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Title: Advanced Taxation
Description: The notes gives clear information on Taxation and they are very quality
Description: The notes gives clear information on Taxation and they are very quality
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ADVANCED TAXATION
STUDY TEXT
Copy r i ght
ALL RIGHTS RESERVED
...
ISBN NO: 9966-760-23-7
© 2009 SUP
First Published 2009
SUP
P
...
Box 59857, 00200,
Nairobi, Kenya
...
v
ACKNOWLEDGMENT
...
CHAPTER ONE
...
3
CHAPTER TWO
...
TAXATION OF SPECIALISED ACTIVITIES
...
81
TAX INVESTIGATIONS
...
107
TAXATION OF CROSS BORDER ACTIVITIES
...
169
TAX SYSTEMS AND POLICIES
...
CHAPTER SEVEN
...
191
CHAPTER EIGHT
...
203
CHAPTER NINE
...
REVISION AID
...
231
Glossary of Terms
...
277
S T U D Y
TAX PLANNING
...
133
S T U D Y
T E X T
vi
A dvanced TA X AT I O N
ADVANCED ASPECTS OF THE
TAXATION OF BUSINESS INCOME
1
S T U D Y T E X T
S T S TDUYD Y E T E X T
U
T
X T
CHAPTER ONE
TAXATION OF
SPECIALISED
ACTIVITIES
S T U D Y
T E X T
2
A dvanced TA X AT I O N
ADVANCED ASPECTS OF THE
TAXATION OF BUSINESS INCOME
3
CHAPTER ONE
ADVANCED ASPECTS OF THE TAXATION OF
BUSINESS INCOME
1
...
To enhance their understanding, various relevant case law examples have
been discussed
...
3
••
••
1
...
Company: it’s an association of persons who contribute capital towards common
stocks for a common aim
...
Exam Context
This topic is highly examined
...
1
...
The major beneficiary of the topic will be the finance manager, tax practitioners
and accountant who will apply the information in making key management decisions
...
In this
chapter, you will be introduced with concepts on advanced aspects of the taxation of business
income
...
In the next chapter you will cover
the taxation of specialized institutions
...
2 Introduction
4
A dvanced TA X AT I O N
1
...
The income of a
partnership is assessed on the partners
...
remuneration payable to him by the partnership together with interest on capital so
payable, less interest on capital payable by him to the partnership; and
ii
...
Where a partnership makes a loss as calculated in (ii) above, the gains or profits shall be the
excess, if any of the amount set out in (i) over his share of that loss
...
Whether a partnership exists or not is a question of fact
...
This suggests that the persons involved bear the attribute of a proprietor and have a profit
motive
...
Common situations which pose difficulties in proving a partnership are:
1
...
Whether the parties concerned are partners or merely employees
...
Joint transactions - JOHN GARDNER & BOWRING & CO V CIR
G arranged during a coal strike to buy imported coal from B
...
ADVANCED ASPECTS OF THE
TAXATION OF BUSINESS INCOME
5
Judgement "whereas these cargoes of coal generally had been formally the simple transaction
of purchase and sale between the parties, they immediately became the subject of a transaction
in which both parties were interested, and in which when one of them had sold the coal, the sale
was not on his behalf but on behalf of the two together the net profit, so obtained was equally
divisible between them"
...
2
...
Dickenson V Gross (Hmit)
E v CIT
E carried on business as a sole trader
...
A Deed was executed stating the partnership commenced on 1 June 1942
...
Neither the son nor any of the daughters contributed property, labour or skill to the partnership
...
Held:
Both the local committee and the High Court ruled that there was no evidence that a
partnership in fact existed
...
The other partners contributed neither property nor labour, nor skill
...
The partners in fact drew no profit
...
CIT V Williamson
A farmer and his sons for several years leased and worked in a farm jointly, but without any deed
of partnership
...
He made no regular payments to his sons but supplied them, on request, with such monies as
were necessary for their requirements
...
S T U D Y
Held:
That as a partnership did not exist in fact, and that there was no partnership for purposes
of income tax
...
The deed provided
inter alia that two farms owned by D should be let to D and his sons at stated rentals, that
accounts should be made up annually, that the net profits should be divided equally between the
partners, and that the partners shall have the right to sign and endorse cheques on behalf of the
firm
...
No distribution of profits was
made
...
6
A dvanced TA X AT I O N
The respondent appealed against additional assessment to income tax in respect of the farm,
raised on the basis that he alone was assessable
...
Opinions
The Lord President (Clyde)
"My Lords the question before us is whether there was a partnership between the father and his
three sons in whose joint names the lease
...
No doubt the lease was in joint names
...
There is no record of any kind to show the existence of any contractual relation of any sort
...
It was never operated
by anybody but him
...
You do not constitute or create or prove a
partnership by saying that there is one
...
Lord Sands
S T U D Y
T E X T
"Stated all the facts and circumstances of the case otherwise, except the matter of the lease,
appear to be against and, indeed almost exclusive of the idea of a partnership"
...
A Deed of assignment was exercised on 15 July 1929
whereby the vendor agreed to stay on in the practice for three months to introduce P to his
patients, with a view to maintaining the connection of the practice and generally to aid and assist
him in the practice
...
P contended that the practice was sold outright to him on 15 July 1929 and that his income tax
liability should be computed on the basis the practice was commenced anew by him on that
date
...
The practice was assessable as a new business in the name of the
purchaser only, and the vendor was in receipt of remuneration for services rendered
...
On 1 January, 1929, he instructed another firm of solicitors, by letter, to draft a partnership deed
...
No formal notice of the partnership was at any time given by advertisement, circular or otherwise
...
From 31 December 1928 the son
was credited with the share of profits to which he was entitled under the partnership deed
...
ADVANCED ASPECTS OF THE
TAXATION OF BUSINESS INCOME
7
Steps in Computing tax on Partnership Income
1
...
Note
that no profit is to be made from another partner
...
Allocate the income adjusted to the partner by first isolating salaries to partners, interest on
capital (net) to partners, bonus to partners, commissions, etc
...
Format of Income Tax Computation of a Partnership
Shs
Net profit as per A/C
Shs
XXX
Add back:
Partnership salaries
XX
Interest paid to partners
XX
Goods taken by partners
XX
Goodwill written off
XX
Partner's insurance
XX
Legal fees on Partnership agreements
XX
XX
Less
Non taxable income
X
Capital deductions allowed
X
(XX)
Adjusted partnership profits
XXX
Income Allocation to Partners
Total
Shs
Partner A
Shs
Salary
XXX
XX
XX
Interest on capital
XX
XX
XX
Interest on drawings
(X)
(X)
(X)
Share of profit
XX
XX
XX
XXX
XX
XX
Partner B
Shs
S T U D Y
T E X T
8
A dvanced TA X AT I O N
Note
The figure of the total profits to be shared is derived from the difference between the adjusted
profits plus interest on drawings minus salaries and interest on capital
...
Computing taxable income of a partnership where the partner has no proper books of
account
Jimna and Mwala are in partnership trading as Jimna Enterprises and sharing profits and losses
in the ratio of 2:1 respectively
...
The following information relates to the financial year ended 31 December 2007:
S T U D Y
T E X T
1
...
The following transactions were reflected in the bank statement of the partnership for the
year ended 31 December 2007:
Debit
Shs
...
800,000
965,000
114,000
705,000
620,000
90,200
19,400
58,000
39,620
40,000
4,000
460,000
840,000
24,000
360,000
5,600
36,000
448,000
20,000
Balance
Shs
100,000
900,000
1,865,000
1,979,000
1,274,000
654,000
563,800
544,400
486,400
446,780
406,780
410,780
870,000
30,780
6,780
366,780
361,180
325,180
(122,820)
(142,820)
(142,820)Dr
ADVANCED ASPECTS OF THE
TAXATION OF BUSINESS INCOME
9
3
...
3,000 per month taken as imprest by each
partner in order to pay for goods drawn from the firm
...
4
...
1,200,000 and
Sh
...
5
...
165,000
and Sh
...
6
...
(2 marks)
(Total: 20 marks)
Attempted solution
Step 1: Compute the figures not provided
...
JIMNA PARTNERSHIP
TOTAL DEBTORS ACCOUNT
Bal b/d
Credit Sales
Shs
...
‘000’
114
30
1,200
1,344
C/B
Bad debts
Bal c/d
Total Sales: Cash Sales + Credit Sales
[(965,000 + 72,000) + 744,000] =
1,781,000
Goods drawn (6,000 x 12) = Shs
...
Miscellaneous expenses include estate valuation fee of Shs
...
2
...
3
...
128,000
10
A dvanced TA X AT I O N
TOTAL CREDITORS
C/B
BAL C/D
Shs
...
‘000’
480
128
608
S T U D Y
T E X T
Step 2: Having obtained the total sales and total purchases figures, we can now use them to
compute the adjusted profit or loss for the partnership for the year 31 December 2006
...
ADVANCED ASPECTS OF THE
TAXATION OF BUSINESS INCOME
ADJUSTED PARTNERSHIP PROFIT OR LOSS FOR THE YEAR TO 31 DECEMBER 2006
Shs
...
‘000’
1,037
...
00
72
...
00
Cost of Sales
Opening stock
705
...
00
Allowable expenses:
Miscellaneous expenses
Electricity expenses
Sales assistants wages
Car running
Salaries and wages (840,000 – 325,000
Advertisement
Ledger fees
Insurance
Legal expenses (20,000 – 14,000)
Bad debts written off
Wear and tear allowance
Net profit
833
...
00)
90
...
40
58
...
62
515
...
00
5
...
00
6
...
00
297
...
‘000’
Shs ‘000’
Sales: Cash
Credit
Receipts for goods drawn (6,000 x 12 months)
Cost of Sales
Opening stock
Purchases – Cash
- Credit
Closing stock
Gross profit
Farming revenue
Allowable expenses:
Miscellaneous expenses
Electricity expenses
Sales assistants wages
Car running
Salaries and wages (840,000 – 325,000
Advertisement
Ledger fees
Insurance
Legal expenses (20,000 – 14,000)
Bad debts written off
Wear and tear allowance
Net profit
(800
...
00
360
...
00
(1,121
...
68
Shs
...
00
744
...
00
1,853
...
00
705
...
00
833
...
00)
90
...
40
58
...
62
515
...
00
5
...
00
6
...
00
297
...
00)
1,053
...
00
1,413
...
32)
291
...
00
S T U D Y
11
12
A dvanced TA X AT I O N
WEAR AND TEAR ALLOWANCE
III @ 25%
SHS ‘000’
CLASS
Brought forward:
Office equipment (net)
Motor vehicle (net)
IV @ 12½%
SHS ‘000’
180
480
Addition: Delivery van
Sub-total
Wear and tear allowance
620
1,100
(275)
825
____
180
(22
...
5
Total wear and tear allowance (275 + 22
...
5
Note:
T E X T
Step 2: Allocate the profits or losses to the partners according to the profit and loss sharing
losses taking into considerations the provisions of Section 4 (b) of the Income Tax Act
...
The net
book value has been used instead as representative of written down values at the beginning of
the year
...
7
JIMNA
SHS ‘000’
165
...
21)
142
...
00
(11
...
89
TOTAL
SHS ‘000’
325
...
32)
291
...
There are no fundamental differences
in the taxation of either private or public companies
...
Therefore, the amount of tax payable shall be determined at the beginning of
each year
...
Once determined, the instalment tax is payable as follows
...
25% of tax due by 20th day of the 6th month during the year of income
...
25% of tax due by 20th day of the 12th month during the year of income
...
However for firms in agriculture sector, instalment tax is payable as:
1st instalment
75% of tax due by 20th day of the 9th month during the year of income
...
final tax
Actual tax payable minus total instalment tax paid on the last day of the
fourth month after the end of the year of income
...
Newly listed companies
Companies newly listed on any securities exchange approved under the Capital Markets Act
enjoy favorable corporation tax rates as follows:
••
••
••
If the company lists at least 20% of its issued share capital listed, the corporation tax
rate applicable will be 27% for the period of three years commencing immediately after
the year of income following the date of such listing
...
”
If the company lists at least 40% of its issued share capital listed, the corporation tax
rate applicable will be 20% for the period of five years commencing immediately after
the year of income following the date of such listing
...
The applicable tax rate will depend
on the percentage of the issued share capital listed at the Nairobi Stock Exchange
...
Export Processing Zone Companies
Companies operating within EPZ have the following benefits:
1
...
2
...
3
...
S T U D Y
In Kenya, the corporate tax rate for a resident company is 30% whilst the tax rate for a permanent
establishment of non resident company is 37
...
A non resident company can have a permanent
establishment in Kenya by opening a branch
...
7
...
14
A dvanced TA X AT I O N
4
...
5
...
There is a refund of import duty on raw materials to manufacture exports
...
••
Emoluments paid to employees and resident directors of EPZ enterprises must subject
to PAYE deductions as required by law even during the period the enterprise is exempt
from tax
...
Resident companies mining specified minerals
Resident companies mining specified minerals under the Income Tax Act – for the first 4 years of
mining operations income is taxed 27
...
S T U D Y
T E X T
1
...
2
Tax Effects of Shortfall Distribution of Company Profits (Section 24)
The profits of a company after taxation may be distributed to the shareholders in full as dividends
or retained to provide finance, or be partly distributed and partly retained
...
The Act requires that a company paying dividends to deduct tax at source and remit it to the
Commissioner
...
When the profits
are subsequently distributed, they will not be taxed on the shareholders
...
Profits after tax from investment income are distributed in full
...
Illustration
Limited made a pre-tax profit of Kshs
...
Trading profits Shs
...
Investment income Shs
...
Dividends from B
...
30m
ADVANCED ASPECTS OF THE
TAXATION OF BUSINESS INCOME
15
State how much the company should distribute as dividends in order to comply with the Section
24 proviso (Assume corporation tax is 40%)
Trading Investment Non-taxable
Total
Profits
Income
dividends
Kshs
...
6)
NIL
NIL
(21
...
4
6
30
50
...
Like for resident companies,
such branches shall be allowed to deduct expenditure incurred in generation of income
...
There is a tax holiday during the first 10 years of
their operations, followed by a lower tax rate of 25% during the next ten year period
...
Special
withholding tax rates exist for certain specified income sources
...
On executive and general administrative expenses except to extent the commissioner may
determine to be just and reasonable
...
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
...
7
...
There is
no lifting of the veil to consider them as part of one group for tax purposes
...
T E X T
Taxation of Branches of foreign companies
...
7
...
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 considerations
...
Dividends paid by one resident company to another one exempted from tax in the recipients
company’s hands if it controls 12½% or more of the voting power of the paying company
...
1
...
5
Compensating tax and Dividend tax account
S T U D Y
T E X T
Compensating tax was introduced in 1993 under Section 7 A of the Income Tax Act
...
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
...
Companies are required to maintain a dividend tax account to monitor the incidence of
compensating tax
...
Thereafter the account is adjusted in the same way for each subsequent year
of income as follows:
Dividend Tax Account format
Particulars
Kshs
Debit
Dividend Tax Account Opening Balance b/forward as above (1
January 199x)
Total income taxes paid during the year
Tax on total dividends received during the year
(dividends x 0
...
7)
Total Refunds by KRA of taxes previously paid and included in the
calculation of income taxes earlier paid
Tax on total dividends distributed (dividends x 0
...
7)
Balance carried forward (if debit)
Kshs
Credit
X
X
X
X
X
X
Compensating tax payable ( if credit)
XX
X
XX
ADVANCED ASPECTS OF THE
TAXATION OF BUSINESS INCOME
17
A credit balance is carried forward to the next year while a debit balance indicates the compensating
tax payable
...
The tax is due for payment by the last day of the 6th month following the end of the
accounting period
...
2008
Details
Profit after Tax
Dividend paid
Dividend received
Kshs
...
DR
Income tax paid (0
...
3/1-0
...
3/10
...
Tax paid excludes withholding tax on qualifying dividends but includes compensating tax
...
7
...
The same principle is
applied in disallowing capital losses, exhaustion of capital e
...
depreciation of fixed assets
...
S T U D Y
Computation of compensating tax
T E X T
Attempted solution
18
A dvanced TA X AT I O N
The distinction between capital expenditure and revenue expenditure is quite essential in the
study of capital allowances
...
To encourage new industrial enterprises;
2
...
To encourage exportation
...
b
...
d
...
Investment Deduction Allowance
Wear and Tear Allowance
Industrial Building Allowance
Farmworks Deduction Allowance
Mining Deduction
(a) Investment Deduction
Based on eligible cost:
Rate %
S T U D Y
T E X T
We provide a summary of the capital allowances on the assumption that the same were covered
in detail in the taxation 1 level
...
E
...
E
...
Investment deduction is granted to lessors on machinery that is
subsequently leased and used for the purpose of manufacture
...
200 million
...
5
Computer and peripheral computer hardware, calculators, copiers
and duplicating machines
30
Other self propelling vehicles and aircrafts (cost of non-commercial
motor vehicles is restricted to KShs 2 million)
25
12
...
E
...
E
...
The wear and Tear Allowance rate for telecommunication equipment is 20%
Industrial buildings
Hotel buildings
Hostels and buildings used for educational purposes
Hostels, Training and educational buildings (W
...
F 12th June 2009)
Rental residential buildings constructed in a planned
Rate %
2
...
E
...
E
...
3%
2007 to date 50%
S T U D Y
Based on cost net of any investment deduction and computed on a straight line basis:
T E X T
(c) Industrial buildings allowance
20
A dvanced TA X AT I O N
(e) Mining allowance
Based on capital expenditure incurred in mining specified minerals:
Rate %
40
10
Year 1
Year 2 – 7
Illustration Question
a) The following is the summarised balance sheet of Faraja Ltd
...
Shs
...
20
each)
10% debenture stocks
15% bank loan
Current liabilities:
Creditors
Accrued general expenses
Total capital liabilities
2,900,000
14,010,000
9,000,000
2,400,000
1,500,000
1,000,000
110,000
12,900,000
1,110,000
14,010,000
Additional information:
1
...
The net book value of these assets as at 1 January 2007 were the same as their
written down values for capital allowance purposes
...
Included in the processing machinery are machinery with a net book value of Shs
...
This machinery are used in designing and moulding products during
the manufacturing process
...
Office equipment as at 1 January 2007 comprised the following assets at net book value:
ADVANCED ASPECTS OF THE
TAXATION OF BUSINESS INCOME
Computers
Telephone
switchboard
Fax machines
Neon sign
Other office
equipment
21
Shs
...
1,200,000
...
The reported profit of the company for the year ended 31 December 2007 was Sh
...
The reported
profit was based on cash sales
...
The following transactions included in the bank statement for the year had also not been
accounted for in arriving at the reported profit:
T E X T
Insurance paid includes a pre-payment of Sh
...
7
...
All
payments from/to trade debtors and creditors were made through the bank account
...
FARAJA LTD
i) CAPITAL ALLOWANCES FOR YEAR TO 31 DECEMBER 2006
a) INDUSTRIAL BUILDING DEDUCTION
Nature of building
Factory building
Qualifying Cost
Shs
...
541
Residue b/f
Shs
...
‘000’
153
...
‘000’
5,526
...
2,800,000
1,400,000
360,000
346,400
550,800
140,000
22
A dvanced TA X AT I O N
b) WEAR AND TEAR ALLOWANCE
CLASS
I @37½%
II @ 30%
III @ 25%
IV @ 12½
S
...
‘000’
SHS
...
‘000’
W
...
V b/f:
Computers
Telephone switchboard
Fax machine
Neon sign
Other office equipment
Motor vehicles
Furniture and fittings
Processing machinery
Sub total
WTA
36
178
1,500
456
(136
...
2
ADJUSTED TAXABLE PROFIT OR LOSS FOR YEAR TO 31 DECEMBER 2006
SHS
...
8 – 50
...
‘000’
153
...
8
375
434
...
564
II
III
V
Total Capital allowances
ii)
840
2,420
3,474
(434
...
75
SUMMARY OF CAPITAL ALLOWANCES
IBD
WTA
T E X T
S T U D Y
240
96
120
SHS
...
00
2,040
...
00
400
...
40
500
...
56
2,180
...
00
(2,345
...
04
DEBTORS ACCOUNT
Bal b/d
Credit Sales
SHS
...
‘000’
2,800
_____
2,800
ADVANCED ASPECTS OF THE
TAXATION OF BUSINESS INCOME
23
CREDITORS ACCOUNT
Bank
Balance carried down
SHS
...
‘000’
1,000
400
1,400
••
••
••
••
••
Partnerships are not legal persons
...
5% respectively
...
There are differences in the taxation of a branch of a foreign company compared to a
resident company
...
There are five major types of capital allowances in Kenya, applicable to expenditure of
a capital nature incurred in the generation of income
...
9 Quiz
Questions one
Name the five capital allowances in Kenya
Question two
Distinguish between taxation of partnerships and private limited companies
...
Question Four
Explain the dates for instalment tax payment for companies
...
8 Chapter Summary
24
A dvanced TA X AT I O N
Question Five
S T U D Y
T E X T
What is compensating tax?
ADVANCED ASPECTS OF THE
TAXATION OF BUSINESS INCOME
1
...
b
...
d
...
Investment Deduction Allowance
Wear and Tear Allowance
Industrial Building Allowance
Farmworks Deduction Allowance
Mining Deduction
Question two
ii)
A partnership is not considered as a separate taxable entity as a company, therefore,
the taxable income of a partnership is allocated among the partners according to the
profit/loss sharing ratio
...
The partners in a partnership are taxed at the graduated scale rates which are lower than
the corporate tax rates
...
5 % for nonresident companies
...
iv) Very important also to consider is that the losses made under a partnership are carried
forward by the Partners individually but not the firm while losses in a limited company
are carried forward by the company
...
The partners may
withdraw and any such withdrawal will be taxed on the individual partner
...
vii) Currently partnership can pay turnover tax at 3% on gross income if the company has
turnover of between Kshs
...
5m within one year
...
Question Three
List the incentives if companies operating in the EPZ zone
...
S T U D Y
i)
T E X T
Distinguish between taxation of partnerships and private limited companies
...
An exemption from all Withholding tax on dividends and other payments to non
residents during the first 10 years
...
Zero rated for purposes of VAT
There is a refund of import duty on raw materials to manufacture exports
...
Instalment tax is payable as follows
...
25% of tax due by 20th day of the 6th month during the year of income
...
25% of tax due by 20th day of the 12th month during the year of income
...
However for firms in agriculture sector, instalment tax is payable as:
1st instalment
2nd instalment
final tax ( tax
balance)
75% of tax due by 20th day of the 9th month during the year of income
...
Actual tax payable minus total instalment tax paid on the last day of the
fourth month after the end of the year of income
...
It is an
additional tax imposed on companies and arise if a company pays dividends from untaxed profits
...
Note that capital gains
tax was suspended in 1985 and stands suspended to date
...
11
27
Past paper Questions analysis
...
The student is advised
to practice the questions so as to enhance understanding of the topic
...
The questions are listed in this
format: Month/year e
...
6/01 represents June or May 2001
...
1, 06/00 Q
...
1, 2, 3, 06/01 Q
...
5, 12/01 Q
...
5, 06/02
Q
...
5, 12/02 Q
...
2, 06/03 Q
...
1 & 2, 06/04 Q
...
5,
12/04 Q
...
3, 06/05 Q
...
3, 06/05 Q
...
1(a), 12/05 Q
...
3, 12/05 Q
...
1, 06/06 Q
...
2, 12/06 Q
...
2, 06/07 Q
...
4(b), 12/07 Q
...
4(a), 12/07 Q
...
1, 06/08 Q
...
4,
12/08 Q
...
5(b)
...
Tax Rates
VALUE OF TAXABLE BENEFITS PRESCRIBED BY CIT (YEAR 2008)
Taxable Employment Benefits - Year 2008
RATES OF TAX (Including wife’s employment, self employment and professional income rates
of tax)
...
12
28
A dvanced TA X AT I O N
Personal relief Shs
...
13,944 per annum)
Prescribed benefit rates of motor vehicles provided
by employer
Monthly A n n u a l
rates
rates
Capital allowances:
(i)
S T U D Y
T E X T
Wear and tear allowances
Class I
37
...
5%
Industrial building allowance:
Industrial buildings 2
...
0%
2007 to date
10%
Farm works
allowance
2006
33%
2007 to date
50%
Investment deduction allowance:
2003 70%
(iii)
2004 100%
(Sh
...
)
Upto
43,200
1750 cc
3,600
43,200
50,400
69,600
86,400
103,200
172,800
Over
1750 cc
4,200
50,400
Land Rovers/Cruisers
7,200
86,400
OR 2% of the initial capital cost of the vehicle for
each month, whichever is higher
...
Sh
...
Other benefits:
Other benefits, for example servants, security, staff meals etc are taxable at the higher of fair
market value and actual cost to employer
...
Briefly discuss the tax implication of the taxation of branches of foreign companies and
companies registered in Kenya
...
The management of Mazuri Limited has presented the following trading and profit and
loss account for the year ended 31 December 2007:
Expenditure:
Goodwill amortisation
Legal expenses
Salaries
Bad debts
NSSF contribution
General expenses
Advertising
Staff meals
Travelling expenses
Donations to a trade association
Property rates
Depreciation
Interest on long term
Interest on bank overdraft
Insurance
Cost of stolen stock
Branch closure costs
Net profit
(7,400)
11,100
120
40
80
100
11,440
25
420
2,000
500
60
600
300
190
180
40
45
150
300
80
124
20
100
(5,134)
6,306
T E X T
4,200
5,600
9,800
(2,400)
Ksh
...
‘000’
Sales
Less cost of sales:
Opening Stock
Purchases
Cost of goods available for sale
Closing stock
Gross profit
Other incomes:
Gain on sale of equipment
Interest on savings account
Refund of import duty
Gain on foreign exchange transactions
30
A dvanced TA X AT I O N
Additional information:
1
...
2
...
150,000
60,000
90,000
100,000
20,000
420,000
3
...
600,000 (selling price Ksh
...
These goods have been included in both purchases and sales for
the year ended 31 December 2007
...
Sales (expense) includes:
Ksh
...
Bad debts include:
S T U D Y
T E X T
Preparation of the Memorandum of
Association
Conveyance fees on purchase of land
Acquisition of leasehold property
Settling customer disputes
Acquisition of a bank loan
Loan to director
Estimated defaults by trade debtors
Ksh
...
Advertising expense includes Ksh
...
Twenty per cent of the travelling expenses relate to the private usage of company
motor vehicles
...
Capital allowances were agreed with the revenue authority at Ksh
...
Required:
i)
Adjusted taxable profit or loss for Mazuri Limited for the year ended 31 December
2007
...
4)
ADVANCED ASPECTS OF THE
TAXATION OF BUSINESS INCOME
31
Question Two
Christine, Atieno and Rose Njeri started a law firm as partners on 1 January 2007
...
The partners opened a joint account where Njeri deposited
Kshs
...
2,000,000 as initial capital
...
Further, they agreed
that interest on capital would be paid at the rate of 5% per annum based on the initial capital
contributions
...
200,000
...
On 11th January 2007, the firm purchased the following assets for use in the business:
280,000
120,000
40,000
16,000
3,000
12,000
6,000
22,000
25,000
The firm did not maintain all the necessary books of account as required under the Income Tax
Act (CAP 470)
...
Professional fees earned amounted to Shs
...
Of this amount, Shs 3,700,000
was received in cash while the balance was directly deposited by clients to the firm’s
bank account
...
The following monthly payments were made from fees received in cash before banking
the balance at each month end:
Shs
...
Analysis of the firms bank statement for the year showed the following summary of
payments:
Shs
Lease payment
400,000
Purchase of motor vehicle(double cabin pick up)
2,500,000
Purchase of other assets
524,000
Office expenses
2,921,000
Advertisement Commission
200,000
T E X T
Cost (Shs)
2,500,000
S T U D Y
Asset
Motor vehicle (double-cabin pick-up)
Other Assets:
Furniture and fittings
Computers and printers
Telephone and fax machines
Reference books
Kitchen utensils (for office tea)
Television Set
Fans
Carpets
Safe (Metallic)
32
A dvanced TA X AT I O N
4
...
(14 marks)
b) Allocation of profit ir loss obtained in (a) above to the partners
...
(2 marks)
(June 2008 1)
Question Three
Starlit company Ltd
...
The company is a
subsidiary of Mega Holdings Ltd
...
The financial statements of Starlit Company Ltd
...
ADVANCED ASPECTS OF THE
TAXATION OF BUSINESS INCOME
33
Profit and loss account for the year ended 31 December 2005
Sh ‘000’
Sh ‘000’
Sales
97,440
Less cost
44,940
Gross profit
52,500
Less expense
Wages
Depreciation
7,500
Interest
1,500
General expenses
9,000
48,000
Net profit
4,500
Proposed dividend
600
Retained profit for the year
3,900
Sh ‘000’
Sh ‘000’
Fixed assets (net)
92,350
Current assets
Stock
6,000
Trade creditors
2,250
Bank balance
15,000
23,250
Total assets
115,600
Capital and liabilities
Ordinary share capital
87,000
Debentures
13,500
Retained profits
10,000
Current liabilities
Trade creditors
4,125
Accrued wages
375
Proposed dividend
600
5,100
Total capital and liabilities
115,600
T E X T
Balance sheet as at 31 December 2005
S T U D Y
30,000
34
A dvanced TA X AT I O N
Bank account for the year ended 31 December 2005:
Sh ‘000’
Balance brought forward
1,500
Receipts from customers
98,250
Sh ‘000’
Wages
30,375
General expenses
9,000
Payments to suppliers
43,125
Interest
1,500
Dividend
750
Balance carried down
15,000
99,750
99,750
Additional information
1
...
2,100,000 representing goods sold to the parent company
...
2
...
‘000’
Flotation cost on issue of debentures
1,400
S T U D Y
T E X T
Stamp duty on issue of debentures
Conveyance fees on purchase of land
800
2,000
Foreign exchange losses relating to the
parent company’s transactions
...
The written down values of fixed assets extracted as at 1 January 2005 were as
follows:
Sh
...
However, the company claimed industrial building reduction (IBD) and
wear and tear allowances on the industrial building and processing machinery respectively
from years 2005 and 2006
...
1,200,000 and freight charges
of sh
...
Required:
(a) (i) Compute the investment deduction allowance that was due to the company in year
2003
...
(4 marks)
(iii) Compute the industrial building deduction allowance due to the company in years
2003, 2004 and 2005
...
(Hint: Start your computation with the reported profit)
(10 marks)
(Total: 20 Marks)
(June 2006 1)
a
...
470) relating to shortfall tax on nondistribution of dividend
...
Samia Ltd reported the following income during the year ended 31 December 2007
...
12,000,000
650,000
1,600,000
S T U D Y
Operating Income (before tax)
Investment income
Rental income(gross)
Additional information:
1
...
Dividend from a company in which Samia Ltd
Holds 20% of the share capital
Interest from fixed deposit accounts(net)
Interest from treasury bills(net)
T E X T
Question Four
100,000
50,000
500,000
650,000
2
...
declared a dividend of Kshs
...
Required:
Determine the shortfall tax (if any) payable by Samia Ltd for the year ended 31 December
2007
...
470), define the term “compensating
tax”
(2 marks)
b) The following information relates to ABC Ltd for the year ended 31 December 2007:
••
••
••
••
••
Profit before tax
Import duty refunded by tax authority
Dividend distributed by ABC Ltd
Dividend received by ABC Ltd
Corporation tax rate
Sh
...
3,000,000
30%
Required
Compensating tax payable by ABC Ltd
...
Identify four areas which may constitute a custom’s area
(4 marks)
d) D
...
where he controls 15% of the voting
capital
...
The following information relates to his income for the year ended 31 December 2007
...
Employment
•• Basic pay Sh
...
1,300,000
•• He was issued with additional 1,000 shares in the company at a price of Shs
...
80per share
...
8,000 per month
...
Rental income
Shs
Gross rent
Less:
Structural alterations
Land rent and rates
Loan interest
Valuation of rental buildings
Commission to estate agents
Purchase of furniture and fittings for tenants
Painting before letting
Legal fees
Net rental income
600,000
48,000
200,000
140,000
28,000
100,000
96,000
24,000
Shs
1,960,000
(1,236,000)
724,000
Land rent and rates include Sh8,000 paid as deposit for water connection
...
Legal fees relate to collection of rent arrears
...
Flower business
This is a partnership with his wife where they share profits and losses equally
...
Sales proceeds for the year to 31 December 2007
amounted to Sh
...
The following expenses have not been deducted from the sales
proceeds:
Salary to wife (arm’s length
Construction of flower sheds
Purchase of pesticides
Foreign exchange losses
Other farm expenses
Shs
600,000
240,000
180,000
64,000
1,200,000
Required:
Total taxable income of D
...
1
Objectives
2
...
In this chapter, you will be introduced to the taxation of other specialized activities or institutions
which include: leasing, banking, insurance, petroleum, trust, co-operative societies among
others
...
In the next topic we shall study concepts in tax investigation
...
3
••
••
••
Key Definitions
Leasing entity: This is a firm or a company involved in the business of leasing
Lease: This is a contract by which a person owning assets grants to a leasee the right
to possess, use and enjoy such assets for a specified period of time, in exchange for
periodic payments
...
Co-operative society: A Cooperative Society is taken to be a body corporate having
its own existence separate from that of its members
...
It
S T U D Y
••
••
••
••
••
••
••
••
••
T E X T
At the end of this chapter, the student is expected to be able to compute tax liability
under the following institutions
...
42
A dvanced TA X AT I O N
••
••
••
••
S T U D Y
T E X T
••
2
...
It is formed under the Co-operative Societies Act
...
Club: A members club means a club or similar institution with all its assets owned by,
or held in trust for the members thereof
...
Charitable Institutions: This is an non profit making organization established in Kenya
which
• Is of public character and
• Has been established for purposes of the relief of poverty or distress of the public
or advancement of education
...
Unit trust:- A Unit Trust or a mutual fund organization is one registered under the Unit
Trust Act
...
The unit holder gets a return (interest) from the Unit Trust tax free
...
The student advised to master the content
and be able to apply the same in exam questions
2
...
It will be helpful to tax or finance managers in various industries or
sectors
...
2
...
All other leases are classified as operating leases
...
Any income derived from leasing activities is taxable at the corporate tax rate
...
6
...
However, this distinction exists
for Value Added Tax (VAT) purposes
...
if the Commissioner is satisfied
that:
a
...
The entire payment is income in the hands of the recipient
...
Related costs such as maintenance are allowable expenses for tax purposes
...
The lessor enjoys wear and tear allowance deductions as long as the equipment was utilized
wholly and exclusively for generation of taxable income
...
In case the lessor is a non-resident with no branch in Kenya, tax is
withheld at a rate of 15% which is a final tax
...
6
...
Operating Lease: Ownership remains with lessor throughout the entire lease agreement
...
Leasing is considered as a service, and lease instalments, being payments for this service, are
subject to VAT
...
Leasing of land, residential buildings, and non-residential buildings are exempted from VAT
...
S T U D Y
2
...
2
T E X T
The lessor enjoys investment allowance and which is deducted from his profits in the same
tax year in which investment is made
...
44
A dvanced TA X AT I O N
Illustration
You are provided with the following information for Anne lease hire Ltd, a company in the business
of leasing vehicles for the year ended 31 December 2008
...
Compute Withholding tax deductible
...
In this case, Kshs
...
2
...
A Cooperative Society is taken to be a body corporate having its own existence separate from
that of its members
...
The accounts of Cooperative Societies must be
audited by a professional accountant
...
7
...
TAXATION OF SPECIALISED ACTIVITIES
45
Mutuality is recognised in general law that a person cannot make a profit from himself
...
g
...
When a cooperative society gets involved in activities which are not its primary objectives,
then income derived thereof is taxable and the society become liable to tax, i
...
7
...
When it acquires a farm from which the main produce is the product is the product of
the society as a farm owner
...
When it has investment income such as dividends and interests
...
For tax purpose,
cooperatives are broadly classified into:
Those registered under the Cooperative Societies Act (Designated Cooperative Societies) are
further classified as follows:i
...
( Secondary
societies)
These are Apex and Union Cooperative Societies
...
Designated Primary Societies
...
The membership of which is restricted to individual persons
...
(SACCO)
Those not carrying on the business of a SACCO
...
Apex societies have membership of
union societies whilst unions members are primary societies
iii
...
e KFA, KCC 2000, KPCU, COOP
Bank
...
Cooperative Societies registered under the Companies s Act are taxed just like any other
company
...
7
...
e
...
However, dividends and bonuses are allowable expenses against
adjusted income up to a maximum of 100% of adjusted profit and must not exceed adjusted
profit
...
Illustration
Kilimo Union Co-Op Society Ltd
Year 2001 Profit And Loss Account
SH’000’
Gross profit
SH’000’
32,000
Less expenses
S T U D Y
T E X T
Salaries and wages
Director’s fees
Rent and rates
Travel and entertainment
Donations
Legal fees-bank overdraft
Income tax paid
Bad debts reserve
Provision for leave passages
Loss on sale of investment
Furniture and fittings
General expenses
Tax Consultation fees
Depreciation
Surplus income
4,400
1,000
1,200
400
1000
1,600
2,400
800
500
300
1,000
2,200
140
2,000
(18,940)
13,060
Required
Compute the adjusted surplus
...
Compute the tax payable by the cooperative
...
00
Surplus as per the accounts
ADDDeductions not allowable
Furniture and fittings
Depreciation
Legal fees-bank overdraft
Income tax paid
Bad debts reserve
Provision for leave passages
Donations ( Note 1)
Loss on investment
Less: Deductions allowable
Wear and tear on Furniture and fittings(12
...
00
2,000
...
00
2,400
...
00
500
...
00
300
...
00
22,660
...
00)
22,535
...
50)
2,253
...
05
Note 1: I have assumed that the donations are to charitable organizations
...
7
...
e
...
1
...
2004)
...
They must have been authorised by the Commissioner of Cooperative development
...
If not paid out then the auditors should guarantee that
the amount will be paid
...
T E X T
S T U D Y
48
A dvanced TA X AT I O N
2
...
5
Taxation of a SACCO
(a) The income of a SACCO is made up of:
(b) Interest from the member’s loans
...
g banks, insurance companies and other financial
institutions
...
(e) Other gains chargeable to tax in the Act
...
Administrative expenses to the SACCO are not allowable
...
• Its gross rental income
...
• Any other income chargeable to tax excluding royalties
...
6,000
255
2,500
300
800
9,855
2,450
300
600
80
35
100
200
140
120
50
25
(4,100)
5,755
TAXATION OF SPECIALISED ACTIVITIES
49
Attempted Solution
Jaribu Sacco
Year 2001 Taxable Surplus and Tax Liability
SH’000’
TAXABLE INCOME
Interest income from KCB
Rental income
Dividends from Wananchi
Total taxable surplus
Tax thereon @ 30%
Less set off taxes
(300x50%)
800 x 100/85 x 50%
150
2500
470
...
588
936
...
8
Withholding tax on KCB interest is not final tax
...
Dividends from XYZ Ltd (Gross) suffers withholding tax at source which is Final tax
...
However, members of taxable trade associations are allowed to deduct the subscriptions
in their income tax computation
...
However,
they may engage in trade
...
In which case, it’s gross receipts from
the transactions with members (including entrance fees and subscription fees) and with other
persons is deemed to be income from the business for that year of income at the corporate tax
rate
...
9
Taxation of Clubs
Under Section21 of the Income Tax Act, a members club means a club or similar institution
with all its assets owned by, or held in trust for the members thereof
...
However, when ¾ or more of such investment is derived from members, the body will not be
taken to be carrying on business and no part of such non investment income will be taxed i
...
S T U D Y
••
••
T E X T
Notes
50
A dvanced TA X AT I O N
Investment income of a club such as dividends, interest, rents, capital gains etc are to be excluded
in the ¾ test mentioned above
...
10
Taxation of amateur sporting association
Under Paragraph 6 of the first schedule to the Income Tax Act, income other than income from
investment of an Amateur sporting association is not taxable
...
11
Whose sole aim or object is to foster outdoor sports and control any outdoor sports
...
Whose memorandum of association or by laws have provisions defining an amateur or
a professional and providing that no person other than an amateur shall be a member
of that association
...
A venture capital company is a company incorporated in Kenya for the purpose of
investing in new and expanded business
...
( A registered
venture capital company is a venture capital company registered by the CDT as such)
Gains arising from trade in shares of a venture company earned by a registered venture
capital company within the first ten years from the date of first investment in that venture
company by the venture capital company are tax exempt
...
11
...
TAXATION OF SPECIALISED ACTIVITIES
51
2
...
2 Prohibited services
The primary activities of a Venture Capital Enterprise shall not include (a) trading in real property;
(b) banking and financial services; or
(c) retail and wholesale trading services
2
...
The income of charitable trusts is exempt under paragraph 10 of the First Schedule to the Income
Tax Act
...
In summary, therefore, the income of a charitable trust is exempted from tax if:
(i) It is public in character
(ii) If it is established for relief of distress or poverty to the public
...
(iv) Its total income is used or spent for charitable purposes
...
S T U D Y
•• The relief of the poverty or
•• Distress of the public, or
•• For the advancement of religion or education established in Kenya
For the income to be exempt, any of the following conditions must also be met:
T E X T
••
••
52
A dvanced TA X AT I O N
2
...
It also does not include a
disposition, trust, covenant, agreement, arrangement, or transfer of assets, resulting from an
order of a court unless that order is made in contemplation of this provision;
The term "child" means a child under the age of nineteen years and includes a step-child, an
adopted child and an illegitimate child;
S T U D Y
T E X T
The term "settlor", in relation to a settlement, includes a person by whom the settlement was
made or entered into directly or indirectly, and a person who has provided or undertaken to
provide funds directly or indirectly for the purpose of the settlement, or has made with another
person a reciprocal arrangement for that person to make or enter into the settlement;
2
...
1Income Settled on Children
Under section 25
...
Provided that it shall not apply to any year of income in which (i) the income so paid does not exceed one hundred shillings; or
(ii) the child attains the age of nineteen years
...
Where tax is charged on and is paid by the person by whom the settlement was made, that person
shall be entitled to recover from a trustee or other person to whom the income is payable under
the settlement the amount of the tax so paid, and for that purpose to require the Commissioner to
furnish to him a certificate specifying the amount of the tax so paid, and a certificate so furnished
shall be conclusive evidence of the facts appearing therein
...
2
...
2 Income deemed to be income of settlor
The income of certain settlements may be deemed to be income of settlor
...
(1)
of the Income Tax Act, all income which in a year of income accrued to or was received by a
person under a settlement from assets remaining the property of the settlor shall, unless that
income is deemed under section 25 to be income of the settlor for an earlier year of income, be
deemed to be income of the settlor for the year of income in which it so accrued to or was received
by that person and not income of another person whether or not the settlement is revocable and
whether it was made or entered into before or after the commencement of this Act
...
• Where, under this section, tax is charged on and is paid by the settlor, the settlor
shall be entitled to recover from the trustees or other person to whom the income
is payable under the settlement the amount of the tax so paid, and for that purpose
to require the Commissioner to furnish to him a certificate specifying the amount of
the tax so paid, and a certificate so furnished shall be conclusive evidence of the
facts appearing therein
...
T E X T
Further, all income, which in a year of income accrued to or was received by a person under a
revocable settlement shall be deemed to be income of the settlor for that year of income and not
income of another person
...
14
Where, under this section, income is deemed to be income of the settlor, it shall
be deemed to be income received by him as a person beneficially entitled thereto
under the settlement
...
14
...
A "petroleum company" means a corporate body that carries out,
in addition to any other activities, operations under a petroleum agreement entered into under
the Petroleum (Exploration and Production) Act
...
A "petroleum service subcontractor" means a
non-resident person who provides services in Kenya to a petroleum company
...
Under Section 4 of the Petroleum Act, no person shall engage
in any petroleum operations in Kenya without having previously obtained the permission of the
Minister
...
"petroleum operations" means all or any of the operations related to the exploration for,
development, extraction, production, separation and treatment, storage, transportation and sale
or disposal of, petroleum up to the point of export, or the agreed delivery point in Kenya or the
point of entry into a refinery, and includes natural gas processing operations but does not include
petroleum refining operations
...
A "petroleum agreement"
means the agreement, contract, or other arrangement between the Government and a
contractor to conduct operations in accordance with the provisions of this Act; or
(c) In such other manner as may be necessary or appropriate
...
Notwithstanding the provisions of this section, the Government may grant to any person, other
than the contractor, a permit for the prospecting and mining of minerals or other natural resources
other than petroleum or the conduct of operations other than petroleum operations within an area
which is the subject of a petroleum agreement, provided that the prospecting, mining and the
other operations shall not interfere with petroleum operations
...
14
...
Determination of income
(1) Under the section, in determining the gains or profits of a petroleum company for a year
of income for the purposes of this Act there shall be brought into account the value of the
production to which a petroleum company is entitled under a petroleum agreement in that
year of income
...
Disposal of petroleum
Where a person disposes of petroleum and, for the purposes of ascertaining the gains or profits
of that person, the market value of the petroleum is calculated at arm’s length, the consideration
for the acquisition of that petroleum, for the purposes of ascertaining the gains, profits or losses
of the person acquiring that petroleum, shall be that market value
...
(2) For the purposes of this Schedule, the market value of petroleum shall be determined in
accordance with the petroleum agreement entered into with the petroleum company but
where the terms of the petroleum agreement do not in any case provide a valuation, the
market value shall be (a) where petroleum is disposed of to third parties at arm's length, the amount actually
receivable for that sale, at the FOB point of export, or at the point that title and risk pass
to the buyer;
(b) in any other case(i) If there have been sales to third parties at arm's length during the current calendar
quarter, the weighted average per unit price paid in those sales, at the FOB point
of export, or at the point that title and risk pass to the buyer, adjusted for quality,
grade and gravity, and any special circumstances;
(ii) If there have been no sales to third parties at arm's length during the current
calendar quarter, the weighted average per unit price at the FOB point of export,
or at the point that title and risk pass to the buyer, paid elsewhere in arm's length
sales of petroleum of a similar quality, grade and quantity, adjusted for any special
circumstances of those sales
...
(2) For the purposes of subparagraph (1), there shall be deducted –
(a) intangible drilling costs;
(b) Geological and geophysical costs;
(c) Payments to the Government, or any agency thereof, pursuant to the provisions of the
petroleum agreement entered into with the petroleum company;
(d) Production expenditure;
(e) Executive and general administrative expenses wholly and exclusively incurred in
Kenya by a petroleum company;
(f) Where a non-resident petroleum company operates in Kenya through a permanent
establishment in Kenya, only those reasonable executive and general administrative
expenses incurred outside Kenya by that person, including management or professional
fees, but limited to the amount that is attributable to the permanent establishment in
Kenya and is fairly and reasonably allocated thereto;
(g) Management or professional fees, including those paid to persons outside Kenya limited
to the amount that is attributable to the petroleum company and is fairly and reasonably
payable thereby; and
(h) Interest paid, including interest paid by a non-resident petroleum company and fairly
and reasonably allocated to a permanent establishment maintained in Kenya by that
company, but no interest paid shall be deductible unless (i) The payment does not exceed the amount that would have been payable on a loan
concluded at arm's length where the loan, repayment thereof, and the interest payable
constitute the only consideration for the making of the loan;
(j) the loan, in respect of which interest is paid, is applied for operations by the petroleum
company in Kenya, but where only part of the loan is applied in accordance with this
paragraph only the interest payable in respect of that part shall be deductible;
(k) Withholding tax on interest has been deducted and paid to the Commissioner
...
(4) Where a well which fails to discover petroleum is drilled and abandoned, the expenditure
incurred in drilling the well, which has not been deducted under another provision of this Act,
shall be deducted in the year of income in which the well is abandoned
...
Assignment of petroleum agreement and disposal of assets
An assignment of a right under a petroleum agreement shall not give rise to Capital gains tax but,
subject to this paragraph, the consideration for the assignment shall be treated as a receipt of
the petroleum company, and tax shall be charged accordingly
...
Where a right under a petroleum agreement is assigned, the Assignee shall be treated as having
incurred, at the date of the assignment, qualifying expenditure equal to the lesser of the total
amount of the consideration paid for the assignment and the market value of rights and assets
representing qualifying expenditure assigned
...
Where an asset representing qualifying expenditure is brought into use without being purchased,
or, without being sold, ceases permanently to be used, by a petroleum company, it shall be
deemed to have been purchased or sold at market value
...
T E X T
The assignment is of part only of the rights held by a petroleum company, or where not all
the assets which represent qualifying expenditure are included in the assignment, the amount
of qualifying expenditure not yet allowed against income which is to be deducted from the
consideration for the assignment shall be apportioned by the Commissioner
...
Some of the salient provisions of the
Schedule are inter alia:
“Paragraph 9: PSS shall be deemed to have made a taxable profit equal to 15%, assumed
profit rate, of all the moneys paid by a Petroleum company (taxable service fee), which
profits shall be taxed at the rates set out in the Third Schedule applicable to nonresident companies which have a permanent establishment in Kenya
...
Paragraph 10: when paying a taxable service fee, the petroleum company (PC) shall:♦♦ Deduct an amount of tax equal to the sum produced by applying the income tax rate
referred to in paragraph 9 to the assumed profit;
Paragraph11: the tax collected by the PC under this paragraph in a month shall be remitted
within 30 days to the Commissioner with a return of amounts paid and tax deducted,
hereinafter referred to as the “subcontractors return” showing…
♦♦ The total taxable service fee paid;
♦♦ The total tax deducted and remitted;
♦♦ The total amount paid for mobilization and demobilization; and
♦♦ The total amount paid for reimbursement of expenses
...
The taxes payable on this amount and for which the petroleum company is subject to
withhold and remit to the revenue authorities is Kshs
...
625 (37
...
The aforesaid taxes ought to be remitted to the tax authorities within 30 days by the PC with a
return referred in the Schedule as “the subcontractor’s return” in respect of that month amounts
as outlined above
2
...
3 Value Added Tax Rules on Taxation of petroleum companies
Some of the goods and supplies used by a petroleum companies to carry out its exploration
activities either by itself or by an subcontractor attract VAT at 16%
...
2
...
4 Customs & excise rules on taxation of petroleum companies
Under the Customs & excise rules, a petroleum company can make an application for duty
remission on its imports
...
Under the terms of the petroleum agreement, the company has
been allowed to explore along the Kenyan waters and share the proceeds with the government
on a 50: 50 basis
...
You are provided with the following information with regard
to Titanic limited
...
5% of
10000)
T E X T
Titanic Limited
Draft Income statement
59
4,000
10,000
Kshs
732,000
14,000
746,000
Adjusted taxable profit
(1,250)
744,750
Corporation tax payable at 30%
223,425
60
A dvanced TA X AT I O N
Part 2
TNM Ltd
Service fee paid
Assumed profit ( 15%)
Corporation tax at 37
...
11,250
and remit the same within 30 days of such withholding to the CDT
...
15
Taxation of Banks
S T U D Y
T E X T
The Banking industry is a very dynamic and competitive industry
...
It is regulated by the Central Bank of Kenya Act (Cap 491, Laws of Kenya) and
regulations and the Banking Act (Cap 488, Laws of Kenya)
...
There is no fundamental difference
between the taxation of Banks and other companies
...
Some unique features are:
••
••
Thin capitalization provisions do not apply to the Banking sector
...
Illustration
The management of Shamrock Bank Ltd
...
The income statement of Shamrock Bank Ltd
...
000
61
Kshs
...
Salaries and employee benefits comprise:
Sh
...
Included in the Directors’ “other” emoluments are:
Sh
...
The movement in provisions for bad and doubtful debts during the year was as follows:
Specific
General
Total
provisions
provisions
Sh
...
‘000’
Sh
...
‘000’
Sh
...
‘000’
At 1 January 2007
630,500
630
631,130
Charge for the year
83,800
Released during the year
(18,600)
At 31 December 2007
695,700
15,300
99,100
(18,600)
15,930
711,630
4
...
The management has confirmed that the loans and advances
are fully secured
...
Capital allowances for the year ended 31 December 2007 amounted to Sh
...
6
...
Required:
(a) (i) Taxable income of Shamrock Bank Ltd
...
(11 marks)
(ii) Tax payable (if any), on the taxable income computed in (i) above
...
2,400,000, show how the tax computed in (a) (ii) above is to be paid,
inclusive of the due dates
...
(2 marks)
(Total: 20 marks)
Attempted solution
(a) (i)
4,920
1,200
600
15,300
20,950
43,700
7,250
Less capital allowances
Gain on disposal of property
Rental income
Adjusted taxable income
Other incomes
18,900
12,300
2,190
Taxable Rental income
Assumed that income from forex dealing is realized hence taxable
Assumed the pension fund is registered hence contributions allowable
(ii) Tax payable =
10,270,000 x 30% =
Business income
Rental income
93,920
42,470
(33,390)
9,080
2190
NB -
-
Sh ‘000’
(51,450)
Kshs’000
9,080
2,190
11,270
3,381,000
Tax @30%
2,724
657
3,381
T E X T
Reported net loss
Add back disallowable expenses
Salaries – provision for staff leave accruals
School fees for chairman children
Traveling cost for expatriate
General bad debt provisions
Provision for interest expense
Depreciation
Loss on disposal of equipment
Sh ‘000’
S T U D Y
Shamrock Bank Ltd
Computation of Taxable income
Sh ‘000’
64
A dvanced TA X AT I O N
(b) Year 2006 tax liability
=
2,400,000 x 30%
=
720,000
Year 2007 instalment tax
=
110% x 720,000
=
792,000
Year 2007 actual tax
=
10,510,000 x 30%
=
3,153,000
20/4/2006 = 1st instalment = 25% x 792,000
198,000
20/6/2007 = 2nd instalment = 25% x 792,000
198,000
20/9/2007 = 3rd instalment = 25% x 792,000
198,000
20/12/207 = 4th instalment = 25% x 792,000
198,000
Total paid
792,000
S T U D Y
T E X T
30/4/2008 = final 15th instalment = 3,153,000 – 792,000 = 2,361,000
(c) Section 15(7) (e) of the Income Tax Act provides for the specified sources of income
...
In the present case
...
A loss from one source of income should not be offset
against the gains of another source of income
...
16
Taxation of insurance companies
2
...
1 Ascertainment of Income of Insurance Companies
1
...
2
...
Gross premium less any premium returned to the insured and premium paid on
reinsurance
...
Other income including commission or expenses allowance received or receivable from
reinsurers and investment income
...
A deduction in respect of a reserve for unexpired risk, at the end of the previous year
...
Addition of reserve deducted for unexpired risks at the end of the previous year
...
A deduction of claims admitted net of any claim recovered from reinsurance
companies
...
A deduction of agency expenses
...
Other deductions allowable under the Income Tax Act
...
Gross premium receivable in Kenya less premiums returned to the insured and premiums
paid on reinsurance other than to the Head Office of the company
...
Other income including commission and expense allowances received or receivable
from reinsurance other than from the Head Office of the company in relation to risks
accepted in Kenya
...
65
Income from investments representing reserves created for or from the business done
in Kenya
...
Reserve for unexpired risk at the end of that year of income in respect of policies whose
premiums are received or receivable in Kenya but after adding the reserve deducted in
the previous year
...
Claims admitted in that year of income less any amount recovered from reinsurance
companies
...
Agency expenses
...
Head Office expenses which would have been allowable if the company had been a
resident company
...
16
...
16
...
These
amendments will come to effect from 1
...
2009
...
Where the actuarial valuation of the life fund results in a deficit for a year of income and
the shareholders are required to inject money into the life fund, the amount of money so
transferred shall be treated as a negative transfer for the purposes of subsection (5) (a):
Provided that the amount of the negative transfer shall be limited to the amount of actuarial
surplus recommended by the actuary to be transferable from the life fund for the benefit
of shareholders in previous years of income, whether or not it was actually transferred
...
Investment income of the life insurance fund except that part of the life fund which
relates to an annuity fund, less management expenses including commissions
...
2
...
T E X T
The income from life insurance business comprises
66
A dvanced TA X AT I O N
(6) The gains or profits for a year of income from the long term insurance business of a non-resident
insurance company, whether mutual or proprietory, shall be the sum of the following:(a) The same proportion of the amount of actuarial surplus recommended by the actuary
to be transferable from the life fund for the benefit of the shareholders, whether or not
it is actually transferred, as the actuarial liability in respect of its long term insurance
business in Kenya bears to actuarial liability in respect of its total long term insurance
business; and
(b) The same proportion of any other amounts transferred from the life fund for the benefit of
shareholders as the actuarial liability in respect of its long term insurance business in
Kenya bears to the actuarial liability in respect of its total long term insurance business;
and
(c) The same proportion of thirty per cent of management expenses and commissions
that are in excess of the maximum amounts allowed by the Insurance Act as the
actuarial liability in respect of its long term insurance business in Kenya bears to
the actuarial liability in respect of its total long term insurance business
...
67
TAXATION OF SPECIALISED ACTIVITIES
Illustration
Afro Insurance Ltd
...
The management has provided you
with the details shown below on their operations for the year ended 31 December 2007:
Motor vehicle
Theft
Sh
...
’000’
24,664
Sh
...
Wear and tear deductions have been agreed with the Income Tax Department at
sh
...
2
...
2,040,000
Interest from fixed deposits in local bank (net)
762,450
Gross dividends from Zim-Re of Zimbabwe (a foreign company)
450,000
Dividends from KELP Ltd
...
The company paid Sh
...
4
...
Part of the office space is
rented out to other tenants
...
2,200,000 net rental income from their estate agents
...
2,400,000 for the year to 31 December 2007 had been deducted
...
Afro Insurance Ltd
...
a locally incorporated
company
...
for the year ended 31 December
2007
...
(2 marks)
(c) Comment on any information you have not used in your computations
...
Computation of taxable profit for year ended 31 December 2007
Theft
Total
Sh
...
’000’
24,664
15,007
Sh
...
’000’
57,532
34,576
4,205
(2,035)
40,005
6,293
(9,259)
36,705
1,466
(668)
15,400
11,964
(11,962)
92,110
2,216
(2,781)
2,755
2,190
5,538
(10,325)
9,416
4,629
1,215
(4,532)
8,756
5,439
8,969
(17,638)
20,927
12,258
Commissions (net) paid
Management expenses
255
1,606
1,546
2,350
890
876
2,691
1,832
Legal expenses
Specific bad debts
Total Expenses
645
80
4,776
420
35
8,980
125
62
7,392
1,190
177
18,148
Underwriting profit/loss
35,229
27,725
8,008
70,962
Total underwriting profit
70,962,000
Gross premium written
Reinsurance ceded
Unearned premium b/f
Unearned premium c/f
Gross income earned
Less allowable expenses
Claims paid
Claims outstanding b/f
Claims outstanding c/f
Claims incurred
Less wear and tear
(454,000)
70,508,000
Investment income
Interest from Treasury bills
Interest from Fixed deposits
Less: investment mgt
...
Fees
Total taxable profit
2,200,000
(2,400,000)
(200,000)
72,860,000
T E X T
Fire
S T U D Y
70
A dvanced TA X AT I O N
2
...
It is important to point out the following unique features:
S T U D Y
Income of certain non resident persons deemed derived from Kenya-When one s on
the business of shipowner, charterer 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 which is embarked, in Kenya
shall be the gross amount received on account of the carriage; and those gains or profits
shall be deemed to be income derived from Kenya; but this subsection shall not apply to
gains or profits from the carriage of passengers who embark, or cargo or mail which is
embarked, in Kenya solely as a result of transshipment
...
••
Exemptions- The income of a non-resident person who carries on the business of aircraft
owner, charterer or air transport operator, from such business where the country in which such
non-resident person is resident extends a similar exemption to aircraft owners, charterers or
air transport operators who are not resident in such country but who are resident in Kenya
...
On purchase of new, unused power-driven ship of more than 495 tons; or
b
...
The rate of shipping investment deduction is 40% (2/5) of Qualifying cost granted in the first year
of use
...
Compensation by way of wear and tear allowance will be granted
...
1
...
40, 000,000
...
36,000,000
...
TAXATION OF SPECIALISED ACTIVITIES
71
Solution:
Capital Deductions Computation
SID @40%
Sh
...
T
...
40,000,000
1) SID Yr
...
16,000,000
24,000,000
2) W
...
A
Class IV @ 12
...
YR 2004 W
...
A
(3,000,000)
21,000,000
YR 2005 W
...
A
(2,625,000)
18,375,000
YR 2006 W
...
A
(2,296,8705)
16,078,140
T E X T
24,000,000
Since ship was sold before 5 years had elapsed, SID earlier granted of Sh
...
e
...
Alternatively
Reclaimed SID
16,000,000
S
...
D withdrawn
Yr
...
T
...
2005 W
...
A
(1,750,000)
12,250,000
Yr
...
T
...
I
...
18
Taxable S
...
D
16,000,000
5,281,250
10,718,750
Taxation of Unit trusts or collective investment schemes
A Unit Trust or a mutual fund organization is one registered under the Unit Trust Act
...
The unit holder gets a
return (interest) from the Unit Trust tax free
...
The scheme will
pay withholding tax on dividends and interest received on behalf of employees at rates of 5%
and 15% respectively
...
The withholding tax paid by a Unit Trust on interest and dividend is final tax, which means that the
Unit Trust is not taxed further on the income
...
Business incomes of such bodies will also be exempt so long as the business income is applied to
investments in securities as mentioned above, income is from rental properties of the scheme and
that such business is carried on by the beneficiaries
...
19 Property developers and contractors
In Kenya, there are no specific guidelines governing the taxation of property developers and
contractors
...
The adjusted profits therefrom will be taxed as
business income of the company
...
The word "property" is not defined in the Income Tax
Act
...
Section 6 provides that "gains or profits from the use or occupation of property includes a royalty,
rent, premium or similar consideration received for the use or occupation of property
...
Rent is not defined and is therefore assigned its normal and usual meaning
...
Another
expression used is "Key Money"
...
C v C
...
T the decision by the Income Tax Department to charge key money was upheld by
the courts on the basis that it was received for the use of an asset
...
TAXATION OF SPECIALISED ACTIVITIES
73
Allowable deductions
Section 15 (i): ll the expenditure incurred wholly and exclusively in the production of rental
A
income
...
(a) Bad debts and specific provision for bad debts
...
g
...
(c) Expenditure incurred in the maintenance of the property
...
The
lease should be for 99 years or less and should not be capable of extension beyond 99
years
...
(f) Expenditure incurred on structural alteration to premises in order to maintain existing
rent
...
g
...
(h) Caretaker wages and salaries
...
The Low Shipping Company Case
(Low Shipping Company Ltd v CIR)
The Appellant company purchased a second hand ship when her Lloyd's survey was overdue
...
On her return six months later the
survey was made and the company was obliged to spend large sums in repairs
...
Held:
that except for such part of the cost of repairs as was attributable to the period during
which the ship was employed in the Appellant's trade, the expenditure in question was in the
nature of capital expenditure
...
The portion attributable to the owner is disallowed
...
The
property should not remain vacant for more than six months
...
S T U D Y
CIT v Overland Company Ltd
...
T E X T
The Overland Case
74
A dvanced TA X AT I O N
Non-resident owners
No deductions are allowable from the gross rent received if the owner is non-resident
...
e
...
2
...
In addition to paying their
taxes, petroleum companies have an obligation of withholding tax to payments
made to the sub contractors
...
(c) If it is established to advance religion or education
...
Cooperative Societies are considered to be body corporates and are taxed at the rate
of 30%
...
S T U D Y
T E X T
••
Chapter summary
2
...
Question three
List the allowable expenditure of a petroleum company while arriving at the taxable profit
Question four
List the applicable tax exemptions to venture capital enterprises
TAXATION OF SPECIALISED ACTIVITIES
2
...
The income of clubs is made
up of the gross receipts, including entrance fees, and subscriptions and such receipts are taxed
in the name of the club at the corporation tax rate
...
e
income from members is not taxable
...
-(sec 21(1)
Question two
Under Paragraph 6 of the first schedule to the Income Tax Act, income other than income from
investment of an Amateur sporting association is not taxable
...
Whose members consist of amateurs or affiliated associations the members of which
are amateurs
...
S T U D Y
Generally trade associations are not considered to be carrying out trading activities
...
Under sec 21(2)of the Income Tax Act, such an association can
choose or elect by notice in writing to the CDT to be considered to be carrying out business
chargeable to tax in respect to any year of income
...
T E X T
A trade association is a body of persons which is an association of persons separately engaged
in any business with the main object of safeguarding or promoting the business interests of such
persons
...
( A registered
venture capital company is a venture capital company registered by the CDT as such)
Gains arising from trade in shares of a venture company earned by a registered venture
capital company within the first ten years from the date of first investment in that venture
company by the venture capital company are tax exempt
...
23
Past Paper Analysis
This topic covers a wide range of concepts
...
The following is an analysis
on how the chapter has been examined in the past
...
g
...
12/02 Q
...
3(d), 06/04 Q
...
2, 12/06 Q
...
5(c), 12/07 Q
...
2(b),
TAXATION OF SPECIALISED ACTIVITIES
2
...
is a resident insurance company carrying out both general and life
assurance businesses
...
‘000’
Shs
...
(ii) Enterprises situated in export processing zones (EPZs)
...
400,000 being salaries to pension
department employees and Sh
...
Investment income comprise:
Interest on fixed deposit accounts (net)
Dividend received (net)
Rental income
General insurance
Life assurance
business
business
Shs
...
‘000’
780
400
3,000
4,800
10,000
11,200
13,780
16,400
3
...
‘000’
800
1,260
Life assurance
business
Shs
...
‘000’
3,240
1,760
Life assurance
business
Shs
...
‘000’
5,640
6,200
Life assurance
business
Shs
...
Reserves for unexpired risk were as follows:
1 January 2007
31 December 2007
5
...
7,600,000 for General
insurance business and Sh
...
Required:
i)
ii)
Determine the taxable income or loss of Linda Insurance Company Ltd
...
(4 marks)
(Dec 2005 Q 1)
Question five-Cooperative societies
(a) Ukulima Savings and Credit Co-operative Society Ltd
...
Sh
...
443,875
Printing and stationery
236,910
Legal expenses
132,500
Medical expenses for staff
271,625
Salaries and wages
General office expenses
Net income
S T U D Y
Traveling
T E X T
Expenses
4,253,350
100,000 5,438,260
3,736,040
Required:
(i) The taxable income for the year and tax payable
...
( 8 marks)
( 2 marks)
(Tax 1 Dec 2001 Q 2)
(b) Explain the basic principles followed in the taxation of the income of cooperative
societies
...
1 Objectives
3
...
It is legal and may be achieved
through taking advantage of the knowledge about tax to reduce the tax burden or liability
...
Generally
speaking tax evasion is illegal
...
3 Introduction
In the previous chapter, we studied concepts on taxation of specialised institutions
...
The tax concepts learnt in this
topic will provide a practical basis in taxation
...
S T U D Y
••
••
••
••
••
••
••
••
••
••
T E X T
At the end of this chapter, the student should know the procedure for tax investigation under the
following headings:
84
A dvanced TA X AT I O N
3
...
As such, a deep understanding of the same will be essential
...
5 Industrial Context
This topic is designed to not only help the students tackle related exam questions, but also to
help tax experts, revenue authority experts and finance managers conduct any tax investigation
...
As such, the content in this text may not be
exhaustive
...
6
Tax evasion, tax avoidance and fraud
Tax avoidance is the use of existing law to reduce the tax payable
...
Some modes of tax avoidance include:
••
Investment decisions: Do you buy an asset of capital nature and claim capital allowances
or incur revenue expenditure?
•• Personal investment decisions: Do you invest in debentures or ordinary shares?
•• Employment income:Take light loans to build a house or buy a house?
•• Do you buy your own car and claim mileage or rely on the company car?
•• Production for domestic or international: EPZ for exports are zero rated for VAT, they
have a tax holiday of 10 years, import duty refund on raw materials imported, 25%
corporate tax rate for years from 11 to 20, ID of 100%
•• Financing decisions: Debt capital interest is allowable unlike equity where dividends
are disallowable
...
Tax evasion is the use of fraudulent and dishonest means to reduce tax payable
...
It can also be defined as the reduction of tax liabilities by illegal means such as concealing
information or supplying false information Tax evasion may be achieved through:
▪▪
▪▪
▪▪
▪▪
▪▪
▪▪
▪▪
▪▪
▪▪
corrupt deals with tax officials,
willful negligence in furnishing tax information(e
...
false returns),
Non declaration of incomes
...
Money laundering
Barter trade transactions
Lighting i
...
not declaring income related to extra employment
Manipulation of accounts( creative accounting)
TAX INVESTIGATIONS
85
3
...
1 Anti-avoidance provision ( Sec 23 of the Income Tax Act)
Under S
...
He can direct for necessary adjustment on
taxable income and issue an assessment accordingly
...
g
...
He would be taxed
on the difference between the low price he pays for the car and the market price for the
car
...
The salary helps to spread tax payable but
the parent controls the child’s income
...
S
...
If a taxpayer disputes an assessment
resulting from forced distribution, the taxpayer can appeal to the Tribunal
...
Such a direction can only be challenged by appealing to the Income Tax Tribunal
...
However, the Commissioner rarely, if ever, does use such powers
...
S T U D Y
Kshs ‘000
T E X T
Under S
...
e
...
g
...
Dividend distribution shortfall would then be calculated as follows:
86
A dvanced TA X AT I O N
However, the following principles have emerged from UK Case Law and which may well be
applied in Kenya:
1
...
Lord Tomlin stated: “Every man is entitled, if he can, to order his affairs so that the tax
attaching
...
2
...
At the time, the most prevalent scheme to avoid tax (especially Capital Gains Tax) was to enter
into a series of transactions, which would facilitate the following:
(a) Conceal the sale of property subject to Capital Gains Tax (CGT)
(b) The exchange of shares for shares, which would not have CGT implications
...
The Ramsay doctrine provides that whether a series of transactions is genuine or artificial would
be dependent on the end result
...
The preordained series of transactions are disregarded if they have no business
purpose other than achieving the preordained end
...
Ltd
...
Francis Vs Dawson
Facts of the Case
George Dawson and family owned two private companies which they wanted to sell
...
Dawson wanted to sell to W Ltd a UK company
...
G Ltd then sold its shares in the two companies to W Ltd
...
3
...
Third party information
Informers e
...
friend, a spouse, former spouse
...
Non compliance in the industry
...
Non compliance detected via compliance check
Staff of the entity
Public media (TV, Newspapers, magazines)
Registrar of companies or business names
...
g
...
(m) Local authorities
...
3
...
Back-duty refers to collection of all kinds of tax in arrears
...
Return forms/materials will be sent to taxpayers in the Domestic Taxes Department
records though the Department is not obliged to issue necessary returns/materials
...
Determination of income through back-duty cases
1
...
2
...
A
capital statement consists of details of assets and liabilities as at a given date or period
...
The
capital statement also considers capital losses or gains, living expenses, income tax paid
etc
...
S T U D Y
An offence will have been committed by a taxpayer under the above mentioned circumstances
and his affairs will be dealt with as a back-duty case i
...
back-duty investigation will be instituted
into the affairs of the taxpayer
...
Where the
above circumstances are due to:
T E X T
1
...
Non-declaration of income
3
...
88
A dvanced TA X AT I O N
Capital statements must appear reasonable to be acceptable by the Income Tax Department and
must
S T U D Y
T E X T
Steps
1) Add all assets of taxpayer both tangible and intangible for a given period
...
Net result will be Net assets for the
period
...
This represents
additional assets that the taxpayer acquired or disposed in the time period
...
g
...
4) If looking for only the undeclared business profits taxable, then deduct any non-trading
business income from growth in Net assets
...
5) Add to the balance (4) living expenses such as water & electricity, income tax paid, interest
on loans, premium on various types of insurance, rents and rates as supported by bills or
invoices
...
6) If capital assets are sold at a loss, add the loss
...
Deduct
any income declared during the year – balance is undeclared income
...
•• Any remittances abroad
•• Marital status or status in society
•• Dwelling place
...
An increase in capital may be due
to: a) Fresh capital introduced (not income)
...
TAX INVESTIGATIONS
89
Add:
Taxes paid, gifts or donations made, non-allowable losses e
...
loss on sale of investments/
assets, personal expenditures, unexplained payments
...
2
...
4
...
Are there other expenses not deductible?
Does the taxpayer have any other income source?
Does the taxpayer lease the freehold land or does he farm it and what is the income?
Why has the taxpayer not claimed capital allowances?
Does the taxpayer have a life insurance policy with a Kenyan company? If so, how much
are the premiums he pays?
3
...
The claim for refund must be made on the appropriate form within a period of 12 months
...
g
...
Where input tax persistently exceeds output tax and this is a regular feature of the
business
...
When payment for supply of goods/services have been received (bad debts) under
Sec
...
A refund for bad debt is made within 5 yrs
...
Where input VAT was charged on goods purchased, civil works, building constructed
etc
...
Such claim for refund is made in form VAT 5 within 30 days from the date of approval of
registration by the Commissioner VAT
...
Such a
claim is made in for VAT 4 within 12 months of paying VAT
...
Documents accompanying claim for refund under Sec
...
S T U D Y
If, for any tax period, a person has overpaid tax, i
...
the input tax claimed exceeds the output tax
for the period, the excess amount is carried forward to be set-off against output tax for the following
period
...
T E X T
Refund of tax
90
A dvanced TA X AT I O N
••
••
••
Copies of relevant tax invoices issued at the time of supply to the insolvent debtor,
A declaration that the debtor and taxpayer are unrelated companies/persons
...
g
...
VAT refund audit procedure
••
S T U D Y
T E X T
Under legal notice issued 18/11/99, tax refunds and claims for tax relief exceeding Kshs
1,000,000 shall be accompanied by the auditor’s certificate
...
•• The following audit procedure is followed by the auditor before issuing such a VAT
refund certificate
...
1
...
2
...
3
...
g
...
The reason for the refund must be soundly based
...
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
...
Select a sample of invoices from VAT 4 and perform the following tests where applicable:
•• Input tax has been claimed within 6 months after the issue of the invoice
...
•• Simplified tax invoices have not been used to claim relief
...
•• Ensure that input tax in respect of imported goods is properly supported by a Customs
Entry form and contained within an original KRA receipt for payment of duty and VAT
...
•• Ensure the input tax does not relate to items scheduled on the blocking order VAT
Order, 1994
...
•• Trace the invoices to the relevant ledger accounts
...
6
...
•• Ensure that sales were accounted for in the correct tax period
...
•• 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
...
7
...
8
...
If not, compute the penalties and interest to
be deducted from the claim, if the trader has not done so
...
Prepare a statement analysing the current claim
...
10
Assessment of VAT not correctly charged
...
Identification of other offences and errors
...
Educating taxpayers thereby ensuring better compliance in future
...
A capital statement
consists of details of assets and liabilities as at a given date or period
...
The capital statement also considers
capital losses or gains, living expenses, income tax paid etc
...
Deduct all liabilities
both personal and business used to finance the assets
...
2) Calculate the growth or loss in Net assets for each time period by taking the Net Assets
of the period and comparing it with the Net Assets of the previous period
...
3) Deduct any non-taxable income that was used to finance the above growth in Net assets –
e
...
income or assets from a legacy or inheritances, capital gains, gifts, money from friends
and relatives
...
The net figure would represent Net Business
savings
...
Add also personal expenses such as food, services, clothing, toiletries, medical
expenses, house servant, holidays, amusements, private motor vehicle running and
maintenance costs, harambee contributions, donations and any cash stolen from house or
shop etc
...
If sold at a profit, deduct the profit
...
A capital statement may be required where:
••
••
••
no accounting records are kept by the taxpayer
taxpayer maintains incomplete records
when a self assessment has been filed but indepth assessment has to be carried out
...
92
A dvanced TA X AT I O N
3
...
Post clearance audits
According to the taxpayer’s charter, a taxpayer may be selected for a post clearance audit
on all Customs related transactions
...
The taxpayer will be notified in advance of the intention to carry out an audit before its
commencement
...
The audit may be completed within 14
days from the date of commencement of audit
...
This examination is carried out after the completion of import clearance
...
The audit is done in order to:
• Check whether the importer’s own initiative declaration was true and correct
...
• Confirm whether the declared value of the imported goods was correct
Customs audits verify:••
••
••
••
••
3
...
Tax audit
The Kenya Revenue Authority may carry out either a compliance check or a comprehensive
audit
...
A comprehensive audit is an audit covering many
types of taxes and multiple issues in the accounts of a taxpayer
...
Sometimes the
taxpayer may be selected for audit in respect of multiple taxes
...
e
...
In the majority of cases, the taxpayer
will be notified in advance of the intention to carry out an audit before the commencement of the
audit
...
In order not to inconvenience the taxpayer, and
subject to the taxpayer’s co-operation with KRA officers, KRA shall endeavour to complete the
audit within:
••
••
10 days from the date of commencement of single issue audits
...
TAX INVESTIGATIONS
••
••
93
One day for a general inspection of an excise factory
...
If the taxpayer has been selected for audit by the Large Taxpayer Office or the Investigations
Department all the multiple taxes will invariably be audited
...
Cases under investigation
will be completed within a period of between two to six months
...
The taxpayer may also be subjected to a compliance check (e
...
computation and intelligence
information) to verify certain information
...
An audit is considered complete when the findings have been fully explained in writing to the
taxpayer giving specific details on how additional tax liability if any, has been arrived at
...
The commissioner general, a departmental commissioner or headquarters tax programmes will
require that the taxpayer be re-audited if it is discovered that the taxpayer’s case was settled
irregularly, or is dissatisfied with the manner in which the case was completed
...
KRA shall acknowledge your objection within 7 days and endeavour to resolve the objection
within 30 consecutive days
...
3
...
Tax evasion is the illegal arrangement of financial affairs so as to minimise a tax
burden
...
The taxpayer has an avenue to object, or appeal against an assessment
...
You must exercise your right to object within a specific period and comply with the
requirements, which include submission of returns together with all supporting documents for the
objection to be valid
...
T E X T
Objections
94
A dvanced TA X AT I O N
3
...
Question two: Audit
What are the two types of audits that can be carried out by KRA?
Question three: VAT refund
S T U D Y
T E X T
Describe the procedure for a VAT refund audit
...
Question five
List the circumstances that may trigger an audit
...
15 Quiz answers
Question one: Tax avoidance and evasion
Tax avoidance is the arrangement of a person’s financial affairs so as to legitimately reduce a
tax liability
...
Question two: Audit
VAT refund audit procedure
••
••
••
••
••
••
••
••
Under legal notice issued 18/11/99, tax refunds and claims for tax relief exceeding
Kshs1,000,000 shall be accompanied by the auditor’s certificate
...
The following audit procedure is followed by auditor before issuing such a VAT refund
certificate
...
Review and document the adequacy of the system of recording and accounting for
VAT
...
Establish why the trader is in refund position (e
...
if trader is an exporter, inputs taxed
at higher rate than outputs, significant capital expenditure, seasonal trading/purchases,
etc)
...
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
...
Input tax has been claimed within 6 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 of imported goods is properly supported by a
Customs Entry form and contained within an original KRA receipt for payment of
duty and VAT
...
A compliance check is
like a spot check to confirm summaries from the ledger/ returns with the taxpayer’s sales and
purchases journal
...
96
A dvanced TA X AT I O N
f
...
Ensure the input tax does not relate to items scheduled on the blocking order VAT
Order, 1994
...
Trace the invoices to the relevant ledger accounts
...
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
...
Trace the invoices to the relevant ledger accounts
...
Ensure that VAT has properly been accounted for in respect of miscellaneous sales
...
Ensure all VAT returns were submitted on time
...
Prepare a statement analysing the current claim
...
Disallowance of input tax incorrectly claimed
...
Levying of penalties and interest for the default and errors
...
Question four: Customs investigation
According to the taxpayer’s charter, a taxpayer may be selected for post clearance audit on
all Customs related transactions
...
The taxpayer will be notified in advance of the intention to carry out an audit before its
commencement
...
The audit may be completed within 14
days from the date of commencement
...
This examination is carried out after the completion of import clearance
...
The audit is done in order to:
• Check whether the importer’s own initiative declaration was true and correct
...
• Confirm whether the declared value of the imported goods was correct
...
3
...
The questions
are listed in this format: Month/year e
...
6/01 represents June or May 2001
...
4, 12/04 Q
...
2
...
3 (b) 12/06 Q
...
5(a), 06/07 Q
...
5(b), 12/07 Q
...
S T U D Y
(a) The following are some of the circumstances that trigger audits by the KRA:
(b) Self confession
...
g
...
(e) Information from related company audits
...
(g) Cessation of business or a large part of the business
...
(l) Large public company e
...
KCC
(m) Government parastatals
...
(o) Investigation using the PIN number
...
17
Revision questions
Question one
(a) You have recently been appointed by an individual running his own business to act on
his behalf in a back duty investigation
...
Your client is puzzled as to how the back duty investigation began
...
Required:
S T U D Y
T E X T
Write a letter to your client advising him:
(i) Of the information the assessor might have received which resulted in an investigation into
his affairs
...
(2 marks)
(b) Your client, Sophia Town, has owned a general retail store since 1 April 2003
...
On your advice, Sophia decided
to co-operate fully with the Income Tax Department and after discussing the matter with her
and investigating her records you have managed to prepare the following statements:
99
TAX INVESTIGATIONS
Year ended:
31 March
31 March
31 March
31 March
2004
2005
2006
2007
Sales (recorded)
Kshs
40,000
Kshs
50,000
Kshs
60,000
Kshs
65,000
Cost of sales
34,000
42,500
45,000
58,000
6,000
7,500
15,000
7,000
300
700
800
1,200
6,300
8,200
15,800
8,200
Gross profit
Bank deposit interest
(undeclared)
Expenditure:
Items for which
receipts are
available
3,510
3,820
4,840
5,120
Other items
1,490
1,680
1,760
2,080
6,600
7,200
1,300
2,700
9,200
1,000
Net profits
(assessed to tax)
You ascertain that the bank deposit account was opened in May 2003
...
Sophia informs you that she banked 1/11 of
her takings in a National Savings Bank ordinary account which earned interest at 5% per annum
throughout the period under review
...
Sophia’s turnover fluctuates very little from month
to month
...
Sophia also
has casual dealings in antiques which have not been declared to the Income Tax Department
...
T E X T
5,500
S T U D Y
5,000
100
A dvanced TA X AT I O N
Preparation of capital statements reveals the following:
1 April
31 March
31 March
31 March
31 March
2003
2004
2005
2006
2007
Kshs
Kshs
Kshs
Kshs
Kshs
25,000
30,000
32,000
36,500
40,000
500
2,500
4,500
6,000
7,000
-
2,800
7,620
9,040
13,150
-
3,000
7,900
14,045
21,122
__ _-
__ _-
7,000
7,000
7,000
25,500
38,300
59,020
72,585
88,272
(20,000)
(20,000)
(20,000)
(20,000)
(20,000)
_____-
(2,000)
(6,000)
(8,000)
(11,000)
(20,000)
(22,000)
(26,000)
28,000
(31,000)
5,500
16,300
33,020
33,020
57,272
Assets at cost:
Shop premises fittings and
stock
Debtors and cash
Bank deposit account
National
Account
Savings
Bank
Investments (legacy from
deceased aunt)
Loan from friend to purchase
shop
Creditors
S T U D Y
T E X T
Liabilities
Close questioning of Sophia reveals that no stock of antiques is held on the above dates and she
has no other assets of significance for investigation
...
Sophia is a widow and living with her mother
...
(13 marks)
(ii) Suggest what factors the Assessor will take into account in negotiating penalties and
interest on the lost tax
...
Dickson Maelfu is a businessman with interest in the manufacturing sector
...
31
December
2004
Kshs
‘000’
31
December
2005
Kshs
‘000’
31
December
2006
Kshs ‘000’
31
December
2007
Kshs
‘000’
36,000
48,000
48,000
52,000
54,000
24,000
28,000
36,000
36,000
38,000
9,000
12,000
12,000
15,000
18,000
3,600
2,960
9,240
4,200
3,540
13,600
8,000
2,640
13,600
9,000
2,530
13,600
7,000
2,980
13,600
7,280
8,640
9,420
8,360
7,890
10,900
800
10,000
700
9,870
600
7,640
870
9,840
640
3,780
3,400
3,780
5,400
3,780
3,600
3,780
3,760
3,780
4,670
2004
Kshs
‘000’
Assets and
Liabilities
Factory
building
Plant and
machinery
Commercial
vehicles
Stock in trade
Trade debtors
Private
residence
Trade
creditors
Bank loan
Loan from an
uncle
Mortgage loan
Bank balance
Additional information:
1
...
2
...
3
...
Mr
...
Interest on the mortgage is at a rate of 15% per annum
...
Maelfu for each of the four years ended 31 December 2004,
2005, 2006 and 2007
...
(8 marks)
Comment on any four areas on which you would seek further clarification from Mr
...
(4 marks)
(Dec 2007 Q 5)
Question three
Mr
...
Pesa
Balance sheet as at 31 December 2007
Assets:
Cash at bank
Sh
...
10,000)
190,000
Office car (depreciation Sh
...
6,200,000
Add: Addition
Sh
...
46,200)
20,000
(less
discount
1,803,800
6,063,800
An indepth investigation has been commenced and you, as the assessor in charge, has been
provided with the following information in support of the above accounts
...
Balances as at 31 December:
2006
2007
Cash at bank
Sh
...
1,910,000
Cash in hand
40,000
85,000
2,200,000
2,500,000
-
3,500,000
2,340,000
1,850,000
Fixtures and fittings
200,000
-
Office car
100,000
-
Stock-in-trade
Sundry debtors
Sundry creditors
2
...
Pesa maintains a steady gross
profit rate of 25% on sales
...
The bills outstanding as at 31 December 2007 were:
S T U D Y
T E X T
Sh
...
The motor car and fixtures are depreciated by 20% and 5% respectively
...
32,000
...
5% interest is allowed on capital
...
Provision was made at 5% for doubtful debts and 2½% on creditors for discounts
...
The cash book analysis shows the following figures among others:
Kshs
Kshs
135,000
13,500,000 Motor upkeep
Receipts from customers
Discounts allowed on them
140,000 Printing and stationery
Further capital introduced
200,000 Drawings
Salaries to 30 November
2007
Office rent to 30 November
2007
Advertising
1,100,000 Payments to creditors
220,000 Discounts allowed by
them
90,000
Travelling expenses
60,000
80,000
660,000
11,200,000
120,000
100,000
General expenses
8
...
215,000
...
TAX INVESTIGATIONS
Provide all supporting details
...
(4 marks)
(Total: 20 marks)
Question four
(May 2002 Q
...
(8 marks)
(December 2006 Q 5)
(b) What circumstances may trigger a Pay As You Earn (PAYE) audit?
(5 marks)
(December 2002 Q 1)
S T U D Y
(e) After your firm issued the VAT refund certificate in (d) above, the VAT department made
their own independent investigations and established that the company’s refund claim was
grossly misstated
...
and
to your audit firm?
(2 marks)
(Total: 20 marks)
T E X T
(a) It may be advantageous for a trader whose turnover is below the legislated turnover
limits under the sixth schedule to the VAT Act to register for VAT voluntarily
...
appointed your firm their auditor with effect
from 1 January 2007
...
You have just completed performing the audit of the
company’s VAT refund claim
...
Prepare a draft VAT audit refund certificate for your senior partner’s review
...
2
••
••
••
••
••
••
••
Objectives
Distinction between trading in and trading with a country
Double taxation agreements; theory, design and application
Regional perspective with reference to the East African Community (EAC) and the
Common Market for Eastern and Southern Africa (COMESA)
Most favoured nation status
Withholding tax provisions
Transfer pricing
Application of relevant case law
Further, the concept of double taxation is crucial in the overall economic policy of a country
...
Income tax is imposed in Kenya on any
person, whether resident or non-resident if the income accrued in or was derived from Kenya
...
Where rates of tax are high, double taxation can be a serious obstacle to growth in
international trade
...
4
...
The measures put in place have to be tax effective as compared to
those established in the average countries in the world
...
In this topic, we will discuss the various
issues arising from the taxation of cross border activities
...
T E X T
4
...
3
Exam Context
The student is expected to demonstrate an understanding of the various taxation issues affecting
cross border transactions
...
Questions on this topic have
been preffered by the examiner in recent exam sittings
...
4 Industrial Context
In the recent past, we have had many companies and individuals complaining of double taxation
of their taxable gains
...
S T U D Y
T E X T
4
...
The issue here is: How is the income earned or derived from
such transactions brought to charge?
The taxation of income of a person is based on the concept of residence
...
a) Resident in relation to an individual means that the individual:
i) Has a permanent home in Kenya and was present in Kenya for any period during the
year of income under consideration; or
ii) Has no permanent home in Kenya but was present in Kenya for a period or periods
amounting 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
the year of income under consideration and in the two preceding years of income for
periods averaging more than 122 days for the three years
...
c) Non-Resident:
▪▪ Means any person (individual or body of persons) not covered by the above conditions
for resident
...
(Income) Accrued in or derived from Kenya
▪▪
▪▪
The income which is taxable is income arising from or earned in Kenya
...
Significance of the concept of residence
••
••
••
••
4
...
Residents pay income taxes at graduated scale rates but non residents pay income
taxes at special rates on certain specified incomes or sources
...
5%
...
Non residents companies with no branch in Kenya have withholding tax deducted at
source on all their incomes while resident and non resident companies with branches in
Kenya have withholding tax deducted from only their dividend and interest income
...
For example, a foreign company establishing a business in Kenya as a branch and
then conducting its business activities in Kenya
...
4
...
This involves countries affected
negotiating an agreement with a view to minimise or eradicate effects of double taxation
...
Each agreement is peculiar to itself
depending on how it was negotiated
...
2
...
4
...
6
...
8
...
Most countries usually give the country in which the income arises prior right of levying tax
...
e
...
This may be triggered by a representation by the business community
...
It is possible to have both arrangements in place to take care of
different income sources and persons
...
The authority was contained in the East African Income tax
Management Act and is not available in the Kenya Income Tax Act
...
2
...
4
...
6
...
S41:
Authorises the Minister for Finance to make arrangements with other countries for relief from
double taxation
...
shall be the amount by which the tax chargeable
...
For example, if the foreign
tax is equivalent to Kshs160,000 and the tax chargeable in Kenya is Kshs100,000, the amount
of relief from the foreign tax shall be limited to Kshs100,000
...
In such a case if the dividend is paid to a company, which
controls 0% or more of the voting power of the company paying the dividend, a credit shall be
obtained in the same way as if a special arrangement existed
...
Kenya has tax treaties for relief from double taxation on income arising in Kenya with the following
countries: United Kingdom, Germany, Denmark, Norway, Sweden, Zambia, Canada and India
...
50%
15%
20%
17
...
(b) The tax so deducted is not more than the tax he would have paid in Kenya if he had
been wholly charged in Kenya, i
...
tax credit is limited to the amount by which his tax
increases because of inclusion of the income from foreign country
...
(d) With effect from 1 January 2002, a taxpayer with foreign employment income shall
be granted double taxation relief whether Kenya has an agreement with that other
country
...
The tax deducted in Zambia was
Kshs 60,000
...
T E X T
S T U D Y
Nonresident
rates
where no
specific
rate exists
20%
11 4
A dvanced TA X AT I O N
Required:
a) The double taxation relief in Kenya
b) The tax payable by Ouma in Kenya
...
8
114,912 @ (15%+ 20%+25%)
68,947
...
8
108,935
...
8
Kshs 114,912 @(15% + 20%)
40,219
...
e
...
These corporations derive benefits by exploiting national law
so as to maximise their results
...
TAXATION OF CROSS BORDER ACTIVITIES
4
...
9
...
East African Community Customs Management Act (2004)
This is an Act that came into force in 2005 following the revival of the East Africa Community
Customs Union
...
Under the Union, goods traded within
the partner sates will be zero rated except for certain specified items from Tanzania and Uganda
albeit for a transition period only
...
4
...
2 Common Market for Eastern and Southern Africa (COMESA)
The Common Market for Eastern and Southern Africa, is a preferential trading area with 19
member states stretching from Libya to Zimbabwe
...
Nine of the member states
formed a Free Trade Area in 2000 (Djibouti, Egypt, Kenya, Madagascar, Malawi, Mauritius,
Sudan, Zambia and Zimbabwe), with Rwanda and Burundi joining the FTA in 2004 and the
Comoros and Libya in 2006
...
S T U D Y
The EAC was originally founded in 1967, but collapsed in 1977
...
EAC is one of the pillars of the African Economic Community
...
T E X T
The first major step in establishing the East African Federation was the East African Customs
union signed in March 2004 and commenced on 1 January 2005
...
A common system of tarrifs will apply to
goods imported from third-party countries
...
4
...
Countries
belonging to trading blocs enter into treaties harmonising the customs and excise duty rates in
order to make exports and imports price within the bloc attractive as compared with the same
commodities outside the particular trade bloc
...
Uniform
customs tariffs would be geared towards increased welfare, economies of scale obtained,
increased competition results in higher production and improved quality of products, flow of
investments in the region
...
Trade blocs include the European Union, The East African
Community, COMESA, ECOWAS (West Africa), The North American Free Trade Area (USA,
Mexico & Canada), Southern Africa Development Community (South Africa, Botswana, Lesotho,
Swaziland)
...
This is nondiscriminate principle extended to all trade partners such that any reciprocal tariff reductions are
negotiated
...
The problem with this arrangement is that tariff
negotiations may be on certain few commodities only
...
Off shore taxation (Tax havens)
Refers to the principle of harmonising Company law, Trust law, Banking and Tax regulations with
a view to attract investors
...
Some of the benefits extended to investors include:
-------
Tax free bank interest
Tax free dividends paid by companies domiciled in these countries
...
Attractive corporate tax rates including nil tax for specified periods
No capital gains tax
Tax free profit repatriations etc
TAXATION OF CROSS BORDER ACTIVITIES
11 7
The countries most involved in utilising the principle of tax haven are those with resources
requirement and depend on the financial investment attracted:
T E X T
Other tax havens:
-- Netherlands
-- British Virgin Islands
-- Isle of Man (UK)
-- Channel Islands (UK)
-- Liechtenstein
S T U D Y
Examples of tax havens:
-- Seychelles
-- Gibraltar
-- Bahamas
-- Cyprus
-- Panama
11 8
A dvanced TA X AT I O N
4
...
(b) Withholding tax on interest income received by a resident individual from the
following sources is final:
! Banks or financial institutions licensed under the Banking Act
...
! Central Bank of Kenya
...
(d) Tax deducted at source on withdrawals from provident and pension schemes
in excess of the tax-free amounts made after the expiry of 15 years or on the
attainment of the age of 50 years, or upon earlier retirement on health grounds
is final
...
The tax rate in respect of consultancy fees payable
to citizens of the East African Community partner states is 15%
...
Note: Various reduced rates of withholding tax apply to countries with double tax relief treaties
with Kenya
...
The withholding tax must be remitted to the Domestic Taxes Department within 20 days of its
being deducted
...
4
...
Transfer pricing is widely in use by multinational entities, which are involved, in
international trade in several countries
...
The
fixing of prices based on non-market criteria results in saving company tax by shifting accounting
profits from high tax to low tax jurisdictions
...
Transfer pricing also leads to balance of payments distortions between the host country and home
country bordering on undermining sovereignty of the host nation
...
Therefore, a country with no transfer pricing controls would
be most attractive to foreign investors
...
Most countries enforce tax laws based on the arms length principle as defined in the Organisation
for Economic Co-operation and Development (OECD) model
...
ii)
Cost plus method (CP)
Is a method generally used for the trade of finished goods and determined by adding an appropriate
mark-up to the costs incurred by the selling party in manufacturing/purchasing goods and services
provided with the appropriate mark-up being based on the profits of other companies comparable
to the tested party
...
This phenomenon is as old
as international trade and as old as the existence of tax boundaries
...
T E X T
Laws guiding multinational corporations ensure that transfer pricing is not abused because several
nations have a tax interest in their operations
...
120
A dvanced TA X AT I O N
The method is generally accepted by the tax customs authorities, since it provides some indication
that the transfer price approximates the real cost of item
...
iv) Profit split method (PS)
Is the method applied when the businesses involved in the examined transaction are too
integrated to allow for separate evaluation and so the ultimate profit derived from the endeavour
is split based on the level of contribution of each of the participants in the project
...
v) Transactional net margin method (TNMM)
Is a method that uses arm’s length operating profit – that is earnings after all operating expenses,
including overhead, but before interests and taxes earned by one of the entities in the transaction
...
Other available methods include advance pricing agreement between the tax authorities and
the tax payer and also mutual agreement procedure for purposes of relief from international tax
grievances
...
13 Chapter Summary
••
••
••
A resident individual is taxed on worldwide employment income while a non-resident
individual will be taxed on the income accrued in or derived from Kenya
...
Transfer pricing is a concept that regulates the prices between related entities or
transactions
...
TAXATION OF CROSS BORDER ACTIVITIES
4
...
Question two
Discuss the concept of the ‘Most Favoured Nation’
Question three
List the various transfer pricing methods that can be adopted
...
S T U D Y
Question four
T E X T
What is withholding tax?
122
A dvanced TA X AT I O N
4
...
Residents pay income taxes at graduated scale rates but non-residents pay income
taxes at special rates on certain specified incomes or sources
Resident companies are taxed at the rate of 30% on their taxable income while non
residents companies with a branch in Kenya are taxed at a higher rate of 37
...
Withholding taxes are deducted at source on all income of Kenyan non-residents but
residents have withholding tax deducted on only some of their incomes
...
Question two
Most Favoured Nation Status
Trade agreement legislation can be based on the most-favoured nation principle
...
Member countries who are signatories of the most-favoured nation status benefit
from negotiations to boost international trade
...
Also benefits may leak to other nonmember countries hence diluting the real purpose of the arrangement
...
The income subject
to withholding tax may be received by a resident or non resident person
...
The withholding tax should be viewed as
income tax paid in advance
...
g
...
For
any given year of income, the payee is assessed on gross income and is given credit
for the tax paid at source except in cases where the withholding tax is the final tax
...
The following methods or definitions
are based on the OECD guidelines:
i)
Uncontrolled price method (CUP)
This method compares the price at which a controlled transaction is conducted to the price at
which a comparable uncontrolled transaction is conducted
...
iii) Resale price method (RP)
This method is similar to cost plus method except it is found by working backwards from
transactions taking place at the next stage in the supply chain, and is determined by subtracting
an appropriate gross mark-up from the sale price to an unrelated third party with the appropriate
gross margin being determined by examining the conditions under which the goods or services
are sold and comparing said transactions to other third party transactions
...
If, for example, Company A sent three researchers to its subsidiary to aid in the development
of a product designed for use in country X market while the subsidiary allocated six identically
compensated researchers to aid in the development of the product, then we would expect that
the subsidiary pays 3/6 that is 50% of the ultimate profits as a royalty fee for the technical
knowledge provided by Company A’s researchers
...
Relative operating profit relative to sales, costs or assets allows comparisons between different
transactions and is a more robust measure of an arms length result
...
T E X T
ii) Cost plus method (CP)
124
A dvanced TA X AT I O N
Other available methods include advance pricing agreement between the tax authorities and
the tax payer and also mutual agreement procedure for purposes of relief from international tax
grievances
...
e
...
This may be triggered by a representation by the business community
...
It is possible to have both arrangements in place to take care of
different income sources and persons
...
The authority was contained in the East African Income tax
Management Act and is not available in the Kenya Income tax Act
...
16
Past paper analysis
The following is a list of questions in which the topic was tested in past examinations
...
g
...
12/00 Q
...
1, 12/02 Q
...
4(a & b), 06/06 Q
...
1(a
& b),12/07 Q
...
3(c), 12/08 Q
...
2(a)
...
17
Revision Questions
Question one
Outline the benefits which may accrue to a country from being a signatory to the most favoured
nations status agreement
(4 marks)
(June 2005 Q 2)
Question two
Kenya has entered into double taxation agreements with a number of countries
...
(4 marks)
(Dec 2003Q 3)
TAXATION OF CROSS BORDER ACTIVITIES
125
Required:
i
...
Mbazo (for tax purposes) for the year ended 31
December 2007
(2 marks)
ii
...
Mbazo for the year ended 31 December 2007
(12 marks)
iii
...
i) Incapacitated persons
ii) Non resident persons
b) Mr
...
Southnet International Ltd opened a branch in Nairobi Kenya on 1
January 2007 and posted Mr
...
The following information relates to Mr
...
His basic pay commencing 1 January 2007 was Kshs 200,000 per month
2
...
The employer paid Kshs 50,000 to the hotel
for his accommodation and meals
...
On 1 February, he rented a house in a Nairobi suburb for a monthly rent of Kshs35,000
...
4
...
The employer paid Kshs25,000
for the air tickets used by the family
...
Commencing 1 July, he received a monthly entertainment allowance of Kshs12,000
from the employer which he spent on visiting local tourist sites
...
In August, passages of Kshs110,000 were paid by the employer for Mr
...
While in South, he purchased a motor
vehicle costing Kshs 2,000,000 for his use in Kenya
...
Three
quarters of the vehicle usage related to official duties
...
On 1 October the employer effected the following changes on Mr
...
Monthly
contributions by the employer to the scheme amounted to Kshs 8,000
8
...
The PAYE remitted from his pay for the year ended 31 December 2007 amounted to
Kshs 200,000
...
Tax deducted amounted to
UK£960
...
A double taxation
agreement exists between Kenya and United Kingdom
...
Karimi has been operating a wholesale business in Nairobi
...
Sales at standard rate include goods sold to the Ministry of Health for Kshs4,000,000
2
...
3
...
4
...
5
...
6
...
Required:
The VAT payable (or refundable) by the business for the month of April 2007
Note: The amounts above are stated exclusive of VAT at the rate of 16% where appropriate
(8 marks)
(Total: 20 marks)
(June 2007 Q 1)
TAXATION OF CROSS BORDER ACTIVITIES
127
Question five
Related companies may understate their taxable profits by engaging in transfer pricing
...
470), briefly explain three transactions
that may constitute transfer pricing
...
1
Objectives
••
••
••
••
••
••
••
Tax planning for individuals and companies
Employment versus self-employment
Identifying opportunities to alleviate, mitigate or defer the impact of direct or indirect
taxation
Remuneration packages
Corporate structure and dividend flows
Anti - avoidance provisions
Transfer of real properties
Pricing policy
Uses of tax incentives
Disposal of business operations and restructuring of activities
5
...
In this
chapter, we will cover tax planning aspects
...
It is determination, in advance, of the tax effect of proposed business actions
and requires a deeper understanding of the tax legislation and sound knowledge of case law
in taxation
...
In the next topic, we will study the various tax systems and policies
...
3
Key definitions
Tax planning - Tax planning is the arrangement of the affairs of a taxpayer in such a way as to
minimise tax liability at lowest cost without contravening any tax law or regulation
Tax avoidance - The reduction of tax liabilities by legal, although possibly artificial means
...
S T U D Y
••
••
••
T E X T
At the end of this chapter, students should be able to discuss the following concepts:
132
A dvanced TA X AT I O N
5
...
This paper
mainly tests the application of the concepts discussed here
...
5
...
This helps an organisation to control costs hence
ensuring profitability
...
6
Tax planning concept
S T U D Y
T E X T
Tax planning is the arrangement of the affairs of a taxpayer in such a way as to minimise tax
liability at lowest cost without contravening any tax law or regulations
...
Tax planning requires:
▪▪
▪▪
A deeper understanding of the tax legislation; and
A sound knowledge of case law in taxation
...
Tax revenue departments have to ensure the following through proper tax
planning: ▪▪
▪▪
Taxpayers comply fully with tax laws and regulations; and
Revenue collection is maximised
...
Aims of tax planning
1
...
2
...
3
...
TAX PLANNING
5
...
1
133
Tax planning for individuals
The tax planning measures of an individual would depend on whether they are employed or
unemployed
...
Owner Occupier Relief
According to Section 15 (3) (b) of the Income Tax Act, interest paid by a person on amount borrowed
from specified financial institution (includes a bank, insurance company or building society) for
the purchase of or improvement of premises that he occupies for residential purpose shall be
deductible against total taxable income of the person
...
An employer should ensure that mortgage interest paid by the employees is allowed for deduction
in the payroll of all eligible employees
...
Examples of benefits that the company could consider
introducing or expanding include the following:
Medical services
This entails the reimbursement to staff of medical expenses incurred for self and dependants
or access to designated hospital facilities where the company holds an account
...
Staff development and training
Training costs directly paid to a training institution for an employee in relation to the
employees’ responsibilities at the work place and for the benefit of the company’s business
are allowable for corporate and PAYE purposes
...
Meals for low income employees
Meals provided to low income employees on employers premises are a non taxable benefit
on the employees
...
29,316
per month
...
However, educational fees for dependants of low income employees paid or
foregone by an educational institutional employer are not taxable on either the employer
or the employee
...
29,316 per month, i
...
employees at income tax bracket of 20% and below
...
The deductible amount paid is subject to a maximum of Kshs
...
5,000 per month)
...
6
...
Some of the reasons companies or entities
should plan for their taxes are:
▪▪
▪▪
▪▪
▪▪
▪▪
Tax is a major expense in company’s P&L;
To take advantage of the available tax incentives
...
Some of the tax planning
opportunities are:
a) Tax compliance
One of the best strategies for tax planning for companies is tax compliance
...
This will avoid unnecessary penalties and interest being
levied on the company for non-compliance in case of an audit by the revenue authority
...
As such,
the company should always claim the proper capital allowances on the qualifying costs of the
assets
...
The company may seek consultancy advice to help utilize the capital allowances
...
Following an amendment in the 2009 Finance Bill, the carry forward of tax
losses is only allowed for the year of income it arose and four subsequent years
...
d) Tax refunds used to reduce tax payable;
The company should utilise tax refunds to reduce tax payable
...
It can be overpayment of VAT, corporation tax among others
...
One can apply to offset a recoverable or a refund from
one form of tax against tax payable in another form
...
Companies can list their shares to make use of preferential tax rates
...
”
If the company lists at least 30% of its issued share capital, the corporation tax rate
applicable will be 25% for the period of five years commencing immediately after the
year of income following the date of listing
...
The corporate tax rate applicable to the company may therefore change if the percentage of the
listed share capital exceeds 20% of the issued share capital
...
f) Instalment tax payment
Under the Income Tax Act, companies are required to pay instalment taxes when they expect to
receive taxable income in that year of income
...
Further, the company can opt to use either the previous year basis or the current year basis while
estimating instalment tax payable
...
g) Application for tax exemptions or remissions
The company can explore the avenue of applying for tax exemptions or tax remissions
...
7
VAT planning
VAT legislation tends to be complex thus making compliance difficult
...
Tax losses may result by failure to plan vatable
transactions
...
VAT should be loaded on the taxable goods and services and passed on to the
customer
...
VAT compliance- payment of VAT by 20th of the following month
...
Use of VAT set off where the company is in refund situation and has taxes payable
...
Use of tax remission scheme such as Tax Remission for Exports Office (TREO)
5
...
6
...
7
...
The company should ensure that input tax is claimed
on a timely basis
...
Claiming for refund of VAT on bad debts
...
Evidence of recovery efforts is however required
...
The commissioner can waive up to Kshs 1,500,000 while the Minister of Finance can waive any
amount upon application
...
T E X T
h) Applications for waiver of penalties and interest
136
A dvanced TA X AT I O N
5
...
The amount of duty on imports will have a significant
effect on cost of goods finally exported to say nothing of competitiveness and profitability of the
business
...
Customs planning can give opportunities in the following areas:
••
••
••
••
••
••
Duty Remission
Customs valuation
Duty Suspension
Classification of goods
Duty deferral
Origin of goods
S T U D Y
T E X T
Duty Remission
Investors can apply to the Minister for duty waiver or exemption under special duty rates
...
Customs valuation
This involves ensuring that the best valuation method is used
...
In practice, the value of the second transaction is used
to calculate Customs value on import
...
Thus applying “first
sale” principle can minimise duty by eliminating “middleman markup
...
A trader in
Tanzania approaches a Kenyan trader for the first time in order to purchase sports shoes
...
Classification of goods
The taxpayer should ensure goods are correctly classified
...
If lower duty is paid, there are risks of paying the
difference after a post clearance inspection
...
Duty deferral
This planning opportunity involves importing goods, storing or further manufacturing the goods,
then exporting the goods to another country or releasing them to the Kenyan market (pay 2
...
Some imports from certain countries enjoy a preferential import duty
...
One would
need to produce a valid Certificate of Origin
...
9
Employment versus self-employment
There is a distinction between employment (receipts taxable as earnings) and self-employment
(receipts taxable as trading income)
...
Taxpayers tend to prefer self-employment, because:
••
••
The rules on deductions for expenses are more generous
...
••
••
••
••
••
••
••
The degree of control exercised over the person doing the work: The higher the degree
of control, the more likely that the contract of service as opposed to a contract for
service where there is minimal control from the entity
...
Whether he provides his own equipment: A person on self employment is expected to
have his own equipment while providing services
...
Whether he hires his own helpers: If he has the authority and powers to hire his own
helpers then he is in self-employment as opposed to employment
...
What degree of responsibility for investment and management he has: The more such
responsibilities, the more likely that it is a contract for services
...
The wording used in any agreement between the parties: the agreement can state
categorically what it is
...
Held: There was no ongoing office which could be vacated by one person and held by another
so the fees received were from self-employment not employment
...
Held: The vision mixer was self-employed, not because of any one detail of the case but because
the overall picture was one of self-employment
...
An
exchange of correspondence between the company and the individuals was not a contract of
employment as there was no provision as to the frequency of work and there was flexibility to
accept work or turn it down as it arose
...
A worker's status also affects national insurance
...
S T U D Y
T E X T
5
...
The employer needs to reward labour in the highest
possible way at lowest cost possible while at the same time observing full compliance with the
law
...
An employee will usually be rewarded largely by salary, but several other elements can be
included in a remuneration package
...
Bonuses are treated like salary, except that if a bonus is accrued in the employer's accounts
but is paid more than nine months after the end of the period of account, its deductibility for tax
purposes will be delayed
...
The cost of providing
benefits is generally deductible in computing trading profit for the employer
However, there are a large number of tax free benefits and there is a great deal of planning that
can be done to ensure a tax efficient benefits package for directors and employees
...
There are items which are commonly referred to as income but are not included in the above
mentioned list of taxable income
...
Pension or gratuities earned or granted in respect to disability
2
...
3
...
g
...
Allowances to the Speaker, Deputy Speaker and Members of Parliament payable to
them under the National Assembly remuneration
TAX PLANNING
139
5
...
(With effect
from June 1987, interest up to Kshs 300,000 is qualifying while the excess is non
qualifying
...
Cost of passage to and from Kenya of a non-citizen employee borne by the employer
...
Employer’s contribution to pension funds or provident funds
...
Benefits, advantages/facilities of an aggregate value of less than Kshs 36,000 p
...
in
respect of employment or services rendered
...
e
...
1
...
2006, non cash benefits are
taxed if their aggregate value is more than Kshs 36,000 p
...
m
...
The first Kshs 150,000 per month for persons with disabilities exempt from taxation
...
e
...
12
...
10
...
(w
...
f
...
June 2009)
JOB OFFER A: MAPATO LTD
Terms of employment
1
...
Free housing for him and his family within the farm , with free water and electricity
...
The electricity is also generated within the
farm
...
Free supply of farm produce subject to a maximum of Kshs 600,00 per month
...
Reimbursement of medical expenses incurred on self and family subject to a maximum
of Kshs 1,500,000 per annum
...
5
...
The employer would bear the tax on this benefit
6
...
He would be required to register as a member of the Institute of Human Resources
Managers and pay the initial registration fee of sh
...
The employer would pay the
annual subscription fee of Kshs 18,000
...
Terms of Employment
2
...
Free housing and meals but only for self
...
Monthly entertainment allowance of Kshs 15,000
4
...
The medical scheme covers all hotel employees
...
However, he has
received two offers of employment which require him to report on duty on 1st July
...
The company owns a large scale farm in Kitale on which it grows maize
and rares dairy cows
...
Mr
...
He
has provided you with the following additional information
...
Payment by employer of his life assurance premiums amounting to Kshs 60,000 per
annum
...
Reimbursement by the employer of annual subscription for the Journal of Human
Resources Managers amounting to Kshs 2,500 per annum
...
A one-week fully paid holiday package worth Kshs 150,000 for his wife and children to
visit him and reside at the hotel once per year
...
Mr
...
Kshs
Self
150,000
Wife and children
300,000
Total average medical expenses
450000
••
His consumption of the farm produce under job Offer A would average to about Kshs
...
S T U D Y
T E X T
Required
Evaluate the two job offers and advise Mr
...
Your evaluation should include both taxable and non taxable benefits
...
Employment income
Basic salary (140,000 x 12)
Benefits
Medical benefits (Reimbursement)
Consumption of farm produce
School fees
Annual membership – golf club
Registration (Institute of Human Resource
Managers)
Annual subscription fees
Electricity
Water
Housing benefit
Higher of 10% x 2,701,200
Actual payment
Annual taxable income
Sh
...
Employment income
Basic salary (180,000 x 12)
Sh
...
T E X T
Benefits
Life assurance premiums
Reimbursement of annual subscriptions
Holiday package
S T U D Y
Allowances
Entertainment allowance (15,000 x 12)
142
A dvanced TA X AT I O N
b) (i) Responsibility of employers for the collection of PAYE due from retirees receiving
monthly pension income
...
a received by a
resident individual are tax exempt so long as the scheme or fund is registered
...
However, if the
employee is above 65 years of age then the whole withdrawal from a pension fund is tax
exempt
...
Lumpsum withdrawals from a pension or retirement scheme of up to K
...
a
received by a resident individual are tax exempt so long as the scheme or fund is registered
...
11 Identifying opportunities to alleviate, mitigate or defer the impact
of direct or indirect taxation
The student should be able to identify opportunities to alleviate, mitigate or defer the impact of
direct or indirect taxation
...
S T U D Y
T E X T
5
...
Forms of decision problem
1
...
3
...
Whether to lease an industrial building or construct one
...
Whether to operate a partnership or a limited company
Determining expenditure tax deductible or non-tax deductible
...
Capital structure and taxation
By capital structure of a company, we mean the long-term financing normally made up of ordinary
share capital
...
Capital structure explains the relationship (proportion) between the various sources of finance
...
Optimum capital structure is achieved where,
among other considerations, the cost of finance is lowest
...
Taxation discriminates
between equity and debt capital
...
Dividends on equity is not tax
deductible
...
is to pay interest on debt capital of 15% where corporation tax rate of 30%
TAX PLANNING
143
Required
Compute the true/effective cost of debt capital
...
5%
=
10
...
Number of shares 1 0 % 50,000 each Kshs
...
K
250,000
XYZ Ltd
50,000 each Shs
...
125,000
Gross income
Required
a) Earnings per ordinary share for each company
...
Solution
ABC Ltd
...
K Kshs ‘000
250,000 Gross income
Less loan interest
Nil Less loan interest
250,000
(12,500)
Before tax
250,000 Before tax
237,500
Corporation tax @30%
(75,000) Corporation tax @30%
(71,250)
Income after tax
175,000 Income after tax
166,250
Less Pref- dividend @
(12,500) Pref
...
25
75000
Effective tax rate
� 100 = 30%
250000
166,250
Earnings per share
3
...
5%
250000
b) Effective cost of debt (XYZ Ltd
...
tax savings = (75,000 – 71,250) = Sh
...
Income taxes and project appraisal
XYZ Company Ltd, a manufacturing company in industrial area, Nairobi requires 2,500 units a
year of a component over a period of 3 years
...
Plan B
To manufacture the component themselves
...
Incremental costs are estimated at Kshs 5 per component
...
Plan C:
S T U D Y
T E X T
To manufacture the component using hired equipment which would be maintained by the owner
without additional charge
...
The company uses a discount rate of 5% per half year
...
Required
Which alternative maximises tax cash inflow? (Take corporation tax rate to be 30%)
...
0
7,500
...
0
17,500
...
0
7,143
17,500
...
0
6,803
17,500
...
67
(717)
Plan C
5000
1500
3500
5%
5000
1500
3500
5%
5000
1500
3500
5%
3500
3,333
3,175
Kshs
21,445
...
7
Release on disposal
Tax effect
Hire charges
Discount rate
Tax effect
36,365
2
10,008
1
The option that maximises tax cash inflows is Option 3
...
One issue nevertheless arise and the directors would wish to obtain tax
advice before making a decision
...
The lease will be for 10
years
...
(Present value of annuity 18%, 10yrs = 4
...
2007)
Option 1
Investment deduction (first year of use of assets)
Kshs ‘000’
ID @ 100% Residue for IBD or WTA
Kshs ‘000’
Kshs ‘000’
Factory building
10,000
10,000
-
New machinery fixed
30,000
30,000
-
4,000
4,000
-
44,000
44,000
Power supply
S T U D Y
T E X T
WTA
Kshs ‘000’
Class IV @ 12½%
Furniture
2,000
2,000
WTA (Yr
...
1
Kshs ‘000’
ID
44,000
WTA
250
Tax allowable capital allowance (1 year only)
44,250
Option 2
Leasing the factory would mean lease hire payments of:
46,000 46,000
Shs'000'
=
4
...
10, 235,640 tax allowable expense against income
before taxation per annum
...
Therefore acquiring the assets from 1st year allowance would be better
...
13
147
Form of business ownership
There are many tax implications involved in deciding the form of business:
••
••
Company or Business
Branch or subsidiary
••
••
••
••
••
••
••
The following are the major tax considerations to take into account in deciding whether
to operate a partnership or a limited company
...
A company is considered to be a separate taxable entity and as
such it will bear its taxes
...
The taxable income or loss of a limited company is taxable on
the company at a flat rate of 30% for resident and 37
...
Partner’s salaries are not tax deductible while director’s salaries in a limited company
are tax deductible
...
The company will be required to pay withholding tax when it is declaring dividends to
its shareholders while a partnership does not declare dividends
...
Companies have compensating tax while partnerships are not subject to the same
...
However,
companies are not subject to turnover tax
...
5%
Expenses of interest, royalties and
management or professional fees
paid to head office in India are not
allowable expenses in deriving taxable
income
...
Expenditure incurred by the branch
outside Kenya is only allowable/
deductible to the extent the
Commissioner of Domestic Taxes
(CDT) may consider
Withholding tax rates
No WHT tax applies
WHT tax will apply to payments
to both residents and non
residents
S T U D Y
••
T E X T
Opening a company or a partnership
148
A dvanced TA X AT I O N
The implications of debt or equity as modes of raising additional capital is as follows:
Corporate form of ownership enjoys legal personality and income is subject to corporate income
tax rates
...
For a corporation, reasonable salaries paid to officers/directors who are also shareholders are
tax deductible
...
Corporate profits are subject to double taxation: first corporation tax and secondly dividends
withholding tax on recipients
...
Illustration:
S T U D Y
T E X T
2
...
1
Mr
...
The details of the
two offers are as follows:
Firm B
Firm A
Benefits:
Housing (market rate) p
...
Sh
...
Required
What offer would you recommend to Mr
...
TAX PLANNING
149
Solution:
(iii) 5% x 780,000
Net taxable income
39,000
61,000 x 12
144,000
______
924,000
144,000
______
876,000
360,000
240,000 15% x 876,000 = 131,400
1,164,000
(39,000)
1,125,000
B
732,000
240,000
30% x 1,236,000 =
370,800
5% x 732,000 = 36,600
360,000
1,236,000
(36,600)
1,199,400
T E X T
Housing benefit: higher of
(i) Mkt value
240,000
(ii) 15% x 924,000
138,600
Pensionable pay
Less pension contribution
By employee: lower of
(i) Set limit
240,000
(ii) 30% x 1,164,000
349,200
A
780,000
Tax liabilities
Firm A on Kshs 1,125,000
First Kshs
...
8
278,632
...
0
264,688
...
8
Firm B on Kshs 1,199,400
300,952
...
0)
Net tax liability
287,008
...
600,000 = 144,000
(ii) Benefit on 2000cc = 86,400
150
A dvanced TA X AT I O N
5
...
23
Under S
...
He can direct for necessary adjustment on
taxable income and issue an assessment accordingly
...
g
...
He would be taxed
on the difference between the low price he pays for the car and the market price for the
car
...
The salary helps to spread tax payable but
the parent controls the child’s income
...
Tax Avoidance: Principles emerging from case law
S T U D Y
T E X T
Section 23 of the Kenya Income Tax Act empowers the Commissioner to order the adjustment of
transactions which in his opinion are effected with the main aim of avoiding or reducing liability
to tax
...
This decision
of the Tribunal is final and there is no right to further appeal
...
Consequently, there is no
such litigation in respect of tax avoidance schemes in Kenyan courts
...
The “Duke of Westminster” Principle
...
is less than it would otherwise be
...
The “Ramsay” Principle: This was established in a Capital Gains Tax Case in relation
to composite transactions
...
This interdependent series of transactions would normally be “circular and self cancelling”
...
Transactions which have no commercial purpose
are treated as a fiscal nullity
...
The same principle was extended in CIR vs BURMAH OIL CO
...
3
...
If they
were sold in UK at a gain, it would be subject to Capital Gains Tax
...
He was advised to sell by an exchange of
shares for shares with an offshore company, G Ltd
...
The scheme succeeded on the
grounds that the end result led to “enduring legal consequences” and therefore the individual
transactions had a business purpose and not artificial as in the Ramsay Case
...
15
Transfer of real properties
Income from ‘sale of land and buildings’ in Kenya is non-taxable income
...
g
...
6
...
(a) A taxpayer (or a partnership) with Kenya rental income is treated as running a business,
his Kenya property business'
...
Profits and losses are computed in the same way as
trading profits are computed for tax purposes, on an accrual basis
...
Non residents
They are taxed at a flat rate of 30% on gross rent income and this is the final tax
...
Residents
For residents, rental income will be brought to tax at the graduated scale rates for individuals and
at the corporation tax rate for companies
...
16
Claim the expenses allowable on the rental income
...
As such the mortgage option is
recommended
...
With the introduction of VAT on commercial rental property, it is important to charge VAT
on any such properties and issue a valid tax invoice
...
A tax efficient pricing policy should be
informed by all considerations including the prices of commodities and the taxes payable for the
commodities
...
S T U D Y
Taxation of rental income depends on whether one is a resident individual or a non resident
...
Rent
income is made up of key money or goodwill, normal rent and premium
...
Transfer pricing is important when structuring transactions
...
However, in view of the tax administration’s increasing
interest in this subject and the pre-eminently ‘affiliated’ nature of shareholder financing, this
subject cannot be avoided in an M&A transaction
...
The fact of not meeting such transfer pricing documentation requirements
might result in severe penalties in said countries
...
In addition to specific, local transfer pricing rules, many countries also
apply the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations
for consistent application of the arm’s length principle at an international level
...
Examples are the substantiation of the (often high) interest charged
by the investor on shareholder financing; the spread in a back-to-back situation; charging or
not charging a fee if a group company stands as guarantor for another group company within
the scope of an overdraft facility; the allocation of the advantage in case of cash pooling; or the
situation in which external bank financing within the group is on lent at a ‘blended’ rate to all
group companies, without involving the stand-alone creditworthiness of the various companies
in the analyses
...
Loan pricing policy
As said, the arm’s length nature of each loan should be substantiated based on the arm’s
length principle, transfer pricing legislation and local documentation requirements
...
In practice, therefore, substantial loans and high-interest loans in particular
have only been documented so far
...
In such loan pricing policy, the credit
rating of the group companies and the currency and term of the loans must be taken into account
...
TAX PLANNING
153
5
...
Some of the
tax incentives include:
Capital allowances
The capital allowances available in Kenya are Farm works, Industrial Building, Investment and
Wear and Tear allowances
...
They tend to lower the effective price of acquiring
capital since the initial cost is recovered
...
Most of the parks are, however, owned by private firms
...
Similarly, the number of
EPZ firms increased from 13 to 22 within the same period
...
This is an exemption from corporation tax for the first
10 years of trading
...
There is an exemption from withholding tax on dividends and other payments to non
residents during the first 10 years
...
Supplies from an EPZ enterprise are zero rated for purposes of VAT
There is a refund of import duty on raw materials to manufacture exports
...
However, these rules were not rigidly applied during the early years of the scheme, with the
domestic firms sometimes exceeding 50%
...
5% import duty is charged on EPZ sales made
to the domestic market
...
This is considered to be a major disincentive for expansion of the
scheme since many Kenyan firms target the COMESA market
...
Up to now,
EPZA has gazetted 16 zones but only half of these zones are in operation
...
These incentives were provided on the enactment of the Export Processing Zone
Authority Act “EPZA Act” in 1990 which established the EPZ Authority (EPZA) as a” one-stop”
centre for facilitating export-oriented investment and administering a number of incentives
...
T E X T
Export Processing Zone incentives
154
A dvanced TA X AT I O N
VAT Remission
The Kenyan tax regime incorporates a remission scheme, including VAT targeted at either
attracting investments or promoting exports
...
Under the original VAT law introduced in 1990 imports made by MUB are zero rated to avoid the
payment of VAT up front
...
Export processing zone enterprises are exempt from registration under VAT Act because they
are not considered as local firms
...
The main trade tax incentive schemes include
export compensation, duty drawback, manufacturing under bond (MUB), and export processing
zones
...
Materials imported for use in manufacturing
for export; the production of raw materials for export; or the production of duty free items for sale
domestically, are eligible for duty remission
...
Manufacture under Bond
The Manufacturing under Bond (MUB) scheme
...
It is a duty or
tariff deferral scheme under which eligible firms were licensed, placed under bond and allowed
to import capital items, spares and raw materials without payment of duty
...
The amount
of the bond is predetermined for each import, with the Customs authorities, canceling when the
firms make exports, using the input on which the tax was waived
...
The goods produced can only be sold on the domestic market with the permission
of the Commissioner of Income Tax
...
The physical controls that exist for monitoring their inputs and output are similar to those
used under the excise regimes
...
Though the scheme continues, the number of firms
has declined drastically to about 12 when, in 1994, the US trade authorities revoked Kenya’s
export quota to that market
...
TAX PLANNING
155
Kenya also offers Duty and VAT remission scheme as a tax incentive
...
Unlike the MUB and EPZ schemes,
the remission mechanism does not cover taxes paid on capital inputs such as equipment and
machinery
...
Double taxation treaties
Kenya has double tax treaties with various governments
...
The agreements
are aimed at eliminating double taxation of income earned by the residents of the respective
countries
...
(b) The rate is 12
...
(c) No Kenya tax is due if the dividend is subject to tax in Zambia
...
5% for management and professional fees
...
Turnover tax
This is a tax on consumer expenditure introduced in the 2006 Finance Act
...
It also acts as a tax incentive for the medium
size businesses with a turnover of less than Kshs 5 million
...
It applies to any person whose gross sales is
more than Kshs 500,000 per annum and does not exceed or is not expected to exceed Kshs 5
million per annum
The applicable rate as per the 2006 Finance Bill was 3% of gross sales per annum and it was to
be a final tax
...
This made it difficult for it to be imposed by 1 January
2007
...
Following this amendment, the turnover tax is expected to be effective
with effect from 1 January 2008
...
K
Zambia
%
S T U D Y
Resident in
156
A dvanced TA X AT I O N
5
...
For the application to be granted, both registered persons must within 30 days furnish the
Commissioner with the following information:
• Details of the transaction,
• Details of the arrangements made for payment of tax due on supplies already
made
• Description of the transaction
• Quantities and value of stocks of taxable goods on hand at the date of disposal,
• Details of arrangements made for transferring the responsibility for keeping and
producing books and records relating to the business before disposal;
T E X T
S T U D Y
The various tax planning opportunities in the disposal of business operations and restructuring
activities are as follows:
Unless the Commissioner has reason to believe that there would be undue risk to the
revenue, and notifies the registered persons accordingly within 14 days of receipt of the
notification, the stocks of taxable goods on hand may be transferred without payment of the
tax otherwise due and payable; and
Further, notwithstanding that the business is being disposed of by the registered person as
a going concern, that registered person shall remain registered and be responsible for all
matters under the VAT Act in relation to the business prior to its disposal, up to the time of its
disposal, until such time as the requirements of this Act have been properly complied with
...
In this case, no election will be made in cases where either the
buyer or the seller is at the time of the sale a non resident person
...
In order for a company to qualify for the tax incentive, the following
conditions must be met:
• There must be a new company to be incorporated in Kenya or an increase of
share capital of an existing company
...
• That the absorbing company is either registered or increases its capital with a view
to acquiring more than 90% of the share capital of the target company
...
TAX PLANNING
157
Section 96 exempts from tax instruments in respect to which it is shown to the satisfaction of the
collector
...
Tax planning for the case of an organisation may involve the following areas remuneration,
duty, VAT or corporation tax
...
5
...
Question two
Discuss the tax planning opportunities with regard to employee taxes
...
19
T E X T
(a) That the effect thereof is to convey or transfer a beneficial interest in property from one
company with limited liability (hereinafter called the transferor) to another such company
(hereinafter called the transferee); and
(b) That either—
(i) One of such companies is beneficial owner of not less than ninety per centum of the
issued share capital of the other company; or
(ii) Not less than ninety per centum of the issued share capital of each of the companies is
in the beneficial ownership of a third company with limited liability;
(c) That the instrument was not executed in pursuance of or in connection with an arrangement
where under—
(i) The consideration for the conveyance or transfer was to be provided directly or indirectly
by a person other than a company which at the time of the execution of the instrument
was associated with either the transferor or the transferee; or
(ii) The beneficial interest in the property was previously conveyed or transferred directly
or indirectly by such a person
...
Question four
Discuss some of the tax planning opportunities with regard to Disposal of business
operations and restructuring of activities
Question five
S T U D Y
T E X T
With the aid of case law, discuss the anti avoidance provisions as provided under Section 23 of
the Income Tax Act
...
21
159
Quiz answers
Question one
Question two
Staff costs are significant operational costs
...
Consider lumpsum payments, benefits, expenses etc
...
Some of them bring tax benefits to the employee only,
some will benefit the employer
...
Duty remission:Investors can apply to the Minister for duty waiver or exemption under
special duty rates
...
2
...
It
would be advisable to import from a manufacturer rather than a middleman
...
As
such, if one has prior information of first transaction and bought directly from the importer
or manufacturer, it would result in duty saving
...
3
...
A trader in Tanzania approaches a Kenyan trader for the first time in
order to purchase sports shoes
...
4
...
Incorrect classification of goods may lead to payment of either higher or lower duty
...
If higher duties are paid, it will result in the pursuit of the duties outstanding
(customs duty and VAT) and even fines or interest in arrears on the duties and VAT
...
Duty deferral: This planning opportunity involves importing goods, storing or further
manufacturing the goods, then exporting the goods to another country or releasing
them to Kenyan market (pay 2
...
6
...
Some imports from certain countries enjoying a preferential
import duty
...
One would need to produce a valid Certificate
of Origin
...
The general position for benefits is that they are subject to income tax
...
However, there are a large number of tax free benefits and there is a great deal of planning that
can be done to ensure a tax efficient benefits package for directors and employees
...
S T U D Y
T E X T
There are items which are commonly referred to as income but are not included in the above
mentioned list of taxable income
...
Pension or gratuities earned or granted in respect to disability
...
Monthly or lumpsum pension granted to a person who is 65 years of age or more
...
That part of the income of the president of the republic of Kenya that is exempt e
...
a
salary duty, allowances, entertainment allowances paid or payable to him from public
funds
...
Allowances to the Speaker, Deputy Speaker and MP payable to them under the National
Assembly remuneration
...
Interest up to Kshs 100,000 per individual on housing bonds, account with Housing
Finance ( formerly Housing Finance Corporation of Kenya, HFCK), Savings and Loans
of Kenya Ltd, East Africa Building Society, Home Loans and Savings
...
)
6
...
7
...
Benefits, advantages/facilities of an aggregate value of less than Kshs 36,000 p
...
in
respect of employment or services tendered
...
e
...
1
...
2006, non-cash benefits are
taxed if their aggregate value is more than Kshs 36,000 p
...
m
...
The first Kshs 150,000 per month for persons with disabilities exempt from taxation
...
e
...
12
...
10
...
( w
...
f
...
June 2009)
Question three
Tax planning is the arrangement of the affairs of a taxpayer in such a way as to minimise tax
liability at lowest cost without contravening any tax law or regulations
...
Tax planning requires:
▪▪ A deeper understanding of the tax legislation; and
▪▪ A sound knowledge of case law in taxation
...
Tax revenue departments have to ensure the following through proper tax
planning: ▪▪
▪▪
Taxpayers comply fully with tax laws and regulations; and
Revenue collection is maximised
...
Aims of tax planning
1
...
2
...
3
...
Tax planning for individuals
The tax planning measures of an individual would depend on whether they are employed or
unemployed
...
An employer should ensure that mortgage interest paid by the employees is allowed for deduction
in the payroll of all eligible employees
...
The deductible amount paid is subject to a maximum of Kshs 60,000 per
annum (Kshs 5,000 per month)
...
Examples of benefits that the company could consider
introducing or expanding include the following:
Medical services
This entails the reimbursement to staff of medical expenses incurred for self and dependants
or access to designated hospital facilities where the company holds an account
...
Staff development and training
Training costs directly paid to a training institution for an employee in relation to the
employees’ responsibilities at the work place and for the benefit of the company’s business
are allowable for corporate and PAYE purposes
...
The maximum allowable interest is Kshs
150,000 per annum (Kshs 12,500 per month)
...
Meals for low income employees
Meals provided to low income employees on employer’s premises are a non taxable benefit
on the employees
...
29, 316 per month, i
...
employees at income tax bracket of 20% and below
...
However, educational fees for dependants of low income employees paid or
foregone by an educational institutional employer are not taxable on either the employer or
the employee
...
For the
application to be granted, both registered persons must within 30 days furnish the Commissioner
with the following information:
••
••
••
••
••
Details of the transaction;
Details of the arrangements made for payment of tax due on supplies already made;
Description of the transaction;
Quantities and value of stocks of taxable goods on hand at the date of disposal;
Details of arrangements made for transferring the responsibility for keeping and
producing books and records relating to the business before disposal;
Unless the Commissioner has reason to believe that there would be undue risk to the revenue,
and notifies the registered persons accordingly within 14 days of receipt of the notification, the
stocks of taxable goods on hand may be transferred without payment of the tax otherwise due
and payable; and, further, notwithstanding that the business is being disposed of by the registered
person as a going concern that registered person shall remain registered and be responsible for
all matters under the VAT Act in relation to the business prior to its disposal, up to the time of its
disposal, until such time as the requirements of this Act have been properly complied with
...
In this
case, no election will be made in cases where either the buyer or the seller is at the time of the
sale a non resident person
...
In order for a company to qualify for the tax incentive, the following
conditions must be met:
• There must be a new company to be incorporated in Kenya or an increase of
share capital of an existing company
...
• That the absorbing company is either registered or increases its capital with a view
to acquiring more than 90% of the share capital of the target company
...
Section 96 exempts from tax instruments in respect to which it is shown to the satisfaction
of the Collector
...
▪▪ Section 96 of the Stamp duty Act
Section 96 exempts from tax instruments in respect to which it is shown to the satisfaction
of the Collector
...
T E X T
Stamp duty incentives
S T U D Y
••
163
164
A dvanced TA X AT I O N
Question five
Anti-avoidance provisions S
...
23, the Commissioner of Income Tax is empowered to reject certain business transactions
when he is of the opinion that the main purpose or one of the main purposes for effecting a
transaction is evasion or reduction of tax liability
...
If the taxpayer disputes the adjustment
and the resulting assessment, the taxpayer can appeal to the Tribunal e
...
••
••
A director buying a car from the company at a throw away price
...
A child paid very high salary for minor duties
...
The Commissioner of Income Tax would disallow
the salary and tax it
...
Such a direction can only be challenged by appealing to the Income Tax Tribunal
...
However, the Commissioner rarely, if ever, does use such powers
...
However, the following principles have emerged from UK Case Law and which may well be
applied in Kenya:
1
...
Lord Tomlin stated: “every man is entitled, if he can, to order his affairs so that the tax
attaching
...
2
...
At the time, the most prevalent scheme to avoid tax (especially Capital Gains Tax) was to enter
into a series of transactions, which would facilitate the following:
a
...
The exchange of shares for shares, which would not have CGT implications
...
The Ramsay doctrine provides that whether a series of transactions is genuine or artificial would
be dependent on the end result
...
The preordained series of transactions are disregarded if they have no business
purpose other than achieving the preordained end
...
LTD
...
21 Past paper analysis
The following is a list of questions covering the topic that were tested in previous examsThe
questions are listed in this format: Month/year e
...
6/01 represents June or May 2001
...
5 (a) 12/05 Q
...
5 (a), 06/08 Q
...
5 (a),
Taxation 1- 12/08,
5
...
(4 marks)
b) Under what circumstances are imported goods considered to have been dumped in your
country?
(6 marks)
c) Write brief notes on the following:
i)
ii)
Tax-free employment benefits
(6 marks)
Set off of import duty
(4 marks)
(Total: 20 marks)
S T U D Y
a) i) Define the term ‘tax planning’
T E X T
Question one
166
A dvanced TA X AT I O N
Question four
“In my judgement, not every payment made to an employee is necessarily made to him as a
profit arising from his employment
...
Justice Upjohn in Hochstrasser v – Mayes (1960) 38 TC 673
...
Expense reimbursement
...
(4 marks)
Question five
a) “Multinational corporations may adopt certain pricing structures for their Kenyan subsidiaries
that shift profits out of Kenya to countries where profits are taxed less and thus divert part of
Kenya’s revenue abroad”
...
Required:
With reference to the statement above and section 18(3) of the Income Tax Act (Cap
...
(4 marks)
ii) Identify four methods of determining an appropriate transfer price as provided in the
Organisation for Economic Co-operation and Development (OECD) model
...
0 Tax systems and policies
6
...
In this chapter we will lay emphasis on developing
tax systems and policies
...
The chapter will assist the student understand the various types of tax systems and be able
to recommend a viable tax system based on International best practices
...
After this chapter the students should have understood the following concepts:
••
••
••
••
••
6
...
Questions in this topic are likely to
be theoretical and could test a candidates’ understanding of tax systems, reforms, modernisation
of the tax systems and design of a tax policy
...
4 Industrial Context
This topic will enable economic experts understand the various tax systems and be in a position
to advise accordingly
...
6
...
It involves the various approaches, structures and policies adopted over time and relating to
taxation and revenue generation
...
2
172
A dvanced TA X AT I O N
Tax policy: is the government's approach to taxation, both from the practical and normative
side of the equation
...
e
...
e
...
Tax reforms: These are changes or amendments of the tax system with the general objective of
revenue adequacy, economic efficiency, equity and fairness and simplicity
...
This improves tax collection and ensures efficiency in the
tax system
...
6
Types of tax systems
Generally, there are two major types of tax systems
...
S T U D Y
T E X T
Unified tax system
A unified tax system has only one form of tax
...
A unified tax is a fixed tax that is paid for a given period of time,
usually one year, to guarantee business entity of all legal protection for the period
...
The regime is usually graduated into
tax schedules defined on the basis of either profitability or employment levels of business entities
such that the higher the level of employment or profitability, the higher the amount of unified tax
payable
...
In Kenya, for example, we have a multiple tax system since there are many taxes applicable
including personal tax, corporation tax, withholding tax, compensating tax, turnover tax, Value
Added Tax, Customs and Excise tax
...
g
...
7
173
Role of taxation in economic development
The role of taxation and fiscal policy in the development strategy of a country has to
be viewed in the background of the functions a taxation system performs
...
a
...
During inflation, the government
imposes more taxes in order to discourage the unnecessary expenditure of the individuals
...
In
this way, the increase or decrease of tax helps to check the big fluctuations in the prices and
maintain economic stability
...
Pay interest on national debt
Taxes are also levied by the government to pay interest on national debt
...
Fair redistribution of income
A major function of taxation is to bring about some redistribution of income
...
Second, the higher income
groups, through a system of progressive taxation, pay a higher proportion of their income in tax
than the less well-off members of the society
...
Protection policy
Taxes are also imposed to give protection to those commodities which are produced in the
country
...
In the view of these taxes, the individuals are induced to buy local products
...
Social welfare
The government imposes taxes on the production of those commodities which are harmful to
human health e
...
excise duty on wines, cigarettes among others
...
Optimum allocation of resources
Taxes are also imposed to allocate resources of the country for their optimum use The amounts
collected by the government from taxes are spent on more productive projects
...
S T U D Y
The revenue is required to pay for the goods and services which the government provides
...
Public goods, such as defense and police are
consumed collectively and no one can be prevented from enjoying them if he wishes to do so
...
Merit goods, such as education and medical
care, could be, and often are, provided privately but not necessarily in the amounts considered
socially desirable and hence governments may subsidise their production
...
Thus, the public may be subsidised because the market does not take
account of all the costs and benefits of the public transport system
...
Raise revenue
174
A dvanced TA X AT I O N
6
...
Setting up an efficient and fair tax
system is not easy, particularly for developing countries that want to become integrated in the
international economy
...
Developing countries face formidable challenges when they attempt to establish efficient tax
systems:
S T U D Y
T E X T
i
...
As they are seldom paid a regular, fixed wage, their earnings
fluctuate, and many are paid in cash, "off the books
...
Nor do workers in these countries typically spend their
earnings in large stores that keep accurate records of sales and inventories
...
ii
...
As a result, governments
often take the path of least resistance, developing tax systems that allow them to exploit
whatever options are available rather than establishing rational, modern, and efficient
tax systems
...
Informal structure and financial limitations of the economy in many developing countries
and hinder the statistical and tax offices from generating reliable statistics
...
As a result, marginal changes are often preferred over major structural
changes, even when the latter are clearly preferable
...
iv
...
Although raising
high tax revenues in this situation ideally calls for the rich to be taxed more heavily
than the poor, the economic and political power of rich taxpayers often allows them to
prevent fiscal reforms that would increase their tax burdens
...
TAX SYSTEMS AND POLICIES
6
...
Simplicity
A tax system should be simple enough to enable a taxpayer to understand it and be able to
compute his/her tax liability
...
It may also create
administrative difficulties leading to inefficiency
...
However, this may not be equitable as some people will not pay tax
...
S T U D Y
Developing countries attempting to become fully integrated in the world economy will
probably need a higher tax level if they are to pursue a government role closer to that
of industrial countries, which, on average, enjoy twice the tax revenue
...
To meet these challenges, policymakers in these countries will have
to get their policy priorities right and have the political will to implement the necessary
reforms
...
vi
...
The need
to replace foreign trade taxes with domestic taxes will be accompanied by growing
concerns about profit diversion by foreign investors, which weak provisions against tax
abuse in the tax laws as well as inadequate technical training of tax auditors in many
developing countries are currently unable to deter
...
vii
...
The effectiveness of tax incentives— in the absence of other necessary fundamentals
— is highly questionable
...
To allow their emerging markets to
take proper root, developing countries would be well advised to refrain from reliance on
poorly targeted tax incentives as the main vehicle for investment promotion
...
Finally, personal income taxes have been contributing very little to total tax revenue
in many developing countries
...
Taxing this income is therefore a
daunting challenge for developing countries
...
175
176
A dvanced TA X AT I O N
2
...
The tax should not be arbitrary
...
There should be readily available information if taxpayers need it
...
This involves appraising different business or investment
opportunities on the basis of the possible tax implications
...
Employers seek to offer the most tax efficient remuneration packages
which would not be possible if uncertainty exists
...
Convenience
The method and frequency of payment should be convenient to the taxpayer e
...
PAYE
...
For example, it may be difficult for many taxpayers to make a lumpsum
payment of tax at the year-end
...
4
...
S T U D Y
A good tax system should be capable of being administered efficiently
...
This refers to the maximum tax which may be collected from a taxpayer without producing
undesirable effects on him
...
There are two aspects of taxable capacity
...
Taxable capacity
a) Absolute taxable capacity
b) Relative taxable capacity
Absolute taxable capacity is measured in relation to the general economic conditions and
individual position e
...
the region, or industry to which the taxpayer belongs
...
Relative taxable capacity is measured by comparing the absolute taxable capacities of different
individuals or communities
...
Neutrality
Neutrality is the measure of the extent to which a tax avoids distorting the workings of the market
mechanism
...
The allocation of goods and
services in a free market economy is achieved through the price mechanism
...
TAX SYSTEMS AND POLICIES
177
7
...
This does not mean overtaxing by the government
...
For example
Value Added Tax was introduced since it would provide more revenue than Sales Tax
...
Elasticity or buoyancy
By elasticity we mean that the government should be capable of varying (increasing or reducing)
rates of taxation in step with the circumstances in the economy, e
...
if the government requires
additional revenue, it should be able to increase the rates of taxation
...
However, care must be taken not to charge increased rate of excise
duty from year to year because they might exert inflational pressures on the economy
...
Flexibility
It means that there should be variety or diversity in taxation
...
A single tax or a few taxes may not meet revenue requirements of the state
...
11
...
Equity is about how the burden of
taxation is distributed
...
Through progressive taxation, those with high incomes pay a large amount of tax as
well as a regular proportion of their income as tax
...
There are three alternative principles that may be applied in the equitable distribution of the tax
burden
...
The benefit principle
b
...
The cost of service principle
6
...
The overall objective was to provide operational
autonomy in revenue administration and enable its evolution into a modern, flexible and integrated
revenue collection agency
...
Diversity
T E X T
It means that there should be no rigidity in taxation i
...
the tax system can be changed to meet
the revenue requirement of the state; both the rate and structure of taxes should be capable
of change or being changed to reflect the state’s requirements
...
The entire tax structure should be capable of
change
...
However, a number of processes remain manual
and KRA is yet to operate as a fully integrated organisation
...
This actuated the Revenue Administration Reform and Modernisation Programme
(RARMP) which commenced in 2004/05 with the objective of transforming KRA into a modern,
fully integrated and client-focused organisation
...
This has
led to the development of an institutionalised administrative framework for the RARMP making it
easier to track progress in the reform initiatives and enhance project ownership and acceptance
to change from both internal and external stakeholders
...
This will be achieved through the implementation of the following seven key
projects:
1
...
3
...
5
...
7
...
Overall,
••
••
••
••
••
••
Revenue collection has increased by 1% of the Gross Domestic Product from Kshs
202 billion in 2002/03 to Kshs 297 billion in the 2005/06 financial year
...
The Simba system was implemented to facilitate self-assessment and Post Clearance
Audit (PCA) function was strengthened
...
The KRA Information Communication & Technology (ICT) strategy was developed to
act as the blue print for all future automation programmes
...
Challenges:
Despite the achievements enumerated above, significant challenges still remain
...
TAX SYSTEMS AND POLICIES
179
••
Implementation hiccups in Simba 2005 towards the attainment of a complete self
assessment regime while faster progress is needed in the implementation of an
Integrated Tax Management System
...
•• Need for sustained efforts in fighting corruption and tax fraud
...
•• Human resource issues like remuneration, skills and integrity
...
Key perfomance indicators
••
••
••
••
••
••
••
••
••
Improve tax compliance by 5% per annum (assuming an overall compliance level of
60%)
...
Improved quality of service to stakeholders
...
Competitive terms and conditions of service for employees
...
Number of KRA functions fully integrated
...
Quality and timeliness of production of statistics
...
This will be done through:
••
••
••
••
••
Implementation of a fully function-based Customs structure and reengineering of
Customs procedures from physically controlled checks to risk based and post release
controls through strengthening of Post Clearance Audit
...
Taking the lead at the regional level Customs in addressing deficiencies in the East
African Management Act to streamline the import/export process
...
Enhancement of staff competencies in critical areas such as risk-based approaches to
cargo management and the adoption of post release verification and audit
...
This will be achieved through:
••
••
Implementation of an Integrated Tax Management System (ITMS) that integrates both
income tax and value added tax operations and takes a single view of the taxpayer
...
Road Transport Department Reform and Modernisation Project
Considerable progress has been made in automating RTD processes
...
The project also
aims to achieve full connectivity of the RTD with all other KRA departments in order to ensure
seamless flow of information
...
S T U D Y
T E X T
Investigation & Enforcements Reform and Modernisation Project
The project seeks to create a modern Business Intelligence unit that will analyse data to assess
the risks inherent in transaction and ownership relationships which constitute the basis for
evasion schemes
...
Infrastructure Development Reform and Modernisation Project
This project aims at ensuring that projects in the reform programme are given adequate support
through timely acquisition and provision of needed utilities, upgrading of KRA infrastructure and
enhancement of asset and security management systems
...
The project will enable a ‘single view of the taxpayer’ across all KRA
functions, ensure efficient and effective revenue collection and attain operational excellence
...
Human Resources Revitalisation Project
This project seeks to upgrade and diversify the skill base at KRA to international best practice
standards with emphasis being placed on competency based management, recruitment and
retention policy, establishment review and clearly defined career path progression
...
KRA has put in place an elaborate
governance structure for the RARMP
...
11 hapter Summary
C
6
...
What is a tax system?
b
...
What are tax reforms?
Quiz
S T U D Y
A tax system is an organised way in which the government collects tax from its citizens
...
♦♦ Tax policy: is the government's approach to taxation, both from the practical and
normative side of the equation
...
e
...
e
...
♦♦ There are two types of tax systems:
• Unified Tax system
• Multiple tax system
♦♦ Role of taxation in economic development
a
...
Economic stability
c
...
Social welfare
e
...
Allocation of resources
g
...
Simplicity
b
...
Convenience
d
...
Taxable capacity
f
...
Productivity
h
...
Flexibility
j
...
Equity
T E X T
♦♦
182
A dvanced TA X AT I O N
Question Two
List and explain the role of taxation in economic development
...
13 Answers to QuIZ
Question One
Tax system: A tax system is an organised way in which the government collects tax from its
citizens
...
Tax policy: is the government's approach to taxation, both from the practical and normative
side of the equation
...
e
...
e
...
a
...
c
...
e
...
g
...
A complex and difficult to understand tax system may produce a
low yield as it may discourage the taxpayer's willingness to declare income
...
The simplest tax system is one with only a single
tax
...
Certainty
The tax should be formulated so that taxpayers are certain of how much they have to pay and
when
...
The government should have reasonable certainty about
the attainment of the objective(s) of that tax, the yield and the extent to which it can be evaded
...
S T U D Y
Question Two
T E X T
Tax reforms: These are changes or amendments of the tax system with the general objective of
revenue adequacy, economic efficiency, equity and fairness and simplicity
184
A dvanced TA X AT I O N
Certainty is essential in tax planning
...
It is also important in designing
remuneration packages
...
Convenience
The method and frequency of payment should be convenient to the taxpayer e
...
PAYE
...
For example, it may be difficult for many taxpayers to make a lumpsum
payment of tax at the year-end
...
Economic/administrative efficiency
A good tax system should be capable of being administered efficiently
...
The tax system should ensure that the greatest possible proportion of taxes collected accrue to
the government as revenue
...
A good tax system ensures that people pay taxes to the extent they
can afford it
...
••
••
Absolute taxable capacity
Relative taxable capacity
Absolute taxable capacity is measured in relation to the general economic conditions and
individual position e
...
the region, or industry to which the taxpayer belongs
...
Relative taxable capacity is measured by comparing the absolute taxable capacities of different
individuals or communities
...
It should produce the minimum substitution effects
...
A neutral tax system
should not affect the taxpayer's choice of goods or services to be consumed
...
This does not mean overtaxing by the government
...
For example
Value Added Tax was introduced since it would provide more revenue than Sales Tax
...
g
...
Excise duty, for instance,
is imposed on a number of commodities locally manufactured and their rates can be increased in
order to raise more revenue
...
Flexibility
It means that there should be no rigidity in taxation i
...
the tax system can be changed to meet
the revenue requirement of the state; both the rate and structure of taxes should be capable
of change or being changed to reflect the state’s requirements
...
The entire tax structure should be capable of
change
...
Equity is about how the burden of
taxation is distributed
...
Through progressive taxation, those with high incomes pay a large amount of tax as
well as a regular proportion of their income as tax
...
They find
the taxes available in Kenya very complicated
...
Financial constraints: Some of the systems involve substantial financial outlay
...
Scope of the reforms: Some of the reforms have a very wide scope and as such they
may take a longer period before their impact is felt
...
g the proposed taxation of Members of Parliament among others
...
This has made the revenue authority ensure
that they under go continuous training to be on top of their game
...
S T U D Y
Equity
T E X T
It means that there should be variety or diversity in taxation
...
A single tax or a few taxes may not meet revenue requirements of the state
...
186
A dvanced TA X AT I O N
••
••
Non tax paying culture: The payment of some taxes is dependent on the culture of the
taxpayers
...
If the taxpayers do not develop a
good tax paying culture, the attempts by the revenue authority to ensure high revenue
collection may not succeed
...
6
...
The questions are
listed in this format: Month/year e
...
6/01 represents June or May 2001
...
4(b),
S T U D Y
T E X T
6
...
Distinguish between single and multiple tax system
b
...
1)
Question Two
Discuss why taxation policies of developing countries should be different from those of developed
countries
...
5)
Question Three
a
...
4(b))
b
...
What role do such TPU’s play in
Kenya
...
1(d))
TAX SYSTEMS AND POLICIES
187
Question Four
Revenue production of a tax system is measured through as buoyancy and elasticity
...
(4 marks)
State and explain two methods that can be used to estimate tax elasticities
...
(2 marks)
(May 2002 Q
...
(10 marks)
S T U D Y
T E X T
188
A dvanced TA X AT I O N
PROFESSIONAL ETHICS IN TAXATION
189
S T U D Y T E X T
S T S TDUYD Y E T E X T
U
T
X T
CHAPTER ONE
SEVEN
PROFESSIONAL
ETHICS IN TAXATION
S T U D Y
T E X T
190
A dvanced TA X AT I O N
PROFESSIONAL ETHICS IN TAXATION
191
CHAPTER SEVEN
PROFESSIONAL ETHICS IN TAXATION
7
...
In this topic we shall
lay emphasis on professional ethics in taxation
...
The chapter will assist the student understand the various types of tax
systems and be able to recommend a viable tax system based on International best practices
...
The objective of this topic is to equip the student with ethical principles that will assist them
in their work place
...
The chapter discusses the
various ethical regulations by the applicable accountancy bodies that go a long way in assisting
the accountants at work
...
3
Form of tax practice and matters relating thereto Obligations to clients
Confidentiality
Matters relating to new clients
Handling of client work
Charging for services
Matters giving rise to conflict of interest
Disclosures in tax returns, computations and correspondence with the Revenue
Authority
Dealing with the Revenue Authority
Moral and social issues in taxation
Exam Context
This is a new topic introduced during the review of the syllabus
...
The examiner could test on candidates’ understanding
of the practical ethical issues at the work place as a tax consultant
...
4 Industrial Context
This chapter will enable accountants and tax consultants acquire skills on how to manage their
tax practices, how to manage client work and charging for services
...
2
192
A dvanced TA X AT I O N
authority
...
7
...
It is the moral standards by which people judge
behaviour
...
6
the quality or state of being complete; unbroken condition; wholeness; entirety
the quality or state of being unimpaired; perfect condition; soundness
the quality or state of being of sound moral principle; uprightness, honesty, and
sincerity
Regulation
The Institute of Certified Public Accountants (ICPAK), like any other professional body, requires
its members to observe the highest professional standards in all aspects of their work
...
Members are also required to comply with statutory and regulatory requirements imposed by the
government
...
It details the fundamental principles and sets out a framework for applying
those principles
...
Normally a member's responsibility will be to a client, or to an employer, but there may be
instances where a member may need to act in the public interest
...
7
Fundamental principles of Ethics
The fundamental principles that govern the ethical issues should be well observed by ICPAK
members as well as students
...
A member should not be associated with information if he believes that the information contains
a materially false or misleading statement, statements or information furnished recklessly, or
omits or obscures information required to be included where such omission or obscurity would
be misleading
...
Relationships that bias or
unduly influence the professional judgment of the member should be avoided
...
Confidentiality
It imposes an obligation on members to refrain from:
The need to maintain confidentiality continues even after the end of relationships between a
member and a client or employer
...
This includes actions which a reasonable and informed third party, having knowledge of all
relevant information, would conclude negatively affects the good reputation of the profession
...
ii
...
7
...
It can be a company
or a partnership
...
Once the firm has been set up, the firm will hire qualified personnel and proceed with business
...
S T U D Y
Disclosing outside the firm confidential information acquired as a result of professional
and business relationships without proper and specific authority or unless there is a
legal or professional right or duty to disclose; and
7
...
23 Using confidential information acquired as a result of professional and business
relationships to their personal advantage or the advantage of third parties
A member should consider the need to maintain confidentiality of information within the firm
...
7
...
8
Obligations to clients
It is advisable that the tax practice enters into a written contract with clients that provide specific
duties and rights under the contract
...
7
...
It also
affects the tax officers
...
In the light of this statement, any tax officer or member of ICPAK should not disclose any
information regarding income of a person unless:
••
••
••
7
...
The recipient should also have made a declaration of secrecy in
relation to information coming to his knowledge in the course of his official duties;
The recipient is an officer under the Higher Education Loans Board and he requires
the name and address of any person granted education loan where such information is
required for the performance of the Board’s official duties in recovery of the education
loans
...
10
...
Before accepting a new client, members should consider whether acceptance of the client or the
particular engagement would create any threats to compliance with the fundamental principles
...
Where it is not possible to implement safeguards to reduce the threats to an acceptable level,
members should decline to enter into the relationship
...
This may require
direct communication with the existing accountant to establish the facts and circumstances
behind the proposed change so that members can decide whether it is appropriate to accept the
engagement
...
This could be through communications with third parties,
such as banks
...
7
...
This is to ensure quality in output and delivery of the
assignment
...
12
Charging for services
The firm should have a policy for charging its clients
...
The fee charged should
be fair and uniform for its clients
...
S T U D Y
The extent to which a client's affairs may be discussed with a prospective accountant will depend
on the nature of the engagement and on whether the client's permission has been obtained
...
T E X T
The main purpose of communication is to enable members to ensure that there has been no action
by the client which would on ethical grounds, prevent members from accepting the appointment
and that, after considering all the facts, the client is someone for whom members would wish to
act
...
196
A dvanced TA X AT I O N
Matters giving rise to conflict of interest
One should take reasonable steps to identify circumstances that could pose a conflict of interest
...
A conflict may arise
between the firm and the client or between two conflicting clients being managed by the same
firm
...
A member may evaluate the threats by considering whether he has any business interests or
relationships with the client or a third party that could give rise to threats
...
The safeguards ordinarily include the member in public practice:
(a) Notifying the client of the firm's business interest or activities that may represent a
conflict of interest
(b) Notifying all known relevant parties that the member is acting for two or more parties in
respect of a matter where their respective interests are in conflict
(c) Notifying the client that the member does not act exclusively for any one client in the
provision of proposed services
T E X T
Where a member has requested consent from a client to act for another party (which may or may
not be an existing client) and that consent has been refused, then he must not continue to act for
one of the parties in the matter giving rise to the conflict of interest
...
The following additional safeguards should also be considered:
(a) The use of separate engagement teams
(b) Procedures to prevent access to information (e
...
strict physical separation of such
teams, confidential and secure data filing)
(c) Clear guidelines for members of the engagement team on issues of security and
confidentiality
(d) The use of confidentiality agreements signed by employees and partners of the firm
(e) Regular review of the application of safeguards by a senior individual not involved with
relevant client engagements
...
7
...
KRA may cross-check the information you provide
...
Taxpayers have an obligation to disclose and produce all relevant information, records and
documents required by KRA officials when carrying out their lawful duties
...
Penalties for this offence have
been prescribed under the various revenue Acts
...
14
Dealing with the Revenue Authority
The work of a tax practice involves frequent correspondence with the Kenya Revenue Authority
officials
...
It is
important that you fully co-operate with the KRA
...
You should not intimidate, abuse, threaten or influence them in any manner,
whether financial or otherwise
...
7
...
Members asked to take up new clients should consider communicating with existing
accountants so as to learn of any pending issues regarding tax and other relevant matters
...
An accountant should evaluate whether his
appointment gives rise to any threats of conflict of interest
...
T E X T
Moral and social issues in taxation
S T U D Y
7
...
17
Quiz
Question One
You have acted for Mr
...
but have discovered a serious tax irregularity which Mr
...
X that you can no longer act for him
...
X
...
X has forbidden
you from divulging any information to him
...
During this year, Maria has a disagreement with Rose and Ella over the
direction of the company
...
18
199
Answers to the Quiz
Question One
You should advise the new accountant that Mr
...
The new accountant should then refuse to act for Mr
...
Question Two
7
...
It is most likely that it would be inappropriate to
continue to act for all the clients, and you will need to cease to act, either for Maria, or for Rose,
Ella and the company
...
Providing
there were no areas where the interests of the clients conflicted, there is no reason why you
should not have acted for all the clients, although it may be advisable to have ensured that, for
example, a different tax manager was responsible for each client
...
1
Objectives
At the end of this chapter, the student should be able to:
appreciate the emerging trends in the Kenyan taxation system
understand the various changes that have taken place in the Kenyan taxation system
8
...
However, the students are expected to keep
abreast with changes in the taxation system
...
8
...
The budget
normally includes some changes in taxation and allowances that are important in businesses
...
8
...
The main role of an ETR
is to improve VAT compliance and administration
...
S T U D Y
In the previous chapter, we dealt with professional ethics in taxation
...
We will also look at various changes that have
taken place in the current budget that warrant to be mentioned
...
T E X T
8
...
The authority’s website
has many portals for access by the common citizen
...
Taxpayers can
also download various forms that are needed to enable them to pay tax
...
Simba system: The Simba System is a Customs automated system that the Kenya Revenue
Authority introduced in an attempt to modernise customs operations
...
Under the Simba System, Customs authorities
require one to be registered as a clearing agent in order to lodge documents electronically
...
8
...
Expenditure on healthcare services and facilities for physically challenged allowable
deduction up to Kshs
...
Reduction of tax burden on senior citizens: The Minister of Finance reduced the tax
burden on senior citizens by increasing the exemption gap of monthly pension income from
Kshs
...
25,000 of monthly, i
...
the first Kshs 25,000 of monthly pension
income is exempted from tax, from Kshs
...
For lumpsum withdrawals, the first Kshs
...
480,000 withdrawals from
a registered pension or individual retirement fund is exempted from tax
...
Previously, the agent was obligated
to furnish the supplier with “acknowledgement of the payment
...
It targets businesses with an
annual turnover of between Kshs
...
5,000,000
...
Turnover tax returns shall be submitted quarterly using a pay-in slip
...
8
...
Allowance is granted at 25% per annum on cost of commercial buildings
...
Qualifying cost of machinery and buildings on investment deduction has been capped to
Kshs
...
i
...
for buildings or machinery to qualify for investment deduction, their
cost must be Kshs
...
An investment deduction has been introduced on filming equipment
...
A special incentive has been introduced for investment in the satellite towns adjoining
Nairobi, Mombasa or Kisumu at 150%
...
It is also an
incentive to encourage regional growth
...
EMERGING TRENDS IN TAXATION
8
...
The Kenya Revenue
Authority also creates awareness to the taxpayers on their rights and obligations, regarding tax
issues
...
8
...
Some of the ideas introduced include use
of an ETR, online filing of returns, the Simba system among others
...
Discuss the role of information technology development in taxation
...
S T U D Y
Question one
T E X T
8
...
11
Quiz Answers
Question one
••
••
T E X T
••
S T U D Y
••
The first attempt by the Kenya Revenue Authority to incorporate information technology in
tax administration is the introduction of the Electronic Tax Register (ETR)
...
Every person chargeable to VAT
is supposed to install an ETR machine and issue an ETR generated tax invoice
...
The authority’s website has
many portals for access by the common citizen
...
Taxpayers can
also download various forms that are needed to enable them to pay tax
...
Simba System: The Simba System is a Customs automated system that the Kenya
Revenue Authority introduced in an attempt to modernise customs operations
...
Under the Simba System, Customs authorities require one to be registered as a clearing
agent in order to lodge documents electronically
...
It targets businesses with an annual turnover of between
Kshs
...
5,000,000
...
Turnover tax returns shall be submitted quarterly using a pay-in slip
...
8
...
Dec 2008 Q 2
EMERGING TRENDS IN TAXATION
207
Question three
S T U D Y
T E X T
Discuss the significance of the East African Community Customs Management Act
(2004) in the Kenyan context
...
Robson
£7,000 not to compete with his company if he
ever left them
Duff v
...
Harrison
Professional footballers benefit
Dale v
...
Foster
company’s articles provided for lump sum when
a director ceased to hold office
...
Hunter v
...
He then received £10,000
...
Warwick
£30,000 paid to relinquish old terms and a
personal connection on accepting managing
directorship
Pudd v
...
Prendergast v
£45,000 to stay on but with less time and smaller
Cameron
salary
...
Seymour
Professional cricketer-benefit match
...
Hearn
Voluntary payment after 25 years faithful service
Cowan v
...
BENEFITS
NOT TAXABLE
...
TAXABLE
...
TAXABLE
...
NOT
TAXABLE
...
TAXABLE
...
NOT TAXABLE
...
TAXABLE
...
EMERGING TRENDS IN TAXATION
Parker v
...
Diggines
Remuneration paid in the form of shares
...
TAXABLE
...
Richardson v Lyon
Ede v
...
Salmon
Employer paid the annual insurance premium
...
Shares allotted to Managing Director at par market
value higher
...
Sum placed on credit under a provident scheme
...
TAXABLE
...
Austin Coy
Smyth v
...
TAXABLE
...
Ricketts v
Colquhoum
Eagles v
...
Court costs of suit to recover
remuneration due to Managing Director
of Ardath Ltd
N
...
Nolder v
...
Dingley v
...
Mills
Lab research student must attend
certain classes
...
Short v
...
Simpson v
...
NA Airline pilot (a) cost
of the Car upkeep for
“house to airport” running
(b) cost of telephone
...
A
...
N
...
N
...
NA
...
A
...
ROBSON
Robson entered into an agreement with his company to continue as director and manager for
five years at a fixed salary plus bonuses
...
Lawrence: The £7,000 comes not from having or exercising an office but from absence from
employment after the cessation of the office
...
The £7,000 is not paid for performing the service in
respect of which he is chargeable under schedule E
...
Removal expenses
S T U D Y
Friedson v
...
SEYMOUR
Cowan acted as unpaid secretary of a company, and later as liquidator
...
The resolution stated “
...
” M
...
(It is)
...
Younger L
...
this was not a profit by reason of the office
...
Held: That the sum voted by the shareholder did not accrue to him by reason of an officer or
employment of profit and was not chargeable
...
BARLOW
Barlow was a director of a company manufacturing metal goods
...
The responsibility for the venture fell
largely on Barlow, who was to be remunerated with a percentage of profits
...
He continued to be the Managing Director of the parent company
...
As the agreement was determined there could rest upon him thereafter, no obligation to
perform his services and such services could not be any part of the consideration for payment
of that sum
...
DAVIS v
...
C
...
e
...
In 1923, he was transferred,
but the football association agreed to Everton’s application to pay £650 accrued benefit
...
simply a payment
...
simply a payment not only in view of his services but for
his services
...
DALE v
...
His service contract was for, £3,000 salary
p
...
for 3 years
...
This actually happened
...
EMERGING TRENDS IN TAXATION
2 11
Sir R Evershed MR: The remuneration for the services took the form of
...
plus a
further sum which he was contractually entitled to
...
It was assessable
...
FOSTER
Foster was a Company director
...
The so-called “compensation for loss of office” equalled the last 5 years salary
...
Howarth MR: In substance
...
was made for services rendered
...
arising from the office
...
HUNTER & DEWHURST
Held: In the circumstances of the case (House of Lords 3-2) the sum was not income assessable
to tax
...
MARWICK
Hose was an insurance broker who had built up an expensive personal connection
...
He became the managing
director of the company
...
(b) He surrender his old rights to remuneration
...
(d) Not to compete when he finally left the company
...
Artkinson J: The £30,000 (was) a payment for giving up something
...
The
£30,000 has nothing to do with his remuneration as managing director
...
Held: That the £30,000 was not remuneration for services rendered or to be rendered, but
compensation for the relinquishment by the appellant of his rights under his previous agreement
for service and his personal connection
...
It was not paid for future remuneration for that was expressed
to be £250 p
...
It seems to me that a sum of money paid to obtain a release from a contingent
liability under a contract of employment, cannot be said to be received “under” the contract
...
T E X T
Hunter was on the same terms in the same company
...
He received £10,000 as compensation
in lieu of the rights he waived
...
COLLINS
Mudd was the paid secretary of a company
...
He argued unsuccessfully that the negotiation was outside his duties and that
payment was a voluntary gift
...
and his employer
gives him something in that respect, that is a profit, it becomes a profit of his office which is
enlarged a little so as to receive it
...
PRENDERGAST v
...
The company wanted to continue using
his services
...
Caldecote L
...
Maugham: The sum was paid to induce him to continue to serve the company
...
S T U D Y
Raner: In consideration of the payment, the appellant agreed to continue to serve as a
director
...
Because the years’ profits greatly exceeded that of the past years,
they voted “a gift of £2,000 tax free
...
RADCLIFFE v
...
REED v
...
The proceeds together with certain public subscriptions were invested in the names of the
trustees of the club and the income therefore paid to Seymour
...
Sargant L: We have to consider whether this (sum) comes to Seymour merely as a member
of the Kent County Eleven, or
...
Viscount Care L
...
is to express the gratitude of his employers and of the cricket loving public
for what he has already done, and their appreciation of his personal qualities
...
Held: That the proceeds of the benefit match was a personal gift and not assessable
...
TILLEY
A company agreed to pay Tilley £6,000 p
...
salary and when he ceased to be a managing director,
EMERGING TRENDS IN TAXATION
213
a pension of £4,000 p
...
for 10 years after cessation
...
a
...
Viscount Simon L
...
The ordinary way or remunerating
...
escape the quality of income
...
to represent the difference
...
of £4,000 p
...
is within the charge on profits from
the office of director
...
is a sum paid for the release of an obligation to provide a pension
...
Held: The portion paid in compromise of reduction if salary was assessable
...
WESTON v
...
PARKER v
...
His commission was
credited to his account
...
Later, the price of the company’s trading commodity (sugar) fell from $125 to
£15 per ton
...
They also realised that the share
issue would not be taken up
...
Rowcatt: A company pays its debts in shares, (it is)
...
Lord Hanworth MR: This commission was a sum which Mr
...
Held: That the appellant was assessable on the full amount of remuneration credited to him
...
DIGGINES
The company paid the tax charged on standard salary, though it entered into no agreement
verbal or written to do so
...
He has received moneys
worth to the extent of the sum which has been paid in respect of that salary to the revenue
...
J:Because the appellant is an employer of the company the company pays his tax
and that is clearly an employment relating to his office as accountant in the company
...
S T U D Y
Held: That the sum was remuneration for services rendered
...
was a gratuity by way of a bonus after 25 years service
...
LYON
By agreement the company agreed to pay the annual premium on a policy on the life of the
employee
...
EDE v
...
He was given the
privilege of acquiring shares in the parent company at par value
...
Woottesley: He has received an advantage
...
Held: That Wilson was assessable on the privilege
...
SALMON
S T U D Y
T E X T
Salmon was a managing director of a company and was entitled to a fixed salary under a service
agreement
...
The market price was considerably higher
...
by
...
It is a privilege, which in itself is not indeed, money, but moneys worth
...
NICOLSS v
...
Austin had previously
intimated that due to the cost of upkeep, he might have to vacate his residence
...
Finlay J: These sums
...
Held: That the sums paid are assessable as profit of his office as managing director
...
STRETTON
Stretton’s terms of service were altered
...
Of the sum due, no part was payable until Stratton left
his employment, and the moiety was contingent on length of service and good conduct
...
the
person who receives it has not got the full right to apply it just as he likes
...
a sum which
really has been added to the salary
...
CALVERT v
...
The bargain made no
reference to tips
...
are assessable to tax
...
Held: That the tips having been given in ordinary way as remunerating for service rendered are
assessable
...
BLAKISTON
An appeal was made by the Bishop and supported by the church wardens stating that it was the
privilege and the duty of the laity to augment the poor stipends of the clergy by personal freewill
gifts which an offer would be collected on Easter Sunday
...
There was a continuity of
annual payments from any special occasion or purpose
...
part of the profits which accrued to him by reason of his office
...
M
...
: (This sum)
...
Held: That the sums paid were assessable
...
There was no obligation to make
or repeat the gift
...
made to the
appellant payment (is) either a (Sch E) emolument
...
a gain
Held: That the sum was assessable
...
CUXSON
A curate received a grant from a religious society, receivable annually on certain conditions, at
discretion
...
Colefidge (C
...
): The payment comes to him at the mere will of a charitable society which at its
own pleasure, pays him
...
Held: That the sum is not assessable
...
C
...
T
...
A single and
solitary transaction - he had never sold property before, which is usually the business of an
estate agent
...
a
...
T E X T
HERBERT v
...
the word ‘business’-and especially when regarded in juxtaposition with the
expression “for whatever period of time
...
” plainly covers a transaction such as the
appellants procurement of the sale of an industrial concern
...
FRIEDSON v
...
He left there to take up a curacy at Edmonton
...
Samkey J: There is all the difference in the world between an expense which you have to incur in
order to go to a place in order to take up your duties and an expense incurred in the performance
of your duties
...
RICKETTS v
...
He also held the office of Recorder
of Portsmouth
...
Viscount Cave LC: (The expenses)
...
They (the expenses) are incurred, partly before he
enters upon (the duties) and partly after he has fulfilled them
...
EAGLES v
...
He started a high court action
for the recovery of the balance of remuneration which he claimed was due to him
...
Counsel for the company
stated in court that “the sum is a comprehensive sum; there are no costs on either side in the
matter”
...
Finlay J: This £45,000 p
...
did not, to any extent represent costs but on the contrary, was a sum
from which costs were excluded (following Ricketts v
...
this was not a sum which
can be deductible
...
NOLDER v
...
He claimed as a deduction expenditure in respect of
a) The cost of upkeep of a car to convey him from his home to the aerodrome
...
c) The expense, over the subsistence allowance granted him when away from home to
duty
...
(The
telephone)
...
He would be entitled to charge something
for the extra expense he is put to by having to spend
...
Held: (a) and (b) not allowable, (c) allowable
...
McNULTY
Dingley was a director of a Benevolent Fund
...
An allowance of 25% was made for expenses and the rest assessed
...
He provided the evidence of expenditure
...
BLACKWELL v
...
SHORT v
...
He claimed
the fee was an expense incurred in performing the duties of the office
...
the money expended in order to get the job was in no sense money spent in the
performance of the duties attached to the job
...
SIMPSON v
...
He belonged to certain professional societies, membership of
which was not a condition of his employment
...
Rowlatt J: He is qualifying himself so that he may continue to hold his office, just as he did qualify
himself before he got the office to enable him to perform it
...
S T U D Y
MacNaughton J: It seems to me impossible to say that when he was listening to the lecturer
...
The expenses permitted to be deducted
must be expenses incurred in the performance of the duties of the office
...
As a condition of his employment, he was
required to attend classes to study for a Bsc
...
He claimed the cost of travelling to and from Chelsea Polytechnic and the cost of text books
...
16 ADVANCED TAXATION
SPECIFIC OBJECTIVES
1
...
Compute the tax liability of leasing entities, co-operative societies, trade associations,
trust bodies and other specialised entities
3
...
Explain the tax implications of cross border business activities
5
...
Analyse various tax systems and policies
7
...
Year of income 2009
Taxable Employment Benefits - Year 2008/2009
S T U D Y
T E X T
Monthly taxable pay(shillings)
Annual taxable pay (shillings)
1
10,165
19,741
29,317
Excess over
1
121,969
236,881
351,793
Excess over
-
10,164
19,740
29,316
38,892
38,892
-
121,968
236,880
351,792
466,704
466,704
Rates of tax % in
each shilling
10%
15%
20%
25%
30%
REVISION AID
225
Personal relief Shs
...
13,944 per annum)
Prescribed benefit rates of motor vehicles provided
by employer
Monthly A n n u a l
rates
rates
(Sh
...
)
(i)
Hotels
2006
4
...
2006 to date
100%
Shipping investment deduction 40%
Mining allowance:
Year 1
40%
Year 2 – 7
10%
Commissioner’s prescribed benefit rates
Services
Monthly rates Annual rates
(i) Electricity (Communal or from a generator)
Sh
...
1,500
500
(ii) Water (Communal or from a borehole)
18,000
6,000
(iii) Provision of furniture (1% of cost to employer)
If hired, the cost of hire should be brought to charge
(iv) Telephone (Landline and mobile phones)
30% of bills
T E X T
Wear and tear allowances
Class I
37
...
5%
Industrial building allowance:
Industrial buildings 2
...
Other benefits:
S T U D Y
T E X T
Other benefits, for example servants, security, staff meals etc are taxable at the higher of fair
market value and actual cost to employer
...
5%
Deductibility of Expenses of interest, royalties
expenses
and management or professional
fees paid to head office are not
allowable expenses in deriving
taxable income
...
W i t h h o l d i n g No WHT tax applies
tax rates
S T U D Y
Expenditure incurred by the
branch outside Kenya is only
allowable/deductible to the extent
the Commissioner of Domestic
Taxes (CDT) may consider
T E X T
a
...
Mazuri Ltd
Adjusted taxable income for year ended 31/12/07
S T U D Y
T E X T
Kshs
...
O
...
20
120
40
80
(1,569)
6,238
Assumed foreign exchange gain realised hence taxable
Golden handshake is for services rendered in the past, present or could have rendered
in future hence allowable
SUGGESTED SOLUTIONS TO EXAM QUESTIONS
233
ii) Tax payable – 6,238,000 x 30% = 1,871,100
Question Two
(a) Christine Atieno and Rose Njeri Partnership
Taxable profit (loss)
For the year ended 31
...
2007
Kshs
...
5%)
WDV b/f
Additions
Motor vehicle
Furniture and fittings
Computer and printers
Telephone and fax
Reference books
Kitchen utensils
Television set
Fans
Carpets
Safe
Class II
(30%)
Class III
(25%)
2,500,000
280,000
120,000
40,000
16,000
3,000
12,000
________
-
WTA
WDV c/f
________
172,000
(51,600)
120,400
__________
2,500,000
(625,000)
1,875,000
T E X T
Allocation/ division of the partnership profit/loss to partners
S T U D Y
Class IV
(12
...
2005 Computation of Investment deduction
part a (i)
Investment Deduction Allowance
Item
Qualifying cost
ID @70%
Residue
17,988,166
W1a
12,591,716
5,396,449
...
00
13,196,449
...
5%
449,704
438,462
888,166
WDV
17,538,462
17,100,000
ID for 2003=Kshs 43,988,165
...
5%
3,250,000
2,843,750
6,093,750
WDV
22,750,000
19,906,250
SUGGESTED SOLUTIONS TO EXAM QUESTIONS
237
(b) 2005 Computation of adjusted profit (loss)
Starlit Company Limited
Computation of Adjusted Taxable profit/loss
For 2005 year of income
Kshs'000
Net profit before tax per the accounts
Add
Add back disallowable expenses
Depreciation
Conveyance fees on purchase of land
Understated sales(100/90x2100)-21000
Kshs'000
4,500
7500
2,000
233
9,733
14,233
Less
Capital allowances
Adjusted Taxable Profit
Notes
(2,696)
11,537
••
••
Flotation costs and stamp duty costs on issue of debentures is allowable by virtue
of Section 15(s) as expenditure incurred in relation to issue of shares to the general
public
...
Further the company
is not thinly capitalised and as such, the exchange losses will not be deferred as per
Section 4A of the Income Tax Act
...
The sales figure has been adjusted accordingly
NB: (3) Wear and tear allowances
S T U D Y
••
T E X T
Notes
238
A dvanced TA X AT I O N
Wear and Tear Allowance schedule
2003
Class 1
Class 2
Class 3
Class 4
37
...
50%
Computers
900,000
Total
Furniture & fittings
600,000
900,000
7,800,000
400,000
4,500,000
3,600,000
2,500,000
600,000
Office equipment
800,000
800,000
7,800,000
400,000
Processing machinery
Office partitions
Lorries
4,500,000
3,600,000
2,500,000
Delivery Van
Pick ups
WDV as at 1
...
2003
WTA
WDV as at 1
...
2004
WTA
S T U D Y
T E X T
WDV as at 1
...
2005
WTA
WDV as at 31 Dec 2005
4,500,000
900,000
6,100,000
9,600,000
21,100,000
(1,687,500) (270,000) (1,525,000)
2,812,500
630,000
4,575,000
(1,054,688) (189,000) (1,143,750)
1,757,813
441,000
3,431,250
(1,200,000)
8,400,000
(1,050,000)
7,350,000
(4,682,500)
16,417,500
(3,437,438)
12,980,063
(659,180)
(132,300)
(857,813)
(918,750)
(2,568,042)
1,098,633
308,700
2,573,438
6,431,250
0
10,412,020
Wear and Tear allowance- Kshs 2,568,042
Question Four
a
...
SUGGESTED SOLUTIONS TO EXAM QUESTIONS
239
For example if the adjusted income for tax for Jitahidi Company Ltd for year of income 2005 was
Kshs
...
2 million then the shortfall distribution would be
arrived at as follows:
JITAHIDI COMPANY LTD
DIVIDEND DISTRIBUTION SHORTFALL
Kshs ‘000
20,000
(6,000)
14,000
(8,400)
5,600
(2,000)
3,600
Adjusted income for tax
Corporation tax @ 30%
Profit after tax
Allowable retention @ 60%
Distributable as dividend
Less actual distribution
Shortfall distribution of dividends
Company’s liquidity position is poor;
Company has entered into heavy capital and development commitments requiring payments of
huge sums;
That the directors do not owe any monies to the company; and
That the shareholders have paid up their Share Capital
b
...
Kshs
...
12,000,000
(3,600,000)
355,000
Rental
Total
income
Kshs
...
1,600,000 14,250,000
(480,000) (4,275,000)
1,120,000
9,975,000
5,040,000
1,120,000
4,835,000
(1,300,000)
3,535,000
S T U D Y
Note that a company is allowed to retain 60% of its after tax profits and to distribute 40% as
dividend from which the commissioner receives a withholding tax
...
6 million dividend
shortfall to the shareholders and deduct withholding tax thereof accordingly
...
“Compensating tax” as per section 7A of the Income 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
...
b
...
3/
...
3/
...
429 Tax paid
______- Compensating tax
4,171
...
714
NIL
2,885
...
429
Note
Tax for year 2007 has not yet been paid by year end
...
c) Four areas which may constitute a customs area are:
••
••
••
••
Airport
Seaport
Customs bonded warehouse
Internal Inland Container depot etc
SUGGESTED SOLUTIONS TO EXAM QUESTIONS
241
d)
D
...
5)
(12½% x 100)
Business income:
Kshs ‘000
Sales
8,000
Less: Pesticides
(180)
Forex losses
(64)
Other farm expenses
907
...
5
242
A dvanced TA X AT I O N
Notes
Structural alterations to premises has been allowed since no rent increase resulted therefrom
...
Legal fees on collection of rent in arrears is normal revenue expense in a continuous process of
rent collection hence allowable
...
All other leases are classified as operating leases
...
S T U D Y
T E X T
Any income derived from leasing activities is taxable at the corporate tax rate for companies
while individuals are taxed at the graduated scale rates
...
However, this distinction exists
for Value Added Tax (VAT) purposes
...
if the Commissioner is satisfied
that:
a
...
The entire payment is income in the hands of the recipient
...
The lessee is entitled to claim VAT on expenses incurred on the leased asset
...
The deduction is made at a rate of 100% of the cost of
investing in machinery and buildings provided these are used for the purpose of manufacturing
...
In case the lessor is a non-resident, tax is withheld at a rate of 15%
...
Operating Lease: Ownership remains with lessor throughout the entire lease agreement
...
It is worth noting that it is only leasing of taxable
goods
...
If equipment that is the subject of a lease is either exempted from VAT or attracts
zero VAT, then the lease payments are similarly exempted from VAT
...
This
exemption does not apply with respect to car park services, conference or exhibition services
...
For the period of 10 years commencing immediately after its initial 10-year
commencing immediately after its initial 10-year period the EPZ will be subject to
corporation tax at the rate of 25%
...
Employees and directors of EPZ if resident are liable to tax and deduction of PAYE
in the normal way
...
A
...
Investment allowance is granted at 100% on cost of qualifying building and
machinery and is claimed on the 11th year after commencement
...
( Ninth Schedule Income
Tax Act)
- Favourable rates of tax on management or professional fees and interest paid to
non-residents by such companies
...
- Non-resident contractors will be deemed to have made a taxable profit of 15%
of the sum paid to them by a petroleum company (exclusive of certain defined
expenses, and the tax on this is deducted when payment is made
...
T E X T
Question two
244
A dvanced TA X AT I O N
Question three
a)
LINDA INSURANCE COMPANY LTD
i) TAXABLE INCOME OR LOSS FOR YEAR OF INCOME 2006
Nature of business:
S T U D Y
T E X T
Kshs
‘000
Premiums received
Commission and management fees
Premiums returned and interest
charged on returns
Net premiums received
Add: Re-insurance Commission
Income from subrogation rights
Recoveries from re-insurance
Income from insurance business
Less allowable expenses:
Premiums paid to re-insurance
Agency expenses
Management expense (1,934 – 456)
Travel
Advertising
General expenses (8,490 – 2,060)
Bad debts (Specific)
Interest paid out of
Annuity paid on surrender of policies
Wear & Tear allowances
General
Kshs
‘000’
15,450
(770)
Kshs
‘000
13,600
(-)
14,680
1,360
1,250
150
17,440
4,680
1,350
1,478
1,800
364
6,430
13,600
3,450
1,800
180
19,030
368
12,000
1,960
2,456
2,400
820
(4,640 – 1,580)
3,060
240
397
...
5
GENERAL
Claims paid
Less outstanding at beginning
Add outstanding at end
Reserves at year end
Less at beginning
Profit for insurance business
Rent income (13,780 – 3,780)
7,600
(5,640)
6,200
1,760
(3,240)
(23,547
...
5)
10,000
3,892
...
5 +
62,850
...
3) = Kshs
...
5)
51,650
...
5
SUGGESTED SOLUTIONS TO EXAM QUESTIONS
245
Question four
Taxation of charitable trusts
Income of a charitable trust is exempted from tax if:
••
••
••
••
It is public in character
It is established for relief of distress or poverty to the public
...
Its total income is used or spent on charitable purposes
...
Taxation of amateur sporting associations
The income other than income from investment of an amateur sporting association is not
taxable
...
(3 marks)
S T U D Y
-
-
-
Question five
(a) (i) Ukulima Sacco
Taxable Income for the year 2007
Rental Income (100% of 2,252,500)
Sh
...
851,445
(ii) Information not used
Interest from loans to members – This is not taxable
Expenses – These are ignored since income is assessed gross
...
g rent
•• The basic notion underlying the new code of taxation is that a co-operative society
is a body corporate having its own existence, separate from that of its members
...
The current law sanctions the deduction from the income of the co-operative
society appropriations to profit made by it from its members
...
These
societies will be liable to tax generally on only their gross investment income that is on
interest and dividends derived from normal investment of surpluses
...
S T U D Y
T E X T
Interest income deducted from members loans not taxable
...
O
...
(i)
The obligation to declare all incomes for tax purposes rests with the person liable to pay tax
(taxpayer) whether or not he has been specifically told to do so by the Income Tax Department
...
You may have been in receipt of farming income from a farming organization and such information
has landed in the assessors hands through informers
...
Whether or not payment of additional tax arrived at in the back duty investigation will cripple your
business financial position
...
Yours faithfully,
Michael Odutu
Partner
S T U D Y
Re: Back Duty Investigation
T E X T
Dear Sir,
248
A dvanced TA X AT I O N
(b) Sophia (client)
(i) Capital Statements
Year of income
2004
2005
2006
2007
Kshs
’000’
Kshs
’000’
16
...
02
Kshs
’000’
44
...
5
33
...
585
57
...
3
16
...
565
12
...
8
5
...
24
9
...
14
0
...
525
2
...
105
2
...
555
17
...
33
17
...
Motive of non-declaration of income
Whether such payment of additional tax plus penalties and interest charges will affect
adversely the taxpayers financial position
...
DICKSON MAELFU
TAXABLE INCOME FOR EACH OF THE FOUR YEARS TO 31 DECEMBER
2004, 2005, 2006 AND 2007
LIABILITIES
Trade Creditors
Bank loan
Loan from Uncle
Mortgage loan
Net worth
Less: Net Assets at beginning of Year
Increase in Networth
Increase in Networth b/d
Adjustments
Inheritance from relative
Living expenses
Interest on mortgages
Estimate taxable income
2005
Kshs
‘000
2006
Kshs
‘000
2007
Kshs ‘000
48,000
28,000
12,000
4,200
3,540
13,600
5,400
114,740
48,000
36,000
12,000
8,000
2,640
13,600
3,600
123,840
52,000
36,000
15,000
9,000
2,530
13,600
3,760
131,890
54,000
38,000
18,000
7,000
2,980
13,600
4,670
138,250
8,640
10,000
700
3,780
(23,120)
91,620
(65,440)
26,180
26,180
9,420
9,870
600
3,780
(23,670)
100,170
(96,720)
3,450
3,450
8,360
7,640
870
3,780
(20,650)
111,240
(106,950)
4,290
4,290
7,890
9,840
640
3,780
(22,150)
116,100
(117,070)
(970)
(970)
70
(150)
26,100
(400)
120
(150)
3,020
90
(150)
4,230
150
(150)
(970)
iii) Four areas for further clarification from Mr
...
Loan from uncle – Was the loan used in business or private purposes and what is the
interest rate if any
...
Fixed Assets - Whether or not any capital allowances had been claimed and the written
down valuers for the respective capital alloances tables
...
Question three
(a) Alternative 1
Sh
...
(1,879,500)
Add: understated sales
2,000,000
Overstated cost of sales
1,000,000
Overstated printing and stationery
10,000
Net discount as per accounts
10,000
1,140,500
20,000
1,120,500
S T U D Y
T E X T
Less: office rent understated
26,200
Add: correct discount net
1,146,700
Adjusted accounting profit
Add back: depreciation
30,000
Provision for bad debts
175,000
Interest on capital
265,000
470,000
1,616,700
Less: tax allowances
Specific Bad debts provision
32,000
215,000
(247,000)
1,369,700
From the workings:
i
...
iii
...
v
...
Sales are understated by Sh
...
1,000,000
Office rent is understated by Sh
...
10,000
Net discounts should be credit of Sh
...
1,000,000
SUGGESTED SOLUTIONS TO EXAM QUESTIONS
251
Alternative 2
Sh
...
3,510,000
1,200,000
240,000
97,500
60,000
137,500
84,500
100,000
215,000
32,000
Workings:
DEBTORS ACCOUNT
Balance b/d (**)
Credit Sales
4,700,000
12,440,000
________
Cash
Discount
Balance c/d
17,140,000
13,500,000
140,000
3,500,000
17,140,000
CREDITORS ACCOUNT
Cash
Discount
Balance c/d
11,200,000
120,000
Balance b/d
Purchases (**)
2,340,000
10,830,000
1,850,000
________
13,170,000
13,170,000
S T U D Y
Add: Discount net
Taxable income
T E X T
(2,069,000)
1,441,000
26,200
1,467,200
252
A dvanced TA X AT I O N
Sales:
Opening stock
Purchases
Sh
...
200,000 fine
and or up to 2 years imprisonment
...
This will enable the trader
claim VAT paid on purchases
...
(b) Refund
VAT refund is properly due under the following circumstances:
•• Where input tax exceeds output tax continually and it is a regular feature of the
business
•• Where goods are imported and then re-exported without being used in Kenya
...
•• Where newly registered persons have goods in stock which are intended for us in the
manufacture of taxable supplies
...
•• Where tax has been paid in error
...
•• Where taxable goods have been imported into Kenya and tax has been paid in respect
of those goods and before being used, the goods are exported under customs control
•• Where in the opinion of the Minister, a refund is due in the public interest
...
1M and above attach audit certificate
Lodge the claim with the VAT department
Trader must have filled a VAT 3 (return form) which must correspond to VAT 4
...
We have examined the attached claim for refund of VAT amounting to Ksh ( … ) made by
KRM Ltd
...
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
...
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
...
The company’s record keeping may not be accurate
...
If it’s more than 12 months old, you apply to the Commissioner to be able to claim the same
...
ii
...
iv
Non-remittance of PAYE which has been deducted
...
Irregularities detected through examination of PAYE end year returns
...
e
...
v
...
vi
...
(8
marks)
T E X T
Kasuku Rolling Mills Ltd (KRM)
S T U D Y
254
A dvanced TA X AT I O N
(b) Circumstances that trigger off PAYE Audit
----------
S T U D Y
T E X T
----
Salaries and wages figure per the audited accounts is higher or lower than the amounts
reflected in the PAYE returns
...
Of late KRA is offering rewards to anybody who divulges information that leads to a tax
recovery by authorised persons only
...
Information emanating from related companies audited
Cessation of business on a large part of a business
Higher salaries awarded to middle level managers compared to those awarded to their
seniors
...
It generally
involves agreement on tax/tariff concessions on particular goods
...
Facilitates comparative advantage as countries specialise in production of what they
produce at lowest cost
Promotes free trade as member countries remove any restrictions on trade barriers on
imports/exports of member countries
...
The foreign tax will be compared with the increase in the Kenyan tax liability and the
lower of the two taxes is allowed as the double taxation relief
...
The double taxation agreement must be gazetted in the Kenya Gazette
...
SUGGESTED SOLUTIONS TO EXAM QUESTIONS
255
Question three
a) Taxation of
ii)
Non-resident persons (Section 47 of Cap 470)
• The income shall be assessed on and tax thereon charged on that person either in
is name or the name of his trustee, guardian, curator or committee or of attorney,
factor, agent, receiver or manager
...
• Non-resident persons are taxed at a specified withholding tax rates
...
b) i)
Mr
...
Mbazo taxable income for year ending 31/12/2007
Basic pay Jan – Sep (200,000 p
...
25 x 3 months)
1,800,000
750,000
2,550,000
Add other benefits
192,500
Rent reimbursed (35,000 p
...
x 1 x 11)
2
Air tickets (not an expatriate)
Entertainment allowance (12,000p
...
m x 3)
Performance bonus
Net taxable income
25,000
72,000
20,000
24,000
150,000
3,033,500
T E X T
Incapacitated person
• According to Section 46 of Cap 470 (Income Tax Act) the income of incapacitated
person shall be assessed on and tax thereon charged on that person in the name
of his trustee, guardian, curator, committee or receiver appointed by the court
...
S T U D Y
i)
256
A dvanced TA X AT I O N
Tax liability (using year 2007 rates)
1st Ksh
...
m x 12
P
...
Y
...
deducted
Net tax liability
12,196
...
2
81,144
...
0)
(200,000
...
ii
...
In terms of the Kenyan taxation laws, Section 41 of the Income Tax Act authorises for double
taxation relief to be granted while Section 42 details on the determination of such relief where
there exists, a double taxation treaty entered into by Kenya with another country
...
Kenya residents, on the other hand may be liable to tax on income derived from outside
Kenya in addition to tax on income derived from Kenya
...
With a view to reduce the tax burden suffered by Kenya residents relating to tax already paid
in other countries, Kenya has signed double taxation treaties, with countries such as Denmark,
Italy, Switzerland, Zambia, UK, Sweden, Norway, Malawi, Uganda, Tanzania, Germany, Canada
and all COMESA countries
...
SUGGESTED SOLUTIONS TO EXAM QUESTIONS
257
b)
DANIEL OTWORI
DOUBLE TAXATION RELIEF DUE FOR THE YEAR TO 31 DECEMBER 2006
Income from UK in Ksh
...
Total income for year Ksh (806,400 + 1,765,000)
=
=
=
=
=
=
[140 x (£960 + £4,800)]
140 x 5,760
Ksh
...
134,000
Ksh
...
Tax thereof:
First Kshs
...
114,912 (15% + 20% + 25%)
Balance Kshs
...
8
68,947
...
8
470,632
...
e
...
(712,552
...
8) = Kshs
...
Kshs
...
134,400
That is relief is Kshs
...
S T U D Y
First Kshs = 121,968 @ 10%
=
Next Kshs
...
2,104,696 @ 30%
=
Gross tax liability in Kenya on combined income
T E X T
Kshs
...
8
68,947
...
8
712,552
...
Karimi
VAT PAYABLE (OR REFUNDABLE) FOR THE MONTH OF APRIL 2007
VAT ACCOUNT MONTH OF APRIL 2007
S T U D Y
T E X T
Std rate Purchases (
...
12 x 100)
Electricity (
...
16 x
150)
Electronic tax register (cost
recovery)
Legal fees (
...
16 x 500)
Returns in (
...
00 Standard rate sales (
...
00 Ministry of Health
2
...
16 x 800)
24
...
00
1280
...
00
150
...
00
80
...
00
979
...
00
____
4608
...
VAT relating to VAT appeals is not deductible
...
Purchase of a photocopier is not part of purchases at standard rate, however VAT
suffered is deductible
...
Water is assumed to be for a public source hence no VAT charged
...
Suppliers to Ministry of Health exempt from VAT
...
Cost of Electronic tax register is deductible with prior approval from the commissioner,
provided that ETR was acquired from the Commissioner, provided that the ETR was
acquired and installed before 31
...
06
Question five
(a) Transactions that constitute transfer pricing include:
••
••
••
Sale of goods to a subsidiary or branch by the head office at a price that is not at arm’s
length i
...
prices that are not granted on sale of goods to third parties
...
Inflating cost of goods which are subsequently sold in a low tax location at lower prices
so as to reflect lowered profits or nil profits for tax purposes in the country of export
...
It involves determining
in advance the tax effect of any proposed business action and decision
...
The aims of tax planning are to:
i
...
ii
...
iii
...
The planning areas in business decisions may include
•
•
•
•
Lease or buy decisions: do we lease assets and pay lease charges (allowable) or
buy assets and enjoy capital allowances?
Financing decisions: do we use debt capital (interest charges are allowable) or
equity capital (dividends not allowable)?
Form of business ownership: do we operate as a partnership, sole proprietorship
or a limited company?
Trading decisions – do we produce and sell locally or export (exports are zero
rated for VAT purposes)?
Question two
Corporate Tax Planning
Tax Planning
Defined as the arrangement of affairs of tax in such a way as to minimise tax liability at the lowest
cost without contradicting any tax laws and regulations
...
It requires a deep understanding of
existing tax legislation and decided case law of taxation
...
Lease or buy decisions: Do we lease assets and pay lease charges (allowable) or buy
assets and enjoy capital allowances
T E X T
♦♦
Tax planning
S T U D Y
a) i)
260
A dvanced TA X AT I O N
ii
...
Trading decisions: Do we produce and sell locally or export (exports are zero rated for
VAT purposes)
Question three
S T U D Y
T E X T
a) Tax incentives to newly listed companies:•• Flotation costs e
...
Legal expenses are allowable
•• Reduced corporate tax rate of 20% p
...
for the first 5 years if listed any time after
1/1/2006
...
The rate applies for first five years of listing
...
•• A reduced corporate tax rate of 27% p
...
for the first 3 years for any company that get
listed after 1/1/2002
...
•• If the country exporting goods to Kenya had imported such goods and either
i
...
c) i)
••
••
••
••
••
••
Tax free (exempt) employment benefits
Fringe benefits
Benefits in kind not exceeding Kshs
...
a (Kshs 3,000p
...
Medical benefits if scheme is non-discriminative
...
Contribution by employer for employees to registered and unregistered pension and
provident funds
...
The assessed benefit will be
equivalent to the cost of the employer
...
The reimbursement of expenses incurred in the
course of carrying out the business of the employer does not constitute a taxable benefit
...
If the amount
reimbursed exceeds the cost to the employee, the difference will be subject to tax
...
Reimbursement of business expenses is tax deductible if the employee has been
taxed
...
(ii) Benefits in kind
Benefits in kind are taxable, unless the aggregate value does not exceed Kshs
...
a (Kshs
...
This amount is not significant enough to be included in an “Executive Remuneration
Package”
...
(iii) Pension Entitlement
(iv) Bonus Schemes
Bonuses constitute cash payments to employees
...
This item will not be tax effective to be included in a
remuneration package
...
Where the shares are given free, the taxable benefit is based on the prevailing market
price per share (MPS)
...
Where the difference between MPS and issue price is 5% or less of the MPS, the
benefit is not taxable
...
Assume
MPS
1
Sh
...
100
Issue price to employee
Sh
...
91
Different/discount
Sh
...
91
% of MPS
4 x 100 = 4%
100
4
9 x 100 = 9%
100
S T U D Y
The employer is tax exempt (e
...
NGO), contributions to unregistered schemes are fully taxable
on the employees
...
However, the employer is not allowed to deduct contributions to
non-registered schemes
...
262
A dvanced TA X AT I O N
Where the shares are redeemable, the taxable benefit shall be the higher of the difference
between:
••
••
Issue price and nominal value; or
Issue price and redemption value
...
ii)
T E X T
i)
Four methods of determining appropriate transfer price provided in the Organisation for
Economic Co-operation and Development (OECD) model
a) Uncontrolled price method
This method compares the price at which a controlled transaction is conducted to the
price at which a comparable uncontrolled transaction is conducted
...
c) Resale price method
Is similar to the cost plus method but is arrived at by working backwards from transactions
taking place at the next stage working backwards from transactions taking place at
the next stage in the supply chain and is determined by subtracting an appropriate
gross
...
d) Profit split method
Is a method applied when businesses involved in the transaction are too integrated to
allow for separate evaluation and so the ultimate profit derived from the endeavour is
split based on the level of contribution of each of the participants in the project
...
In addition, some countries have
got turnover tax that is the only tax
which is final
...
For
example, in Kenya we have a multiple tax
system since there are many taxes applicable
...
g
...
Most workers in developing countries are typically employed in agriculture or in small,
informal enterprises
...
" The base for an income tax is
therefore hard to calculate
...
As a result,
modern means of raising revenue, such as income taxes and consumer taxes, play a
diminished role in these economies, and the possibility that the government will achieve
high tax levels is virtually excluded
...
It is difficult to create an efficient tax administration without a well-educated and
well-trained staff, when money is lacking to pay good wages to tax officials and to
computerize the operation (or even to provide efficient telephone and mail services),
and when taxpayers have limited ability to keep accounts
...
iii
...
This lack of
data prevents policymakers from assessing the potential impact of major changes to
the tax system
...
This perpetuates inefficient tax
structures
...
Income tends to be unevenly distributed within developing countries
...
This explains in part why
many developing countries have not fully exploited personal income and property taxes
and why their tax systems rarely achieve satisfactory progressivity (in other words,
where the rich pay proportionately more taxes)
...
Developing countries attempting to become fully integrated in the world economy will
probably need a higher tax level if they are to pursue a government role closer to that
of industrial countries, which, on average, enjoy twice the tax revenue
...
To meet these challenges, policymakers in these countries will have
to get their policy priorities right and have the political will to implement the necessary
reforms
...
vi
...
The need
to replace foreign trade taxes with domestic taxes will be accompanied by growing
concerns about profit diversion by foreign investors, which weak provisions against tax
abuse in the tax laws as well as inadequate technical training of tax auditors in many
developing countries are currently unable to deter
...
SUGGESTED SOLUTIONS TO EXAM QUESTIONS
265
vii
...
The effectiveness of tax incentives—in the absence of other necessary fundamentals—
is highly questionable
...
To allow their emerging markets to
take proper root, developing countries would be well advised to refrain from reliance on
poorly targeted tax incentives as the main vehicle for investment promotion
...
Finally, personal income taxes have been contributing very little to total tax revenue
in many developing countries
...
Taxing this income is therefore a
daunting challenge for developing countries
...
Question Three
Harmonisation and rationaliation of Kenya’s tax rates
...
Question Four
(a) (i) Buoyancy
Buoyancy of a tax is the responsiveness of tax revenue to changes in national income
and to discretionary changes
...
Where discretionary changes are the changes in tax rates and rules governing the tax
system
...
t
Log (Ti) =
Log a + Log bi + log (βi) + ei
Where: T
β
e
bi
=
=
=
=
adjusted HTSTD to discretionary tax changes
tax base (or GDP aggregate level)
disturbance term
tax elasticity
(ii) Adjusted HTSTD with time trends or dummy variables as proxies for discretionary tax
measures
...
The proportional adjustment method
The constant rate structure method
The dummy variable approach
S T U D Y
••
••
••
••
T E X T
TPU’s role is to make policies relating to Kenyan taxes specifically issues relating to:
266
A dvanced TA X AT I O N
(c) (i) Value Added Tax (VAT)
This is tax elastic because a slight change in VAT rate leads to a significant fall in
revenue
...
However, for zero-rated and exempt goods, VAT is tax inelastic
...
For individual taxes reduction or increase in tax rates does not significantly change tax
collectible but works to encourage or discourage tax evasion or tax avoidance
...
Customs tax however is tax elastic and increase in import tax discourages imports
leading to low customs tax collected
...
An employer has an obligation
to deduct tax on graduated scale rates
...
The remuneration is the reward or pay for work or
service rendered, for example, in the case of a minister, civil servant, company directors, company
secretary, accountant, clerk, engineer, and all those commonly referred to as employees
...
Such a benefit is
taxable on the employer at the corporation Tax Rate
...
The imposition of the turnover tax is contained in Section 12 (c) of the Income Tax Act
...
According to Section 12C of the Income Tax Act
and the Turnover tax regulations, income from business includes gross receipts, gross earnings,
revenue, takings, yield, proceeds or other income
...
Withholding tax is applicable on payments to both residents
and non-residents
...
Value Added Tax- VAT is tax on spending which is collected by businesses and passed on to the
government
...
The current VAT rate is 16% and the taxable turnover is Kshs
...
Compensating tax- Compensating tax was introduced in 1993 under Section 7 A of the Income Tax
Act
...
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
...
SUGGESTED SOLUTIONS TO EXAM QUESTIONS
267
Stamp Duty- Stamp duties are chargeable in respect of certain legal documents as specified
in the stamp duties Act
...
Customs and Excise Tax-This is the duty on tax paid in goods imported through the port of
Kenya or imported and which are specified in the first schedule
...
5% for non resident companies
...
T E X T
Question two
S T U D Y
It depends on whether there are any relationships between the two that could give rise to a conflict of interest
...
Even so, it may be sufficient to
ensure that each is aware that you act for both, provided you keep the position under review
...
Chapter Eight
Question one
••
••
••
••
••
••
Tax avoidance measures implemented by tax payers
Good set targets but bad measures to meet the targets
Technological limitations- The fact that many of the taxpayers have no access to nor
understand technology, hampers the tax authority’s attempts to achieve its target
...
They
find the taxes available in Kenya very complicated
...
Evolving tax avoidance strategies- Some tax payers have adopted well calculated and
complicated mechanisms of tax evasion
...
Lack of enough assessors (personnel) to ensure compliance- The revenue authority
does not have enough personnel to be able to enforce the taxation laws and such
268
A dvanced TA X AT I O N
••
collect taxes
...
For example, the payment of turnover tax will depend on the integrity of the
tax payers to disclose the sales as required by law
...
Question two
••
••
••
••
••
Objectives of the Customs Union:
To raise revenue for the government
To protect local industries from multinational or foreign based industries by imposing
high customs duty to discourage consumption of imports
Prevention of dumping of goods into the Kenyan market
Discourage production of harmful goods e
...
beer and cigarettes
Question three
S T U D Y
T E X T
East African Community Customs Management Act (2004)
This is an Act that came into force in 2005 following the revival of the East Africa Community
Customs Union
...
Under the Union, goods traded within
the partner sates will be zero rated except for certain specified items from Tanzania and Uganda
albeit for transition period only
...
Customs duty rates
Duties are charged at varying rates as published by the Council of Ministers under the Common
External Tariff
...
The Customs duty
rates range from 0 to 25%
...
With effect from 1 January 2005, the East African Community Partner States (Kenya, Uganda
and Tanzania) agreed to charge import duties as follows:
(a) Common External Tariff (CET) on goods coming into the EAC from third party states
...
The Partner States agreed on a transitional provision to eliminate the internal tariffs under the
principle of asymmetry: that with effect from 1 January 2006 the Kenyan exports to Uganda and
Tanzania would attract duty at reducing rates as follows:
Tanzania
Duty rate (%)*
10
8
6
4
2
0
25
20
15
10
5
0
* Maximum rates for the year
...
Deductions Allowed - For expenditure to be deductible it must be wholly and exclusively incurred
in the production of income
...
The functional test - A structure will be regarded as plant if it fulfills the function of plant in the
trader's operations
...
The measures put into place
have to be tax effective as compared to those established in the average countries in the world
...
Tax avoidance - The reduction of tax liabilities by legal, although possibly artificial means
...
Zero-rated Supplies - Where a supply is not charged to taxation and the supply will in all other
respects be treated as a taxable supply
...
Customs Duty - This is the duty on tax paid in goods imported through the port of Kenya or
imported and which are specified in the first schedule
...
Custom warehouse - This is a place approved in CCE for deposits
...
S T U D Y
Balancing charge and balancing deduction - In case a firm is being liquidated trading receipt
is called balancing charge which is a taxable income while the trading loss is called balancing
deduction which is an allowable expense
...
The failure to honour the commitment leads to consequences,
which include forfeiting of an asset that may have been given out as a security
...
S T U D Y
T E X T
Indirect exporters - A manufacture/producer who imports goods for use in the production of
goods for supply to another manufacturer for use in the production of goods for export
...
6, 85, 150, 164
B
Back duty
...
273
Balancing deduction
...
v
Business
...
273
E
Excise Duty
...
273
G
Group Registration
...
90, 95
insurance
...
42, 71, 72, 122, 123
S T U D Y
D
T E X T
Customs Duty
...
273
280
A dvanced TA X AT I O N
L
Liquidation
...
116, 122
O
Off shore taxation
...
273
Pension
...
175, 183
R
Receivership
...
274
S
Setting test
...
132, 273
Tax evasion
...
131, 132, 157, 160
trading loss
...
273
Transfer pricing
...
85, 148
Withholding tax
...
273
Title: Advanced Taxation
Description: The notes gives clear information on Taxation and they are very quality
Description: The notes gives clear information on Taxation and they are very quality