QUESTION ONE
(a) List and explain any three deductions
that may be available against gains or profits from employment. (2
marks)
b) Mr.
Hesabu has recently opened an Income Tax Consultancy office in Nairobi. He has
been approached by his clients
on the following matters.
(i) M/S Watu, Wote, Wao are three partners
operating WWW Enterprises. In 2005, they
made profits of Sh.180,000. They share
profits in the ratio 3:3:4. Wao had
overdrawn on his account and was charged Sh.30,000 interest. Watu and Wote received interest of Sh.25,000
each from the partnership. The interest
account is included in the above profits.
Mr. Wote wishes to know how much tax he would pay. He has no other source of income. (6
marks)
(ii) Live Well Foundation is a
Non-Governmental Organisation formed for the purposes of addressing people’s
spiritual needs. It will derive its
income from donations of all kinds, charitable walks and sale of religious literature. They wish to know if they will be required to
pay any tax.
(4
marks)
(iii) Mrs. Mjini is a happily married
housewife residing in Kilimani Estate, Nairobi. Since her compound is big she engages in
backyard gardening during her spare time and she derives a lot of satisfaction
from it. She also maintains very
accurate records of the performance of her garden. Details for the three years ending 31
December 2005 are as follows:
Year
ended 31 December 2003 Profit Sh.20,000
Year
ended 31 December 2004 Loss Sh.40,000
Year
ended 31 December 2005 Profit Sh.50,000
Garden produce consumed by
Mrs., Mjini’s family during the year of income 2005 was sh.60,000 (not included
in the above results).
She
wishes to know how much tax she should pay from this activity in 2005.( 4 marks)
(iv) New Plastic Limited, manufacturers of
plastic products wishes to sponsor research into plants that may produce
plastics related materials. They have
set aside Sh.20,000,000 which will be awarded to the Department of
Biochemistry, Ubora
Science University. They wish to know if there is any tax
advantage which may arise. (
4 marks)
Required:
As Mr. Hesabu’s tax manager, write a memorandum on each
of the points for his consideration.
(Total:
18 marks)
QUESTION
TWO
(a) Specify
the rules relating to payment of Income tax under the Pay As You earn rules. (5
marks)
(ii) What are the consequences of failure to
deduct and pay tax under PAYE?
(3
marks)
b) You are provided with the following details:
1. Installing
a system of ventilation in the factory.
2. Legal
expenses incurred when acquiring a new building
3. Giving
the factory a fresh cost of plant
4. Replacing
200 tiles on a roof damaged by wind
5. Expenditure
incurred in demolishing part of a wall to make room for a recently purchased
machine.
Required:
(a) From an Income Tax perspective
indicate for each of the above items whether it is capital or revenue
expenditure. Explain. (5 marks)
(b) Explain
the role and functions of a Value Added Tax tribunal. (4 marks)
QUESTION THREE
(a) It is common in Kenya to have
individuals who cannot distinguish between taxes and charges. Explain the difference between a tax and
National social Security Fund deductions. (6 marks)
(b) Specify the basic rules in Income Tax
with regards to payment of pension from a registered scheme to:
(i) The pensioner, (3
marks)
(ii) The widow or widower of a pensioner. (4 marks)
(c) Specify
the main rules relating to a registered pension fund. (5 marks)
QUESTION FOUR
(a) Name and
briefly explain items which may be included in the qualifying
expenditure for the purposes of
investment deductions. (4
marks)
(b) Write
short notes on the following:
(a) Industrial
Building – “Hotel” (4
marks)
(b) Exempt
Dividend Income. (4
marks)
(c) Non-Resident
Individual (4
marks)
(d) Memorandum
of Appeal & Statement of Facts. (4
marks)
(Total:20marks)
QUESTION FIVE
Write explanatory notes on the taxes listed below and in
each case indicate whether the tax complies with the main principles of a good
tax system.
(a) Presumptive
tax on agricultural produce. (5
marks)
(b) Cess on
agricultural produce. (5
marks)
(c) Trade
licence chargeable to professionals. (5
marks)
(d) Stamp
duties on transfer of properties. (5
marks)
(Total:
20 marks)
ANSWERS
QUESTION ONE
(a) Deductions that may be available against gains or profits
from employment are:
-
Mortgage interest (owner occupied interest) paid
on loan to buy or improve a residential house up to a maximum Ksh.150,000. Note that where the mortgage interest paid is
less than the maximum, the actual interest paid is claimed. Where actual mortgage interest is higher than
maximum only maximum allowable can be claimed
-
.Actual amount contributed by an employee to a
registered pension or provident fund which shall be the lower of (i) Actual
contribution or Sh. 240,000 or 30% of pensionable income or set lime of sh240,000
-
Contribution to a registered Home Ownership Savings
Plan up to Ksh.48,000 p.a., that is Ksh.4,000 p.m.
-
N.S.S.F of Kshs 200 p.m (Kshs 2,400 p.a)
-
Subscriptions to professional associations such as
LSK, ICPAK etc.
(b) MEMO
FROM: TAX MANAGER
TO: MR.
HESABU – TAX CONSULTANT AND DIRECTOR
REF: TAX
CONSIDERATIONS ON POINTS RAISED BY CLIENTS
(i)
|
Mr. Wote’s taxable income is arrived at as follows:
Partnership profits reported
Add back interest to Watu and Wote (Sh.25,000 x 2)
Adjusted Partnership profit
Distributed as follows:
|
180,000
50,000
230,000
|
|
Partner
Interest on Capital
Balance of profits
|
WATU
SH.’000’
25
54
79
|
WOTE
SH.’000’
25
54
79
|
WAD
SH.’000’
-
72
72
|
TOTAL
SH.’000’
50
180
230
|
|
Therefore Mr. Wote’s taxable income in equivalent to
KShs. 79,000
|
|
|
|
|
|
|
|
|
|
(ii) Live Well Foundation being a
Non-Governmental organization formed to address people’s spiritual needs is of
a Public character and sources of its income include donations, charitable
walks and sale or religious literature and where such income is entirely
expended in Kenya
for the same purpose, no tax liability arises.
(iii) Liability to tax on farm income to wife
rests with the husband. Secondly where
farming is established to be hobby farming then losses will not be offset
against tax. We are told that family
consumption is Sh.60,000 for the year and that she derives a lot of
satisfaction from this activity. This
may be an indicator to hobby farming.
However if 25% or less of the farm produce is consumed then profits are
taxable. For year 2005 taxable farm
profit would be computed as follows:
Profit year 2005
Add: Own Consumption
Less loss b/fwd (40,000 loss – 20,000 profit)
Taxable farm income
|
Sh. 50,000
Sh. 60,000
Sh.110,000
Sh.(20,000)
Sh. 90,000
|
Taxable farming income of Ksh.90,000 will be added to
the husbands income and total assessed to tax on him.
|
(iv) By sponsoring research into plants to
produce plastic related materials which they manufacture, New plastic Limited
will be allowed to deduct the contribution against taxable income of such year
of income. This reduces taxable income
and tax liability. Section 15(i) (ii)
(iv) states: ‘a sum paid to a university, college, research institute research
mentioned in sub-paragraph (iii):’ as deductible against taxable income.
Signed
TAX MANAGER
QUESTION
TWO
(a) (i)“Pay as You earn” is
deductible from weekly wages, month salaries, annual salaries,bonuses,
commissions, directors fees (whether the director is resident or non-resident)
pensions paid to pensioners who reside in Kenya.
It is the employer’s statutory
duty to deduct income tax from the pay of his employees whether or not he has
been specifically told to do so by the Department.
The law requires an employer to
remit the income tax deducted from his employee’s pay before the tenth day of
the month following the deduction.
If the total amount of tax
deducted, from all employees in any month is less than hundred shillings or
when no tax has been deducted, the employer must complete the relevant portions
of the top copy of a credit slip and send it direct to his Income Tax office
before the tenth day of the following month.
Where total amount of tax
deducted is less than Ksh.100, it should be carried forward to later months
until it exceeds Ksh.100 or until December, whichever is the earlier, and then
paid-in.
(ii) If any employer fails to comply with the provisions of
Section 37 and with the
provisions of any rules made
under Section 130 which deals with the payment over of tax deducted and the
accounting for it to the commissioner, the commissioner may, by order, impose a
penalty equal to twenty five per cent of the amount of tax involved ,
and the provisions of the Act relating to the collection and recovery of the
tax shall apply to the collection and recovery of any tax payable and such
penalty as if it were tax due by the employer.
1. Cost
of installing a ventilation system in the factory:
This is a capital expenditure
(not allowable) since such installation would occur before the building is put
into use and is thus capitalized.
2. Legal expenses incurred when acquiring
a new building.
This is a capital
expenditure. Such expenses are
capitalized and disallowable since they are not incurred in generating taxable
business income.
3. Giving
the factory a new fresh coat of paint.
This is revenue expense since
it is basically a maintenance cost used on a factory already existing and used
in generating taxable income.
4. Replacing
200 tiles on a roof damaged by wind
This is allowable expense since
tiles are replaced with tiles. If tiles
are replaced with other roofing materials, the cost is treated as capital in
nature hence disallowable.
5. Demolition
cost to accommodate a new machine
This is a capital expenditure
and should be capitalized as part of the qualifying cost of the machine. It is incurred before the machine is put into
use. It is disallowable expense.
(b) ROLES OF THE VAT TRIBUNAL
The role of a value added tax
tribunal is that of an appeals body for the purpose of hearing and deciding on
appeals where a taxpayer is dissatisfied with the ruling by the commissioner
for value added tax.
The appeals Tribunal has powers
of a subordinate court of the first class to summon witnesses, to take evidence
upon oath or affirmation and to call for the production of books and other
documents.
QUESTION THREE
(a) A tax
is a compulsory contribution by persons liable to pay tax to the state to
defray the expenses incurred in the common interest of all, without reference
to special benefits conferred. By
compulsory we mean any person who refuses to pay a tax is liable to
punishment. Tax revenue is used for the
benefit of all and there is no direct ‘Quid Pro Quo’ payment.
The National social Security
Fund is a government fund which was established by the National social Security
Fund Act 1965 for the benefit of workers.
It is a compulsory savings scheme into which the employer pays a
statutory contribution for every employee who is a member of this fund. The scheme is applicable to those employers
having five or more employees. The
average rate of contribution is 10% of a worker’s wages half of which is paid
by the employer and half by the worker subject to a maximum of 2400p.a
The
following benefits are provided under this scheme:
o
Age benefits – paid to a member at age of sixty or
when he retires from paid employment, whichever is later.
o
Withdrawal Benefit – paid to a member who is at
least fifty-five years of age and has not engaged in paid employment during the
previous three months.
o
Invalidity Benefit – Paid to a member who is
permanently incapable of work because of physical or mental disability.
o
Survivors Benefit – Paid to the dependants of
deceased member
o
Immigration Grants – Paid to a member who is
permanently emigrating from Kenya.
(b) (i)
Payment of pension from a registered scheme to a pensioner will be based on the
following rules:
the first Ksh.300,000 received
by a resident individual in a year of income in respect of pensions or
retirement annuities is exempted and is not chargeable to tax.
Lump sum payment of first
Ksh.600,000 is exempted from income tax upon maturity of employment.
(i) Payment
to widow or widower of a pensioner will be treated as follows:
- the first Ksh.1,400,000 of such a
lump sum payment will be consolidated income not chargeable to tax as income of
the beneficiary.
(c) The following
are the main rules relating to a registered Pension scheme – Sec.22:
(i) Deduction in respect of contributions
of an employee in a year shall be limited to the lesser of:-
the sum of the contributions
made by the employee to registered funds in the year, or thirty per cent of the
employee’s pensionable income in the year, or two hundred and forty thousand
shillings per year
(ii) Pension funds in respect of an employee
may be transferred to another registered fund or registered individual retirement
fund and not be treated as a withdrawal under Sec.3 (2) ©.
(iii) Where registered fund is wound up, any
surplus funds therein shall be deemed to be the funds of the employer and shall
be immediately withdrawn by the employer unless the trust deed in respect of
such registered fund specifies the contrary.
Other rules:
- Funds must be registered
- contribution cannot be withdrawn
before 5 years have expired neither can contributions be used as security.
QUESTION FOUR
(a)
Qualifying expenditure – the cost of the asset (used for generating taxable
income) which should qualify for a capital allowance/deduction
The items to be included as
qualifying expenditure include:
- Buying
price of the asset
- Any
customs duty and Vat paid on the asset
- Installation
costs
- Insurance
on transit and transport costs before the asset is brought into use
- Cost
of demolition of a building to accommodate the asset
- Any
repair cost incurred before the asset is brought into use
- As
a rule, any incidental cost incurred before the asset is brought into use
is a qualifying expenditure
(a) Industrial
Building – “Hotel”
This is a hotel building or
part of a hotel building which the Commissioner of Domestic Tax has certified
to be an industrial building, including any building directly related to the
operations of the hotel such as kitchens, staff quarters and entertainment and
sporting facilities.
(b) Exempt dividend income
Dividends from outside Kenya
Dividends received by a company
which owns 12½% or more of the voting power of the paying company.
Dividends received by an exempt
person, e.g registered pension and provident funds
Dividends received by an
insurance company from its life insurance fund
(c) Non-Resident Individual
Is an individual person who has
a permanent home in Kenya and was not present in Kenya for any period
during the year of income under consideration; or he has no permanent home in
Kenya and was not present in Kenya for a period or periods amounting in
aggregate to 183 days or more during the year of income under consideration; or
he has no permanent home in Kenya and was present in Kenya for any period
during the year under consideration and in each of the two preceding years for
periods not averaging more than 122 days for the three years.
(d) Memorandum of Appeal & Statement of Facts
These are the most important
documents (Memorandum of appeal and statements of facts) which must be
submitted to the clerk of the Local Committee.
Memorandum of appeal is a document stating the grounds/reasons for the
appeal. The original and 9 other copies
for the members of the Local Committee.
A statement of facts, on the other hand, is a document which gives a
sequence of events on the assessment before appeal to the local committee, i.e.
dates assessment was issued and objected to, confirmed, etc.
QUESTION FIVE
(a) Presumptive Tax on Agricultural Produce
·
This tax was levied on the value of gross sales of
specified agricultural produce.
Introduced in 1989 was charged at rate of 5% and collected by the
authorized agents specified in the 19th sechdule of the Act. These agents are required to remit this tax
to the commissioner in 30 days of making such deductions.
·
This tax is charged under the provisions of
Section 17 (a) of the Income tax Act and based on the presumption that farmers
who grow certain crops or produce derive gains and profits chargeable to tax
under Section 3 (2) (a).
·
The rate was later reduced to 2% which was final
tax in the case of individual farmers only.
·
The tax complies with principles of a good tax in
that gains to farmers are also brought to taxation in line with canon of
equality/equity or fairness.
·
It is convenient and economical since it is
collected by authorized agents appointed by Government and that it is based on
gross sales made. It is certain since it
is collectable at points of sales of agricultural produce affected.
(b) Cess on Agricultural Produce
Is a levy imposed by Rural
local authorities on traders of the main commodities found in such local
authority such as Agricultural produce, building materials, e.g. Sand, Stones,
Quarry chips. The purpose of the levy is
to maintain roads and essential facilities provided by such local authority.
(c) Trade Licence Chargeable to Professionals
Trade licences fees are charged
in accordance with provisions of Trading Licenses Act (Cap 497). These are licenses on annual basis to grant
the permission to conduct professional work for a gain. This charge ensures that the right persons
get the authorization to conduct professional work and protects such
professionals from non-qualified persons who may wish to join the trade. It is convenient and economical since the
licenses will normally be issued by the local authority concerned as a
Government body. It may not be
productive given few number of professionals require such permit per year but
satisfies principle of equity or fairness as professionals desiring to practice
are also brought into the tax net.
(d) Stamp Duties on Transfer of Premises
Stamp duties are charges by
Government in respect of some documents which are specified in the Stamp Duties
Act. Stamp duties are charged in Kenya in
accordance with the provision of Stamp Duties Act Cap 480. Instruments must be stamped where property
transfers are effected. Conveyance or
transfer duty is charged on every instrument or court order in respect of the
transfer of any property as a result of sale.
Stamp duty on transfers of premises is equitable/fair since the property
owners contribute tax, it is convenient since it is only applicable upon such
transfer.
