PAYE on Director’s fees & Drawings

Case study: Seven Seas Technologies Ltd v Commissioner of Domestic Taxes (Appeal 1245 of 2022) [2024] KETAT 11 (KLR) (Civ) (26 January 2024) (Judgment)

SSTL was issued with a demand of Ksh. 900,443,330.00 vide the KRA’s letter dated 27th August, 2020. The demand was for the period 2015 to 2019 in respect to Value Added Tax, PAYE and Withholding tax

SSTL objected to the demand on 22nd September, 2020. There followed various correspondence between the parties, mainly the request and provision of documents.

KRA vide a letter dated 10th March 2021 issued its objection decision confirming the tax liability of Kshs. 900,442,330.00, which was inclusive of penalties and interest.

In this analysis, we will dwell on PAYE.

Aggrieved by KRA’s decision, SSTL filed its Notice of Appeal dated 21st October 2022, on 27th October 2022.

Among the grounds of appeal were:

• That KRA erred in law and fact in demanding for payment of PAYE in respect of accrued director fees which were not paid and were later reversed hence no taxable benefit that was accorded to the direct
• That KRA erred in law and fact in demanding for PAYE amounts in respect of director’s fees, more specifically, for Michael Macharia and Wanjiku Muchemi yet the amounts thereto had already been subjected to tax in the payroll.
• That KRA erred in law and fact in charging PAYE on payments made by classifying the same as directors’ drawings. However, the drawings selected related to the amounts used to settle business expenses that were wholly and exclusively incurred by SSTL in generating its income.

SSTL contended that:

• KRA erred for demanding payment of PAYE in respect of accrual director fees which were not paid and were later reversed in the general ledgers, hence no taxable benefit that were accorded to the said directors as no payments were made.
• KRA erred in demanding for PAYE amounts in respect of director’s fees, more specifically MM and WM, yet these amounts had already been subjected to tax in the payroll. It argued that it provided for director’s fees in its books for the periods 2015 and 2016 and that due to financial constraints, SSTL is to date yet to make any payments to the said directors for the respective fees as booked in SSTL’s books. Based on this, SSTL stated that KRA disallowed the expensed directors’ fees in its computations for the periods 2015 and 2016.
• KRA erred in charging PAYE on payments made by classifying the same as director drawings. However, the drawings selected related to the amounts used to settle business expenses that were wholly and exclusively incurred by SSTL in generating its income. It argued that in its assessment, KRA charged PAYE on payments by allegedly classifying the same as director drawings and yet the selected drawings were used to settle expenses that were wholly and exclusively incurred by SSTL in generating its income. It averred further that KRA did not provide any evidence to show that these amounts were linked to or associated with the directors of SSTL.

KRA responded that:

• A review of SSTL’s ledgers indicated that the directors earned director’s fees upon which PAYE was not operated contrary to Section 3(2) (a)(ii) of ITA which provides that gains or profits from employment or services rendered is income upon which tax is chargeable. Further that Section 37 of the ITA also provides that an employer paying emoluments to an employee shall deduct therefrom, and account for tax thereon, to such extent and in such manner as may be prescribed.
• KRA charged directors fees of Kshs 24,431,521.00 for the years 2015 and 2016, which SSTL had stated that the amounts were reimbursements to directors in respect of salaries paid by them to employees on behalf of the company. However, SSTL did not provide supporting documentation for this assertion.

The following documents ought to have been provided:

1. Breakdown of the staff salaries per month showing the breakdown of the employees paid and the amounts due to them
2. Details of how the monies were actually paid to the employees
3. Bank transfers, including evidence of monies moving from the director’s bank to the company account,
4. Corresponding company Paye returns demonstrating to the respective months for which the amounts were paid.
5. The amounts paid by directors would have been to the company repayable at a future date, and the company needed to demonstrate whether this amount was paid.

• A review of SSTL’s bank Statement; Cooperative Bank Account showed that there were amounts drawn by directors against which no explanation was provided. Further that SSTL indicated that these amounts were payment for VAT, yet it did not provide further evidence, including evidence of payment of VAT and respective months VAT related to.
• SSTL did not provide the following documents in support of its objection; certified bank statements highlighting the amounts marked as drawings and matching them to the amounts in the bank statements, petty cash control accounts; and directors bank statements to demonstrate that the directors’ fees as declared in the financial statements were indeed reversed and that the directors did not enjoy the benefit.
• Upon audit, it was noted that the directors earned fees upon which PAYE was not charged contrary to Sections 3(2) (a) (ii) and 37 (1) of the ITA. Further that no documents were adduced in support of SSTL’s assertion that the amounts for the period of December 2015 and 2016 were reimbursements to the directors in respect to salaries paid by them to employees on behalf of the company. Likewise, SSTL failed to provide documentation to prove that the PAYE on drawings were payment of VAT.
• From an extract of the director’s fees account that for the year 2014 no PAYE had been charged and that the amounts in the directors’ accounts were expensed and that what was presented earlier were the Directors’ accrual account.

In its ruling on 26/01/2024, the TAT observed that:

• Section 56(1) of the TPA places the burden of proof on the taxpayer. It provides as follows: –

“In any proceeding under this part, the burden shall be on the taxpayer to prove that a tax decision is incorrect”.

• In respect of this tax head, SSTL was unable to provide the following documents:

1. Certified bank statements highlighting the amounts marked as drawings and matching them to the amounts in the bank statement
2. Petty cash control accounts.
3. Directors’ bank statements to demonstrate that directors’ fees as declared in the financial statements were indeed reversed and that the directors did not enjoy the benefits.

As such SSTL lost

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