On 31 August 2020, your first interim payment under the Income Tax Act1 will become due, as things stand now. This is the first interim payment for tax year 2020. Yes, there is still plenty of time till that date, but it’s always better to plan and prepare in advance. Given the current situation and the uncertainties that COVID-19 has brought upon businesses, planning ahead is ever more essential.
Although interim payments are not new to us – as they have been in place under the BPT regime2 as well – the new Income Tax Act has provided businesses with an alternative mechanism of calculating their interim payments. Here, I look at the new rules on interim payments, which I think is quite relevant – and taxpayer-friendly – in uncertain times like that of today.
What is an interim payment?
Income Tax is payable by businesses in 3 instalments: first interim payment (due on 31 July of the year), second interim payment (due on 31 January of the following year), and a final payment (which is due on 30 June of the following year, along with the person’s income tax return). In practice, the final payment is any balance that is payable after having set-off the two interim payments from the person’s tax liability for the year.
Under the BPT regime which was effective until 31 December 2019, each of the interim payments was half of the tax payable for the preceding year. For instance, if a company had a BPT liability of MVR 100,000 in 2019, the company’s interim payments for 2020, must be MVR 50,000 each. However, if at the end of the year, the company’s tax liability for 2020 is more than MVR 100,000, the amount so exceeds will be paid for 2020 as the final payment so that the full liability for the year is settled by way of the two interim payments and the final payment.
Essentially, this is the regime that has been brought into the Income Tax regime as well.
Issues with the old rules
By having a predetermined formula for calculation of the interim payments, there created a fundamental issue in payment of the interim payments, especially when business is not performing the same as the previous year. If the business is facing a loss, or if you are considering to cease the business, the situation is worse. That is, despite the fact that you know that the current year’s tax liability will be lower than that of the previous year, or that you will face a business loss during this year, the interim payments (i.e. half of the previous year’s liability) is payable nonetheless.
What this meant is, that if the business performs badly as expected, tax would be paid for the year in excess. At a time that you badly need cash flow, your money is just stuck with the State.
Revised interim payment rules
When the Income Tax Act came into force on 1 January 2020, it gave an option to the taxpayer to estimate their interim payment in cases where there are reasonable grounds to believe that the tax liability for the year would be less than that of the previous year. This, however, does not mean that a taxpayer may “get away” with making a lower or no interim payment on the argument that they were based on estimates.
As per the Income Tax Act, your estimated interim payment must be at least 80% of the final liability for the year. If the estimate is less than 80% of the final liability, you will be deemed to have underpaid the interim payment and fines will be applied accordingly.
So, what does this mean in practice?
For example, assume that your liability for 2019 is MVR 100,000. As a general rule, your interim payment for 2020, must be MVR 50,000 each. However, because of COVID-19 pandemic, you estimate to have a final tax liability of only MVR 40,000 in 2020. If so, you can pay MVR 20,000 as your first interim payment on 31 July 2020 and MVR 20,000 as the second interim payment on 31 January 2021.
Application of fines
As it turns out, your business was not as bad as you thought it would be. By the end of 2020, you made a decent profit and had a tax liability of MVR 90,000, which is 125% more than your estimated liability. As the estimated liability must be at least 80% of your final liability, in this case, you would be deemed to have underpaid the interim payment. The question then is how will fines be applied?
The rule given in the Income Tax Act is that if an estimated interim payment is deemed to be short, the taxpayer’s interim liability due is by default set based on the previous year – the general rule of determining interim payments. As such, the amount of the shortfall will also be the difference between the “default interim liability” and the amount paid based on estimated. In the above example, the shortfall would, therefore, be MVR 30,000 for each interim payment (MVR 50,000 – 20,000) and fines will be applied on this amount.