Claiming income tax refund under the current PAYE mechanism

by Ali Muraadh

With the enactment of Income Tax Act¹, an Employee Withholding Tax (“EWHT”) – or what is commonly referred to as pay-as-you-earn (“PAYE”) mechanism – was adopted. PAYE is a simplified mechanism for individuals to account for tax on their employment income. It ensures that tax on employment income is deducted from employees’ remuneration and paid to the tax authority on a monthly basis. 

Various countries adopt different systems for calculating the amount of PAYE to be withheld. Most common of these systems are simple PAYE, cumulative PAYE, and year-end-adjusted PAYE.

The Maldives has adopted a “simple PAYE mechanism” whereby the employer deducts PAYE based on the monthly withholding table without any adjustments for the cumulative effects of salary changes. The following example illustrates how the simple PAYE mechanism works.

Ahmed earns a monthly taxable remuneration of MVR 50,000 during the first 6 months of the year. During the remaining 6 months, he earns a taxable remuneration of MVR 70,000. Hence, his annual taxable income is MVR 720,000 (i.e. 300,000+420,000).  The annual tax paying brackets of individuals under the Income Tax Act are as follows:

Table 1: Income Tax rates

Annual income bracket (MVR)	Tax rate (%)
0-720,000	0
720,000-1,200,000	5.5
1200,000-1,800,000	8
1,800,000-2,400,000	12
2,400,000 and above	15

In a simple PAYE mechanism, employers are generally required to deduct PAYE based on the monthly withholding table, without considering the cumulative effects of the salary changes. The monthly withholding table under the Income Tax Act is illustrated below.

Table 2; Monthly Withholding Table

Monthly income bracket (MVR)	Tax rate (%)
0-60,000	0
60,000-100,000	5.5
100,000-150,000	8
150,000-200,000	12
200,000 and above	15

As can be seen from Table 1 above, Ahmed’s annual income of MVR 720,000 is within the tax free bracket. However, in a simple PAYE mechanism, Ahmed’s employer would deduct EWHT from his employment income during the second half of the year. This is as Ahmed’s monthly remuneration during the second half of the year is MVR 70,000 – which falls within the 5.5% tax bracket based on the monthly withholding table as specified in Table 2 above. Hence, Ahmed’s employer would have accounted for MVR 550 per month (i.e. 5.5% of MVR 10,000, which is the remuneration which exceeds MVR 60,000) totalling to MVR 3,300 as EWHT for the year. Ahmed is allowed to claim this excess tax paid from the MIRA by filing his annual income tax return.

Although the simple PAYE mechanism was adopted for the ease of employees, it does not allow the employer to accurately withhold the correct amount of tax in some situations. This could happen in the following circumstances.

1. Existence of unutilised amounts under lower brackets during some months ( as in Ahmed’s case where during the first 6 months, he had unutilised amounts in the tax free bracket amounting to MVR 60,000).
2. Irregular payments (eg: service charge and bonuses)  resulting in the employee’s income being pushed to higher tax paying brackets.
3. Unclaimed deductions (this happens as the employer is only allowed to deduct pension contributions of employees in accounting for PAYE, while other eligible deductions such as zakat-al-mal or donation can be claimed by filing an annual tax return).

Some countries such as the United Kingdom have adopted a cumulative PAYE mechanism whereby EWHT is continuously recomputed having regard to the cumulative effects of remuneration changes, so as to ensure that the amount of tax withheld is as close as possible to the final income tax liability. If such a system is adopted in Ahmed’s case, the employer would not be required to withhold any tax during the second half of the year, as he is still within the tax free bracket according to his annual cumulative taxable income.

Given this fundamental flaw in the current system, one could argue that the purpose of the PAYE mechanism is not fully achieved as the tax paid by the employer on behalf of the employee is  generally much higher compared to the actual annual tax liability of the employee resulting in a refund. Nevertheless, many individuals are unaware of this scenario and as a result do not opt to file a final return to claim the available tax credits.

I would like to note that a new cumulative rule was incorporated to the Income Tax Regulation² to cater for such scenarios where the regular remuneration of the employee does not exceed MVR 60,000. However, this new rule does not provide a full solution as it computes EWHT on a cumulative basis only if the employer has declared that the employees’ regular remuneration does not exceed MVR 60,000. 

How to claim a refund

Similar to Ahmed, many individuals would face this scenario if their remuneration is variable throughout the year. In such cases, the excess tax paid to the MIRA is only refunded upon filing an annual income tax return. This return has to be filed by the employee (and not the employer). Further, the refund will only be credited to the employee (and not the employer) as per Section 123(c) of the Income Tax Regulation, even if the EWHT was borne by the employer. 

Hence, even though individuals who earn employment income from a single employer are not required to file a final return, in order to claim the eligible refunds, individuals such as Ahmed should file a final tax return. Such returns can be filed online via the MIRAConnect account. After the submission of the final tax return, the MIRA will process the refund. 

Additional administrative burden

Since the only available mechanism to claim these refunds is through filing a final tax return, it creates an additional burden for taxpayers to declare and pay the correct amount of income tax. Moreover, as the refund is made only to the employee, it further complicates the process for the employer to get a refund in cases where the employer bears the tax liability of the employee.

In addition to above, the final income tax return could also be perceived as a complex form for non-finance professionals, which might make filling the form a daunting task. 

What is the solution?

A PAYE system is supposed to reduce compliance burden on tax authorities, employers and employees. However, as indicated earlier, the current simple PAYE mechanism does not fully achieve this objective as in majority cases, the withholding tax deducted is not equivalent or even close to the final tax liability of the employees. A cumulative PAYE system, or a hybrid mechanism where the employer can calculate the final month’s EWHT on a cumulative basis and make year end adjustments would perhaps be more effective.

 
References