TAXATION OF NON-CASH EMPLOYMENT BENEFITS
Generally, employers are known to incentivize their employees by either giving out cash or non-cash benefits. A non-cash benefit may range from employees purchasing shares at a discounted price through an Employee Share Ownership Plan (ESOP); A rent-free house, a vehicle for private use or an Employer (being an educational facility) allowing its teaching staff to pay discounted school fees; Below market-rate loans, etc. All non-cash benefits are required to be taxed at their cost value or at the fair market value, whichever is higher. And where such value cannot be determined, then the Taxman may prescribe the value of the benefits.
Employers need to understand how non-cash benefits are considered under the Income Tax Act (Cap 470) and the Income (PAYE) Rules. Non-cash benefits are special perks exclusively enjoyed by someone being an employee in that particular organization. The ‘benefit’ or ‘advantage’ derived by the employee is considered a ‘gain or a profit” and brought under the charging sections of the Income Tax Act.
In an attempt to briefly discuss how such non-cash benefits have been treated by the Taxman during its tax compliance audits, I will focus on two interesting tax appeal decisions previously determined by the High Court. I’ll attempt to quickly gloss over them. First, Tax Appeal No. E027 of 2021 involving Brook House School Limited. In the said case, Brook House had extended discounted school fees benefits to the children of its teaching staff members. The quibble was whether such discounted school fees was an allowable expense deductible when determining the general income or as a “gain or profit” on the part of the employee thus subject to PAYE tax?
Crucially, one should understand the charging provisions under the ITA. Section 3 (2)(a)(ii) subjects all income of a person accrued in or derived from Kenya to income tax. Further, the section provides that chargeable income, include “gains and profit” from any business, employment or services rendered; any right granted to any other person for use or occupation of property etc.
Additionally, Section 5(2)(b) of the ITA actualizes Section 3 of ITA by defining what constitute ‘gains and profits’’ to include: wages, salary, leave pay, sick pay, commission, bonus, gratuity, travelling, entertainment or other allowance received in respect of employment or services rendered, or any amount so received in respect of employment or services rendered in a year of income.
Therefore, Brook House extending discounted school fees to members of its teaching staff, simply meant that the school fees payable was lower or discounted than what other parents would ordinarily pay based on its fee structure. To that extent, the court found that- any facility, benefit, advantage given to an employee for the services rendered during their term of employment amounts to a gain or profit as long as the amount is in respect of employment or services rendered. It is this benefit, gain or profit that is brought under the charging section under section 3(2)(a)(ii) read with Section 5(2)(b) of the ITA. Accordingly, the Court found that Brook House Limited was liable to collect PAYE.
The second case involves Tax Appeal No. 2 of 2021 where Equity Bank Limited (EBL) through its Employee Share Ownership Plan (ESOP) allowed employees to purchase shares at a discounted share price compared to the market value. Generally, ESOPs are established to encourage or facilitate the holding of shares in a company for the benefit of the employees. An employee would therefore be required to stay with the organization for a particular period before exercising his/her share options on the vesting date.
The question before the court was whether EBL was required to account for the PAYE on all the staff benefits accruing on the vesting date. Section 5(2) on “gains and profits” generally includes such share purchases as a “financial benefit” subject to tax, and calculates the value of the benefit as the difference between the market value per share and the offer price per share at the date the option is granted by the employer.
In the above case, EBL argued that the shares were acquired by the employees own independent initiative and not facilitated by EBL as an employer, thus EBL could not be subjected to account for the PAYE on the benefits. However, both the Tax appeals tribunal as well as the High Court, ruled that any offer of shares below the prevailing market price confers a taxable benefit to the beneficiary. Therefore, once the shares were vested, the Bank was required to charge PAYE as provided under the ITA. The ITA provides that any benefit under an ESOP is considered to have accrued to the employee either at the time the option vests on the employee or when the option is exercised by the Employee.
Based on the above decisions, employers need to understand how non-cash benefits are treated and considered under the ITA. This will help companies understand whether such benefits are tax deductibles capable of lowering their tax payables or taxable benefits.