Legal clinic: Did you know that gratuity is taxable?

Is there a law that specifies what should be taxed or not when one reaches retirement age?

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Hi Wakili,

I have often heard that when one reaches retirement age, (60-65 years), their income should not be taxed. Is this outlined in our constitution? My gratuity was taxed. Is there a law that specifies what should be taxed or not when one reaches retirement age? I contacted KRA and no help was forthcoming.

Senior citizen.

Dear Senior citizen,

Your concern evidences Kenya Revenue Authority (KRA) having sought tax from your income, which is part of its mandate. Income tax is an annual tax charged on a person or body corporate’s income accrued while in Kenya. Such a person or corporate body can either be resident or non-resident, and of any age.

Part II of the Income Tax Act (Cap 470) provides for what may constitute income to be return from business, dividends and interests, employment income (salary), royalties, rental income, pension incomes, income from a digital market place; natural resource income, leases and capital gains, besides any income, in the practicality of the word, and within the definition of KRA deemed to be income. In the wisdom of a tax agency, the aforementioned sources of income are taxable, and this may be the reason that informed levying of tax on the gratuity you claim to have earned.

In this context, it is important for our readers and the public at large to understand the meaning and difference of certain words. There is need to know that Kenya has dichotomous tax structure. This dichotomy is brought about by the existence of direct and indirect taxes. Direct taxes are those that are levied on the income of a person, and the burden of such tax falls on the very person who earns the income. Therefore, income tax is part of the direct taxes that Kenyans pay to the government in lieu of services.

Salary, may refer to the money an employee receives from an employer in return for their services, which are often rendered in a specific timeframe, within and alongside certain parameters agreed upon and coined in a contract of service. Salaries accrue as part of the terms that define employer-employee relationship. Part of the terms is for the employer to deduct and remit taxes within the Pay as You Earn (PAYE) scheme, for any employee paid more than Sh24,000, before the 9th day of every succeeding month. Further, as a consultant offering services that are within a contract for service, such a person is expected to pay withholding tax, 5% of which is remitted directly by the service recipient to KRA.

Gratuity is a monetary benefit provided to an employee by an employer upon working for a specific period of time. Section 35 subsection 5 and 6 of the Employment Act (2007) provides conditions within which gratuity can be paid to an employee. Gratuity is a token of appreciation for an employee’s service towards an institution, in this case, an employer. Such payment is dependent on organisational policies often provided for in the human resource management framework.

Gratuity is sometimes not paid to all employees for the following reasons: it cannot be paid for an employee who is a member of a registered pension or provident fund scheme under the Retirement Benefits Act (No. 3 of 1997): when an employee is a member of any other scheme established by the employer, whose terms are more favourable than the gratuity scheme: in line with the favourable terms provision, sometimes the qualification of being a member of a pension scheme is overlooked by the courts, as was held in the matter of Elijah Kipkoros Tonui v Ngara Opticians T/A Bright Eyes Limited [2014] where the claimant was awarded service pay despite being a member of NSSF. The court cited inferior social security of the NSSF. In regard to the preceding discussion, gratuity in the wisdom of KRA, is qualified as an income and therefore taxable.

When gratuity and salary are qualified as income, it is important to define what income is. Income is looked at as the revenue a business earns from selling its goods and services or the money an individual receives in compensation for his or her labour, services, or investments. The businesses in this case could include money earned from property such as rent, leasing of land and houses amongst others, while individual compensation could comprise, amongst others, return from consultancies or professional fee charged for services offered.

Age and taxation come into play when pension is the subject of focus. Any pension money is taxable according to the Income Tax Act. However, age at the point of accessing pension, besides conditions for one’s withdrawal or retirement and consistent membership to a pension scheme could influence taxation on pension. The law entitles a pensioner to tax-free lump sum from the pension fund of Sh60,000 for every year of membership in the scheme up to a maximum of Sh600,000. The balance is then taxed as stipulated in the Income Tax Act. The difference on how the Income taxation bands work depend on the age of the pensioner, and ascertainment of whether their discontinuation from the scheme was due to ill health or infirmity of the body.

Eric Mukoya has over 17 years’ experience working in the social justice sector. He’s the executive director of Undugu Society of Kenya. Legal query? Email [email protected]