Inevitably there comes a time when an individual has to leave their current employment.
This can be initiated by either of the parties to the employment contract, the employer or the employee, or due to the coming into force of specific terms contained in the contract.
Depending on the terms of the contract and the manner in which the termination arises, one party may be obligated to compensate the other.
In this article, we are going to provide an outline and insights on some of the scenarios which arise when processing tax on final dues for employees.
In accordance with the Employment Act of 2007, the party intending to terminate an employment contract should provide sufficient notice to the other.
Failure by either the employee or the employer to provide such notice automatically triggers the obligation to pay the other party the remuneration which would have been earned or paid by the other party for the notice period.
The payment in lieu of notice (also hereinafter referred to as “PILON”), is considered as income in the hands of the receiving party and should be taxed accordingly.
It is a common occurrence for employees to be indebted financially to their employers. Such debts should be recovered from an employee’s final dues after the calculation of Pay As You Earn (PAYE) and other mandatory statutory deductions.
The employer should observe the Employment Act provisions pertaining to the maximum amount of deductions that may be made from an employee’s wages at any given time.
On another level, not all separations go according to plan. A legal battle may ensue if a disgruntled former employee who perceives some injustice due to a purported lack of procedure or reasons for the termination takes matters to court.
In the event that the employer is found culpable, the court may calculate and award damages to the employee. In the majority of such cases, courts tend to award financial compensation to the employee.
This compensation is taxable in the hands of the employee and should be paid by the employer after withholding the appropriate deductions including tax.
There are also instances when an employee leaves employment before the end of the payment period, and the employer needs to apportion the employee’s regular earnings and benefits accordingly.
In most cases, the employer may not be in a position to tell if the employee is already working for another employer during the period between the last working day and the time of payment of the final dues.
According to the tax law, the employer should ensure that the correct tax is deducted from the earnings with reference to the tax tables.
In practice, where the compensation comprises trailing payments only such as bonuses and stock awards, these should be taxed at the marginal tax rate and tax reliefs should not be applied.
There are also nuances to the tax treatment on termination that is dependent on the existence or lack thereof of a contract and the exact terms of the contract that should also be considered.
In conclusion, different types of termination payments such as severance pay, ex-gratia payment, redundancy pay, PILON, and accrued leave among others attract different tax treatment and should be assessed separately, but reported together in the employer’s monthly payroll return (or Form P10).
The return should be submitted to the Kenya Revenue Authority on or before the 9th day of every month.
Finally, a tax deduction card (or form P9A) should also be supplied to the leaving employee covering up to the date of leaving and should include all taxable final dues paid to the employee.
The authors are senior managers with PwC Kenya’s People Risk Assurance team.
