The Final Deduction System (FDS) is a tax calculation method that ensures employees’ tax liability is calculated on total earnings as they are paid throughout the year. Once an employer selects a method (either Averaging or Forecasting), they must stick to it for the entire tax year.
The Averaging Method calculates PAYE by determining an employee’s average taxable income to date, annualizing it, and applying the tax rates accordingly. This approach smooths out tax deductions over the year, ensuring stability.
Key Elements in Tax Calculations
1. Regular Earnings Regular earnings include a fixed monthly salary and allowances. These earnings are predictable and annualized for tax calculations (i.e., multiplied by 12 to estimate yearly income). 2. Allowable Deductions Before calculating tax, certain statutory deductions are subtracted from the gross income, including: •NSSA (National Social Security Authority) contributions •NEC (National Employment Council) levies •Trade Union fees •Pension contributions 3. Irregular Earnings Irregular earnings refer to payments that are not received regularly, such as Cash in Lieu of Leave (CILL). Unlike regular earnings, these figures are not annualized but are simply added to the annual taxable income in their exact amount. This ensures that the irregular income is appropriately accounted for in the total taxable income. 4. Bonuses These are also treated as irregular income. The tax-free portion is first deducted, and the remaining taxable amount is included in the total taxable income for that specific period. The tax on this taxable bonus portion is then calculated in a similar manner to how irregular earnings are handled. 5. Tax Credits Tax credits reduce the total tax payable and are available for specific employees, such as: •Elderly persons (55+), mentally or physically disabled persons, and blind persons. •Employees who incur medical expenses or contribute to medical aid for themselves or their immediate family—defined as their spouse, children under 18, or child students—are eligible for a tax credit equal to 50% of their contributions or expenses. |
Steps to Calculate PAYE Using the Averaging Method
1.Calculate cumulative taxable earnings to date (sum of earnings so far, minus allowable deductions). 2.Determine the average taxable income by dividing cumulative taxable earnings by the number of months worked. 3.Annualize the income by multiplying the average taxable income by 12. 4.Calculate the annual tax payable using the tax tables. 5.Find the average monthly tax by dividing the annual tax by 12. 6.Determine cumulative tax payable to date by multiplying the average monthly tax by the number of months worked. 7.Deduct any tax credits claimed to date. 8.Add the 3% AIDS Levy to the cumulative tax payable. 9.Subtract cumulative tax already paid in previous months. 10.The remaining amount is the PAYE due for the current month. |
Worked Example: PAYE Calculation Using the Averaging Method
Normal Salary Mr Ashton had the following earnings and deductions for the period from January to March 202X
The following steps outline how to determine the tax for March.
If Mr. Ashton received a bonus of $1,200.00 and CILL of $200.00 in March then tax would be calculated as follows:
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