taxation topic 3

7/29/2019 Taxation Topic 3

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TOPIC 3:DETERMINATION OF TAXABLE INCOME

3. 1Persons

Those assessable or chargeable to tax are called persons by the Act. The term person embraces

individuals (natural persons) and artificial persons created by law . The persons liable to be are

the following:

a. All persons resident in Kenya whether or not they are Kenyan citizens.b. All persons not resident in Kenya but derive income from any property, trade, profession,

vocation or employment in Kenya.

A taxable person does not include a partnership. A partnership is not taxed on its income but the

partners are taxed on their share of profit or loss from the partnership.

Income arising from abroad, whether or not it is remitted to Kenya is not liable to tax here

though exemptions to this rule are:

i. If a business is established in Kenya and has branches in foreign countries, profits madeby its foreign branches will be taxed in Kenya.

ii. Resident individuals are taxed on all employment income wherever earned.

3.4.2Residence

Residence is a matter of physical presence. A person can have only one domicile but he/she may

be resident in several countries at the same t ime. Residence status of a person helps to find out

who is responsible or liable to income tax in Kenya. There are conditions for being a resident in

the case of an individual and also in the case of a body of persons.

a. IndividualsSec 2 (1) defines a resident in relation to an individual as one who:

i) Has a permanent home in Kenya and was present in Kenya for any period during the yearof income under consideration or

ii) Has no permanent home in Kenya but was present in Kenya for a period or periodsamounting in total to 183 days or more during the year of income under consideration or

iii)Has no permanent home in Kenya but was present in Kenya for any period during theyear of income under consideration and in the two preceding years of income for periods

averaging more than 122 days for the 3 years.

b.Body of Persons


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Resident in relation to a body of persons (e.g. companies) means that;

i) The body is a company incorporated under the laws of Kenyaii) The management and control of the affairs of the body was exercised in Kenya in

the years of income under consideration or

iii) The body has been declared by the minister for finance by a notice in the gazetteto be resident in Kenya for that year of income.

c.NonResident

This means any person (individual or body of persons) not covered by the above conditions

for resident.

Importance of Residence:

From the point of view of an Individual

1. Kenya resident individual pay Kenya income taxes on their income from Kenya andworld wide employment, but Kenya non residents pay Kenya income taxes only on their

income from Kenya.

2. Kenya resident individual pay Kenya income taxes at graduated scale rates but Kenyanon residents pay income taxes at special fixed rates on certain specified income or

sources.

3. Withholding tax is deducted at source on all income of Kenya non resident individualsbut Kenya residents individuals have withholding tax deducted on only some of their

incomes S(35).

From the point of view of Companies:

1. Kenya resident companies are taxed at only 30% on their chargeable incomes whereasnon-resident companies with branches in Kenya are taxed at 35% on their chargeable

income. Non resident companies with no branches in Kenya are taxed on certain

specified incomes at special fixed rates which are lower than the above two rates.

2. Non resident companies with no branches in Kenya have withholding tax deducted atsource on all their source of income, but resident companies and non resident companies


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with branches in Kenya have withholding taxes deducted at source only on income in the

form of dividends and interest.

It should be noted that non-resident companies without branches in Kenya are treated

exactly like non-resident individuals.

3.4.3Taxable Income

A tax payer is taxed on his chargeable or taxable income. This is the total income from all

sources listed in the Act excluding income exempted by the Act. Such income maybe reduced by

reliefs or allowances. The income which is taxed is income in respect of:

i. Gains or profits from businessii. Income from any employment or services rendered.iii. Income from use of occupation of any property e.g. rent.iv. Dividend and interestv. Pension charge or annuity and withdrawals from registered pension and provident funds.

vi. An amount deemed to be income of a person under the Act or rules made under the Act.

Exemptions from Income Tax

Sec 13 of the Act to be read with Part I of the 1st

schedule specifies the incomes exempt from tax

as follows:

1. The part of income of the president of Kenya that is derived from salary, duty allowancesand entertainment allowances paid or payable to him from public funds.

2. Income of parastatal bodies.3. Income of a sporting association other than income from its investments.4. The income of agricultural societies5. The income of any local authority6. Interest on tax reserve certificates issued by the Kenya government.7. The income of a registered pension scheme.8. The income of a registered trust scheme.9. The income of a registered provident fund.


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10.Investment of an annuity fund as defined in Sec 19 of the Income Tax Act of aninsurance company.

11.Pensions or gratuities granted in respect of wounds or disabilities.12.Interest on savings account held with the Kenya Post Office Savings Bank.13.Interest paid on loans granted by the Local Government Loans Authority.14.The income of a non resident person who carries on the business of air transport provided

where in the country where the person is resident offers similar facilities to Kenya

residents.

15.The income of registered individual retirement fund.16.The income of a registered home ownership savings plan.17.Interest upto a maximum of 300,000 earned by individuals on housing bonds from:

i. HFCKii. Savings and loans Kenyaiii. EABSiv. Home loan and savings

18.Monthly or lump sum pension to a person who is 65 years of age or more.

Y tax or the tax on Y is charged on Y of a person for each year in accordance with Sec 3(1) of

the Y Tax Act.

The Year of Income

The year of income refers to a period of 12 months with reference to which the income of

individuals and business units is assessed for tax purposes.Taxation year in Kenya is from 1 st

January to 31st

December of any particular year e.g. 1st

January to 31st

December 2011.

If the accounting period of a business concern ends on a date other than 31st

December then the

year of income of that business concern maybe treated according to that specific date. In this

case also a period of 12 months must be taken for tax purposes. If a companys financial year

ends on 30th

June every year then the year of income of this company will be taken as from 1st

July to 30th

June the next year e.g. 1st

July 2010 to 30th

June 2011.


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Example

Walters income for the 3 years is as follows:

Employment Income Kshs.

Year to 31.12.2002 50,000

Year to 31.12.2003 65,000

Year to 31.12.2004 70,000

His Business Profits

Year ended 30.06.2002 120,000

Year ended 30.06.2003 140,000

Year ended 30.06.2004 130,000

His taxable income will be as follows:

For the year of income 2002 Kshs. 50,000

Kshs. 120,000 Kshs. 170,000


Kshs. 140,000 Kshs. 205,000


Kshs. 139,000 Kshs. 200,000

Section 27 of the Income Tax Act states that the accounting period not coinciding with the year

of income i.e. 31st

December maybe taken according to the special dates in which the accounting

period of some persons or business concerns ends. The year of income for a period of 12 months

ending on a day other than 31stDecember maybe, possible in the following cases as prescribed

in Sec. 27 of the Act, then the accounting period will be treated as the year of income.

1. In the case of a company, all income earned during a specific period of 12 months.2. Incase of individuals, all income earned during a specific period of 12 months except

employment income. It must be noted that employment income will be shown separately

and assessed for tax purposes for a period of 12 months from 1st

January to 31st

December as usual.

3. If a person prepares accounts of his business for a period longer or shorter than 12months then the Commissioner may consider the income of such accounting period as the

income of the year and charge tax accordingly. In this case some adjustments can be

made if necessary.


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4. In the case of a partnership, all income earned during a specific period of twelve monthsexcept the employment income of individual partners earned elsewhere. The employment

income of the partners will fall within the normal year of income i.e. 1st

January to 31st

December.

As per Finance Bill 1996, for incorporated businesses a prior notice of 6 months is required to

change accounting date. For unincorporated businesses the accounting date will be 31st

December e.g. partnership and sole proprietors.

Sec 3 (1) states that a tax to be known as income tax shall be charged for each year of income

upon all the income of a person, whether resident or non-residentwhich accrued in or was

derived from Kenya.

3.2Employed and Self Employed

There is usually a distinction between employed and self employed persons. The income of an

employed person is subjected to PAYE whilst that of self employed is not subjected to PAYE.

a.Employed:

A person who works under an employment contract and mutuality of obligations exist between

the employee and the employer i.e. A worker in a company. The employee is someone who;

- Who has to work certain hours- Has to work in a certain way- Is not allowed to sub contract- Has most of the facilities provided (e.g. place of work, equipment etc)- Is paid regardless of how well or poorly the work is done.- Usually (but not always) has only one employer.

b.Self Employed

When a person works from his own premises, in his own way and has no obligation to anyone

(i.e. employer), then usually he will be considered as self employed. He/she is responsible to

himself/herself for:

- Finding his own work and clients


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- Financing the business- Controlling the way in which the business is run- Suffering losses and enjoying profits- Dealing with tax matters (i.e. VAT, PAYE for employees etc)- Providing his own equipment.

Apart from businessmen, the actors, part to time lecturers, agency workers etc fall under this

group. It is usually very difficult to claim any tax allowable personal expenses against

employment income but self-employed persons usually have tax allowable personal expenses

e.g. books, equipment, subscriptions etc to profit and loss a/c.

3.2.1 Taxable Employment Income

Section 5 sub section 1(a) of the Income Tax Act specifies the basis on which an income from

employment is liable to income tax in Kenya. These are as follows:

a. Any amount paid to a person who is a resident in Kenya in respect of any servicesrendered by him whether in or outside Kenya.

b. Any amount paid to a non resident person in respect of any employment or servicesrendered to any employer who is resident in Kenya or employment or services to an

employer who is not a resident of Kenya but has permanent establishment in Kenya.

Income of Employed persons under the Income Tax Act

The following items are included as part of income of an employed person:

1. Wages, salaries, leave pay, sick pay, payment in lieu of leave, commissions, loans,gratuity etc.

2. Subsistence, travelling, entertainment or other allowances received in respect ofemployment or services rendered. If incurred wholly and exclusively in the production of

employment income then they will be deducted from an employees income.

3. Value of any benefit, advantage or facility of whatever nature granted in respect ofemployment or services rendered if it is excess of Kshs. 24,000 in any one year of

income. This excludes premises provided for residential purposes and life insurance


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premium paid for the benefit of an employee. Any benefit in kind in excess of Kshs.

24,000 in any year of income is taken as taxable benefit.

4. Insurance premium paid by an employer for any insurance policy or the life of hisemployee or any of his dependants is a taxable benefit.

5. An amount paid by an employer as a contribution on behalf of an employee or director toa provident fund which has not been registered according to the provisions of this Act. If

it is a contribution to an approved provident fund or pension scheme then it is a non

taxable benefit to employees.

6. Medical expenses: Where the employer has a written plan or scheme or practice providesfree medical services to all his employees, then this is a non taxable benefit to full time

employees and whole tax service directors of a company. If it is given to only some

employees then it is a taxable cash payment.

7. Passages: If passages are paid by employer it is a taxable benefit to the employee.However it will not be taxed if the following conditions are fulfilled;

i. The employee is recruited from outside Kenya.ii. He is in Kenya solely for the purpose of serving his employer.iii. He is not a Kenyan citizeniv. The amount is actually spent on passages.

8. Housing Benefits: The following conditions shall apply;i. If an employee is provided with a house, 15% of his total benefit from

employment will be added as housing benefit.

ii. If the employee is required to pay nominal rent for the house provided, then suchrent shall be deducted from 15% to total benefit to arrive at the net value of the

housing benefit.

iii. If the actual rent is paid to the employees, housing benefit of 10% of gains fromemployment less rent shall be considered to arrive at housing benefit.

iv. In the case of directors other than whole time directors, the housing benefit istaken as 15% of the directors total income excluding gains from property.

v. Whole time service directors are treated as other employees.vi. If an employee occupies only the house for part of the year then the housing

benefit will be reduced proportionally.


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vii. From the year of income 1994, if the gains or profits of an employee or a wholetime service director are more than Shs. 600,000 p.a. excluding value of premises

then housing benefit will be determined on the basis of higher of the value

determined under section 5(3) (c).

However, as per Finance Bill 1998, the sub section (5(3) has been amended to

ensure that directors (whether whole time service directors or otherwise) who may

have influence on a company pay their fair share of tax i.e. fair market rental

value are taken into account.

9. Low Interest Benefit:Where an employee receives a loan from the employer by virtue ofhis employment at a low interest rate then this low interest benefit will be taxable. The

interest benefit shall be the difference between what the employer charges and the

interest rate based on market lending rates at the discretion of the commissioner for the

year of income 1995 and onwards. However from 11th June 1998 as per Finance Bill

1998, the low interest benefit has been excluded from gains or profits from employment

and a new tax known as fringe benefit tax has been introduced which is payable by the

employer and not the employee. This excludes wants granted before this date which are

subject to terms at the time of offer. They shall however be subject to 15% or the market

lending rates whichever is lower.

10.Gratuity: This is taxed in the periods for which it was earned and NOT in the year inwhich the total amount was paid.

Salary arrears paid to employees are taxed in the year to which they relate. However, if

the arrears relate to more than immediate past four years, only the arrears for the

immediate past four years will be liable to tax on those four years. The arrears for the

period behind the past 4 years will be added together and taxed in the preceding fifth

year.

11.Compensation for loss of employment: Any amount received as compensation fortermination of contract of employment to service is taxable whether or not provision is

made in the employment contract for the payment of such compensation. The tax payable

on such compensation shall be calculated as follows:


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a. Incase of a director who is not a whole time service director, the compensation istaxed in the year it is accrued or received by him.

b. In the case of employees or whole time service directors:i) Whose contract is for a specific term of service then if terminated before the

expiry of such period, the amount of compensation that is taxable is equal to the

income that could have accrued to the employee in the unexpired period. Any

amount paid in excess of this would be tax free.

ii) Whose contract is for unspecified term then the compensation is assumed toaccrue evenly over the period following termination at the rate per annum as

earned just before termination until the amount is fully exhausted.

iii)Whose contract is for unspecific term not providing for compensation, then theamount of compensation is taxed only during the 3 years following the

termination of contract at an annual rate of salary drawn by the employee in the

year of termination. Any amount paid in excess of three years salary is tax free.

12.If an employee is provided with house servants, company car and other specific servicesthen these benefits are taxable. The taxable values of these benefit is determined by the

commissioner for specific year. The following rates have been fixed for the year of

income 2003 onwards.

3.2.2 WIFES INCOME

Wifes income as per section 45, is considered as the income of the husband and this income

must be added to the husbands income in order to ascertain his total income. The wifes income

can be from any source e.g. employment, rent, business, profession, dividend etc.

A married woman will be treated as living with her husband and her income taxed on the

husband unless:

a. They are separated under an order of court or a written agreement of separationb. They are separated in such circumstances that the separation is likely to be permanent.c. She is a resident person and the husband is non residentd. Where she opts to file a separate return with effect from 1.1.2006.


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Wifes Employment Income and Self Employment Income

For purposes of calculating tax payable, wifes employment and self employment income

qualifying for separate taxation is segregated from the husbands income and the tax on it

separately calculated at wifes employment income rate which is the same as individual rate of

tax.

The wifes income will not qualify for separate taxation if she is employed by any of the

following;

a. A partnership in which her husband is a partner.b. A company where the husband / or wife jointly control 12% or more of the voting

power directly or indirectly of the company.

c. A trustee or manager of a trust created by her husband.

Note:Self employment income for a married woman means business by the wife where husband

is not a partner nor employs the wife.

Wifes Professional Income

Wifes professional income is also segregated from the husbands income and the tax on it

separately calculated at wifes employment and wifes professional income rate which is the

same as individual rate of tax. Such professions include; accountancy, medical, legal, survey etc.

The wifes professional income will not qualify for separate taxation if it is from a partnership

where her husband is a partner.

The wifes loss is deemed to be the loss of the husband. The deficit at the time of marriage

becomes the husbands deficit to be offset against future income of the wife which is taxed on

the husband.

3.2.3 INCOME FROM PENSION

The pension income received by a resident individual from a pension fund is taxable. Similarly

the pension income received by a resident individual from any pension scheme outside Kenya in

respect of employment or services rendered by the individual is also taxable.

Finance Bill 1992 defines pensionable income as:


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a. The employment income including employee benefits. It means that now all emolumentsand benefits subjected to PAYE will now constitute pensionable income.

b. The gains or profits from business earned as the sole proprietor or a partner of thebusiness in the case of an individual eligible to contribution to a registered individual

retirement fund.

Pension Schemes

a. On maturity of employmentThe lump sum payment of the 1

st360,000 is exempted from income tax. Incase of a benefit paid

out of NSSF, the 1st

360,000 is exempt from tax and in addition 50% of amount in excess of

360,000 is also exempt from tax. With effect from the year 2004 the amount has been increased

to Shs. 480,000.

b. On termination of employmentThe amount withdrawn on termination of employment is exempted from tax to a limit based on

the lesser of:

i. The 1st 480,000 per full year of service with the employer.ii. The first 480,000.

This provision is aimed at ensuring that an individual will not withdraw tax free amounts in

excess of Shs. 480,000 even if the period of service is more than 10 years.

Provident Fund Schemes

The amounts received against the registered provident funds are exempted from tax to a limit

based on the least of:

i. The first 480,000 per full year of service with the employer.ii. The first 480,000.

From 1996, withholding tax will be at the following rates in excess of the tax free limits.

10% on the first 400,000

15% on the next 400,000

20% on the next 400,000

25% on the next 400,000


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30% on the next 1,600,000

Upon the death of an employee who is a member or beneficiary of a registered fund;

a. The widow, widower or dependants will qualify as a group for the same tax exemptamounts out of pension income and lumpsum payment.

b. Where the registered fund provides for the payment or retirement benefits other than thepayment of lumpsum to an estate, the first 1,400,000 of such lumpsum amount be exempt

from tax.

Registered Home Ownership Savings Plan (HOSP)

A registered home ownership plan means savings plan established by an approved institution

and registered with the commissioner for receiving and holding funds in trust for depositors for

the purpose of enabling individual depositors to purchase a permanent house.

As per Section 22(c) a depositor will be eligible to deposit funds with a registered home

ownership savings plan and an amount of Kshs. 4,000 every month is exempt from tax thus

48,000 per annum.

3.3Steps in Computation of IncomeTax

1. Ascertain gross income from all sources2. Deduct amounts allowable to such income that may not be taxable.3. Ascertain net income4. Calculate gross tax using tax rates as applicable to the particular year of income5. Deduct relief allowable from gross tax6. Ascertain net income tax for the year7. For employed persons (PAYE) deduct PAYE from net income tax. The amount arrived at

is the tax payable.

Johns return shows the following income for the year 2004.

i. Salary Shs. 250,000 per annum (PAYE 20,000)ii. Wifes employment income shs. 60,000 as lady secretaryiii. Pension received from former employer 100,000 (PAYE NIL)


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Required: Johns net tax liability for the year of income 2004

solution

Salary 250,000

First 116,160 @ 10% 11,616

Next 109,440 @ 15% 16,414

Next 24,400 @ 20% 4,880

Gross tax liability 31,912

Less relief 12,672 (1,162 per month)

Net Tax Liability 20,240

Less: Tax Credit PAYE 20,000

Tax Payable 240

3.4.PARTNERSHIPS

For purposes of imposing tax a person does not include a partnership. The income of a

partnership is assessed on the partners.

Under the Income Tax Act Cap 470under Section 4(b) the gains or profits of a partner from a

partnership is the aggregate of:

a. Remuneration payable to him/herb. Interest on capital receivable, less interest on (drawings) payable by the partner to the

partnership.

c. His/her share of adjusted partnership profits.

Determining the Existence of a Partnership

Under English and Kenyan Law, a partnership is not a person but is the relationship that subsists

between persons carrying on a business in common with a view to making profit(s).

Whether a partnership exists or not is not a question of fact. The basic criterion is whether two or

more persons carry on a business in common with a view to profits. Usually a partnership deed

or written agreement will be drawn up by the partners but in some cases orally made.

Steps in computing tax on partnership income:

1. Determine or compute the adjusted income or loss for the partnership


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a. Salary to partners is not allowable expense.b. Interest paid to partners is not allowablec. Interest paid by partners is not taxabled. Wifes salary is not allowablee. Drawings of commodities dealt with in the partnership are added back at cost. Note

that no profit is to be made from another partner.

2. Allocate the income adjusted to the partner by first isolating salaries to partners, intereston capital (net) to partners, bonus to partners, commissions etc. The balance is either

profit or loss to be shared out among partners according to profit sharing rat io or as per

partnership agreement.

Format of Income Tax Computation of a Partnership

Shs. Shs.

Net profit/(loss) as per a/c xx

Add back:

Partnership salaries xx

Interest paid to partners xx

Goods taken by partners xx

Goodwill written off xx

Partners insurance xx

Legal fees on partnership agreements xx

xx

Less

Non taxable income (xx)

Capital deductions allowed (xx)

(xx)

Adjusted partnership profits /loss xxx

Income Allocation to Partners


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Total Partner A Partner B

Kshs Kshs Kshs

Salary xx xx xx

Interest on capital xx xx xx

Interest on Drawings xx xx xx

Share of Profit xx xx xx

Taxable income xxx xxx xxx

Example:

Mr. Unga, Mr. Safi and Mr. Ngano are partners trading under the name Ngano Safe enterprises.

They share profits and losses in the ratio of 4:3:3. Given below is the P&L ac/ of the partnership

as at 31/12/2003.

Nganosafe Profit & Loss A/C for the year ended 31.12.2003

Shs. Shs.

Salaries and wages 280,000 Gross profit 2,300,000

Rent, rates and taxes 150,000 Misc. receipts 150,000

Office expenses 204,000 Discounts 80,000

Printing and stationery 64,000 Rent from property 132,000

Installment tax paid 45,000 Profit on sale of shares 100,000

Advertising 73,000 Interest on deposits 120,000

Interest on capital

Unga 60,000

Ngano 70,000

Safi 80,000

Legal charges 82,000Commission to partners

Unga 45,000

Ngano 35,000

Depreciation 92,000


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Bad debts 68,000

General expenses 99,000

Donation to famine relief 100,000

General reserve 120,000

Local taxes on property 12,000

Electricity 46,000

Show room expenses 117,000

Net profit 1,040,000

2,882,000 2,882,000

The partners have provided the following information in support of the accounts:

1. It has been the practice to value the stocks at the cost price, however the closing stock (asat 31.12.2003 is Shs. 180,000) valued at market price which is less by 10% of its cost

price.

2. Salaries and wage include salaries amounting to Shs. 40,000 paid to Safi.3. Advertising includes Shs. 10,000 spent on advertising campaign to introduce a new

product on the market.

4. Legal charges include a sum of Shs. 12,000 paid as a fine and penalty.5. Capital allowances have been agreed with the commissioner of income tax at Shs.

90,000.

6. Mr. Ungas other income includes Shs. 120,000 from rent. He has brought forwardbusiness loss of Shs. 135,000 from the assessment of income of 2002 of the partnership .

7. Mr. Safi has got no other income.8. Mr. Ngano has income of Shs. 200,000 from bet winnings. He has brought forward

business loss of Shs. 135,000 from assessment of the year of income of 2002 partnership.

Required:

a. Compute the taxable income from the partnership business.b. Allocate the profit amongst the partners.


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c. Calculate the taxable income of each partner for the year of income 2003.

Solution

a. Ngano Safi Enterprises Computation of Taxable IncomeKshs Kshs

N.P as per P&L a/c 1,040,000

Add: deductions not allowed

Loss on valuation of closing stock

(100

/90 x 180,000)

20,000

Salary: Safi 40,000

Instalment tax paid 45,000

Interest on capital: Unga 60,000

Safi 70,000

Ngano 80,000

Fine and penalty 12,000

Commission: Unga 45,000

Ngano 35,000

Depreciation 92,000

Donation 100,000

General reserve 120,000

719,000

Less: income exempt

Rent from property (132,000)

Profit on sale of shares (100,000)

Interest on deposits (120,000)(352,000)

1,407,000

Less: capital allowances (90,000)

Adjusted partnership income 1,317,000

b. Distribution of Income among Partners:


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This is done as per their profit / loss sharing ratios 4:3:3 (Unga : Safi : Ngano)

Particulars Total Unga Safi Ngano

Kshs Kshs Kshs Kshs

Salary 40,000 - 40,000 -

Interest on capital 210,000 60,000 70,000 80,000

Commission 80,000 45,000 - 35,000

Share of balance 978,000 394,800 296,100 296,100

Taxable income 1,317,000 499,800 406,100 411,100

c. Calculations of taxable incomeParticulars Total Unga Safi Ngano

Kshs Kshs Kshs Kshs

Income from partnership 1,317,000 499,800 406,100 411,100

Add

Rent from property (4:3:3) 132,000 52,800 39,600 39,600

Rental income 120,000 120,000 - -

Less:

Business loss b/f 270,000 135,000 - 135,000

Taxable income 1,299,000 537,600 445,700 315,700

3.5.LIMITED COMPANIES

Limited companies in Kenya can either be private or public. There are no fundamental

differences in the taxation of either private or public companies.

Companies incorporated in Kenya are expected to pay installment tax before the end of the

accounting year hence the amount of tax payable shall be determined at the beginning of eachyear. This is based on the lesser of:

i. The budgeted profits of the year orii. 110% of the last years tax liability.

Once determined, the installment tax is payable as follows:

1st installment 25% of tax due by 20 th day of 4th month during year of income


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2nd installment 25% of tax due by 20th day of 6th month during year of income

3rd installment 25% of tax due by 20th day of 9th month during year of income

4th

installment 25% of tax due by 20th

day of 12th

month during year of income

Final taxActual tax payable minus total(tax balance) installment tax paid on the last day of 4th

month after end of year of income.

However, for firms in the agriculture sector, installment tax is payable as:

1st


day of 9th


2nd


day of 12th


Final tax -Actual tax payable minus total (tax balance) installment tax paid on the last day of the

4th month after the end of year of income.

Corporation Tax Rates

In Kenya, the corporate tax rate for a resident company is 30% whilst that for a permanent

establishment of non resident company is 37.5%. A non resident company can have a permanent

establishment in Kenya by opening a branch. However different tax rates apply for the

following;

1. Newly Listed CompaniesCompanies newly listed on any securities exchange approved under the capital markets act enjoy

favourable corporation tax rates as follows:

% of issued share capital listed Computation tax

rate

Period commencing

immediately after year of

income (yrs)

Listed shares exceeds 20% of

issued share capital

27% 3 years



25% 5 years



20% 5 years


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2. Export Processing Zone CompaniesCompanies operating within EPZ have the following benefits:

i. A tax year tax holidaythis is an exemption from corporation tax for the first 10 years oftrading.

ii. A lower corporation tax rate of 25% for the subsequent years after 10 years tax holiday.iii. An exemption from all withholding tax on dividends and other payments to non residents

during the first 10 years.

iv. Investment deductions are 100% of the capital expenditure claimable in the 11 th year aftercommencement of production.

v. Zero rated for purposes of VATvi. There is a refund of import duty on raw materials to manufacture exports.

Note:

- EPZ enterprises must submit annually returns of income and supporting accounts tothe CIT.

- Emoluments paid to employees and resident directors of EPZ enterprises must besubject to PAYE deductions as required by law even during the period the enterprise

is exempt from tax.

3. Resident Companies Mining Specified MineralsSuch companies under the Inzome Tax Act for the first 4 years of mining operations, their

income is taxed at 27.5% while the normal rates shall apply from the 5th

year of operations.

4. Taxation of Branches of Foreign CompaniesNon resident companies with branches in Kenya are liable to pay corporation tax at a

comparatively higher rate of 37% on incomes generated by their local branches.

No deductions shall be allowed in respect of expenditure incurred outside Kenya by a non

resident person for purpose of ascertaining gains or profits of a business carried on in Kenya

except as determined by the CIT and in particular no deduction shall be made in respect of

expenditure on remuneration for services rendered by the non resident director who is not full

time director of a non resident company.


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On executive and general administrative expenses except to the extent the CIT may determine to

be just and reasonable. No deduction shall be allowed in respect of interest, royalties or

management or professional fees paid or purported to be paid by the permanent establishment to

the non resident person. Sales abroad by a branch of goods produced in Kenya will be deemed to

generate income derived in Kenya and such income is taxable in Kenya. A branch does not

suffer any withholding tax on remittances of profits to head office.

5. A group Comprising the Holding Company and Subsidiary CompaniesUnder the Income Tax Act companies are treated as legal persons independently. As such the

law does not permit any form of consolidated return combining the profits and losses of affiliated

companies or the transfer of losses from loss making to profit making members of the same

group of companies.

Where assets qualifying for wear and tear allowances are transferred between companies under

common control, the sale consideration is deemed for tax purposes to be the open market value

of those assets. However, if this treatment would give rise to a taxable balancing adjustment in

the computations of the transferor company, the two companies may jointly elect for tax written

down value to be substituted as the sale consideration. This election is possible only if both

companies are resident in Kenya.

Dividends paid by one resident company to another one exempted from tax in the recipients

companies hands if it controls 12% or more of the voting power of the paying company.

Real estate may be transferred free of stamp duty where the beneficial ownership does not

change.

Shortfall Tax on Non Distribution of Dividends (Sec.24)

The profits of a company after taxation may be distributed to the shareholders in full as

dividends or retained to provide finance or to be partly distributed and partly retained. If a

company fails to distribute as dividends that part of its income which in the opinion of the CIT is

in excess of its requirements within a period of 12 months after the accounting period, the CIT

may direct that the income be deemed to have been distributed to the shareholder as dividends.


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In such a case the company will have to deduct tax at source (withholding tax) and distribute the

shortfall to the shareholders.

In practice, the commissioner usually allows for the retention of 60% of the profits after tax

derived from the trading income. Profits after tax from investment income are distributed in full.

Non taxable dividends are also distributed in full.

Companies excluded from Shortfall Regulation

i. Companies that are subsidiaries of each other.ii. Companies that are subsidiaries of foreign companies and have no resident shareholders.iii. Companies which have 51% or more of the shares held by non residents.

Circumstances where Companies will be entitled to more than 60% Permissible Retention

i. Where the companies authorized capital is fully issued and therefore it cannot obtainfurther funds from shareholders and can only rely on its internal reserves to finance its

investment plans.

ii. The company does not have any liquid funds.iii. The company has liquid funds but is reserving them to clear maturing obligations e.g.

loans, mortgages or plans to purchase plant and machinery, building etc.

iv. The company is expanding its business and trading operations and requires additionalcommitment in inventory.

v. The company has committed itself to purchase another business as long as the companyto be purchased is not a company that is a source of raw material of a distribution

company for its products.

vi. Any company controlled directly or indirectly by the government of Kenya.Calculation of Shortfall Dividends

Steps to be followed:

i. Show each type of income in a separate column.ii. Deduct corporation tax where applicableiii. Deduct permissible retentioniv. The balance is the distributable dividend


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v. Deduct the actual dividend declared and the remaining balance (if any) is the shortfallof dividends.

Example:

XYZ made a pre-tax profit of Kshs. 100 million comprising of:

a. Trading profit Shs. 60mb. Investment income Shs. 10mc. Dividends from B limited (a subsidiary) Shs. 30m (the company owning more than 12

% of ordinary shares)

State how much the company should distribute as dividends in order to comply with Sec. 24

proviso (Assume Corporation Tax is 40%).

Solution

Trading

Profits

Investment

Income

Non Taxable

Dividends

Total

Kshs (millions) Kshs (millions) Kshs (millions) Kshs (millions)

Pre-tax profits 60 10 30 100

Corporation Tax 40% (24) (4) - (28)

Profits after Tax 36 6 30 72Maximum Retention 60% (21.6) Nil Nil (21.6)

Distributable Profits 14.4 6 30 50.4

Distributable profits will be 50.4 to shareholders but this amount is liable to withholding tax.

Shareholders need not be taxed again.

Compensating Tax and Dividend Tax Account

Compensating tax was introduced in 1993 under Section 7A of the Income-Tax Act. It is an

additional tax imposed on companies and arises if a company pays dividends from untaxed

profits.


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Untaxed profits would occur in cases where the company declares dividends out of profits

arising from sale of fixed assets, investments or other gains that are not taxable. Note that capital

gains tax was suspended in 1985 and stands suspended to date.

Companies are required to maintain a dividend tax account to monitor the incidence of

compensating tax. According to the tax act, the initial balance in the dividend tax account will

either be:

a. Zero orb. Sum of the total taxes paid and tax on dividends received, less tax on dividends

distributed and tax refunded by the company with respect to 1988 to 1992 years of

income. Thereafter the account is adjusted in the same way for each subsequent year of

income as follows:

Dividend Tax Account Format

Particulars Debit Credit

Kshs Kshs

Dividend tax account opening balance b/f as above (1st Jan 199x) x

Total income taxes paid during the year x

Tax on total dividends received during the year (dividends x

.

/0.7) xTotal refunds by KRA of taxes previously paid and included in the

calculation of income taxes earlier paid

x

Tax on total dividends distributed (dividends x./0.7) x

Balance carried forward (if debit) x

Compensating tax payable (if credit) x

xx xx

A credit balance is carried forward to the next year while a debit balance indicates the

compensating tax payable. Where the tax is paid in a given year the balance carried forward to

the next year is zero. The tax is due for payment by the last day of the 6th

month following the

end of the accounting period.


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Example:

The following information was obtained from the books of Nyachio Ltd for the year ended 31 st

December 2008.

Details Kshs

Profit after tax 4,200,000

Dividends paid 6,400,000

Dividends received 1,500,000

Additional Information

A tax refund of Kshs. 360,000 was received by the company for the year ended 31/12/2008.

Required:

Compensating tax, if any payable by Nyachio Ltd for the year ended 31/12/2008.

Solution

Computation of Compensating Tax

Dr Cr

Income tax paid (0.3 x 4,200,000) (excludingdividend withholding tax)

1,260,000

Dividend received (1,500,000 x./1-0.3) 642,857

Dividend paid (6,400,000 x . /1-0.3) 2,742,857

Tax refund 360,000

Compensating tax 1,200,000

3,102,857 3,102,857

Definition of Compensating Tax

Compensating tax as per section 7A of the Y Tax Act is an additional tax imposed on companies

arising where tax paid plus tax on dividends received is less than tax on dividends paid and tax

refunds by the company.


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Tax paid excludes withholding tax on qualifying dividends but includes compensating tax.

Taxation of Companies

ABC Ltd has presented the following trading and P&L a/c for the year ended 31/12/2007

Kshs. 000 Kshs. 000

Sales 18,500

Less: cost of sales

Opening stock 4,200

Purchases 5,600

Cost of goods available for sale 9,800

Closing stock (2,400 (7,400

Gross profit 11,100

Other incomes

Gain on sale of equipment 120

Interest on savings account 40

Refund of import duty 80

Gain on foreign exchange transactions 11,400

Expenditure

Goodwill amortization 25

Legal expenses 420

Salaries 2,000

Bad debts 500

NSSF contribution 60

General expenses 600

Advertising 300

Staff meals 190Traveling expenses 180

Donations to a trade association 40

Property rates 45

Depreciation 150


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Interest on long term loans 300

Interest on bank overdraft 80

Insurance 124

Cost of stolen stock 20

Branch closure stocks 100 (5,134)

Net profit 6,306

Additional information

1. The closing stock on 31/12/2007 was valued at a cost plus a mark up of 20%2. Legal expenses related to:

Preparation of memorandum of association 150,000

Conveyance fees on purchase of land 60,000

Acquisition of leasehold property 90,000

Settling customer disputes 100,000

Acquisition of a bank loan 20,000

420,000

3. The Directors had withdrawn goods costing Kshs. 600,000 (selling price Kshs. 720,000)for their personal use. These goods have been included in both purchases and sales for the

year ended 31/12/20074. Sales (expenses) include:

Kshs

Directors allowance 720,000

Christmas gifts to staff 600,000

Golden handshake to a retiring director 400,000

5. Bad debts includes: KshsLoan to director 200,000

Estimated defaulters by trade debtors 120,000

6. Advertising expense include Kshs. 100,000 for a neon sign7. 20% of the traveling expenses relate to the private usage of company motor vehicles.8. Capital allowances were agreed with the revenue authority at Kshs. 200,000


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Required

i. Adjusted taxable profit or loss for ABC Ltd for the year ended 31 st Dec, 2007.ii. The tax payable by ABC Ltd (if any) for the year ended 31/12/2007

ABC Ltd adjusted taxably Y for the year ended 31/12/2007

Kshs 000 Kshs 000 Kshs 000

Profit as per P&L a/c 6,306

Add: disallowable expenses

Preparing memorandum of association 150

Conveyance fees 60

Bank loans (processing) 20

Bad debts:

Loan to directors- 200

General bad debts 120

Advertisingneon sign 100

Travelling expenses private 20% of 180 36

Goodwill amortization 25

Donations to trade association 40

Cost of goods withdrawn 600

Depreciation 150 (1,501)

Less; allowable / deductible expenses

(items)

Capital allowances (200)

Sales to directors (720)

Overstated closing stock (2,400

,

/1-20) (400)Gain on sale of equipment (120)

Interest on savings a/c (40)

Refund of import duty (80) (1,569)

Taxable income 6,238

Tax thereon 30% of 6,238,000 = 1,871,100

taxation topic 3

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