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Is it possible to create an online refund to PayPal? I am going to Sales -> Orders Selecting the order I want, then select Invoices from the menu at the left and click Credit Memo, however the only option is to Credit Offline.

Am I missing something or do I need to need to configure anything extra in Magento?

I am using PayPal Websites Standard on Magento Community Edition 1.8.

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By default, the community edition of Magento has refunds disabled in the Paygate Models. In order to enable them you need to create a custom Model and overwrite a protected variable.

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For refund online you have to refund invoice not an order.

Like you need to take following step:-

Sales -> Orders -> Select an order -> click on invoice from the left side tab(but you should generated invoice already)

Then you can see generated invoice, so click on that where you will see credit memo button again, so click on that, now you will see the option of online refund.

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It is possible, You can save customer PayPal id (Encrypted) on your database in order to refund OR use the invoice number of the transaction, You can use PayPal's RefundTransaction api. Also PayPal only allows the refund up to only 60 days of the transaction, after that period, merchant will not be able to refund using this API.

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