TAX LAW NOTES

  Class Notes

Historical development

Tax structure-Taxes levied in Kenya

Personal and business taxation

Tax assessment principles and guidelines

HISTORICAL DEVELOPMENT-COLONIZATION AND NEED FOR TAXATION

The Berlin conference of 1885 and 1886 were used by imperial powers to partition East Africa among them so that for East Africa, one part, which later became Kenya was under British sphere of influence while the other part (lower) Tanganyika came under German sphere of influence. Zanzibar remained in the hands of Sultan of Oman. The British part became East Africa protectorate, which had been expanded in 1880 through the 1880 agreement by extending boundaries between British East African protectorates across Lake Victoria to the Congo to include Uganda in the British sphere of influence. Of particular importance is the fact that both Germans and British administered possession through private companies with both political and proprietary rights over this possession. The imperial British East African company was used to administer the protectorate.IBEAC was granted a charter with three mandates

Penetrate open and administer East Africa from Coast to Uganda

Establish a safe trade route to Uganda

Construct a rail road along that route

To enable the companies to finance its activities, it was given political and economic power to extract taxes and any other tariffs from the population in its protectorate. The new intruders the company could not at that point in time find any activities it could levy taxes on.1887-1888 in process of which it continued to seek grants from British colonial government, which the British could only get through taxing their own citizens, bewildered inhabitants of this protectorate. In 1895, Britain declared protectorate status over East Africa and used the staff of the company that was already in the territory to administer British rule. It sought to recover expenses of this rule through taxing the inhabitants who were four. Their mandate was to make East Africa self sustaining through economic activities. By executing this mandate, they separated the Ugandan part from the Kenyan part, which required some injection of settlers from abroad. The chief native commissioner of that period was Sir Charles Eliot for purposes of raising tax bases in East Africa he wrote several memos to the British government to send over settlers who would start businesses where the natives would be employed. The natives salaries would then be taxed. Unfortunately, for Sir Eliot the British decided to send settlers who were mainly old and poor. He then turned to Europe where they wanted the Jews to come and settle in East Africa. He also wanted Indians but the Indians could not manage to come since they wanted to move in all villages. The settler has feared Indian competition and this discouraged them.

Legal framework

It was laid in 1892 when the hut tax was introduced on Africans assessed on a man in relation to the number of huts in his compound. Tax legislation came in 1903 when tax ordinance was enacted which allowed imposition of a poll tax in 1910 which was assed upon the whole population and was being introduced in order to force Africans to look for employment in white settlers farm to raise the tax revenue used as a mechanism for creating labour for the settlers farms. The rate was three rupees per head and was raised to eight rupees in 1920.Indians and white settlers were not paying any of these taxes. In 1922 around several police stations, Harry Thuku and others held riots protesting against excessive taxation of Africans. One consequence is that it became very troublesome for Africans and they had to look for employment to pay the taxes. Africans resorted to tax avoidance mechanisms. African boys were forced to pay taxes at 16yrs.In connection to this state of affairs, Van Zwanenberg in his book Colonial capitalism and labour in Kenya 1919 to 1939 he observed :-

The Tax system was unjust because of the low level of wages in relation to the tax demands and because the Africans received too little for their taxes. This latter fact should be understood in relation to the indebtnes, which was a direct consequence of government expenditure upon infrastructure.

European settlement needed supporting services in Agriculture, veterinary and medical fields and a police force to protect the European property and enforce restrictions on African movement. Burden of direct and indirect taxes fell on Africans whose taxes were restricted towards development of the Europeans.

The amendment of the 1903 Tax ordinance in 1910, allowed for distress of property on tax defaulters. In the default of property, it allowed for three months imprisonment and subsequently detention of three months with hard labour.

Economic Effect

Confiscation of property

If no property was to be confiscated, still there was no money to pay the tax

In 1933, the tax ordinance was repealed and replaced by native tax and hut native tax ordinance, which was more draconian. 

Sec 8(1) allowed hut of defaulting taxpayers to be burnt down

Zweinberg stated, If a hut owner cannot pay if they are destitute and posses no goods that can be detained upon, they are expelled from their huts after 21 days when another tax is due, the hut is seized and may be burnt

As this drew to a close, the family becomes desperate and in one place where famine relief had been distributed, the home of one gathering was burnt while in custody as a tax detainee.

ADMINISTRATION OF KENYAN TAX LAW

By colonial Government through district officers

Through East African high commission

East African service organization

Kenyan Tax departments through Commissioner General

K.R.A

The main characteristic was that D.Os not trained in any field were deployed in various capacities relied on chiefs and head men, their main aim being to force Africans to look for employment so as to pay taxes.

In 1920, British colonial office forced the Kenyan colonial government to tax Indians and Europeans if forced to increase rate of Native taxes led to enactment of income tax ordinance. It was later repealed and in its place import tax increased on wheat, sugar and tea imported by settlers and consumed by Africans.

Subsequently through industries to process most of these products were set up which meant a few Europeans middle class had to be attracted to manage this industries. Companies had to be incorporated to manage these businesses.

Nicholas Sweinson in a book, The development of corporate capitalism in Kenya observed that the lifespan of these companies was very short i.e. 5-9 years but between 1922-1945 companies became more stable and after world war 11, kept attracting other nationals through James finlay and co. which then meant that the companies were engaging in trading acts to attract tax to tax both co operations and people who manage them. Administration had to shift from District officers to provincial officers to professionals which led to the setting up of the East African High Commission in 1947.

Harmonizing Tax Law in East Africa

In 1937 income Tax ordinance had been enacted in Kenya followed in 1940 by similar ordinances in Uganda, Tanganyika and Zanzibar, which all joined to form a single income Tax department. In 1952, income tax ordinances were consolidated to form the East African Tax (management) Act No 8 of 1952 of East Africa High commission.

Impact of the Act

The Act evolved the rates of tax and personal allowances to be prescribed by each of the territories

Introduced taxation of companies

In 1958, another East African income Tax (management) Act replaced the 1952 Act its major object being to reinforce taxation on companies. It however made rates of corporate taxation to be proportional while that of individuals was progressive. Individuals were being taxed more than companies were thus as a tax avoidance measure individuals would form companies hence a lower rate and level of taxation. The other way the taxpayers used to avoid taxation was to retain dividends until such a time when income of other shareholders was known and declared exempted.

-Income splitting

-Dividend stripping

The 1958 Act allowed the commissioner to set aside any settlement or taxation aimed at tax avoidance or reduction of tax liability

B.D.E and Company vs. Income Tax Commissioner

Company x owned half shares of company y where Mr. Z owned the other half shares. Company x was in receivership while company Y was profitable and had made profits capable of paying dividents.Mr.Z already had a large dividend income so that any profits from company Y would be taxed at the punitive tax levels/rates.Inorder for both company Y and Mr. to avoid paying taxes, it was agreed company X would buy half the shares of Mr. Z after which it would then declare dividends payable to itself which it would use to pay off its debts but not sufficiently to have it declare profits that would be taxed on it and thereafter resell the shares to Mr. at a lower price than that paid for purchase to enable Mr. have  capital gain which was not taxable and thereby avoid the taxes that would have been paid if profits had been declared by company Y earlier. The commissioner resisted. On Appeal, it was Held that the commissioner had powers to set aside Taxation aimed at avoiding Tax. Shareholder X was deemed to have earned dividends, as it was the second shareholder. The commissioner also had power to set aside any dissolution of companies that had retained earnings by deeming those companies to have distributed 6o% to shareholders thus taxing the companies at individual shareholder rate.

East African Common Services Organization (1961-1973)

Formed in the place of East African High Commission and provides common services to the East African countries. In 1962, another East African Income Tax Management Act was enacted to replace the 1958 Act. Its major aim being to increase rate of corporate taxation while reducing rate of income tax for private companies. The Tax regime was very complicated. In 1965, another Act was enacted to replace the 1962 Act, which now harmonized rates at 8shillings per pound on all incomes of corporation.

Non-taxability of capital gains. Issue rose, what point is it known if a capital gain or income has been made.   

Eisner vs. Macomber

It may not be good to tax capital. Capital may be likened to a tree while income may be likened to a fruit. Taxing capital may affect the tree that bears the fruit.

Z co.ltd vs. Commissioner of income Tax

Issue was whether a person makes capital gain/profit when a company authorized by its articles to deals with land deals with land, it will be presumed to be carrying on a trade/business in land. Commissioner is authorized to ensure that companies keep their records in English

Each country establishes its own income tax department

Kenya Revenue Authority

1955: consolidates all revenue departments into a parastatal and enhances financial independence of the parastatals by shielding it from the central government budget inefficiency with power to collect all taxes, revenue, duties, fees, levies, charges or other monies

POLITICAL ECONOMY OF TAXATION 

Because Tax is an intrusive act of taking property that belongs to citizens, there has evolved a practice that tax may only be levied on the authority of law, so that they have specific tax Act, statutes that authorize the government to levy taxes including income tax Act, Customs and excise Act, VAT Act, Stamp duty Act, etc and this brings the linkage between those who charge tax upon those whose Tax is charged upon their representatives. The underlying assumption is that the government must at least charge Tax in order for it to function

Is the government necessary?

What role should it play that is forcing it to need such amount of money?

Importance of Government

Manages the public sector; Sector involving central government, local government, public corporations, all of which together with the private sector enables the economy too efficiently and equitably allocate resources. Because the private sector is motivated by profit, services given may be out of reach for a majority.

Importance of government in authorizing the public sector

Helps promote competition; this is through the regulation of the private sector which in relying on forces of supply and demand, determines prices for both resources and finished products provided there is always a fair market in place. Where monopolies arise, the government promotes competition and prevents abuse of monopoly power through Outright Monopoly Law on Anti Trust through taxation and subsidies.

Provide public goods and services, defense, adjudication over disputes, infrastructure, security, mass education, public health etc. These are services, which though also provided for by the private sector in varying degrees, must be consumed by everybody, and the government at considered or reasonable prices provides them.

The government also protects society from future costs of private sector decisions. This is mainly because the private sector entities make their decisions based on private costs and benefits analysis of production and consumption. The effects of these decisions on the public or on future generations are not usually brought into the question, this is where environmental problems are created by private entities, and the government comes in to regulate and prohibit some of the private sector decisions.

Enforcement of private sector obligations: Private entities enter into contracts and other obligations which tend to give them assurance that the people they engage with will perform their part, but when there is a breach, some recourse to law, through the fiduciary or recognized arbitration mechanisms are availed. The government thus helps in encouraging trusts by helping those who will breach regulations know what will happen to them and helps others to enforce their rights.

Redistribution of income and wealth: Private sector deals only with those who participate in it, so that if you do not have goods you may not be benefiting. The government steps in to enforce social welfare by emphasizing goods and services and taxing others, which helps, bring some parity amongst its citizens.

      6) Promotion of macro-economic objectives where at national levels, issues of                                                                 unemployment, balance of payment etc have to be coordinated by a uniform treatment done by the government. T

His helps in directing economic development for the whole economy and thereby for the whole country.

Constitutional Provisions as to Public Finance.

Sec 99-105 of the current constitution deals with finance in chapter 7.Section 99 establishes consolidated fund and other funds of the government of Kenya. Under Sec (1) on revenues and other monies raised or received by Government of Kenya are paid into and form a consolidated fund. No withdrawal may be made out of the consolidated fund except with authority of the constitution, an Act of parliament or a vote on account passed by parliament.

Sec 99(2)Parl man provide for revenues or other monies received by Kenyan government to be paid into some public fund or retained by authority that received them to defray its expenses but no money may be withdrawn from such without authority or under a law.

Sec100 creates a process known as appropriation, which authorizes expenditure from the consolidated fund. This section is responsible for making the Minister of finance an executive

Sec 100(1) provides for an annual budget before the National assembly each final year estimates of revenue and expenditure of Government for the next following financial year.

Sec 100(2) upon approval of establishment of expenditure by National assembly an appropriation bill shall be introduced to provide for issues from the consolidated fund of sums necessary to meet that expenditure and appropriation of those funds for purposes specified therein

Sec 100(3) It allows the finance minister to lay supplementary estimate or a statement of excess before parliament where either of two things occurs:-

If the amount appropriated is insufficient or a need has arisen for expenditure for a purpose for which no amount has been appropriated by that Act or where any monies have been expended for a purpose in excess of amount appropriated to that purpose by the appropriations Act or for a purpose to which no amount has been appropriated by the Act

Sec 101 provides for the authorization of expenditure in advance of appropriation .This is usually allowed if the appropriate Act for the financial year has not come into operation or is unlikely to come into operation at the beginning of that financial year. Parliament may by a vote on account authorize withdrawals from the consolidated fund provided the withdrawals do not exceed half of the estimates of expenditure laid before the assembly.

Any monies withdrawn on authority of a vote on account must be included under vote for specific services for which it was withdrawn.

Section 102 provides for the establishment of a contingency fund from which the Minister of Finance may make advances to meet urgent and unforeseen needs not otherwise provided for in the Appropriations Act

Section 103 allows for withdrawal from the Consolidated Fund for which the government is liable.

Section 104 provides for the remuneration of certain constitutional officers for example judges, without the need for authority from parliament.

Section 105 creates the office of the controller and auditor general as officer in public service with threefold duty:

 

       1) Satisfied that any proposed withdrawal from the Consolidated Fund is authorized

          By law. If so satisfied, approve the withdrawal.

     

       2) Satisfied that all monies appropriated by parliament have been applied for the     

          Purposes they were so appropriated and that expenditure conforms to the authority  

          That governs it.

       

       3) At least once in every year, to audit and report on public accounts of the

          Government of Kenya and several other offices/authorities.

Should we have general consequences- how to control those who misuse tax funds?

STRUCTURE OF TAXATION IN KENYA.

How the government has to decide which of the taxes to levy.

General purposes of taxation. - Wealth of Nations (Adam Smith) provides that a good tax system must have the following:

The subjects of every state ought to contribute to and support the government as     near as possible in proportion to their respective abilities i.e. in proportion to revenue they respectively enjoy under the protection of that state. 

The tax which each individual is bound to pay ought to be certain and not arbitral

Each tax ought to be levied at the time in the manner it is most likely to be convenient for contributors to pay it.

Every tax ought to be so contrived as both to take out of and take out of the pockets of the people as little as possible over and above that which it brings to the public treasury of the state.  

Cannons of a Good Tax System.

1) Equity/Fairness

   People should pay taxes according to their ability to pay them. Those in the same

   Income bracket should pay similar taxes, and bring fairness and equity both

   Horizontally and vertically in terms of those with higher incomes being called upon to    

   Pay higher taxes.

2) Certainty of taxes.

   Avoid arbitrariness so that quantum and circumstances are certain and clear to both the 

   Taxpayer and tax collector who help avoid unnecessary and costly disputes.

3) Convenience of payment

   Where method, manner and payment of taxes should be convenient to the taxpayer to 

   Encourage him to produce more.

4) Tax Administration Cost

   The cost of administering a tax should be low for both the taxpayer and the tax  

   Collector so that tax yields should be lower than that used in collecting it.

CLASSIFICATION OF TAXES.

     1) Direct taxes

     2) Indirect taxes.

Direct taxes are levied on income wealth or spending power or any combination of the three.

Indirect taxes are levied on goods and services and may be applied by either unit or percentage of value or at a flat rate or in any other combination of lump sum.

The relationship between an individual tax and income of a taxpayer may also help us classify the effect of those taxes; classified as proportional, progressive, or regressive.

Proportional taxes: Percentage of tax payable remains constant even as income rises.

Progressive taxes: Percentage of income paid will increase as income rises because rates of the taxes will be increasing progressively as income rises.

Regressive taxes:  Percentage of income paid in taxes decreases when income rises. These taxes are usually a single figure.

Most of the people who determine which taxes to charge may actually decide that they themselves do not get charged or that those applicable to them are proportional or progressive.

Governor Ronald Reagan (as he then was) in commenting about the U. S tax structure observed,

     Once you are told the income tax will never be greater than 2% of the income and  

       That only from the rich. In our lifetime this law has grown from 31 to more than 

       440,000 words. We have received this progressive tax direct from Karl Max who 

      Designed it as an essential of a socialist state

In the proportional tax bracket, the steepest rate of increase occurs through the middle income range where are to be found the bulk of our small businessmen, professional people and supervising personnel, the very people whom Max said  should be taxed out of the system.

At 16,000-18,000 shillings of income, a man reaches the 50% rate; the government can only justify this bracket on a punitive basis.

There can be no moral justification for the progressive tax, thats why bureaucrats 

Pretend that it is proportionate taxation.

1) Direct taxes

They are levied on income, wealth and spending power with consequences that usually they are referred to as direct taxes because attainment brings the taxpayer directly in contact with the taxman. In some situations, this may not be the case.

They are usually preferred because they help maintain horizontal equity so that those who earn the same income are subjected to the same tax rate.

They also reflect equity in ensuring high income earners who rely more on the state for either the opportunities to earn that income or opportunity to protect that income are made to pay.

Progressive tax rates are utilized then vertical equity is achieved and the state uses the direct taxes to redistribute income. It is amenable to lower tax avoidance since people must earn a living.

Direct taxes have however been criticized on grounds that they may discourage people from working harder because if through a progressive tax rate, that is both high and steep, the taxes take a greater percentage of income than the person who earned it, the person will be discouraged from earning  that income.

Under what circumstances may the progressive system be both steep and high?

Direct taxes may encourage tax evasion by encouraging people not to report circumstances relating to income thus resulting into a black market.

2) Indirect taxes.

Imposed on outlay of goods and services. They are indirect in the sense that the prices of goods may be inclusive of tax so that in paying for the goods, the taxpayer also pays for the tax. The burden is shifted to the consumer who may not realize the burden.

It increases the choices to taxpayers so that the taxpayer may choose to either spend on less tax or choose whichever of the goods that may be attracting the taxes.

It helps in inequitable allocation of resources so that some activities that may have an effect on health, the environment or other public affairs may be taxed out of existence.

Disadvantages of indirect taxes

Most indirect taxes tend to be regressive i.e. same rates apply to all the taxpayers and the more able to pay tend to pay less and tend to be subsidized by those who are less able to pay hence affecting the vertical equity.

In relation to foodstuffs, basic commodities etc, low income earners spend less income on these commodities and in paying the same taxes, shoulder the same budget.

The indirect taxes tend not to take into account the personal circumstances of the taxpayer.

Income tax of business

 

It is divided into three:

      -Capital gains tax

      -Estate/Inheritance tax

      -Payroll tax

Income tax on business

Income Tax Act deals with tax of businesses and individuals.

Section 2 defines business as any trade, profession or vocation and every manufacture and venture or concern in the nature of trade but excluding any form of employment.

Income tax is then charged on all the income of the business whether resident or non-resident which has accrued in or derived in Kenya or is deemed so.

A corporation or other association of persons will be regarded as being resident if either the company is incorporated in Kenya or its affairs are managed or controlled in Kenya by the Minister through a notice in the gazette.

Income to be taxed is that to be received or accrued through business profit, services rendered, and income from agricultural activities, royalties, pensions or annuities.

Foreign sourced income is not taxable unless the company carries on business partly in Kenya and partly outside in which case all profits of the company should be liable to tax subject to any double taxation treaty, which may allow any taxes so paid to be deducted.

Income tax of individuals

Taxed on resident individuals on Kenyan sourced income, and on any foreign sourced income for employment or services rendered. however if Kenyan individual party carries on business in Kenya and abroad then it will be liable to tax, income tax will be charged on income from employment services rendered, rental income, interest pensions annuities, royalties and income from agricultural produce.

Capital gain tax

This is charged on capital gains realized on disposal of capital assets where gains are calculated between difference of  purchase and sale price discounted by inflation as measured by consumer price index for the period in which asset was held.

It was abolished on 14 June 1985 although it remains to be charged on gains realized on transfer of property in Kenyan model on or before 14th June 1985. It is still chargeable under the 8th schedule.

Death or estate duties. 

It is charged upon transmission of property from a deceased owner to his heirs as a form of transfer of wealth. It helps the state to share in appreciation of assets from the time those assets were acquired to the time of transfer.

In 1982, MP for Karachuonyo moved a motion and an Act known as Estate Duty Abolition Act, which abolished estate duty on transfer of property from the deceased person who died. In Kenya, it is still charged on deaths that occurred by this date from time of granting of letters of administration.

Land charges

Stamp duties on any inter vivo transfers of land and the coming into effect of a registered doctrine. Local authorities also have land rates for property read in their localities, others in local authorities paid on transfers

Payroll Taxes

Collected by an employer PAYE on behalf of employee. Payment for insurance, retirement, pension, medical and other schemes handled by the employer on behalf of the employee.

Indirect Taxes include the following:-

Sales Tax(VAT)

Excise duty

Customs duty

Export duty

Hotel accommodation Tax

Catering levy

Second hand motor vehicle Taxes

Telecommunication Tax

Air passengers Tax

Betting and Gaming Taxes

Sales tax

The sales Tax Act was introduced in 1973.It levied on Sale of manufactured goods/importation of goods. It administered this through allowing manufacturers to add Tax on prices of goods so that eventually they collected the Tax alongside the price. It was easy to administer due to price control. It is charged on imports so that importers pays much like customs duty but law did not allow importers to levy sales tax on goods it did not prohibit it either through prices of goods not regulated 

1999. It was changed to VAT and it was imposed on goods delivered in or imported to Kenya or for certain services rendered in Kenya.

Section 6(4) makes tax a liability of the person making the supply and is payable at the time of making the supply. Under Section 5(6), on importations charged as if it were a customs duty payable on the person who imports the goods. The person receiving the taxable services imports the services to Kenya payable under Section 6(6). VAT is generally calculated as a percentage of value of the goods. 

Imported goods: Value as ascertained from customs.

Manufactured goods: Selling price.

Tax levied at every stage of production and distribution so that it is added to purchases of raw materials, fuel and other capital goods and shifted to the final consumer. Distributors are allowed to deduct input VAT.

Customs Excise Duty

Imposed on imported goods as a barrier of the entry of those goods into the market. It is used as a barrier because it increases the value and price of those goods thus lowering their demand.

(Tariff barriers) may be applied Ad Van Loren (percentage of value) assessed  on CIF  of the goods if applied as specific duties assessed on net weight, size and quantity of imported goods. Rates depend on whether goods are essential, substituted or locally manufactured.

Excise Duty

These are taxes imposed on sale of goods not necessarily imported or deemed addictive or widely used by the population. Usually assessed on goods not subject to VAT including tobacco, wines, spirits, other alcohol, soaps matches etc.

Export Duty

Charged on exports that Kenyans make e.g.  flowers, tea, coffee. Usually charged in a progressive manner depending on the weight or tonnage.

Accommodation Tax

Charged on all persons who occupy or hire accommodation in hotels.

Catering Levy

Charged on hotels and catering establishments and are generally collected and help in maintaining staff in the industry and paid along the consumer.

Telecommunication Tax

Charged upon hiring and use of telecommunication equipments, operators and other services affected by the Telecommunications Commission of Kenya.

Air Passenger Transport Tax.

Charged on all air passengers.

Betting and Gaming Tax

Betting and Lotteries Control Act; all forms of betting, casinos and other forms of betting.

Entertainment Tax

Charged on nightclubs, discos etc

Video Tax

Charged on hiring of video tapes.

PERSONAL AND BUSINESS TAXATION

Section 3(1) of the ITA created a tax known as income tax, which shall be charged for each year of income upon all the income of a person whether resident, or non-resident, which occurred in or was derived in Kenya. Subsection 2 identifies the source of this income as;

Gains and  profits from:

           -A business for whatever period carried on

           -Employment or services rendered

           -A right granted to another for use or occupation of property.

b)   Dividends/ Interests

c)   -Pension charge or annuity 

      -Any withdrawals from a registered pension fund or a registered provident fund or              

        A registered provident fund or a registered individual retirement fund.

      -Any withdrawals from a   registered home ownership savings plan.

d)  An amount deemed to be the income of a person under the Act or rules there under

e)  Gains accruing in terms of the 8th schedule which relates to accruals and

     Computations of gains from property other than investment shares.

Capital gains relating to property acquired before 1st January 1975 and transferred 

Before 13th June 1985;

  

Section 3(1)

1) Each year of income

2) Upon all the income- what does income mean?

3) Who is a person?

4) Whether resident or non-resident. What does residency entail?

5) Which accrued in or derived in Kenya.

   

Year of Income

It is essentially the base year. A tax base is the object transaction with respect to which a tax is charged. Since tax is charged on each year of income and a year is a period of 12 months, the issue of timing is raised. - When within that year is this tax due?

A taxpayer would prefer payment of tax in arrears but the government prefers that tax be paid in advance. Canons of a good tax structure mitigate that the government demands tax in advance. Year of income is defined as a period of 12 months commencing on 1st January in any year and ending on 31st December of that year. This may cause hardships for persons whose accounting period does not coincide with this calendar year. The governments financial year is from 1st July to 30th June. Section 27provides for computation of accounting years not coinciding with calendar years. 

For a company whose accounting period does not end on 31st December, that accounting period shall be year of income for all chargeable income of that company.

For an individual who makes account for his business periods shorter or longer than 12 months, then such period shall be a year shall be e year of income for all chargeable income except employment income.

For partnerships who calculate each partners share of profit, year of income shall be a year which income was earned except income for employment or services rendered.

The Commissioner is empowered to make such necessary amendments including reducing accounting periods for years coinciding to 31st December or reducing longer periods to 1 year.

To enable the government to get revenue to finance acts throughout the year several measures in the Act under Section 12 provides for installment tax since 1980 for persons who do not pay (P.A.Y.E) on employment income, advance tax chargeable under section 12 A for those with PSV vehicles, since 1996.

Presumptive tax is chargeable in section 17A by those paying for any agricultural produce.

Withholding tax under section 35. Charge and interest where anyone paying charge/ interest/ annuity or insurance commission/ a pension/ consultancy agency or contractual fee or royalty is registered to withhold tax from the payment and remit it to the government. The same is applied on non-resident persons where withholding tax will be deducted from payment on any management or professional fee alongside other sources. Section 37 provides for withholding tax for emolument committed as P.A.Y.E for all employment income. All these deductions are remitted to the government at the end of every month to enable the government meet its expenditure needs.

What should one do if income earned in tear one for services delivered is not paid in that year but is received in year three? 

In accounting, it is solved by accrual / realization method. Accrual method is income treated whenever received to year in which it accrued. When services are rendered in a year, realization, treats income, and charges it to the year in which it has been realized. The Income Tax Act favors accrual method, because section 3(1) talks of income that accrued in or was derived from Kenya.

In charging all the taxes, the personal rates and reliefs applicable are issued by the minister in the Finance Bill after every Budget Day. Section 4-11 elaborates on each of the sources.

  

Person

Entity being taxed. The Act does not define a person to be a natural or individual person. Companies as defined in section 2.

Trusts- although some trust income is exempted from income tax, some income may be exempted. 

Partnership

Section 3(3) excludes partnerships from the definition of a person but is useful as conduits of information relating to income and expenses of partnership as apportioned to each of the partners for tax purposes.

Clubs may also be persons unless three quarters of gross receipts are not from members.

Commissioner of Income Tax vs. Law Society of Kenya  

It was argued that it was exempted from taxation. It was held on appeal that it was not since it did not have power to refuse admission or to refuse those who qualify as advocates deemed to be carrying on business and therefore liable to tax. 

Section 21 of the Income Tax Act allows a body of persons including those who may be getting more than three quarter of revenue from members if they elect in writing to be treated as carrying on a business.

Resident or Non-resident

Section 3(1) deals with residency and is defined under section 2.

a) A resident individual is one who has a permanent home in Kenya and in addition was   

    Present in Kenya for any period in that year of income.

b) Who has no permanent home in Kenya but was present in Kenya:

-For a period or periods amounting to 183 days or more in aggregate in that year of

  Income.

-Was present in Kenya in that year of income and in each of the two preceding years

  Of income of periods averaging more than 122 days in each year of income.

For a Company

1) A company incorporated under the laws of Kenya

2) A company whose management and control of affairs was exercised in Kenya in a

    Particular year of income under consideration.

3) A body, which has been declared as a resident by the minister in the gazette.

                                                                                                                                     

As a tax concept, Kenya uses residency, nationality or domicile and the significance is that Kenyan residents pay income tax on their income from Kenya and on income for services rendered anywhere else in the world with reprieve in section 41 of Double Tax Relief. If worldwide income was earned in a city, where there is a double taxation treaty

1) Ordinary residents: Voluntarily accepted for taxation purposes.

2)  Habitual residents: Regular physical presence ending for some time.

Citizenship refers to law by which a person is governed by birth or if a company by incorporation while citizenship may be acquired, nationality not. Domicile refers to a residence acquired as a final abode plus the intention to retain it permanently.

- It may be domicile of origin, which may be equal to citizenship because law assigns it at 

   Birth.

- Domicile of choice acquired voluntarily upon one attaining legal capacity.

- Domicile by operation of the law; assigned to those who cannot acquire domicile by 

  Choice.

   

Sir George Arnatoglu vs. Commissioner of Income Tax

The appellant, in 1960, had a home in Dar es Salaam and was present in Tanganyika for 249 days. In 1961, he sold his home and was in Tanganyika for 124 days. In 1962, he had no home but was present for 62 days. In the tax assessment for 1962, he was assessed as being resident but disputed the assessment arguing that he was not a resident in terms of East Africa Management Act whose section 2 was similar to Kenyas.

He argued that the definition of resident in the 1928 Act did not permit it to aggregate periods of residency with periods of mere presence.

That averaging in section 1b (2) meant that four months presence was required in each of the relevant years.

It was held that to be permissible under the Act, to aggregate period of residence and those of presence in territory, period to be averaged in paragraph b (11) was the total of days spent in territory over the three years.

      

       I wish to draw attention to the general scheme of residency. An individual is defined 

        As residing in the territory if he in fact does so. An individual is deemed to reside in

        The territories if facts are such that he will not normally be regarded as residing in 

        The territory or there would be doubt as to whether he did so. I wish to emphasize 

        That the deeming provision of this provision only comes into play if facts are such 

        That the individual will not normally be regarded as residing in the territories. I also 

        Wish to point out that modern legislature requires something to be deemed that of 

        Necessity means that it is to be treated as a thing different from what it in fact is. If 

        Deeming provisions are resorted to, then one seeks to ascertain whether a person 

        Who is in fact not a resident, should be treated as one. For purposes of deeming 

        Provision, it is immaterial whether he had a home in the two preceding years so long 

        As on the basis of averaging he was present in each of these two years for the 

        Requisite period. Appeal dismissed.

    

Commissioner of Income Tax vs. Nooran

The appellant appealed against the High Court decision that had held the respondent to have been resident in East Africa in years of income 1962- 1965. The respondent was born in Mombasa where he had some properties. He then moved to Tanzania where he lived from 1932-1960. When he went to England for treatment, and for the education of his children, he had a home in Tanga and a flat in Mombasa. In 1962-1965, he had occupied a guest home at Tanga and eventually a whole house for intermittent period. He sold it in 1968 and finally settled in Mombasa in the same year. He retained business and bank accounts in East Africa during the period he was away in England. In 1964, he became a Kenyan citizen. After living for England in 1960, he returned to East Africa on  12th  December 1962 where he stayed for 54 days. In 1964, he  came to East Africa for 52 days. In 1965, he came for 48 days. In 1967, he stayed for a few days. In 1968, he settled permanently. The issue was whether he had a home in East Africa in terms of the E. A. Act section 62 and for purposes of clarity. Residence in territories when applied to any year of income:

    -to an individual, this means that an individual resides except for such temporary 

    Absences as the commission may determine to be reasonable in any of the territories

  -An individual shall be deemed to reside in territories if he has a home in any of the 

    Territories, which for at least a portion of the year was available to him and was 

    Kept for purposes of his use and dwelling.

  -The home did not have to be occupied for a whole year to qualify as a home.

The fact that he had a home in England was immaterial since a person may have one or more homes at the same time. Appeal was dismissed.

Normally,  a person will be said to be a resident by the mere fact that the first part refers to temporary absence as the commissioner may determine to be reasonable does not mean that it lies within the commissioners power to exclude the first part merely by refusing  to deem it unreasonable.

Other jurisdictions base tax liability on domicile with consequences that those not domicile in the jurisdiction may not be charged tax or may be charged a higher tax.

I R C vs. Bullock

Bullock domiciled in Canada but had lived in England for 45 years. During that period, he won the love and affection of a fair English woman and married her. One day he told her that if she ever pre-deceased him, he would never return to Canada. Before this happened, he filed income tax forms indicating that he was domiciled in England. This was contested by the commissioner and assessed a higher rate than that of a foreign domicile person upon the first tribunal ruling in his favor. The commissioner appealed. 

Domicile is residence plus intention to remain permanently. Bullock   domiciled in Canada and they assessed a higher domicile rate.

Bangs vs. Inhabitants of Brewster

B was a shipmaster living in Brewster MA went to see oceans and sent his wife to Orleans in Louisiana with the objective of setting up a new home in Orleans and shifting from Brewster. Eventually, he joined her there. In the meantime, authorities demanded tax from Bangs as a domicile of their country, which Bangs paid under protest and filed a suit to recover the same on grounds that he had changed domicile to Orleans.

It was held that his application be allowed since he had sent his wife to Orleans with the intention that he makes it his new home. That changed his domicile as establishment of a new home and the intention to retain it permanently in Orleans entitled him to a refund.

Cesena Sulphur Co. vs. Nicholson

A company was incorporated in England to   take over and work sulphur mines in a place called Cesena in Italy. Manufacture, sale and management of the company business was done in Italy.  The MD of the company was permanently resident in Italy and registered there where three quarters of the shares were also resident. However, the Board of Directors served in London from where it controlled sale, order direction and management of the company.  Annual General Meetings were also held in London where dividends were also declared.

The issue was whether the company was a resident in England to subject the whole of its worldwide income to tax or whether it was resident in Italy. Since every act of the companys management was done in England, main place of management of the company was London and they were a resident in England with consequences that all its worldwide income was subject to English taxation.

Section 2 defines residence.

Section 4A deems any profit of a business partly in Kenya and partly outside Kenya to be that of a resident company.    

Accrued in/ Derived from Kenya

Sec 4(a) deems certain worldwide income to be accrued in or derived from Kenya. Trouble comes up in the way courts have looked at it.

Sec 10 deems certain income to have accrued in Kenya.

Sec 9 (1), (2) also deems income from use of a ship/aircraft in Kenya ports to have accrued in or derived from Kenya unless otherwise.

Sec 9(2) income from business or transmitting cable or radio messages from apparatus established in Kenya is also deemed to have accrued in or derived in Kenya.

Sec 10 touches on payments by Kenyan based residents persons and any persons who  are non residents in respect of management /professional fees,royalties,interests,use of property in Kenya and for any appearance or performance or any place for entertainment or sporting, then any such payments will be deemed to have accrued in or derived from Kenya and will be subject to a W.H.T (persons paying withholds tax from that payment and remits it to the Government.

Esso standard Eastern i.n.c vs. Tax commissioner 

The appellant was a neo-cooperation but had lent money to a Kenyan co-operation with rights plus construction of an oil refinery at Mombassa and for working capital account to loan arrangement, repayment for loan money to be made in New York in U.S dollars that agreement had also been drawn and where money was paid to the Kenyan Government. The appellant contested payment of tax on the interest and the issue was whether interest on loan had accrued in or was derived from Kenya in terms of Sec 3(1) of the Income Tax Act.

HELD: Appeal be allowed because the words accrued or derived from were anonymous and were the source of interest in this case was the contract made in New York and the location of the source was New York and thus the interest neither accrued nor was it derived from Kenya

Ec Boucher vs. income tax division

The appellant in 1953 and 1955 settled shares in a Kenyan company in discretionary trust in favor of his infant children by deeds executed in the US. Settler trustees and beneficiaries were at all relevant times resident in the UK but dividends accruing to these trusts from shares in 1951-1960 were deemed income of the appellant under Sec24 of the East African Management Act and assessed that income on him. The first appeal to the supreme board dismissed the matter. The second appeal to the court of appeal (East African) was that income being captured by Sec 24 was income of beneficiaries under UK settlement and neither accrued in or was derived from Kenya. It was held that dividends on Kenyan shares accrued as income of the settlement on which the trustees would be assessed at standard rates upon which after such assessment and tax being paid it was then paid to or for the benefit of the children and should therefore not be chargeable to tax under Sec 3 because it derives from settlement whose laws was in the  UK.

Income tax commissioner vs. Amboni establishment holdings and five others 

First second and fourth respondent were directors of the sixth respondent company while the second respondent were executors of the will of a deceased director of the company and the fifth respondent was managing director of the company. The company was incorporated in Gurnsey and carried on business in Tanganyika. Articles of association of the company provided for remuneration of directors of an additional seven and a half % of the net profit of the company. Upon such renumeration,the company sought to deduct as an expense the amounts paid for directors but the commissioner assed the company by denying such deductions and argued that the same was income and accrued in/derived from Tanganyika and was subject to taxation. Director not resident in Tanganyika except managing director duties fund in Gurnsey account. Although the MD was resident in Tanganyika for some time, his work was mostly in Switzerland where his service agreement was drawn and where he received his remuneration and neither has he/any of the other directors remitted any of the remuneration they had received in Tanganyika of which reason assessment was allowed. On appeal, it was held that where directors remuneration is paid in good faith under a purely commercial arrangrement, entered into by the company then the income tax commissioner cannot question its quantum as expenses. This company not having been a Tanganyika company directors remuneration said to be derived from Gurnsey Switzerland, which are places where to maintain principle and central accounts, and not from Tanganyika

Concept of Income

Under Section 3, the sources of income are given and expounded upon by section 4-12. Lord Mc Naughten observed that income tax from him was tax but did not define income.

  

Eisner vs. Macomber

This case dealt with the issue is stock dividends income? Standard O.  C. company of California, which had an authorized share / capital stock of 100 million US dollars, had issued stock amounting to 50 million US dollars, unissued stock of half its unauthorized capital. In its trading account had surplus undivided profits invested in plant, property and other business necessary for the cooperation amounting to 45 million dollars of which 20 million had been earned after 1913 and the balance  after that date.  To adjust its capitalization, directors resolved to issue additional shares to existing shareholders   to constitute stock dividend of 50% of outstanding stock and to account an amount equal to such issue. The new stock was divided among stockholders and upon delivery of receipts, the respondent was asked to pay a tax on the same assessed at the value of the new shares. He paid the tax under protest and sued the commissioner for recovery. 

A majority held that value of shares and not income and therefore should not be taxed.

J Bitney observed, The fundamental relationship of capital to income has been much discussed by economists, the former being likened to the free or land, the lather to the fruit or crop. The   former depicted as a reservoir from springs, the lather as outlet streams to be measured by its flow during a period. Income may be described  as the gain derived from capital from labour or from both combined provided it  is  understood  to include profits  gained  through sale/ conversion  of  capital assets.  A stock dividend shows that a companys accumulated profits have been capitalized instead of being distributed to stockholders or being retained as surplus available for distribution in money or in kind should the opportunity arise. Far from being a realization of profits for the stockholder, it tends to postpone such a realization, in that the fund represented by the new stocks has been transferred to capital and is no longer available for actual distribution. The essential and controlling fact is that stockholders have received nothing out of the companys assets for separate use and benefit. It should contain every dollar of his original investment together with whatever accumulation resulting from his employment of his business money in the business of the company still remains   property of the company. 

Susna Oliver and Brandy dessented.

The stockholder received income equal to the value of stock dividends and should therefore be taxed on the same.

Financiers with  the aid of lawyers devised  long  ago two  different methods by which a corporation can without  increasing its indebtedness keep for corporate purposes accumulated  profits and  yet in effect distribute these  profits amongst its shareholders.

The capital stock is increased, the new stock is paid up with accumulated profits and new shares of paid up stock are then distributed among stockholders pro rate as dividends.

Arrangements  are made for an increase  in stock to be  offered to stockholders prorate as  per and  at  the same  time, payment of cash  dividends  equal to the  amount which   the stockholder  will be required  to pay to the  company if he avails himself of the  right of the new stock. If stockholders take  the new  stock,  he  may  endorse the dividends  cheque received  to the corporation and  it  thus appears that among  financiers and  investors, the  distribution  of the stock by  whichever method  is  called a stock  dividend and  that the  two methods by  which accumulated profits  are legally retained for  corporate purposes and  at the same time distributed as dividends are  recognized to be equivalent. If  stock dividends represents profits are held  exempt from  taxation, then  owners of  the most successful businesses in America  will be able  to  escape taxation on  a   large part of what  is  actually their income and so  far  as their  profits are  represented by  stock  received as  dividends they will pat those  taxes  not upon their income  but only upon  the income of  their income.

Old Colony Trust Co.  Vs. Commissioner

The company paid taxes of some of its director sand the issue was whether payment of taxes of a director was additional compensation and the income to him.  It was held to be income and was taxable because it was in consideration of the services of that employee.

Commissioner vs. Glenshaw Glass Co.

The respondent had earned damages which comprised additionally both  exemplary damages for  fraud and punitive  damages  represented two thirds and  it was held  that these  were  also income because:

         -They were an increase in the net worth of the taxpayer

         -Money received that represents those profits was clearly taxable just like profits 

           They had been if they had been earned.

E. A. N Ltd vs. Income Tax Commissioner

The appellant bought a plot for purposes of building a petrol station with a view to distributing petroleum oil products from Caltex under anticipated distributorship products. Distributor rights however refused  and the  appellant sold the plot at a profit whereupon  the  Commissioner assessed the profit to tax arguing  that they were income to the appellant since it had  changed its business for petroleum purposes  and was now engaged in trading activity of selling plots  for which it  was liable to  tax on the profits.

The appellant appealed and it was held it be allowed since the profit was not from an adventure in the nature of a business but one from an earlier investment.

Section 4a of the  Income Tax Act deals with taxation of income from businesses where  it provides  that where business is partly in Kenya and partly  outside Kenya, its deemed to have accrued in  Kenya and though Section 4doesnot define business,  Section 2 does so and defines business as including any  trade, profession, vocational  or even manufacture adventure and  concern in  the  nature  of trade but does not include employment.

J Ltd vs. Income Tax Department

The appellants company carried on insurance business but also invested in equities and government stock and upon sale of equities and retention of government stock, at a profit, the commissioner assessed a tax on that profit arguing that this was income from a trading activity against which assessment the appellant appealed. It was held that the appeal be dismissed as the appellant had been involved in the trade of buying and selling stocks and shares.

Income Tax Commissioner vs. Laringnatesho Ltd

The respondent taxpayers had been incorporated to carry on a farming business but were allowed under its objects to purchase and sell shares and stock. From 1967 onwards, they sold shares and were not assessed to tax. In 1971, when the commissioner assessed tax on income, earned on shares in and after 1971,the respondent appealed to the local committee  contending that first, he  was not carrying on business of dealing in shares but  was merely realizing its initial investment for  which the local  committee held in his favour. The  commissioner  appealed to the High Court which  dismissed the appeal arguing  that the failure by the commissioner to raise any assessment on  such taxation before 1971 raised  a presumption that such  profits were not chargeable to tax  and  that onus  was on the commissioner to  show that purposes for which taxation  were carried out had  changed before these profits  are taxed. The commissioner  appealed to the  court of appeal which  allowed the appeal  and held that the High Court ought to have indicated in referring to findings of  the local committee whether it agreed with them or not and to have evaluated that evidence and reached  its  own conclusion and  secondly, that once an  assessment to income had been made on the taxpayer,  the onus of proving it was excessive was placed by the law on  the taxpayer who was  required if he disputes an assessment to object to the  same by  a notice in writing. Consequently, these profits were taxable.

Section 8 of the Income Tax Act gives that provision.       

Bapoo case

B lived in Tanzania and was declared bankrupt in 1931.He was later discharged in 1941 during this period of bankruptcy, he managed his wifes business, which had acquired two shipwrecks, which he did in order to recover bad debts owed by owners of the wreck.

After discharge took over, the wires business had also began to deal in second hand machinery. After failing to sell the shipwreck, he broke them up to sell them as scrap metal in which he made some profits. The commissioner assessed the profits made both from the broken up ship and from the hulks that he sold later. He appealed the cost assessment where the high court allowed the appeal on the profits from the sale of the hulks butt affirmed the assessment from the sale of broken up parts of the ship. The commissioner appealed to the court of appeal of East Africa and it was held that the commissioners appeal be allowed because although the single taxation man ordinarily needs not to be a businessman, an earlier case had held that in specified circumstances, a single tax can amount to business in East Africa. It  was immaterial that the shipwreck were taken over to liquidate bad debts it being established that the taxation were an operation or a business in carrying out a profit making venture and were therefore taxable.

Income tax v Sidney tatee 

The respondent bought a coffee estate, which he found unprofitable, he abandoned it and began a quarry in the same farm. It also became unprofitable and he abandoned it. He subdivided the land, installed sewers and roads and then advertised it for sale. He borrowed money from a bank, which were then used in these later developments. Later he sold plots at a profit and the commissioner assessed the profit to tax arguing he had traded in land and the profits realized were from a business of trading in land. He appealed against the decision and all that he had done was to realize the capital investment which the supreme court agreed with against which the commissioner applied to the court of appeal arguing that tax payers as an investor in coffee estate had upon abandoning that business notionally sold the farm to himself as a trader in land on which grounds he had installed sewer lines and roads upon subdivision and was therefore taxable on profits. It was Held, The respondent merely realizing earlier investment in land which he had failed  to recover at earlier attempts at coffee, dairy farming and quarrying therefore not traded in land and profits were not taxable

Sec 4(b) sets out the manner of calculating the tax

Sec 4(c) Taxation of damages and other compensation for loss. The money received under insurance against loss of profits, then Sec 4(c) assess them in parts and such a sum is taxed as income of the year in which it is received. It is only these relating to loss of profits that are taxed

Modern building ltd v Income tax

The appellant awarded by the consent a sum of money as liquidated damages in settlement of all claims in suit for breach of contract on account of having been supplied with a defective machine by supplier. The commissioner assessed the whole sum to tax. On Appeal it was held that only these damages for agreed compensation of a sum had been agreed for unliquidated damages, capital and income and hence the whole sum wasnt taxable.Sec 4(d) raises the amount put as read with Sec 15(2)a

Sec 4 (d) aims at capturing any income recovered in subsequent years when a reserve or provision to meet any liability has been made if that recovery either releases liability otherwise makes the reserve unnecessary.

Sec 5 Employment incomes

Gains a profit from employment defined in Sec 5(2) to include wages, salaries and several other allowances. The second provision excludes income for subsisting, traveling, entertainment or other allowance that represents solely the reimbursement to a resident of an amount expended by him wholly and exclusively in production of his income from employment

Persons: Any income in respect of any employment or services by him shall be deemed to be derived from Kenya, worldwide income may then be subject to taxation.

Importance of Section 5(2) in excluding reimbursed income in those taxpayers will have used his sum, of money wholly and exclusively for purposes of carrying income from employment that will be taxed.

Income received as compensation for termination of contract of employment 

Durga dass bawa v income tax

The appellant paid Ksh 100,000 upon termination of distributorship agency, which was written as an exgrata payment. Thee commissioner assessed the whole sum to tax against which he appealed. It was held that the payment was taxable.

Southern Ireland tobacco union ltd vs. Mc Queen

The respondent was employee of appellant whose services had been terminated. He sued the appellant and was awarded damages for wrongful dismissal comprising four years salary. He appealed against the award arguing that it should have been reduced by the amount of tax payable thereon.Held, appeal be dismissed because although amount of income tax chargeable on damages for wrongful dismissal ought to be recovered. Award ought to be paid full award so that they pay tax on that compensation.

Justice Windham observed, The sole question before us is whether the word compensation in the above paragraph can be held to include damages for damages cant in any case be taxable till they are recovered before and paid to the plaintiff 

Liquidator manzinde est. ltd vs. I.T commission.

The concern was whether the appellant who had agreed to pay a sum of money to a purchasing company in consideration of the purchasing company accepting full and complete liability in respect of claim made by some of its employees would deduct such a sum from its income for only and exclusively having been incurred in the calculation of its income.

Held: The Appeal is dismissed, as money was not a contingent liability or severance allowance for the year of assessment.

Sec 5 (2)a touches on loans given to employees or directors by deeming it to be a benefit if it is less than the market rate of interest and then applies a prescribed rate of interest 

Sec 6 deals with income from use of property gains from royalties, rent, premium or similar consideration for use or occupation of property

Such receipts said to be income receipts if they do not lead to relinquishing or deducting of the capital asset itself-this would make proceeds to be capital gains, not income.

Dhanji v I.T Comm. 

The appellants were property owners in Nairobi. They leased premises to four tenants, in addition to rent, tenants paid some premiums loosely known as goodwill and the commissioner assed premiums to tax and the issue was whether they were income or capital receipts. Held to be an income receipt and therefore taxable.

Sir Ronald Sinclair vs. Pobs

“There may be cases where granting of a lease is in substance if not in form, a disposal of the       lessors capital investment. In such a case, the sum representing the recoupment of this   capital will not be income and profit if any might be either a capital gain or income according   to circumstances. If this judgment is thought to work hardship to the taxpayer, income tax is such that it is useless to try to relate it to any standard of natural justice”  

By which way may a lessor dispose off all capital investment in   a lease in such a   way that disposal is not treated as a capital gain?

D Ltd vs. Commissioner of Income Tax.

The appellant was a landlord of a business premises, which he let out on a long lease. Tenants got permission to alter the premises on condition that they get them back to how they were at the end of the lease. At the expiry of the lease, tenants assessed cost of restoration work and paid the full value to the appellant. The commissioner later assessed the sum so received to tax arguing that it had exceeded expenditure actually carried out... The appellant upon unsuccessfully appealing, applied to the High Court which held that since alterations by the tenant had depreciated a capital asset, and payment was made to restore the asset to income producing condition, then this payment was a capital receipt and therefore not taxable, it being immaterial that the money had  not been spent.

Section 6 targets payment on income from the use of intellectual property e.g. patents, trademarks etc.

Income from dividends is taxed under section 7 and although Section 3(2) b touches on income tax and interests on dividends. Section 7 does not spell out the manner of taxing the same.

Section 10 c covers the same and deems interest paid by a resident person as income that has accrued in or has been received in Kenya.   

Under section 7, any dividends received by a resident company is taxed as income of the year in which it is payable while paragraph c touches tax on any profits realized on a voluntary winding up of a company which are then distributed because they are deemed to be incomes from dividends.

Subsection d and e deem any debentures or redeemable preference shares issued by a company to its shareholders either at no payment or at a sum less than 95% of nominal value to be dividends valued either at nominal or redeemable value in the first place or in the second place at excess of nominal value in the issue price in the second place.

Consequent issue: Where a company is deemed to have issued dividends in the circumstance, tax will be charged on that company. In imposing tax on a company, the commissioner will be making the company to pay tax that may be due from shareholders because of shares received. When the company eventually, if at all distributes dividends to the same shareholders, it would be entitled to recover the debts paid from dividends due from each of the concerned shareholders, unless dividends, subsequently declared unpaid are far less than those deemed to hove been earned earlier.

The Finance Bill 1992 introduces compensation tax on dividends and requires companies to have an account (dividend tax account) where dividends are acquired from any company it is invested may also be entered. Section 7a

Interest income is targeted in section 10. Interest is defined in section 2 as any amount paid in any manner in respect of a loan, deposit, debt, claim or other right/obligation  or any premium or discount by way of interest, paid in respect of a loan, deposit, debt etc

Section 5 talks about qualifying interests as that which has fallen due and is the aggregate interest discount receivable by a resident individual, from a bank or other institution duly licensed. Some institutions are exempted from 1st schedule of Income Tax Act.

Income from pensions and Home Ownership Plans. Section 8 provides that any pension or annuity and any withdrawals from and payments out of a pension, provided or individual retirement fund.

Pensions are payments that have been saved for purposes of securing the life of workers in retirement and this becomes a security against the risk of living long after retirement and perhaps not able to afford the lifestyle one was accustomed to during employment.

Accumulated pension funds form important sources of investment capital and under section 15(2) b, I.T.A; the government encourages employees who will have formed schemes attached to employers to deduct any amount paid into the scheme as pension contributions on behalf of the employee. However, where contributions are being withdrawn to be used by the employee will become realized in the hands of the employee and then targeted for taxation with a humane face. Section 8(4) exempts the first 150,000 Kenya shillings from taxation. Section 8(5) goes on to set out rates of exempting other pension receipts.

-First 360,000 of a lump sum from a registered pension fund.

-First 360,000 paid out of N.S.S.F

Incase of a lump sum paid out of a home ownership plan, amount used to purchase an interest in the plan or construction of a permanent house for occupation of depositor, read in conjunction with the Retirement Benefits Act. Section 22 excludes a portion representing the capital element of an annuity from the definition of income under section 3(2).

Section 22 A limits the operations of section 16(2) d and e with respect to deductibility of contributions to an annuity by an employee or employee for defined contributions defined benefits and other retirement schemes sponsored by employees.

Section 12c Home Ownership Plans   

   

Exemptions, Deductions, Set offs and Reliefs.

After ascertaining the total income from all sources, Law is either of the view that certain specified income might be exempted from taxation to encourage recipients or in fear of what recipients would do to the taxman.

In addition, between expenses carried in earning of that income, have to be deducted from the total income because the taxpayer may have incurred his own money already subjected to tax, which he may have expended in the earning of the total income. Furthermore, either tax already paid, as withholding or advance tax will need to be set off against any due tax.

Certain Relief Shelters are granted to certain specified people in certain specified conditions in order to reduce their tax liability to the extent of the relief. In this way, the government tries to mitigate the effect of tax on certain specified groups.

EXEMPTIONS

Section 13 and 14 of I.T.A.

Section 13 leads us to the first schedule, specifies a person, organizations whose income is exempted from tax. Effectively means, income they earn will not be subjected to tax. Regulation 3 of the 1st schedule exempts the president, other regulations exempt specified parastatals e.g. Tea Boards, Pyrethrum Boards etc.

Income of an amateur or sporting association, income of a registered pension fund, schemes, trust schemes, local authorities    

Section 14 exempts from tax any interest income payable on any charge on the consolidated fund.

DEDUCTIONS 

Deduction of funds from income under Section 35 requires any resident taxpayer to deduct withholding Tax from income payable to non-resident persons.

Section 36 requires the deduction of withholding tax on annuities.

Section 37 requires deduction of tax from employment income (PAYE)

Deduction of expenses from income on areas that tax payer incurred expenses in earning out of that income.

Section 3-Gross income may indicate the taxpayers status cannot necessarily be a fair indicator of tax liability

In allowing deductions of expenses, the law has to be carefully in distinguishing expenses of a business nature and those of personal consumption.

Business expenses are non-discretionary and must wholly and exclusively have been incurred in the earning of the income. The ones of a personal nature are discretionary and therefore not allowed to be deducted.

While Section 15 allows certain specified deductions associated with expenses incurred by taxpayers businesses or investment activities.

Section 15 disallows all personal living and family expenses together with expenses generally of a capital nature.

ALLOWED DEDUCTIONS

Section 15(2) as amplified by schedule 2 paragraph a deals with allowing deductions of bad and doubtful debts. To remain unpaid, and in allowing the deduction we are allowing the business to continue in production on grounds that it incurred this bad and doubtful debt as an expense of doing the business. When eventually the business recovers the bad and doubtful debts, we tax them

Income Tax commissioner v P ltd

 The respondent had lent money on security of a mortgage over his farm. After attempting to recover his money through a receivership and failing, it agreed to purchase the farm and transfer it to its subsidiary in discharge of the whole debt. The respondents share in the subsidiary company however sold at less than the original debt and the incurred loss on shares in subsidiary then sought to deduct the loss thereby incurred as a bad debt, which the local committee allowed but the commissioner appealed against.

It was held that the commissioners appeal be allowed because there was no longer any debt due to the respondent after date of agreement for transfer of the firm which extinguished the debt

The respondent that any debt still existed which had become bad because none of the guarantors of the business had been called to pay up had not established it

The Respondent bought a capital assent, which upon subsequent sale was now no longer deductible as a revenue loss since this was a capital loss.

Uganda Co. Ltd vs. Commissioner of Income Tax

The appellant operated a business of merchants until 1950. For year of income 1951, had been allowed to deduct 18,526 as bad debts because it continued to receive income from Uganda in 1951, received £ 12,023 and in 1953, recovered a further £1000 which the commissioner now sought to include the two sums in income for purposes of taxation since a reserve for bad debts had already been deducted from the income of the company.

It was  held that the appeal be dismissed because profits from a trade which had ceased to be carried on were still liable to tax and the fact that bad debts already provided for but now recovered did not change their character as gains.  

Robson & Another vs. Income Tax Commissioner

The appellants were advocates practicing in Nairobi who also doubled up as directors for various companies. The first appellant had been instructed to incorporate a company of which he became a director and shareholder based on which positions he guaranteed the company to obtain an overdraft. The company went into liquidation and the first appellant was called upon to pay up the guarantee amounting to Ksh 800,000, which he paid to creditors. In preparing accounts for the partnership, the appellant sought to deduct the sum from their income as bad debts being incurred wholly in the process of production. The commissioner disallowed the pay and they appealed.

It was held that the appeal be allowed because:

1) The amount was properly deductible

2) Their deductibility had not been precluded by the Act.

Mandavia vs. Income Tax Commissioner

The appellant received a notice for a return of his income in 1951. He did not object to the notice within the time specified. He furnished the return where he claimed allowance, premiums, and bad debts. The commissioner disallowed both deductions in default of full information in relation to insurance policy and property audited and credited account for bad debts. At the hearing, the appellant sought an adjournment, which was rejected, but he produced an affidavit from an accountant who said he will be away during the hearing but had examined the account. This was rejected and the appeal dismissed.

It was held that failure to object in time and furnish particulars requested estopped the appellant from raising any issues of notice on appeal because he had not discharged the onus to discharge the assessment as the accountants affidavit was not sufficient evidence.

  

Deductions under the 2nd Schedule (Section 15 (2) (d)

These are allowed less than six general parts:

1) Deductions in respect of capital expenses on certain buildings

2) Deductions in respect of capital on machinery

3) Deductions on mining machinery

4) Deductions on agricultural land.

5) Investment deductions/ allowance

6) Deductions for manufacture under bond in EPZ for shipping companies

 

1) Deductions in respect of capital expenditure on certain buildings

 Paragraph 1(1) 2nd schedule allows TP to deduct any expenses utilized by them on the construction of an industrial building to be used in a business to be carried on by TP or his lessee. This is the deduction of the construction expenses for that building. For the building to qualify, as an industrial one there must be some machinery in the building such that by the time of the deduction:

-The building will already have been constructed

-Use will be manifested by the machinery

Income Tax Commissioner vs. B (1973) EA 323

TP sought to deduct expenses of alleged industrial buildings used by TP as stores with no machinery in them, which ICT disallowed on grounds that a building without machinery could not be exempted. It was held that allowing the commissioners appeal that deductions was only available for an industrial building that had machinery in it. The stores did not qualify.

TP Ltd vs. Income Tax Commissioner (1974) EA 415

The appellant had been allowed to operate a casino on government land for 15 years and was required to release the land to revert to the government after that period. By that time, he had constructed buildings and  sought  to  deduct cost  of construction  from the gross income on grounds that the same had been wholly and exclusively incurred in the earning of the income and that the argument to surrender the land and buildings to the government  made  the cost of construction to be an income of capital expense. The appellant claimed that under Section 141 of the EAIT (management), Act, which is similar to Section 128 of Kenya,s Inct Act and which far from empowering commissioners to   allow deductions, it allows the commissioners discretion to either abandon or remit/compromise a tax payment under specific circumstances.

It was held  that since land and buildings were a capital asset, their surrender constituted a loss, diminution, or exhaustion and capital was  therefore not deductible under  the Section relied on which merely gave power to the commissioners to refrain from assessing  or tax did not allow deductions.

Income Tax Commissioner vs. P Ltd

The respondents owned an industrial building, which they leased to their subsidiary, which then bought and installed machinery and sought to deduct its cost. The commissioner resisted where local commissioner allowed the deduction. On appeal, it was held that the commissioners disallowance is reinstated coz for a deduction for machinery to be allowed but building and machinery must belong to the same TP

Deductions in respect of capital expenditure on machinery

Allowed under paragraph 7 which is a depreciation allowance for wear and tear on machinery owned by TP and used by his business

In dealing with this deduction, courts are more liberal even in defining what machinery is.  

Income Tax Commissioner vs. I A Ltd (1973) EA 572

The respondent bought furniture and installed them in its hotels, then sought to deduct costs of the worth of furniture installed in its hotels as machinery installed in an industrial building. The commissioner contested this arguing that the only object that could be attached and become part/structure/industrial building could be installable. Furniture was movable. It was held that the commissioners appeal be dismissed because it was not necessary for the plank to be connected with the cloth for it to be installable.

Pauls Bakery & Confectionary Ltd vs. Commissioner of Income Tax

The appellant purchased machinery after obtaining a dollar domination financing from a Kenyan bank. At the end of the year, the value of the Kenyan shilling had dropped against the dollar, which meant TP was to pay more in foreign exchange than what had earlier been the exchange rate. They computed increase in value of the loan after conversion of the currencies, which reflected an exchange loss, which they sought to deduct as a deduction under part of from the value of the machinery that had been purchased. (The approved rate is 12 and a   half %). The commissioner resisted this coz this was not a loss/expense on machinery but the local committee rejected the commissioners disallowance. An appeal was lodged by the commissioner to the High Court, which allowed the commissioners appeal.

It was held that the appeal be allowed coz rule 7 of the 2nd schedule a deduction in respect  of machinery used  during  the year and  coz  the value to be put on the machinery at the  end  of the year so  as to  compute the  deduction was to be in Ksh calculated on the basis of the prevailing rate of exchange at the end of the financial year. The deduction be allowed. The local committees decision was to be reinstated and confirmed

Paragraph 7 gives the various machinery and sets out the appropriate rates to be applied.

 

Deductions in respect of capital expenditure on mining activities

Allowed under Section 17  and is  available for mining business where expenditure  is incurred on the search, discovery and testing of minerals and acquisition of rights over deposition, provision of machine and construction of  buildings necessary for mining and other  incidental expenses.  The rate of deduction is two-fifths% expressed in the year of starting and a tenth of expenses in subsequent years.

 

Commissioner of Income Tax vs. Buhemba Mines Ltd

The company had incurred and paid costs worth Ksh 96,940 and successfully resisting a petition for winding up. The company then sought to deduct legal costs from the total income that they were costs for a mining company but the regional commissioner of Income. Tax from Tanganyika disallowed the deduction. The company successfully appealed but the commissioner made a further appeal

ISSUE: Whether legal costs were expenses incurred wholly and exclusively in production and income of the company in terms of Section 14 of the Income Tax Management Act 

HELD: These costs were not expenses wholly and exclusively incurred in production and deduction was not allowed.  

Deductions on capital expenditure on agricultural land

Allowed under paragraph 22 where expenses on construction of farm works on agricultural land for husbandry would be allowed deductions.

Income Tax Commissioner vs. Kagera Saw Mills

The plaintiffs cultivated sugarcane on their land where they had a sugar mill and refinery factory. They incurred expenses on  construction of  an  irrigation system but sought a  deduction on the basis of  the construction of  farm works on agricultural  land which was a  20% deduction.  The  commissioner disallowed  the deduction but   allowed one  at 12  and  a  half % on the  basis  of machinery, the High Court held  that irrigation system housed diesel engine fixed pump a series of movable pipes connected to a sprinkler network could be  savored into two:

  -machinery (diesel engine)

  -farmworks (pipes, sprinklers)

Such that 12 and a half %would be on the machinery and 20% on farmworks. The commissioner  appealed to  the court of  appeal and the plaintiffs conceded that pump was  machinery but sought  to have a capital expenses  deduction on  the purchase, installation and  alteration of  machinery in  the  sugar  mill.   The commissioners disallowed that on  grounds that the TP was engaged solely in the  trade  of  husbandry and  agricultural land and  not into trades  of   growing  and refining sugarcane  as contended  by TP.

Held: The commissioners appeal be dismissed coz pipes and sprinklers were farmworks and not an integral part of machinery. As the TP carried on to separate trades of growing and refining sugarcane, he was entitled to deductions on machinery as applied.

Investment Deductions/ Allowances

Paragraph 24 of schedule 2.It is essentially for the production of buildings and installation of machinery therein. For it to be deducted, the taxpayer must own both building and machinery. The major emphasis of this deduction is to encourage industrialization in two major fronts.

(1)  Allow deductions at a higher rate if construction of industrial building and machinery is done out of Nairobi and Mombasa then in the year 1999 the deduction would be at 16% of the cost of building and machinery.

1990-75 %.The rates for Mombasa and Nairobi are higher than other towns.

Deductions of capital expenditure on buildings and machinery for purposes of manufacture under land

Mechanisms of investment encouraged under customs  and excise Act for people  to  build industries in  which they install machinery in buildings to be bonded by  customs and excise department in terms of products they make may be meant for export so that on being  bonded can only be released through a mechanism allowed by the customs department.

Schedule 24a of the second schedule gives rates for Nairobi, Mombasa and other towns.

By 1992, Para 24B was introduced into the 2nd schedule to take care of   deductions of expenditure on machinery for use in the export processing zones.

When paragraph 24 B is operational, paragraphs 24 and 24A will not be available to   industries under the export processing zones

Deductions with respect of shipping companies

Paragraph 25-Ship owners who incur expenses on the purchase of new or used ship at rates of 40% provided only one shipping investment, deduction is allowed on any one ship 

S ltd v income tax ltd

The appellant company bought two ships and incurred capital expenditure in refitting them to suite their business. They sold one ship without using it but used the second ship for which they sought to deduct expenses incurred in re-fitting it. The taxpayer sought to deduct expenditure for the second ship, which the commissioner disallowed. The taxpayer appealed contending that he was entitled to the deduction but the commissioner responded arguing that for this deduction to be allowed the cost to be deducted must be equal to the total expenditure and in this case, the cost of refitting the ship was less than 20% of the total expenditure. The deduction was disallowed. It could only be allowed if used by the purchaser taxpayer and if cost of refitting the ship for the business of the taxpayer exceeds 25% of the total expenditure. Appeal was dismissed.

Paragraph 25C deals with deductions under the 9th schedule.Specialised form and incorporation and expenditure of petroleum companies.

Paragraph 25D deals with assortment of deductions relating to land, timber and growing of specified goods thereon

Section 15(2) paragraphs C, D, F, I, J and L deal with deductions in relation to land.

Paragraph C allows deductions by owner/occupier of farmland for any expenses incurred on activities to prevent soil erosion

Paragraph D allows deduction of expenditure on legal cost and stamp duty for a question of a lease of less than 99 years.

Paragraph s allows deductions for legal cost and other expenses incurred in relation to issuance of security to the public.

Paragraph e: allows deduction of capital expenditure incurred before the commencement of a business if it is to set up that business.

Paragraph f allows deduction of expenditure on structural alterations to premises provided it is necessary to maintain existing rent but not for any extension to or replacement to those structures.

Paragraph I allows deductions of gains of an owner from sell of standing timber which was growing on land at the time of purchase of that land.

Paragraph j allows deductions of gain from sell of standing timber by a person whop purchased right to fell that timber.

Section 15(2) paragraph L allows deductions of expenditure of a capital nature by the owner/tenant of agricultural land if it is expected to affect the clearance.

This allowance was contested in the case of

Kiwege and Mgude farm ltd v commissioner of income tax

 The appellants purchased 3 sisal farms /estates on which they expended  13805 pounds in clearing the land and planting sisal while on the other they expended 15584 pounds for clearing and planting sisal.Appelants sought to deduct as expenses monies expended both on the clearing and planting of sisal and on maintaining the sisal farm. The commissioner resisted this deductions arguing that this paragraph only allowed deductions for money expended on clearing and the crop. The appeal was dismissed as the taxpayer was now including cost for maintenance, which was not deductible under this head, which limited deductions for clearing and planting.

Rally estate ltd v commissioner of income tax

The appellant bought 2 sisal estate and 2 additional land adjoining them from Tanganyika government for a 99 year lease and a concentration of 491,000 pounds designated as the full purchase price of which 317,000 pounds was to be paid as premium, while the balance of 174,000 pounds was to be paid in instalments.The appellant sought to deduct 174,000 pounds as outgoings and expenses incurred by them in production of income in terms of sec14 of the East Africa income Tax management Act of 1952 similar to our sec 15.The commission disallowed it. On appeal, the High court dismissed it. The court of appeal dismissed the appeal because amounts of installments of 174,000 pounds were capital expenses and should not be deducted as income expenses

Commissioner of income tax v Jaffa brothers ltd

A deduction of sh 6000 from income of the respondent tax payer was allowed by the High court notwithstanding that it  was an inducement by the tax payer as the landlord to its tenants in a protected tenancy to enable them leave the space for the  taxpayer to use for its business. Premises avail to the taxpayer for generation of income

Income tax commissioner v cotecha estates

The respondent taxpayer bought a sugar estate but the price was not apportioned between land and sugarcane thereon growing as crops. Two years later, he sought to deduct the price of sugar and the value of growing sugar from its income. The commissioner resisted. The local committee allowed that deduction but spread it a full 100,000 over 4 years against which the commissioners appealed and it was held because purchase of the estate was a capital expense. No amount of growing sugarcane should be deducted as an income expense. Apportionment of 100,000 pounds over 4 years also refused as it was not permitted by law. Deductions were only allowed in the year of income.

Miscellaneous deductions

Paragraph G: The commissioner is allowed to allow deductions he considers just and reasonable representing the diminution of value of any implements, utensil or similar implement that is not machinery because machinery will have enjoyed paragraph 2 deductions

Paragraph H allows withdrawals of subscription/annual fee paid by the taxpayer to a trade association or club, which has made election under sec22 for its income to be taxed

Paragraph M allows deduction of income from a mining company 

Paragraph N allows deduction of expenditure incurred by a person for purposes of research carried on by him or if that deduction is for-

-expended 

-A sum paid to a scientific research institution that is dully approved by the commissioner as having the object of undertaking scientific research related to class of business to which the business relates

Paragraph 3.Sum paid by University, college or research institution approved by the commissioner for scientific research related to class of business to which that business belongs

 

Kenya Meat Commission v Income Tax Commissioner

The appeal by the taxpayer against the commissioners refusal to allow a deduction of 200,000  made by the appellant as a donation to the  Kenya National Fund on  condition  that the  money  be used for research or  other  work  that will benefit  the Kenya beef and mutton  industry.

HELD: Appeal be allowed because the  donation incurred  by  the taxpayer not only wholly and  exclusively  for the  production  of its income but also for the  purpose of trade carried on by the taxpayer within  the  meaning of section14(2) b of  the E.A.I.T.M.A  now replaced by section 15(2) N of the  Kenya Income Tax Act.

T Ltd vs. Income Tax Commissioner

The appellant carried on certain surveys including both thermal and power production. It was disallowed on grounds that none was on scientific research. On appeal it was held that it be partially allowed because expenditure on thermal generation schemes  and  transmission lines was not on scientific research but that on hydroelectric  was   an activity  in natural science and  was clearly scientific  research.

Paragraph P allows deduction of expenditure on advertising and marketing.

Paragraph R allows deduction of amount of emoluments from the employment of a non-citizen individual under specified circumstances.

Para S allows deduction of expenditure of a capital nature by a person on legal costs and incidental expenses relating to issues of share, debentures or other securities.

Interest on loans & dividends on shares by building societies

Section 15(2) allows deduction of dividends paid by building societies on deposits by members.

Section 15(3) (a) On money  borrowed by the taxpayer which was wholly and exclusively employed in production of employment income which is  chargeable to tax subject to that amount of deduction not  exceeding investment  income of that loan which  is chargeable to tax.

The above section also allows  deduction of an amount  as interest not  exceeding  56,000 p.a. from  monies borrowed from registered financial institutions e.g. banks, coop societies  etc If it was applied for  the purchase  of residential equipment occupied by  that  taxpayer 

Provided a person occupies that residential premise and only one deduction is allowed.

Paragraph C: Partners  are  allowed to  deduct amount of  excess  of  any loss incurred  on the partnership in  respect  of:

   -Deductions on loans realized on investment in shares.

   -Deduction of a business loss. Covered by section 15(4) which allows deduction of a 

     Deficit from ascertainment of total income for a person beginning in 1974 with limitations 

     On married women whose income is deemed to be that of their husband.

Subsection (5) allows deduction of benefits with relation to a person who   succeeds to a business either under a will/intestacy attributable to any loss incurred by the deceased in earlier years.

Section15 (7) then as it were builds Chinese walls between specified sources of income and

-Rights for use and occupation of immovable property, employment of personal services          

  For wages, salaries and other rewards

-Employment forming part of wifes employment income or professional income.  

-Agricultural, pastoral, horticultural, forestry or similar acts.

-Other sources of income chargeable to tax not falling in the above sub paragraph

SECTION 16: DEDUCTIONS NOT ALLOWED

Takes two approaches:

-Section 16(1) Allows specified deductions, which would otherwise not be allowed on     

Condition that some other section of the Act allows them.  Save as otherwise expressly provided for purposes of ascertaining the total income of a person, no deduction shall be allowed.

-Section 16(2) even those deductions allowed by any other section of the Act if they fall 

  On the list in Section 16(2) then they will not be disallowed.

(a) Expenditure   of a person in maintenance of himself or family established or for any 

     Other personal or domestic purpose including 

      -Entertainment expenses for personal services.

      -Hotel, restaurant/catering expenses unless incurred on meals or accommodation on  

        Business trips or during training courses or work related conventions/conferences 

        Alternatively, meals provided for low-income employees n employment expenses.

      -Educational trips for self/relatives.

      -Club fees including entrance and subscription fees

Rosenberg vs. U.S

The appellant was a jewelry sales clerk who maintained no home but used his brothers home in Brooklyn New York to collect mail. He traveled in line of work and sought to deduct meals and lodging expenses incurred because they were incurred while away from home in business.

HELD: While these deductions would be allowed if

            -Reasonable and necessary 

            -Incurred in the pursuit of business/ trade

          -Incurred while away from home- taxpayer must have a home.

Deductions not allowed.

Smith vs. Commissioner of Income Tax

Taxpayer  working couple deducted  babysitting expenses on grounds that  since Mrs. Smith would have  been unable to leave her work, nurse  maid  fees  should be regarded as a business  expense.

Dismissed. Childcare was a basic fixation and it was a mistake to allow a nursemaids fees to be deducted as being essential. Then all expenditure will require to be deducted yet they are personal expenses, which are not allowed.

Commissioner of Income Tax vs. John Gray

The respondent paid money to his estranged wife.  The Legal Committee allowed deductions on the money. The respondent appealed   and it was allowed because he was not paying money as alimony nor allowance pursuant to a written agreement. Since the effect of allowing deduction was that, same amount, would be income in the hands of the recipient and then taxed there. This was not the case. Deduction not allowed.

1958 Act:  Education and childcare allowed to taxpayers who meet certain conditions.

B. A. Shah vs. Income Tax Commissioner

The appellant educated his bro 23 years in University, his sister 21 years in Art School. He sought a child allowance deducted from income coz he was taking care of children.

ISSUE: Whether those were his children/whether, the term children included bros and sisters

             Or included ones own offspring.

HELD: The term child in section 52 did not input age but any person with relation of 

             Illegitimate, adopted, or child. The bro & sister did not meet this condition hence 

             Deductions did not qualify.

Rasiklal vs. Income Tax Commissioner  

 

Section 44 of the income tax management Act of 1958 claimed deductions because of his brother-19yrs but living with his parents in India. The argument was that Sec 44 allowed a taxpayer who expended money on children by virtue of a custom of community to which the taxpayer belonged. He argued that his parents not being able to maintain their children these were in his custody according to custom. It was held that since parent had abdicated responsibility to the respondent and custom was that older children assume responsibility, they were in the hands of the taxpayer. It was not relevant that they were not his.

(b). Section 16 disallows expenditure recoverable under an insurance contract.

(c) .Income tax paid on income unless it is in another country

(d) Contribution to pensions/provident funds that are not operating nationally.

(e) Premiums paid under annuity contracts.

(f). Expenditure by a non-resident/one without a permanent resident in Kenya.

(g)  Was incurred by a business not carried on with view to profit.

(h)  Expenses for hiring a non-commercial vehicle after 18th June 1976.

(i) Interest paid by companies if it either exceeds 3 times of revenue reserves or paid up capital of all shareholders of capital or sum of all loans incurred 1by the company by 16 June 1968

(k) Any payment for rent, hire or other payments unless solely for the use of an asset or whole some is income in the hands of the recipient.

(l) Expenses disallowed in the absence of section 7(3), Section 15(2) a, Section 19 and Section 19(4)

RELIEF

Relief in Section 29,30,31,32,33(I.T.A).But subsequently the relief in section 31  and 32 were repealed so that we now  have personal relief in Section 30  and insurance relief in Section 33.In Sections 40,41 and 42,the Act  had made provision for double taxation relief.

Personal Relief

Allowed under Section 30 at the rate determined under the third schedule, which sets rates of relief. Presently set at 1162 shillings per month, which accumulates to 13942 shillings per year. The effect of this relief is that after total income has been declared, allowable deductions deducted, and the applicable rate of tax applied, whatever amount of tax due from the taxpayer is reduced by the amount of personal relief. Relief is from net tax payable hence, it has more economic value than a deduction.

Where a taxpayer comes to a country or leaves in the course of the year, reliefs is restricted to dates he was either in the country or alive.

Insurance relief (Sec 33)

Calculated at the rate of 15% of premium paid under an insurance policy either on the tax payers life or that of his wife/child or it secures a capital sum payable in Kenya shilling (annuity) or on educational policy for a minimum of 10 years relating to a term of a life of an education policy begins on 1st January 2003.It had been repealed in 1996 and re-introduced in 2003.

Double taxation relief (Section 41)

Sub Section 1 empowers the finance minister to make double tax treaties with other countries, provide relief fro-double tax of income tax imposed either by laws of that country to apply in Kenya or vice versa. The minister must lay it before parliament and give notice thereof in the Kenya gazette 

Section 42 allows the commissioner of income tax to give a tax credit under special circumstances with a treaty/agreement, which the taxpayer may be required to pay on income. Section 43 limits time of claiming a tax credit to 6 years.

SET OFF OF TAXES

Here the deduction of amount of set off from tax due section 39, any tax deducted as VAT or PAYE or which already borne by a trustee or administrator of estate shall be deemed to have been paid and received by the commissioner and will be set off from tax charged on that person.

Section 39: A person who has paid provisional tax upon provisional assessment will set off from final tax due.

Section 39A allows set off of import duty paid under Customs and Excise Act for capital goods which qualify for depreciation or wear and tear, deductions under 2nd schedule so that apart from deducting amount of depreciation under the 2nd schedule, a person is allowed to reduce tax payable by amount of customs paid.

The Act makes certain provisions

Section 17 sets out how to determine the income of farmers 

Section 18 sets out how to determine the income of non-resident persons.

Section 19 sets out how to determine the income of insurance companies.

 Section 20 sets out how to determine the income of unit trusts

Section 21 sets out how to determine the income of members of clubs and trade associates

Section 22 sets out how to determine the income of purchased annuities saved for retirement                       schemes

Section 28 sets out how to determine the income of a business that has ceased to trade.

TAX AVOIDANCE

The art of dodging tax without actually breaking the law or lawfully carrying out of taxation to missing tax liability. Tax avoidance is said to be legal if it does not break the law.

Contrasted with  tax evasion-non payment  of  due  tax  that  law charges on ones income.Legislture  may  proceed to seal  loopholes that give a tax  avoidance opportunity while tax payers look for opportunities within law that limit payment of taxes.

Reactions have been varied. The judiciary tends to be friendly if the taxpayer has not stretched the law to engage in tax avoidance.

Lord Sumnre in I.R.C v Executors  observed the highest authorities  have  always  recognized that  subject is entitled so to arrange his affairs as  not to attract taxes imposed by  the crown so far as he can do  so within the law and that he may legitimately claim advantage of  any terms or omissions he can find in his favor  in the taxing statutes in so doing, neither has a liability nor incurs claims.

Levin v I.R.C

His  majesty subjects are free  if they  can, to make their own arrangements  so  that their cases may fall outside the scope of taxing Acts, they incur no legal  penalties and no  moral censure  if having considered lines drawn by legislature for imposition of taxes they make it their business to work outside them

Anti-Avoidance Legislation

Because tax avoidance is a struggle but legislation and ingenious taxpayers on the other hand, legislature seeks through the introduction of provisions that impose tax to ensure that objective of raising revenue for the government is achieved and thus blocks potential loopholes that may be used for tax avoidance.

This may take any of the following three forms

May take specific  provisions

May impose specific ant-avoidance provisions

May  use general   anti-avoidance provisions

1. Specific provisions

The legislature may impose tax in certain  circumstances or  upon certain taxations whether or not there is a motive for tax avoidance. It will not give exceptions. It thereby casts a net so wide that every conceivable taxpayer is caught and perfectly innocent taxations are subject to tax.

2. Specific anti-avoidance provisions

Law may after imposing a tax under certain circumstances may aim at specific taxation that may be entered into for purposes of tax avoidance. Provisions tend to cancel tax advantages in certain taxations and this cast a duty on courts that interpret this kind of statutes to consider the taxpayer and whether acts amount to tax avoidance or give him/her a tax advantage.

Depending on statutory  definitions of tax advantage, the taxation must be one where if it were  carried out in one way, there would be a liability to pay either tax or a greater amount of tax  than if carried out in any other way.

Lord Upjohn in I.R.C vs. .Brebner .However circumscribed circumstances under which a tax advantage may bee removed by saying, When the question of carrying out a general commercial taxation as this was and reviewed the fact that there were two ways of carrying it out.

1) Paying the maximum amount of tax

2) Paying more or much less tax

It  would be quite wrong s an  unnecessary through  inference  that in  adopting another  course, one of the main object  is  for purposes of  the  section, avoidance of tax. No commercial man in his right senses will carry out a commercial transaction except a 

3) General anti-avoidance provisions

Seeks to nullify tax avoidance in general and in England have been rejected as a mechanism of tax laws- insisted to have specific anti avoidance provisions. In the Commonwealth countries, this is what the British exported and it is what most tax laws have for tax avoidance statutes.

Lord Denning in Newton vs. Commissioner of Taxation (Australia)

The directors of a company increased the capital and simultaneously made a capital payment to shareholders out of undistributed profits. Was this arrangement to avoid tax? It was held that this arrangement was to avoid tax and it was therefore set aside.

In order to bring an argument within this section, you must be able to predicate by looking avert acts by which it was implemented in such a way as to avoid tax

If you cannot so predicate. You have to acknowledge that taxation is capable of reference to ordinary or family dealings and as such, they do not fall under this section.

Mancin vs. I.R.C

The appellant leased land to trustees upon which wheat was planted. Trustees were to hold the land for one year, cultivate it at a nominal rent. Under trust, any income that was to arise was to be held on trust for the benefit of appellants wife and children for which he did a separate trusts.Appelant employed by trustee to plant, harvest and sell what crop whose proceeds he accounted to trustees. He paid for the labor and expenses in return. The bulk of the .NET profit was distributed to the wife for benefit of the children. This continued for three years and the effect was to reduce appellants income, which trust, settled on wife and children from which the wife and the children claimed allowances and paid tax at owners rates.

Under general aanti-avoidancce provision, the commissioner sought to set aside taxation and hence appealed.Held, dismissing appeal by taxpayer, scheme was advised for sole purpose of escaping liability on substantial part of taxpayers income.

TAX AVOIDANCE IN KENYA   

The general anti avoidance provision adapted the commonwealth trend. Section 23 empowers the Commissioner of Income Tax to adjust any taxation designed to avoid tax liability in any way that counteracts that avoidance.

The commissioner has power to suspend any taxation carried out in any in any provision of the Act and which tax avoidance intentions on the part of taxpayer, which he may counteract by adjusting the taxation

Section 24 deals with dividend stripping. This empowers the commissioner where a company has not declared dividends to direct any undistributed dividends to be deemed as distributed and have the company pay tax on undistributed dividends at individual taxpayers rates.

Section 25(a) income stripping

Settlement of income on children and other persons settlement enable commissioner to deem settled income. If a child is below 19 years, settlement is deemed valid

       

To tax and to please is not given to men. – Edmund Burke

Whose interests does the law reflect?

One of the objectives of law is equality but is it possible???

INCOME TAX

Whom do you tax?  What is the basis of taxation?  Is it income in which case you can only tax income earners, Is it Purchase in which case you tax everyone as in VAT?

Who is the most taxed person?  Is it the wage earner who pays 30% on his income? 

Ideologies of Taxation:

These are 3:

1. Ideology of the ability to pay:

2. Ideology of the barriers and deterrents.

3. Ideology of equity.

Ideology of ability to pay:

This ideology is based on the basis that taxes should be apportioned or distributed in accordance with the ability to pay and the ability to pay should be determined by income or wealth.  It should be progressive that is the theory but is it possible to be progressive.  It is not always feasible to have a progressive tax and we do the best we can.  The assumption is that income is ability to pay but is it really? This is not always the case so this ideology is not applicable in full, individuals are not allowed to deduct their cost of production and this way we cannot have a progressive tax as some people have more expenditure and are left with no income whereas others are without a lot of expenditure.  This ideology is not realistic.

Ideology of the barriers and deterrents:

This has 3 concepts

1. Progressive rates diminish incentives to work; - when one is earning a salary this really does not matter because either way you still work but for a business person progressive tax might reduce the incentive to work again corporate tax is not progressive and therefore this does not apply in business, whether one earns high or low the tax is the same.  But if done in partnerships, the tax is progressive as it is deemed to be income to one and rises in accordance to ones earning.

2. Progressive rates discourage incentives to invest: - 

3. Progressive rates irreparably impair the sources of new capital -  

Ideology of equity:

 This is the ideology that says you tax those in the same level and the same amount, equality among equals.  Those who earn the same amount should be similarly treated, the more you earn the more you get taxed.  Equals at income should be treated the same.  The principle is supposed to be income based, but in Kenya it is not.  VAT is an unfair tax as here there is no equality, everyone pays the tax irrespective of how much they earn.

GENERAL INTRODUCTION TO TAX

Tax is the only source of self-income to governments i.e. it includes donor income. Tax is their only guaranteed income and under their country.   The richer one is the lower ones income could be in this country.  Income from business is taxed at the level of 12% corporate tax while we tax 30% in income tax.   If the government can get people to earn more, they can lower the level of taxation.  The fundamental purpose of taxation is to raise the revenue necessary to provide government services.

The government has all kinds of taxes but the purpose of taxation for us is among other things to

1. Finance public expenditure;

2. Distribute income;  - if the income is progressive, it can be distributed by taxing those who have and giving those who do not have.

3. It is supposed to enhance government policies one of the policies being to encourage positive behaviour.

The government uses two rationales to impose taxes

1. Benefit Rationale- the government is a shopkeeper, and people pay for the service, the government taxes and provides services security, health, education etc.  The benefit rationale cannot be achieved 100% although we do expect at least 75% below that people ought to complain.

2. Ability Rationale – the government taxes people on the basis of their ability to pay.  Where one gets the money, the government has no interest.  In Kenya it seems the government is only using the ability rationale and not the benefit rationale.

Tax is compulsory; there is no tax that is voluntary.  It is a compulsory charge by the state.

Taxes can be classified in 3 categories depending on their impact on the people

1. Regressive

2. Proportional

3. Progressive

Progressive – where the marginal rate of the tax rises with the income then it is progressive.

Proportional – if different blocks are taxed at different levels.   Both progressive and proportional are equitable although progressive is more equitable than proportional.  Corporate tax is a proportional tax.  Takes the same from everyone.

Regressive – tax increases with ones fall of income.  It requires that low and middle-income families pay a higher share of their income in taxes than upper income families.

PRINCIPLES OF TAXATION

Tax is governed by certain principles:

Simplicity and efficiency are principles of taxation.  Taxpayers should be able to understand taxation.  It is meant to be governed by simplicity so that people can understand it.  Taxation can be made complex by inefficiency so simplicity and efficiency go hand in hand.  It should be clear and understandable to the taxpayer.

Cost of complying with the tax laws should be minimal.  The cost is not very high in Kenya although it could be lower.  Communication system should be simplest to lower the cost of tax collection.  

Accountability: - the collector should be accountable to the people for the tax they have collected.  The collector should be accountable to the taxpayer.  In Kenya the government has never been accountable to the taxpayer and this is because of the corruption.  This is one of the principles that is furthest from reality in this country.   May be in future when the people are informed on how their money is being mismanaged, then they will do something about it.

Certainty: - There has to be certainty, it has to be understood to be the same by every taxpayer and every Minister.  Taxpayer must know what they are entitled to pay.  It is supposed to be extensively and adequately publicised and every Finance Act should be publicised in simple language, clearly visible and nothing should be hidden from the taxpayer.  Complicated tax rules make the tax system difficult for citizens to understand.  Complexity also makes it harder for governments to monitor and enforce tax collection.

PRINCIPLE OF EQUITY:

All taxes should treat all taxpayers the same.  People in similar situations should be treated the same in terms of rate, the amount, collection etc.  The interpretation of who is a taxpayer should be the same.  They should be charged in accordance with their economic status and their ability to pay.  Being treated equally.   The terms of tax paid and the achievement from those taxes should be equal.  No one should be allowed to avoid tax while enjoying the benefits that are being taxed for those services.

PRINCIPLE OF NEUTRALITY:

The market economy should not be interfered with.  There should be no practical interference with the market economy.   Taxes should not interfere with market forces.  Business communities are supposed to bear minimum impact on the spending of tax.  The lower the tax the better for the business community.  In the Kenyan situation our tax system interferes a lot with the business community and is therefore not neutral.   In Africa, Botswana and South Africa may be the only countries following the principle of neutrality.  VAT is not a neutral tax because it interferes with business; it has been likened to an expenditure tax.  

TAX STRUCTURE:

The tax structure is made of individual elements and it is only through changes of those individual elements that a change in the level of tax can come about.  Each element has a growth rate and base and each of them is related to distinct economic variables.

Tax Base:

A tax base of a given tax is the source of revenue and it is that source that is taxable.  Every taxation has to have a source.  The basis available to any country would set the limit for the possible tax structure.  In Kenya like in many poor countries the base of taxation is very narrow.  Our structure here is based mainly on employment and business.  Production is very little and so production tax is very low.  We are traders. 

The more agriculture is taxed the more they kill it.  Agriculture is our main source of income but it is very heavily taxed.  In the early stages of our development the tax structure was in itself a reflection of a tax base.  If there was no basis for direct taxation there was more indirect taxation.  Tax has now become a reflection of a political culture i.e. taxes get amended to raise campaign money etc.

The tax handle fee that relates the structure to the base.  The close link of tax structure to tax bases is normal.

1. At an advanced stage (when we become rich) the problems of revenue collections shift from looking for tax bases to devising means of collecting and yielding tax more effectively.  Tax is not increased but concentration is on collection.  Waweru is increasing the base by sealing the loopholes of tax evasion, he is not increasing taxes.

The income tax lays down certain rules:

1. Ascertainment of income – the qualifying conditions for personal allowances rules are laid down, 

2. The same rules decide which allowances qualify, whether singles relief, medical, personal etc.

3. The rules provide for the Procedure of assessment such as self assessment – this is one way where people can avoid tax by assessing themselves on the lower side, avoidance is not illegal evasion is illegal. When one leaves the procedure of assessment to the tax collector they pay more and so the rules must provide for assessments.

4. The rules provide for penalties. Income tax penalties can be demobilizing.  Under the Income Tax Act the High Court and the Magistrate courts have no original jurisdiction on tax issues, the original jurisdiction is with the tax department and only facts of law are appealable.  The tax department has denied the courts original jurisdiction on tax matters.

In addition to being revenue device taxation can be used for more, today we use it as a revenue device.   We use tax to encourage or discourage certain kinds of behaviour, we might tax cigarettes more to discourage people from smoking, and taxes are also used to distribute income.  In Kenya we tax because we need the revenue.   In the long run tax can be used not only for tax collection but also for other activities e.g. to encourage education, to encourage investments and so on.

OVERVIEW OF INCOME TAX.

The income tax Act firstly determines what income is; note it does not even define tax as its interest and basis and source of tax.  Out of the income, not all income is taxable.  

What is taxable income?

Income:   

Whose income do we tax?

What is the source of that income?  It has to be income from a specified source.  In Kenya we only tax residents.  Who is a resident for purposes of income tax?

Allowable deductions, every income has deductions so what are the allowable deductions..

Income Tax is payable by

1. Individuals

2. Partnerships – partners are taxed as individuals

3. Corporate Bodies – flat corporate tax

4. Trustees -

5. Cooperative Societies – pay taxes as societies

Income tax is a direct tax.  It is direct because both its impact and incidences mainly fall on the same person.  The impact is on the person who pays the tax to the income tax people or to the authorities while the incidence is on the one who bears the burden.  When one is an employee he is the one who pays the income tax to the income tax person although the employer sends it there.  The burden of any direct tax falls on any person who makes that income.  Gifts are not income and therefore not taxable.  Gift is not a recognised source and is not even defined.

Income tax is generally progressive to a certain level at least in Kenya it is up to 30%.  The marginal rule increases with the income.  If one earns an income of 300,000/- or 300,000,000/- you still pay 30%.  It ought to be progressive all the way but it is not certain that we can afford that.  This progressiveness is not necessarily good as the higher the income, the less tax one pays.  

The base of our income tax is what we call income.  Income for the purposes of our law is not clear,

Section 3 of the Income Tax Act is the definition section but does not define income.  If there is a dispute between what is income between one and the income tax, it would be because income tax is payable on income.  They don’t define income because sources of income keep on increasing. 

The Act however defines total income – “total income in relation to a person is the aggregate amount of his income.  Other than income exempt from tax under Part III of the Act.”  

Part III of the Act deals with exemption of taxes.  The law imposes a tax under Part II of the Act Section 3 of the Act creates a Section Charge of Tax and it says that “subject to and in accordance with this Act a tax to be known as the Income Tax shall be taxed on all income of a resident…Total income is chargeable to tax under the law if it is not exempt under Part III.

Part IV deals with ascertainment of total income. 

The law presumes that we know what income is.  It is also a legal assumption that one is supposed to know the law is and this is an irrebutable presumption of the law.  

Subject to income, income tax is income of a person.  According to Section 3 it is income of a person and it uses the term sources of income, it does not define income.  Income is not necessarily source and therefore not necessarily taxable.  Income must be recognised as a source before it can be taxed.

INCOME TAX

Section 3 definition – it is based on sources of income

3 (2) Gains of profits from business, employment, services rendered and rent or rights granted to other persons for rent, dividends and interest, pension, annuity any amount which is deemed to be income of a person under this Act or under any other Act.  Gains from petroleum companies and petroleum service sub-contractors.

3(2)(f)  gains arising out of disposal of depreciable assets

it is assumed that any shares can depreciate in prices so that is why all shares are classified as depreciable interest, so when one sells that stock, that is considered income from which 30% income tax is payable.  The tax is chargeable on a person, not every person pays income tax, there are specific persons who pay income tax they are considered on the basis of residency not citizenship.  Any income which is earned locally or outside the country by a resident is taxable.  Therefore to be taxed one has to be a person and a resident.

Not all persons pay income tax.  

All taxes are payable by individuals in the long run.  

For residents, income they earned abroad while in Kenya is taxable.

NON-RESIDENTS:

Non-residents are also liable to tax but only for income derived in Kenya.

Diplomats are residents but they are exempt from tax.

For the purposes of imposing tax, the basis is residence.  What is residence, who is resident?

Section 2 of Income Tax Act – when it is applied in relation to an individual these are the categories

1. if you have a permanent home in Kenya and you are present in Kenya for any period of time in the year in question.

2. If you have no permanent home in Kenya but you are present in Kenya for a period or periods

1. A period amounting in aggregate to 183 days during the year of income; or

2. Present in Kenya in that year of income and in each of the two preceding years and aggregate the number of days to 122 days in each year.  E.g. 2001 = 122, 2002 = 122 and 2003 = 122

When this is applied to a body corporate, which is not a natural person the management and control of the affairs of that body is supposed to be exercised in Kenya in that particular year of income. 

3. The body has been declared by the Minister by a notice in the Kenya Gazette to be a resident; what if the company is not registered under the laws of Kenya but its exercise and management are in Kenya?  That is how the Minister comes in.  Local branches of non-resident firms are classified as resident.  But only for income derived in Kenya; any income derived out of Kenya is not taxable.

A parent company that is based in Kenya is treated as a resident for purposes of income tax and all its income derived from Kenya and outside is taxable.

So in order to pay tax one has to be a resident and people have raised issues at who is a resident. 

In the case of Sir George Arnautoglu V Commissioner of Income Tax

 [1967] EA 312

The Appellant disputed his assessment of his income tax in 1962 on the ground that he was not a resident in the territory in 1962.  The facts were that in 1960 he had a home in Dar-es salaam and was there for a total of 249 days and in 1961 he sold that house but was still present there for a total of 124 days and in 1962 he had no home but was present for 62 days.  On average he was there for 4 months in each of the 3 years.  He argued that in relation to the definition of residence, according to Income Tax Management 1958 he argued that firstly it was not permissible to aggregate the periods of residence with periods of mere presence and secondly that averaging in accordance with (1) paragraph (b) (ii) of that Act it meant in effect that four months presence was required in each of the relevant years.  The definition of residence under that Act for which the construction depended.  They said that it was permissible for purposes of income tax 1958 to aggregate periods of residence with periods of presence.  The court went on and said that first “an individual is defined as residing in the territory if he in fact does so.” And secondly an individual is deemed to reside in the territory if the facts are such that he would not normally be regarded as residing in the territory or there would be doubt as having done so.  

The deeming provisions in Income Tax (deemed to be) according to Justice Charles Newsbold that the deeming provision only come into play if …  (it is like a presumption, you are presumed to be) deemed to be is presumed to be, to bring the presumption into play is by bringing the aggregate period

BASIC CONCEPTS OF INCOME TAX:

Income Tax will be on income only, it is not on assets

The only income which is provided that is taxable is that income which is from sources that are taxable, the income has to come from a classified source, there is no simple and comprehensible definition of income tax but it may be put in 3 broad categories

1. Income from personal services that are rendered by one person to another; contractual service generally, as long as it earns money it is income and the assumption is that the services have to be legal;

2. Income from property this is income, which generally when one sells property, one pays various types of tax but when the seller receives the money when declaring income at the end of the year, the proceeds from property must be declared.

3. Income from profits of a trade, profession or vocation.

Income tax is different from capital but for purposes only of paying tax but it is not always easy to distinguish between capital and income, if you cannot classify any receipt as income, it is generally classified as capital.  Patent Rights in England is charged under income tax, it is capital until one sells it, then it becomes capital.  

The only law that operates retrospectively is 

The basic approach is that capital is considered as the tree while income is the fruit.

Liability to Income Tax arises out of

1. An assessment, to be liable there has to be an assessment as a notice to one as a taxpayer that there is a tax that is due from one.  There can be a self-assessment or the assessment, which is done by the income tax.  Basically all of us except for employment which is assessed in advance, the rest is basically self-assessment as in when one files returns they are assessing themselves.  Where the CIT disagrees he can do his own assessment.  

2. Amended assessment provided by the Commissioner of yourself

3. Instalment assessment is only applicable to corporate tax not individual tax.

4. Deduction:  once you are assessed you will be deducted and the deduction is from the receipt you have already received, e.g. an employee’s PAYE is deduction.  Every employer is termed as an agent of the commissioner for purposes of deducting the taxes.  

Income tax is basically one tax and this was declared in 1901 by Lord Macnaghten in the case of 

The London County Council V. Attorney General

(1901) AC  26 at 36

 he defined income tax as “Income Tax if I may say so is a tax on income, it is not meant to be a tax on anything else.  It is one tax not a collection of taxes in every case the tax is a tax on income whatever may be the standard by which the income is measured.”  It means it does not matter how you measure income but it has to be income and if it is not classified as income then one cannot pay income tax on it.  Profit is basically income for purposes of tax, the gross turnover is not income for purposes of tax but once you get your net income, it is income for purposes of tax. In Kenya it is an annual tax.  It is not possible to make an assessment in the current year, as one has to wait until the year is over and then audit their accounts.  Although the returns are filed the following year, we still call it current year of income.  It is based on the source from which it comes.

One can reduce their tax as a payer either legally by an allowance or by a tax relief or by an exemption like the church gets.  Or one can actually avoid tax.

Tax avoidance involves one of the following things:

1. One can claim that certain receipts do not constitute income;

2. Arguing that you were not resident in that year of income;

3. You can claim that you have deductible costs, when they agree, you increase the costs;

4. Increase the number of personal reliefs that one is claiming, if they are accepted the tax is reduced

5. Transfer income to another person, you for example transfer income to your spouse who earns less and thereby reducing the tax burden.

6. Transfer deductions from one year to the other year,

All these are ways of tax avoidance, which is not illegal, if not genuine one may pay penalties but it is not illegal.

The difficulty of assessing any one individual income is also very difficult in developing countries, even fixing rates in countries where people are already overtaxed is difficult. 

Tax falls under income which excludes by general rule gains and losses, losses only for purposes of business not for purposes of employment and it is expected to be progressive until it reaches a certain level except corporate tax where all are taxed at the same rate.  Tax falling on income is what is called a definitive principle, when we say progressive that will be the equitable principle, the one upon whom the income falls is not equitable.  

The second principle is based on a current social consideration of justice.  Corporate tax do not have this principle as they all pay a fixed amount but we assume that since everyone pays a fixed amount there is no progression but lets remember corporates pay dividends to individuals that are tax and are progressive.  The progression ends at 30% where after everyone pays the same amount.

People have a heavier burden to carry when it comes to income tax if they are rich.  The first aspect is the ability to arrange the income tax arrangement.  You pay a professional to arrange them in such a way that you pay the least, sometimes you pay only on your ability to arrange, when you have a better arrangement to arrange tax, you pay less although your income could be the same as with someone who earns the same.

INTERNATIONAL ASPECTS OF INCOME TAX:

1. Competitiveness

International competition in business does pressurize our policy makers in the way they organise their tax systems.  We grant tax rebates, give exemptions so that we are able to compete in the international market because taxes are an expense.    Both direct and indirect taxes are used.  The Export Processing Zone is a good example where tax exemptions are offered to encourage exports.

2. Reliability

The taxation and revenue should be reliable.  Rules should be reliable and adequate.  Income tax or taxation in general is the State diet without which the State would starve.  It is vital to the economy and therefore the flow should be reliable, we should be able to know when it flows and how it flows and how much of it is there since we rely on it for services.  Government expenditure ought to be anticipated so that we can hinge our tax assessment on the anticipation.

3. Interpretation

When we interpret law, the interpretation is required to be very strict.  Where there are two interpretations, we take the interpretation that is most favourable to the taxpayer.  You can only go to court on a question of law or on a question of mixed facts and law, on a question of fact you cannot go.  In the case of T M Bell V Commissioner of Income Tax (1960) EA 224 

Income Tax V Holdings Limited

 (1972) EA 128 

The general rule is that a taxpayers business or other ventures are considered together as one (your income is your income does not matter from what source) chargeable income should be arrived at by aggregating all the taxpayers income and then deducting all expenditure incurred from the production of this income.

In interpreting the Section (58) or any section the whole Act must be considered in relation to the particular section and especially with reference to the interpretation section and the methods set out in the Act in this case our Income Tax Act Cap 470 to arrive at what is chargeable income.  One must consider the provisions of the Act and if the Act provides on what to consider as chargeable income, then you consider that if not, you look elsewhere.  It does not matter how harsh the Act is, it must be followed.  This is the theory, assuming that the taxpayer goes to court.  The theory is that the law is pro-taxpayer but in reality, the law is pro commissioner of income tax.

ADMINISTRATION AND JUDICIAL ORGANIZATION OF INCOME TAX

LAW

JUDICIAL ADMINISTRATION OF TAX

Income Tax Collection falls in two levels

1. Administrative level or main level where the bulk of the calculation is done

2. Judicial Level wherever there is a dispute one is supposed to go to court

Administration aspect falls into 3 categories

1. General Administrative Management.  They have to establish who ought to pay income tax and where they are.  There is a legal definition of who is supposed to pay tax i.e. who falls within that definition; they also trace to find out where the taxpayers are. Where are the taxpayers?  Administratively the tax collectors are supposed to establish where the taxpayers are.

2. Ascertaining the amount payable by each taxpayer by assessing the income.

3. Collecting Data – they have assessed, ascertained how much then they go ahead and collect it.

Judicial Elements are brought about by the above 3 administrative elements where disputes arise whether one is a taxpayer, whether what is being taxed is income and the amount to be collected.

The revenue department falls

Assessing and collecting taxes is what brings most arguments, it is the most complex because we have very few tax collectors.

TAX ASSESSORS

The Assessors are the people who identify one as a taxpayer and then proceed to send them their tax returns so that they can file tax.  The returns are sent to the taxpayer to show that they have paid tax and also if there is any extra income that has not been paid for under the PAYE then one has to pay for it.  Normally the assessors do no assess businesses and they will request that they be told what one has done, only after which they will do their own assessment.  Secondly they receive the returns and then they assess the amount of tax due to one in accordance with the returns.  It is the assessors who receive the appeals where there are appeals (referred to as objections) and deal with them and they are the ones who produce the Commissioner’s case to the committee and also to the courts.

TAX COLLECTOR:

Done by tax collector.  They receive the money that comes in and follow-up the defaulters.  In the process of doing this they issue one with notices and charge penalties and interests for non-payment.  They issue receipts for all the monies paid, if you have overpaid, they issue a credit note or a cheque.

JUDICIAL PART

Anywhere there is a dispute that went beyond the tribunal and went to court, it becomes official.  It is not a criminal matter unless it is a matter of tax evasion but disputing is not an offence.

SOURCES OF TAX LAW IN KENYA

Tax law in Kenya is all based on statutes, it’s all statutory, and not just income tax but every tax is provided for by statutes.  Wherever there is a dispute, then the courts come in to interpret the statute.  The courts interpret the statutes but do not establish the taxes themselves.  It is to be found in our law in Cap 470 Income Tax Act.  There is no general power to delegated legislations to create any taxes.  They show how exemptions are created.

There are certain areas where the law will grant the minister some powers to deal with the income tax Sec. 41 deals with Double Taxation.  Where the Act imposes tax to exempt one by way of double taxation he can only do this under the power granted by the financed

Income tax is imposed each year although once it gets here it is permanent.  We have provisional Acts that are created to increase rates.  Section 3 of the Income Tax – Imposition of Tax (1) Income Tax from businesses, exemption falls under Part III of the Act which starts with Section 17, then we go to collection and objections.  Local committees and tribunals do not have judicial binding decisions although they are followed.

OBJECTIIONS & APPEALS

PART X of the Income Tax Act  -

Objections and appeals are provided for in Section 82.  The committees and tribunals appointed by the Minister hear the objections and their decisions are not final but their findings on facts are final.    The decision of a court of law on a point of law is binding and final and no one can argue against it, neither one or the commissioner can argue against it even if it is wrong unless one seeks a review.

Interpreting tax law certain principles are used.  These are principles established by English courts, which we have been following and our law is based on them

1. The onus or burden of proof is on the State to prove that there is a valid tax law which imposes the tax and that that law covers the taxpayer in question; to quote Pennyquick in the case of 

Reed and International Ltd V CIR [1974]

1 All ER 385, 390

he said duty is chargeable on any particular subject matter or if that subject matter falls within the words of that statute.

2. The taxing statute must be construed or interpreted strictly by reference to its actual words.  This has a lot of case law and one of the earliest case is 

Partington V Attorney General

(1869) L.R. 4 H L 100, 122

 he said “if the person sought to be taxed comes within the letter of the law he must be taxed however great the hardship but appear to the judicial mind.  However apparently within the spirit of the law the case might appear to be … a construction is not admissible in a taxing statute…” there is no question of equitableness.  It looks strictly at the letter and does not care about being inequitable.  In the case of

 Cape Brandy Syndicate V IRC 

[1921] 1 K.B. 64 71 

  Rowlett J. said “.. In a taxing Act one has to look merely at what is clearly said.  There is no room for any internment, there is no equity about tax, there is no presumption as to a tax, nothing is to be read in, nothing is to be implied, one can only look fairly at the language imposed.”  Courts have been looking at Substance rather than form.  Looking at form requires a literal translation while looking at substance …it is more likely that if there is an ambiguity in any section that carries weight against the taxpayer, that ambiguity will be used in favour of the taxpayer or the ambiguity will be removed in favour of the taxpayer.  The court has to give a clear meaning to the ambiguity however unreasonable it is.  It is not for the court to clear the ambiguity.

3. The Object of the construction of a statute is to establish the will of parliament and so it should be presumed that neither injustice nor absurdity was intended. If interpretation will produce absurdity or injustice and the language admits such an interpretation, which would avoid it, then such an interpretation may be adopted.  This means that the language of parliament has not excluded that kind of interpretation.

4. The history of an enactment like the Income Tax and the reasons that led to its being passed may be used as an aid to its construction. So one can look at the history of the Act to see why it was enacted and use that to interpret it.    Mangin V IRC [1971] AC 73 CH 746 Lord Donovan said “…

PRINCIPLE OF RETROSPECTIVITY 

The law can be retrospective in various ways

1. It may impose a tax on income that was acquired before the law; this type of retrospectivity has been enforced but it has been classified as “improper and immoral”  nobody said that the law should be proper or moral and in tax law, it can be done.  Income tax, your income can precede that law unless in the case of Kenya if the matter ever comes to court, it’s a law that needs to be changed.  If the Constitution says it cannot do that then it would be unconstitutional but at the constitution declares that parliament can make any law. 

James V I.R.C

[1977] STC 240

 The taxpayer (James) challenged the validity of Section 8 of the Finance Act of 1974 it increased the rate of surcharge Retrospectively for the year of assessment 1972-73, the taxpayer was saying that the Crown had set that rate and in some cases had even collected the Tax, it was therefore contrary to common law and natural justice for that rate to be subsequently valid as it amount to reopening the transaction.  Slade J dismissed the Case.  Although he sympathised with it and he actually described that Section as retrospective legislation of extreme kind which would operate harshly on taxpayers.  However he did not agree that it was illegal and this is what he said “…it is in my judgment that as the constitutional law of England stands today parliamentarians have the power to enact by-statute any fiscal law whether of a prospective or a retrospective nature and whether or not it may be thought by some persons to cause injustice to individual citizens and note.. If the wording of the legislation is clear the court must give effect to it even though it may have or will have a retrospective effect.  It has no power to refuse to give effect to it on the ground that the protection private citizen required.”  In the case of

Ingle V Farrand 

[1927]11 TC 446

Where they were interpreting whether it was public office or employment in the case of Great Western Rly & Co. also and later parliament passed a law which changed that interpretation retrospectively.   There was nothing they could do and the courts went ahead and enforced it.

A statute can change provisions that may have been announced in a provisional collection of taxes Act.  Our Act is Cap 495 and the Finance Act when it comes can change that, this is changing the law retrospectively and the things is our law allows that assessment be made can be changed by the Finance Act that is Section 2 which says that in relation to any year of income in respect ….  Under the provision collection of taxes and duties Act..  Cap 470 can change any assessment set out in the provisional, this is legal retrospective.

A retrospection may be introduced to reverse a decision of a court i.e. an Act may be changed retrospectively to reverse the decision of a court.  An example cited in England is Section 62 of the Finance Act 1987 was introduced to reverse the case of the decision of Padmore V I.R.C.  S [1987] STC 36.  

Law can be introduced retrospectively to clarify an old law or some confusion in a past law.

When it comes to interpretation of taxation, the consequence of a transaction one either uses form or substances but there are questions to be asked i.e. is the law being interpreted relating to a specified transaction or literally or using the rationale rule of interpretation.  Do you try and read the intention of Parliament in the words, the style or form.  If you use the style it means you don’t.  Refer to the case of I.R.C. V Westminster (1936) C 1  - he was trying to create a trust for his employees for future payments and the question was if those people had asked for the money that he had created a trust for, could he have been taxed that amount? Was it an income or future income?  It was contentious issues and according to the law they were saying no, that the law should have been interpreted using the substance doctrine and..  The special commissioners at that time held that they were wages and therefore taxable.  This decision was accepted by Finley J. in the High Court who said that looking at the substance and not the form it must be regarded as the case of someone remaining in the Duke’s employ and therefore wages.  The Court of Appeal reversed the decision and the House of Lord held that the C.A. was right.  The document said that they were created for trust saving for after service and that is what they were, they were not wages, look at the substances.  The House of Lord said Lord Atkin dissented “… I do not myself see any difficulty in view taken by the Commissioner and Finley J. that the substance of the transaction was that which was being paid was remuneration so construed the correct interpretation appears to be that they were wages but the other members of the House of Lords overruled him saying that they could not accept the substance approach.

C J CLARK LIMITED V IRC

[1973] 50 T.C 103

 This case was talking about “… when parliament sweeps away one provision in amending act enacts in its place another provision which is drafted rather differently … he who says yes and later changes his mind and says no does not demonstrate for him yes means no.   One is allowed to use a rational interpretation rather than a literal interpretation

Consolidation Act – Finance Act, which comes out every year

Lord Diplock – the only mischief a consolidate is supposed to remove is a peace-meal Act.  In the case of IRC V Joinder [1975] 50 TC 449

Any Act consolidating any law are not to be interpreted differently it is the original Act that matters, the consolidated Act.

PRINCIPLES OF STATUTORY CONSTRUCTION

The Ramsay Principle – it is important to interpret how far it is permissible when one comes to the Act they have to look at the substance of the Act as opposed to the Form.  

In 1936 the House of Lords held that the Inland Revenue Authority could not invoke the supposed doctrine of substance in income tax.  According to them you interpret it formally.  They said that one could not invoke the substantive doctrine of interpretation so as to uphold the legal rights and interests of the parties.  The legal rights of the taxpayer are to pay in accordance with the income tax law.  They went on to say that the only situation in which a document could be disregarded for tax purposes was to find out whether or not it was bona fide or intended to be acted upon.  They said “any attempt to pray aid in the so called doctrine of substance was merely an attempt to make a man pay tax not withstanding that he has so ordered his affairs that the amount of tax sought from him is not legally claimable.  They are saying that if you have filed your returns correctly, and you have not cheated but the way they are organised has resulted in the lowest profit, they are saying that using this doctrine, one would pay more than he is legally entitled to pay.”  How one uses information may make a big difference.

In our case Section 110 of the Income Tax Act – incorrect returns “ a person shall be guilty of an offence if he without reasonable cause makes an incorrect statement in a return of income by omitting or..  It makes it a criminal offence to file an incorrect return.   If you tailor it in such a way that you save money, this is not an offence.  What is wrong information?   As far as income tax is concerned, one looks at form and not substance.

In the case of the 

Duke of Westminster

it was held that every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it would otherwise be.  If he succeeds then, however unappreciative the commissioner of Inland Revenue or his taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax.  Lord Tomley

The subject cannot be taxed by inference but only by strict interpretation of the law.  This doctrine was looked at in the case of 

Ramson V Higgs

[1974] 50 TC

 and then it went on to become what we live on today which is the Ramsay Principle.  

W T Ramsay Ltd V IRC

[1981] 54 TC 101

RAMSAY PRINCIPLE

1. The principle is a principle of construction for words involved in taxes and

2. Secondly tax avoidance par se does not bring the Ramsay Principle into play.  It is not part of the judicial function to nullify any step that one as a taxpayer chooses to organize their tax affairs although they are supposed to modify the Westminster principle.  One can organize their matters so that they can avoid tax and it is not for the courts to go behind ones style to prove that one is avoiding tax unless there is a specific provision avoiding tax avoidance.  

3. Thirdly a tax avoidance motive of a prior transaction does not enable it to be treated as one with a subsequent transaction i.e. tax avoidance is not an authority; one has to look at the current transaction independent of the previous transaction.  

4. Fourthly, they say that there is no moral dimension to the Ramsay Principle i.e. they don’t do it for moral purposes.  According to them any idea that the principle in Ramsay is a moral principle or that it is supposed to catch tax avoiders is wrong and it is defeated by the interpretation that there are, Ramsay Principle is a principle of statutory construction and not a moral principle.  

5. Fifthly the principle is only concerned with ascertaining what is the reality of the transaction  

6. The Ramsay Principle is not a substance doctrine; and it’s a formal interpretation

7. The basic approach where Ramsay applies was that it is not that the court looks at the behind returns but the returns were not properly done.  They did not prepare a proper return.

PRINCIPLES OF STATUTORY INTERPRETATION

Principles of tax statutes interpretation.  As set out in the case of Ramsay

1. A subject or taxpayer should only be taxed on clear words of the statute not in accordance with any intendment or intention;

2. A taxpayer is entitled to organize his returns in such a manner that he reduces his liability to tax as much as possible.

3. It is for the fact finding commissioners to find whether the document is genuine or not, if it is genuine they argue with it and if they find that it is a sham, that is the information they bring to court.  The court can go behind the document to determine whether the document is a forgery or not.  The justification of a court will only be to look behind that document only if the commissioner raises the point

4. Given that a document is genuine the court will not go behind it to look at underlying substance.

JURISDICTION OF OUR LAW

Parliament in Kenya has jurisdiction to make law.  Income Tax Act applies to all Kenya including Kenya’s continental shelf.  Outside Kenyan territory by exclusion one is not bound.

On the 1st January 1974 the East Africa Tax became the Kenya Income Tax Act Cap 470.  It is only effected to persons who are found within its jurisdiction in accordance with its definition.  Its definition includes some elements of Kenyan residence not Kenyan citizenship.  It creates territorial limits, which are 

1. Person to be taxed is either resident or non-resident

2. Income to be taxed – the income that should be derived from all accrued to one in Kenya 

3. It is annual

Section 3 tells us how income tax is effected, annual, upon income of a person, whether resident or not that accrues to or is derived in Kenya.  The type of tax, the period, the geography and the source.

The person who is to be taxed is not determined either by residence or anything but by income, without income, income tax has no interest in one.  The income chargeable is provided for under Section 3(2) of the Income Tax Act.  Any income that does not fall under that section is not income for the purposes of this Act.  The person to be taxed is defined under Section 3(1).

What type of tax in subsection 2, is it gains or profits from business?  From whatever period of time as far as business is concerned.  From dividends or interests, from a pension?   Definition in 3(2) a person does not include a partnership.

Section 10 gives details of what type of income, details of what gains and profits are.

What is a year of tax – 12 months from 1st January to 31st December …

A foreigner has to be in Kenya for 183 days in a year or for an average of 122 days for 3 years.

Who is a residence, can one be a resident if they have not been in Kenya for several years, according to English Law, yes one can, you can be held to be a resident although physically absent.

In the case of

Rogers V. IRC

(1879) 1 ITC 225

 – Mr Rogers went out of the UK for a whole year.  He was a commander of a ship and left his wife and children in England.  The income tax people wanted him and he argued that he was not a resident and therefore not liable to tax and the court said no that he was a resident not on the basis of a wife but “… every sailor has a residence on land” it is a presumption which is correct.  His evidence was his wife and children.  They used the substantive principle and reversed their own principle of using only formal interpretation; to be resident you have to be there physically or legally declared to be resident.

In Kenyan practice the average period spent counts to be a resident, a visit to Kenya and a permanent home counts.  If you don’t have a permanent home and you make a visit, you have to have stayed for a 183 days.  Rogers had a permanent home in England but had not visited.

The purpose of the visit is immaterial Section 3.  If the income is derived in Kenya the purpose of the visit if immaterial.  Section 5 will require that income (1)(a) – an amount paid to a person who is or was at the time paid the amount for services rendered …

It is not where you are paid but where you are.  (2) Gains of profit – includes all that  a, b, c, d, e, f.  One can make a permanent visit here but the work is not being done here.

I R C V. Zorah 

(1926) 11 TC 289 

Zorah was a retired British worker (member of Indian Civil Services) who visited the UK for 6 months with the sole object of seeing friends.  The Commissioner tried to tax him, the matter went to court and he was held not to be a resident in the UK for the purposes of Income Tax..

Where one is resident in Kenya but not of his own free will, he will still be held as resident.

In the case of 

IRC V Lysaght

(1928) AC 234

Lord Buckmaster stated “I understand the judgment of the Court of Appeal to mean this that they regard the objects of his visits to show that he could not be regarded as a resident.  They said that it was not of his own free choice but in obedience to the necessities of his position in relation to the company that he was over there.  The CA considered that as very important, the fact that he was not there.  A man might well be compelled to reside here, completely against his will.  The exigencies of business often forbid the choice of residence.  He went on to argue that a man may have his home somewhere else and stay in England because business compelled him.  But according to the House of Lords the periods of which and the conditions under which he stays are such as may be regarded as constituting residence and so he was a resident.  The court went to the formal interpretation.

When it comes to the interest of the taxpayer, courts have no other business but looking at the substance but when it comes to looking at the interests of the commissioner to look at it formally.

Permanent home is not defined in the Act.   We go by English decisions of ownership of accommodation.  You don’t have to own any accommodation in Kenya going by authorities in order to own a home.  For purposes of income tax all that is necessary is that an individual has access to the property whenever he/she wishes, it does not have to be permanent. 

 This was decided in the case of 

Lowenstein V de Salis

(1926) 10 TC 424

This man was Belgian and used to visit the UK every year where he stayed no more than six months and he stayed in a hunting box and that box belonged to a company where he was a director. Not only was he a director in this company but owned 90% of the shares so he had a place to stay in England, it was old.  The court here looked at substance although we are told that substance is not applicable in income tax, the court held that the hunting box was available de facto to him whenever he came to the UK although he was neither the owner or the lessee but he had access to it whenever he wanted to and for that reason he was resident in England because he had a permanent home.  The commissioners in England came to a conclusion that where a person residence turns on whether or not he has accommodation, for this purpose, ownership is immaterial.  The opposite is also true that if you have a house, which you own but you have leased it out but have no access to it, then you have no home.  They seem to be extending the definition of ownership.  In addition the English if one has a spouse who lives some where, where she lives will be considered to be available by the Act unless of course you are separated but when you are still husband and wife whether it is owned by the wife, you still have access, a partner’s home is his/her home.  We talk of permanence because in Kenya if you have a permanent home, you don’t have to be here for 183 days you just have to be here and it is enough, you are entitled to pay tax.

In England they have a rule that we have not provided i.e. if the place being rented is being rented for 2 years and it has furnished accommodation or less than one year but unfurnished accommodation then it is permanent.

INCOME FROM EMPLOYMENT

We are studying income tax for the natural and artificial person.

A natural person can be employed but an artificial person cannot be employed and thus a natural person’s income comes from employment and artificial persons income comes from business.

The business a natural person does would always be individual business unless it is a partnership and unless it is a company.

An income from office can be from an individual or income from employment.

The history goes back to 1918 when Public offices and employment were charged and income tax law does not define its terminology it leaves it open so that everyone could fit in. 

1922 they transferred employment charges from schedule D to E. 

However it does not matter under which schedule you are charged

1956 Act charged income from all employment in schedule E and our law today charges from sources of income under part II of the Act, and this is a very important part because it affects you and imposes taxes on all incomes.

Part – II is actually called imposition of tax and they base it on all income the most famous section 2(1) 

Income tax does not know citizenship whether you are an Australian you can be liable to Kenyan income tax.

Income tax is chargeable on an annual basis and it is taxed separately independently, and it is upon income it is not from anything else. But if you look at the section of the Act there is no definition of income and yet that is what you pay tax on. 

You are required to pay tax as a resident and not as a Kenyan.

Section 3 (2);

What is income?

They don’t tell you but they tell you “ income upon which tax is chargeable” subsection 2 says, “gains and profits from the following:

1. Business for whatever period of time carried” even if you carry business for half a day in a year you will be taxed on it;

2. Income from employment or services rendered;

3. A right granted for another person for use or occupation of a property (this is for the landlords and the right they are taking for granted to another person is meant a tenant” if it is ex gracia then there is no income 

4. The second item they classify is dividends and interest

5. A pension charged or annuity 

6. An amount deemed to be an income of a person under this Act

7. Any gains accruing in the circumstances and ...in the 8th Schedule;

8. For the purposes of this section person does not include a partnership (so that they tax you as a person on gain from your partnership and then they charge you as a partnership being a company)

 When they say annual income that does not mean that you have to work for a year, what it means is that income for whatever periods in a year.

From the income of employment they charge you under section 5 you look at part – II, again you assume that it is well defined. This section has A and B 

Two things have to be address:

1. Whether you are taxable and

2. To what extent you are taxable 

You may even be exempt from paying tax on a particular transaction such as Ndwiga.

When you are exempt from tax there are times when you as individual may be exempt from tax including even customs say when you an Ambassador, even if you are a resident in Kenya but your income does not come from Kenya. However if you are to buy from Uchumi you are not exempt even if you an Ambassador if you want tax free items you have to go to a duty free shop, but if you are a Kenyan then you will be given an identity to buy from a duty free shop.

In order to decide whether you are a taxpayer you have to look at the following:

1. Do you hold an office or employment;

2. Is that income from that office taxable 

3. You have to look whether that taxable income falls within any income provisions;

4. What deduction you have to make (you are not the one making a deduction that is why you are asked to file returns and you tell them that this is what I have earned and this is my tax)

5. Then you have to look at section 5 and that is what charges you.

Under Part – II – imposition of tax subject to Income Tax Act income refers to gains and profits from employment or services rendered. However there is no definition in the Act for the term employment and even in England there was no statutory definition of the term office. But you get some definition in cases. Look at the case of

Great Western Railway Co v. Bater

(1920) 8 TC @231

Rowlatt J SAID:

“ That definition is something which is a subsisting permanent substantive position, which had an existence independent of the person who filled it, and which went on and was filled in succession by successive holders” This is the definition of the term office by Rowlatt.

However Gachuki does not agree that the office has to be permanent, but he does agree that it has to be independent of the person who is occupying it even if you retire, die or fall sick the position remains.

This definition went on until it was looked upon in the case of Edward v. Clinch (1981) 56 TC @367

In this case where a person was regularly appointed to act as an inspector of public inquiries. This was an office created by a statute but it was not a permanent job only when it was necessary.

When he was appointed the issue arose whether that office was an office within Schedule E subject to income tax.

The House of Lords decided that it is open to the courts and it is also right for the courts to consider the Rowlett definition (because this was not a dictionary definition).

According to them it was still appropriate and that they could continue using the term office under Schedule and Rowlett definition was correct except that rigid requirement of permanence cannot be accepted. And when it comes to question of continuity it does not exist even they went on to say that the terms trade or vocation they are the same as employment and office.

Although in Kenya the most used term is employment.

According to their view the continuity is not necessarily permanent and it has to be independent of the employee so that any person appointed to that position may leave it and the position still remains the same.

In their case every appointment had to be personal to a taxpayer for the purposes of tax, it has to have an independent existence and has to be continuous.

If you look at these provisions and then you look at the office say the Office of the Vice – Chancellor, you will see that the office is continuous but should the University of Nairobi cease to exist the continuousness ends and the statutes provides for it and there will be no Vice – Chancellor of the University of Nairobi however, Makogha as a person will still exist.

If I sit in Makhogha’s office and I earn twice as much I will pay more tax than Makhoga paid because the tax is personal to me and even if I am exempt from tax I will not pay tax because the tax is personal to me notwithstanding that Makhoga did pay tax sitting in that office based on his employment.

The term employment is more extensive than the term office because every office including casuals are employed and they don’t hold office however they are employed – this is as per Gachuki.

Employment can exist where there is no office – such car wash on the street, however in that case the judges decided differently.

The leading case in this is 

Davies v. Braithwaite

(1931) 18 TC @109

The facts of the case there was an actress, she contended that one of her separate theatrical clearances was.. And each separate appearance was a contract of employment and thus should be taxed as income from employment (perhaps tax from business was higher than it is today). 

But Rowlett rejected this argument saying that 

“When the legislator used the term employment in Schedule D and then shifted it to Schedule E, alongside offices the legislature had in mind employments which were something like offices. And I thought of the expression posts. He moved on to say that as far as he was concerned where there was any method of earning you earn of livelihood from a method and its not from a post (as you find in an office)  and it is a series of engagement.  Then it means that moving from one engagement to another should not be considered as employment”.

In employment the Schedule was thought to be something like office - they were similar and schedule E was where they were charging employment and Schedule D 

The term employment was in Schedule E together with term office 

Two factors can be taken into account when you determine whether you are employed or you are carrying out a business:

1. Whether or not the services are those of a professional and that is what you refer to as vocational services;

2. You look at whether there are a number of different engagements that that person has undertaken over a period of time;

3. However there are no conclusive decisions and this was decided in the case of 

I.R.C. V. Brander and Cruinkshank

( 1971) 46 TC @574

This was a firm of advocates and carried on legal services and at the same time they acted as registrars to a client and they would register a company occasionally.

They did two cases and they charged 2, 500 Pounds. The Commissioner argued that that money that they received was income to their firm or profession or business.

The House of Lords rejected saying that that was more of an office than the profession.  And according to them they were saying that where you have a selected or an appointed person appointed to a position where he has to perform some type of work rather than where you have a category of a person who is appointed to carry out a particular task which is a profession and that is business. According to them one of the jobs is not employment. In Kenya there are professional servers instead of keeping a court clerk they offer services of a court clerk to perform service but they are not employed by anybody. However, there are certain services that can only be performed by professionals, those services are performed for the hospital to the patients

In tax law courts are very resistant to taxation.

Look at the case of 

Market Investigations Ltd v. Minister of Social Services

(1969) Vol II, QB, @`73

Where the court rules:

“The fundamental test to be applied in distinguishing between a contract of service and a contract for services is this person who has engaged himself to perform these services performing them as a person in business on his own account? If the answer is yes then it is a contract for services. If the answer is no then it is contract of service. And the court tells you to have regard to the following things:

1. The terms of services and if you find that those terms allow that person to exercise control of the work carried out and the manner in which it is carried out then it will be a contract for services because it is business. 

2. But if the control of the work carried out and the manner in which the work is carried out is by the person who is recipient of services then it is a contract of service.”

Part timers in Gachuki’s view are providers of professional services generally.

Fuge V. Mc Claelland 

(1956)VOL 36 TC 1

Taxpayer was married and his wife was a full time teacher during the day then she agreed to teach the evening classes and the pay for the evening classes was under a different contract. The question was whether the pay for the evening classes income from employment or a business. If it s income from employment then the husband will pay or whether it is a business and then he will not have to pay.

For the some reason court said that it was income from employment.

Tax from Employment:

Lindsay V IRC

[1964] TR 167 –

There was a man who held a fulltime post as a radiologist in a certain hospital.  At the same time he delivered lectures in the same hospital not as a radiologist but as a different kind of job.  The Income Tax argument was that the fee he received, as a teacher was taxable although according to our Income Tax Act it is any income received from employment or for services rendered so we can consider this as services rendered.  The court held that this income was taxable as the argument was that it was not part and parcel of his employment income.

Walls v Sinnet 

(1987) STC 236 –

A taxpayer who was an employee worked for 4 days per week for a college.  The college was owned and ran by a local authority.  He worked for them and they did not control him at all.  The local authority did not exercise control over the way he carried out his duties at the college. The argument was since the so called employer did not exercise any control over this employee, then his income was not taxable as income under Schedule E in England and in Kenya Section 3 …

The commissioners ruled in the first place that it was taxable, then he went to the local commission and appealed and the commissioners decided that it was not employment, it was schedule D, then the matter went to court and overturned the decision saying that although no control was exercised over him on how he performed and he had income from other sources during that time, it was still taxable.  So the rule is and it has been adopted here in Kenya, that one has to bring any other source of income plus the employment income so it can be taxed together as employee income.  The argument is that although nobody exercises control it is tax as income from employment.

One can be held to be employed full time and at the same time carrying a professional job, it does not Matter.  This was decided in the case of 

Mitchell Edon v Ross

(1962) 40TC56

The taxpayer was in private practice and also held a job on which he was paid a salary under the National Health Scheme.  His argument was that his private practice would not have been successful without his employment and therefore his employment should be treated as part of his profession.  He wanted his income treated as business income, rather than employment income.  He argued that it should be included under Schedule D but the Court refused to do that.  Whether income is from employment or from professional may not be learnt easily.  One has to bear certain considerations like firstly, does the taxpayer occupy an office, and the next to consider is “do you undertake any employment under that office, Do you merely render services in the course of the exercise or practice of his profession, or the office he occupies or does he only render services in the course of the private profession.  

Income tax is taxable on a current year basis and that is how it is assessed so that the taxpayer in any year of assessment will be charged all the income for that year in relation to employment or services rendered.

Section 3 (2) (a) (i) Subject to this Act income which is chargeable under this Act …  Section defines an employer as including any resident persons responsible for …  employee is not defined neither is the definition of employment.

Heaton v Bell

[1969] L46TC 211 –

The court in this case defined liability to tax of a taxpayer   “it is well settled that a taxpayer or tax or liability ….

The meaning is that one is taxed on their earnings and not on net received.  Income to be earned is not taxable.  Even where one gives part of their earnings to charity, they are taxed on their taxed earnings. 

Section 5(2) Gains or Profits from employment or services rendered for purposes of section 3 (a) (ii) gains or profits include wages, salary, leaves paid, payment in lieu on leave, fees, commission, gratuity or allowances.

Section 15 disallows donations exemptions donations are not allowed as a deduction

Section 16 – donations are expressly disallowable since they are personal and the decision is the employee’s.  

Section 5 – 3 methods under which amounts payable by virtue of contracts being terminated.  Where there is a contract that defined what is to happen in case of breach, where there is no contract and where there is no provision at all depending on these 3 situations, taxation of income arising out of the time a contract has ended that that amount is taxed.

In our case all income is taxed under Section 3(2) (a) (ii) – profits from employment including pension, which is earned as income.  For it to be termed as tax it must be derived from that office or employment, if it is income from a harambee for example, it is not earnings and therefore does not fall anywhere and is thus not taxable.

The general principle was provided for in the case of 

Hochstrasser v Mayes

(1959) 38 TC 673

 IN this case Upjohn J. decided and gave the authorities and summarised them saying they seemed to have answered the question that in the light of every particular fact, every case whether or not particular payments are made or is not from employment.  Not all payments made to any employee as gains or profit to an employee, the authorities said that that profit must have been in reference to the services rendered in that employment.  If it was not income made in relation to services rendered in that office, then it is not taxable.  It must be in the nature of a reward for services.  The Court of Appeal agreed with that and it is the current definition.  In Kenyan case where income tax is on earnings or for services rendered, you pay tax on it.  

Payment in respect of employment or services only for an employee, services which are rendered in Kenya or outside Kenya in the case of a resident person or if the payment is made to a non-resident, all of this may be taxed but only on the following condition, if the non-resident is employed or rendering services to an employer who is resident is Kenya, his income is taxable or if he is rendering services to a non-resident who has a permanent resident in Kenya for which one works, for example if he has a company here. Which means that even if one works for World Bank but they are resident in Kenya they will be taxed.

In case of a non-resident a person is chargeable to tax only on income that is accrued or derived from Kenya.  There are cases in the English system where employee’s income has been held not to be taxable.  There are 3 situations

1. Where you have paid a gratuitous payment to an employee i.e. it is a gift or any other voluntary payments;

2. Where an employee has received payment under a contractual right which is considered to be outside the scope of his employment;

3. Where an employee receives payment after his employment has ceased or after it has come to an end.

The first category of gift and other voluntary payments – the case of

Seymour v Reed

(1927) 11 TC 625

 In this case the House of Lords summarised the general principle in relation to income tax or chargeability of gifts to income tax as follows “it must be settled that the words salary, wages, fees … whatsoever (Section 5(2) (a) according to the judge One these profits include payments made to the holder of an office by way of remuneration for his services even if those services are voluntary so long as they are made as payment by way of remuneration for services rendered.  But these do not include a mere gift or present.  There are two types of voluntary gifts, when employer makes a gift to an employee; this is made on a personal ground and not by way of payment, secondly where someone other than the employer makes the gift to an employee.  In the case where the gift if made by employer to employee the court went to say that they would have to be very exceptional circumstances for the gift not to be taxable, for example if one was to give their employee money to pay an ambulance for a spouse, that is a personal payment and is not a remuneration for services rendered, it is a gift being given for an employee but not in remuneration for services rendered.  The other example is where an employer gives a donation for burial for an employee’s kin as a harambee, this is a free gift given not in relation to services rendered but on personal grounds.  It is not in the contract.

Ball v Johnson

 (1971) TC 155

In this case the taxpayer was a bank clerk and his contract of employment required him to sit for some examinations referred to as examinations of the institute of bankers, which was a condition. He fulfilled that and he studied sat for the exam and passed.  He was doing this at his own time not at his employer’s time.  After that the employer gave him £130 pounds, which was normal and was a gift stated in the handbook as a gift.  Was this a gift in relation to employment when he had done this examination at his own time, the employee was only fulfilling a term of the contract which does not mean rendering services.  The Judge held that that was not income that had arisen from his employment and therefore was not taxable.  Not all judges decide this for example in

Laidler v Perry

(1966) 42 TC 351 –

In this case a group of companies gave each of their employees that had worked for them for more than a year a gift voucher of 10 pounds as a Christmas present.  They could use the voucher in a shop of their choice.  Was that income for services rendered?  The matter went all the way to the House of Lords and they decided that the vouchers were taxable under Schedule E as income from employment in our case Section 3(2) (a) (ii).  However the court went on to say that a gift by an employer on purely personal grounds and not by way of payments for the employee’s services is not taxable for example a bonus paid to a single employee for exemplary service rendered.  It is not a contractual right and it is just a gift.  If it is given to one person it is a personal gift, given to all employees it is not personal.  Some of the courts went on to say that even tips are taxable.  If an employer gives employee money under pure benevolence, that income is not taxable.  The general rule is that gifts to an employee by his employer are taxable we have not reached there maybe because we are incapable of chasing those gifts.  

Where a person who is not an employer makes gifts – it raises two problems, where rewards are given as a result of services rendered but as voluntary gifts by people who are not employers.  Sometimes these are taxable, if earned by virtue of employment but where the gifts are given personally and on personal grounds irrespective or whether or not services have been rendered is not taxable.  Good case in point is that Wangari Mathai’s gift of 110 million is not taxable.

In the case of Calvert v Wainwright (1947) 27 TC 475 – A famous good Judge Lord Atkinson held that the tips that are received by a Taxi Driver in the ordinary course of business are taxable.  In Wings v O’Connell (1927) IR 84 It was held that the presents that a jockey wins are taxable.  In Blakiston v Cooper (1909) STC 347 it was held that a Parson’s Easter offerings to the Church of England were taxable.

Taxability of gifts may depend on the frequency or regularity in which they are given, if they are given frequently and regularly then they may be considered as income for services rendered.  Lord Jenkins in the case of 

Moorehouse v Dooland

(1955) 36TC 1

 Summarised it as follows:  

1. That income which is voluntary or the voluntary gift should be looked at as to whether it is by virtue of his office or employment, 

2. If the recipient of the gift in his contract of employment entitles him to receive that payment, in that case it will be most likely to be held that it arose out of rendering services.  

3. The fact that the payment is of a periodic or recurrent character may also support taxability although that would not by itself lead to a conclusion that it is taxable. 

4. Any voluntary payment which is given by way of a present on personal grounds may lead to a likely conclusion that it is not a profit accruing from employment and therefore not taxable.

CONTRACTUAL RECEIPTS NOT ARISING FROM EMPLOYMENT:

Under the common law it is possible to receive from an employer payment which one is entitled to not as payment for services rendered.  The best example is one given by Lord Denning in the case of 

Jarrod v Bousted

(1964) 41 TC 701

 in this case he gave the example as follows:  “ suppose there was a man who was an expert organist but who was very fond of playing golf on Sundays and asked to become an organist for a church for the 7 months that would follow at a salary of £10 pounds a month but this church expressly provides that he would never play golf on Sunday for those months he was working for them.   The organist said that if he had to give golf on Sunday they would have to give him an extra £5 pounds for not playing golf on Sunday and they obliged.  Lord Denning asked if the £5 pounds is payment for him as organist?  Is it income for services rendered?  Lord Denning said that this was not payment for services rendered to the church as an organist but a payment for relinquishing what the organist considered to be an advantage to him.  On the basis of this reasoning, the Court of Appeal held in that case that a signing on fee for an amateur rugby player to a professional rugby player, the signing on fee is a fee for turning professional and for agreeing to pay for that particular club.  It was not income but a capital sum, which is compensation for his giving up the amateur status and not income for services rendered.

A different case decided otherwise in 

Riley v Cogland

(1964) 44 TC 481

 Ungoed Thomas J. held that signing on fee of a Rugby player was taxable because according to him it was paid into consideration of the taxpayer playing for the club for the rest of his career.  This was in the High Court in 1964.

The House of Lords has also held that the fact that any payment would not have been made to an employee unless he was an employee is not enough to make any income taxable, one must have been paid because of that employment to be taxed the employment must be the cause of the payment for services rendered.

There are substituted forms of remuneration and an example was given in the case of 

Holland v GeogheTAX LAW NOTESgan

(1972) 48 TC 484

 Here this taxpayer was on strike with his colleagues and the employer paid him £450 pounds so that he can go back to work, there was no requirement in his contract because under contract he could only remain at work for 7 days and so the £450 pounds was meant to make him to leave his trade union friends and come back to work. The judge held that the main reason for payment of that money was to get the employment back to work and that when he received that money it is by way of a substituted form of remuneration and therefore it was taxable.