Contractors in Kenya operate under a distinct tax regime compared to formally employed individuals on the PAYE (Pay As You Earn) system. As independent entities, contractors are responsible for managing their income tax obligations.
As such, navigating the intricacies of tax laws and regulations is crucial for contractors to ensure compliance and avoid penalties.
This guide will explore key strategies to sidestep tax penalties, emphasizing the importance of familiarizing oneself with the applicable tax laws, understanding tax rates, adhering to filing deadlines, and maximizing allowable deductions without evading your tax obligations.
There are two ways to sell your services and skills in the labour market: as an employee or independent contractor.
As an employee, your engagement is a “contract of service.” This means you have an employment contract and work under the control and direction of the employer.
As an independent contractor, your engagement is a “contract for service.” This means you do not have an employment contract; you are not an employee of the hiring entity and, therefore, considered self-employed.
If you are formally employed, you will be taxed through the Pay As You Earn (PAYE) regime.
This is a system of tax collection whereby employers are required to deduct tax from the employment income of their employees and remit the tax to the Kenya Revenue Authority.
In this regime, an employer is required to apply the Individual Income Tax Rates (Bands) that range from 10% to 35% depending on the employee's monthly salary if they earn more than Ksh24,000.
If you are an independent contractor, you will be taxed under the withholding tax regime. This is a method of tax collection whereby a payer of certain incomes deducts tax upon payments of certain incomes to payees and then remits the tax deducted to KRA. The deduction rate varies depending on the type of income payable and ranges from 3% to 30%.
Independent contractors pay a withholding tax of 5%. Like PAYE, the person making the payment deducts the withholding tax before paying the due amount to the contractor.
However, management, professional, training, and contractual fees whose aggregate value is Ksh24,000 and below monthly are exempted from withholding tax.
After making the deduction, the payer is required to generate a withholding tax certificate on iTax, which is automatically sent to the payee once the payer remits the withholding tax to KRA. All this should be done within 5 working days after the deduction is made.
An independent contractor is anyone who charges management fees, training fees, or professional fees, runs a consultancy or agency, or offers sales promotion, marketing, and advertising services. All payments made for any of these services are subject to a withholding tax of 5%.
Let’s break them.
Management Fee Contractor: Independent contractors who provide management services and charge a fee for overseeing and directing specific aspects of a business or project.
Example: A project manager hired to coordinate and oversee the development of a real estate construction for a client may charge a management fee for their services.
Training Fee Contractor: Independent contractors who specialise in providing training services and charge a fee for educating individuals or groups on specific skills or knowledge.
Example: A freelance software trainer hired by a company to conduct workshops and training sessions for employees on the latest programming languages, charging a training fee for their expertise.
Professional Fee Contractor: Independent contractors with specialized professional skills who charge fees for their expertise in areas such as law, accounting, design, or other professional services.
Example: A graphic designer who works independently and charges professional fees for creating unique and customized visual content for clients.
Consultancy or Agency Contractor: Contractors who run consultancy firms or own agencies that offer clients a range of services and expertise. They may charge fees for consultation, project management, and other services.
Example: A marketing consultant who runs their own consultancy, providing strategic marketing advice, planning, and implementation services to businesses for a fee.
Sales Promotion, Marketing, and Advertising Contractor: Independent contractors who specialize in sales promotion, marketing, and advertising services and charge fees for creating and implementing campaigns to promote products or services.
Example: An influencer hired by a company to create and manage online advertising campaigns, charging a fee for their expertise in driving brand awareness and customer engagement.
Withholding tax is not a final tax on resident payees. You are required to declare the income and the withholding tax certificates upon filing individual tax returns and pay any income tax due. The withheld 5% is a prepayment of the final income tax liability.
As a contractor, when 5% is withheld and remitted to KRA, you keep the remaining 95% of your income. However, this 95% is not exempt from taxation.
When filing annual tax returns, you are required to declare the total income earned, including the amount subject to withholding tax.
When you file your annual tax returns, you add the amount received (the 95% you kept plus the 5% withheld) as your yearly income. Depending on your total income, you may have additional tax obligations after considering deductions and exemptions—more on this below.
The applicable tax rate will depend on your income tax band, which is between 10 percent and 35 percent. Depending on the total income you earned as a consultant, you may find that the withholding tax does not cover your entire tax liability.
After filing your annual tax returns and determining your total tax liability, you should calculate the withholding tax already remitted on your behalf. This amount is then deducted from your Total Tax Payable. Here, you will run into three possible scenarios.
KRA considers contractors to be self-employed, so if you earn income as a contractor, you may have to file your taxes as a business owner. This means you will have to file your taxes like a company filing in the profit and loss sections and the balance sheet.
Independent contractors don't have an employer covering their costs or reimbursing work expenses. Therefore, they can claim those business-related costs as contractors' tax deductions, offsetting their income and lowering their tax bill.
Deductibles allow you to take advantage of tax breaks you qualify for. When something is tax deductible, you can reduce your total taxable income by the amount of the qualifying expense.
Many, but not all, costs you incur are tax deductible. To reduce your taxable income by the largest possible amount, you must keep track of all deductible business expenses.
Maintain detailed records of your income, expenses, and any relevant documents. This includes invoices, receipts, and contracts. Accurate records will help you during tax filing and can serve as evidence in case of an audit.
When filling out your returns, you will need to download and complete the Income Tax – Resident Individual form. You will go to "Section B: Profit and Loss Account" on the form and fill out the total turnover and expenses you incurred. You will then subtract the expenses from the turnover; the difference will be your taxable income.
The form will show you any expenses and deductions you qualify for, and you will insert the amounts where applicable. Examples of deductions include travel expenses, advertising expenses, professional development costs, office supplies, etc.
Every Kenyan with a KRA PIN must file this return yearly regardless of whether they earned an income. Be aware of the tax filing deadlines, and pay your taxes on time. Late payments may result in penalties and interest charges.
You can file your Individual Income Tax Returns for a particular year of income anytime between 1st January and 30th June of the following year.
Late filing can attract a penalty of Whichever is higher between 5% of the tax due or Ksh2,000. On the other hand, a late payment will attract a penalty of 5% of the tax due and a late payment interest of 1% per month on the unpaid tax until the tax is paid in full.
If you run into a roadblock when filing your tax returns as a contractor, consider consulting with a licenced tax professional or accountant. This is crucial for understanding your specific tax situation and ensuring compliance with the law. They can provide personalized advice based on your income, expenses, and business structure.