CHAPTER ONE
INTRODUCTION TO TAXATION
Definition and Features of a Tax system
Taxation is part of public finance and it deals with public revenue and public expenditure. A tax is
defined as a compulsory contribution to the government from its citizens that is used to pay for
expenses incurred for the common interest of all persons without reference to any special benefits
being conferred to the payers. A tax is also said to be a compulsory contribution of the wealth of a
person to the state.
The above definition points towards three characteristics/features of a tax:
(a) It is a compulsory contribution imposed by the government against the people residing in a
country. For this reason, failure to pay taxes is a criminal offence which is punishable by the law.
However taxes are only paid by those people who come under their jurisdiction. Special groups
of people residing in the country such as diplomats, refugees and asylum seekers do not pay taxes
in Kenya.
(b) It is a payment made by taxpayers, which will be used by the government for the benefit of all
citizens i.e. in providing social and public goods and services. The state uses the revenue
collected from taxes in the provision of hospitals, schools and public universities etc that benefit
all the citizens of that country.
(c) A tax is not levied in return of any specific service rendered by the government and an individual
cannot ask for any benefit in return for taxes paid. The essence of a tax is the absence of a direct
“Quid Pro Quo” (something for something) benefit between a taxpayer and the tax authority.
This implies that a taxpayer cannot claim for something equivalent to the tax paid to the
government. A taxpayer cannot refuse to pay taxes on the grounds that he does not use public
services.
Taxes are meant to cover the expenses of the government and as such they are not levied for any
particular purpose. The government makes no promise to perform a specific service in return of taxes
paid.
Functions of the State
a) Protection Function
It is the responsibility of the government to maintain peace, order and security in the country.
The state is charged with the responsibility of defending its citizens and borders against external
aggression. For this purpose the government maintains a police force and armed forces.
b) Administrative Function
The government is responsible for the proper administration of the country. For this purpose
various ministries, departments, sections etc have been set up in the government to ensure proper
and efficient administration.
c) Social Function
The government provides social amenities to its citizens such as education, health, transport and
communication, housing, entertainment etc.
d) Development Function
The development of the various sections of the country and infrastructure is not possible without
government’s intervention. For this purpose the government undertakes the development of
agriculture, commerce, industry, transport and communication etc. All such developments
significantly contribute to the rapid growth of the economy of the country.
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To perform the above functions effectively and efficiently, the government requires funding
which is primarily sourced from taxation. Taxation therefore becomes a very important source of
revenue to the government. The income that the government derives from taxes and other sources
is known as Public Revenue.
Sources of Public Revenue
1) Taxation
This is the most important and largest source of public revenue (already defined)
Examples of taxes are:
(a) Income tax- this is levied on individuals-PAYE on employment income.
(b) Income tax- this is levied on corporations-corporation tax
(c) VAT- this is imposed on value added on the supply of goods and services in Kenya
(d) Excise duty- it is imposed on the production of certain commodities.
(e) Customs duty: It is imposed on the importation of goods in the country.
(f) Stamp duties
(g) Trade licences
(h) Airport taxes
(i) Motor Vehicles Taxes and Licences
(j) Property taxes
(k) Petroleum levy
2. Fees
These are amounts that are recovered by the government for rendering certain services or as the
price paid to receive an official permission e.g. Trade license fees, driving license fees and import
license fees.
3. Prices
These are amounts recovered by the government when it renders commercial services e.g. sale of
publications by government printer.
4. Fines
Lawbreakers in the country receive punishment in the form of fines and sentences to
imprisonment. Fines constitute a significant source of revenue to the government.
5. State Property
The government is the custodian of all state property such as mines and other natural resources,
investments in other companies etc. The income received from such property constitutes a
significant source of revenue of the government.
Purposes of Taxation
Taxes are mostly levied with the objective of raising public revenue. However there are other
subsidiary purposes of taxation.
a) Raise Public Revenue (discussed above)
b) Economic Stability
Taxes are imposed with a purpose of maintaining economic stability such that during inflation,
the government increases the levels of taxation to discourage unnecessary expenditure and take
away excess money supply. In times of depression, the government reduces the level of taxation
to encourage individuals to spend more. In this way, taxes become an important tool of economic
stability.
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c) Fair Distribution of Resources / Incomes
Taxes are imposed to achieve equality in the distribution of national income. Taxes are imposed
at higher rates on those people with higher disposal income and used to provide welfare facilities
to poor people. In this way, taxes become a vehicle for the redistribution of national resources.
d) Protection Policy
Taxes are imposed to implement the protection policy of the government. In order to give
protection to commodities produced in the country, the government raises taxes on imports. This
causes such imports to be more expensive and thus people will resort to locally manufactured
goods that may subsequently boost local infant industries.
e) Social Welfare
Taxes are imposed on the production, consumption and importation of commodities, which are
harmful to human health e.g. the customs and excise duties on cigarettes, beer, cosmetics and
other harmful products. This raises their prices and discourages their production and
consumption.
f) Higher Levels of Employment
The government imposes taxes in order to initiate, finance and complete development projects
and other public works. All such programs create employment to undertake such public works.
The government is the largest employer in the country and all such employees are paid from
public funds derived mainly from taxation.
Taxation Powers
The management of public finance is the responsibility of the government. The Constitution of the
Republic of Kenya authorizes the government to levy taxes. Taxes are therefore obligatory upon all
individuals who come under their jurisdiction. Additionally, local governments e.g. Municipalities
and County Councils have been given delegated powers that permit them to levy taxes such as
municipal rates and taxes.
Canons of Taxation
The government imposes taxes and they create burdens to taxpayers. However, the same taxes are
used for the welfare of all citizens. This means that taxes have both good and bad effects. An
optimum or a good tax system is defined as one, which helps to achieve the maximum possible
number of principles of taxation. Adam Smith was the first economist who laid down the first four
important Canons of taxation.
1) Canon of Equity (Equality/Justice)
This is the most important canon of taxation. In the words of Adam Smith, ‘Every subject of a
state ought to contribute with their respective abilities in proportion to the revenue that they
respectively enjoy under the protection of the state”. It means that every citizen of a country
should pay taxes according to their ability but not necessarily in the same amount. The rich person
should pay more than the person with lower income. This canon also implies equality of sacrifice
i.e. the higher the income the greater the sacrifice one shall be called upon to make. This canon
was put in the forefront of all other canons with the view that all others have been derived from
this one.
2) Canon of Certainty
According to Adam Smith, there should be certainty in taxation since uncertainty breeds
corruption. Certainty means that every taxpayer ought to be sure of how much they ought to pay,
the time of payment, the manner of payment, the procedures involved etc. It also means that the
government should be sure as to the amount of tax revenue it should collect, the time and manner
that such amounts shall be received by the exchequer.
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3) Canon of Convenience
This canon states that both the time and mode of payment of tax should be convenient to the
taxpayer. In the words of Adam Smith, ”every tax ought to be designed so as to be levied at the
time or in the manner it is most likely to be convenient for the taxpayer to pay”, e.g. VAT is
conveniently paid only when the person has the means to spend. It is also convenient in the sense
that it is included in the price of a commodity. PAYE is conveniently paid when an employee has
earned income at the end of the month. Custom duty is conveniently payable only when a person
is able to import.
4) Canon of Economy
A good tax system should attain economy in two ways:
a) Economy in collection
Where collection costs of tax outweigh the tax collected by way of salaries, allowances,
administrative and secretariat charges or expenses etc such a tax should not be levied in the
first place.
b) A tax should be economical to the taxpayer i.e. a taxpayer should afford to pay all the taxes
levied on him and afterwards have sufficient cash left with him to cater for his consumption,
savings and investment needs. Heavy taxes discourage saving and investment and end up
undermining the productive capacity of a person.
5) Canon of Productivity
A tax should be productive in that it should bring in more revenue to the government. However
in its quest for more revenue, the government should not overburden its citizens with many or
heavy taxes since such a move will be counter productive. One tax that brings in more revenue is
better than a multiplicity of taxes that are expensive to operate and thus uneconomical.
6) Canon of Elasticity
This Canon is closely related to that of productivity. It requires that the government should be
able to raise rates of taxes when it needs more revenue. In other words a tax would be elastic e.g.
excise duty can be levied on a number of commodities and their rates can be increased every year
to raise more revenue. However care must be taken to ensure that the rates are not raised unduly
high since they will result in inflationary pressure in the economy.
7) Canon of Flexibility
Flexibility means that there should be no rigidity in the tax system. A tax system should be
changed to meet the revenue requirements of the state while elasticity means that the revenue can
be increase under the existing tax system as a result of changes in tax rates. However there cannot
be elasticity in a tax system without flexibility since some changes being made on the tax rates
may alter the tax structure.
8) Canon of Simplicity
A tax system should be simple, plain and intelligible to a common taxpayer. It should be simple
to understand how it is computed and how much is to be paid, when it is to be paid and where.
The forms to be filled in for calculation and payment of tax should be simple and intelligible to all
taxpayers.
9) Canon of Diversity
Every tax system should be diverse in the sense that a single or few taxes will neither meet the
revenue requirement of the state nor will they be equitable. An economy should have a variety of
taxes so that all citizens contribute towards state revenue according to their various abilities to
pay. Broadly there should be direct and indirect taxes. However, a large multiplicity of taxes
becomes difficult to administer and uneconomical.
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Problems of Justice in Taxation
Equity is the most important canon of taxation since it helps to achieve justice in taxation. Equity means
that the burden of tax being the fundamental problem in public finance is addressed from the point of
how vital the burden can be redistributed. For this purpose, both direct and indirect effects of a given
tax must be closely studied otherwise the question of justice will not be understood. It must also be
understood that the public burden cannot be fairly apportioned amongst the citizens. A number of
principles have been advanced to try to explain the question of justice in the tax system.
a) Cost of Service/Purchasing Theory
This is the first and simplest principle for justice in taxation. It is a payment for public services and
a payment being equal to the cost of the service rendered. The deal of purchases and sale of goods
or services between the state and the citizens is unachievable since this is not the nature of the state.
The theory can be objected to as follows:
- It is not possible to distribute a service among individuals and subsequently charge them in
proportion to the distribution.
- The theory implies that a citizen is free to refuse to pay taxes since he doesn’t receive the
service.
b) Benefit or Insurance Theory
This is also referred to as the quid pro quo method. It maintains that justice in taxation can be
secured by taxing its citizens in proportion to the benefits they derive from the activities of the state.
This theory is advanced upon the following objectives:
- The poor receive greater benefits from the government in form of healthcare, education and
other social amenities. Even though they are the greatest beneficiaries of public goods, they are
least able to afford payment for the goods or services.
- It would be impossible to determine the proportion of the benefit and government expenditure
that would accrue to an individual. However the benefits theory does not apply to taxes but to
other charges e.g. fees, prices etc. Such charges are levied in proportion to benefits directly
received by a person who is making such payments.
c) Theory of Equal Sacrifice
To achieve justice in taxation, the issue of sacrifice entitled by taxpayers should be taken into
consideration. An ideal situation is whereby the taxpayers are called upon to make equal sacrifice
and therefore this becomes the ground on which progressive taxes are levied. This theory can be
justified whereby heavy taxes are imposed on very rich persons, leaving the general public tax free
(but this is not practical).
d) Ability Theory
The solution to the question of justice in modern taxation will depend on the concept of the ability
to pay. However, there is difficulty in measuring the ability to pay: For instance, should the ability
to pay be viewed in terms of expenditure or property? A single best test for a person’s ability to pay
is his income and therefore taxes should be levied on the incomes earned. For the purpose of this
theory, a tax should not be based on one single test. When taxing a person, more than the person’s
property, savings and expenditure should be considered.
Effects of Taxation
Every tax system produces various types of consequences on production, consumption, national
income distribution and the level of economic activities. The effects of every tax are both good and
bad. However the best tax system from an economic point of view is the one that has the least
negative effects on economic activities.
The effect of taxation can be viewed from two points:
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i)
ii)
Its effect on production\productivity.
Its effect on distribution of income.
Effects of Taxation on Productivity
The effects on taxation on productivity can be explained from 3 points of view:
a) Ability to Work and Save
Taxes which lower the efficiency of taxpayers will lower their ability to work and subsequently affect
production. For each tax levied, the taxpayers’ purchasing power is reduced and he will be forced to
cut down on expenditure towards necessities and comfort. People with lower incomes are forced to
reduce their expenditure as a result of the tax levied. This effect is not only found in commodity taxes
such as VAT and excise duty, it is also found in progressive income tax e.g. PAYE. This is because
income tax which is a direct tax reduces a taxpayer’s income consequently affecting his ability to
work and ultimately production. Taxes also affect one’s ability to save. If a taxpayer maintains the
same standard of living after the imposition and increment of tax, he will save less or none at all since
savings depend on one’s income. The imposition or increment of tax will reduce them.
b) Desire to Work and Save
Tax affect on production through the desire to work and save depends partly on:
(i)
Nature of Tax
Moderate commodity taxes will have little or no effect on a persons desire to work and save and
hence no effect on production. Since commodity taxes are not felt directly, they leave the taxpayer
indifferent and for this reason the taxpayer will continue to work, save, invest and produce. Therefore
production will not be affected. However, highly progressive income taxes and corporation taxes will
discourage a person’s willingness to work, save and invest. This will affect production e.g. for an
industrialist, if the inputs are highly taxed, the cost of production will rise and so will the price of
commodities. The effect will be reduced demand and a fall in production.
(ii)
Nature of Individual Reaction
The immediate reaction of the taxpayer upon the announcement of tax proposals in a budget is to
adversely affect his willingness to work and save. However, this effect is not uniform to all taxpayers.
A person’s reaction will depend on his elasticity of demand for income. Elasticity of demand for
income is the intensity or desire for obtaining a particular income level on the part of the person. A
person’s demand for income is elastic when he is not prepared to work or save more to maintain that
level of income. His demand for income is said to be inelastic if he works to earn at least so much so
as to maintain his income. Therefore the imposition of taxes will retard the desire to work and save if
a person’s desire for income is elastic. If a person’s demand for income is inelastic, the desire to work
and save is encouraged. Generally, the elasticity of demand for income is inelastic. This is because
people like to maintain a minimum standard of living and desire to save for the future and for running
their own businesses.
c) Composition and Pattern of Production
Taxation affects this through diversion of resources between different industries. Such diversions
have both positive and negative effects. Taxation of luxury products will raise their prices and reduce
their demand and hence their production. As a result, the factors of production involved in producing
such products will shift into the production of necessities. In regions where tax concessions,
exemptions and tax holidays are granted to industries, resources will flow into them from those
regions where taxes are high. Diversion will take place in form of establishment of new industries
causing the opening up of and diversion to new regions. As a result, more employment opportunities
will be generated, production will increase and also income. Similarly, when protection is granted to
certain domestic industries in form of grants, subsidies, tax concessions and exemptions, there will be
diversion of resources to these industries and will lead to increased production in the country. Heavy
taxation in a country tends to reduce the returns on foreign investments and this will lead to capital
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flight to other countries. This will adversely affect local industries where production will fall due to
lack of capital. Heavy taxation on the production of necessities will cause an increase in price and a
decrease in demand and ultimately production. When this happens, the factors of production will be
diverted to the production of non-essential goods where taxes are low.
Effects of Taxation on Income Distribution
One important objective of taxation is to reduce the gap between the rich and the poor. A tax that’s
levied with this motive is a redistributive tax.
The effects of taxation on distribution of income will depend on:a) Nature of Tax
Taxes that are regressive or proportional in nature tend to increase the inequalities of income and
wealth since they adversely affect the lower income groups. From a distribution point of view, the
best taxes are progressive taxes. Accordingly the rich are required to pay more and the lower income
groups less; e.g. PAYE in Kenya
b) Types of Taxes
Taxes, according to their impact (direct or indirect) will affect the distribution of income and wealth.
Indirect taxes on necessities e.g. VAT and excise duty, are regressive in nature because the low
income groups spend a high percentage of their incomes on necessities while the high income groups
are likely to spend a smaller percentage. Therefore, when a tax on necessities raises their prices, their
consumption is likely to decline especially on the part of low the income groups which will cause an
increase in inequalities. On the other hand, taxes on luxuries will affect the rich more. This will imply
that highly priced goods may be taxed at higher rates and that there is a broad element of progression.
Therefore higher tax rates on luxuries and lower tax rates on necessities will have a beneficial
redistributions effect. A highly progressive direct taxation will reduce the circulation of income and
wealth and will also reduce the concentration of wealth in the hands of the few rich persons. However
this should not be an excuse to tax the rich heavily since this will affect savings, investments and
hence production.
Impact, Incidence and Tax Shifting
Tax Impact
This is the first point of contact of tax on the taxpayers. It’s upon those persons who bear the first
responsibility of paying it to the government.
Tax Incidence
This is the final resting place of tax. It’s upon those economic units which finally bear the money
burden of it and which the tax money comes from. It involves the transfer from one person on whom
the tax is imposed initially to the ultimate taxpayer who bears the ultimate money burden of the tax.
The tax transfer process is known as the tax shifting while the settlement of the burden on the
ultimate taxpayer is known as tax incidence.
Tax shifting
It is the process of transferring the tax liability to other people through transactions. Tax shifting can
be backward or forward.
Forward Shifting
It occurs when an initial taxpayer passes the tax in part or as a whole to the buyer of his product
which was taxable. This occurs by the inclusion of the tax element in the product’s price e.g. sales
tax, VAT, customs and excise duty etc.
Backward Shifting
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It occurs when the producer shifts the money burden of the tax onto the suppliers of the factors of
production by urging them to accept lower wages or prices for their services.
Taxes may be shifted depending on the extent of the rise in the price of the commodity. If the price of
the commodity rises in equal to the amount of the tax, the entire money burden of the tax is shifted
from the producer to the consumer. If the price of the commodity does not rise with the entire money
burden of the tax, the consumer will only pay part of the tax (partial shifting) which is equal to the
difference between the new price and the price before tax price of the commodity. If the price doesn’t
rise even after the tax levy, the tax incidence will remain with the producer or there will have been a
backward shifting. It’s very uncommon that backward shifting will occur.
Factors Influencing Tax Shifting
a) Elasticity of Demand and Supply
The more elastic the demand, the lower the incidence on the sales. The higher the elasticity of
supply, the higher the incidence on supply.
b) Nature of Markets
In an oligopolistic market, tax shifting to buyers is higher since few sellers can team up to
determine the market price. For a monopoly, the entire tax burden is borne by the buyer.
c) Time Available for Adjustment
The person (buyer or seller) who can adjust will be able to shift tax e.g. if the buyer can shift to
substitutes products, then the seller will bear the tax burden.
d) Geographical Location
If taxes are imposed in certain regions, it’s hard to shift to consumers since they will move to
regions of low tax.
e) Government Policy on Pricing
In case of government price control, it will be impossible for the suppliers to increase prices
hence impossible to shift the tax burden to the buyers.
f) Nature of Tax
Whether direct or indirect tax? Direct taxes such as PAYE and corporation tax cannot be shifted
whatsoever. For indirect taxes, these can be shifted through price increases.
g) Rate of Tax
If too low, the producer may absorb it and retain his customers. If too high, it can be partially or
fully shifted to consumers
CHAPTER TWO
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CLASSIFICATION OF TAXES
Taxes may be classified based on:
(a) Administrative collection arrangements: Direct taxes and indirect taxes.
(b) Tax bases
(c) Tax rates: Progressive, proportional, regressive and digressive taxes
(A) Classification Based on Administrative Collection Arrangements
1) Direct Taxes
This is a tax that requires a taxpayer to remit his tax to the tax authority directly. It is levied on
persons and it can vary with the status of taxpayers. Its impact and incidence fall on the same person.
This implies that such a tax can neither be shifted forward nor backward.
Merits
a) Direct taxes are related to the ability to pay since the tax rates are chosen with respect to
taxpayer’s ability. Consequently they are suitable in achieving income and wealth re-distribution
purpose of the state.
b) Direct taxes are revenue elastic in that as income of the community goes up; the tax yield also
goes up.
c) Direct taxes fulfil the central authority’s need for social and economic justice since taxpayers are
taxed fairly with continued change in their incomes.
d) Direct taxes do not cause distortion in resource allocations thus leaving taxpayers better off than
indirect taxes. This is a suitable attitude towards resource allocation because it leaves taxpayers
neutral.
e) Direct taxes inculcate a spirit of civic responsibility among the taxpayers.
Demerits
a) Direct taxes violate the principle of convenience since they are paid in lump sum e.g PAYE
b) Direct taxes are a disincentive to work extra hours i.e. it limits the supply of labour and thus
limiting investments and savings.
c) It is not easy to attain the principle of vertical equity. The progressive tax can either be too heavy
or too low on the various income levels. The basic difficulty lies with the inability to determine
taxpayers’ ability to pay.
d) It discourages capital accumulation.
e) Direct taxes are easy to evade.
f) It is expensive to collect because of the many collection points
2) Indirect Taxes
This is a tax levied on a ‘thing” and paid by an individual by virtue of his association with that
“thing”. It is included in the product’s price / service and is unknown to the buyer. The impact could
be on one person and the incidence on another through tax shifting, e.g. customs duty, VAT and
excise duty.
Merits
a) Indirect taxes have fewer collection points and making it convenient to collect them
b) It is not easy to evade as they are included in the product’s price / service.
c) They present no difficulty in definition i.e. there is no room for manipulation of the tax base.
d) Since indirect taxes are related to consumption of luxury and semi-luxury goods, increases in such
taxes may give incentives to save more and consume less thus providing funds for capital
accumulation / formation. Such taxes may free foreign exchange for importing capital goods for
development and minimize foreign exchange crisis.
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e) Indirect taxes are convenient since they are paid in small instalments at times of sale or purchase
and therefore it may be argued that they are not burdensome since they are not felt directly.
f) They are most relevant to developing countries because the revenue turnover from them is high.
g) It is a flexible tax system that can be applied selectively. The rates can easily be modified to suit
the central authority’s wishes to steer the economy in the desired direction.
h) They are imposed on different types of products consumed by different consumers differently /
selectively.
i) Indirect taxes can be used as an economic tool in moulding the production and investment
activities of the economy by guiding the economic resource allocation to remedy the defects of
price mechanism.
Demerits
a) They negate the principle of ability to pay and are unjust to the poor. By their nature, they are
spread over to cover items that are purchased generally by the poor thus making them regressive
in nature.
b) They militate against the objective of least aggregate sacrifice. This ill effect of indirect taxes is
sought to be corrected by heavily taxing luxury items. However, such a correction can only be
partial since taxing luxuries alone will not yield adequate revenue for the state.
c) They feed inflationary forces. They begin by adding to selling prices of the taxed goods without
touching on the purchasing power of the taxpayer. The result is that in their case inflationary
forces are fed through higher prices, higher cost and wages and again higher prices (cyclical effect
of taxes).
(B) Classification Based on Tax Rates
The term tax rate is used to denote the amount of tax per unit of the tax base. The base of a tax is the
legal description of the object to which the tax applies, such as net income, output, expenditure,
imports, exports etc.
1) Progressive Taxes
These taxes that take a larger proportion of people’s income when their incomes are increased. It is a
tax where, with increased income the tax liability not only increases in absolute terms but also as a
proportion of the increased income. The graduated scale rates used in taxing individuals in Kenya are
based on this system.
Advantages
a) It conforms to the canon of ability to pay.
b) It helps in the achievement of social justice by endeavouring to achieve least aggregate sacrifice
of taxpayers’ resources.
c) It helps to redistribute economic resources by taxing the rich and applying their excessive wealth
on essential services that benefit the poor. This reduces the gap between the rich and the poor.
d) It deters the rich from misusing economic resources on luxuries, non-essential goods and services
that do not have productive benefit to the society.
e) It helps to achieve a state of good health and productivity of masses thereby avoiding a state of
civil unrest or social disorder.
f) It helps the economy to have firm/stable demand because the rich are heavily taxed during boom
periods and also they get high tax credits during the depressed periods.
g) It is administered conveniently resulting in less administrative and collection costs.
Disadvantages
a) It kills the incentive to work harder because extra earnings are taxed off thereby leaving no
benefits to hard workers who would prefer leisure.
b) It reduces savings ability. The rich save from their excesses to facilitate capital accumulation.
However progressive taxes draw all the would be savings to the public spending, thus denying the
private sector from saving to invest for further economic growth.
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2) Proportional Taxes
These are taxes that take the same percentage of peoples’ incomes irrespective of their levels of
income. The tax increases in the same proportion as the increase in income. This implies a direct
linear relationship between the tax payable and amount of income.
Advantages
a) Basing on the human inability to determine the correct degree of progression, proportional tax is
assumed to be better.
b) It is simple to administer because it is easy to be decided and enforced without requiring
complicated rates.
c) It does not change the relative position of different taxpayers since each is subjected to the same
proportion of tax on his earnings. This implies a quality of neutrality to the allocation of
resources.
Disadvantages
a) It is a regressive tax because it weights heavily upon the poor and leaves the very rich to pay little
tax with continued increases in their wealth.
b) It negates the principle of least aggregate sacrifice.
3) Regressive Taxes
This is a tax, which takes a smaller percentage of peoples’ incomes when their incomes increase.
People who earn lower incomes are taxed heavily than those who earn higher incomes in relative
terms. It implies that the tax rates increase at decreasing rate with increase in income consequently
the poor are taxed heavily than the rich on their additional earnings.
Advantages
a) It results in increased earnings of government revenue since the tax base is broadest being based
on the majority poor.
b) It forces the accumulation of capital formation and savings which the poor would not otherwise
save being with a higher propensity to consume. Such capital accumulated may be invested in
strategic projects for the benefit of all.
c) Wealth is left with the rich to save and invest in strategic private enterprises that promotes the
private sector and creates more employment.
d) It motivates people to work harder and enter higher income brackets thereby increasing economic
wealth.
4) Digressive Taxes
The tax is called digressive when the higher income earners do not make a due contribution or when
the burden imposed on them is relatively less. This will happen when a tax is only mildly progressive
i.e. when the rate of progression is not sufficiently steep.
A tax may be progressive up to a limit beyond which the same rate is charged. In that case, there may
be lower relative sacrifice for the larger incomes than for the smaller incomes. Another way in which
a digressive tax may occur is when the highest percentage is set for that given type of income on
which it is intended to exert most pressure; and from this point onwards the rate is applied
proportionately on higher incomes and decreasing on lower income, falling to zero on the lowest
incomes.
(C) Classification Based on Tax Base
A tax base is a legal description of the object with reference to which the tax applies. Broadly taxes
may be classified based on:a) Current flows of output, income or expenditure e.g. on output – excise duty, on income – income
tax e.g. PAYE and Corporation tax, on expenditure- VAT
b) Taxes on stocks of capital goods wealth e.g. inheritance tax, capital gains tax.
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c) Taxes on imports or exports e.g. import duty and export duty.
Each tax base has to be defined legally and it is to be quantified for determining tax liability of
taxpayers. When determining a tax base, the cost of collection, administration cost and the tax effect
on the economy are put into consideration.
Tax bases can be extended or narrowed by including certain new items that previously were not
included or excluding old items that were previously included respectively e.g. VAT.
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CHAPTER THREE
BUDGETARY POLICY AND FISCAL POLICY
The government, for the purpose of economic stability and acceleration of economic growth adopts
budgetary and fiscal measures.
The aspects of budgetary and fiscal policies are
1) Budget
A budget is an annual statement tabled before the National Assembly by the Minister of Finance,
which consists of revenue and expenditure estimates for a particular fiscal year.
There are three kinds of budget: a) Deficit budget (Revenue < Expenditure)
b) Surplus budget (Revenue > Expenditure)
c) A balanced budget (Revenue = Expenditure)
Budgets may also be classified as:
Revenue Budget (Short-Term Budget)
This represents the normal day-to-day spending by the government. The main source of income for
this budget are the normal taxes collected within the country such as PAYE, corporation tax, customs
duty, excise, VAT etc. The main expenditure heads for this budget include: provision of services
such as health, defence, administration, education etc.
Capital Budget (Long-Term Budget)
This relates to development projects or long-term investment of the government (public works). The
main sources of revenue for this budget include the following:
a) Long term loans from external international financial institutions such as IMF, World Bank,
African Development Bank etc.
b) Aid or donations from friendly countries and from Aid Agencies such as; JAICA, USAID, GTZ,
DANIDA, WORRLD VISION, KEFINCO, OXFAM etc.
c) Public debt e.g. sale of treasury bills or treasury bonds.
d) Sale of state property.
e) Privatisation of state corporations.
The main expenditure heads under this budget include development projects such as construction of
roads, airports, state building, establishment of new agricultural projects etc.
When the budget is presented before the government, it is deliberated on by members of parliament
and once approved it becomes a law of the land.
A budget plays an important role as an instrument of development planning. A budget is a plan of the
use of the national resources plus the nation’s output capacity. The budget does not confine itself to
the review of public sector but also addresses the private sector and the informal sectors. Thus the
budget becomes an overall regulator of all the determinants of economic growth. Through a budget
the government is able to encourage / discourage private expenditure.
An annual budget is usually prepared in terms of a 5-year development plan. The 5-year plan is a
framework of a 20-year plan.
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Budgetary policies measures designed to achieve specifically defined budgetary objectives such as
price stability, acceleration of employment levels, investment acceleration etc. A budget is thus a
major measure by which the government is able to regulate the economy towards the desired
direction.
2) Fiscal Policy
The issues of fiscal policy are relatively modern thoughts in economics and were as a result of a work
of Lord Keynes who advanced the Theory of Interest, Money and Employment. The fiscal policies
can be defined as those policies according to which the government uses money and other revenue
programs to achieve economic objectives and reduce undesirable effects on the economy, on national
income, production and employment.
These policies are also concerned with determining the type, timing and procedure that shall be
followed in making government expenditure and the time of obtaining government revenue to
undertake activities that ensure economic growth.
In Lord Keynes analysis, a fiscal policy uses public finance and subsequently causes development in
the economy. Thus fiscal policies could be said to be a combination of those deliberate changes in
government expenditure programs, government revenue programs, tax programs, debt management
policies etc. to bring about economic development.
Main Objectives of Fiscal Policy
a) Achievement of desirable price levels
b) Achievement of desirable development levels
c) Achievement of desirable employment levels
d) Achievement of desirable wealth re-distribution
However fiscal policies are not universal worldwide since countries are not the same. Fiscal policies
of a developed country are different from those of a developing country and those of a least
developed country.
Main Fiscal Policy Objectives of a Developing Country
a) To increase the level of employment
b) Encourage the flow of investment into the desirable areas of the economy.
c) To attract foreign and local investment investments
d) To promote import substitutions
e) To promote accountability in public finance and resources (good governance of public institution)
The main instruments of fiscal policy are: Public expenditure, public revenue and public debt.
Effective Tax Policy of a Developing Country
A developing country must have different tax policies from those of a developed country. This is
because for a developing country the objective is:a) Achievement of higher economic development and not merely an economic stability.
b) Greater attention is paid to the maximization of revenue and not merely people’s ability to pay.
c) It has to follow a policy of active intervention in the economic affairs of the private sector.
d) It aims at accelerating economic growth as opposed to reducing economic inequalities.
A developing country must aim at raising rates of savings and diversion of resources to productive
investments. Any good tax policy must mobilize economic surpluses i.e. the excess of current output
over essential consumption for the purpose of accelerating the savings.
In an underdeveloped country greater attention needs to be paid to indirect taxes because;
a) They promote development by checking any unnecessary consumption e.g. on luxuries and semi
luxuries.
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b) They mobilize resources for the public sector
c) They increase the savings ratio
However, suitable tax policies for an under-developed country must all the time aim at:
a) Diversion of resources to the private sector
b) Reduction of consumption of goods and services
c) Encouragement of exports and import substitution
d) Increase in local and foreign investments.
Summary
There is need to understand the nature and types of taxes to be imposed when establishing a tax system.
Failure to know and understand the effects of a tax can result in very serious consequences in an
economy. To avoid this there must be a clear understanding of the types of taxes, proper planning and
thorough knowledge of the impact and incidence of any tax to be levied. Ignoring the obvious dangers of
a given tax is tantamount to "plunging headlong for disaster"
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CHAPTER FOUR
INCOME TAX IN KENYA
Introduction
Income Tax was introduced in Kenya in 1936. For the success of the tax system established there must
be a set of rules and regulations. The Income Tax Act, Chapter 470 of the Laws of Kenya, governs
income taxation in Kenya. The Income Tax Act (Cap 470) consists of 14 parts, 133 sections and 12
schedules.
Administration and Application of Income Tax
The Kenya Revenue Authority (KRA) was established by an Act of Parliament, Chapter 469 of the
laws of Kenya, which became effective on 1st July 1995. The Authority is charged with the
responsibility of collecting revenue on behalf of the Government of Kenya.
A Board of Directors, consisting of both public and private sector experts, makes policy decisions to
be implemented by KRA Management. The Chairman of the Board is appointed by the President of
the Republic of Kenya.
The Chief Executive of KRA is the Commissioner General who is appointed by the Minister for
Finance.
Purposes of Kenya Revenue Authority


Assessment, Collection, Administration and Enforcement of laws relating to revenue.
Organization; The Authority is a Government agency that runs its operations in the same
way as a private enterprise.
In order to offer better single-window services to taxpayers, KRA is divided into five Regions as
follows:
a)
b)
c)
d)
e)
Rift Valley Region
Western Region
Southern Region
Northern Region
Central Region
In terms of revenue collection and other support functions, the Authority is divided into the following
Departments:
a) Customs Services Department
b) Domestic Taxes Department
c) Road Transport Department
d) Support Services Department
Each Department is headed by a Commissioner. In addition to the four divisions the Authority has
seven Service Departments that enhance its operational efficiency.
These are as follows:
a)
b)
c)
d)
Investigations and Enforcement Department
Human Resources Department
Finance Department
Board Corporate Services and Administration Department
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e) Internal Audit Department
f) Management Information Services Department
g) Research and Corporate Planning Department
Role of Kenya Revenue Authority in the Economy
a) To administer and to enforce written laws or specified provisions of written laws pertaining to
assessment, collection and accounting for all revenues in accordance with these laws.
b) Advise on matters pertaining to the administration or and the collection of revenue under written
laws.
c) Enhance efficiency and effectiveness of tax administration by eliminating Bureaucracy,
Procurement, Promotion, Training and Discipline.
d) Eliminate tax evasion by simplifying and streamlining procedures and improving taxpayer service
and education thereby increasing the rate of compliance.
e) Promote professionalism and eradicate corruption amongst K.R.A. employee by paying adequate
salaries that enables the institution to attract and retain competent professionals of integrity and
sound ethical morals.
f) Restore Economic Independence and Sovereign pride of Kenya by eventually eliminating the
perennial budget deficits by creating organizational structures that maximize revenue collection.
g) Ensure protection of local Industries and facilitate economic growth through effective
administration of tax laws relating to trade.
h) Ensure effective allocation of scarce resources in the economy by effectively enforcing tax
policies thereby sending the desired incentives and shift signals throughout the country.
i) Facilitate distribution of income in socially acceptable ways by effectively enforcing tax laws
affecting income in various ways.
j) Facilitate economic stability and moderate cyclic fluctuations in the economy by providing
effective tax administration as an implementation instrument of the fiscal and stabilization
policies.
k) Be a 'watchdog' for the Government agencies ( such as Ministries of Health, Finance, etc ) by
controlling exit and entry points to the country to ensure that prohibited and illegal goods do not
pass through Kenyan borders
Imposition of Income Tax in KenyaRef: ITA Cap 470
Sec. 3(1) of the Income Tax Act Cap 470 states “subject to and in accordance with this Act, a tax to
be known as income tax shall be charged for each year of income upon all the incomes of a person
whether resident / non resident which is accrued in or was derived in Kenya”. Income tax is a tax on
income. Sec. 3(1) imposes a tax on such incomes.
The Income Tax Act has made no express definition of income. However Sec. 3(2) classifies
incomes by reference to the sources from which they are derived. It states, “subject to this Act
income upon which tax is chargeable under this Act shall be income in respect of;
a)
b)
c)
d)
e)
f)
A business for whatever period of time carried on.
Employment or services rendered (employment and professional incomes)
Rights granted to another for the use or occupation of immovable property e.g. rents and royalties.
Dividends and Interest (investment incomes).
Pension scheme or annuity (incomes of retired employees)
Deemed incomes.
Specified Sources of Income (Sec. 15{7} [e])
a) Rights granted to other persons for use or occupation of immovable property;
b) Employment (including former employment) of personal services for wages, salary, commissions
or similar rewards(not under an independent contract or service) and self employed professional
vocation;
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c) Employment gains or profits from which is wife’s employment income or profession, the gains or
profits from which is wife’s professional income and wife’s self employment the gains or profits
from which is wife’s self-employment income, (incomes of a married woman derived by her at
arm’s length);
d) Agricultural, pastoral, horticultural, forestry or similar activities, not falling in (a), (b) or (c)
above;
e) Surplus funds withdrawn by or refunded to an employer in respect of registered pension or
registered provident funds which are deemed to be income of the employer under Sec. 8(10) of
ITA; and
f) Other sources of income chargeable to tax under Sec. 3(2) (a), not falling within subparagraphs
(a), (b), (c) or (d) of this paragraph.
Tax is charged upon a person’s total income i.e. from all the sources mentioned above. Income is not
necessarily a receipt of money but rather a profit of an income nature. Thus certain benefits in kind
from employment may be taxed in the same way as cash emolument received by way of employment.
To be taxable, profit can either be money or money’s worth but if the money worth is not capable of
being turned into money by the person receiving the benefit, such shall not be regarded as income for
tax purposes.
Income must come from a designated/specified source as per Sec.15 (7) (e) of the Act. It is on the
basis of the designated sources that most casual profits or increments are not taxed e.g. donations,
gifts of money from friends, dowry and charity winnings. To be taxable, income must arise from one
or more of the sources enumerated in Sec. 3(2). However under Sec. 3 (2) (e), legislative powers
have been given to deem something as an income which may not necessarily fall within any of the
other sources
Deemed Incomes
a) Income of a married woman shall be deemed to be the income of the husband, Sec. 45 (1)
b) Sums received from an insurance against or compensation for loss of profit shall be deemed to be
gains or profits of the year of income in respect of which they were received, Sec. 4)c).
c) Business income arising from a business that is carried on partly in Kenya and partly outside
Kenya shall be deemed to be derived in Kenya, Sec. 4 (a).
d) Sums recovered or released from previous years provisions and reserves, Sec. 4 (d)
e) On cessation of a business balancing charges which arises, Sec. 4 (e).
Balancing charge = s.p-wdv
wdv= cost-total capital allowances
Income must be distinguished from capital profits. A particular receipt or expenditure must be tested
to see if it has a quality of capital or income by ascertaining whether it has been received or paid on a
fixed or circulating capital.
Incomes Exempted from Income Tax
The Part 1 of the First Schedule of ITA specifies the incomes which are exempt from Kenya Income
Tax. These include the following:
a) That part of the income of the President of the Republic of Kenya that is derived from salary, duty
allowances and entertainment allowances paid or payable to him from public funds.
b) The income of parastatal bodies
c) The income, other than income from investment, of a sporting association.
d) The income of agricultural societies.
e) The income of any local authority.
f) Interest on any tax reserve certificates issued by the Kenya Government.
g) The income of registered pension scheme.
h) The income of any registered trust fund.
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i) The income from investment of any annuity fund as defined in Sec. 19 of the ITA, of an insurance
company.
j) Pension or gratuities granted in respect of wounds or disabilities.
k) Interest on a savings account held with post bank.
l) Interest paid on loans granted by the Local Government Loans Authority.
m) The income of a non-resident person who carries on the business of air transport provided the
country where that person is resident offers the same facility in the similar business.
n) The income of a registered individual retirement fund (IRF).
o) The income of a registered home ownership savings plan.
p) The allowances to the Speaker, Deputy Speaker and Members of Parliament payable under the
National Assembly Remuneration Act.
q) Partially exempt interest up to maximum of Ksh. 300,000 per individual earned on housing bonds
account.
2) Sec. 14 of Part II of the First Schedule of the ITA specifies that interest on the following
securities is exempted from income tax:
a) Kenya Government securities.
b) East African Commission securities.
c) Nairobi City Council securities
Note: This exemption applies to only non-resident persons.
3) Any class of income which accrues in or derived from Kenya can be declared exempt from tax by
the Minister of Finance in the Kenya Gazette. The Minister can withdraw any exemption
previously granted
4) If resident companies receive dividend from companies where they control more than 12.5% of
the voting power of the dividend paying company, the dividend is exempted from income tax,
Sec. 7 (2).
5) A dividend received as income under Sec. 3 (2) (a) (i) by a financial institution specified in the
Fourth Schedule of ITA Cap 470, shall be exempted from taxation.
6) The following income of individuals is exempted from taxation:
- The cost of passages to and from Kenya of non-citizen employees borne by the employers,
Sec. 5 (4) (a).
- The value of any medical services provided by the employer to full-time employees, WTSD
and Non-WTSD; but to the maximum of Ksh. 1,000,000 in the case of the Non-WTSD.
- Employer’s contribution to the pension/provident fund/schemes, Sec. 5 (4) (c).
- Benefits, advantages or facilities of an aggregate value of less than Ksh. 36,000 p.a. in respect
of employment or services rendered. This is exclusive of those benefits which are expressly
chargeable to tax, Sec. 5 (2) (b).
- The first Ksh. 180,000 p.a. of pension, retirement annuities and NSSF received by a resident
individual in Kenya from registered pension schemes only, Sec. 8(4).
Assessable Persons
Sec. 44 of the Income Tax Act states, “Where under this Act the income of a person is chargeable to
tax, that income shall, subject to this Act, be assessed on, and the tax thereon charged on, that
person”. Note: A person shall include individuals i.e. natural persons and bodies of persons (artificial
persons) i.e. companies. Company under the companies Act Cap 486 includes co-operative societies,
trade, estates, trust etc.
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However partnerships are not assessable persons, since they are not separate legal entities. They are
therefore not separate taxable entities. The income from a partnership is indeed income of the
partners as individuals and thus taxed in their own names. This feature is recognized under sec 3 (3),
which states, “for the purpose of this section, a person does not include a partnership”.
Exceptions to Sec. 44 of the Income Tax Act.
1) Sec. 45-Incomes of a Married Woman
The income of a married woman living with her husband shall be deemed for tax purposes to be that
of the husband. Effectively the incomes of the two spouses will be combined in one assessment that
will be assessed to the husband. In case of a polygamous marriage each of the wives is for the
purposes of sec 45 a married woman living with her husband and her income therefore deemed to be
the income of the husband.
2) Sec. 46 –Incomes of an Incapacitated Person
The income of an incapacitated person shall be assessed on and the tax thereon charged on that
person in the name of his trustee, guardian etc. in the same manner and to the same amount as that
incapacitated person would have been assessed on and the tax thereon charged on that person in the
name of his trustee, guardian etc. in the same manner and to the same amount as that incapacitated
person would have been assessed and charged if he were not an incapacitated person. An
incapacitated person is defined as a minor, or a person adjudged under any law whether in Kenya or
elsewhere to be in a state of unsoundness of mind however described. For the purpose of this section,
a person can only be an individual.
The self-assessment return will be made out of the name of the trustee or the guardian and giving the
name of the incapacitated person on whose behalf it is being assessed or charged. In the year in which
the person attains majority, the full year’s income will be computed and the tax calculated and two
self assessments will be prepared, one for the period before majority and the other one for post
majority with income divided on a time basis and the tax divided pro rata to the income. One selfassessment will be in the name of the trustee or guardian etc while the other assessment will be in the
name of the individual who henceforth will be assessable in his own name.
3) Sec 47(1)-Incomes of a Non-Resident Person
Income of a non-resident person shall be assessed on and the tax thereon charged on that person
either in his name or in the name of his trustee, guardian etc. This will include an agent, a receiver, a
manager, liquidator etc.
Sec. 47(2) and Sec. 9 (1) Incomes of a Non-Resident Ship or Aircraft Owner
Where a non-resident person carries on the business of ship owner, a chatterer or air transport
operator and a ship or aircraft owned or chartered by him calls at any port or airport in Kenya, the
gains or profits from that business from the carriage of passengers who embark, or cargo or mail that
is embarked, in Kenya shall be that percentage of the full amount received on account of the carriage
which the Commissioner may determine to be just and reasonable: and those gains or profits shall be
deemed to be income derived from Kenya: but this sub -section shall not apply to gains or profits
from the carriage of passengers who embark or goods or mail which is embarked , in Kenya solely as
a result of transshipment.
4) Sec. 48(1) – Incomes of a Deceased Person
This section provides that income that is accrued to or received prior to the date of death of a
deceased person and not already assessed on him shall be assessed and charged to his executor or
administrator.
Sec. 48(2) - Incomes Received by Executors of a Deceased Person
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An amount received by the executors or administrators of a deceased person which would, but for his
death, have been his income for a year of income shall be deemed to be income of the his executors
or administrators and shall be assessed on, and the tax charged on them for that year of income.
Residence
The residential status of a person is relevant in relation to income tax since it will affect: a) The scope of the charge to tax i.e. applicable rates, exemptions, tax at source and
b) The grant of relief.
Residence for tax purposes implies the physical residence or presence in Kenya in a particular year of
income. Tax residence has got nothing to do with ones nationality or citizenship or domicile. Physical
presence in Kenya means being within:
a) The Kenya airspace or
b) Within the Kenya territorial waters or
c) Within all that land within the boundaries of Kenya.
A resident person can be either an individual or a body of persons.
Residence in Relation to an Individual
Sec 2 of the Income Tax Act defines residence when applied to an individual to mean.
a) He has a permanent home in Kenya and was present in Kenya for any period or periods in the
year of income under consideration, or
b) Has no permanent home in Kenya but was present in Kenya for a period or periods amounting in
the aggregate to 183 days or more in that year of income or,
c) Has no permanent home in Kenya but was present in Kenya in such a year of income under
consideration and in each of two preceding years of income for periods averaging more than 122
days, in each year of income.
In relation to individuals, residence is determined in relation to year of income and thus a person may
be resident in one year of income and not in another. A person for the purposes of personal relief may
be deemed resident for part of the year only. An individual must be physically present in Kenya
however short a period during a particular year of income before he’s deemed to be a resident for that
year. If an individual has a permanent home in Kenya and sets foot in Kenya in a year of income no
matter how short the time, he will be deemed to be resident for the whole year. He needs not visit his
permanent home.
The term “permanent home” has not been defined by the Act, but it should be construed in its
ordinary sense. In the Commissioner General of Income Tax Vs. Nurudin Hassan Ali Nurani an
indication is given as to how the courts would interpret the expression permanent home. This case
was concerned with whether the taxpayer “had a home in the partner state,” i.e. the definition
contained in the East African Income Tax Management Act. In interpreting home the courts
considered the following points: a) An individual could have more than one home and one of it could be outside the partner states
without contradicting the definition.
b) A home does not necessarily mean a house or a bungalow or flat where you live. It could even be
a hotel room.
c) The home may be owned or rented
d) The home must be available at least for a part of the year.
e) In a home one could expect to find the family and or personal belongings
f) The individual and or his family must occupy the home.
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Residence in Relation to Body of Persons
Body of persons for income tax purposes is normally referred to as “company”. A body of persons is
formed in Kenya through incorporation by an Act of parliament e.g. Public or private limited
companies through the companies Act or co-operative Societies through the Co-operative Societies
Act, Trade Associations, members clubs, estates, trusts etc
Sec. 2 of the Act it defines residence in relation to a body of persons to mean:
a) That the body is a company incorporated under the laws of Kenya
b) That the management and control of the affairs of the body was exercised in Kenya in a particular
year of income under consideration.
c) The body has been declared by the Minister of Finance by a gazette notice to be resident in Kenya
for any year of income.
When determining the place where control and management of a company lies, this becomes a
question of fact. In each case the normal test would be to consider where meetings of the board of
directors are normally held since the management and control of a company is usually vested in its
directors.
Tax Implications of Residence
Resident persons have certain tax advantages over non-resident persons.
In Respect of Individuals
a) Resident individuals are eligible to claim personal relief but non-resident individuals do not claim
such relief.
b) The total income of resident individuals is taxed as an aggregate amount at the graduated scale
rate of tax whereas for non-resident individuals certain incomes are taxed at specified rates.
c) Resident individuals are allowed on certain expenses while non-resident individuals are taxed on
the gross income i.e. no expenses allowed.
In Respect of Corporations
a) The corporation tax rate for resident bodies of persons is lower than for non-resident companies.
b) The taxable income of resident companies is taxed on the basis of aggregate amount while for
non-resident companies it is based on specified incomes at specified rates.
c) Resident companies are allowed on certain expenses (Sec. 15) whereas non-resident companies
are not allowed on such expenses.
Year of Income
Year of income is a period in reference to which income is brought to tax. It is a period of 12 months
commencing on 1st of January and ending on 31st December each year. It is the same as a calendar
year. An accounting year is a period in which the accounts of an organization are drawn up. It may
not necessarily end on same date as calendar year.
Sec 27(1) of ITA states,” where a person usually makes the accounts of his business for a period of
12 months ending on a day other than 31st December, then, for the purpose of ascertaining his total
income for a year of income, the income of an accounting period ending on that other date shall,
subject to such adjustments as the Commissioner may consider appropriate, be taken to be income of
the year of income in which the accounting period ends.
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CHAPTER FIVE
EMPLOYMENT INCOME
Introduction
This is one of the separate sources of income by itself. An employee is normally taxed on cash and noncash payments arising from employment. Employment income is one of the most common sources of
income and therefore requires particular attention.
The source of income is determined by residential status of the employee and where he was recruited
from. In Kenya, a resident employee is taxed on employment income earned from any place in the world
so long as he was recruited in Kenya by a resident employer or a permanent establishment in Kenya of a
non-resident employer.
The ITA does not define employment but covers any relationship between master and servant arising
from a contract or agreement. The scope of the Act extends to services rendered by one person to
another other than in the course of employment or as part of business.
Definition of Terms
Employer
An employer is taken when necessary to include:
a) Any person having the control of payment of remuneration of another.
b) Any agent, manager, or other representative in Kenya of any employer who is outside Kenya.
c) Any paying officer of the government or other public authority.
d) Any trustee or insurance company or any other body paying pensions.
An employer will thus include a manager of a branch or a firm. The employer must decide which
offices shall be the paying point and ensure that those in charge of the paying are adequately
instructed of their duties under PAYE scheme. The paying point is the place at which the
remuneration is paid.
Employee
This word is defined as inclusive of any holder of an appointment of office, whether public or
otherwise, for which remuneration is payable. “Employee should be read as including for example
minister, chief, any public servant, company director (resident or non-resident), secretary, etc, in
addition to those more commonly known as employees. It includes an employee who retires on
pension and stays in Kenya where the registered pension fund benefits exceed Ksh. 180,000 per
annum.
Gains and Profits from Employment
Gains /profits from employment or services rendered will include both cash and non-cash payments.
Cash Benefits
a) Cash payments such as salaries, wages, leave pay, sick pay, payment in lieu of leave, directors
fees, overtime, commissions, bonuses whenever paid, gratuity and compensation for termination
of a contract of employment or compensation for loss of office.
b) Cash allowance and all round sum expense, allowance paid by an employer e.g. house, hardship
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c)
d)
e)
f)
and commuter allowances.
Any private expenditure of an employee that is paid for by the employer. Usually such expenses
are in the name of the employee but are paid for by the employer e.g. electricity bills, water bills,
shopping bills, school fees for employees’ children, insurance premiums etc.
An amount of subsistence, travelling, entertainment and mileage allowance. However where these
are paid to an employee as mere reimbursements (refunds) of the employer’s expenses they will
not be taxable. All reimbursements must be documented i.e. they must be supported with
documentary evidence.
Amounts that are deemed to be gains or profits from employment derived from Kenya i.e. an
amount that is paid to a resident person for employment or service rendered inside or outside
Kenya. A resident individual is taxed on employment income arising in Kenya or from outside
Kenya i.e. worldwide employment Income
Any amount that paid for employment or services rendered to an employer who is resident in
Kenya and who has a permanent establishment in Kenya by a non-resident person will be taxed in
Kenya.
Non-Cash Benefits
Any benefits, advantages or facilities of whatever nature that arise by virtue of ones employment. The
value of benefits in kind that are taxable should aggregate to Ksh. 3,000 p.m (36,000 P.A). With
effect from1 1 2006 (previously it was Ksh. 2,000 p.m.).
1) Facilities such as free lunch, transport, gifts to employees, free meals etc.
2) Provision of Servants
This include a house servant, a cook, watchman, gardener, an Ayah (maid), bodyguard,
messenger, chauffer etc. The values of such benefits are taxed on the higher between the market
cost and actual cost incurred by the employer, the employee is taxed on the higher.
3) Provision of Services
They include water, telephone, electricity, furniture, alarm system etc. The CDT quantifies the
value of such benefits to the employee through the quantified benefits tables. Where the
quantified benefit is different from the cost of providing the service to the employer, whichever is
the greater shall be the taxable value.
4) Provision of Motor Vehicles
Previously the value of the motor vehicle benefits would depended on the engine capacity rating
i.e. CC rating (cylinder capacity). The Commissioner has similarly issued the quantified benefit
rates in respect of m/vehicles on the basis of the cylinder capacity. The higher the CC rating the
greater the benefit. Up-to 31st December 1995 the taxable benefit of a motor vehicle was based
only on the cc rating irrespective of the cost to the employers. As from 1 st January 1996, the
Commissioner introduced a different perspective in respect of the taxation of motor vehicle
benefit by introducing an element of original cost of the motor vehicle. As 1.1.1996, the taxable
value of a motor vehicle benefit shall be the greater of: - The Commissioners quantified benefit based on cc rating; or
- A percentage of the initial cost of the motor vehicle, as 1996- 12%p.a. (1% p.m.), 1997- 18%
p.a. or (1.5% p.m.), 1998-to date 24% p.a. or (2% p.m.)
5) Housing/ Quarters Benefit
Housing benefit arises where an employee is housed by his/her employer in a house either owned
by the employer or the employer pays rent directly on account of a house occupied by the
employee. To determine the amount of housing benefit that accrues to an employee, employees
are classified into the following categories:a) Ordinary Employees and Whole Time Service Directors.
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In this case, the housing benefit shall be taken to be 15% of employment income (cash + non cash
benefits).
b) Agricultural Employees Including Whole Time Service Directors (WTSD)
An agricultural employee is one whose terms and conditions of employment require that he reside
within the plantation or farm. The housing benefit shall be 10% of employment income (cash +
non-cash benefits).
c) Employees Earning over Ksh. 50,000 per Month
As from 1st Jan 1995 where an employee earns income in excess of Ksh. 50,000 p.m. (Ksh.
600,000 p.a.) the housing benefit shall be the greater of:
- The market rental value of the house and
- The computed housing benefit based on type of employee.
d) Employees Provided with Housing and Free Meals
Where an employee is accommodated within the hotel premises and takes his meals there, the
value of the benefit shall be 10% for accommodation and 10% to cover meals giving a total of
20% of employment income (cash + non-cash benefits).
Note: With effect from June 1998, the Commissioner introduced new provisions regarding the
value of housing for whole time service directors and directors other than WTSD. Quantification
of housing benefit for other employees remains as before.
e) Whole Time Service Director
Definition: Means a director of a company who is required to devote substantially the whole of
his time to the service of that company in a managerial or technical capacity and is not the
beneficial owner of, or able, either directly or through the medium of other companies or by any
other means, to, control more than 5% of the share capital or voting power of that company.
The housing benefit shall be taken to be 15% of employment income provided that:- If the employer pays rent under an agreement not made at arms length with a third party the
value of the quarters shall be the fair market rental value of the premises in that year or the
rent paid by the employer which ever is greater; or
- Where the premises are owned by the employer the fair market rental value of the premises
shall be the taxable benefit.
f) Directors Other than WTSD
The housing benefit shall be 15% of total income (income from all sources), provided that: a) If the employer pays rent under an agreement that is not made at arms length with a third
party, the value of the quarters shall be the fair market rental value of the premises in that year
or the rent paid by the employer, which over is the greater;
b) Where the premises are owned by the employer the fair market rental value of the house shall
be taxable amount.
Note: The fair market rental value should be taken to mean the amount of rent that the premises
would attract if it were floated in the open market for leasing. An independent registered land
valuer should carry out the valuation.
Additional Notes in Respect of Housing Benefit
a) Where the employer provides an employee with a house for only part of a year, the housing
benefit shall be reduced proportionately to a period of occupation.
b) Where an employee pays nominal rent towards a house provided by the employer, such amount
will be deducted against the housing benefit.
c) Where an employee occupies only part of a house provided by an employer, the housing benefit
25
shall be computed on a basis, which the Commissioner thinks will be just and equitable.
d) House allowance should be taxed as a cash allowance but not be used in the computation of
housing benefit.
Exceptional Cases on Taxation of Housing Benefits
There are certain instances that would provide a strong case for employees not to be taxed on the
benefit of a house provided by the employer; for example:
a) Where a house is provided as a basis for effective performance of the duties of an employee e.g. a
house provided to a building caretaker.
b) Where housing is of necessity to an employee’s proximity to their work e.g. matron of a school,
captain of ship etc.
c) Where an employee is under a form of threat or where the accommodation is part of a security
detail e.g. the occupation of soldiers within the barracks housing provided to researchers in
undisclosed residences.
e) Low Interest/Interest Free Loan Benefit
When an employer provides a loan to an employee or a relative of an employee and charges interest,
which is below the Commissioner’s prescribed rate of interest, then the difference between the
prescribed rate and employer’s rate shall be taken as a benefit chargeable to tax of an employee.
Low interest rate on employment benefit also applies to directors and it will continue to apply even
after the employee or the director has left employment and as long as the loan remains unpaid.
Following the amendments to the law and the introduction of fringe benefit tax, which is, payable by
the employer, the determination of the chargeable benefit will now be in two categories i.e.
a) For loans provided on or before 11th June 1998. The employee will continue to be taxed on the
low interest rate benefit in respect of such loans based on Commissioner’s prescribed rate.
b) For loans provided after 11.6.1998, or loans provided on or before 11.6.1998, and whose terms
and conditions have changed after 11.6.1998, the value of fringe benefit will be the difference
between the interest that would have been paid on the loan calculated at the market rate, and the
actual interest rate. A tax known as fringe benefit tax (Sec 12 B) has been introduced on such
loans and will be payable by employers commencing 12th June 1998. The fringe benefit shall be
taxable at the corporation tax rate ruling then.
The fringe benefit tax shall be charged on the total taxable value of fringe benefit each month and
the tax payable paid on the normal PAYE date. Thus employers will be required to pool all the
fringe benefit tax in each month. The provisions for fringe benefit tax shall include any loan from
a non-registered pension fund. Market rate of interest means the average rate of interest for 91day treasury bills issued in the last quarter of the year. Fringe benefit tax is payable even where
corporation tax is not due from employer in question.
Non-Taxable Benefits from Employment
1) Passages for Expatriate Employees
A passage is an expenditure on transport and translocation between Kenya and any other place
outside Kenya which is borne by the employer for an expatriate employee and his family. However,
such passages shall be excluded from taxation but subject to a number of conditions:
The employee must not be a citizen of Kenya.
The employee must have been recruited or engaged from outside Kenya. However, an expatriate will
not loose a passage for changing jobs while in Kenya.
The employee must be in Kenya solely for serving his employer.
26
Where an expatriate engages in commercial or any other activity outside the terms and conditions of
employment, he may loose the passage. Where an expatriate employee receives cash either
periodically or in one amount, which he is free to save or spend on whatever passages he chooses or
for any other purposes, such shall be taken as taxable cash allowances. The provisions for passages
also include leave passages to his employees and their families. Passages are in form of air tickets
purchased by the employer and remitted to the employee to facilitate the travel or reimbursing the
employee on amounts incurred on the passage.
2) Medical Expenses/Benefits
Where an employer has a written plan or scheme or by practice he provides free medical services to
all his employees (non-discriminatory medical scheme), the value of such medical services /benefits
is non-taxable on the ordinary employees, whole time service directors and non-whole time service
directors (but to the maximum of Ksh. 1000,000 for this last group). Where the employer has no
written plan or scheme or has a medical scheme that caters for some employee’s only e.g. senior staff
(discriminatory medical scheme), the payment of medical bills / benefits will be taxable benefits on
the recipients.
3) Employer’s Contributions to Retirement Schemes
Amounts of contributions by the employer on behalf of an employee to a pension/provident fund or
scheme whether registered or not with the Commissioner. However, with effect from 1.7.2004,
employees of organisations not chargeable to tax will be liable tax on contributions the employer
makes to an unregistered fund or on the excess contribution to a registered fund.
Allowable Deductions from Employment Income
1) Employee’s Contribution to Registered Pension and Provident Fund
The deductible amount will be the lesser of:
The actual amounts contributed by employee or
30% of the employment or pensionable income; which means all emoluments and benefit subject to
PAYE or
The CDT’s ceiling of Ksh. 20,000 p.m. (Ksh. 240,000 p.a. from 2006) and was Ksh. 17,500 p.m.
(Ksh. 210,000 p.a. up to 2005).
2) Registered Home Ownership Savings Plan (RHOSP)
A depositor (employee) shall in respect of a year of income be eligible for a deduction against his
employment income in respect of a fund deposited in an approved institution under the registered
home ownership savings plan. In the qualifying year and in subsequent years of income, deductible
amounts are, Ksh4,000 pm ( sh48,000) However, for this deduction to be made;
a) The employer will be the one to deduct and remit the amount to the approved financial institution
on behalf of the employee.
b) The employer must have evidence to confirm that the approved institution in which the employee
wishes to save is registered with the CDT.
c) The employer will attach to a Form P9A (HOSP) a declaration signed by the eligible employee.
This declaration will serve as a verification and confirmation by the employer that the employee
does not directly or indirectly own an interest in a permanent house.
Approved Institution
The financial institution specified under the Fourth Schedule of the Income Tax Act includes:
a) A bank or a financial institution licensed under the Banking Act.
b) An insurance company licensed under the Insurance Companies Act.
c) A building society registered under the Building Societies Act.
27
3) National Social Security Fund Contribution
Contributions made to NSSF qualify as deductions as from 1.1.1997. Where an employee is a
member of a pension /provident fund and at the same time the NSSF, the maximum allowable
contributions should not exceed Ksh. 20,000 p.m. in aggregate, (Ksh. 240,000 p.a. from year 2006)
4) Owner Occupier Interest /Mortgage Interest on Owner Occupied Property
The interest paid by a person /individual on an amount borrowed from a specified financial institution
shall be deductible. The amount must have been borrowed to finance either:
a) The purchase of premises or
b) Improvement of premises, which he occupies for residential purposes
The amount of interest allowable under the law must not exceed Ksh.100, 000 per year (equivalent to
Ksh. 8,333 per month and Ksh. 8,337 in the month of December from 1.1.2000) and Ksh. 150,000 per
year (equivalent to Ksh. 12,500 p.m. from year 2006).
If any person occupies any premises for residential purposes for part of a year of income, the
deduction shall be reduced accordingly. On the other hand no person may claim a deduction in
respect of more than one residence. Following an amendment to Sec. 45 of the Income Tax Act
through the 1999 Finance Act, a married woman can now file her own separate return of income and
declare income from employment, professional or self-employment. In view of this, she has the
option to claim for deduction of interest paid if the property is registered in her own name. Employer
must obtain a signed declaration to the effect that she is the one claiming the deduction to avoid her
husband making a similar claim.
Employers will be required to ascertain and allow interest paid on money borrowed to finance owner
occupied residential premises under the PAYE system subject to the following conditions:
a) The amount of interest to be allowed must not exceed Ksh. 12500 p.m. (Ksh. 150,000).
b) Where the employee redeems such loan in the course of the year and no interest is subsequently
payable, such allowable deductions shall cease forthwith upon redemption of loan.
c) The employee shall sign a declaration-indemnifying employer against any false claim in this
respect.
d) The employer shall attach to P9A photostat copy of preceding years’ certificate or confirmation of
current year’s borrowing whichever is applicable from the financial institution advancing the
loan. The certificate must show the current loan balance, rate of interest, and amount of interest
paid in the preceding or current year if any.
e) Employers are expected to review their payrolls starting the month of September and make
necessary adjustment to ensure that by the end of the year correct amount of interest has been
allowed.
5) Rent charged by the employer (nominal rent)
6) If an employee uses his private motor car for the purpose of production of income from employment,
he is allowed a capital deduction. In case of motor cars, it is 25% of written down value.
7) If an employee pays any expenses for the production of income from his employment and if such
expenses are not reimbursed by his employer, these may be deducted from his gross earnings to
arrive at his chargeable income. Such expenses include the following:
a) The cost of travelling in the performance of the duties. This does not include the cost of
travelling from home to the place of work.
b) The extra cost of living away from home when necessitated by employment.
c) Cost of tools and implements if the employee provides his own.
d) Vehicle running expenses when an employee uses his personal car which enables him to perform
his duties. If the car is also used for private purposes, the allowance will be reduced
proportionately.
e) Cost of special clothing required if not provided by the employer.
28
Disallowable Deductions against Employment Income
a) Traveling expenses from home to place of work
b) The cost of normal clothing.
c) The cost of meals while on duty.
d) Amount paid to an employment agent to find employment.
e) Education fee, examination fee, subscriptions etc paid to colleges, universities and polytechnics
by an individual to improve his employment capability.
Offences and Penalties under PAYE
No. Offences
Failure to pay tax on due date:
1
2
3
Penalties
- 5% filing penalty charges
- 20% penalty on unpaid amount plus 2% p.m. for
the period more than one month after the due
date until paid.
Failure to operate the PAYE System - Penalty of Ksh. 10,000 or 6 months
satisfactorily
imprisonment or both
Failure to deduct PAYE by a corporate - Penalty of not less than Ksh. 10,000 but not
body
more than Ksh. 200,000 or two years
imprisonment or both.
29
CHAPTER SIX
RATES OF TAX, RELIEFS AND WITHHOLDING TAXES
Introduction
After establishing the sources of income and obviously the administrative machinery of the Income Tax
the next task is the collection of tax. The question therefore is at what rate, and how and when do we
collect tax? The rates of tax, personal relief, set-offs and withholding tax are taken into consideration
while computing the net tax liability of taxable persons.
Rates of Tax
These are given in the Third Schedule of the Income Tax Act (Cap 470). These rates are revised from
time to time. The rates of tax are given separately for individuals and body corporate.
Personal Relief
It is relief claimed and granted to resident individuals only. A relief is a set-off against taxes payable.
The effect of a relief is to reduce one’s tax burden.
General Application of Relief
a) Only resident individuals are eligible to claim personal relief. Therefore non-resident individuals
and corporations do not get personal relief.
b) Where an individual dies during the year of income, the relief is given up to the date of death and
not thereafter.
c) Where an individual departs from Kenya during the year of income, the relief is given up to the
date of departure.
d) Where an individual arrives in Kenya with the intention of being a resident, the relief will be
granted from the date of arrival.
From 1.1.1997, all other relief (Family relief, Single relief, Special Single relief and Insurance relief)
were abolished and replaced with one relief that applies to all individuals equally, known as Personal
Relief. The rates are as follows: Ksh. 7,200 (1997), Ksh. 7,920 (1998), Ksh. 8,712 (1999), Ksh. 9,600
(2000), Ksh. 11,520 (2001), Ksh. 12,672 (2002), Ksh. 13,944 (2005/2006) per annum.
Note: Insurance relief has been reintroduced with effect from 1.1.2003 with special provisions as
explained below.
Insurance Relief
A resident individual shall be entitled to insurance relief at the rate of 15% of premiums paid subject
to maximum relief amount of Ksh. 5,000 per month (or Ksh. 60,000 per annum) if he proves that:
- He has paid premium for an insurance made by him on his life, or the life of his wife or of his
child and that the insurance secures a capital sum, payable in Kenya and in the lawful currency of
Kenya; or
- His employer paid premium for that insurance on the life and for the benefit of the employee
which has been charged to tax on the hands of that employee; or
- Both employee and employer have paid premiums for the insurance:
Provided that:
- No relief shall be granted in respect of part of premium for an insurance which secures a benefit
which may be withdrawn at any time at the option of the insured.
30
-
Premiums paid for an education policy with a maturity period of at least 10 years shall qualify for
relief.
Only premiums paid in respect of an insurance policy taken on or after 1st January 2003 shall
qualify for relief.
Notes
- Employers must avail to the employer a certificate from insurer showing particulars of the policy
e.g. name of insured, type of policy, capital sum payable, maturity date, premiums payable and
commencement date of the policy.
- Employers should review their pay-rolls towards the end of the year and make necessary
adjustments to ensure that the correct relief had been granted. No relief is available in respect of
insurance policy that elapsed in the course of the year.
- Employer shall attach a copy of the certificate furnished by insurer confirming premiums paid and
that the policy was still in force to the employee’s P9A, P9B and P9A (HOSP) Tax Deduction
Card for that year.
- For the purposes of insurance relief “child” include a step child and an adopted child who was
under the age of eighteen years on the date the premium was paid.
Withholding Taxes
The Income Tax requires withholding taxes or taxes at source to be deducted from the point of
payment and such taxes remitted to the CDT. Examples of incomes whose taxes are deducted at
source are:
a) Employment income
b) Dividends and interest
c) Pension income.
d) Insurance commissions
e) Farming income subject to presumptive income tax.
This means that the incomes that are subject to withholding tax received by a resident or non-resident
person will be received net of taxes. Withholding tax is not an additional tax nor a separate tax nor a
special tax. It is a mere administrative procedure of deducting and remitting income tax on certain
incomes and minimizes chances of tax evasion.
Besides, it is administratively cheaper for the DTD to collect taxes through withholding tax since the
cost of collection is borne by the person who has been given the statutory obligation to collect such
taxes. Withholding tax is an advance payment of tax. The person making payment of the incomes
which are subject to withholding tax has a statutory obligation to deduct the withholding taxes at their
appropriate rates before making the payment to the person they are due and;
a) Remit the tax so deducted to the DTD, (PAYE by the 9th of the following month and for other
incomes subject to withholding tax, by the 20th of the following month following the month of
deduction).
b) To pay the payee the amount net of tax.
c) Issue the payee with the certificate of WHT or the tax paid at source.
At the end of the year the person will be assessed on the gross income but a credit will be given as a
set-off for all taxes paid in advance, except in those cases where WHT is a final tax. A set-off tax
must be made in the same year in which the deduction took place.
31
Withholding Tax Rates
Management fee
Royalties
Leasing equipment
Dividend
<12.5% voting power
>12.5% voting power
Interest from financial institutions and 2 yr. bearer bonds
Interest form bearer certificates
Housing bond interest
Rents – immovable property
Pension and taxable withdrawals from pension/provident funds
Insurance commissions
Contractual fees
Consultancy and agency fees
Consultancy fee to EA Community Countries
Surplus pension fund withdrawals
Shipping Business
Gross amount of consideration for disposal of property
Resident
Payee
5%
5%
15%
5%x
Exempt
15%x
25%x
10%x
N/A
10%-30%
10%x
3%
5%
N/A
30%
N/A
3%
Notes
1
2
3
3
3 and 4
5
6
7
7
8
9
Non-Resident
Payee
20%x
20%
15%
15%x
10%
15%x
25%x
15%x
30%x
5%x
20%x
20%
20%
15%
30%
2.5%
3%
x Means final tax.
1. Agency fees on export of flowers and from 1.7.2006, on fruits and vegetables, are exempted. From
1.1.2006, audit fee for analysis of maximum residue limits paid to a non-resident laboratory or
auditor are exempted.
2. Aircraft leasing exempted
3. This applies only to individuals. The non-resident rate is 15%. The resident rate is as shown but is
not a final tax for corporations.
4. Limited to income of Ksh. 300,000 per annum.
5. These rates apply only on the graduated PAYE tax rates (for early withdrawal) or in bands of Ksh.
400,000 (for withdrawals after a 15 year period or at 50 years of age).
6. 5% if paid to a resident broker.
7. If fees are in excess of Ksh. 24,000 per month when paid to a resident person.
8. For taxable shipping business
9. For capital gains items.
Payroll Preparation
The preparation of a Tax Deduction Card should not be confused with preparation of a Payroll. The
Tax Deduction Card is prepared to calculate how much tax should be deducted from the salary of the
employee while a Payroll is prepared to show the gross salary, deductions and net wages.
A payroll is a list of all employees showing for each employee the gross pay, various statutory and
other deductions and the net pay. Various deductions from the employee’s pay include the following:
a) P.A.Y.E tax
b) National Social Security Fund (NSSF)
c) NationalHospital Insurance Fund (NHIF)
32
d) Other deductions for Welfare Fund, Union Fees, Salary advance, Co-operative Loans etc.
The following are the statutory deductions, which must be made where applicable, by all employees:
a) PAY As You Earn (PAYE)
b) National Social Security Fund (NSSF)
c) NationalHospital Insurance Service (NHIS)
National Social Security Fund (NSSF)
The National Social Security Fund is a Government Fund that was established in 1965 by the NSSF
1965 for the benefit of workers. It is a compulsory scheme into which the employer pays a statutory
contribution for every employee who is a member of this fund. The scheme is applicable to those
employee having more than five employees.
The average contribution is 10% of a worker’s wage, half of which is paid by the employer and half
by the worker. The Act provides that the maximum contribution payable in respect of:
a) A member paid monthly shall be Ksh. 400 of which Ksh. 200 may be recovered from the
employee’s wage.
b) A member paid fortnightly shall be Ksh. 200 of which Ksh. 100 may be recovered from the
employee’s wage; and
c) A member paid weekly shall be Ksh. 100 of which Ksh. 50 may be recovered from the
employee’s wage.
Provisions of NSSF Scheme
a) Age Benefits-This will be paid to a member at the age of sixty or when he ultimately retires from
paid employment, whichever is later.
b) Withdrawal Benefit-This will be paid to member who is at least fifty-five years of age and has
not engaged in paid employment during the previous three months.
c) Invalidity Benefit-This will be paid to a member who is permanently incapable of work because
of physical or mental disability.
d) Survivor’s Benefit-This will be paid to the dependants of deceased member.
e) Emigration Grant-This will be paid to a member who is permanently emigrating from Kenya.
Each of the above mentioned benefits will consist of the total sum outstanding to the credit of the
member at the time i.e. the member’s contributions, his employer’s contributions and the interest
earned by those combined contribution over the years of his membership.
Exemption from NSSF
As the scheme is a national one exemption from it is strictly limited and controlled. Exemptions are
given under the following two categories:
a) Automatic exemption without the need to make formal application has been granted to the
following:
- Pensionable officers in Government and Local Government Service.
- Pension under International Convention are exempt from Social Security Schemes.
- Members, other than civilian employees of Military, Air Force, the Prison Service and the
National Youth Service.
- Persons subject to the superannuation schemes for universities.
b) Formal application through the employer is required in respect of an employee for whom
exemption is being claimed on the following grounds:
33
-
As an employee who is not ordinary resident in Kenya
As a person in the service of any University or College who is entitled to receive benefits
under a superannuation scheme other than the superannuation scheme for University.
NationalHospital Insurance Service (NHIS)
This is a statutory deduction made under the National Hospital Insurance Act. The Act requires every
employee earning Ksh. 1,000 or more per month to contribute Sh.20 per month towards this fund.
The stamps are to be affixed on each contributor’s cards, which are provided by the NHIS. The
stamps are then cancelled either by employer’s rubber stamp or by initialing across the face.
Married women and employees earning less than Ksh.1, 000 are exempt from this contribution.
However, an employee earning less than Ksh. 1, 000 can become a member of the voluntary scheme.
Members or contributors and their families (husband, wife or children) are given certain refunds
when they are hospitalized. The refund depends upon the grade of the hospital and the nights spent in
the hospitals.
It should be noted that refunds are applicable to in- patient hospital expenses and not outpatient
expenses.
34
]
CHAPTER SEVEN
INCOMES OF A MARRIED WOMAN
Introduction
Up to 1994, a married woman was assessed separately from her husband's income on her employment
and professional income. From 1995, her self-employment income, mainly from business in her name is
also assessed separately on her.
Incomes of a Married Woman Ref: Sec. 45 of ITA Cap 470
The income of a married woman living with her husband is all the time deemed to be the income of
her husband and is taxed on the husband. However when calculating the tax payable by the husband,
wife’s employment income, wife’s professional income and wife’s self-employment income will be
segregated from the husband’s income and tax thereon determined at wife’s employment income rate
of tax, wife’s professional income rate of tax and wife’s self-employment income rate of tax
respectively, which are the same as the personal/graduated/ individual scale rates of tax. Where a
married woman is not living with her husband, each of the spouses for the purposes of the Act shall
be treated as if they were unmarried. For the purposes of the Act, a married woman is treated as living
with her husband unless;
(a) They are separated under a court order or a written agreement of separation; or
(b) They are separated in such circumstances that the separation is likely to be permanent; or
(c) She is a resident person while the husband is a non-resident person.
Note: Mere physical detachment of spouses due to the demands of work does not constitute a
separation.
1) Wife’s Employment Income
As from 1.1.1980 and for the purposes of calculating the tax payable by the husband, wife’s
employment income will be segregated from the income of the husband and tax thereon calculated
separately at the wife’s employment income rate of tax, which is the same as the graduated scale rate
of tax. Wife’s employment income means the gains or profits of a married woman living with her
husband from employment including pensions, lump sums and withdrawal from registered funds
from a contract of employment or service.
For wife’s employment income to be assessed to tax separately, it must be derived from an
employment where the husband has no control whatsoever of the income or the employment of the
wife i.e. such incomes must have been derived at arm’s length (independently from the husband).
Wife’s income will not be assessed on her separately if derives it as;
(a) A partner in a partnership where the husband is a partner; or
(b) An employee of the husband; or
(c) From a company where the husband and/or the wife or both of them jointly control 12.5% or
more of the voting powers or the share capital of the company directly or indirectly; or
(d) As a trustee or a manager of a trust created by the husband for the benefit of their children.
2) Wife’s Professional Income
As from 1.1.1989, wife’s professional income will be segregated from the income of the husband and
tax thereon computed separately at the wife’s professional income rate of tax, which is the same as
the graduated scale rate of tax. Wife’s professional income means the gains or profits of a married
woman living with her husband derived by her from the exercise of one of the professions specified
in the 5th Schedule of ITA Cap 470 and having the qualifications specified in that schedule relevant to
that profession. The qualifying professions are:
35
a)
b)
c)
d)
e)
f)
g)
h)
i)
Medical profession under the Medical Practitioners and Dentists Act Cap 253.
Dental profession under the Medical Practitioners and Dentists Act. Act Cap 253.
Legal profession under the Advocate’s Act Cap 16.
Surveyor; either a land surveyor registered under the Surveyors Act Cap 299; qualified and
registered as a fellow, a profession of the Royal Institute of Chartered Surveyors.
An architect or quantity surveyor, registered under the Architect and Quantity Surveyors Act Cap
525.
Veterinary surgeon registered under the Veterinary Surgeons Act Cap 366.
An engineer under the Engineers Registration Act Cap 530.
An accountant or an auditor registered under the Accountants Act Cap 531.
Certified Public Secretary registered under the CPS Act Cap 534.
Where a married woman derives professional income from a professional practice where the husband
is a partner or has control, such income will not be assessed on her separately. The loss of the wife is
deemed to be the loss of the husband. A deficit at the time of marriage becomes the husband’s deficit
to be offset against future income of the wife, which will be taxed on the husband. Where a man is
married to more than one wife, the incomes of the wives are still deemed to be the incomes of the
husband. Where the husband fails or is unable to pay tax due, the CDT will collect the proportion of
such taxes from the wife that relates to her income taxed on her husband.
3) Wife’s Self-Employment Income
As from 1.1.1994, wife’s self employment income will be segregated from the husband’s income and
tax thereon computed separately at the wife’s self employment income rate of tax which is the same
as the graduated scale rate of tax. Wife’s self-employment income means the gains or profits arising
from a business of a married woman living with her husband, which is chargeable under the Act. This
will however not include any income derived by her from providing services or goods to a business,
partnership or company owned by the husband. Wife’s self-employment income entails business
carried on by a married woman on a full-time basis without the control or intervention of the
husband.
4) Wife’s Income
The Act gives no express definition of the term wife’s income but it is implied to be the income
derived by a married woman living with her husband derived from other sources not fitting the above
descriptions, and include;
(i)
Employment income where the husband has control.
(ii)
Self-employment income where the husband has control.
(iii)
Professional income where the husband has control.
(iv)
Dividends and interest (incomes from investments).
(v)
Rent and royalties (income from use of property).
(vi)
Farming income.
Such incomes will be taxed alongside the husband’s incomes as an aggregate.
36
CHAPTER EIGHT
INVESTMENT INCOMES
Introduction
These are specified sources of incomes, which are taxed according to the income tax rules. The tax rules
governing the taxation of these incomes, as in other cases of income, are revised from time to time.
Topic 1
Dividend Income
Ref. Sec. 7 of ITA Cap 470
A dividend is a distribution of profits of a company in which one has invested. A dividend is received
by a shareholder as a proportion of one’s shareholding in a company. A dividend is income of the
receiver. However, a distribution that is made by a company during a complete liquidation of a
company is not treated as a dividend but simply a return of capital, which was originally invested in
that company and therefore not taxable.
Deemed Dividends
a) In a voluntary winding up of a company, such amounts distributed as profits including any profits
realized on the disposal of fixed assets of a company, whether before or during the winding up
and whether paid in cash or otherwise.
b) The issue of debentures or redeemable preference shares or ordinary shares for free. The dividend
amount shall be taken to be the greater of nominal or redeemable value and the market value.
c) The issue of debentures or redeemable preference shares or ordinary shares at a discount provided
the discount factor exceeds 5% of the nominal/par value. In this case the discount amount shall be
taken as the dividend and taxed accordingly.
Exempt Dividends
a) Dividends received by a company that owns or controls 12.5% or more of the voting powers of
the paying company.
b) Dividends received from outside Kenya or from non-resident companies.
c) Dividends received by a resident insurance company from its investment income of the life
insurance fund.
d) Dividends amount being the discount factor on the issue of debentures or redeemable preference
shares or ordinary shares provided the discount factor is less than 5% of the par value.
e) Dividends received by financial institutions specified in the 4th Schedule to the ITA which
include: Banks, Financial Institution and Mortgage Finance Companies registered under the
Banking Act; Insurance Companies under the Insurance Companies Act; Building Society under
the Building Societies Act; Co-operative Society under the Co operative Societies Act, Post Bank,
AFC and HP companies.
Points to Note
a) Dividends are taxable in the hand of the recipient in the year such are received.
b) Dividends are subject to withholding tax.
Qualifying Dividends
As from 1.1.1991 dividends taxed at source and referred to as qualifying dividends have a final
withholding tax. This means that such dividends will not attract any more tax than the withholding
tax. The purpose of this is to encourage the growth in capital markets whereby dividends are not
37
subjected to double taxation i.e. at withholding tax point and the income tax point/corporation tax
point. The current withholding tax rate on these dividends is 5%. Qualifying dividends are paid by
limited companies and SACCOS.
Non-Qualifying Dividends
These are dividends whose withholding tax is not a final tax, i.e. they are availed for further taxation
when a return of income is being prepared and then given a tax credit on advance tax. These are
dividends paid by designated co-operative societies other than SACCOS. The withholding tax rate is
15%.
Topic 2
Income from Interest
Interest is any amount payable for use of money and it includes;
- A charge in respect of any loan, debt, claim or other obligation.
- Premium or discount by way of interest.
- Commitment or service fees paid in respect of any loan or credit.
- Discount upon the final redemption of a bond, loan or other obligation.
Interest is income of the recipient and is taxed on the accrual basis i.e. it is taxed when earned and not
necessarily when received.
Exempt Interest
a) Interest earned from a saving held in an account in the post bank.
b) Interest earned from Tax Reserve Certificates issued by the Kenya government. Tax reserve
certificates are issued by the government through the treasury as a form of borrowing by the
government and also a form of investment and saving to the bearer. It is a saving in the sense that
such monies are used to pay subsequent tax liability of the taxpayer and investment in the sense
that the government pays interest on such amounts which is exempted from taxation.
c) Any interest that is earned from outside Kenya.
d) The partly exempt interest of up to Ksh. 300, 000 from housing development bonds. This interest
is also referred to as qualifying interest and is receivable by an individual that buys housing
development bonds issued by;
- A financial institution licensed under the Banking Act;
- A building society registered under the Building Societies Act and approved to issue HDB
and receives interest from such bonds.
The above limit is partially exempted from taxation in that the withholding tax at 10% on it is the
final tax. Such financial institution issues HDB for the purposes of enabling the bearer to redeem
them at a certain given time in future and use the amount for acquisition, development or
improvement of a residential building.
e) Interest on Government Stocks (non-residents only).
f) Interest on Nairobi City Council Stocks (non-residents only).
Interest is income subject to withholding tax. As from 1.7.1996, w/holding tax deducted on interest
received by an individual from the following institutions shall be final tax:
- Banks and financial institutions
15%
- Buildings societies
15%
- Central Bank
15%
- Bearer Instruments
25%
The withholding tax on interest from other sources is not final.
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CHAPTER NINE
INCOMES FROM USE OF PROPERTY
Rent and Royalties
Sec. 6(1): For the purposes of Sec. 3(2) (a) (iii), “gains or profits” include a royalty, rent, premium or
similar consideration received for the use or occupation of property. Sec. 6(2): In the case of a lease
or similar transaction, the income of a lessor shall be determined in accordance with such rules as
may be prescribed under the ITA Cap. 470.
Rents are defined as income from rights granted to any other person for use or occupation of any
property. It includes premium, key money and royalties.
Royalties are a special class of income paid in relation to the use or right to use any copyright of
literary, scientific or artistic work including cinematography material such as videos, films, tapes etc,
and use of any patents and trademarks. Rent income received by a non-resident person is taxable in
full through withholding tax. Rent income but is subject to an annual tax return if received by a
resident person.
Deductions Allowed from Rent Income
The following deductions are allowed in determining taxable rent income: a) Expenses incurred as structural alterations to the premises where such alterations are necessary to
maintain the existing rent.
b) Maintenance expenditure on the up-keep of the property including
- Land rent and rates
- Salaries and wages to workers, watchmen and care- takers etc.
- Insurance on the premises
- Painting, repairs etc on the premises
- Valuation of the building for business insurance purpose.
c) Bad debts in form of unrecoverable rent (Sec.15 (1)(f)) provided the CDT is satisfied that the
income is unrecoverable
d) In the case of owner-occupier, interest on mortgage or overdraft raised to purchase the property,
Sec.15 (3). The amount of interest deducted will be apportioned if some part of the property is
rented.
e) Legal costs on debt recovery and defence of rights over the property and in respect of acquisition
of a lease for a period not in excess of 99 years Sec.15 (2) (d).
f) If included in the rental income, depreciation (wear and tear allowance charges) on furniture,
utensils and other similar articles Sec.15 (2) (g).
g) Industrial building allowance where the buildings are used for in a qualifying business e.g. factory
building.
h) Reasonable advertising or promotional costs Sec. 15(2) (p).
i) Expenditure incurred during regular inspection of the premises by the landlord or his agent.
j) Management fees or commissions paid to property agents.
k) Cost of water, telephone, light, cleaning and sundry service charges if these are included in the
rent income.
l) Where property is let for short periods and is a common feature for such properties e.g. cottages,
hostels etc, the expenses for the full year will be allowed.
Deductions Not Allowed from Rent Income
a) Cost of any extension to the property
39
b) Structural alterations that lead to increase in rent
c) Expenses relating to any part of the premises occupied by the owner. In such cases all such
expenses will apportioned pro rata.
d) Any expenses incurred before property is let.
Points to Note
a) Where property is let for a short period other than 12 months, the expense will be apportioned.
b) Rent income is taxed in the year of receipt since accruals not taxed.
40
CHAPTER TEN
BUSINESS INCOME 1
Definition, Incomes from Business, Allowable and Disallowable Deductions
Business income is generally taxed through an annual tax return whether earned by a resident or nonresident. Taxes are imposed on business entities under Sec. 3(2)(a)(I) of the Income Tax Act, which
reads, " Subject to the Act income upon which tax is chargeable under this Act is income in respect of a
business for whatever period of time carried on".
When considering how such income shall be taxed it is important to consider the form of business
organization. A business can either be run as incorporated (registered) or un-incorporated (unregistered).
The period a business is carried on does not matter in taxing business income. In either case, the
allowable and disallowable deductions are generally the same; the main difference being in the
application of tax rates and certain rules relating to different forms of business organization.
Definition of Business
Under Sec. 2 of the ITA, "Business includes any trade, profession, or vocation and every manufacture
and adventure and concern in the nature of trade but does not include employment."
Any business in the nature of trade will usually involve the buying and selling of goods and services.
However, the process of selling goods or services may not on its own constitute a trade e.g. where a
person undertakes to sell his personal property for profit or not, this does not constitute a business. Trade
constitutes the activities of commerce.
Going by the definition of business,
Profession
Vocation
Adventure
Concern
- means practising as a professional person, qualified upon undergoing qualified exams.
- means passing ones life in earning a living e.g. self-employment.
- means any business adventure such as smuggling, poaching, etc (illegal business)
- means any commercial enterprise.
A business may be carried on for a short time or for a full year. The period that it is carried on is
irrelevant in taxing such incomes and thus the use of the phrase "for whatever period of time." Similarly,
the Act is not concerned with the legality of the income or of the business and therefore incomes from
business adventures such as smuggling, poaching, drug dealing etc are all taxable.
Factors to Consider when Ascertaining Whether a Business in the Nature of Trade is carried on
a) Profit Motive; this is the "reason to be" for any trading concern. This must be the overriding and not
the incidental motive of the existence of a business.
b) Number of Transactions; a transaction that is of a series indicates that it constitutes trade. However
it is quite possible that a single isolated transaction may constitute trade.
c) Method of Financing; where the proceeds from the sale of goods are used to acquire more goods for
resale, it indicates that the goods are in a trade cycle and therefore implying a business in the nature
of trade being carried on.
d) Method used to Generate Sales; most businesses in the nature of trade promote sales through
advertisement, publicity and other forms of promotion.
e) Nature of assets acquired and the quantities involved e.g. a person who owns a lorry cannot deny that
he is doing transport business.
41
f) Mode of Acquisition of an Asset e.g. if a gift or inherited goods are sold, this may not constitute a
trade. If items are purchased for resale, this will constitute a trade. If items are bought for private use
but at a later date disposed off, this may not constitute a trade.
g) Length of Time the Asset is Held and How it is Used. e.g. if a car is bought and used for
sometimes before it is sold, the sale may be construed as a realisation of a capital asset. However, if
it is bought and sold before use, the sale may be taken as a trade.
Taxable Business Incomes
a) Amount of gain from ordinary business arising from buying and selling i.e. trading.
b) Where a resident person carries on a business partly in Kenya and partly outside Kenya, the gains or
profits are deemed to have been derived from Kenya and will be taxed in Kenya. Sec 4 (a).
c) Amount of an insurance claim received for loss of profit or damage or compensation for the loss of
trading stocks.
d) Amount of a trade bad debt recovered which was previously allowed when written off.
e) Amount of a balancing charge.
f) Amounts of a trading receipt.
g) Amount of realised foreign exchange gain, but if the gain is not realised, it is not taxable.
h) Where a person receives a sum of money after the cessation of his business, which, if it had been
received before the cessation would have been included in the gains or profits of the business, that
sum shall be income of that person for the year of income in which it is received (Sec. 28[1])
Non-Taxable Business Receipts
a) Income from overseas investments.
b) Reduction in the general provision of bad debts.
c) Additional capital introduced by the owner or the partners.
d) Recovery of a bad debt which when written off was not allowed for tax purposes i.e. the non-trade
bad debts.
e) Any income that is exempted from taxation under the 1st Schedule of the ITA.
Format of Adjusting Income for Tax Purposes
In computing taxable income, always start with net profit as per accounts then: - Add back all expenses not allowable and taxable income omitted.
- Deduct allowable expenses not included in the accounts e.g. capital allowances.
- Deduct non-taxable and exempt incomes included in arriving at net profit.
- Deduct incomes whose withholding tax is final
Allowable and Disallowable Deductions
Expenses or Deductions Allowed Against Income under Sec. 15, Second Schedule, and Ninth
Schedule of the Income Tax Act
Introduction
Any item of income is either taxable as defined in the Income Tax Act or not taxable if it is left out in the
list of taxable incomes. When it comes to expenditure, it can be similarly stated that an item of
expenditure is either allowable against taxable income or not allowable. The expenses or deductions,
which are not allowable against taxable income, are listed in the Income Tax Act. These expenses are
looked at in more detail below.
Expenses or Deductions Generally Allowed Against Income
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Sec. 15(I) of the Income Tax Act generally allows expenditure, which is wholly and exclusively incurred
in the production of taxable income.
Sec. 15 (1): For the purpose of ascertaining total assessable income of a person, there shall be deducted
all expenditure, which is expenditure wholly and exclusively, incurred (by the person) in the production
of that income.
This can be said to be a general provision for allowing expenses of a business:
a) Which are charged in the profit and loss account under normal accounting practice subject to any
prohibition or extension made by the Income Tax Act.
b) Which are the usual commercial/operating expenses of a business e.g. wages, rent, purchases,
transport, salary, water.
The nature of the business is very important in determining the expenditure, which is wholly and
exclusively incurred in the production of income. Given the type of business, there are expenses that are
certainly expected to be incurred in the production of income for example;
Butchery
Coffee farmer
Transport
Hotel
Clinic
- Purchase of meat, purchase of beef livestock etc.
- Picking, fertiliser, mulching, wages for farm labourers
- Fuel and oils, tyres, salaries of crew, repairs etc.
- Purchase of food, soft drinks beer and salaries of workers etc.
- Purchase of medicine, detergents, salary of a nurse etc.
This is the nature of expenditure wholly and exclusively incurred in the production of taxable income
that is allowed.
Expenses Specifically Allowed against Taxable Income (Sec. 15 of ITA Cap 470)
In addition to Sec. 15(1) allowing expenditure, which is wholly and exclusively incurred in the
production of taxable income, Sec. 15(2) allows specific items of expenditure against taxable income.
The items of expenditure listed below must be allowed against taxable income where the expenditure is
incurred;
a) Trade bad and doubtful debts. Trade debts arise in the course of trade e.g. on the sale of trading
stock or service on credit. The following are allowable against taxable income:
- By an identified individual or legal person.
- The amount of trade bad debts written off
The amount of provision of specific doubtful trade debts. This is a provision of a debt owed. The
following are not allowable against taxable income:
- The amount of general provision for bad debts e.g. provision of 5% on all debts.
- The amount of any bad debt on sale of capital item and any other non-trade activities like
friendly loans.
Arising form the above, the following should be noted:
- If a trade debt was previously written off and is recovered, it becomes a taxable income for the
year in which it is recovered.
- A debt previously not allowed as a write off (non-trade bad debt) is not taxed when recovered.
- Allowed provisions no longer required or no longer necessary are taxed in the year they are no
longer required e.g. if a specific doubtful debt is provided for in full in a given year and one half
of the debt is paid in the following year, then 50% of the provision would not be required and the
amount would be taxed.
b) Capital expenditure for the prevention of soil erosion in a farmland. The capital expenditure should
be incurred by the farmer or occupier of the farmland for example on construction of gabion,
terraces, contours windbreaks etc.
c) Capital expenditure on clearing and planting permanent or semi-permanent crops. The common
examples of permanent crops are cashew nuts, citrus, coconuts, coffee, passion fruits, paw-paw,
pineapples, pyrethrum, sisal, sugar-cane, tea, apples, pears, peaches, plums, bananas, roses etc.
43
d) Pre-trading expenses; this is expenditure incurred before the commencement of business, which
would be allowable, if the business was operating. The pre-trading expenses are allowable when
business commences. Two examples of pre-trading expenses will suffice here:
- In case of a new hotel - the cost of recruiting and training of staff before the hotel opens for
business
- In case of new coffee or tea farmer – the cost of cultivation, fertiliser, and other farm expenses
for two to three years before picking commences.
e) Legal costs and stamp duty for registration of a lease of business premises. The lease period must not
be in excess of or capital of extension beyond 99 years.
f) Legal costs and other expenditure including capital expenses related to the issues of shares,
debentures or similar securities offered for purchase to the general public. This is the expenditure for
turning a company public and thus enabling it to be quoted on the Nairobi Stock Exchange. The
allowance of these expenses is intended to boost the capital market (buying and selling of shares) on
the bourse.
g) Expenditure on structural alterations to enable premises to be let e.g. subdivision of open rooms in a
house, which is necessary to maintain existing rent. The expenses relating to extension or
replacement of premises are not part of structural alterations and are therefore not allowed against
rent income. If there is a rent increase as a result of structural alterations, the expenditure is
disallowed against rent income.
h) Diminution or decrease in value of implements, utensils or similar articles e.g. loose tools in
workshop or factory; crockery, cutlery, kitchen utensils in hotels or restaurants; jembes, hoes,
pangas, etc in a farm. These are not machinery or plant for which wear and tear allowance is given.
In practice, the DTD accepts a taxpayer's valuation of tools and implements. Most taxpayers take the
life of loose tools to be about three years thus writing of their cost over that period.
i) Entrance fee or annual subscription paid to a trade association e.g. Kenya Chamber of Commerce
and Industry and Kenya Association of Manufacturers. The trade association must have elected to be
treated as trading by giving notice to the Commissioner of Domestic Taxes under Sec. 21 (2) of the
Income Tax Act. Members clubs and trade associations are deemed not to be trading but if 75% or
more of their gross receipts other that gross investment receipts (interest, dividends, royalties, rents,
etc) are from members, they are deemed to be trading. They can then elect by notice to CDT to be
treated as trading and entrances fee deemed income from business Sec 21(1) (2).
j) Expenditure incurred for scientific research whether of capital or revenue nature.
k) Amount of contribution to a scientific research association, which undertakes research, related to the
class of business of the contributor. The research association must be approved by the CDT. For
example, Ruiru Coffee Research, Friesian Cattle Society etc.
l) Amount of contribution to a university, college or research institution approved by CDT for scientific
research e.g. University of Nairobi, Kenya Polytechnic, AMREF, KEMRI, KARI, ICIPE, ILRI,
KETRI etc. The research must be related to the class of business of the contributor.
m) Contributions by employer on behalf of employees to national social security fund (NSSF).
n) Expenditure on advertising. This includes expenditure intended to advertise or promote directly, or
indirectly, the sale of goods or services provided by a given business e.g. advertisement in television,
radio, press, calendars, sports like football clubs, golf tournament, rally cars, horse races, Olympic
teams etc. Advertisement in the form of passengers sheds at bus stops, neon signs, billboards and
signboards are capital expenditure and not allowable, but the expenditure qualifies for wear and tear
allowance.
o) Mortgage interest (also called owner-occupier interest) to the maximum of 150,000 from 2006 (this
was explained earlier).
p) Club subscription for use by employees
q) The amount of loss brought forward from previous year’s income. The losses should be on the basis
of specified sources of income. Sec. 15 (7) (e).
r) Amount of trading loss that arises the where business is continuing and all the assets in a class of
wear and tear allowance are sold for less than the written down value (see chapter on capital
allowances).
44
s) Amount of balancing deduction. The balancing deduction arises where a business has ceased and all
the assets of a class of wear and tear allowance are sold for less than the written down value (see
chapter on capital allowances).
t) Amount of interest on money borrowed and used in the production of income e.g. interests on loan,
overdraft, debentures etc.
u) Amount of realised foreign exchange loss (capital or revenue) with effect 1.1.89. If the foreign
exchange loss is not realised or incurred, it is not allowed against taxable income.
v) Capital deductions under the Second Schedule of the Act (see chapter on capital allowances).
w) Where a sum is paid by a person after the cessation of his business, which if it had been paid prior to
the cessation, would have been deductible in computing his gains or profits from that business, it
shall be deducted in ascertaining his total income for the year of income in which it paid. (Sec. 28[2])
Expenses or Deductions Not Allowed against Taxable Income
Sec.16 (I) of the Income Tax Act lists expenses, which are either generally not allowable against taxable
income or specifically stated to be not allowable against taxable income.
Expenditure Generally Not Allowable Against Taxable Income
Sec.16 (I) of the Income Tax Act generally disallows expenditure, which is not incurred in the
production of taxable income.
Sec.16 (1): for purpose of ascertaining the total income of the person no deduction shall be allowed in
respect of expenditure, which is not wholly and exclusively incurred by the person in the production of
income.
This is a general provision for disallowing:
a) Expenses which under normal accounting practice are not allowable against income, subject to any
extension made by the Income Tax Act;
b) Expenses that are not commercial/operating expenses of a business e.g. notional rent salary to selfetc.
Specific Items of Expenditure Not Allowable Against Taxable Income (Sec. 16[2]) of ITA Cap 470)
In addition to Sec.16 (I) generally disallowing expenditure, which is not wholly and exclusively incurred
in the production of taxable income, Sec.16 (2) disallows specific items of expenditure if charged against
taxable income. The items of expenditure listed below must be disallowed where charged against taxable
income.
a) Amount of capital expenditure, loss, diminution or exhaustion of capital e.g. depreciation,
amortisation, write-off of assets, loss on sale of fixed asset etc. These are disallowed unless
specifically allowed in the Income Tax Act.
b) Amount of personal expenditure incurred by an individual in the maintenance of himself, his family
or for domestic purpose. With effect from 1.6.91 the disallowed expenditure includes;
- Entertainment expenses for personal purposes;
- Hotel, restaurant, or catering expenses except; on business trip, during training or work related
convention or conferences;
- Meals provided to low income employees on employer’s premises.
- Vocational trips except those provided to expatriates;
- Education fee;
c) Amount of expenditure or loss recoverable under insurance contract or indemnity.
d) Amount of income TAX paid and any other taxes paid including expenses relating to taxes such as
costs of tax appeal, interest on money borrowed to pay tax etc.
e) Up to 31.12.90, the amount of contribution to pension and provident schemes, savings or funds,
which were not registered with Commissioner of Domestic Taxes (this was covered earlier).
f) Amount of premium paid under an annuity contract. This is paid to an insurance company for the
purpose of receiving annuities (regular amounts annually) in future especially for retirees.
g) The amount of expenditure in the production of income by a non-resident person with no permanent
establishment in Kenya. The income is taxable at source at non-resident rates of tax. The expression
of a permanent establishment is defined by the Act as a fixed place of business in which that person
45
carries on business. A fixed place means building site or a construction or assembling project that has
existed for six months or more in relation to a person.
h) Amount of loss from hobby business. This is business is not carried on with a view to making profit
e.g. keeping of three cows on the estates of a Nairobi suburb. The issue of losses from hobby
business has been weakened by the concept of specified sources of income. Sec. 16(2) (h). Where
more than 25% of the business expenditure is for personal or domestic nature, the business is outright
hobby business.
i) The amounts of lease hire rentals relating to lease hire agreements entered into with effect form
17.6.88. The lease hire agreements entered into before the above date were allowable.
j) Amount of appropriations of profits to reserves, provisions, dividends and other appropriations. It
should be noted that the provision for specific trade bad debts is specifically stated to be allowable
expenditure.
46
CHAPTER ELEVEN
Taxation of Sole Proprietorships
Proprietorships
A business structure in which an individual and his/her company are considered a single entity for tax
and liability purposes. A proprietorship is a company which is not registered with the state as
a limited liability company or corporation. The owner does not pay income tax separately for the
company, but he/she reports business income or losses on his/her individual income tax return. The
owner is inseparable from the proprietorship, so he/she is liable for any business debts. also
called sole proprietorship
A sole proprietorship does not have a separate legal entity and for this purpose it is not treated as a
separate taxable entity. The gains or profits from this form of business organization is taken to be the
income of the individual running the business and will be taxed on him as income from a separate
source.
For this purpose, income from all sources including gains from business will be taxed as an aggregate
amount using the individual scale rate of tax. Any additional capital is not regarded as a taxable income.
Drawings by the owner and other private expenses are not tax deductible. All provisions of Sec. 15
(allowable deductions) and Sec. 16 (disallowable deductions) of the ITA will apply accordingly.
METHOD OF ADJUSTING FOR PROFIT
INCOME TAX COMPUTATION
YEAR OF INCOME 20XX
K£
Net profit as per accounts
Add back: Disallowable expenses
Taxable income omitted
Deduct: Non-business income
Allowable expenses omitted
Total taxable profit
K£
xx
xx
xx
xx
xx
xx
Taxation of Partnerships
A Partnership Business Is Not Recognised In Law As A Legal Entity. This Applies Equally As Far As
Tax Law Is Concerned (Income Tax Act Cap 470). A partnership is a business relationship that subsists
between two or more persons carrying on a business with view of making profits/sharing losses. The
adjusted income from the partnership (for tax purposes) shall be allocated amongst partners at their profit
sharing ratios as stipulated in the partnership deed. Each of the partners shall then be taxed on his share
of partnership income as a distinct individual.
A partner shall be taxed on the aggregate of the following incomes from a partnership Sec. 4(b):
a) Remuneration paid to him by the partnership; and
b) Any interest on capital paid to him by the partnership i.e. interest on capital, less any interest paid by
him to the partnership, i.e. interest on drawings; and
c) Share of the adjusted partnership income, adjusted with (i) and (ii) above.
The income from partnership will be added to the partner’s assessable incomes from other sources and
tax on them calculated on the partner as an individual at the personal/graduated scale rate of tax. Where a
47
partner’s adjusted share is a loss, this can be offset against any other income that he may have in that
year or be carried forward and offset on any other income in future years without any limit.
All provisions for Sec. 15 (allowable deductions) and Sec. 16 (disallowable deductions) of the Income
Tax Act shall apply accordingly. The specific disallowable deductions of a partnership are interest on
capital, salaries paid to partners and any other form of appropriation.
Distribution of Profit Schedule
Salaries
Interest on capital less interest on drawings
Profit/loss share (using profit ratio)
Adjusted taxable partnership profit
Add Other Assessable Incomes:
Rent
Interest from third parties
Employment
Dividends
Total taxable income
A
xx
xx
xx
B
xx
xx
xx
C
xx
xx
xx
Total
xx
==
xx
==
xx
==
xx
==
xx
xx
xx
xx
xx
==
xx
xx
xx
xx
xx
==
xx
xx
xx
xx
xx
==
xx
xx
xx
xx
xx
==
xx
xx
xx
Taxation of Legal Persons- Limited Companies
A limited company/corporation has a separate legal entity whose existence is quite distinct from that of
the owners/shareholders. For this purpose a company/corporation is a separate taxable entity and its
income will be taxed on its own name and not on the names of its owners. Companies are taxed at the
corporation tax rates ruling in a certain year. The corporation tax rate is a proportional tax levied at a flat
rate irrespective of the size of income. Corporation tax rates are 30% for resident companies and 37.5%
for non-resident companies (2006).
The rules of ascertaining taxable income for sole traders and partnership will be applied. Attention will
be paid to the following:
a) Salaries and allowances paid to directors are allowable.
b) Transactions between the company and directors or shareholders are treated as business for tax
purposes.
Where a company derives income from other sources other than from its principal activity (trading), this
shall be taken to be incomes of the company and will be taxed in aggregate at the corporation tax rate.
The rules for final tax on dividends shall apply.
Other corporations include: trusts, co-operative societies, insurance companies, charitable organisations,
members clubs, sporting associations etc. the incomes of such entities will be taxed at the corporation tax
rates
48
CHAPTER TWELVE
CAPITAL ALLOWANCES
Introduction
The Second Schedule to the Income Tax Act enumerates all capital deductions that are granted to a
taxpayer in respect of capital expenditure incurred by a person on the production of taxable income.
Capital expenditure, losses, diminution, exhaustion of capital, depreciation, amortisation, loss on sale of
an asset, obsolescence, provision for replacement of an asset etc, are all not allowable for tax purposes.
In the generation of taxable income, taxpayers invest in fixed assets. These assets suffer loss in value due
to reasons such as wear and tear allowance, out of usage breakdown, inadequacies, economic factors etc
(factors that cause depreciation).
For this purpose, the Income Tax Act seeks to standardise the charge in respect of losses of capital assets
by granting uniform capital allowances in respect of capital expenditure. Capital allowances are also
granted for other purposes such as an incentive to investors who would make investment in capital items
e.g. buildings and machinery used for manufacturing. In earlier years up to 1994, higher capital
deductions were granted to investors invested in buildings and machinery outside the principal
municipalities of Nairobi andMombasa to encourage rural industrialisation. However as from 1st of
January 1995, capital deduction rates were harmonised by the CDT for all taxpayers irrespective of the
location of the investment.
Capital Deductions are Categorised as Follows
a)
b)
c)
d)
e)
Wear and tear allowance in respect of machinery
Diminution in respect of machinery not qualifying for wear and tear allowance
Farm works deduction in respect of farm works put up by a commercial farmer
Industrial building deduction in respect of industrial buildings and tourist hotel buildings
Investment deductions:
- Investment deduction for ordinary manufacture
- Investment deductions for bonded manufacture
- Shipping investment deduction in respect of shipping business
- Investment deduction for tourist hotel buildings
f) Mining deductions in respect of mining operations.
Topic 1
Wear and Tear Allowance
This is a capital allowance granted in respect of machinery. It is given on account that machinery used
for business will loose in value and subsequently a standardised charge other than depreciation is
granted.
49
Paragraph 7 of the 2nd Schedule reads, "Where during the year of income, machinery owned by a person
is used by the person for the purpose of his business, there shall be made in computing the persons gains
or profits a deduction referred to as wear and tear allowance ".
Note: Wear and tear allowance is granted in respect of machinery owned by a taxpayer who uses it for
his business at any time in a year of income.
For the purposes of wear and tear allowance, the term machinery has not defined by the Act, but it has
been given a very wide meaning in practice and includes fixed assets such as tractors, lorries, motorcars,
buses, plant and machinery, furniture and fittings, equipment, aircraft, ships, carpets, partitions etc.
For the purpose of wear and tear allowance, machinery is categorised by being placed into four distinct
classes i.e. pools. Each of the pools/classes will be granted wear and tear allowance on a given
percentage on a reducing balance basis. The pools/classes are as follows.
Class I, 37½%
This is a class for heavy earth moving equipment and heavy self-propelled machinery such as tractors,
combine harvesters, lorries of a load capacity of 3 tonnes and over, buses, loaders, bulldozers,
caterpillars, fork lifts, mounted cranes, break downs, tippers trucks, graders, trains, airbus etc.
Class II, 30%
This class was introduced in respect of office machinery purchased on or after 1st Jan 1992. It includes
computers, and all peripheral equipment, printers, electronic calculators, fax machines, scanners,
duplicating machines, electric-typewriters, photocopiers, office calculators, internet, telephones etc.
Class III, 25%
This is a class for all other light self- propelled machinery such as motor cars, motorcycles, lorries of less
than 3 tones load capacity, vans, aircraft, pick-ups etc.
Class IV, 12½%
This is a class for all other non-self propelled machinery except a ship and include assets such as factory
plant and machinery, furniture, fixtures and fittings, bicycles, partitions, shop counters, shelves, office
safes, sign boards, fridges, freezers, carpets, ships, motor boats, neon lighting, billboards, trailers (if they
can be separated from tractor or lorry engine-head) etc.
Software 20% issued from 2010
Format of Wear and Tear Allowance Schedule
XYZ LIMITED
WEAR AND TEAR ALLOWANCE COMPUTATION
YEAR OF INCOME, 20XX
CLASS I
CLASS II
1
37 /2%
30%
000
000
Wdv. b/d 1:1:20xx
Add: Additions in current year
Processing machinery
Fork-lift
xx
Motor vehicles
Computers
xx
Furniture
Less: Disposals in current year
Printers
(xx)
Tractors
(xx)
Motor vans
50
CLASS III
25%
000
-
CLASS IV
121/2%
000
-
xx
-
xx
xx
(xx)
-
Furniture and fittings
Less: Wear and tear allow.
Wdv. c/d 31.12.20xx
xx
(xx)
xx
xx
(xx)
xx
xx
(xx)
xx
(xx)
xx
(xx)
xx
Notes on the Wear and Tear Allowance Schedule:
1) Written Down Value (WDV)
This represents the residual amount after granting wear and tear allowance. This value is carried forward
at the end of the year of income of income, and brought forward at the beginning of the subsequent year
of income.
2) Additions
This represents fixed assets qualifying for wear and tear allowance acquired in the current year of
income. The cost of an asset which qualifies for wear and tear allowance as an addition is:
a) The historical cost of the qualifying asset, (actual cost) whether new or old and whether assembled
/made in the business or purchased from a third party.
b) The expenses after purchase (incidental expenses) but before the use of a machinery shall be
capitalised alongside the cost of machinery e.g. custom duty, installation expenses, alteration that are
incidental to installation and commissioning costs. Note that operating costs of the machine after
commissioning are expensed in the profit and loss account.
c) In a trade-in or part-exchange situation, the trade-in or part exchange value plus the cash paid shall
be considered as an addition for wear and tear allowance i.e. the full value of an asset shall be
considered.
d) In hire purchase transaction, the cash price of an asset shall be considered. The hire purchase interest
is allowed as an expense in the profit and loss account.
e) For assets brought into the business without being purchased e.g. through donations, grants, gifts etc,
the most likely open market value of such assets shall be considered.. In this case the CDT will
normally accept the taxpayers own valuation unless he feels it is unreasonable. Any asset donated by
any government will not qualify for the deductions.
f) For non-commercial vehicles i.e. some vehicles in class III (25%) their cost is restricted for additions
as follows.
Years of income
Restricted amounts Ksh.
Up to 31.12.1980
30,000
From 1981 to 1989
75,000
1990 to 1996
100,000
1997
500,000
1998 to 2005
1,000,000
2006 esq.
2,000,000
g) From 1:1:1987 where machinery qualifies for wear and tear allowance and also qualifies for
investment deduction, additions for wear and tear allowance shall be the residual after investment
deduction.
3) Disposals
This represents fixed assets qualifying for wear and tear allowance disposed of in the current year of
income. The value of an asset which qualifies for a disposal is:
a) Amount of cash proceeds or cash equivalent on sale of a wear and tear allowance machine.
b) In a trade in situation the trade in or part exchange value is taken.
c) On the disposals of non-commercial vehicles the sales proceeds or cash equivalent must be
restricted by the following factors:
Years of income
Up to 31.12.1980
Restricted amounts Ksh.
30,000 over cost
51
From 1981 to 1989
1990 to 1996
1997
1998 to 2005
2006 esq.
75,000 over cost
100,000 over cost
500,000 over cost
1,000,000 over cost
2,000,000 over cost
The following formula is used to restrict the value on disposal of non-commercial vehicle whose
acquisition cost was beyond the limits given above.
Disposal value = Sales Proceeds x Restricted Value in year of Purchase
Original Cost
d) The amount of insurance claim received for wear and tear allowance machinery lost through theft,
fire or accidents shall be taken as the disposal value.
e) In a continuing business:
- If all assets in a class of wear and tear allowance are sold for proceeds that are more than the
written down value, the excess is referred to as a trading receipt. This arises when wear and tear
allowance was previously over-provided and it becomes a taxable income.
- If all assets in a class of wear and tear allowance are sold for proceeds that are less than the
written down value, the deficit is referred to as a trading loss. This arises when wear and tear
allowance was previously under-provided and it becomes an allowable deduction.
f) On the cessation of a business:
- If all assets in a class for wear and tear allowance are sold for proceeds that are more than the
written down value, the excess is referred to as a balancing charge. This arises when wear and
tear allowance was previously over-provided and it becomes a taxable income.
- If all assets in a class for wear and tear allowance are sold for proceeds that are less than the
written down value, the deficit is referred to as a balancing deduction. This arises when wear and
tear allowance was previously under-provided and it becomes an allowable.
Commercial Vehicle
Motor vehicles are machinery qualifying for wear and tear allowance under Class I or Class III,
depending on their nature. For non-commercial vehicles under Class III (25%), their value for addition
for wear and tear allowance as well as on disposal is restricted. Although the Income Tax Act does not
define a non-commercial vehicle, nevertheless it defines a commercial vehicle as one that the CDT is
satisfied that:
a) It is manufactured for carrying goods and it is so used in connection with trade or business e.g. a
lorry, a pick-up, a van etc.
b) It is a motor omnibus within the meaning of that term in the Traffic Act Cap 403 e.g. all public
service vehicles such as buses, matatus etc.
c) It is used for carrying members of public for hire or reward e.g. taxis, tour operator’s vehicles, car
hire vehicles etc.
Additional Notes on Wear and Tear Allowance
a) Wear and tear allowance is calculated on a reducing balance basis and is allowable for tax purposes.
The following formula is used to derive the written down value of an asset: WDV = C (1-r)n (where
C= original qualifying cost of an asset, r is the rate used to compute the allowance in a specific class,
n is the number of years the asset has lasted up to the beginning of the current year. This formula is
particularly important where you are given the original cost of an asset acquired in the past and you
are required to compute wear and tear allowance in the current year.
b) Where a business has been carried on for a full year, full wear and tear allowance will be granted
irrespective of the date that the qualifying asset was acquired.
c) Where a business has operated for less than 12 months, the annual wear and tear allowance shall be
restricted to the period that the business has existed and not to the period of ownership of the asset.
52
d) Where a business has operated for more than 12 months, wear and tear allowance shall be increased
proportionately to the period of operation.
e) Where assets are partly used for business and partly for private purposes e.g. motor vehicles, the
wear and tear allowance shall be restricted to the proportion of business use. For the purposes of
wear and tear allowance the full wear and tear allowance shall be taken into account.
f) Where there is succession to a business without payment of any money the written down values of
the machinery will continue getting wear and tear allowance as if there was no change in ownership.
Revaluations are not considered for wear and tear allowance.
g) Where a person owns machinery, which is leased to another who uses it for his business, wear and
tear allowance will be claimed by the lessor i.e. the owner since he is the one who incurred the
capital expenditure. Rental charges paid by a lessee on leased machinery are allowable for tax
purposes.
h) Where a person purchases machinery qualifying for wear and tear allowance that were previously
owned by a person who had used them and claimed prior years wear and tear allowance, to the new
owner, the mount qualifying for wear and tear allowance shall be the amount paid for the assets
(purchase price).
Topic 2
IndustrialBuilding Deduction
It is granted in respect of capital expenditure on industrial buildings as per paragraphs 1 of the Second
Schedule to the Income Tax Act. Paragraph 1(1) of the Second Schedule reads, “Where a person
incurs capital expenditure on the construction of an industrial building and the industrial building is
used for business carried on by the person or lessee, a deduction called industrial building deduction
shall be made in computing the person’s gains/profits from the business.”
Rates for IndustrialBuilding Deduction
a) Standard rate, 2.5% (1/40th) of the qualifying cost per year for 40 years on a straight-line basis.
The life of an industrial building is usually estimated at 40 years.
b) An agreed rate with the CDT. Where a taxpayer considers that the life of his industrial building is
less than 40 years, he can make an official representation to the CDT for an accelerated rate i.e. a
rate greater than 2.5%. If the CDT agrees to grant a higher rate, then this shall be the special rate
for computing industrial building deduction for that person.
c) In the case of hotel buildings certified by the CDT to be industrial buildings under the Act and
gazetted in the official Kenya Gazette, the rate for industrial building deduction is 4% i.e. 1/25th
of the qualifying cost per annum for 25 years on a straight line basis.
d) Hostel buildings for commercial educational institutions at 10% p.a. on a straight-line basis, (with
effect from July 2006).
Definition of Industrial Buildings
An industrial building means:
A. A Building in use:
(i) For the purpose of a business carried on in a mill or a factory or for any other industrial purpose
e.g. paper mill, sawmill, sugar mill, coffee mill etc.
(ii) For the purpose of transport, dock, bridge, tunnel, inland navigation, water, electricity or hydro
power undertaking. A bridge means a bridge the use of which is subject to a charge or a toll; a
dock includes a harbour, a pier or a jetty or other works in which vessels can ship or unship
merchandise or passengers provided that such jetties are not used for recreation; electric
undertaking means an undertaking for the generation, transmission, conversion, or distribution of
electrical energy; hydro power undertaking means an undertaking for the supply of hydraulic
power; a water undertaking means an undertaking for the supply water for public consumption
e.g. water reservoir.
(iii) For the purpose of business which consists of the manufacture of goods or materials or the
subjection of goods to any process e.g. buildings within the EAB, EAI, BAT etc. The concept of
53
“subjection of goods to a process” is the subject of numerous disputes. This is because the
subjection of goods/materials to any process is not precise.
Case Studies: these cases will help make the concept of subjection of materials to a process be
clearer:
a) Vibro-Plant Ltd. VS Holland
It was held that buildings used by plant hire operators for cleaning , servicing, and repairing the plant
on the premises was not an industrial building, on the basis that each item was treated individually
according to the amount of services it required.
b) In Crusabridge Investment Ltd. Vs Casing International ltd.
It was held that the examination and grading of used tyres where the only alteration was marking of
defects with chalk did not amount to the subjection of tyres to any process.
c) Kilmarnock Co-Operative Society Vs Inland Revenue Commission
It was held that a building in which gold was prepared before it was resold qualified for industrial
building deduction on the basis that gold was being subjected to a process.
d) Bourne Vs Norwich Crematorium Ltd.
A company owned a crematorium and used it in carrying on the trade of the disposal of human dead by
cremation. The company claimed that a furnace chamber and a chimney tower at its crematoria were
industrial buildings on the basis that they were used for the subjection of goods to a process. It was held
that the cremation of human remains was not the subjection of goods/materials to a process.
e) IRC Vs. LeithHarbour and Dock Commissioners
It was held that grain elevators were within the expression “mills, factories or other similar
premises”
f) Ellerker Vs. Union Cold Storage Company Ltd.
Cold stores were held to be within that expression on the basis that they were equipped with
machinery for the purpose of subjecting meat and other commodities to an artificial temperature,
and thus were buildings where goods were treated or processed by means of machinery provided
for that purpose.
g) Buckingham Vs. Securitas Properties Ltd
It was held that a building which was used, interalia, for breaking down bulk cash into individual
wage packets was not an industrial building.
h) IRC Vs. Lambhill Ironworks Ltd
A company carried on a business as structural engineers. The company claimed IBA on its
drawing office. The drawing office was used for the preparation of drawings for tenders and
making scale drawings and blueprints for contracts already placed with the company. The
company contended that the office was used for industrial purposes. The revenue department
contented that the drawing office was an “office”. It was held that the drawing office was an
industrial building on the grounds that it was in use for purposes ancillary to the industrial
operations carried on in the rest of the works
From the above cases it can be seen that in deciding whether goods/materials are subjected to a
process:
- Some alteration or change in the goods/materials must be necessary
- The application of machine may not prove the existence of a process.
54
-
The repairing of articles is not a process but the building used for such purposes may qualify for
industrial building deduction on other grounds.
(iv)
For the purpose of a business which consists in the storage of goods/materials:
a) Which are to be used in the manufacture of other goods or materials, or
b) Which are to be subjected in the course of a business to any process, or
c) Which having been manufactured or produced or subjected in the course of a business to any
process have not been delivered to a purchaser, or
d) On arrival by sea/air into any part of Kenya e.g. Inland container depots at Embakasi;
container depots at the ports of Mombasa and Kisumu; go-downs, warehouses and stores
owned by clearing and forwarding agencies.
(v)
A building in use for the purpose of a business consisting of ploughing or cultivating
agricultural land but not by a farmer. An agricultural contractor uses these buildings.
(vi)
A building in use for the purpose of a business, which may be declared by the Minister of
Finance in a gazette notice.
(B)
(C)
(D)
A prescribed dwelling house constructed for and occupied by employees of a business carried
on by the person owning the dwelling house and which conforms to prescribed living
conditions as specified by the Ministry of Labour.
A building, which is in use as a hotel or part of a hotel building which the CDT, is satisfied
that it is an industrial building. Such a building must be gazetted under the Tourist Act. As
from 1.1.1993 and for the purposes of industrial building deduction, a hotel building will
include any building(s) that are directly related to the operations of the hotel complex
including staff quarters, kitchens, entertainment, sports and fitness facilities.
A building in use for the welfare of workers employed in any business or undertaking referred
in (A) above e.g. staff canteen, staff sports house, staff social hall, staff club, staff dispensary,
staff pavilion etc.
Additional Notes on IndustrialBuilding Deduction
As from 1.1.1995 the following civil works and structures within the meaning of the term industrial
building, within the premises of a building, shall be deemed to be part of an industrial building and
shall qualify for industrial building deduction where they relate or contribute to the use of the
industrial building:
a) Roads and parking areas.
b) Railway lines and related structures.
c) Water, industrial effluent and sewerage works.
d) Communication and electric posts and pylons and other electrical supply works.
e) Security walls and fencing.
As from 1.1.1995, construction of an industrial building shall include the expansion, or substantial
renovation or rehabilitation of an industrial building but it shall not include the routine repair works.
Non-Qualifying Costs for IndustrialBuilding Deduction:
a) Cost of land on which the building is constructed.
b) Any incidental costs incurred on the acquisition of the land, on which the building is constructed
e.g. legal cost, stamps duty, conveyance costs etc.
c) Cost of items in the building that are treated as machinery for wear and tear allowance purposes
e.g. partitions, shelves, counters etc.
d) Capital expenditure on a non-qualifying part (showrooms, retail-shops, administrative offices and
residential areas) of a building where such is greater than 10% of the total cost of the building i.e.
qualifying plus the non-qualifying part.
e) Cost of such items of structures including civil works up to 31.12.1994.
55
More Notes on IndustrialBuilding Deduction
a) Where an industrial building is used for part of an accounting year, the annual industrial building
deduction will be reduced proportionately to the period in the year that it was used. Similarly
where a building is used for more than 12 months, the industrial building deduction will be
extended proportionately to the period it was used.
b) Where an existing building is extended by further construction, the extension will be treated as a
separate building and will qualify for investment deduction provided it is used for manufacture or
it’s part of the structures included as from 1.1.1995 (civil works).
c) Where a building in use is sold and continues to be used as an industrial building by the purchaser
or his lessee, the new owner will inherit the residue of expenditure not yet claimed by the former
owner. Thus the price paid for such a building shall be irrelevant for the purposes of industrial
building deduction of the new owner.
d) Where a building is sold before use:
(i) By a person other than a builder (contractor), the qualifying cost to the buyer shall be the
lower of the price paid and the construction cost.
(ii) By a builder, the qualifying cost shall be the price paid.
(iii) Where a building is sold more than once before use, the last price paid shall be the qualifying
cost for industrial building deduction.
e) Where a building has been put to use and subsequently disused, and then used again, for the
purposes of determining the residue of expenditure, a notional industrial building deduction shall
be computed in respect of the disused period.
Illustration
A building is purchased in 1980 for Ksh. 50m. It is used for business purposes for the first 10 years
Then disused for the next 10 years and then reused for the last 20 years. The IBD status will be as
given in the table below:
Year(s)
1.1.198031.12.1989
1.1.199031.12.1999
Status
of Cost of
Building
Building
Period
of Ksh. 50m
Use
Period
of Ksh. 50m
Disuse
1.1.200031.12.2019
Period
Use
of Ksh. 50m
Computed IBD for the Tax Effect on Business
Period
50mx2.5%x10yrs=12.5m Claimed against business
income in the period.
50mx2.5%x10yrs=12.5m Notional IBD assumed to
be claimed by a taxpayer
(lost IBD).
50mx2.5%x20yrs=25m
Claimed against business
income in the period.
f) As from 1.1.1987, industrial building deduction is computed on the residue after investment
deduction.
Topic 3
Investment Deduction
Investment deductions are granted as per paragraph 24-26 of the 2nd Schedule to the Income Tax Act.
Investment deductions are granted on a once and for all basis i.e. in the first year of use of the
qualifying assets.
There are four types of investment deductions:
(a) Investment deduction in respect of buildings and machinery used for ordinary manufacture.
(b) Investment deduction in respect of buildings and machinery used for manufacture under bond.
(c) Investment deduction in respect of a hotel building certified by the CDT under the Tourist Act to
be an industrial building.
(d) Shipping Investment Deduction (SID)
Reasons Why Investment Deductions are granted
56
The purpose of investment deduction is geared towards attracting investment in form of capital
expenditure in the country to create employment, enhance economic development and earn foreign
exchange. Up to 31.12.1994 investment deduction was granted at varied rates whereby investments in
buildings and machinery situated outside the principal municipalities of Nairobi and Mombassa were
granted higher investment deductions relative to investments situated within the two municipalities.
As from 1.1.1995, the CDT harmonized rates for investment deduction irrespective of the location of
the investment.
This was prompted by the fact that most investors started to concentrate their investments around the
periphery of the two principal municipalities for obvious reasons:
a) The higher investment deduction
b) Better infrastructure that already existed, proximity to banks, labour etc.
Definition of Terms used in Investment Deduction
a) Manufacture/Process
Manufacture means the making, including packaging of goods or raw materials from raw or partly
manufactured goods to other goods.
b) New: means not previously having been used by any person or acquired or held by any other
person except the dealer or supplier in the normal course of business.
c) Installation: means fix or affixed to the fabric of the building either on the wall, ceiling or floor
in a manner that is necessary for the proper operation of the machine.
Qualifying Costs for Investment Deductions
The cost, which qualifies for investment deductions on buildings and machinery used for ordinary
manufacture, IDBM and for tourist hotel buildings, shall be:
a) Cost of construction of a building and the purchase and installation therein of machinery and the
owner or his lessee uses the machinery in that building for the purpose of manufacture, (new
building plus new machinery will qualify for investment deductions). As from 1.1.1992, a
building used for manufacture will qualify for investment deduction on its own provided it had
not been used for any other purpose prior to being used for manufacture.
b) On the purchase and installation of new machinery used for manufacture in any part of a building
other than a building that was previously used for manufacture, (new machinery installed in an
old building will qualify for investment deductions). As from 1.1.1992, either new or old
machinery will qualify for investment deductions if installed and used for manufacture.
c) On the construction of a hotel building which is certified to be an industrial building under the
Tourist Act.
d) On the construction of a building and on the purchase and installation therein of new machinery
and the owner of that building uses it for the purpose of manufacture under bond.
e) As from 1.1.1995, civil works and structures that are deemed to be part of an industrial building
including any immovable machinery fixed to the fabric of the building will also qualify for
investment deduction. Such are the buildings and structures which contribute or relate to the use
of the building and they include:
- Roads and parking areas.
- Railway lines and related structures.
- Water, industrial effluent and sewerage works.
- Communication and electric posts and pylons and other electrical supply works.
- Security walls and fencing.
As from 1.1.1995, machinery for the purposes of investment deductions will mean machinery and
equipment used directly or indirectly in the process of manufacture and will include machinery used
for the following auxiliary/ancillary purposes:
a) Generation, transmission and distribution of electricity.
b) Clean-up and disposal of industrial effluent and other industrial waste products
c) Reduction of environmental damage.
d) Water supply or disposal of the same.
57
e) Workshop machinery for the repair of machines.
Note: As from 1.1.1995, the requirement that manufacturing machinery must be fixed to the fabric of
a building for it to qualify for investment deduction was relaxed.
Non-Qualifying Costs for Investment Deduction
a) Cost of land on which the building is constructed.
b) Any incidental costs on the acquisition of land e.g. stamp duty, legal costs, conveyance costs etc.
c) Cost of items or activities that are only supplementary to manufacture e.g. administration,
transport, storage, design, security, etc.
1) Rates of Investment Deduction on Ordinary Manufacture
No. Year of Income
1
2
3
4
5
6
7
8
9
Prior yrs. up to 1985
1.1.1988-31.12.1988
1.1.1989-31.12.1989
1.1.1990-31.12.1994
1.1.1995-30.6.2000
1.7.2000-31.12.2001
1.1.2002-31.12.2002
1.1.2003-31.12.2003
1.1.2004-31.12.2008
Investment Located Within
the Principal Municipalities
of Nairobi and Mombasa
10%
25%
35%
60%
100%
85%
70%
100%
Investment Located Outside
the Principal Municipalities
of Nairobi and Mombasa
20%
50%
75%
85%
60%
100%
85%
70%
100%
Additional Notes on Investment Deduction
a) Non-qualifying parts (showrooms, retail-shops, administrative offices and residential areas) of an
industrial building within the factory will only qualify for investment deduction if their cost is less
than 10% of the total cost (qualifying +non-qualifying).
b) Where an existing building is extended by further construction, the extension will be treated as a
separate building and will qualify for investment deduction provided it is used for manufacture or
it’s part of the structures included as from 1.1.1995.
c) Where a building is sold before use:
- By a person other than a builder (contractor), the qualifying cost to the buyer shall be the
lower of the price paid and the construction cost.
- By a builder, the qualifying cost shall be the price paid.
- Where a building is sold more than once before use, the last price paid shall be the qualifying
cost for investment deduction.
d) A building that qualifies for investment deduction shall automatically qualify for industrial
building deduction; however the reverse is not always true.
e) As from 1.1.1987, industrial building deduction and wear and tear allowance shall be granted on
buildings and machinery respectively based on the residue after investment deduction.
2) Investment Deduction for Bonded Manufacture
This deduction was introduced as from 1.1.1988. It is an extra investment deduction granted to
investors who manufacture under bond i.e. such manufacturers are bonded by the Customs and
Excise Regulations for a period of at least 3 years to manufacture goods solely for export. In these 3
years all the goods produced by such concerns will be destined to foreign markets through
exportation.
Should a manufacturer cease to manufacture under bond prior to the expiry of 3 years, the previous
deduction, which had been granted, will be clawed back i.e. withdrawn and treated as a taxable
58
income in the year of cessation. The qualifying costs for investment deduction bonded manufacture
were given earlier under this topic. As from 1.1.1996, investment in the purchase of machinery
whether new or old will qualify for investment deduction bonded manufacture, whether or not the
investor owns the building in which they are installed. As from 1.1.1989, an investor under bonded
manufacture will be able to recover 100% of the qualifying expenditure in buildings and machinery.
Rates of IDBM Based on Qualifying Cost of Buildings and Machinery
No. Year of Income
1
2
3
4
5
6
7
8
1.1.1988-31.12.1988
1.1.1989-31.12.1989
1.1.1990-31.12.1994
1.1.1995-30.6.2000
1.7.2000-31.12.2001
1.1.2002-31.12.2002
1.1.2003-31.12.2003
1.1.2004-31.12.2008
Investment Located Within
the Principal Municipalities
of Nairobi and Mombasa
75%
75%
65%
40%
0%
15%
30%
0%
Investment Located Outside
the Principal Municipalities
of Nairobi and Mombasa
25%
25%
15%
40%
0%
15%
30%
0%
3) Investment Deduction in Respect of Hotel Buildings
Where a person incurs capital expenditure on the construction of a hotel building which has been
certified by the CDT and gazetted under the Tourist Act as an industrial hotel building, he will be
eligible to claim investment deduction in the year of first use of the hotel. The rates for investment
deduction in respect of hotel buildings are the same as those for investment deduction on ordinary
manufacture. As from 1.1.1993, hotel buildings for the purposes of investment deduction shall
include any building(s) that are directly related to the operations of the hotel complex e.g. staff
quarters, kitchens, entertainment, sporting and fitness facilities such as gyms, swimming pools,
saunas, basketball courts etc.
4) Shipping Investment Deduction (SID)
Shipping investment deduction (SID) is granted to resident ship owners in the shipping business i.e.
the qualifying business, which is the ferrying of goods or passengers over the Kenyan waters for hire
or reward. Shipping investment deduction (SID) is granted to resident ship owners who incur capital
expenditure:
- On the purchase of a new power driven ship of more than 495 tonnes tare weight, or
- On the purchase and subsequent refitting for the purposes of the qualifying business of a used
(second hand) power driven ship of more than 495 tonnes tare weight.
The rate for shipping investment deduction (SID) is 40% of the qualifying cost, which is granted on a
once and for all basis and in the year of first use of the ship for the qualifying business. As from
1.1.1987, wear and tear allowance on the ship (12.5%) shall be granted on the residue after shipping
investment deduction.
Additional Notes on Shipping Investment Deduction
a) A ship can only be granted shipping investment deduction once in its lifetime i.e. in the year of
first use.
b) If a qualifying ship is sold within 6 years of qualifying, the shipping investment deduction granted
will be withdrawn/clawed back by the CDT and treated as a taxable income. This is meant to
prevent investors claiming shipping investment deduction and subsequently selling such ships
within a short period at massive profits.
Topic 4
Farm Works Deductions
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This is an allowable capital deduction granted in respect of capital expenditure on farm structures
constructed on a commercial agricultural land as per paragraph 22 and 23 of Second Schedule of ITA
Cap 470.
Paragraph 22 reads, "Where the owner or tenant of any agricultural land incurs capital expenditure on
any agricultural land on construction of farm works, a deduction referred to as farm works deduction
shall be made in computing the gains or profits from the farm".
FWD is granted at the rate of 33 1/3 % i.e. at 1/3rd of the total qualifying cost per annum for 3 years
on straight lines basis. With effect from 1.1.2007, the rate of FWD has been increased to 50% per
annum on straight-line basis.
Farm Land/Agricultural Land
This means land occupied wholly or mainly for purpose of trade in commercial farming i.e. crop
husbandry such as tea, sugar cane coffee, horticulture, floriculture, pyrethrum, maize, wheat, cashew
nuts etc or animal husbandry such as dairy cattle, ranching, pigs, poultry farming, ostrich farming,
dog breeding, snake farming etc.
Types of Farm works
a) Farm houses for the occupation of the farmer or directors of the company. In the case of a
farmhouse occupied by the owner of farm as his/her residence, only 1/3rd of the cost shall qualify
for FWD and on only one farmhouse. In case of a limited company in agricultural business, the
value of farmhouses will not be restricted since such are treated as labour quarters.
b) Labour quarters/labour lines for the occupation by farm workers.
c) Other building(s) or structure(s) that are necessary the proper operation of the farm to generate
taxable farming income e.g. fences, cattle dips, water and electricity supply works other than
machinery, fish ponds, stables, bomas, access roads, granaries, stores, silos, irrigation networks
etc.
Points to Note:
a) Full farm works deduction shall be made for farm works constructed during the accounting year
without restriction provided the farming business has been carried on for a full year.
b) Where items qualifying for FWD are sold to another farmer, the new farmer can only claim the
residue of expenditure of the former and thus the purchase price paid by the new farmer shall be
irrelevant for the purposes of FWD.
c) Apportionment of unclaimed deduction will be done on the basis of the period of ownership in a
year of income.
d) Other assets owned by a farmer will qualify for their relevant capital allowances.
Topic 5
Diminution
Items such as implements, loose tools such as utensils in a hotel, loose tools on a construction site,
containers, computer software etc, are not formally depreciated by use of the conventional methods of
depreciation. Such items normally represent a substantial investment of a business concern and their
nature is such that they are prone to losses, breakages, leakages. Such assets are depreciated using the
revaluation method. For tax purposes, such items do not qualify for wear and tear allowance. Capital
expenditure incurred to acquire them qualify for a diminution i.e. a loss in value at the rate of 33 .33% on
a straight-line basis for 3 years.
Topic 6
Mining Allowance
Part III of the Second Schedule grants capital allowances in respect of expenditure incurred by a
person on mining operation. These capital deductions are granted in respect of mining operations due
to their peculiar features such as:
a) The working or production life of a mine depends largely to the amounts of deposits and the
extent to which they can be won.
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b) The prices of minerals largely depend on the world prices.
c) Any capital expenditure in mining operations is largely dependent on the life of the mine such
that upon exhaustion of the mine, some of the buildings and machinery would hardly be used for
any other purpose.
A fall in the prices of minerals will cause the extraction or production unjustifiable although the mine
could still have substantial deposits. Much of the mining in Kenya is of marginal type. Such
operations are brought down by: world prices and scarce deposits whose extraction cannot justify the
cost
Qualifying Costs for Mining Allowance
A claim shall be made in respect of capital expenditure incurred in Kenya on mining operations:
a) In the search for or in discovering and testing of the minerals including the winning of access to
the deposits.
b) In acquisition of or the rights in or over the mine or acquisition of the deposits other than the
acquisition from a person who has carried on mining in relation to those deposits.
c) In the provision of machinery, which will have little or no value to that person if the mine ceases
to be worked on.
d) On the construction of a building or works, which will have little or no value if the mine ceased to
be worked on.
e) On the development, general administration and management prior to the commencement of
production or during a period of non-production.
Non-Qualifying Costs
a) Expenditure on acquisition of the site of the deposits or the site of those buildings or works or
rights over the site.
b) Expenditure on the works constructed wholly or mainly for subjecting the raw produce of the
deposits to a process except a process designed for preparing the raw materials for use.
For the purposes of this deduction, minerals will not include: common clay, murrum, limestone,
sandstone, brine, diatomite, gypsum, anhydrite, sulphur, dolomite, kaolin, bauxite, sodium, potassium
and any other mineral substance, which is not declared to be a mineral under Sec.2 of the Mining Act.
Minerals shall include copper, gold, silver, carbon-dioxide gas, mica, etc.
The rate of mining allowance is 40% of the qualifying expenditure in the first year and 10% for the
next 6 years on a straight-line basis. A mine is deemed to have a life span of 7 years. Where a person
considers that his mine has a life of less than 7 years, he can make an official representation to the
CDT for an enhanced capital deduction rate.
An additional advantage exists where a person carrying on the mining operation is charged to tax at a
corporation tax rate of 27.5% in the first 4 years after which they revert to the normal corporation tax
ruling then.
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CHAPTER THIRTEEN
VALUE ADDED TAX (VAT) CAP 476
Introduction
The Value Added Tax was introduced in Kenya on 1.1.1990. It replaced Sales Tax and is charged under
the VAT Act. It is administered by KRA with effect from 1.7.95
VAT is tax on spending, which is collected by businesses as agents of the government and passed on
to the government. It is also collected on imports. VAT is a development from sales tax system,
which was abolished in 1988 and replaced with VAT in 1989. VAT is applicable to goods as well as
services mainly in the business areas such as accountancy, legal services, estate agency, management
consultancies, engineering etc.
VAT is payable if supplies of taxable goods or services are supplied:
(a) In Kenya
(b) By a taxable person
(c) In the course of furtherance of business
VAT is a multi-stage tax that is deducted at every stage of handling goods or services and passed on
to the government. The basic Kenya VAT laws are contained in VAT Act of 1989 and any
regulations arising there from.
Liability to Tax
They’re various rates of VAT:
(a) General rate, currently 16% (2006-2007)
(b) Rates specified in part II of the First Schedule
(c) Zero rate specified in the 5th schedule
Note:
The lower rate of VAT applicable to hotel and restaurant services has been abolished. The rate,
pegged at 14%, has now been removed from the Act, with the effect that there are only two VAT
rates applicable in Kenyan legislation; 0% and 16%. Zero rate is applicable to exports. No taxes are
payable on the zero-rated supplies even though such supplies are treated as taxable supplies in all
respects. Supplies of goods listed in the 2nd Schedule of VAT Act and supply of services of a type not
specified in the 3rd Schedule of the Act are exempted from taxation i.e. no VAT is charged on them.
How VAT works
If you are a registered person making taxable supplies, you will be required to account to the CVAT
for any tax due. This is the output tax recovered on the sales, i.e. the tax on the supplies of taxable
goods or services going out of your business. This tax will be charged to customers if they’re
registered for VAT and such supplies being used in their business. Your suppliers’ taxes are your
input taxes i.e. taxes on taxable supplies or services coming into your business.
Taxable Persons
Any person who is a manufacturer or a supplier of taxable goods or services is liable for registration
under the 6th schedule of the VAT Act. Generally any person who makes or intends to make supplies
of taxable goods or supplies will be treated as a taxable person and who may be required to register
for VAT.
Taxable Supply
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It is the supply of goods or services made or provided in Kenya. The Act defines taxable goods to
include electricity and other manufactured goods other than those specified in the 2nd Schedule, which
deal with exempt supply.
Supply of Goods
VAT is chargeable on the supply of goods or services. The supply of goods will include:
a) The sale, supply or delivery of taxable goods to another person.
b) The sale or provision of taxable services to another person.
c) Appropriation by a registered person of taxable goods or services by a registered person for his
own use outside the business.
d) The making of a gift of any taxable good/service that include the loaning of goods or any goods
supplied in satisfaction of a debt or goods retained by a taxable person when he ceases to be a
taxable person or provision of samples, unless such samples are:
- Fully distributed for the furtherance of a business
- Have a value of less than Ksh. 200 each.
- Are freely available.
- Distributed to not less than 30 persons in a month.
e) The letting of taxable goods on leasing and any other transfers.
f) The provision of taxable services by a contractor to himself in constructing a building and related
civil engineering works for his own use, sale or renting to other persons.
g) The receipt of a sum of money by a registered person for loss of taxable goods or services.
h) The appropriation of taxable goods by a registered person for use in a business where, if supplied
by another person, the tax charged on the supply would have been excluded from the deduction of
input tax.
i) Any other disposal of taxable goods or provision of taxable services.
Place of Supply
The place of supply is a location of the goods when they are allocated to a customer’s order. If goods
are located outside Kenya when they are being allocated to a customer’s order, the supply is deemed
to have taken place outside Kenya and is therefore outside the scope of VAT.
Tax Point
This refers to the time when a supply is deemed to have taken place and tax becomes due and payable
then. VAT becomes due and payable at the earlier of the following:
a) The goods or services are supplied to the purchaser.
b) An invoice is issued in respect of the supply.
c) Payment is received for or part of the supply.
d) Certificate is issued by an architect, surveyor or any person acting in a supervisory capacity in
respect of the service.
e) When goods are supplied on a continuous basis or metered supplies, tax is chargeable from the
date of the first determination or the first meter reading and subsequently at each determination or
meter reading.
Vat Registration
Compulsory Registration
The 6th Schedule to the VAT Act requires that any person shall be registered compulsorily for VAT
if:
a) In the course of business has manufactured and supplied or expect to manufacture and supply
taxable goods or has supplied or expects to supply taxable services or both, the value of which is
Ksh. 5,000,000 or more in a period of twelve months;
b) The person is a designated dealer dealing in designated goods other than designated jewellery,
pre-recorded music and timber and has supplied or expects to supply taxable goods or services or
both, the value of which exceeds in any of the limits in those periods as given in (a) above; or
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c) The person is a designated dealer in designated jewellery, designated pre-recorded music and
designated timber; or
d) The person is a saw miller; or
e) Any person who in any one year sells 4 or more motor vehicles; or
f) Provides accountancy services, including bookkeeping or similar services; or
g) Provides services supplied by auctioneers, estate agents and valuers; or
h) Provides legal and arbitration services; or
i) Provides reports, advice, information or similar technical services; or
j) Provides computer services; or
k) Supplies services of architects, draughtsmen and interior designers; or
l) Offers services of surveyors and assessors; or
m) Offers consulting engineering services; or
n) Is an agent, excluding insurance brokers, stock exchange brokers and tea and coffee brokers; or
o) Provides security and investigation services; or
p) Provides advertising services; or
q) Offers telecommunication services; or
r) Offers services supplied by contractors; or
s) Provides clearing and forwarding services; or
t) Provides company secretarial services.
In each of the above cases, the taxable person shall within 30 days, on which he becomes a taxable
person, apply in a described manner for registration to the Commissioner of VAT.
Voluntary Registration
Voluntary registration is permissible under the law but is granted at the discretion of the
Commissioner.
Upon registration, a person who has goods on which tax has been paid, or has constructed a building
or civil works or purchased assets within one year before registration, he may, within thirty days or
such longer period as allowed by the Commissioner, claim the input tax charged thereof. Such a
person must have submitted the application for registration within the prescribed time limit.
Note:
With effect from 16 June 2006, the period within which an application for relief of tax on stocks,
assets and buildings held as at the date of registration has been extended indefinitely, subject to
obtaining the Commissioner’s approval. Previously, the application could only be made within 30
days of registration.
Designated Dealer
This means any person who by way of business offers for sale any designated goods or offers to
repair, alter or process any designated goods or who acts as an agent of such a person. Designated
goods are those specified in the 4th Schedule of the VAT Act.
Rights of a Registered Person
a) To deduct VAT on inputs for taxable supplies. However, as a taxable person your right to deduct
input tax only applies if you are dealing in taxable supplies but not on exempt supplies. In
addition, the right to input tax deduction is restricted to six months from the date the tax becomes
due and payable.
b) To get refunds if your input tax always exceeds your output tax.
c) Free access to the Commissioner or any other senior officer or manager if you have genuine
complaints about the conduct of any VAT officer.
d) To get relief for stock in trade as at the time of registration
e) To get relief or refund on capital goods (including buildings) acquired or put up within twelve
months prior to the date of registration.
f) To get refund of VAT on bad debts
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g) To defer payments of tax due to a date not later than 20th day of the month succeeding that in
which the tax is charged
h) To request for reconsideration of an assessment
i) To appeal to a VAT Tribunal on any matter concerning tax.
j) To demand that every authorized officer identifies himself.
k) To expect that information obtained in the course of duty by the VAT officers shall be treated in
confidence.
Obligations of a Registered Person
a) To apply for registration as a taxable person.
b) To display your certificate of registration in a clearly visible place in your business premises.
c) To charge VAT on all your supplies of taxable goods and services.
d) To issue a VAT tax invoice immediately after each supply but in any case within 14 days of each
supply.
e) To keep proper records and books.
f) To file VAT returns on due dates.
g) To pay (monthly) whatever tax is due to the Department according to your calculation in the
monthly return (Form VAT 3 i.e. the VAT Account).
h) To retain books and records available at all reasonable time for inspection by authorized officers
of the VAT Department.
i) To provide the VAT Department’s officers with any information pertaining to your business and
access to your business premises whenever required to do so.
Value of Supplies or Value for Tax
Value for VAT is the value on which the VAT is due. The amount of tax is the value for tax
multiplied by the tax rate. Generally the value for tax of a supply will depend on what is given in
exchange for the supply i.e. the consideration which is give as follows:
a) Consideration of a supply includes any payments that are given to cover the cost of making the
supply.
b) Consideration that is wholly in money worth: the value for tax shall be based on that amount. If
customers are offered cash discounts, the value of tax will be based on the discounted value. If
customers are allowed to pay by instalments, the value for tax shall be based on the total amount
cash instalments, and tax is due on the full value at the time of supply, (any hire purchase interest
is expensed and allowed in profit and loss account).
c) If the consideration of a supply is not money worth e.g. barter transaction or consideration is
partly in money and partly in something else e.g. a part exchange, the value for tax is the open
market value for the transaction i.e. the price excluding VAT which the customer would have paid
for the supply if the consideration was only in money.
d) The value for VAT in case of imported goods is the value for duty plus duty.
e) For warehoused goods, the value for VAT is the value for duty plus duty at the time of release of
goods from a bonded warehouse.
f) The taxable value of goods will include excise duty, where applicable (with effect from
16.6.2006).
In determining the price of any goods for purposes of ascertaining the value for tax, the charges for
the following items must be included:- Wrapper, package, box, bottle or other container in which the goods are contained; and
- Any other goods contained in or attached to such wrapper, package, box, bottle or other container;
and
- Any liability the purchaser has to pay to the vendor by reason of the supply in addition to the
selling price, including any amount charged for advertising, financing, servicing, warranty,
commission, transportation, etc.
65
-
Where taxable goods are sold in returnable containers and the containers were purchased or
imported and the input tax paid thereon, then no tax will be chargeable in respect of the
containers.
- Where tax has been charged in respect of returnable containers, which are then returned to the
supplier, the supplier will be entitled to take credit for the tax in his next succeeding return.
Points to Note
- A taxable person who is a retailer and mainly supplies taxable goods or services to unregistered
persons is required to quote or label a price that is inclusive of VAT
- Where prices are quoted inclusive of VAT, the amount of tax is determined by applying to the
price the tax fraction, t/ (1+t), where t is the rate of tax applicable.
- Where prices are quoted exclusive of VAT, the amount of tax is determined by applying to the
price the tax rate t, where t is the rate of tax applicable.
- The value of taxable services must include any incidental costs incurred by the supplier of the
service in the course of making his supply, excluding and disbursements which the supplier has
made to a third party as an agent of his client.
- The taxable value of hotel accommodation and restaurant services shall exclude any Catering
Levy and service charge made in lieu of tips or gratuities, provided; the proceeds of the service
charge are distributed directly to the employees of the hotel or restaurant in accordance with
written agreement between the employer and the employees, and the service charge does not
exceed 10% of the value of the service, excluding such service charge.
- The taxable value of mobile cellular phone services shall be the value determined for excise duty
under the Customs Act.
- Where goods are purchased under hire purchase terms in accordance with the provisions of the
Hire Purchase Act, the consideration for the supply will represent the cash price and the
additional interest or finance charge will be disregarded in determining the value of the goods.
- Where interest is charged for late payment of the price of a taxable supply, it shall be disregarded
in determining the value of goods.
- There is no special provision in the Act for determining the value of second hand goods. But such
goods will be subjected to tax just like other normal supplies.
Supply of Services
For a person who does anything for consideration other than for the supply of goods including
granting, assigning, surrender of a whole or part of right, these shall be treated as supply of taxable
services. Such services will include the provision of professional service e.g. legal services,
accountancy, engineering, architecture, and other professional services. The Act defines services as a
supply by way of business that is not the supply of goods or money except a service provided by an
employee to his employer for a wage or salary. In the case of services, the place of supply is where
the taxpayer belongs or some fixed establishment. The tax point is taken as the same as for the supply
of goods.
Exempt Services
(Third Schedule to the VAT Act)
Following the amendments containedin the Finance Bill 2001, the services listed below shall be
exempt services for the purposes of the Act. All services that are not in this list are taxable and the
providers shall register with the VAT Department immediatelya) Financial services excluding the following: - Financial and management advisory services;
- Safe custody services;
- Executorships and trusteeship services.
Note:
Only financial services offered by banks and financial institutions will be exempted from VAT.
Conversely, financial services offered by any organisation other than banks and financial
institutions will be subject to VAT (with effect from 16.6.2006).
b) Insurance and reinsurance services.
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c)
d)
e)
f)
g)
h)
i)
j)
k)
l)
m)
n)
o)
p)
q)
Note: Management and related insurance consultancy services, actuarial services and services of
insurance assessors and loss adjusters offered by insurance companies will now be subject to
VAT at the standard rate (with effect from 16.6.2006)
Education and training services offered to students by institutions and establishments registered
by the government.
Medical, veterinary, dental and nursing services.
Sanitary and pest control services rendered to domestic households.
Agricultural, animal husbandry and horticultural services.
Social welfare services provided by charitable organizations registered as such, or which are
exempted from registration, by the registrar of Societies under the Sec. 10 of the Societies Act, or
by the Non-Governmental Organizations Coordination Board under Sec. 10 of the NonGovernmental Organization Coordination Act, 1990 and whose income is exempt form tax under
paragraph 10 of the First Schedule to the Income Tax Act and approved by the Commissioner of
Social Services.
Burial and cremation services, including services provided in the making of arrangements for or
in connection with the disposal of the remains of the dead. Note: Any services rendered after
burial will be subject to VAT.
Transportation of passengers by any means of conveyance except where the means of conveyance
is hired chartered or leased.
Renting, leasing, hiring or letting of land and residential and commercial buildings.
Postal services provided through supply of postage stamps including rental of postal boxes and
mailbags and any subsidiary thereto.
Community, social and welfare services provided by Local Authorities.
Insurance agency, insurance brokerage, stock exchange brokerage and tea and coffee brokerage
services.
Hiring, leasing, or chartering of goods listed in Part I of the Second Schedule and Part B of the
Fifth Schedule but excluding chartering of aircrafts and hiring of buses. The following should be
noted:
- Chartering of aircrafts and hiring of buses will become taxable with effect from 1st September
2001.
- Chartering of aircrafts for use outside Kenya will be services exported out of Kenya and
therefore zero-rated.
- Leasing of aircraft is exempt.
Tour operation and travel agency services including travel, hotel, holiday and other supplies made
to travellers but excluding in-house supplies and services provided for commission earned on air
ticketing. For purposes of this paragraph in-house supplies means supplies which are either –
- Made from own resources rather than bought in from third parties; or
- Bought in from third parties but materially altered so that the supply made is different to that
purchased.
- Services rendered by trade, professional and labour association to members.
The following entertainment services- Stage plays and performances which are conducted by educational institutions, approved by
the Minister for the time being responsible for education as part of learning;
- Sports, games, or cultural performances conducted under the auspices of the Ministry of
Culture and Social Services;
- Entertainment of a charitable, educational, medical, scientific or cultural nature as may be
approved in writing by the Commissioner prior to the date of the entertainment for the benefit
of the public;
- Entertainment organized by a non-profit making charitable, educational, medical, scientific or
cultural society registered under the Societies Act where entertainment is in furtherance of the
objects of the society as may be approved in writing by Commissioner prior to the date of the
entertainment.
Accommodation and restaurant services provided within the premises;
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-
Establishments operated by charitable or religious organizations registered under the Societies
Act for charitable or religious purposes.
- Establishments operated by an educational training institutions approved by the Minister for
use of the staff and students by that institution.
- Establishments operated by a medical institution approved by the Minister for the time being
responsible for health for the use by the staff and patients of such institutions.
- Canteens and cafeterias operated by an employer for the benefit of his low-income employees,
which the Commissioner may approve subject to such conditions as he may prescribe.
r) Conference services conducted for educational institutions as part of learning where such
institutions are approved by the Ministry for the time being responsible foe education.
s) Car park services provided by local authorities and by an employer to his employees on the
premises of the employer.
t) Entertainment services offered by local Kenyan artistes (with effect from 16.6.2006)
Imported Services
Where a person in Kenya imports a taxable service from overseas, the importer will be required to
account for the VAT to the VAT Department. This is referred to as a reverse charge. In order to assist
the collection of tax, the Central Bank is required to ensure that any person applying for foreign
exchange has remitted the fees overseas and has accounted for VAT to the department. Such person
will be required to produce a tax clearance certificate from the Commissioner of VAT certifying that
the VAT has been paid.
Private Use of Goods
Where taxable goods belonging to a business have been put to private use outside the business, the
person is said to have made a taxable supply. This will include any goods which are introduced by
one or goods that are held in stock or any other taxable business asset. Private use will include the
person’s own personal use of the business asset. It also covers use outside the business by any other
person such as an employee, relative or friend.
Input and Output Tax
Input Tax
(a) A tax on the supply to a registered person of any goods or services for the purpose of a business
carried on by him.
(b) The tax paid or payable by a registered person on the importation of goods or services used or to
be used for the purpose of a business carried on by him.
(c) Tax paid on the removal of goods from a warehouse.
Thus, input tax is the VAT charged on a business purchase and expenses including goods or services
supplied in Kenya or imports of removal from a warehouse. A person carrying on a business must
pay VAT on goods or supplies of services. Where no relief is to be obtained for VAT paid (input tax),
the person will incur such liability. However, this possibility shall be removed in certain cases by a
provision in the Act which enables input tax to be deducted against output tax recovered and the
difference paid over to the government.
Output Tax
It is a tax due on a taxable supply. A registered person may make taxable supplies and therefore
charge VAT on invoice cost to his customers. Thus output tax is VAT that is recovered or received
on sales or provision of taxable services in Kenya.
Output and Input tax shall be compared and the difference is either tax payable to government or tax
carried forward or claimed as a refund from VAT Department. However, not all Input tax is
deductible. The deductible input tax will be governed by the nature of supplies made.
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Types of Supplies
1) Standard Rate Supplies (Taxable Supplies)
These are supply of goods or services on which VAT is chargeable either at the specified or high
rates. In most cases all the input tax in respect of taxable supplies may be deductible.
2) Zero Rated Supplies (Taxable Supplies)
Zero rated supplies means;
(a) No tax will be charged on the supply, but
(b) The supply will in all other respect be treated as a taxable supply; accordingly rate of tax which is
chargeable on the supply will be zero.
(c) However such supply is taken into consideration in determining whether the supplier is a taxable
person required to be registered. A registered person making zero rated supplies will not charge
any tax on the supply, but will obtain a return of the VAT paid by him on his goods or services.
Being a zero-rated person/firm, the company will claim a refund from the CVAT.
Zero Rating Applies to the Following
- Goods or taxable services that are exported;
- Supplies to designated foreign aid funded capital investments projects;
- Supplies to EPZ enterprises;
- Ship stores supplied to sea and air carriers on international voyages and flights;
- Services supplied by hotels to foreign travel and tourism promoters subject to specified
conditions;
- The supply of tea for export to the tea auctions;
- The supply of coffee;
- Supply of below hundred kilowatt-hours of electrical energy to domestic consumers;
- Supply of taxable services in respect of goods in transit;
- Supply of taxable airport services to transit aircraft;
- Taxable supplies to aid agencies for their official use;
- Taxable supplies to cotton ginning factories;
- Goods listed in Part B and C of the Fifth Schedule to the Act;
- Goods imported or purchased by public bodies, privileged persons and institutions specified in
Part A of the Eighth Schedule to the Act;
- Special goods subject to zero rating as specified in Part B of the Eighth Schedule to the Act;
- Supply of water drilling services;
- Electricity imported into Kenya;
- Persons with diplomatic privileges as provided in Part C of the Eighth Schedule to the Act;
- Electronic Tax Register
- Wheat flour and natural water supplied and treated by local authority or any other approved
person.
- Tyres and semi-trailers for agricultural tractors.
- Napkins and napkin liners.
- Feeding bottles for babies.
- Computer hardware accessories and spare parts.
A list of zero rated goods is provided in part B of the 5th Schedule. These are mainly essential goods,
which will include vaccines, medicines, packaging material for farming goods, dentist chairs, animal
feeds, spectacles, milk containers of up to 10 gallons etc.
3) Exempt Supplies
Where a person makes an exempt supply;
a) He is not regarded as carrying out a taxable supply.
b) VAT is not chargeable in respect of exempt supplies.
69
c) The value of exempt supplies is disregarded when determining the taxable turnover and the need
to be registered for VAT.
d) A person who makes only exempt supplies will not be able to deduct the input tax suffered, nor
can he carry it forward, nor can he reclaim it from the Commissioner. Such a supplier will incur
such liability in its entirety.
e) Exempt supplies include education, health services, goods such as live animals, fruits, coffee and
many foodstuffs.
Where a person deals with all the supplies i.e. Taxable (standard rated and zero-rated) plus exempt
supplies, there will be need to determine to what extent input tax can be deducted. The deductible
input tax for which a registered person can make a deduction shall be;
a) The whole of the input tax if all the supplies are taxable.
b) Such part of the input tax that can be attributed to taxable supplies; (taxable plus zero-rated),
where only a proportion of the supplies are taxable. Input tax is deductible only where there’s a
related or attributable output tax. Thus there is no output tax for exempt supplies hence no
deduction of input tax on exempt supplies.
Zero rated supplies are taxable but the output tax is zero and therefore there is a related output tax,
hence the input tax on the zero rated supplies is deducted. For exempt supplies, these are not taxable
supplies and there is no output tax, therefore non-of the input tax on exempt supplies is deductible.
Where a person makes all types of supplies, the deductible input tax shall be limited to the proportion
of output tax that bears on the taxable supplies. A person can claim all the input tax provided the
input tax that relates to exempt supplies is always less than 5% of the total input tax.
For a person making all types of supplies, he will determine the deductible input tax by any of the
following formulas:
a) Proportionate Method
Deductible Input Tax
= Value of Taxable Supplies
Value of Total Supplies
x
(Total Input Tax-Input Tax on goods for sale in same state)
Note: The supplies quoted in the formula above represent sales figures net of VAT if any.
Deduct all input tax attributable to taxable goods purchased and sold in the same state and nondeduction of input tax that is attributable to exempt supplies. The remainder of the input tax is
apportioned using the formula above.
b) Allocative Method
The amount of restricted input tax to be claimed or offset against output tax is influenced by the
amount of standard rate purchases that are subsequently sold as standard rate supplies.
The following steps are used to compute the deductible input tax using the allocative method.
-
Step 1
Out of the total input tax, deduct the input tax relating to standard rate purchases which were
sold as standard rate supplies.
-
Step 2
Out of the total supplies, (SR+ZR+ES) deduct the standard rate supplies which were
purchased at standard rate.
-
Step 3
Out of the total taxable supplies, deduct the standard rate purchases which were sold as
standard rate supplies.
70
-
Step 4
Apply the proportional method (as given above) to determine the restricted input tax to be
offset against the output tax.
Example: December 2004 Q4 (c) (Tax II)
i.
Total Output Tax
= 45,000,000x16%
= 7,200,000
ii. Total Supplies Value = 45,000,000+10,000,000+20,000,000
= 75,000,000 Less: 20%x45,000,000
= 66,000,000
iii. Total Input Tax less 20% of SR Purchases
= 16 %( 25,000,000+700,000+500,000)-20%x25,000,000
= 3,392,000
iv. Total Taxable Supplies less 20% of SR Sales
= (45,000,000+10,000,000)-(20%x45,000,000)
= 46,000,000
v. Using the proportional method to restrict the deductible input tax
Deductible Input Tax = Taxable Supplies x Total Input Tax
Total Supplies
= 46,000,000x 3,392,000
66,000,000
= 2,364,141.2
A person can reclaim the input tax on each monthly return using any of the above methods. However
the input tax determined by the above methods is usually a provisional amount, which can be affected
by seasonal variations during the year of purchases and sales. Therefore at the end of the year, the
registered person will be required to make an annual adjustment to recalculate amount of input tax
claimable using annual figures. Any differences between the amount reclaimable as input tax
calculated at the end of the year and the total amount computed on a monthly basis (just like
computation of income tax at the end of the year as compared to the total PAYE calculated monthly)
computed monthly will either be an over or under declaration and this amount must be entered in the
VAT Account for the VAT period of 12 months.
Non-Deductible Input Tax
The VAT Order, 2002 specifies items for which tax paid may not be deducted, except where such
goods are sock in trade. The Items covered in the order include:
a) Fuels and oils to be used in vehicles, ships and other vessels other than fuel used in the
manufacture of other taxable fuels and oils;
b) Passenger vehicles and minibuses, except where such vehicles and minibuses are used for leasing
or hiring services;
c) Bodies, parts and services for the repair of passenger vehicles and minibuses except where these
are used in the supply of repair and maintenance services or other taxable goods or services;
d) The leasing or hiring of passenger vehicles and minibuses;
e) Furniture, fittings and ornaments of decorative nature, except where such items are permanently
attached to buildings, or for use in hotels and restaurants (subject to the approval of the
Commissioner);
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f) Household or domestic electrical appliances other than those approved by the Commissioner for
use in the manufacture of other taxable goods or supply of taxable services;
g) Liqueurs and other alcoholic beverages, non-alcoholic beverages and soft drinks;
h) Entertainment services;
i) Restaurant services;
j) Returnable containers, crates, bottles and similar goods for packing beverages;
k) Returnable containers, cylinders, and similar taxable goods used for packing liquid petroleum gas.
VAT Records and Accounts
The VAT Act enumerates all he records and documents including accounts that a registered person
shall keep and these will include:
Public Notice No. 18 (Revised)
The Commissioner of VAT wishes to inform taxpayers and the general public, that stock records are
required to be maintained with effect from 1st of January, 2002 as earlier directed. The purpose of this
public notice is to give guidelines on the requirements for stock records.
a) Purpose of Stock Records
The purpose of the requirement to maintain stock records is to enable the CVAT to confirm
through such records that any taxable goods dealt in by the business have been fully accounted for
in terms of physical quantities either as:- Sales; or
- Stock-in hand; or
- Stocks written off due to losses occasioned by any reason whatsoever.
This public notice only specifies the minimum records that taxpayers should maintain. It does not
prevent any enterprise from maintaining any additional records that it deems essential for its own
business operation and control.
b) Stock Records
For purposes of regulation 7(2) of VAT Tax Regulations, stock records will constitute the following:- A list of stock items (Stock sheets) physically counted periodically at least once a year to coincide
with the taxpayers financial year end.
- Original documents received and copies of original documents issued indicating movements in
quantities of stock items in and out of the business premises, and within the premises such as;
purchase invoices, cash sales and/or goods received notes, goods issued notes, delivery notes, etc;
and
- Production records of manufactured goods; and
- Any other records, if maintained by the business to account for stocks such as stock ledgers, stock
summaries, stock variance records; etc.
c) Items Included
Taxpayers are required to maintain stock records of all items of stock-in-trade except those exempted
from this requirement. For this purpose, stock in trade shall mean only those items sold by the
business; whether purchased and sold in the same condition; or manufactured, processed or repacked
for sale by the business. However, if the taxpayer maintains stock records in respect of other items
e.g. raw materials, then VAT inspectors may inspect the same in the course of an audit.
d) Items Excluded
For purposes of Regulation 7(2) of the VAT Regulations, stock records in respect of items specified
in the schedule below are not required. However, all other records required under the VAT
Regulations in respect of taxpayers activities must be maintained in respect hereto:- Raw materials
- Scrap Metal
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-
Second hand motor vehicle spare parts.
Where the value of an individual stock item is below Ksh 100 selling price. Stocks of such goods
sold in packs of more than one item must be accounted for if the value is more than Ksh 100.
Unprocessed timber (logs and beams).
Unprocessed agricultural produce e.g. raw milk, vegetables produce etc.
Sand, ballast, quarry and other materials on building sites.
Items manufactured on order. However, production records must be availed when required or on
demand.
Any other items that are not produced to standard measurements subject to the approval of the
Commissioner.
Where the taxpayer maintains stock records in respect of the above items, then VAT inspectors may
inspect the same in the course of an audit.
e) Frequency of Stock Records
Stock sheets should be prepared at least once a year. Annual stock sheets should coincide with the
date of the end of the financial year to which the taxpayer normally prepares accounts of the
business. However, where the trader prepares stock sheets more often, then such records may be
inspected by the VAT Inspectors.
f) Updating Stock Records
All original documents relating to the movement of stocks (as defined above) should be maintained in
chronological order (e.g. in a file) or in such a manner as to enable an accurate assessment of stock
movements to be made and a theoretical balance of any stock item to be reckoned by VAT Inspectors.
Theoretical stock balance in this case means opening stock as at the beginning of the period plus
purchases minus sales during the period. If the trader maintains a stock ledger then this will be
updated annually to coincide with the date on which a stock count is taken.
g) Purpose of Regulation
For purposes of this regulation no explanation will be required for stock quantity variances not
exceeding 10% loss. However, stock losses exceeding 10% may be assessed to tax unless adequate
evidence is availed indicating loss or destruction of the same. Stock losses in this case mean
theoretical stock balance minus actual stock as at the date of stock count.
h) Stock Variances
Where in the course of their audits, VAT Inspectors are unable to reconcile any stock differences
noted, the Commissioner may require an actual count of any item to be carried out by the
trader in the presence of VAT Inspectors for purposes of such reconciliation.
i) In situation where stock variances exceed 10% (in quantities) and are consequential to such
factors as thefts, pilferage, breakages, destruction, fire, obsolescence, etc; the same shall be
supported by evidence such as:- Police abstract: or
- Insurance claim certificates; or
- Court conviction cases; or
- Physical evidence of destruction or return of the goods to the vendor.
Where such evidence as required cannot be availed, the Commissioner shall exercise discretion based
on the merits of each case. Factors such as the magnitude of the loss, frequency and preventive
measures taken against the recurrence of losses will be taken into account in determining the extent of
merit thereof.
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Requirements for Taxable Persons to Keep Stock Records
Since the inception of VAT in 1990, keeping stock records has been a requirement in the VAT Act.
Paragraph 6(1) of the Seventh Schedule to the VAT Act requires every taxable person to keep full
and true records written up-to date of all transactions, which may affect his tax liability. The main
transactions that affect a taxable person’s tax liability are the delivery of supplies into the business
premises and supply of goods and services from the business premises. Without records of these
transactions, a taxable person’s records cannot be full and true as required by the law.
The Authority is aware that most taxable persons keep stock records for their own business purposes
and the aim is to avoid interference with their current systems as much as possible.
However, taxpayers must be open and ready to share such records with VAT Department to ensure
that they are kept in the correct manner as required by the law. The basic records expected from
various business types to keep include:
a) Manufacture
i) Store records (raw materials)
- Goods received into the premises and taken to the store.
- Goods received into the premises and taken direct to the manufacturing line.
- Goods issued from the store to the manufacturing line.
- Stock balances
- Details of goods delivered into the premises and sent out again.
ii) Manufacturing Line
- Details of goods manufactured
- Details of wastages (if possible)
iii) Details of Manufactured goods
- Goods manufactured and delivered into the store
- Goods delivered from the store destined for persons outside the factory.
- Details of sales document (delivery notes, invoices or cash sales).
- Details of goods delivered from the factory and returned back.
- Stock balances.
- Details of breakages, thefts, expired goods, goods destroyed (e.g. by fire, accidents etc).
c) Wholesaler
- Goods delivered into the premises
- Goods delivered from the premises
- Stock balances
- Details of breakages, expired goods, thefts (if substantial) and destroyed goods e.g. by fire.
- Details of sales documents (delivery notes, invoices or cash sales) if possible.
- Goods delivered from the premises and returned into the premises.
d) Retailer (Including Supermarkets)
- Goods delivered into the premises
- Goods delivered from the premises
- Stock balances
- Details of breakages, expired goods, thefts (if substantial), destroyed goods (e.g. by fire).
- Goods delivered from the premises and returned.
e) How to Keep Records
The medium to be used to keep the stock records will depend on the convenience of particular
taxpayers. A computerized business will keep computerized stock records, while a business that is
not computerized will keep hand written records such as Bin Cards, Kalamazoo Ledger, simple
74
ledger etc. Provided that the records kept contain the main details required to give true picture of
movement of goods into and out of the business, the Authority will accept the same.
f) When to Up-Date the Records
Paragraph 6(1) of the Seventh Schedule to the VAT Act requires a taxable person to keep full and
true records written up-to-date of all transactions which may affect his tax liability. This simply
implies that transactions should be recorded as they take place. However, the CAT Department
appreciates the fact that it may not be possible for every business to up-date its records immediately.
The Authority is therefore ready to accept periodic update provided that the same is done at least once
every month.
g) Verification of Stocks
An authorized officer may physically count the existing stock where he believes that it is necessary to
do so.
h) Stock Variances
The Authority appreciates the fact that physical stock will not reconcile to the last unit with the stock
records, due to such factors as thefts, pilferage, breakages, destruction etc. A reasonable level of
variance (below 5%) may therefore be allowed. Substantial variances shall be supported by
acceptable documentary proof of causes.
i) Effective Date
Although the amendment to the VAT Regulations was effective from 15th June 2001, the VAT
Department appreciates the fact that some taxpayers need time to put their records in order. Such
taxpayers will therefore be allowed up-to 31st August 2001 to ensure that they have up to date stock
records. Any taxpayer who requires assistance may call at his/her nearest VAT office.
Tax Invoice
Whenever a taxable person supplies taxable goods or services, he must furnish the purchaser with tax
invoice within14 days of the completion of supply. However where cash sales are made from retail
premises, the Commissioner may allow other methods for accounting. The buyer will need such tax
invoices to reclaim any input tax that they may have been charged by the seller. Similarly, when a
taxable person purchases taxable goods or services from a registered person, he should obtain a tax
invoice, which will support a reclaim of input tax. A person cannot issue a tax invoice for any supply:
a) Which is not a supply of taxable goods or services, and
b) If the person is not registered.
If such invoices are issued, the person will be liable to pay the tax to the Commissioner of VAT
within 7 days.
Information Contained in the VAT Tax Invoice
a) Name, address and VAT registration number of the person making the supply.
b) The serial number and date.
c) The date of supply if different from (b) above.
d) The name, address and the VAT registration number of the person to whom the supply is made.
e) Description, quantity, price of goods or services supplied.
f) Taxable value of goods/services if different from the price charged.
g) The rate and amount of tax charged on each of those goods and services provided.
h) Details of cash and other discounts.
i) Details of whether the supply is for cash or credit.
j) Total value of supplies and total amount of VAT charged.
If cash sales are made from the retail premises and provided such are not for than 500/= to any one
person, the Commissioner may authorize alternative accounting methods as follows:
75
a) In the case of goods, the registered person should;
- Record the value and brief details of each supply as it occurs and before the goods leave the
premises
- Keep a cash register or book or other suitable record at each point of sale in which he shall enter
all the details of cash received and paid at the time such were made and at the end of each day, the
records shall be totaled and a balance determined.
- At the end of each day record the output tax chargeable on supplies made and the deductible input
tax in respect of supplies received.
b) In the case of services, if the supply is made for cash, a tax invoice should be issued at or before
the time the cash is received.
EXAMPLE OF A VAT TAX INVOICE
INVOICE No:…………………..
Date:……………………………...
From:……………………………
P.O. Box:.……………………….
…………………………………..
VAT Reg. No……………………..
Date of Supply:…………………..
To:………………………………
VAT Reg. No:……………………
P.O. Box:………………………..
…………………………………..
Quantity
Description and Amount Exclusive VAT Rate Amount of Amount
Price
of VAT
VAT
Inclusive of
VAT
Totals
xxxx
xxxx
xxxx
Credit Notes and Debit Notes
Where a registered person issues credit notes to customers, an adjustment will be required to adjust
the original VAT charged. Thus the issue of a credit note decreases the amount of output tax and the
customer’s input tax. A copy of all credit notes issued should be kept. A credit note should show:
- The identifying number and date of issue.
- The number and date of original tax invoice.
- Company’s name, address and registration number.
- The customer’s name and address.
- Reason for the credit.
- Description, which identifies the goods or services.
- The quantity and amount credited for each description.
- Total amount credited excluding VAT.
- Rate and amount of VAT credited.
VAT Treatment on Returns of Goods
If the returned goods are replaced with similar items, you can either let the VAT charge stand or may
cancel it by issuing a credit note if a tax invoice had been previously issued and subsequently charge
VAT on the replaced goods. If the original vat is allowed to stand, there will be no need to account
for VAT on replaced goods provided the replacement is free of charge. If the replacement goods are
supplied at a lower price than original goods, the VAT charge should be reduced by issuing a credit
note provided a tax invoice had been issued originally. If the replacement goods are supplied at a high
price than their original price, then the original VAT must be increased. VAT payment cannot be
waived on the ground that payments have not been received from the customer
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Other Records
Generally a registered person must keep records and accounts of all taxable goods and services,
which are received or supplied in the course of the business. This will include the zero rated supplies
made. A registered person must keep a summary of all input tax paid and all output tax received for
each calendar month i.e. the VAT Account. All these records must be kept up to date in either Swahili
or English and must be of sufficient detail so as to allow the calculation of any VAT payable to the
Commissioner or the VAT to be carried forward as credit to the following month.
Records should not be kept in any set way. They must be kept in a way, which will enable VAT
officers to check easily the figures that were used to fill the VAT Account/Return. If records do not
satisfy the requirements of the VAT Act and any regulations, the Commissioner has the powers to
direct that necessary changes be made. Where a person decides to keep records in a set way, this must
be done to enable them to be readily available to VAT officials on demand. Such records must be
kept in the principal place of business of a registered person unless the Commissioner allows that
they be produced elsewhere. All such records must be kept for at least five years. Other records that
are necessary are:
- Copies of all invoices issued in serial number order.
- Copies of all debit and credit notes issued in chronological order.
- All purchase invoices, copies of customs entries, receipts for the payment of duty or tax, credit
and debit notes all filed in chronological order either by the date of receipt or under the supplier’s
name.
- Details of amounts of tax charged on each supply made or received.
- Total of output tax and input tax in each period and the net amount of tax payable or excess tax
carried forward at each end of the month i.e. the VAT Account.
- Details of goods manufactured and delivered from the factory of the taxable person.
- Details of each supply of goods and services from the business premises unless such details were
available at time of supply on invoices issued on or before that time.
- Orders delivery notes, relevant business correspondence, appointment and job books, and
purchase and sales books.
- Records of daily takings.
- Annual accounts including trading, profit and loss accounts.
- Import and export documents.
- Bank statements and paying in slips.
- Visitors’ books.
- Any record, which may be kept on the computer.
When the business of a registered person is subject to an independent audit, the audit should cover the
VAT Account and other records relating to the VAT Account.
The VAT Return (Form VAT 3)
When a person is registered, he will be required to submit a VAT return, (Form VAT 3) by the 20 th of
the subsequent month. Where the 20th day of the following month falls on a weekend or a public
holiday, the return shall be submitted on the last working day prior to the weekend or the public
holiday. This return shall show separately for each rate of return, particulars for;
a) The particulars of total value of tax,
b) The rate of tax for which the return was liable,
c) Amount of tax payable for any taxable supplies made during the month immediately preceding
that to which the return was made.
The return should show separately for each rate of tax the;
a) Total value of supplies recovered,
b) The rate at which the tax was paid and the amount of tax paid in respect of which the deductible
input tax is claimed.
77
If a registered person does not make or receive any taxable supplies during the preceding month, he
must submit a “Nil Return”. A registered person should keep for record a copy of the VAT return.
Registered persons are advised to make prompt payments to avoid fines and penalties.
Failure to make a return when due, the Commissioner may assess the amount of tax due and shall be
payable forthwith. Failure to pay the tax on time, an additional tax penalty of 2% or part thereof as
the amount is unpaid shall be due. All payments are to be made by banker’s cheque, or bank
guaranteed cheques or cash. Where payment is by cheque the cheque shall be made payable to the
Commissioner for VAT, crossed and endorsed with the words “account payee only”. Payment,
together with the return, should be made at the Central Bank of Kenya or to designated banks in areas
not served by the Central Bank of Kenya.
FORMAT OF VAT ACCOUNT (FORM VAT 3)
Input Tax VAT
Date Type of Supplies
-
-
-
-
-
-
-
-
-
Value of
Supplies
Output Tax VAT
Date
Type of Supplies
Opening Stock
Purchases
for
business
VAT on Imports
xx
xx
Rate
of
Tax
xx
xx
Amount
of Tax
xx
xx
-
Value of
Supplies
Rate
of
Tax
Amount
of Tax
VAT on Sales
xx
xx
xx
xx
xx
xx
-
Provision
of
Taxable Services
xx
xx
xx
Services utilized
e.g.
audit,
consultancy, etc.
Add: VAT on
debit
notes
received
from
suppliers
Some expenses
incurred
e.g.
electricity,
telephone
bills
etc.
Reverse Charge
(tax
on
an
imported service)
Over-declaration
of VAT from
previous periods
(year)
Excess Input Tax
from
previous
month
Less: VAT on
credits received
from suppliers
Total Input Tax
Deductible
VAT PAYABLE
xx
xx
xx
-
VAT on Exports
(Zero-Rated)
00
00
00
xx
xx
xx
Add: VAT on
debit notes issued
to customers
xx
xx
xx
xx
xx
xx
-
Less: VAT on
Credit
Notes
issued
to
customers.
(xx)
(xx)
(xx)
xx
xx
xx
-
xx
xx
xx
xx
xx
xx
-
Under-declaration
from
previous
period (year)
Reverse Charge
(tax
on
an
imported service)
xx
xx
xx
xx
xx
xx
-
-
xx
xx
xx
(xx)
(xx)
(xx)
-
Closing Stock
xx
xx
xx
xxx
-
XXX
-
Total
Output
Tax
VAT
CLAIMABLE
xxx
XXX
Issues of Changes in Particulars Requiring Notification to the Commissioner
Where the following changes occur in the particulars of a registered person, the person must notify
the details to the Commissioner within 14 days.
a) The address of the place of business.
b) Additional premises used or to be used for the business.
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c) Premises cease to be used for business.
d) If the name or trading name of the business is changed.
e) In case of a limited company, a person or a group of persons have obtained an interest of more
than 30% of the share capital.
f) Changes in persons authorized to sign returns e.g. changes in signatories.
g) Change occurs in the trade classification of the goods or services being supplied.
h) Death, Insolvency, or Legal Incapacitation: If a registered person dies or becomes insolvent or is
legally incapacitated, the executor or liquidator or the person conducting the business must notify
the Commissioner of such changes without delay.
i) Transfer of Business as Going Concern:
Where a registered person dispose of their business to another person, the seller and the buyer should
provide the Commissioner with the details of the transactions, of arrangements made for tax due on
supplies already made, on description, quantity and value of stocks of taxable goods on hand at the
date of disposal, any arrangements made for the transfer of responsibility for keeping and producing
the books relating to the business before disposal. Provided that the Commissioner is satisfied with
the above details, he will notify the person within 7 days that the stocks of taxable goods on hand
may be transferred without payment of tax otherwise due and payable. The person disposing off the
business will remain registered and shall be responsible for all the matters under VAT Act in relation
to the business prior to its disposal until such a time that the requirements of the Act have been
properly complied with.
j) De-registration
If a registered person ceases to make taxable supplies, he should notify the Commissioner of the date
of cessation and shall furnish him with a return showing the details of all materials and other goods
in stock and their values. The registered person must pay any taxes due on such goods within 30
days from the date on which he ceased to make taxable supplies.
If the value of taxable supplies made in any 12 months does not exceed Ksh. 5,000,000, a registered
person will be subject to turnover tax under the ITA, upon notifying the Commissioner (with effect
from 1.1.2007).
If the Commissioner is satisfied that a trader should be deregistered, he will do so from the date
when that person pays the tax in respect of goods or materials on which tax has not been paid or
input tax has been claimed
Remission and Rebate of Tax
The Commissioner may remit wholly or part of the tax due on taxable supplies, if it is in the interest
of the public to do so. Remission of tax now applies to all taxable persons. The remissions granted
shall only apply in respect of:
- Capital goods (excluding motor vehicles) imported or purchased for investment, subject to the
Regulations;
- Other goods including motor vehicles and computers donated or purchased for donation to a nonprofit making organization or institution approved by the Government;
- Goods imported or purchased by a company that has been granted an oil exploration or
prospecting license, subject to specified conditions;
- Capital goods and equipment for use in a customs bonded factory for export only;
- Official aid funded projects;
- Taxable supplies to projects funded through donations approved by the Government for the
benefit of poor and destitute persons;
- Goods for use by the Kenya Armed Forces;
- Ship stores for the national carrier etc;
- Goods, including motor vehicles imported or purchased by any company granted geothermal
resource license;
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-
Goods imported under bond for manufacture of exports, indirect exports, goods free of import
duty, and goods for use in official aid funded project.
Refund of Tax
Refund of tax is only given in the following circumstances: - Where goods are exported under customs control;
- Where tax has been paid in error;
- Where input tax exceeds output tax continually and it is a regular feature of the business;
- Where newly registered persons have goods in stock which are intended for use in the
manufacture of taxable supplies;
- Rebate of bad debts;
- Where in the opinion of the Minister, it is in public interest to do so.
Forfeiture and Seizure
If goods are sold without the payment of tax, these goods and anything used to transport these will be
liable to forfeiture. Likewise the package, in which the goods are contained in, will be liable to
forfeiture.
Tax Evasion
Evasion of tax by way of: a) Suppression of sales;
b) Over claiming of input tax;
c) Making of false document, information or statement;
d) Failure to register;
e) Holding oneself out to be a registered person, shall be guilty of an offence.
VAT Audit
Value Added Tax Refund Audit (ICPAK’s Technical Release)
a) The VAT Regulations were recently amended by adding a new regulation 13A dealing with
refunds of VAT. The new provisions make it mandatory for VAT registered persons to obtain an
audit certificate from the entity’s auditors for refunds in excess of Ksh. 1 million. To the extent
that the person does not require a statutory audit, a firm with the Institute may be used. This has
been necessitated by the inordinate length of time it has been taking the VAT department to audit
and action refunds.
b) The purpose of this technical release is to set out the responsibility of the auditor and the VAT
registered person with regard to Regulation 13A.
c) Regulation 13A applies to refunds in excess of Ksh. 1 million, but ICPAK’s discussion with the
VAT Department indicates that it is possible to batch several claims together in order to meet the
prescribed minimum figure.
d) A VAT refund audit must be treated as any other audit currently conducted by Institute members.
Firms must ensure that VAT refund audits are properly planned and conducted to ensure that an
opinion on the truth and fairness of the amount claimed can be given.
e) The VAT Department has undertaken to refund amounts claimed within 2 weeks of receiving a
claim accompanied by a clean audit opinion but reserve the right, after making the repayment, to
visit the registered person or review the auditor’s working papers to verify the claim themselves.
They are likely to do this on a test basis.
f) Auditors and registered persons will not be penalized for errors that arise in the claim unless the
VAT department can prove fraud or gross negligence. Differences of opinion arising from the
interpretation of
VAT law and regulations will simply require adjustment in a claim and be subject to the usual
appeal procedures.
g) A copy of the certificate that must be issued is as illustrated below. Variation of the content of the
certificate is not permissible, except in the opinion paragraph if a qualification is required.
80
h) Minimum scope of work that an auditor should carry out before providing the certificate is
provided below. This has been agreed with the VAT Department, although members are free to
add to the scope to suit circumstances.
i) In order to lodge a refund claim, form VAT 4 must be completed by the registered person as
normal and submitted together with the auditor’s certificate.
j) To the extent that claims were made before the introduction of regulation 13A but have not been
audited by the VAT department, the claim may be resubmitted with an auditor’s certificate.
Auditors Certificate under the VAT Regulations
[Registered Person]
Period(s) ended 20XX
We have examined the attached claim for refund of VAT amounting to Ksh. xxx made by [registered
person] for the from dd.mm.yy to dd.mm.yy to ensure compliance with the VAT Act and
Regulations, and have obtained all the information and explanations necessary for the purposes of our
examination.
Our examination was designed to enable us to obtain reasonable assurance that the claim is free from
material misstatement, and included verification, on a test basis, of evidence supporting the amount
claimed. It also included an assessment of the adequacy of the [registered person’s] system of
recording and accounting for VAT.
In our opinion the attached VAT claim gives a true and fair view of the amount claimed and is
properly refundable under the VAT Act and Regulations.
Certified Public Accountant
Date
Auditors’ Certificate under the Regulation 13A of the VAT Act
Regulations
Suggested Scope of Work
The following is a suggested program of work to be carried out by an auditor certifying a VAT
refund. It is not exhaustive and may require tailoring to circumstances.
a) Review and document the adequacy of the system of recording and accounting for VAT.
b) Ensure that the VAT 4 corresponds with the supporting VAT return and that the entries in the
return agree to the books of account.
c) Establish why the trader is in refund position (e.g. trader is an exporter, inputs taxed at higher rate
than outputs, significant capital expenditure, seasonal trading/purchases, etc). The reason for the
refund must be soundly based.
d) Check if the trader is subject to partial exemption rules, and if so, whether the rules have been
applied correctly as required by regulation 17, especially the annual adjustment.
e) Select a sample of invoices from VAT 4 and perform the following tests where applicable:
- Input tax has been claimed within twelve months after the issue of the invoice.
- The invoices meet the requirement of Regulation 4.
- Simplified tax invoices have not been used to claim relief.
- The invoices are not photocopies or fax copies.
- Ensure that input tax in respect imported goods is properly supported by a Customs Entry
form and contained within an original KRA receipt for payment of duty and VAT.
- Ensure that tax has been properly accounted for in respect of imported services (reverse
charge).
- Ensure the input tax does not relate to items scheduled on the blocking order-VAT Order,
1994.
- Ensure input tax has not been claimed in advance.
81
f)
g)
h)
i)
- Trace the invoices to the relevant ledger accounts.
- Confirm that the expenditure is business related and not private.
Obtain the workings supporting the output tax on the VAT return, if any, and select a sample and
perform the following tests where applicable:
- Check that the correct rate of VAT was applied.
- Ensure that sales were accounted for in the correct tax period
- Trace the invoices to the relevant ledger accounts.
- In the case of exports, ensure a payment has been received in respect of the goods or services
exported and the proper documentation supporting export is in place.
- Ensure that VAT has properly been accounted for in respect of miscellaneous sales.
Ensure, where applicable, that VAT on intra-group transactions has been properly accounted for.
Ensure all VAT returns were submitted on time. If not, compute the penalties and interest to be
deducted from the claim, if the trader has not done so.
Prepare a statement analyzing the current claim.
Note: any registered person who knowingly makes any fraudulent claim for refund of excess VAT
will be required to pay a penalty of double the claim. The penalty is in addition to the usual penalties
specified in the VAT legislation. In addition, upon conviction, the registered person will be liable to
imprisonment for a term not exceeding three years.
Visits by VAT Officers
From time to time a registered person may be visited at his place of business by local VAT Officers.
The main reason for such visits is to ensure that the registered person understands the VAR system
and is applying it properly. The officers are empowered to enter the premises at any reasonable time
provided the premises are used in connection with the supply and storage of goods which are taxable,
inspect them and any goods in them. This will facilitate the officers to understand your business. A
registered person is advised to avail all such records as the officer may require including tax invoices,
VAT Account, credit and debit notes, bank statements, paying in slips, official audited accounts,
import and export documents etc. Business people have claimed harassment by VAT inspectors and it
is advisable that the registered person maintains the following upon a visit by the VAT inspectors;
a) A visitor’s book where such inspectors can sign to make the visit official.
b) Request a list of all questions requiring an answer, and if possible such a list should be passed to a
registered person’s auditor or accountant for a response where they cannot be answered
immediately.
c) Must be required to produce identification from the VAT Department’s office.
Recovery of Tax Due
The Commissioner is given wide-ranging power under the Act to collect tax that is due and payable.
The Commissioner may collect tax through:
a) Appointing any person who purchases taxable goods or services to be a tax withholding agent.
Such as agent is required to withhold the VAT applicable to such taxable supplies received and
remit it directly to the Commissioner, whether VAT had been charged or not.
b) The Commissioner may collect tax by distress, rather than sue for the recovery of unpaid tax. To
do so, the Commissioner is empowered to order and empower an officer to exercise distress upon
goods and chattels of the person from whom tax is recoverable. For the purpose of executing the
distress, he may require a police to be present. All costs incurred in levying the distress will be
borne by the taxpayer.
A distress levied shall be kept for ten days during which the taxpayer can pay the tax and distress
costs to recover the goods and chattels distrained upon or else they shall be sold by public
auction. The proceeds from the auction shall first be applied towards the costs of levying the
distress, keeping and selling the distrained goods and finally, towards tax. Any amounts
remaining shall be paid to the distrainee.
c) The Commissioner may recover tax due and payable from a person who owes money to the
taxpayer. Accordingly, the Commissioner may, by notice in writing, require any person:
82
-
From whom any money is due or accruing or may become due to a taxable person; or
Who holds or may subsequently hold money on account of the taxable person; or
Who holds or may hold money on account of some other person to pay money to the taxable
person; or
- To pay to the Commissioner that money or so much thereof as may be sufficient to pay the tax
so due and payable.
Where such a person required by the Commissioner to pay any tax on behalf of a taxpayer is
unable to do so he should inform the Commissioner within seven working days of the inability.
d) Where a person who is the owner of land or buildings situated in Kenya fails to pay tax due and
payable, the CVAT may notify that person of his intention to apply to the Registrar of Lands to
have the land and buildings to be the subject of security for the tax. If, after thirty days of issuing
the notice, the taxpayer fails to pay the tax due, the CVAT may, by notice in writing, direct the
Registrar of Lands that the land and buildings be the subject of security for the tax. Such notice
will be registered as if it were an instrument of mortgage.
e) In order to secure payments of tax by any person of any tax, the CVAT may require the person
concerned to furnish security in such manner and in such amount as may be prescribed.
Generally, the security shall be in such sum not exceeding the total tax payable. Where the
security is not in cash or equivalent securities, it shall take the form of a bond in such form and
given by such sureties as the CVAT may approve.
f) The CVAT may recover any tax due and payable as a civil debt due to the government. Where the
amount of tax does not exceed one hundred thousand shillings, the debt shall be recovered
summarily.
Issues Regarding Appeals
Where a dispute arises between a registered person and the Commissioner over any matter arising out
of the VAT Act, the registered person can appeal within 30 days to a VAT Appeals Tribunal. Such
appeals can only be lodged provided all returns have been made by the Act and d 50% of the VAT
assessed has been paid to the Commissioner. Where taxes are to be refunded, this will be done
without interest. The Minister of Finance through a gazette notice establishes an Appeals Tribunal.
The Tribunal consists of a chairman and 2 other members. The decision of the Tribunal is final.
No.
1
OFFENCE
Late payment of tax
PENALTY
Additional tax at 2% per month compounded.
2
Failure to comply with the Commissioner’s notice
to pay money owed to a taxable person from whom
tax is due, or furnish a return showing monies held
or due to a person from whom tax is due
Failure to produce books, records, or provide
information as required by an authorised officer
Failure to produce books, records, statements or
other documents or to attend summons or to answer
questions put by the VAT Appeals Tribunal.
Making false statements, producing false
documents,
providing
false
information,
involvement in fraudulent evasion of tax, a nonregistered person who holds himself out as a
registered person
Failure to display registration certificate in a visible
place in the business premises
Fine not exceeding Ksh. 15,000 and/or up to
6 months imprisonment and liability to pay
the amount discharged.
3
4
5
6
7
Late submission of application for registration
REFERENCE
Section 15 (1)
and (2)
Section 19 (6)
Fine not exceeding Ksh. 15,000 and/or up to
6 months imprisonment
Fine not exceeding Ksh. 15,000 and/or up to
2 years imprisonment
Section 30 (2)
Fine up to Ksh. 400,000 or double tax
evaded, whichever is the greater and/or up to
3 years imprisonment. In addition, any
taxable goods connected with the commission
of the offence may be subject to forfeiture.
Default penalty of up to Ksh. 20,000 and a
fine of up to Ksh. 200,000 and/or
imprisonment for up to 2 years.
Penalty of Ksh. 20,000
Section 40
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Section 35
Sixth Schedule
paragraph.10 (2)
6th
Schedule
paragraph 11
8
Failure to apply for registration
Penalty of Ksh. 100,000
6th
Schedule
Paragraph 12
9
Failure to issue a tax invoice as required
7th Schedule
Paragraph 5
10
Failure to keep proper books or records
11
Failure to submit a return
Penalty of between Ksh. 10,000 and Ksh.
200,000. Any goods connected with the
offence are liable to forfeiture
Penalty of between Ksh. 10000 and Ksh.
200,000
Penalty of Ksh. 10,000
12
General penalty for offences under the Act for
which no specific penalty is prescribed
Failure to withhold VAT, remit withheld VAT, or
submit withholding VAT Return
Withholding VAT without being appointed as a
withholding VAT agent
Making a fraudulent claim for VAT refund
13
14
15
A maximum fine of Ksh. 500,000 and/or up
to 3 years imprisonment
Penalty of Ksh. 10,000 or 10% of tax due,
whichever is higher
Penalty of Ksh. 10,000 or 10% of tax due,
whichever is higher
Penalty of double the amount claimed or to
imprisonment for a period not exceeding
three years or both.
Offences and Penalties on VAT
84
7th
Schedule
paragraph 6
7th
Schedule
paragraph 9
Section 43
7th
Schedule
paragraph 10
7th
Schedule
paragraph 10
Section 40
CHAPTER FOURTEEN
TAX ADMINISTRATION
Part I
Returns, Assessments and Notices
Introduction
The DTD normally sends returns of income to all persons who are in their records to declare income
from all their sources liable to taxation at the commencement of the year. Those not in records should
inform the Department before the end of the fourth month of the following year.
Returns of Incomes and Notices
A taxpayer has a responsibility of informing the Commissioner about the details of his tax position
relating to:a) Taxable income or loss
b) Sources of his income e.g. business, employment rent etc
c) The claim of tax reliefs
d) The payments of taxes at source etc.
A taxpayer will inform the DTD about the details of his tax position through the submission of an annual
return of income. A return of income is also referred to us a return. A return is a standard form that is
issued by the DTD for completion by the taxpayer in respect of losses/incomes for the year. Three kinds
of taxpayers are required to submit returns of income.
a) Individuals i.e. natural persons
b) Legal persons e.g. limited companies, clubs, trusts co-operatives etc.
c) Partnerships (though partnerships are not taxable entities)
Types of Returns
By 1993 there were 5 types of returns, some of which now have been abolished.
a) Provisional Return of Income (abolished)
b) Final Return of Income (abolished though still applicable for partnerships and the only return for
partnerships)
c) Instatement Return of Income
d) Self Assessment Return
e) Compensating Tax Return of Income (only applicable to limited companies)
a) Self Assessment Return of Income
Was introduced for the year of income ending 31/12/92 and thereafter. A self-assessment return is a new
concept in the payment of taxes whereby a taxpayer is called upon to assess himself to tax and
subsequently notify the Commissioner of such a position. Ordinarily the Commissioner will accept the
taxpayer’s assessment unless he feels it is unreasonable. A self-assessment return is due for submission
by the end of the 6th month after the accounting year-end for corporations but by the month of June every
year for individuals.
b) Instalment Tax Return of Income
85
All companies and individuals submit an instalment return of income unless exempted. The purpose of
instalment returns is to facilitate a taxpayer in declaring incomes and assessment as the current year
progresses. It is anticipated that all taxes relating to a current year's income shall be payable within the
same year. The taxes are spread out in form of instalments and are due for submission as follows, as
from 1990.
Fourth
Month
25%
1990
1991
1992
1993
1994
1995
1996/to date
Sixth
Month
15%
30%
25%
Ninth
Month
15%
30%
45%
60%
60%
45%
25%
Twelfth
Month
20%
25%
25%
25%
Note:
-
Due dates in each is 20th day of the month.
All these due dates are in the current year of income.
Where a person derives more than 2/3rds of his total income from agriculture, pastoral, horticulture and
similar activities, he will be required to pay instalments as follows:
From 1994
Fourth
Month
Sixth
Month
Ninth
Month
Twelfth
Month
-
-
75%
25%
c) Compensating Tax Return of Income
It was introduced from the accounting year starting on 1st January 1993 and later years. A compensating
tax return should be submitted by companies (resident) only. The purpose of this return is to determine
how much compensating tax is payable by companies when they compare the corporation taxes paid on
dividends received and corporation taxes paid on dividends paid. This is done through maintenance of a
dividend tax account. A compensating tax return is due for submission by end of the 6th month after the
accounting year. Any compensating tax due shall be payable by the end of the fourth month after an
accounting year end.
Matters Relating to a Return of Income Carried Under Sec 52 of Income Tax Act
A return of income is a statement of income, which accrues to a person. Sec. 52 of ITA states that the
CDT by giving a notice in writing may require any person to furnish him within a reasonable time not
later than 30 days from the date of such notice with a return of income, that he is chargeable to tax. If by
the end of the 4th month after an accounting year a person has not been requested by the CDT to make a
return of income, he must within 14 days after the expiry of the 4th month notify the Commissioner of his
chargeability to tax. The CDT may also require by notice is writing that any of the following render a
return of income at any time whether before or after the year of income for which the return was made:
a) Executors or administrators of a deceased person
b) Liquidators of a resident company
c) From a bankrupt
d) A pensioner who is about to leave Kenya
In the above 4 cases time is of essence and thus the Commissioner is empowered to act swiftly to protect
any revenue.
Contents of a Return of Income
86
The following items will be included in a return of income
a) The date stamp
b) The file number
c) The originating tax district/region.
d) The full name and address of the taxpayer
e) The sources of income including deemed incomes.
f) Any interest on amounts borrowed etc.
Sec. 54 of ITA requires certain documents to accompany a return of income. Any person carrying on a
business who makes a return of income and whose accounts have been prepared and examined by an
accountant or tax consultant must accompany a return of income with following documents:
a) A copy of his accounts signed by him and by his accountant/tax consultant
b) A certificate signed by his accountant specifying:
- The nature of the books of accounts
- The extent of his examination of the above books
- Whether such accounts reflect all the transactions of the business.
- Whether the accounts present a true and fair view of the gains/profits of the business reported on.
c) In the case of a company or a partnership a certificate of all payments and benefits in kind paid to
directors and other partners or employees earnings more than Ksh. 80,000 per year.
Returns Submitted by Individuals
1) Instalment Return and Tax
This is a form issued by DTD for completion by an individual taxpayer. The instalment return was
introduced as from 1:1:1990. An individual will not be expected to submit an instalment return if:
a) All income is from employment
b) If his tax liability for a year does not exceed Ksh. 40,000.
c) The individual has non-employment income and such incomes being less than 1/3 of the total
income.
In all other cases an individual must submit an instalment return by the due dates.
Determination of the Instalment Taxes
Instalment tax is calculated by using either:
- Preceding year's actual tax x 110%, or
- Current years estimates,
- Whichever is the lower- (minus) the current year’s taxes at source.
When completing an instalment return, the following details must be provided.
a) Year of income for which it is submitted
b) Instalment tax payable
c) Basis of calculating the instalment tax
d) A signature of the taxpayer making the return.
Failure or lateness in submitting the instalment return and tax will expose a taxpayer to penalties.
2) Self-Assessment Returns
Introduced in 1992 and submitted in respect of the year-ended 31:12: 92 and thereafter. A selfassessment return is a detailed return of income, which combines both a declaration of income i.e. a
return of income and assessment to tax. The self-assessment return for an individual is also a selfassessment tax whereby the taxpayer assesses himself to tax. This return requires a taxpayer to:
a) Declare income and their sources or losses on the basis of specified sources of income as per Sec.
15(7)(e) and Sec. 3(2) of ITA Cap 470.
b) Compute the tax payable for the year
c) To claim taxes paid at source or withholding taxes
d) To show the net tax if any which is payable by the due dates.
87
e) Where taxes are overpaid, tax credits to be reflected.
An individual making a return must make a declaration in the self-assessment return that it contains a full
and true statement of income tax liable. Failure to submit a self-assessment return will expose the
taxpayer to penalties.
3) Returns Submitted by Companies/ Corporations
A company or a corporation for tax purposes include company registered under the Companies Act,
clubs, trusts, co-operate societies, trade associations etc. Companies submit the following returns.
a) Instalment returns and taxes
b) SAR and tax
c) Compensating tax return (CTR) and tax.
An instalment return for a company is a standard form issued by DTD for completion by company. It
was introduced as from 1:1:1990. All companies are required to submit the IR by the due dates. Any
taxes must be payable by the same dates that the instalment return is due for submission. The basis for
calculating instalment tax is as seen before. When completing this return, the following details must be
shown.
a) The year of income for which it is submitted
b) The instalment tax payable
c) The basis of calculating the instalment tax
d) The declaration by one of the principal directors of the company making the return.
Failure or lateness in submitting an ITR will expose a taxpayer to penalties.
4) Self Assessment Return of Income and Tax
Self-assessment returns were introduced in 1992 and were submitted in respect of year of income ending
31:12:92 and thereafter. This return for a company combines a declaration of income and an assessment
tax. An SAR is due for submission by the end of 6th month after the accounting year-end. Any selfassessment tax is payable by the end of the fourth month after accounting year end. A self-assessment
return for a company is also self-assessment to tax and it has facilities for the company to:
a) Declare the amounts and sources of incomes/losses on the basis of specified sources of income Sec.
15 (7)(e) and Sec. 3(2) of ITA Cap 470.
b) To compute the tax payable for the year
c) To claim any taxes paid at source or withholding taxes,
d) To show the net tax payable if any. Such taxes are payable by the end of the fourth month after an
accounting year end.
e) To reflect tax refunds where there are over payments of taxes.
f) To declare residence
g) A principal officer of the company must sign the declaration in the self-assessment return that the
self-assessment return contains a full and true statement of the income that is liable to tax.
Failure to submit and self-assessment return and any self-assessment return tax due will expose the
taxpayer to penalties.
5) Compensating Tax Return (CTR)
The CTR was introduced as from 1:1:93 and thereafter, to be submitted by resident companies only. The
compensating tax returnis an issued by the DTD to enable a company pay compensating tax. It is due for
submission by the end of the 6th month after the accounting year-end. Any compensating tax payable
shall be due by the end of the fourth month after an accounting year end.
Note: Compensating tax returnand self-assessment returns are submitted on the same date.
6) Returns Submitted by Partnerships
A partnership is required to submit to DTD only one return of income i.e. partnership final return. The
return is issued to the partnership by the DTD and should be submitted by the end of the 4th month after
88
the partnership’s accounting year-end. A partnership is not a separate taxable entity. However each of
the partners will submit their own returns of incomes. When completed, this final return will contain:
a) The total income/loss of the partnership and how it was shared between the partners. Supporting
documents must be submitted alongside this return.
b) A signed declaration that a return of income contains a full and true statement of partnership income
or losses.
Sec. 52 of ITA states that the precedent resident partner will submit a return from a partnership.
Penalties on Returns and Taxes
Where a person, either individual or a company fails to submit a return of income and taxes thereon by
due dates, the CDT has the powers to impose penalties on defaulters. Such penalties shall be treated as
additional taxes payable alongside the tax. Additionally where a person fails to submit a return of income
or tax thereon, the CDT is required by the Act to estimate the tax charge and raise an assessment
accordingly. The minimum penalty generally for a company is Ksh. 5,000 and for individuals Ksh.
1,000. As from 1:1: 1996 the general penalty where no other penalty is specifically provided under the
Act shall be a maximum of Ksh. 100,000 or imprisonment of a term not exceeding 6 months or both.
Specific Penalties
1) For Instatement Tax and Return
The CDT has the power to issue an instalment assessment on an estimated basis where a taxpayer has
failed to submit an IR on due date. The CDT will impose a penalty of 20% of the difference between the
amount of instalment tax payable and the instalment tax actually paid. An additional interest of 2% p.m.
on the amount remaining unpaid including the penalties shall be imposed. The under-estimation penalty
is chargeable where the difference between the amount of instalment tax payable and amount actually
paid exceeds 10% of the amount paid.
2) Self Assessment Returns and Taxes
A self-assessment combines a return of income for a given year and an assessment to tax on income
declared. Where a self-assessment return is submitted late including the tax thereon, a penalty of 5% of
the total tax payable shall be imposed. Where a tax is paid after a due date i.e. a late payment penalty of
20% will be imposed on amounts remaining unpaid. Additionally, for any taxes paid after due date, a late
payment interest of 2% p.m. on the outstanding amounts including penalties.
3) Compensating Tax and Returns
Only resident companies submit the compensating tax returns. The CDT will impose a penalty of 5% of
every month or part of the month that the return is late. If the compensating tax is not paid by due date
additional penalties are as follows:
- Negligence on part of an authorized agent - Penalty is ½ of the additional taxes payable up to a
maximum of Ksh. 50,000 for the negligence.
- Where there is gross negligence or willing negligence or there is fraud on part of the authorised
agent, a penalty of between Ksh. 50,000-Ksh. 200,000.
- Where there is wilful omission of information from a tax return the penalty - double the difference
between tax chargeable by the return and the normal tax properly chargeable after adjusting for the
omission.
Other Returns
- P.A.Y.E. Return
- Dividend Return
- Interest Return
- Rent Return
- Commission Return etc.
89
Notices of Assessment
A notice of assessment or merely an assessment is a tax bill, which is issued by the CDT to all taxpayers
for each year of income. Where income has been declared, the appropriate rate of taxes shall be used to
arrive at the tax payable by a taxpayer for a year of income. In case of a loss, a notice of assessment is
still issued for the year on the basis specified sources of income (Sec. 15(7)(e) and Sec. 3(2).
A notice of assessment is also measurement of income that is issued by the Commissioner for each year
of income. Note that after the introduction of self-assessments, assessments originate only from
taxpayers as opposed to preciously when the Commissioner would originate assessments. Sec. 73 of ITA
states that the CDT will assess every person who is chargeable to tax as quickly as possible after the
submission of returns. The CDT can issue an assessment at any time before expiry of seven years after
the year of income to which an assessment relates.
However the CDT can issue an assessment at anytime in respect of:
a) Fraud or wilful negligence has been committed by the person submitting the return.
b) Upon the executors or administrator of a deceased estate wherein the limit is 3 years.
The CDT will assess a person to tax on the basis of returns submitted. Where he has a reason to believe
that the return is not true/correct, he will on the basis of the best of his knowledge, determine the
person’s income and assess him accordingly.
As from 1:1: 1992 and thereafter, a person who is chargeable will be required to submit a return with a
self assessment. Where the Commissioner is satisfied that the assessment is correct, he will accept it and
issue no further modifications. From the year of income 1990 and thereafter, the Commissioner will
make an estimated instalment assessment in respect of a person concerned where the person chargeable
did not submit an instalment return. The CDT in this case can make an estimated instalment assessment
on the person on his knowledge of judgment.
Every assessment must be submitted with:
a) Audited accounts where applicable
b) Income tax computation were applicable
c) A cheque for the balance of tax due after setting off instalment taxes already paid
d) Dividend tax account where applicable
e) A cheque for compensating tax where applicable
Contents of an Assessment
A notice of assessment is a standard form issued by the CDT. It contains the following information:
a) A notice to the person named therein i.e. taxpayer, that he has been assessed under that ITA.
b) Information on the person assessed that he has a right to object where he does not agree with the
assessment. Note that ordinarily the Commissioner will not entertain abjection against an assessment.
c) The amount of tax assessed or the losses carried forward.
d) The amount of relief available especially for individuals
e) The amount of any taxes paid at source
f) Any interest penalties where applicable i.e. penalties as per ITA
g) The amount for tax payable, due dates and where taxes had been over paid, shall reflect a refund.
The CDT is required to issue a notice of assessment within the requisite time i.e. within seven years after
the year of income in respect to which the assessment is to be issued. Where an assessment originates
from the CDT, taxes as per the assessment are due for payment by the 20th of the following month. If the
tax is not paid by the due date, a late interest penalty of 20% shall be imposed + 2% interest p.m. of the
outstanding amount.
Collection and Recovery of Taxes
90
Where taxes assessed are not collected by due dates, the Collector of income tax has the power to
collect the tax due as a debt owed to the government. Such a debt can be collected as follows.
a) The taxpayer can be sued for the recovery in a court of law.
b) The taxes can be collected through an authorised agent. In this case an organisation or individual
known to be making payments to the defaulting taxpayer can be appointed as an agent, shall be
legally required to make payments to the Commissioner any amounts that was due to the defaulting
taxpayer and the obligation shall be taken to have been legally satisfied. When the agent defaults in
paying as an agent, the tax shall be collected from him as if it were due from him initially including
the requisite penalties. Various institutions can be appointed as agents e.g. banks, marketing
organisations e.g. NCPB, KCC, KTDA, KPCU, KFA etc.
c) Destraining order against the taxpayer. In this case the CDT can seize the property of the defaulting
taxpayer, which would be auctioned so as to satisfy the tax debt.
Types of Assessments
a) Self-Assessments (covered)
b) Amended Assessment.
The CDT issues it after a taxpayer has lodged a notice of objection to the CDT against an assessment
or has applied for a relief of error or mistake or has made an appeal to Income Tax Local Committee
or Income Tax Tribunal or the Courts of law against an assessment. The amended assessment can
either be amended upwards or downwards.
c) Estimated AssessmentIt is issued by CDT on any income that CDT estimates for the best of his judgment where:
- The taxpayer has failed to submit an instalment return.
- The taxpayer had failed to submit a self-assessment return.
- The CDT does not agree with the taxpayers self-assessment return
- Returns have been made but the accompanying accounts and other documents don't satisfy the
Commissioner
d) Additional Assessment
It is issued where the Commissioner had issued the original or the first assessment and has reasons to
believe that the person has been under - assessed. It could also be issued where the Commissioner is
not satisfied with a taxpayer’s self-assessment return.
Assessment (ii), (iii) and (iv) are not mentioned by ITA but arise as result of DTD practice.
Part II
Objections, Appeals, Penalties and PIN Number
Introduction
Taxpayers are required to pay tax on their income on the basis of the assessments made on the income.
However, if they feel that they have been unfairly assessed they have a right to object to the assessment
made in the prescribed manner to the CDT.
Objections by Taxpayers
A taxpayer is required to pay taxes on the incomes as per assessments, either self-assessments or
originating from the Commissioner. However, where a taxpayer feels that the income as per an
assessment arising from the Commissioner is too high, he has a right under ITA to object to such an
assessment. An appeal shall then be registered for hearing.
Note: A taxpayer will not be allowed to appeal against his/her own self-assessment. The only remedy
against a self-assessment error would be "a relief of error or mistake", (Sec 90 of ITA). An objection
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raised by a taxpayer is referred to as a "Notice of Objection". For such a notice to be treated as a valid
notice of objection it must be:
a) In writing - a taxpayer cannot object orally
b) It must state the grounds of objection i.e. the reasons why the objection is lodged.
c) Must be made within 60 days from the date of service of the notice of assessment, plus 10 more days
(days of service) to give 70 days. The 10 days of service are taken to be the maximum time that mail
will have been delivered to any address in Kenya or abroad.
A taxpayer can dispute a notice of assessment due to mistakes or errors relating to:
a) The amount of income or loss assessed
b) The amount of tax payable
c) Allowances or deductions made or omitted to have been made when computing chargeable
income/loss.
d) Imposition of penalties under Sec. 72 of ITA
e) Relief granted or omitted to have been granted
f) The due dates for taxes.
The assessment is time barred if it is issued 7 years after the year of income to which it relates. Provided
the grounds of the objection are clearly stated, the CDT is obliged to register the objection. However,
where the grounds of objection are unfounded or not material or not fundamental due to the taxpayer’s
lack of knowledge or mere arithmetic errors, such matters can be cleared through correspondence
between the taxpayers and the Commissioner. An agreement shall be struck between the two parties
where the taxpayer withdraws the objection while the Commissioner withdraws the assessment through
an amended assessment.
There are certain instances when the taxpayer will not be able to beat the 60-day deadline that a notice of
objection should be made. Provided there being good grounds Sec. 54 of ITA provides that a taxpayer
can lodge a late notice of objection.
The CDT will only admit a late objection provided the taxpayer can demonstrate that:
a) He was prevented from objecting in time by reason of sickness
b) Absence from Kenya or other reasonable causes.
c) There was no unreasonable delay on the part of the taxpayer.
In this case the Commissioner will expect that the taxpayer had paid part of the estimated taxes.
A late notice of objection should also be served to the Commissioner within 60 days from service of
notice of assessment including 10 days of service. A taxpayer who lodges a late notice of objection
must: a) Put in writing
b) State the grounds of the objections
c) State the reason for objecting late
In this case the CDT will accept a late notice of objection on the grounds that;
a) The return of income for the year and the accounts where applicable had been submitted to the
Commissioner.
b) The reason for lateness is either due to the taxpayer being absent from Kenya, sickness or any other
reasonable delay. The Commissioner will require proof.
c) There was no unreasonable delay on the part of the taxpayer
d) The tax due is paid together with any late penalties.
Where the CDT is satisfied that the tax due is excessive he can waive the last condition.
Where a late objection is accepted, it becomes a valid notice of objection. If the Commissioner doesn't
accept the late notice of objection, the notice of objection objected to as per assessment shall remain in
force. However the taxpayer has a further right to appeal to the Income Tax Local Committee against the
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CDT’s refusal to accept a late objection.
How a Valid Notice of Objection is dealt With (Sec. 85)
Where a taxpayer has lodged a valid notice of objection against an assessment for any year of income,
the objection will be dealt with in any of the following ways;
a) The CDT can amend the assessment in accordance with the objection i.e. the CDT may agree with
the taxpayer’s grounds of objection or
b) He can amend the assessment in light of the objection with some adjustments and the taxpayer
agreeing with the adjustments i.e. an agreed amended assessment is issued by the CDT with both
parties agreeing.
c) He can amend the assessment i.e. change the assessment in light of the taxpayer’s objection with
some adjustment with taxpayer not agreeing to the adjustments i.e. a non-agreed amended
assessment is issued by the CDT. When this assessment is issued, the taxpayer must be informed of
his rights to dispute it in an Income Tax Local Committee.
d) Commissioner may refuse to amend the assessment and issue a notice to the taxpayer, which
confirms the disputed assessment. The taxpayer should be notified of his rights to appeal to the
Income Tax Local Committee against such a confirming notice.
e) He can take no action where the taxpayer decides to withdraw the notice of objection.
f) He can take no action where the objection is invalid.
A taxpayer who is aggrieved by the manner, in which a notice of objection against an assessment has
been dealt with by the Commissioner, has further recourse to appeal to appellate bodies i.e. appeal bodies
established under the ITA or through courts in Kenya.
Tax Appeals
Tax Appeal Bodies
a) Income Tax Local Committee
b) Income Tax Tribunal
c) The High Court
d) The Court of Appeal
A taxpayer has a right to appeal against any decision made by the CDT regarding an assessment, which
he has not agreed to. The appeal shall be made by the appellate against the respondent to the appellate
bodies established by Minister of Finance under the ITA.
1) Income Tax Local Committee
The Income Tax Local Committee is an appeal body and it is not part of the DTD. The Minister of
Finance establishes it by a notice in the official Kenya Gazette. An Income Tax Local Committee is
appointed for every Tax District in the Republic e.g. the Kisumu District Local Committee, Thika
District Local Committee etc. The duties of the Income Tax Local Committee are to hear and determine
appeals lodged by taxpayers on matters pertaining to tax district, more so on decisions taken by the
Commissioner that may not go down well with taxpayers. Only taxpayers can appeal to an Income Tax
Local Committee against the Commissioner's decision.
The Income Tax Local Committee consists of 9 members, who are appointed by the Minister of Finance
consists of:
a) A chairman
b) Not more than 8 other members i.e. a full Income Tax Local Committee has 9 members.
The period of office for the Income Tax Local Committee is usually 2 years unless;
a) A member tenders a resignation or
b) The Minister revokes member's appointment for reasons of failure to attend three consecutive
Income Tax Local Committee meetings or
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c) A member being unfit to perform duties of is office due to reasons of mental or physical disability.
Income Tax Local Committee Rules
The procedure governing the conduct of an Income Tax Local Committee is refereed to as the Income
Tax (Local Committee) Rules, and they shall be followed in relation to:
a) The manner in which an appeal may be made to the Income Tax Local Committee.
b) The procedure of hearing an appeal and the records to be kept by the Income Tax Local Committee.
c) The manner in which to convene meetings, the venue and the time to hold an Income Tax Local
Committee meeting.
d) The scale of costs that may be awarded by an Income Tax Local Committee.
e) The general matters of carrying out an Income Tax Local Committee appeal.
Procedure of Appeal to Income Tax Local Committee
A taxpayer has a right to appeal to Income Tax Local Committee against the CDT's decision against him
on the following tax matters.
- Where the CDT refuses to amend an assessment after the taxpayer has lodged a valid notice of
objection. The taxpayer will have a right to appeal against such a confirming notice.
- Where the CDT issues a non-agreed amended assessment.
- Where the CDT refuses to accept a late notice of objection. The taxpayer has a right to appeal
against such a decision.
- Where the CDT issues a notice to the taxpayer requiring him to maintain his books and accounts in a
specific language.
- Where the CDT refuses to make a refund of taxes; the taxpayer can appeal to enforce a repayment.
- Where the CDT determines the market value of property (especially assets received without payment
for them).
When considering the appeal, the two parties in the appeal i.e. CDT and taxpayer, will be required to file
appeal documents as follows.
a) The taxpayer must notify the CDT of his intention to appeal to the Income Tax Local Committee by
giving a notice within 30 days after receiving the notice from the Commissioner or after receiving
the CDT’s decision.
b) The notice of intention to appeal must be copied to the clerk of the Income Tax Local Committee.
c) Copies of the memorandum of appeal and a statement of facts must be sent to the CDT.
The taxpayer will submit the following documents to the clerk of Income Tax Local Committee.
(i)
(ii)
(iii)
(iv)
A Memorandum of Appeal
This memorandum will state the grounds of appeal and shall be submitted in original plus 9
copies.
A Statement of Facts
The statement will give the sequence of events, which took place regarding the assessment,
objection and eventually the appeal. It will give the information of the date of assessment being
objected to, the date it was confirmed or when a non-agreed amended assessment was issued.
Similarly the statement shall be the original plus 9 copies.
A copy of the letter i.e. the notice of intention to appeal to the Income Tax Local Committee,
which was sent to the CDT.
A copy of the CDT’s decision against which the appeal is being lodged, e.g. a copy of the nonagreed amended assessment or a copy of the confirming notice.
When all the appeal documents have been filed in time to the clerk of Income Tax Local Committee, the
appeal will be registered for hearing. The clerk will not register a late appeal for hearing unless the
taxpayer is prevented from lodging an appeal in time to the Income Tax Local Committee for reasons
such as absence from Kenya, sickness or any other reasonable cause. In this case the Income Tax Local
94
Committee can give the taxpayer an extension of time within which to lodge an appeal. On appeal of
extension of time, the taxpayer must state why the appeal was not lodged in specified time.
A Valid Appeal
Where all appeal documents have been lodged in valid time, there is said to be a "Valid Appeal". The
clerk of Income Tax Local Committee on registering the appeal will appoint a date and venue, which
will be notified to both the appellant and respondent. The Income Tax Local Committee will meet and
hear the appeal case and a decision shall be reached which will be communicated in writing to the two
parties.
2) Income Tax Tribunal
The Income Tax Tribunal is an appeal body established by Minister of Finance by a notice in the Kenya
Gazette. It consists of:
a) Chairman
b) Not less than 2 and not more 4 other members i.e. minimum 3, maximum 5. The quorum for an
Income Tax Tribunal is the chairman and 2 other members.
The Income Tax Tribunal is governed by the Income Tax (Tribunal) Rules. An Income Tax Tribunal
will hear appeals on assessments that are based on the CDT’s directives under Sec. 23 and Sec. 24 of
ITA. Under Sec. 23 the CDT is empowered to reject certain business transactions where he is of the
opinion that they were meant to avoid or reduce taxes. He can direct for the necessary adjustments on
taxable income and issue an assessment accordingly. If the taxpayer objects to this adjustment and
subsequent assessment he has a right to appeal to the Income Tax Tribunal. Examples of such taxes
which the taxpayer may object which the Commissioner may feel are suspect are:
- A child being paid very high salaries for performance of minor duties
- A director of a company buying a car from a company at a throw way price.
The Commissioner is empowered to reject such transactions and raise an assessment accordingly.
Under Sec. 24 of ITA, the CDT is empowered to direct that a company makes a further distribution of
dividends i.e. where the CDT is satisfied that there has been a shortfall. Where the CDT directs for the
distribution, the taxpayer can appeal against such kind of direction. Matters relating to an appeal to an
Income Tax Tribunal are normally handled at the head office. Once the case has been registered in the
respective tax district, the tax payable will be stood over i.e. suspended for being paid first and relevant
offices are informed.
The file will be sent to head office for further instruction. Where a taxpayer is not satisfied with the
decision of an Income Tax Tribunal, he can make an appeal to a high court by giving a notice within 15
days after he has been served with the decision.
c) Appeals to Courts of Law
Where a taxpayer disputes a decision by an Income Tax Tribunal or in very rear instances from Income
Tax Local Committee or also where the CDT disputes a decision by an Income Tax Tribunal, such can
further appeal to the high court. Appeals to high court will only be on the questions of the law or mixed
law and facts.
For the appeal to the High Court, the appellant who could either be the CDT or taxpayer must serve the
respondent with notice of intention to appeal to the court within 30 days of being served with decision
from other appeal bodies.
The appellant must file in court the following:
- Memorandum of appeal listing the grounds of appeal
- Statement of facts giving sequence of events leading to decision, which is being appealed against.
- A copy of the decision or notice being appealed against.
A taxpayer cannot appeal to the courts;
95
Against the CDT's refusal to accept a late objection since the Income Tax Local Committee’s
decision is final.
- Against lodging appeals late. Here a taxpayer can only apply to Income Tax Local Committee for
extension of time. If the Income Tax Local Committee refuses, there would be no further appeal.
A taxpayer wishing to appeal to courts must first give a notice of intention to appeal by letter within 30
days and a further 10 days for non-residents.
-
Application for Relief of Error or Mistake in a Return Sec. 90
Where the CDT has issued an assessment in accordance with a return of income submitted by
taxpayer’s self-assessment return, the taxpayer cannot subsequently object to such an assessment.
This is because the assessment has been raised in accordance with his own assessment. However, a
taxpayer can make an error on mistake when completing a return of income form, e.g. wrong figures
of income resulting in excessive taxes. The taxpayer can make an appeal to the CDT under Sec. 90 of
the Act for the error or mistake to be rectified. This application is referred to as an application for
relief of error or mistake in return. If the application is accepted, the assessment is amended
accordingly so as to rectify the error or mistake. The time limit for such an application is seven years
after the year of income to which the error or mistake relates.
Refund of Overpaid Tax (Sec. 105)
If the CDT is satisfied that any particular taxpayer has overpaid tax in respect of a year of income, then
the overpaid tax must be refunded together with any interest due under the ITA. If the person claiming
the refund has any tax due then the amount of refund will be set off against the tax due. The time limit to
claim the refund of overpaid tax is seven years after the expiry of the respective year of income.
OFFENCES AND PENALTIES
No Offences
Penalties
1
Failure to submit/furnish return of income - 5% of tax payable each year or part of year;
minimum for companies. Ksh. 5,000 and Ksh.
1,000 for individuals.
2
Failure to submit final return with self - - 5% of tax payable each year or part of year;
assessment
minimum for companies. Ksh. 5,000 and Ksh.
1,000 for individuals
3
Failure to submit compensating tax return - 5% of compensating tax which should have been
shown for each month.
4
Unpaid tax or late payment of tax
- 20% of tax unpaid plus 2% interest per month
compounded.
5
Under-estimation of tax
- 20% of difference between instalment tax payable
and instalment tax paid times 1.1 or 110%.
6
Fraud or wilful omission in a return
- Double the amount of tax underpaid
- Fine not exceeding Ksh. 200,000
- Imprisonment not exceeding 2 years.
7
Failure to deduct or remit PAYE
- 25% of the amount of tax involved; min. Ksh.
10,000.
8
Failure to keep adequate books of - Penalty of Ksh. 20,000
account.
9
Negligence on part of an authorized agent - Penalty is ½ of the additional taxes payable up to a
Where there is gross negligence or
maximum of Ksh. 50,000 for the negligence.
10 - Where there is gross or willing - A penalty of between Ksh. 50,000-Ksh. 200,000
negligence or there is fraud on part of
the authorised agent
11 - Where there is wilful omission of - The penalty will be: double the difference between
information from a tax return.
tax chargeable by the return and the normal tax
properly chargeable after adjusting for the
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omission.
Note: The CDT has powers to waive penalties up to a maximum of Ksh. 500,000. Waivers exceeding
this figure require the approval of the Minister of Finance.
Personal Identification Number (PIN)
Ref. 13th Schedule of ITA Cap 470 and Sec. 132 of ITA
Sec. 132(1): Every person whose income is chargeable to tax under ITA Cap 470 shall have a PIN
number, which shall be produced when required under the rules prescribed by the CDT.
Sec. 1132(2): for the purpose of collection or protection of tax, any person whom the CDT may so
require shall have a PIN number.
Sec. 132(3): Any person required under the Act to make a return, statement or other document shall
include the PIN number in every document, return or statement for proper identification of that person.
The 13th Schedule includes the names of the institutions and purposes of transactions for which PIN
numbers are required. These include the following:
a) Commissioner of Lands- for registration of titles and stamping of instruments
b) Local Authorities- for approval of plans and payment of water deposits.
c) Registrar of Motor Vehicles- for registration of motor vehicles, transfer of motor vehicles, licensing
under the Traffic Act Cap 403.
d) Registrar of Business Names- for new registrations
e) Registrar of Companies- for new registrations.
f) Insurance Companies- for underwriting of policies.
g) Ministry of Commerce- for import licensing or trade licensing.
h) Commissioner of VAT- for application for registration.
i) Central Bank of Kenya- for application for foreign exchange allocation or licensing of financial
institutions.
j) Customs and Excise- for importation of goods, customs clearance and forwarding.
k) Kenya Power and Lighting Company Ltd. - for payment of deposits for power connections.
Sec. 132(7): a failure by the named institutions to comply with the CDT’s requirements will render such
institutions liable to a penalty of Ksh. 2,000 for every omission.
Advantages of PIN
a) Prevention of tax evasion
b) Enables the government to maximize on revenue collection
c) Eases collection of tax on imports.
d) Easier reference of taxpayers matters at KRA in case of a dispute
QUESTIONS
VAT
Kisumu hardware Ltd. a registered supplier of vat able goods presented the following
information relating to the company’s transactions for the six months ended 30 June 2010.
January
February
March
April
Purchases
Sh
1,500,000
1,800,000
1,700,000
1,500,000
Sales
Sh
2,200,000
2,700,000
2,000,000
900,000
97
May
June
400,000
2,000,000
600,000
2,600,000
The amounts stated above were inclusive of VAT at a rate of 16%
1.
2.
3.
Additional information.
All purchases were made on cash basis while all sales were on credit basis. The cash due on
credit sales was received in the month following the month of sale.
Ten percent of the purchases made by the company in the month of April were returned
to the suppliers in the same month.
Included in the sales for the month of May was Sh 200,000 for which the debtor
defaulted and was subsequently declared bankrupt on 30 June 2010.
Required:
Prepare a VAT account and determine the VAT payable or refundable for each of the six
months from January to June 2010.
(12 marks)
Capital Allowance
Modern Solutions Ltd. is a manufacturing company operating in Nairobi Industrial Area. The
following information was obtained from the books of the company for the year ended 31
December 2009.
The written down values of assets for capital allowance purposes as at 1 January 2006 were as
follows
Computers
Plant and machinery
Tractors
Furniture and fittings
Motor vehicles
390,000
3,640,000
940,000
120,000
740,000
The factory building constructed on 1 January 2005, and put into use on 1 January
2006 had a written down value of Sh 1,665,000 as at 1 January 2009.
The following assets were constructed or acquired during the year.
Asset
Cost (Sh)
Warehouse
784,000
Security wall
160,000
Showroom
348,000
Computer and peripherals
96,000
Motor vehicles
2,000,000
Lorry (3 tonnes)
1,290,000
Office cabinets
84,000
Conveyor belts
180,000
Processing machinery
680,000
1.
2.
During the year, a motor vehicle (saloon) which was purchased in 2000 for Sh 600,000 was
disposed off for Sh 240,000
The company sunk a water borehole at a cost of Sh 560,000 which was put into use on 1
September 2009.
Required:
Capital allowances due to the company for the year ended 31 December 2009 (10 marks)
Partnership
98
John and Jane have been in the operating a bookshop for many years sharing profits and losses in the
ratio of 2:3 respectively. Their profit and loss for the year ended 31 Dec. 2009 showed the following:
Shs.
Gross profit
Less: expenses
Rent, rate and heating
Sundry expenses
Staff salaries
Bank interests
Repairs and renewals
Legal and professional fees
Stationary
Traveling expenses
Partner’s salary
Depreciation
Cars
Equipment
Interest on capital
John
Jane
Donation to local youth club
Net profit
Additional information:
i.
ii.
iii.
iv.
Shs.
273,900
38,000
14,000
50,100
1,000
5,600
5,000
1,100
26,000
17,000
600
100
600
400
3,500
163,000
110,900
Sundry expenses
Staff Christmas party
Trade journals
Training for staff
Subscription to Kenya national chamber of commerce
General allowable expenses
Repairs include sh 3,000 for partitions to the office
Legal and professional fees
Legal fees- debt collection
Alteration to partnership deed
Professional fees- accountancy
Traveling expenses
Staff traveling
Car expenses
sh
4,000
500
4,300
200
5,000
14,000
1,600
400
3,000
5,000
9,500
16,500
26,000
It has been agreed with the commissioner that 1/3 of the car expenses is for private use of the
partners
v. Partners salary
John
8,000
Jane
9,000
17,000
vi.
Capital allowances were agreed as follows
Car before taking into account the private use
450
Equipment
80
Required:
a) Compute the adjusted partnership profit for income tax purposes
99
b) Show the allocation of the profits among the partners and the tax payable by each
partner.
c) What assumption (s) have you made in ‘b’ above (20 m)
Assignment
a. Highlight four ways that the government has used to reduce tax evasion in the country.
(4 marks)
b. With reference to Income Tax Act, explain the tax treatment of dividends income received
by a company
(4 m)
c. Options Ltd has the following income statement for the year ended 31 Dec 2009.
Sh
sh
Sales
29,489,600
Less cost of sales
20,902,400
8,587,200
Less expenses:
Salaries and wages
4,543,200
Rent and rates
1,708,800
Stationery
89,600
Motor vehicle expenses
332,000
Depreciation- motor vehicle
96,000
Legal expenses
99,200
Redundancy payment to staff
46,400
Sundry expenses (allowable)
114,800
Bad and doubtful debts
44,800
Loss on sale of motor vehicle 36,000
7,140,800
1,446,800
Dividends received from YZ ltd
102,400
Net profit
1,548,800
Additional information:
a) Capital allowance of sh 84,000 have been agreed with the commissioner for income
tax.
b) Bad debts account was as follows
Bad debts account
Debts written off
Balance b/f
Customers
31,200
General provision
14,400
Staff
1,600
specific provision
21,600
Balances C/F
Debts recovered
General provision
24,000
(preciously allowed) 4,000
Specific
28,000
Profit and loss a/c
44,800
84,800
84,800
c) legal expenses consist of:
Advice on staff service contracts
sh 23,200
Tax appeals
38,400
Debt collection
37,600
99,200
Required
i.
Compute the adjusted taxable profit or loss for Option ltd for the year 2009.
(8 m)
ii.
Calculate the tax payable
(2m)
iii. If Option ltd paid instalment tax by the due dates, when is the final tax for 2009
payable
(2 m)
100