Will you pay Income Tax under one bracket or many?

With the introduction of the Income Tax Act on new year’s day, one question seems to be quite popular: what is my bracket?  The ensuing debate seems to be equally interesting as well: one bracket or many brackets?

If we can simplify the debate purely from a legal point of view, here is what we would say.

We know that the law is going to impose an income tax on everyone whose earnings exceed MVR 60,000 per month. We know that the income tax speaks of a progressive tax and not a flat tax.

In simplest of terms, that means if you earn more, you will pay more.

The table of tax brackets in the law looks like this:

  1. If you earn under MVR 60,000 you pay 0%.
  2. If you earn between MVR 60,001 and MVR 100,000 you pay 5.5%.
  3. If you earn between MVR 100,001 and MVR 150,000 you pay 8%.
  4. If you earn between MVR 150,001 and MVR 200,000 you pay 12%.
  5. If you earn MVR 200,001 and more you pay 15%.

On the face of it, this table looks easy to understand. It is even easier to pinpoint a bracket and say now there is my bracket, and that is where my income will fall.

For example, if you earn a monthly income between MVR 150,000 and MVR 200,000 per month, it is easy to identify at a quick glance that your tax bracket will be the fourth bracket above, and that you will pay income tax at 12%.

But that may not be the case.

In effect, you may not be taxed only under one bracket at 12% if we go by the example above, and you may be taxed under all other ‘previous’ or ‘lower’ brackets as well.

If I could illustrate my point with an example, it will look like this:

You will start from the very beginning of the table. Your first MVR 60,000 will be taxed at 0% rate. You pay nothing for that bracket. Your remaining income up to MVR 100,000 will be taxed at 5.5%. Your remaining income thereafter but up to MVR 150,000 will be taxed at 8%, and the amount remaining, the excess amount, will be taxed at 12%.

That probably is the benefit of this form of progressive taxation.

The table in the law would have been clearer if the tax brackets provided in the law were provided with the additions indicated below:

  1. If you earn under MVR 60,000 you pay 0%.
  2. If you earn between MVR 60,001 and MVR 100,000 you owe 5.5% on the excess over MVR 60,000.
  3. If you earn between MVR 100,001 and MVR 150,000 you owe 8% on the excess over MVR 100,000.
  4. If you earn between MVR 150,001 and MVR 200,000 you owe 12% on the excess over MVR 150,000.
  5. If you earn above MVR 200,000 you owe 15% on the excess over MVR 200,000.

Based on the above illustration and our simplified approach, it is safer to conclude that you will not be taxed under a single bracket but you will have to pay tax under each of the brackets under which your income has overgrown the threshold for those brackets.

This interpretation is further reinforced by the language of section 7(b) of the Income Tax which is found right below the tax brackets table in the law.

For convenience, the clause is translated as follows:

The total of the tax payable under sub-clause (a) of this clause is the total tax payable when tax amounts for each of the tax income brackets provided in the table found in that sub-clause is calculated individually.

You may want to sit down with your tax advisors and understand the:

  • true volume of your earnings (in money or money’s worth);
  • exemptions that may be of use for you;
  • extent of allowed deductions which apply to you;
  • statutory tax rate and effective tax rate applicable to you; and
  • actual amount of money you will have to pay in income tax.