Tax Implications of the Employee’s Income Tax Borne by the Employer
Employment income has become subject to income tax, effective from 1 April 2020. Under the Income Tax Act1, employment income encompasses all types of remuneration received in respect of employment. This includes basic salary, allowances, service charge, bonus and such. It also includes benefits in kind. The total remuneration received from employment is subject to income tax unless a specific exemption is granted or a deduction is allowed for tax purposes.
As the deduction of tax (i.e. employee withholding tax) reduces the employee’s “take-home pay”, some employers may decide to pay income tax on behalf of the employee. In some jurisdictions, such tax payments made by the employer are not considered as a taxable benefit. The case, however, is not the same in the Maldives. In this article, I want to illustrate how this applies in practice, and how it affects the tax liability of the employee.
As taxable remuneration includes all consideration received in respect of employment, and because there is no exemption granted for the tax borne by the employer, the amount of tax borne by the employer is also considered as part of the taxable remuneration. This means that income tax borne by the employer must be included in the computation of the taxable income of the employee – pushing up the employee’s tax liability.
This treatment is implied in Section 38 of the Income Tax Regulation2, which states that where the employer fails to deduct tax from the salary of the employee, the net remuneration must be ‘grossed up’ and that such calculation should be done for each tax bracket separately.
The said Section requires that, when tax is borne by the employer on behalf of the employee, the amount of tax payable by the employee is calculated using the formula shown below.
Tax payable = Remuneration subject to tax under each tax bracket x [t / (1-t)]
Where “t” equals the marginal tax rate applicable under each bracket
Example 1
Ahmed is employed by Company Y and the company agrees to bear income tax on his behalf. Following are the details of the income received for the month of January 2021. Total remuneration is inclusive of pension paid to the Maldives Pension Administration Office.
- Gross remuneration (excluding tax) – MVR 120,000
- Employee contribution to the pension fund – MVR 2,800
- Employer contribution to the pension fund – MVR 2,800
- No other benefits are given to Ahmed during the period
Computation of tax payable by Ahmed for January 2021
| Details | Amount in MVR |
| Salary for the month | 120,000 |
| Less: | |
| Exempt income (Employer Contribution) | (2,800) |
| Amounts deductible (Employee Contribution) | (2,800) |
| Notional taxable income | 114,400 |
| Tax payable under the first bracket (60,000 x 0%) | 0 |
| Tax payable under the second bracket (40,000 x (0.055 / [1-0.055]) | 2,328.04 |
| Tax payable under the third bracket (14,400 x (0.08 / [1-.08]) | 1,252.17 |
| Total tax payable | 3,580.22 |
Effectively, what the formula does is calculate tax on tax at each bracket separately. This can be illustrated as follows.
| Details | Amount in MVR |
| Notional tax payable under the second bracket (40,000 x 5.5%) | 2,200 |
| Tax on 2,200 @ 5.5% | 121 |
| Tax on 121 @ 5.5% | 6.66 |
| Tax on 6.66 @ 5.5% | 0.37 |
| Notional tax payable under the third bracket (14,400 x 8%) | 1,152 |
| Tax on 1,152 @ 8% | 92.16 |
| Tax on 92.16 @ 8% | 7.37 |
| Tax on 7.37 @ 8% | 0.59 |
| Total taxable payable | 3,580.22 |
The following example illustrates tax computation where an employee gives a fixed amount as a tax allowance.
Example 2
Assume that the facts remain the same as above and the only fact that has changed is that the Company Y gives MVR 3,580 to Ahmed in cash as tax allowance instead of paying tax on his behalf.
Computation of tax payable by Ahmed for January 2021
| Details | Amount in MVR |
| Salary for the month | 120,000 |
| Add: Tax allowance | 3,580 |
| Total income | 123,580 |
| Less: | |
| Exempt income (Employer Contribution) | (2,800) |
| Amounts deductible (Employee Contribution) | (2,800) |
| Notional taxable income | 117,980 |
| Tax under the first bracket (60,000 x 0%) | 0 |
| Tax under the second bracket (40,000 x 5.5%) | 2,200 |
| Tax under the third bracket (17,980 x 8%) | 1,438 |
| Total taxable payable | 3,638 |
Having analysed the above examples, you may notice that the tax position of the employee differs even if the cost to the employer remains the same. The main reason for this difference is because the Regulation requires a special calculation to be performed in the case where the employer pays tax on behalf of his employee – the grossing up taxable remuneration attributable to each tax bracket separately in calculating the tax liability of the employee. However, when the employee receives an amount in cash as a tax allowance, the Regulation does not require to perform a “tax on tax” calculation. Instead, such allowance is treated as any other taxable allowance, and tax payable by the employee will be determined based on the applicable marginal tax rates (in this case, the higher marginal rate of 8% is applicable on the fixed allowance). Because of the said differences in tax treatment, the employee will be better off if the employer pays tax on behalf of the employee instead of providing the same amount as a tax allowance.
Impact of Section 38 of the Regulation: A distortion in the tax paying brackets
As per Section 79(u) of the Income Tax Act, remuneration includes all receipts of an employee in relation to their employment. Further, as per the Act and Regulation, tax borne by the employer is neither an exempt nor is deductible for tax purposes. Therefore, if a benefit (such as tax borne by the employee) is received by an employee, such benefit will form part of the gross remuneration and should be subject to tax accordingly.
While declaring and paying the correct amount of tax is always crucial, the steps to be followed are generally simple and straightforward. The first step in computing the amount of tax payable is identifying and valuing the receipts that constitute remuneration. Following that, the next would be deducting all the exempt and deductible receipts to arrive at the taxable remuneration. Thereafter, the final step would be applying the applicable tax rates as per the specified brackets.
Having said the above, if we apply Section 38 of the Regulation to the case where an employer bears income tax on behalf of the employee, it results in the valuation of the amount of tax to be withheld – not the valuation of the underlying benefit itself. Further, it effectively results in some distortion to the taxpaying brackets specified in the Act. This is because Section 38 requires the grossing up adjustment to be done separately for each income bracket.
The consequent changes to the taxpaying brackets can be explained as follows.
With reference to the tax paying brackets specified in the Act, as a general rule, individuals (in this case employees) will be subject to tax if the taxable remuneration surpasses MVR 60,000 per month. Let me explain, with the help of an example, the impact on the given tax brackets where Section 38 is applied.
For ease of understanding let us assume that the facts remain the same as the first example. Based on the graduated tax rates applicable to individuals, the maximum amount subject to tax at the second bracket – after considering the tax free threshold – would be MVR 40,000. But if the grossing up adjustment is applied (assuming tax is borne by the employer) the amount subject to tax at the rate of 5.5% would be MVR 42,328 instead of the MVR 40,000 stated in the Act. Technically, in this case MVR 2,328 should have been taxed at the rate of 8%. This is because the Act states that the remuneration exceeding MVR 100,000 and up to MVR 150,000 should be taxed at 8%. Therefore, the tax allowance received by Ahmed in the example given above should be taxed at 8%. If the formula given in Section 38 is applied, Ahmed is taxed effectively at a lower rate.
In my view, tax borne by the employee should be treated like any other taxable benefit for tax purposes. That is, it should be valued separately and should be included in the gross remuneration. In some jurisdictions, such as Singapore, such benefits are also separately valued, and the total remuneration is taxed based on the applicable marginal tax rates. The benefit of treating as a separate and distinct taxable benefit is that it would result in no distortion to the tax brackets prescribed in the Act.
The calculation can, therefore, be done by applying the formula given below:
Computation of tax allowance = [Tax calculated based on marginal tax rates x (t/(1-t)]
Where “t” equals to the highest marginal tax rate applicable
Computation of tax allowance
| Details | Amount in MVR |
| Salary for the month | 120,000 |
| Less: | |
| Exempt income | (2,800) |
| Amounts deductible | (2,800) |
| Notional taxable income | 114,400 |
| Tax under the first bracket (60,000 x 0%) | – |
| Tax under the second bracket (40,000 x 5.5%) | 2,200.00 |
| Tax under the third bracket (14,400 x 8%) | 1,152 |
| Total tax | 3,352 |
| Tax on tax [3,352 x (8/(100-8)] | 291.48 |
| Total amount borne by the employer | 3,643.48 |
Actual tax computation considering it as a separate benefit
| Details | Amount in MVR |
| Salary for the month | 120,000 |
| Add: Tax allowance | 3,643 |
| Total income | 123,643 |
| Less: | |
| Exempt income (Employer Contribution) | (2,800) |
| Amounts deductible (Employee Contribution) | (2,800) |
| Taxable income | 118,043 |
| Tax payable under the first bracket (60,000 x 0%) | |
| Tax payable under the second bracket (40,000 x 5.5%) | 2,200 |
| Tax payable under the third bracket (18,043 x 8%) | 1443 |
| Tax payable for the period | 3,643 |
As shown in examples 1 and 2 above, it can be seen that even if the benefit to the employee is the same (MVR 3,580), the employee receiving a cash allowance will end up paying a higher tax compared to the employee on whose behalf the employer pays tax. However, this would not be the case when the tax borne by the employer is treated as separate taxable benefit as explained above. In my opinion, taxpayers in equal earning capacity should pay the same amount of tax. If not, it can be said that the tax regime lacks fairness, which is one of the fundamental principles of a tax system.
With the introduction of the Income Tax Act, enhancing tax efficiency would be one of the primary focuses of businesses as well as employees. As such, both parties should be aware of the tax implication of the remuneration package being offered and it would be in the best interest of the employee to be remunerated in the most tax efficient manner. In this article I have illustrated the tax implications to an employee and how tax liability should be calculated as per the Act and Regulation when the employer pays tax on behalf of the employee, and when the employee receives a fixed sum as tax allowance. In consideration of the distortions to the tax paying brackets when the Regulation is applied, perhaps a reconsideration of Section 38 of the Regulation is required.
