Paying a director looks simple until the tax authority asks how it was treated. Was it employment income, run through payroll, or a fee for services, paid against an invoice? The two have different mechanics, and a company that picks one by habit can find the other applied to it years later. This article explains where the risk sits and how to reduce it. It is not tax advice for any particular arrangement, and several points below are for a tax adviser to confirm.
Two charging routes in the same section
Section 3(2)(a) of the Income Tax Act charges tax on gains or profits from “any employment or services rendered”. Employment and services are listed side by side, so the Act does not make director’s fees tax-free on either route. The statute also defines “director” to include a member of the board of a body corporate. The question is not whether the money is taxable, but which mechanism collects the tax.
If it is employment: PAYE and the employer’s duty
Section 37 requires an employer paying emoluments to an employee to deduct tax and account for it, in the manner prescribed. The duty sits on the company. If the company treats a director as an independent supplier and the tax authority treats the arrangement as employment, the company is the party exposed for deductions it did not make. Section 37(2) deals with an employer’s failure to deduct or account for tax, so the consequences do not fall on the director alone.
If it is a fee: withholding and the “management or professional fee”
The Act defines a “management or professional fee” as a payment to any person, other than a payment made to an employee by an employer, for managerial, technical, agency, contractual, professional or consultancy services. The exclusion for payments to an employee by an employer shows how much turns on classification. If the director is not an employee, a fee for professional or consultancy services may fall within the withholding regime. If the director is an employee, the payment is emoluments and the employer’s PAYE duty applies instead.
The rate, any threshold, and the rules for residents and non-residents are set outside this short article and are amended often. Obtain the current position on each payment date. The point to take from the statute is that the line between the two regimes is the employment relationship itself.
VAT is a separate question
Where a director supplies services as an independent professional, VAT may arise as well. A taxable supply is one made in the course or furtherance of a business carried on by the person, and registration is required once taxable supplies reach five million shillings in twelve months (VAT Act, sections 2 and 34). Many directors fall below this on one board. Some do not, particularly where they hold several appointments through a consultancy.
Where companies get it wrong
- Using whichever route the director prefers. The relationship decides, not preference. Read our article on whether a director is an employee and our summary of PAYE or VAT for a local director.
- Mixing the signals. A monthly fixed sum, a company email address and set hours, paid against invoices, looks like employment to a reviewer.
- Paying executive directors twice. An executive director has a salary for the job and perhaps a fee for the board seat. Document each, and tax each correctly.
- Ignoring approval. Directors’ remuneration usually needs authority under the company’s Articles. Tax correctness does not cure a payment that was not properly approved.
- Silence on who bears the tax. The contract should say who bears any tax, interest or penalty if the treatment is challenged.
A simple review before the first payment
- Decide the relationship: office-holder with fees, or employee with salary.
- Check the working arrangements against that choice.
- Get written tax advice on withholding, PAYE and VAT for that structure.
- Record Articles approval for the remuneration.
- Put the tax allocation clause in the contract and keep the calculations on file.
A short illustration
A company pays a local director a flat monthly amount against a monthly invoice and withholds nothing. The director works set days at the company’s offices, has a company email address and no other clients. If the tax authority treats that as employment, the company’s exposure is the PAYE it did not deduct under section 37, and the director’s own filings may need correcting. Now change the facts: the director is an independent consultant who sits on three boards and invoices each. The services route is far easier to defend, and the live questions become withholding on the fee and VAT registration. The paperwork is identical in both cases. Only the facts differ.
The short version
Director’s fees are taxable either way. The risk is in using the wrong collection mechanism, which leaves the company answerable for PAYE it should have deducted or for withholding it should have applied. Decide the relationship first, test the facts against it, and get written tax advice before the first payment.
How We Can Help
Clay & Associates Advocates drafts directors’ appointment letters, executive employment contracts and services agreements, and works with tax advisers so the paper matches the tax position. Reach our corporate and commercial team. For a general test of status, see our article on employee or independent contractor.
Sources: Income Tax Act (Cap. 470), sections 2, 3(2) and 37; Value Added Tax Act, 2013, sections 2 and 34.
Frequently asked questions
Are director’s fees taxable?
Yes. Gains or profits from employment or services rendered are chargeable under section 3(2)(a) of the Income Tax Act.
Who is liable if PAYE was not deducted?
The employer carries the statutory duty to deduct and account under section 37, so the company is exposed.
Does withholding apply to every director?
Not automatically. The definition of a management or professional fee excludes payments to an employee by an employer. Confirm the current rules for your arrangement.
Do we need a tax opinion?
For any non-trivial arrangement, yes, because rates, thresholds and practice change.
Need advice on your own matter?
Tell us what you are dealing with. You will know what it involves and what it costs before you commit.
This article is general information on Kenyan law as at its publication date, not legal advice. Reading it does not create an advocate and client relationship.
