Navigating Tax Compliance in the Construction Industry in Kenya

• Navigating tax compliance in the Construction industry in Kenya

Players in the construction industry, just like other businesses in Kenya, need to know the taxes relevant to them.

The Kenyan business landscape is ever changing and thus the need for continual improvements, including understanding the latest information about tax obligations.

These obligations may impact on construction projects or even the businesses of the individual players like construction companies and professionals in the industry.

Obligations on income tax, VAT, withholding tax, and payroll tax have their own rules thus necessitating careful planning and compliance strategies for construction business owners.

Income Tax

Construction companies are subject to corporate income tax on their business income. Corporate income tax is levied at a rate of 30% of the taxable profit for resident companies and 37.5% for non-resident companies.

Construction firms need to carefully account for revenues and expenses to ensure that accurate taxable profit is derived.

For example, without fully accounting for all revenues there is a risk of understating the tax obligations and therefore being penalized by the taxman.

Similarly, if all expenses are not accounted for, the taxable profit may be overstated leading to payment of more than deserved taxes.

Accurate financial reports (and therefore the tax returns) are produced by a good accounting system.

Such a system comprises of accounting software, policies and procedures and a well-trained team that is well supervised and guided.

Value Added Tax (VAT)

VAT is charged at a standard rate of 16% on the value of taxable supplies (goods and services).

In the construction industry, common physical goods include construction materials like cement, steel and others that can be categorized as hardware. In addition, there are many service providers in construction including architects, engineers, quantity surveyors, contractors, plumbers, electricians and designers, just to name a few.

Bills from each of these players include VAT elements that should be properly accounted for.

However, supplies to certain construction projects, such as those involving government housing schemes or donor-funded projects, may be exempt from VAT.

Zero-rating or exemption is specifically linked to specific projects under specific legal provisions and therefore one must be careful to confirm such provisions.

VAT compliance involves ensuring that input VAT (on purchased materials and services) is correctly claimed and deducted from the output VAT (VAT on sales).

Maintenance of proper records is therefore crucial to support all transactions thus enabling accurate filing of VAT returns.

In Kenya, the KRA has also appointed certain institutions as VAT withholding agents and they therefore withhold part of the VAT as they pay their suppliers.

Withholding Tax

Withholding tax is applicable on payments made to non-resident and resident contractors or other service providers.

Withholding tax is withheld at the point of payment and it is part of the overall income tax of the party being paid.

It therefore follows that whatever has been withheld should be properly accounted for and included in the annual income tax return.

For instance, withholding tax on management or professional services provided by a non-resident is 20%, whereas payments for such services provided by a resident entity are subject to a 5% rate.

Similarly, contractual fees (for building, civil, and engineering services) are subject to a 20% withholding tax for non-resident contractors, while resident contractors face a 3% rate for these works and services.

Therefore, property developers, as customers of construction companies, must diligently withhold and remit the correct amounts to the KRA.

Failure to comply with withholding tax obligations can result in penalties and interest.

Payroll Tax Obligations

Payroll tax compliance is a crucial area for players in the construction industry, especially those with a large or diverse workforce.

Employers in Kenya are required to deduct and remit Pay As You Earn (PAYE) tax for employees, which is calculated using progressive rates of between 10% – 35% based on employee earnings.

It is worth noting that PAYE is not a tax in itself but a form of deduction and remittance of income taxes on employment income.

The employee is therefore expected to declare the income tax deducted through PAYE, in addition to any other income, in filing annual income tax returns.

It is good to mention that some players think that, as employers, they can choose to place their staff under PAYE or withholding tax regime.

This can result in contravening the income tax laws and specifically the PAYE regulations.

Withholding tax is withheld on invoiced amounts (from suppliers like consultants and contractors) while PAYE is “withheld” from employees’ salaries. Remember that it is now a requirement that all invoices must pass through eTims for them to be recognized as valid business expenditure.

Other Statutory Deductions

Additionally, players in the construction industry should make contributions to the National Social Security Fund (NSSF). NSSF contributions are made by both the employees and employers and based on scale provided by law.

The NHIF has now changed to Social Health Insurance Fund (SHIF) and is levied at 2.75% of employee’s gross salary.

Affordable Housing levy is also levied at 1.5% of gross income for all person who receive income or whose income is accrued in Kenya.

Classifying workers correctly—whether as permanent employees, contract workers, or independent contractors—is essential for ensuring proper payroll tax compliance.

Errors in classification can lead to non-compliance issues and penalties.

Essentially, for permanent employees, employers are required to deduct and remit PAYE from employees’ salaries to tax man, while for independent contractors, to withhold a 5% tax on payments made.

Strategies for Effective Tax Management

To navigate the tax landscape seamlessly, construction industry players  should consider implementing several strategic practices, including but not limited to the following:

1. Accurate Record-Keeping: Proper bookkeeping of all financial transactions, including income, expenses, payroll, and equipment usage.This data is vital for precise tax filings and for defending deductions and credits.
2. Use of Technology: Invest in robust accounting and project management software that can track costs and revenues by project and location. Automation helps reduce errors and improve efficiency in tax preparation.
3. Regular Training and Updates: Tax laws change frequently, and staying informed is crucial. Regular training for finance and accounting teams can help keep the company compliant with the latest tax regulations.
4. Professional Guidance: Given the complexities involved, consulting with tax professionals can provide significant benefits. These experts can offer advice on tax planning, and compliance strategies.
5. Proactive Tax Planning: Engage in proactive tax planning to leverage tax credits, deductions, and incentives available specifically to the construction industry. Planning can also help defer taxes and improve cash flow management.

Navigating tax compliance in the Construction industry can be complex, but you don’t have to do it alone.

For professional advice or assistance in managing your tax obligations, contact us at info@johndaniel.co.ke or call +254 722 817 818. Let our experienced team help you stay compliant and maximize your gains