A Nairobi court has ruled that subjecting compensation for unfair termination of employment to housing levy and social health insurance deductions constitutes an unfair labour practice.
The judgment, delivered by the Employment and Labour Relations Court, stemmed from a post-judgment dispute between financial services provider Fourth Generation Capital Ltd and its former employee Alexander John Frank Stubbs.
The case followed an earlier ruling in which the court awarded Mr Stubbs Sh2.8 million as compensation for termination of his employment and pay in lieu of notice.
However, his employer deducted Sh1 million in statutory deductions —including PAYE, NSSF, the Social Health Insurance Fund and the housing levy— before releasing the balance to him.
This triggered a fresh legal battle involving contested executions and an unlawful attachment of the company’s vehicle to recover the compensation.
Eventually, the dispute narrowed to one key question concerning which statutory deductions legally apply to court-awarded compensation?
Mr Stubbs challenged the deductions, arguing they were unlawful and undermined the purpose of compensation for unfair dismissal.
He contended that payments awarded after employment termination could not be classified as employment income.
The company, however, maintained that all deductions were lawful, citing precedents treating compensation as taxable income. It referenced Section 37 of the Income Tax Act, which mandates employers to deduct and remit tax on employment-linked payments.
The claimant rejected this position, insisting that post-employment awards should not be treated as ordinary income or attract salary-linked levies.
He argued that deductions beyond PAYE unlawfully punished employees twice and cited authorities holding that income tax should not apply to court decrees.
He further maintained that Section 49(2) of the Employment Act —which subjects unfair termination payments to statutory deductions— applied only to Labour Officer awards, not court rulings.
The court acknowledged legal ambiguity around Section 49(2) and carefully examined the law’s intent. It noted that while the Act expanded remedial authority from labour officers to courts, it did not alter the nature of such awards.
Crucially, the court distinguished housing levy and health insurance deductions, ruling that compensation is not salary and cannot be treated as ongoing income for deductions tied to active employment.
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The judge questioned the fairness of demanding housing levy payments post-employment, stating it would amount to double payment.
Similarly, the court found the Social Health Insurance Act already provided contribution mechanisms for active or self-employed individuals. Using Section 49(2) to recover additional contributions from compensation would be improper, amounting to unfair labour practice.
“Would it therefore be fair labour practice to demand that the employee or employer pays the housing levy after separation?” the judge asked. “In this court’s view, that would amount to double payment of the housing levy on the part of the parties.”
The court held that the Social Health Insurance Act already provides mechanisms for registration and contributions for those in active or self-employment.
Ultimately, the court drew a clear distinction stating that PAYE may be deducted, but housing levy and health insurance deductions may not.
It ordered Fourth Generation Capital Ltd to refund unlawfully withheld amounts within 30 days.
On PAYE, the court upheld its validity, rejecting arguments that court-ordered compensation fell outside taxable income.
Sections 3 and 5 of the Income Tax Act explicitly define taxable income to include termination compensation, leaving no room for doubt.
“The law is explicit that compensation awarded in cases of unfair termination qualifies as gains or profits,” the judgment stated, affirming its taxability under Section 3(2)(a)(ii) of the Income Tax Act and is subject to the payment of tax.
The court concluded that only PAYE may be deducted from compensation for unfair termination.
All other deductions, including the housing levy and social health insurance contributions, were unlawful.
The ruling provides much-needed clarity for employers, employees, and legal practitioners navigating unfair termination disputes, reinforcing that only PAYE deductions are permissible on such awards.
