A recent court ruling was a significant win for thousands of Kenyan workers regarding work contracts that affect PAYE. The courts are increasingly ruling against employers who keep staff on “temporary” contracts for years, hence avoiding PAYE.
Temporary work contracts deny workers the benefits and security of permanent employment. This is against the requirements of the Employment Act and also has tax implications.
While the ruling is foremost a massive victory for workers’ rights and dignity, it also highlights a significant, yet often overlooked, problem for the country. This represents a substantial leak in our national tax revenue.
This practice of perpetual “temporary” work contracts may be one of the reasons the government is struggling to collect adequate taxes to balance the national budget. Are we then surprised that year after year, the country has budget shortfalls that affect us all?
But how does a worker’s contract affect national taxes? The answer lies in one crucial system: PAYE. In this article, we will examine how temporary employment affects employment tax, specifically PAYE.
What is PAYE?
Let us break it down. PAYE stands for Pay As You Earn. It is the system the Kenya Revenue Authority (KRA) uses to collect income tax from employees and directors’ remuneration. The following example illustrates how PAYE works in practice.
Example
Imagine Ruth, a marketing officer, who earns a gross monthly salary of kshs 80,000. Her employer does not give her the entire amount. Before her salary is even deposited into her bank account, her employer calculates the income tax due (PAYE), deducts it, and pays it directly to the KRA on her behalf.
Ruth receives her net salary (the amount after tax). Her tax obligation for that month has already been settled. This system is efficient, automatic, and ensures tax compliance by Ruth and her employer.
PAYE is the backbone of personal income tax collection in Kenya. It is reliable and provides a steady stream of revenue every month. It funds public services, such as roads, schools, and hospitals.
How Temporary Contracts Bypass PAYE
Temporary contracts act as the broken link between the employee’s earnings and the tax kitty. That is a problem. So, where does the problem come in?
When a worker is kept on a series of short-term contracts for years, they often exist in a financial grey area. Here is how this leads to tax revenue loss:
a. The “Consultancy” or “Casual” Label
Many workers are misclassified as consultants or casual laborers. Instead of a regular salary that is subject to PAYE, they might receive a lump sum payment categorized as a fee. The fees are subject to withholding tax instead of PAYE. If the amounts are above a certain threshold.
The withholding income tax rates are currently lower than the PAYE rates. Due to this categorization, it becomes the individual’s responsibility to declare the income to the tax commissioner and pay the tax accordingly.
This process is often complex, intimidating, and easy to avoid, whether intentionally or not.
b. Unstable Income Streams
Temporary contracts are just that – temporary. The work is not permanent. It is often intermittent in nature. This poses a problem for PAYE collection. People get jobs when there is work available.
The work periods vary. They are for periods such as a three-month contract with a one-month gap or a six-month contract. This is problematic for the PAYE system. PAYE is remitted on a monthly basis.
Even if an employer attempts to deduct PAYE from a temporary contract, the period worked is not consistent. This makes accurate tax calculation and remittance complicated. It is often prone to error or underpayment. The tax commissioner will raise questions.
c. No Access to Benefits, No Incentive for Formalization
Temporary workers are in this precarious situation because they do not benefit from other statutory deductions. They are often denied payslips, SHA, and SHIF NSSF deductions.
This lack of formal work organization pushes workers and employers who exploit this model further into the shadows of the informal economy. This is far from the watchful eye of the tax commissioner.
The result? Many people are effectively working full-time jobs but are not consistently contributing to the PAYE system. This means billions of shillings in potential tax revenue are lost every year.
A Win for Workers is a Win for the Taxes
The recent court rulings forcing employers to convert long-term temporary staff to permanent employees are a fundamental change. This is not only a win for the workers but also for tax collection.
Here is why:
a. Automatic Compliance
Once a worker is on a permanent payroll, PAYE deductions become mandatory and systematic. The employer handles it, ensuring a consistent flow of tax revenue from that employee on a month-to-month basis.
b. A Broader Tax Base
Formalizing thousands of workers instantly expands the number of people reliably paying income tax – PAYE. This is referred to as “broadening the tax base.” The government has been struggling to broaden the tax base for some time now.
Formalizing the jobs is a much healthier way to increase tax revenue than repeatedly raising taxes. The government has been trying to raise revenue from the same, already over-taxed persons – individuals, and entities, taxpayers.
c. Boost to Other Revenues
Permanent employees should also be enrolled in the SHIF NSSF and SHA NHIF. Formalizing employment will also increase their contributions to these vital social funds.
Their stable income also makes them more reliable consumers. They pay VAT on their purchases, which further boosts government revenue.
Beyond the Courtroom
While the court rulings are crucial, more can be done in other areas beyond dealing with employers only. The following are three actions that can be undertaken.
a. Strict Enforcement of Labour Laws
The government must proactively audit large employers. This exercise should be specifically designed to audit the private, formal, and informal sectors. The goal is to identify and address the misuse of temporary contracts. This is for the benefit of the employees and employers.
b. Simplification of Tax Returns Filing
Many individual taxpayers find it daunting to file their tax returns. For genuine consultants and freelancers, the tax commissioner could simplify the tax filing process. This will make it less daunting for them to comply with the tax requirements voluntarily.
c. Public Awareness
There is a need for massive awareness campaigns to educate the public about work contracts. Workers themselves need to be educated about their rights and the tax implications of their employment status.
Final Thoughts on PAYE in Contract Work
Fair labour practices are not only about temporary employment. They are also about a more robust and fair tax system. This is about ensuring every worker is on the right contract.
It will also ensure that every worker pays their fair share of taxes through PAYE. This will be a critical step toward a country where everyone contributes to and benefits from national development.
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