by Madeeh Ahmed
The Income Tax Act (ITA)1 imposes tax on income of non-residents that is sourced from the Maldives2. The ITA defines rules for determining the source of income, mostly under Section 11 of the Act. Under that section, income of non-resident service providers is generally sourced from the Maldives if it is derived from a business carried out through the non-resident’s permanent establishment (PE) in the Maldives.
However, payments to non-resident contractors are subject to non-resident withholding tax (NWHT) mechanism under Section 55 of the ITA as well. As such, there arises a question of whether Income Tax can be imposed on non-resident contractors (NRCs) who do not have a PE in the Maldives. In my view, it can’t be. The source rules under the ITA do not allow imposing tax on a non-resident service provider, who has no PE in the Maldives, despite the fact that the service under the contract may have been performed in the Maldives.
What constitutes a PE?
A PE is generally a fixed place of business through which the business of an enterprise is wholly or partly carried on. Place of management, branch, office, factory, workshop are typical examples. More importantly, the ITA also includes service PE provisions where the performance of services in the Maldives for more than six months may give rise to a PE in the Maldives irrespective of whether the non-resident has a fixed place of business. Further, a building site, construction, assembly or installation project would also constitute a PE if such project or activities last for more than six months.
A non-resident having a PE in the Maldives is required to pay tax on the person’s net taxable profits, just like a resident3. Where NWHT is suffered on the income of the PE, the non-resident can opt to declare tax on a gross receipt basis4 although in most of the cases, the PE will most likely choose to pay tax on a net profit basis.
Withholding Tax on non-resident contractor payments
A person paying for the services performed in the Maldives by a NRC is required to deduct/withhold 10% of the gross payments made to the NRC. The payment is required to be withheld despite the fact that the NRC has a PE in the Maldives. This is where the problem begins – a PE, who will ultimately be filing a tax return to the MIRA declaring its final tax liability based on the net profits, is not exempt from the NWHT mechanism.
The problem arises as the NWHT is imposed on the gross payment to NRC (which will be the non-resident’s gross income). However, the non-resident is allowed to pay tax on their net taxable income (i.e., income less allowable deductions) by filing a tax return to the MIRA after the end of the year. In this case, any taxes withheld from their income and paid to the MIRA will be treated equivalent to interim payments and therefore will get adjusted from their final tax liability. Hence the NWHT on NRCs, in this case effectively becomes an interim tax rather than a final tax. In the majority of cases, the NRC will end up claiming a refund from the MIRA after the year ends as illustrated below.
Example: MV Co assigns NR Co to undertake a construction project in the Maldives for a contract value of MVR 100 million. The construction project takes more than 6 months and thus NR Co has a PE in the Maldives. MV Co, when making the payment to the NR Co, will withhold 10% of the gross payment (i.e., MVR 10 million) and only pay the remaining MVR 90 million to NR Co.
NR Co, will also be required to file a tax return to the MIRA after year end. The final tax liability of NR Co will be based on the net taxable income, which is calculated as depicted below:
|Gross income||MVR 100 million|
|Deductible expenses||say, MVR 50 million|
|Net taxable income||MVR 50 million|
|Tax free threshold||MVR 0.5 million|
|Profit subject to tax||MVR 49.5 million|
|Tax liability at 15%||MVR 7.4 million|
|WHT already deducted||MVR 10 million|
|Refundable eligible||MVR 2.6 million|
Although NR Co has a net profit margin of 50% (which is abnormally high by industry standards), the Company is still in a refund position at the year end. To have a final tax liability that is more than the NWHT already paid, a non-resident’s profit margin has to be more than 66.67%.
This means that excess money is held up with the MIRA every year and the MIRA may in majority cases, end up having to pay refunds to the NRC after the year ends; resulting in direct cash flow implications for NRCs as refunds could take prolonged periods to be processed. As a matter of fact, cash refunds are rarely processed by the MIRA. Even if refunds are processed on time, taxpayers will still have to wait until the year end to claim the refund, which will definitely impact their cash flow position.
The very broad scope of NRC payments
The ITA defines NRC as a non-resident who undertakes to perform services of any kind in the Maldives. The only exception to this is the services performed as an employee. The scope of these services are not very clear from the ITA. On the face of it, it seems all kinds of services by non-resident contractors will fall within this definition. Further, the MIRA’s interpretation, as given in their draft Non-resident Withholding Tax Guide, seems to be that where the contract value also includes goods components, the full contract value will still be subject to NWHT.
What is the solution?
The issue of NWHT on NRC payments, as the law stands now, poses a significant challenge for non-resident contractors doing business in the Maldives. While the current laws do not seem to address the business and commercial reality in case of non-resident contractors, I believe a legislative intervention is needed. Perhaps, as an interim solution, some sort of exemption from NWHT on NRC payments, in case where the contractor has a PE in the Maldives and is compliant in filing their tax return could be considered.
Until then, non-resident contractors must be very careful when they negotiate contracts in the Maldives.
1 Law Number: 25/2019
2 Section 10(b), ITA
3 Section 5, ITA
4 Section 27, ITA