Pay as You Earn (PAYE) - Ep1

Transcript

Titus Mukora

Welcome to our ongoing series of podcasts in PwC Kenya tax. Today we're going to be speaking on PAYE and the changes that have come through in the Finance Act 2023. I've got some very esteemed guests with me today, and I'm very happy to have you here. So, on my immediate right, I've got Obed Nyambego, and on my left, I've got Shreya Shah. I’ll ask them to do a quick introduction about themselves. Obed?

Obed Nyambego

Thank you, Titus. My name is Obed Nyambego. I'm a tax partner at PricewaterhouseCoopers, and I'm happy to be part of this conversation on the taxation in Kenya.

Shreya Shah

Thanks, Obed and Titus. My name is Shreya Shah and I'm a senior manager in the tax team providing employment tax consulting services.

Titus Mukora

Thank you very much, guys. So, let's just get right into it. Obed, the first question I'm going to give to you. Obviously, this has been a very controversial Finance Act. One of the things I think that's really gnawing at people is around the taxation rates. We now have a top tax rate of 35%. How does that compare with other countries in East Africa? Are we out of kilter with the rest of Africa, or are we more or less aligned?

Obed Nyambego

Thank you, Titus, and that's a great question. So, one of the highly debated issues in this year's Finance Act is the top tax rate of 35%. Now, when you step back and compare, in Africa, some select countries: for example, in West Africa, Ghana has a top tax rate of 30%; Nigeria has 24. You’ve got the southern part of Africa: South Africa has a high rate of 45% and Mauritius has 15%, which is really the lowest in Africa. Now when you come to the East Africa region, our immediate neighbours: Uganda has 40%, which is the highest in the region, and Kenya then has gone to 35%, while Rwanda and Tanzania are at 30%.

But I think if you also take a global view, countries in the Nordic part of Europe, they actually have very high tax rates, some as high as 60%. But the difference in those countries is that then they receive a lot of services like education and health, which are really free.

Titus Mukora

Yeah. And this issue about high tax rates, I mean, it's an evolution because I think back in the day the top tax rates for Kenya were actually pretty high and then have come down. But we seem to be going back to those days of a high marginal tax rate?

Obed Nyambego

Yeah, I have been in tax practice for about 25 years and individual tax rates in Kenya were very high. The top tax rate in 1986, believe you me, was 65%. This was pretty high. But it was our policy to progressively bring down those tax rates — and up to the year 2000 they had come to 30%.

Now, we stayed at that rate for over 22 years. From 2000 to 2022, we were at a 30% top tax rate. There is one year during the COVID era when it dropped to 25% just to cushion people against the impact of COVID. But then we went back to 30%. Now we seem to be seeing a movement to 35% this year. So, one would probably then ask, is it a policy change then to revert to the higher tax rate, or is that a one-off move?

Titus Mukora

And is there an impact in terms of having a different top tax rate within the East African community as we are trying to integrate as an East African community? But now we seem to have a different top tax rate as compared to the other East African community countries. What is the impact of that, or the consequence?

Obed Nyambego

One of the impacts you could say … I mean, all of us here, we know we’re in a fiscal space where either the government borrows to finance its operations or taxes people.

Now, they seem to be saying that we have reached a limit in our borrowing and are therefore reverting to taxation. But studies have been done to show that higher taxes do not necessarily lead to higher revenue. I mean, one of the famous studies is by the Laffer Curve, which demonstrated that, actually, higher tax rates could even lead to lower taxes, then, because people are not incentivized to pay taxes.

I think then the other thing you want to see of higher taxes is, obviously, in Kenya we are trying to position ourselves as a hub. So, there are a lot of companies that are headquartered here serving the East Africa region and some parts of Africa. And therefore, when those people come here to Kenya, one of the key things they look at is the tax rates.

If you have a very high tax rate, of course, the net take home is lower and therefore Kenya becomes less attractive. And those people then can consider other countries. Now, the impact of that is that, if those people relocate to other regions, we don't just lose their taxes, but also, we lose what benefits they bring the economy in terms of consumption in our hospitality industries, restaurants, hotels, the education institutions where they take their kids.

The travel industry suffers. And I think the other impact that we will see is, when you have a higher tax rate, then the employment costs are higher and you’re expecting to see employees agitating for a higher pay rise. Therefore, actually what you've seen, people cut down the number of hires they're making so that they can be able to pay higher taxes.

Titus Mukora

And in respect of integration with EAC, is there an impact for us?

Obed Nyambego

If you remember, we are trying to harmonize. So the integration has to be the harmonization. And one of the things we have to harmonize is the tax rates. Now, when you look at the East African market, for example, the corporate income tax rate is pretty much standard at 30% for Kenya, Uganda, Tanzania and Rwanda. When we look at VAT, it's actually standardized at around 18% for Rwanda, Tanzania and Uganda, and Kenya has a lower rate of 16%. So not too much dissimilar. But when you go to employment taxes, the top tax rate, as I said earlier, for Uganda is 40%, for Kenya is 35% and then Rwanda and Tanzania is 30%.

So we see a bit of disparity in that case. And therefore, what then happens is that we do not have a double tax treaty within the region that has been in negotiation forever, never been signed and ratified, and therefore with that now you find that Kenyans who are working, for example, in Tanzania, when they come to Kenya, their higher tax rates, then they have to pay additional taxes in Kenya, which actually makes it costly for them.

And think I probably want to say one more point, that Kenya obviously has a set of taxes that are paid in our country, in Kenya, but now it requires individuals to come to Kenya, calculate their taxes in Kenya, and then offset it with what is happening in other countries, and pay some additional taxes. So it really doesn't do justice to the harmonization agenda.

Titus Mukora

Absolutely, and it sounds quite complex also in terms of our compliance burdens. Let me just pull Shreya now into this conversation here. Shreya, what are you hearing from your clients around some of the practical issues in terms of complying with this Finance Act 2023 and the changes that have come through?

Shreya Shah

I think one is being the accelerated effective date of bringing in the new PAYE rates of 32.5% and 35%. Under the Finance Act, this is likely to come into effect from 1st of July. So this is quite a challenge, especially given that the implementation of the Finance Act has stalled due to the court case. So most of our clients are calling us. They are in limbo as to what rate to apply, and some clients do have two payments in a month.

Payroll software needs to be updated in the next few days as well as updating various sort of parameters in terms of bringing into effect the new rates. So, this is quite challenging. It's a notable departure from previous changes in the PAYE rates. We would have expected them to come into effect at the beginning of the calendar year, which ties into the start of Kenya's tax year.

Secondly, I think there will be a challenge in terms of, say, bonus payments, which may straddle two rates. During 2021 when there was the COVID pandemic and we had two rates, most of our clients struggled with filing their tax returns given the two rates. So, I think there should have been some more thought in terms of delaying the start date to the 1st of January.

Titus Mukora

Yeah, I guess at the beginning of a calendar year is the best time for PAYE changes to come through. I think we can't leave this discussion without talking about one of the most controversial aspects of the Finance Act, which has been the housing levy. And I think what we ended up with in the final Finance Act in terms of the housing levy was a bit different from what was originally proposed in the Finance Bill.

So just maybe take us through what's the final version of — I'm not sure whether it's a housing levy, a housing tax, a housing contribution. Give us a rundown of the sort of final status that we have on that.

Shreya Shah

So of course, they've named it the affordable housing levy; I think affordable is tongue-in-cheek. Notable changes from the proposals in the Finance Bill 2023. One, we were expecting it to be at 3% of the basic salary, payable by the employer and the employee, but capped to 5,000 per month.

The new proposal — the new changes in the Finance Act are based on 1.5% of the gross monthly salary. And this is at an uncapped rate payable by the employer and the employee. So quite a significant difference. Also, it wasn't supposed to be a levy payment. Of course, we know that all levy payments in Kenya are non-refundable. So, it's effectively become a tax, meaning employees who remit this levy will no longer get access to their contributions, which was previously suggested under the Finance Bill.

And I think the big one is around it being 1.5% uncapped on the gross monthly salary. So in addition to the salary, it brings into the mix bonuses, any other cash allowances, non-cash benefits. So quite a significant hit on the take home pay for employees in the wake of rising inflation and high cost of living — and of course also a significant cost of employment because most employers haven't budgeted for such a high increase in their cost of employment.

Employers are also going to have to pay this levy at an uncapped rate. We've seen that the PAYE return has already been updated on iTax and the payment date is aligned to the ninth of the following month, which is aligned to the PAYE payments.

There's also going to be a penalty based on 2% per month of the unpaid amount, which employers will be liable to pay if they default on this. So, I think this saga will continue, especially given the Finance Act implementation has stalled. We wait to see what unfolds.

Titus Mukora

I can't wait to see my pay slip at the end of this month.

Obed Nyambego

I’m not sure that you’ll like it. One other thing, Shreya, that I saw in the Finance Act, which I didn't see in the Finance Bill, was a tax exemption for non-residents. Tell us a bit more about it.

Shreya Shah

This was around where the government has agreements with its development partners. There is a proposal to provide a tax exemption on any grant income. So, yes, this was not in the Finance Bill, probably a welcome move. But one thing to note is that it will only apply to non-resident subcontractors or employees. So, I guess if you do become resident, then perhaps the tax exemption will not apply because that's how it has been worded in the Finance Act.

It's important for such individuals to really watch their days in the country and look at the definition of residency in the Income Tax Act or the double tax treaty that applies.

Titus Mukora

Okay. Excellent. I think I do want to bring this discussion to a bit of a close. And I just wanted to ask whether you have some closing remarks on other implications that might be there in terms of the Finance Act, in terms of PAYE or other consequences that you think would be important for our viewers or our listeners to know about?

Obed Nyambego

Yeah, Titus, thank you. Two thoughts from me. One, when you speak to a number of finance directors and HR directors, they actually say that this is going to be quite a hit on the employees. So, for example, most people are just at the margins. What they were taking home was very small: people’s loan obligations, other commitments they are doing — and taxes.

And remember other levies: NSSF, NHIF, the housing levy and all that. So the other pieces of legislation in the Employment Act actually places a cap on the maximum deduction you can cut from an employer to tax. Now with this introduction of additional levies, it’s going to be a challenge to stay within that cap — and therefore likely not to be able to meet that.

I would have loved to see where actually the laws around harmonizing the impact is thought through. The other point I probably want to say is that there appears to be sort of an onerous burden on employees to bear higher tax costs. So, there is a fixation on taxing employment income, but perhaps what you should be thinking about is casting the net wider so that people actually can contribute towards their fair share to the taxation in Kenya.

Titus Mukora

And Shreya, some closing thoughts from you?

Shreya Shah

I know there's been a lot of debate as well and in the press around NHIF. I know it's not been part of the Finance Act, but you know, if NHIF rates also go up to 2.75% at an uncapped rate along with the levy, I think employees will have a severe hit on their take home pay.

And I think some more thought needs to be brought into broadening our tax base. In the budget statement the CS stated that just over 26,000 employees will be hit by the 32.5% and 35% rates and also 57.5% of the 3.3 million workers are the ones who are paying tax.

That means the additional revenue from the increased rates will only impact 0.8% or so of the people. So I think: is the government really going to achieve its objective of making the tax system more progressive? I think more thought needs to be given to broadening the tax base and bringing the informal sector on board so as to achieve that objective of collecting more revenue.

Titus Mukora

I'd like to thank both of you, Shreya and Obed. Really enjoyed listening to you guys around some of these aspects of the Finance Act. I think this is going to be an ongoing saga, an ongoing discussion point. I look forward to welcoming you guys back on the next podcast. And yeah, thank you very much.

Obed Nyambego

Thank you so much, Titus, and thank you so much, Shreya.

Shreya Shah

Thank you.