Tax considerations when terminating an employee

According to the tax law, the employer should ensure that the correct tax is deducted from the earnings with reference to the tax tables.

Inevitably there comes a time when an individual has to leave their current employment. This can be initiated by either 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 how the termination arises, one party may be obligated to compensate the other as per the terms of the contract.

In this article, we outline some of the scenarios that arise when processing tax on final dues for employees.

Under the Employment Act of 2007, the party intending to terminate an employment contract should provide sufficient notice to the other party.

Failure by either the employee or the employer to provide such notice 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 is considered income in the hands of the receiving party and should be taxed accordingly.

Final dues

It is common 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 tax and other statutory deductions.

The employer should observe the provisions of the Act pertaining to the maximum amount of deductions that may be made from an employee's wages at any one given time.

On another level, not all separations go according to plan. A legal battle may ensue if a disgruntled former staff who perceives some injustice due to a purported lack of procedure or reasons for the termination takes matters to court.

Financial compensation

If 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.

The authors are Senior Managers at PwC Kenya’s People Risk Assurance team