lieu of notice applies

Payment in lieu of notice allows either party to terminate employment without serving the full notice period by paying salary for the unserved portion, as permitted under Section 13(1) of the Employment Act. It is commonly used where immediate separation is preferred by the employer or employee, but it is only valid if allowed under the employment contract or mutually agreed. Forcing payment in lieu where the contract requires notice to be served may constitute a breach of contract and expose the employer to an unfair dismissal claim.

Probationary employees' notice periods

Probationary employees are not exempt from notice requirements. If the employment contract specifies a notice period during probation, that period applies. If the contract is silent on probationary notice, the statutory minimums apply based on service length, though probationary periods are typically short (1-6 months), meaning most probationary terminations involve the 4-week minimum notice or, if the employee has worked less than 1 month, termination without notice.​

Calculating notice period pay

The formula for calculating payment in lieu of notice is straightforward:

Payment in Lieu = (Monthly Salary ÷ 30 days) × Notice Period in Days

The denominator of 30 represents the standard calculation of daily wages in Malaysia (monthly salary ÷ 30 days per month, rather than the actual calendar days).​

The proper termination process (step-by-step)

Step 1: Review employment contract and policies

Before any termination decision is finalized, conduct thorough legal review of the applicable employment contract and company policies. Determine:

• Employment classification: EA or Non-EA employee?
• Specified notice period and payment in lieu provisions.
• Probationary period status (if applicable).
• Fixed-term or permanent contract.
• Any collective agreement or union recognition requirements.
• Specific disciplinary procedures required by policy.
• Any special protections (maternity/medical/union activity leave status).

This review prevents costly errors such as applying incorrect notice periods or missing procedural requirements.​

Step 2: Document performance or conduct issues

Establishing clear, contemporaneous documentation of performance or conduct concerns is critical for defending termination decisions in potential Industrial Court proceedings. Documentation should include:

Document issues contemporaneously when they occur, not retroactively before termination. Courts are skeptical of documentation clearly prepared specifically to justify a pre-determined termination decision.​

Step 3: Issue show-cause letter

For misconduct dismissals, issue a written show-cause letter to the employee, informing them of alleged misconduct, providing supporting evidence, and requesting response within a specified period (7-14 days typically). The show-cause letter should:​

• Clearly identify alleged misconduct or performance concern.
• Provide factual details (dates, times, specific incidents).
• Include relevant evidence (emails, incident reports, witnesses).
• Explain policy or contract provisions allegedly violated.
• State that failure to provide satisfactory response may result in dismissal.
• Request response in writing within specified timeframe.
• Indicate when inquiry will be scheduled (if response unsatisfactory).

Serve the show-cause letter personally to the employee if possible, obtaining signed acknowledgment. If personal service is not feasible, use certified mail or registered courier with tracking. Document delivery method and date.

Step 4: Conduct domestic inquiry (if required)

Establish an impartial panel (typically 2-3 members) to hear the case. Panel members should be neutral, without personal conflict, and reasonably senior to the employee. Include HR representation and, if unionized, union representative if required by collective agreement.​

Inquiry procedure

• Notify employee in writing of inquiry date, time, location, and allegations.
• Present employer's evidence clearly, calling witnesses as necessary.
• Allow employee opportunity to respond, present defense, call witnesses, and cross-examine employer evidence.
• Maintain professional, fair tone throughout.
• Document proceedings: attendance, evidence presented, employee response, findings.
• Adjourn for panel deliberation if needed.
• Communicate findings to employee in writing.​

Impartiality, fair notice, opportunity to respond, clear evidence presentation, documentation, and proportionate outcome aligned with misconduct severity. Skipping any single step can render the inquiry procedurally unfair.​

Step 5: Decide and issue termination letter

Based on inquiry findings and documentation, decide whether dismissal is justified. Consider whether:

• Misconduct is proven on balance of probabilities.
• Misconduct is sufficiently serious to warrant dismissal.
• Dismissal is proportionate to the misconduct (considering history, seniority, past treatment).
• Alternative discipline (suspension, demotion, warning) might be appropriate.
• Proper procedure was followed.

If dismissal is determined to be justified, issue a formal written termination letter specifying:

• Clear termination statement ("We regret to inform you that your employment is terminated...").
• Effective termination date.
• Reason for termination.
• Notice period (or payment in lieu amount if not serving notice).
• Final payment details and timeline.
• Any outstanding benefits calculation.
• Company property return requirements.
• Contact information for questions regarding final settlement.

Ensure the termination letter is signed by an authorized representative (HR director, CEO, or senior manager specifically delegated this authority). This demonstrates organizational process and establishes clear decision-making chain for potential legal proceedings.​

Step 6: Settle final pay and benefits

Final pay must be settled immediately—the law requires payment within 7 days of termination date. This includes wages, severance (if applicable), accrued leave, and payment in lieu of notice.​

Components of final settlement:

Accrued annual leave

For EA employees, calculate accrued but untaken leave at statutory rates: 8 days for <2 years service, 12 days for 2-5 years, 16 days for 5+ years. For non-EA employees, use contract-specified rates. Multiply days by daily rate (monthly ÷ 30).​

Notice period pay or payment in lieu:

If serving notice, pay regular salary during notice period. If payment in lieu, calculate per formula:

(Monthly ÷ 30) × Notice Period Days.​

Severance pay (if eligible):

for terminations not due to misconduct or resignation (redundancy, business closure, poor performance), calculate severance per statutory formula:

(Monthly ÷ 30) × Years of Service × Eligibility Days (10/15/20 depending on tenure)

Tax implications:

Under Income Tax Act 1967, compensation for loss of employment (including severance) is taxable, but eligible for exemption based on years of service. The exemption is RM 6,000-RM 10,000 per completed year of service depending on the year payment is received.

For example, an employee with 10 years' service might receive RM 100,000 in severance, with RM 100,000 exempted (10 years × RM 10,000), resulting in no tax liability for the severance component (though back wages portions may be taxable).​

Final payslip:

Generate a final payslip showing gross salary, all deductions (EPF, income tax, SOCSO, any employee loans), and net payment due. Provide this to the employee concurrent with payment.​

Evidence of payment:

Retain proof that final payment was made: bank transfer confirmation, signed receipt, or cleared check copy. This documentation is critical if the employee later disputes whether payment was made.​

Severance pay and termination benefits

Termination benefits (severance pay) are not automatic eligibility depends on the reason for termination and employment classification.​

Only EA employees (earning ≤RM 4,000/month) have statutory severance entitlements. Non-EA employees receive severance only if specified in their individual employment contract.​ The statutory minimum severance pay for EA employees is calculated per length of service:​

Formula:

Severance = (Monthly Salary ÷ 30 days) × Years of Service × Daily Rate Multiplier

Daily rate multipliers by service length:

Prorate based on completed years and nearest complete month. An employee with 3 years 2 months of service is credited with 3 years; an employee with 3 years 8 months is credited with 3 years (not 4) unless they completed 4 full years.​

When no severance pay is due

• An employee dismissed for serious misconduct after due inquiry receives no severance pay, regardless of service length or salary. This is the primary exception incentivizing employees to maintain conduct standards.​
• An employee who voluntarily resigns receives no severance; only accrued leave and final salary are due. However, if the employee can prove constructive dismissal (employer actions forced resignation), they may be eligible for severance despite technically resigning.​
• If a genuine fixed-term contract expires naturally (not terminated early by employer), the expiry is not "termination" in legal sense, so severance does not apply. However, if the employer terminates a fixed-term employee before the contract end date, severance is due for the unexpired period.​
• If the employment contract specifies a retirement age and the employee reaches that age, termination is not "premature," so severance may not apply if the contract clearly states no severance at retirement. However, many employment contracts provide retirement gratuity instead.​

Tax treatment of termination payments

Under Section 13(1)(e) of the Income Tax Act 1967, compensation for loss of employment is taxable income, including severance pay, payment in lieu of notice, and back wages from unfair dismissal awards.​ Importantly, Schedule 6, Paragraph 15(1)(b) of the Income Tax Act provides an exemption for compensation based on years of service. The current exemption is RM10,000 per completed year of service (the rate was RM6,000 in earlier years, increasing to RM10,000 more recently).​

An employee with 10 years of service receives RM 100,000 in severance pay:

• Gross compensation: RM 100,000
• Exemption: 10 years × RM 10,000 = RM 100,000
• Income chargeable to tax: RM 0
• No income tax liability on the severance

Conversely, an employee with 5 years' service receiving RM75,000:

• Gross compensation: RM 75,000
• Exemption: 5 years × RM 10,000 = RM 50,000
• Income chargeable to tax: RM 25,000
• Income tax liability on RM 25,000 (at applicable rate)

Payment in lieu of notice is taxable. Severance pay per statutory formula is subject to above exemption. Back wages from Industrial Court awards are taxable (but subject to exemption). Reimbursement of medical expenses or genuine financial compensation for hardship may be non-taxable capital receipts in some circumstances.​

Unfair dismissal and industrial court claims

Unfair dismissal under Section 20 of the Industrial Relations Act 1967 occurs when an employee is dismissed "without just cause or excuse." The concept is deliberately broad, allowing case-by-case interpretation reflecting principles of natural justice and fairness rather than prescriptive rules.​

• The employer cannot demonstrate a valid reason for dismissal (no proven misconduct, no genuine redundancy, performance targets were unrealistic, or reason is discriminatory).​
• The employer failed to follow fair procedures (no show-cause letter for misconduct, no domestic inquiry, inadequate opportunity to respond, biased decision-maker).​
• The dismissal was motivated by retaliation for protected activity (union membership, health complaints, maternity leave, whistleblowing) or discrimination (race, religion, gender, age, disability).​
• The employee was not afforded fair hearing, opportunity to respond, or adequate notice.​

If the Industrial Court finds unfair dismissal, the court may award:

• The employee returns to their previous position, or an equivalent position if the previous one no longer exists. The employee receives back wages from dismissal date until reinstatement (minus deductions if the employee obtained interim employment).​
• If reinstatement is not feasible (due to breakdown of trust, changed circumstances, or employee preference), the court awards compensation calculated as back wages plus additional compensation based on service length. Common calculation is 1 month's salary per year of service, though courts have discretion.​
• The court calculates wages due from dismissal date through court decision, minus income from alternative employment obtained during this period (to prevent double compensation).​

Recent amendments to the Industrial Relations Act permit the court to impose 8% interest on monetary awards if the employer was found at fault.​ In some cases, courts award reinstatement with compensation for loss of seniority or benefits during dismissal period.​

Typical timeline of Industrial Court proceedings

Termination of foreign employees in Malaysia

Foreign employees in Malaysia must hold valid work authorization tied to their specific employer and role, which typically ceases upon termination of employment. Employers must align employment termination with immigration requirements, including cancellation of the work permit and arrangements for the employee’s departure or approved transfer to a new employer. Failure to properly coordinate termination and immigration compliance may result in violations and penalties for both the employer and the employee.

Reporting obligations to immigration and MOHR

Upon employment termination, the employer must formally cancel the foreign employee's work permit through the Immigration Department. The cancellation must occur within three business days before the employee's intended departure or within one month after departure. Failure to cancel timely can result in negative records affecting future work permit applications and the employee's ability to travel to Malaysia.​

Some retrenchment scenarios involving foreign workers may require notification to MOHR (previously Ministry of Labour), particularly if multiple foreign workers are affected. Specific notification requirements vary based on sector and scale of retrenchment, but employers should verify applicable notification obligations with HR/legal counsel.​

Employment passes (EPs) are issued to professional/managerial foreign workers earning typically RM 5,000+ monthly. When terminating an EP holder, the employer must:

• Notify the Expatriate Services Division (ESD).
• Request work permit cancellation.
• Coordinate departure timeline.
• Ensure all statutory settlements are paid before departure (foreign employees cannot remain in Malaysia post-employment termination without alternative work pass)​.