How to pay your employees – net or gross?

For the period January to October this year, at least 13 tax cases have been decided at the Court of Appeal of Tanzania. In exercising its statutory powers to administer tax laws in Tanzania, the tax authority (TRA) makes various decisions. If a taxpayer, for any reason, disagrees with a tax decision made by TRA, a tax dispute arises.

Generally, if a taxpayer disagrees with the TRA’s decision he is entitled, as a first step, to object against the decision to TRA before considering an appeal. There is a three-tier appeal system in Tanzania – the Tax Revenue Appeals Board, the Tax Revenue Appeals Tribunal (TRAT), and the Court of Appeal of Tanzania (CoA) – the highest court in Tanzania.

Courts, usually, are expected to approach cases with similar scenarios and facts are in the same way (Stare decisis). Also, all lower courts are bound to follow the rulings (precedents) of the CoA. So, decisions at the CoA are very crucial to the stakeholders of the tax system in Tanzania. My previous article highlighted two lessons from the CoA decisions. One is that, for civil tax cases, the burden of proof lies on the taxpayer. And second, only appeals on points of law can go the CoA. In this article, we continue to draw some more lessons from these recent CoA’s decisions.

Imagine this. You are recruiting a new employee and you are in the process of negotiating one of the key terms of the employment contract – the salary! The problem is that what goes into the employee’s bank account (‘net’ salary) and what comes out of the employer’s bank account (‘gross’ salary) are not the same. Why? Because of statutory deductions such as PAYE (Pay-As-You-Earn) and social security contributions that the employer is obliged to make and remit to the relevant authorities.

So, should the negotiation and the contract be on ‘gross’ or ‘net’ basis? Who should bear the burden of income tax on the salary (Paye) – the employee or the employer? These areas may bring (tax) issues if they are not handled carefully in the negations and in crafting the employment contract. If the employee must be recruited from abroad, the tax risks are even higher.

The appeal by Pan African Energy Tanzania Limited (PETL) against the Commissioner General of TRA (Civil Appeal number 81 of 2019) decided in March 2020 by the CoA helps to answer some of the above questions. Paye is essentially an income tax on employment income collected by way of withholding by the employer. And so, PAYE should be borne by the employee. The employer must deduct the Paye from the employee’s employment income and remit the same to TRA.

For simplicity, let us assume the agreed salary reflected in the employment contract is Sh10 million a month. And the Paye due to that salary is Sh3 million. The employer is obliged to deduct the Sh3 million (Paye) from the gross salary and remit it to TRA and then pay the balance Sh7 million to the employee.

However, for various reasons, some employers decide to shoulder the burden of the PAYE on behalf of their employees. In our example, say the employer decides to remit the Sh3 million to TRA and pay the employee the full salary of Sh10 million (without deduction of PAYE). In this scenario, based on the CoA decision on the PETL’s case, there is an additional income (benefit) of Sh3 million to that employee and a further PAYE is due.

Impliedly, this means the employment contract should reflect a gross salary. Then PAYE and other deductions are made from this gross salary.

By Shabu Maurus, Tax Partner, Auditax International.

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