Across various sectors, many businesses often opt to outsource their workforce to labour agencies. This approach usually presents several benefits to the recipient company, including reduced administrative roles related to human resources, flexibility in engaging the right-sized workforce according to business demands, and access to a larger talent pool.  In the long run, labour subcontracting helps businesses to achieve cost efficiency.

Despite the numerous benefits arising from this arrangement, parties involved in such contracts should structure the transaction appropriately and maintain adequate documentary evidence to avoid tax non-compliance pitfalls. 

 

In recent Court rulings on disputes arising from labour subcontracting transactions, some of the glaring issues include:

  1. VAT treatment of the payments received by the labour agency

In line with the VAT Act, where a supply made by a registered person is neither exempt as per the First Schedule nor Zero-rated as per the Second Schedule, then it falls under the taxable category at the standard rate. However, in determining the taxable value of a supply, Section 13(5) of the VAT Act allows for the exclusion of disbursements subject to the satisfaction of the Commissioner on the same.

In Stratostaff E.A Limited v Commissioner of Domestic Taxes, TAT 1149 of 2022, the tax authority assessed output VAT on the lump-sum payments received from the appellant's clients without segregating the salaries & wages portion from the management fees. However, in its ruling, the TAT held that based on the contracts the appellant had with its clients, it was clear that the salaries and wages portion of the payment was a mere disbursement, hence not subject to VAT. The TAT held that the contracts demonstrated that the appellant was a mere facilitator in the recruitment and facilitation of salary payments for the outsourced workforce.

In contrast, in Commissioner of Domestic Taxes v Techsavana Company Limited (Income Tax Appeal E228 of 2023) [2025] KEHC 6643 (KLR) the High Court held that based on the Service Level Agreement between the respondent and its clients, it was evident that the respondent was providing a technical service and not acting as a mere agent. The Court therefore upheld the tax authority’s assessment of VAT on the service fee (which included salaries & wages and agency fees) received from the respondent’s clients.

 

  1. Withholding tax on payments made by the recipient company

Section 35, as read together with the Third Schedule to the Income Tax Act of Kenya, provides for the deduction of withholding tax on payments made in relation to management or professional fees, however calculated.

In Keitt Exporters Limited v Commissioner of Domestic Taxes, TAT 991 of 2022, the tax authority assessed withholding tax on the gross payments made by the appellant to the labour agency without segregating the direct labour cost element from the management fees. The TAT upheld the tax authority’s assessment and held that the Appellant did not substantiate its claim that the direct labour cost was a mere reimbursement of cost to the labour agency that should not be subjected to withholding tax. 

 

Conclusion 

Deducing from the Court rulings, it is therefore paramount for entities engaging in labour subcontracting to evaluate whether:

  1. They have in place proper agreements/contracts whose terms should specify the roles and obligations of each party;

  2. The invoices raised differentiate the reimbursement of costs/disbursements from what should be the income of the labour agency; and

  3. The description in the books of accounts of the payments made to or received from either party has been recorded correctly to avoid misconstruction.

 

Caveat

This publication has been prepared by RSM (Eastern Africa) Consulting Ltd, and the views are those of the firm, independent of its directors, employees and associates. This publication is for general guidance, and does not constitute professional advice. Accordingly, RSM (Eastern Africa) Consulting Ltd, its directors, employees, associates and its agents accept no liability for the consequences of anyone acting, or refraining from acting, in reliance on the information contained herein or for any decision based on it. No part of the newsletter may be reproduced or published without prior written consent. RSM (Eastern Africa) Consulting Ltd is a member firm of RSM, a worldwide network of accounting and consulting firms. RSM does not offer professional services in its own name and each member firm of RSM is a legally separate and independent national firm.