On PAYE tax, there is no free lunch

 

Students study at the Kenya National Library Service Mombasa Branch as schools remained closed over the teachers’ pay dispute on September 21, 2015. PHOTO | KEVIN ODIT 

Opinion and Analysis

By JOSEPH THOGO

One area that habitually presents challenges in the taxation of employment income is the issue of the emoluments that are paid to workers as a result of employment.

Here, I am referring to both cash and non-cash benefits that an employee is entitled to from his employer. These can be in the form of a cash salary and other benefits which are paid in kind, for example, the provision of housing, a car, club subscription, shares in the company, school fees and medical insurance.

This is not exhaustive; variations in the types of benefits are boundless and diverse depending on employer-employee negotiations. All these are considered gross income to the employee and where they are subject to tax, it is the obligation of the employer to account for tax.

Imposing and collecting tax on the bit that is paid in cash should be straightforward – at the end of every calendar month the employer deducts 30 per cent income tax and remits it to the KRA by the due date.

This is the case where the employment contract states a gross amount, for example, a gross salary of Sh100,000. It means that the total employee expense in the employer’s books is Sh100,000 since the tax will be computed from this amount and the employee will take home the amount after tax.

A slight complexity arises where the employment contract states a net figure payable to the employee. This in essence means that the employer shoulders the tax burden on behalf of the employee.

From my example above, the employee takes home Sh100,000 which means that the employer has to gross-up this figure to find the tax payable. This means that the total employee expense in the employer’s books will definitely be higher than the Sh100,000 since he has to pay the employee’s income tax from his pocket.

The fact that the employer shoulders the employee tax burden in a net contract has been construed to be a taxable benefit on the employee, which should be taxed as well. This creates a situation where benefit becomes taxable payable in perpetual since every payment by the employer is considered a benefit.

Right or wrong, this has been at the centre of acrimonious debates between tax authorities and employees around the world.

Technically, whether an employee is paid in cash, a benefit, property or use of property, the payment is considered to be gross income to the employee unless indicated otherwise.

Payments in kind can be categorised into those that are subject to tax and those that aren’t. Those that are not subject to tax will often be expressly stated in the taxing legislation and include such items like medical insurance provided to employees.

There are other benefits which are not expressly excluded from tax but which are excluded because it would be impractical and administratively challenging to tax them.

Take the example of an employer who has an office coffee maker and employees are allowed to consume all the free coffee they want.

Realistically, reporting and enforcing the reporting of such income is impossible. Similar conclusions can be reached with respect to a secretary’s typing of a personal letter for the boss or the occasional personal use of the company photocopying machine.

Even though their value is conceptually gross income, nevertheless to some extent the tax authority, even without statutory authorisation, has allowed taxpayers not to report them.

Given that the burden of accounting for the tax on a worker’s employment income rest with the employer, it is his obligation to ensure that tax is accounted for on both cash and non-cash benefits.

The first step should be to understand the nature of the employment contract and whether it is a gross contract or a net-pay contract.

It is, therefore, important to ensure that employment contracts are reviewed for compliance with not only the Employment Act but also the Income Tax Act.

The second step should be to ensure that all non-cash benefits accruing to an employee as a result of their employment are identified and their tax status determined.

It is important to mention that the benefits need not accrue to employee directly; they could accrue indirectly by being paid to the employee’s spouse, children or indeed to a third party at the direction of the employee – the litmus test is usually whether the benefit is accruing as a result of employment.

The penalty for non-compliance can be quite punitive and the taxman will seek his pound of flesh from the employer as his statutory tax agent under the PAYE mechanism.

However, where there has been initial non-compliance by the employer in accounting for the tax due on the benefits paid to an employee, it seems that it would be possible to institute a civil suit against the employee for the recovery of the tax that he (the employer) should have accounted for on the benefits but did not [Co-operative Bank of Kenya Ltd versus Erastus Kamau Mureithi].

This implies that there is no such thing as a free lunch and employees have a part to play in assisting their employers meet their compliance obligations.

Mr Thogo works with Deloitte East Africa. jthogo@deloitte.com