A company that brings a local director onto its board has to decide how to pay them. Payroll with PAYE, or an invoice for services with VAT and possibly withholding tax? The choice looks administrative, but it follows from the legal nature of the relationship and it has consequences for both sides. This article sets out how the tax statutes frame the question, and which points to put to a tax adviser before signing.
Start with the relationship, not the tax
Under the Income Tax Act, income is chargeable where it is a gain or profit from a business, or from “any employment or services rendered” (section 3(2)(a)). Both routes are therefore taxable. What differs is who accounts for the tax and when.
If the director is an employee, the employer must deduct PAYE from emoluments and account for it (section 37). If the director is an independent supplier of services, the director is responsible for their own tax affairs, and the company may have to withhold on the payment. Our article on whether a director is an employee explains why the legal classification comes first. The tax treatment should follow the facts, not the other way round.
Route one: payroll and PAYE
Payroll suits a director who works for the company in a defined role, under its direction, for a salary, with benefits and leave. The company deducts PAYE each month and carries the statutory deductions that attach to employment. The Employment Act also applies in full, including minimum terms that cannot be waived.
The trade-off is cost and rigidity. The company takes on the employer obligations, and it must follow the Employment Act on notice and termination. For a non-executive board seat with a few meetings a year, payroll is often a poor fit because the person is not really employed.
Route two: fees for services and VAT
A services agreement suits an independent professional who sits on the board as one of several clients, controls how and when they work, and invoices the company. Two tax questions then arise.
VAT. VAT is charged on a taxable supply made by a registered person in Kenya (section 5). A taxable supply is a supply made “in the course or furtherance of a business carried on by the person” (section 2). A person who makes, or expects to make, taxable supplies worth five million shillings or more in twelve months must apply for registration within thirty days (section 34). A director with modest fees from one board may well be below that line. A professional with several engagements may not be. The registration question belongs to the individual, so ask them to confirm their position rather than assuming it.
Withholding tax. 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. That definition matters because it excludes employees. Whether and at what rate the company must withhold on fees paid to a resident individual is set by the Act, the withholding rules and the current Finance Act. Rates and thresholds change, so confirm them on the date of each payment instead of relying on an old figure.
Where this goes wrong
- A services agreement on paper, employment in practice. Fixed monthly pay, set hours, company equipment and no other clients point to employment. If the Kenya Revenue Authority treats the arrangement that way, the company may face PAYE it did not deduct, with interest and penalties. Section 37 puts the duty to deduct on the employer.
- Payroll for a person who is not an employee. This can create employment rights the company never intended to grant.
- No VAT or withholding analysis at all. Each invoice then carries an unpriced risk for both sides.
- Independence. For a director who must be independent under the Capital Markets Authority rules, a contract of service can itself defeat independence. See our article on independent directors and contracts of service.
Questions to put to your tax adviser
- Does the person’s own position make them a VAT registrant, now or within twelve months?
- Must we withhold on these fees, and at what rate, today?
- Do the working arrangements look like employment to the Kenya Revenue Authority?
- Do the company’s Articles require members to approve director remuneration, and has that been done?
- Who bears the tax if the classification is later challenged, and does the contract say so?
A short illustration
Take two hypothetical appointments. Company A engages a retired banker to chair its audit committee for a fee per meeting. She has other clients and sets her own schedule. A services agreement fits, and the questions are VAT and withholding. Company B appoints a local managing director on a fixed monthly sum, with leave, a company vehicle and set hours. That is employment in substance, and PAYE applies whatever the document is called.
How We Can Help
Clay & Associates Advocates drafts both versions of the document, a director’s employment contract and an independent director services agreement, with the exit terms aligned. We work with your tax adviser so the paper and the tax position match. Contact our corporate and commercial team. For a general test of classification, 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, 5 and 34; Employment Act, 2007 (Cap. 226), sections 2 and 3(6).
Frequently asked questions
Can we choose PAYE or VAT freely?
No. The legal nature of the relationship decides it. The parties choose the structure, but the facts must match it.
Does a director have to charge VAT?
Only if they are a registered person making taxable supplies in the course of a business. Registration is required once supplies reach five million shillings in twelve months.
Is withholding tax due on director’s fees?
It depends on the classification and the current rules. Confirm with a tax adviser before each payment cycle.
What if we get it wrong?
The exposure sits mainly with the party that had to deduct or account for tax, plus interest and penalties. Say in the contract who bears it.
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.
