The Tax Man’s Cut: Statutory Deductions on Compensatory Awards in Employment Claims

Claimants in employment and labour relations disputes will readily approach the courts in the hope that in the event of a finding that their claim is meritorious, judgment will be entered in their favour and if they are lucky – despite seemingly unlucky circumstances leading to the claim – an award of equivalent to 12 months’ salary.

Claimants will typically quantify their claims to seek the maximum award of 12 months’ salary pursuant to Section 49 (1) (c) of the Employment Act. This quantification will invariably be on the basis of the employee’s last gross salary before statutory deductions. However Section 49 (2) of the Employment Act provides that an award of compensation for unfair dismissal made under the Act is subject to statutory deductions.

Nevertheless, the courts in their judgments, will sometimes award compensation to a claimant by reference to a specific number of months but without reference to statutory deductions. Consequently, and unsurprisingly, whether an award of compensation in a claim for unfair dismissal is subject to statutory deductions has been the subject of litigation and in this article we consider some of the decisions of the courts on the matter.

In Joseph Omondi v SBI International Holding Kenya [2015] eKLR, the ELRC held that there is no doubt that Section 49 (2) envisages deduction of income tax from an award of the court. Subsequently in William Kilonzi v Bamburi Cement Ltd [2016] eKLR,
the ELRC looked at the interplay between the Employment Act and the Income Tax Act. Section 5 (2) (c) of the Income Tax Act provides that taxable income from employment includes compensation for termination of employment. In view of this the court held that the award of Kshs. 10.2 Million by the court to the claimant was subject to deduction of income tax pursuant to Section 49 (2) of the Employment Act read with Section 5 (2) (c) of the Income Tax Act and thus the net amount payable to the claimant reduced to Kshs. 8.8 Million.

Similarly, the Court of Appeal in Directive Assurance Co Ltd v Khavra [2016] eKLR held that a lump sum award of compensation is subject to statutory deductions.

Recent decisions of the ELRC have upheld the position that income tax is payable on compensatory awards in employment claims. However, in Stubbs v Fourth Generation Capital Limited [2025] eKLR the court took the view that the statutory deduction applicable to compensatory awards is income tax and not other employment related deductions. In rendering its decision the court held that deductions towards NSSF, NHIF and housing levy are not applicable to such awards as these are dependent on subsistence of an employment relationship -which in the context of a claim for unfair dismissal- has already ended. The court went on to characterize deductions from awards other than income tax as constituting an unfair labour practice and ordered the former employer to refund amounts deducted towards statutory payments apart from income tax.

In view of the foregoing, it is important to note that in the event of a finding of unfair dismissal of a former employee against an employer, any award of compensation may be subject to deduction and remission of income tax in accordance with Section 49 (2) of the Employment Act as read with the Income Tax Act.