When money is short before payday, many employees ask for a salary advance, and some employers offer staff loans for school fees, rent deposits or emergencies. These arrangements look similar but are taxed differently. Handling them badly can create PAYE problems for the employer and unexpected deductions for the employee. This guide explains the difference and the records to keep.

Salary advance versus staff loan

A salary advance is a payment of wages the employee has already earned or will earn soon, recovered from the next payslip or two. It carries no interest and is simply wages paid early. A staff loan is a larger sum repaid over several months, often with interest. The key tax question is whether the loan gives the employee a benefit.

Advances are not extra income

Because an advance is the employee's own pay moved forward, it does not create additional income. PAYE, NSSF, SHIF and the housing levy are calculated on the full gross pay in the month the pay is earned, not when the cash moves. If an employer withholds PAYE on the advance and again on payday, the employee overpays, so the payroll should treat the advance as a deduction after tax: gross pay, statutory deductions, PAYE, and then the advance recovery. Use the PAYE calculator to check that the tax is the same with and without the advance.

When a loan becomes a taxable benefit

A loan on which the employee pays no interest or less than the prescribed rate gives a benefit equal to the difference between the interest that would have been charged at the prescribed rate and the interest actually charged. That difference is added to taxable pay and is subject to PAYE. The Commissioner publishes the prescribed rate, so employers should check the current rate each quarter. Loans that attract market-level interest produce no benefit. The same treatment applies to a loan written off by the employer: the amount forgiven is taxable pay in the year it is written off. The wider list of taxable perks is in taxable allowances and company benefits, and the taxable benefits calculator values the common ones.

Recording deductions properly

For each loan, keep a signed agreement stating the amount, interest rate, repayment months and consent to deduct from pay. The Employment Act limits deductions from wages, so a written agreement and a reasonable monthly figure protect the employer against a later claim. Then:

  1. Record the loan on a salary advance and loan tracker with the balance after every payroll.
  2. Show the recovery as a separate line on the payslip, so the employee sees the balance falling.
  3. Post the loan to a receivable account in the books, not to expenses.
  4. Review balances when an employee resigns, because unpaid loan amounts can only be recovered from terminal dues within the legal limits. See what you are owed when you resign.

Loans from Saccos and banks via payroll

Many employers deduct Sacco and bank loan repayments directly from pay. These deductions are not tax deductible for the employee, and they do not reduce PAYE. They come out after tax, so the take-home pay shrinks while the tax stays the same. Employers should remit them to the lender on time, as shown in the statutory remittance tracker.

Worked example

An employee earns KES 80,000 gross. The employer pays a KES 20,000 advance mid-month. At month end payroll calculates NSSF, SHIF, the housing levy and PAYE on KES 80,000, then subtracts the advance. The net pay is lower by exactly KES 20,000, and PAYE equals the normal figure. If instead the employer had lent KES 600,000 at no interest and the prescribed rate was 9%, the annual benefit would be KES 54,000, or KES 4,500 a month added to taxable pay.

Practical tips for employers

  • Set a limit, for example a share of net pay, so deductions do not cut take-home pay below a safe level.
  • Keep loans out of the PAYE calculation unless a benefit arises.
  • Do not pay advances in cash without a record; use M-Pesa or bank transfers so there is a trail. See keeping records with M-Pesa business.

Tips for employees

Borrowing from your employer is cheaper than most digital loans, but read the clause on what happens if you leave. Compare gross and net pay using the net to gross salary calculator before you commit to repayments you cannot afford.

For the wider picture of what payroll must handle, see the employer obligations checklist, the guide to running payroll for a small business and the payroll run checklist.

Frequently asked questions

Is interest on a staff loan taxable to the employee? Only the shortfall below the prescribed rate is a taxable benefit. Interest the employee actually pays is not income to them.

Can my employer deduct a loan from my final pay? Yes, within the limits of the Employment Act and with your written consent in the loan agreement. Deductions cannot take your pay to nothing.

Does a salary advance change my tax? No. PAYE is based on the pay earned in the month, whenever the cash was received.

What if the employer forgives the loan? The amount written off is treated as additional pay in the year it is forgiven and taxed through PAYE.