A guide to Kenya's tax framework for individuals and businesses

Kenya has a broad taxation system covering income tax, value-added tax (VAT), and Customs and excise duties. These are governed by independent legislation that establish provisions for the charge, assessment and collection of the respective taxes. The Kenya Revenue Authority (KRA) employs different divisions that deal with the three areas, undertaking reviews on companies to confirm they are paying the right taxes. An equally important factor for the protection of revenue leakage is corporate governance, which is at the core of business operations in Kenya.

Corporate Entities

The operation of corporate entities in Kenya is governed by certain rules and regulations. A corporate body that intends to conduct business in the country can either operate as a company or a branch. The Companies Act, 2015, governs the setup and operation of these entities.

Those persons wishing to set up corporate entities in the country are required to submit the necessary documentation – such as memorandum, articles of association, and details of directors and shareholders – to the registrar of companies. Established under the Companies Act, the registrar is responsible for registering and regulating the operations of corporate entities in Kenya, and is also responsible for registering incorporated trusts and business names.

Under the Companies Act, one or more persons can form a company, while a private company can have up to 50 members.

Foreign entities are permitted to operate in the country as a company or a branch. In addition, the act also stipulates that companies are required to file annual returns with the registrar, as well as any changes in the corporate status, company name, share capital or directorship, among others.

Sector Rules

Companies operating in certain sectors of the economy may be required to obtain additional approvals and licences from the relevant regulatory bodies governing them. For instance, banks are regulated by the Central Bank of Kenya through the Banking Act, insurance companies are regulated by the Insurance Regulatory Authority through the Insurance Act, while telecommunication firms are regulated by the Communication Authority of Kenya. Further, county governments have certain by-laws governing businesses operating in their localities, which establish levies, fees, related charges and business permits.

The Capital Markets Authority (CMA), meanwhile, governs the issuance of shares to the general public. All companies which intend to list on the Nairobi Securities Exchange (NSE) must make an application to the CMA and the exchange. There are set terms and conditions for listing which they must comply with to be granted the necessary approvals.

Tax laws apply to corporate entities, local and foreign, conducting business in the country, whether incorporated or operating through permanent establishments. All corporate entities are required to register for a personal identification number (PIN) with the KRA. In addition, businesses are required to enlist for applicable tax obligations, including income tax, pay as you earn (PAYE, or personal taxes), VAT and excise duty.

Meanwhile, firms must register with the National Hospital Insurance Fund, which is mandated to collect contributions as well as run a national health cover, and the National Social Security Fund, the body mandated to collect and administer pension contributions. In addition, they are required to register with the National Industrial Training Authority.

In a bid to attract both local and foreign investments, the government has introduced a number of reforms to ease the cost of doing business in Kenya. A number of notable pieces of legislation have been enacted in the recent past, including the Insolvency Act, 2015; the Companies and Insolvency Legislation (Consequential Amendments) Act, 2015; the Business Registration Service Act, 2015; and the Special Economic Zones Act, 2015. The establishment of one-stop investment centres, known as Huduma – or “service” centres – has also eased the process of registering businesses.

Navigating the country’s regulatory environment can sometimes prove challenging, and the assistance of professional service providers is always beneficial. It is the responsibility of every entity to ensure that it complies with all regulatory requirements, including tax.

Corporate Taxation

Corporate entities in Kenya are subject to corporate income tax, which is governed by the Income Tax Act, Cap 470 of the Laws of Kenya. This is the tax levied on the income of legal entities. The government taxes corporations on income derived or accrued from the country. Companies that operate branches outside of Kenya are required to report all their income in the country and claim a relief of any tax paid in the foreign countries if there is a double tax agreement in place.

Corporation tax is imposed on taxable income, which is the accounting calculation of profit or loss adjusted for certain deductible and non-allowable expenses. The deductibility of expenses is premised on the fact that they were wholly and exclusively incurred in the generation of taxable income.

The corporation tax rate for resident companies is 30%, but this is reduced in certain special cases, such as a newly listed company or a company constructing a prescribed minimum number of housing units in Kenya.

Inside the country, residency for a legal entity may arise through incorporation; management and control of an entity; and the declaration by the cabinet secretary in charge of the Treasury that the person is a resident.

Non-resident companies with a permanent establishment in Kenya are taxed on the income earned or derived in the country at the rate of 37.5%, with some restrictions on deductible expenses. Non-residents without a permanent establishment are taxed under the withholding tax system in cases where the payments made are eligible to withholding tax.

Resident companies or non-resident companies with a permanent establishment in Kenya are allowed to offset their taxable losses against their taxable income during the year in which they occur, and the next nine consecutive years of income.

A partnership is taxed at the partners level, and not that of the entity, whereby the partners are subject to tax on the partnership’s earnings for each year of income, irrespective of whether they are distributed or not.

The Income Tax Act provides a provision for the exemption of the income of certain entities upon satisfying the following criteria:

• It is established solely for purposes of the relief of poverty or distress of the public; or

• It is established for the advancement of religion or education. This is upon satisfying the commissioner that the income is to be expended either in Kenya, or in circumstances in which income expenditure is for purposes that result in the benefit of local residents.

Advance Tax & Withholding Tax

The Income Tax Act provides for the payment of various taxes by resident corporations either in advance or through third parties. These include:

• Advance tax, which is paid in respect of every commercial vehicle; and

• Withholding tax, which is imposed on certain services and deducted on payments made to the service providers. These taxes are allowed as tax credits when entities are declaring and paying their final corporation tax.

Instalment Taxes

Every person who is chargeable to tax is required to pay instalment tax. The amount of instalment tax payable by any person for the current year of income shall be lesser of:

• The amount equal to the tax that would be payable by that person if his total income for the current year was an amount equal to his instalment income; or

• The amount specified in the preceding year assessment multiplied by 110%. This is payable in four equal instalments by the 20th day of the fourth, sixth, ninth and 12th months of a year of income. This is applicable to all persons other than agricultural companies, which are required to pay the tax in two instalments, that is, 75% and 25% on the ninth and 12th month, respectively.

Final Tax & Self-Assessment Return

The final tax is payable by the last day of the fourth month following the end of the year of income, while the self-assessment return is due on or before the end of the sixth month after the end of the year of income. The payment of taxes and filing of tax returns has been automated, and are now done through an online platform known as iTax.

Capital Allowances

The Income Tax Act provides a range of capital allowances – amounts deductible for tax purposes – for persons engaged in various business activities. These include:

• Investment deduction, provided mainly to entities undertaking manufacturing activities;

• Industrial building allowances, provided on qualifying assets utilised by persons during a year of income to generate taxable income;

• Wear and tear allowance, provided on the purchase of machinery;

• Farm works allowance, provided on the purchase and installation of farm works in an agricultural land; and

• Shipping allowance, provided to persons carrying on the business of a ship owner.

Penalties

Failure to pay taxes or file returns within the time limits specified in the act attracts penalties and interest. These are assessed on the taxpayer and are deemed to be taxes due and payable.

Capital Gains Tax

Capital gains tax (CGT) had been suspended in Kenya since 1985. On January 1, 2015, however, CGT was reintroduced on the transfer of property situated in Kenya, whether or not the property was acquired before January 1, 2015. The tax is levied at the rate of 5% on the net transfer value over adjusted cost. It is a final tax and cannot be offset against other income taxes. Despite various controversies, the KRA has been of the view that CGT is a transaction-based tax, and should therefore be paid upon the transfer of property, but not later than the 20th day of the month following the completion of the transfer. Its introduction was marked by various challenges in its implementation and administration, especially in relation to gains realised from listed securities. Effective January 1, 2016, securities traded in the NSE were exempted from CGT.

Presumptive Tax

Due to the numerous challenges that have been associated with the collection of turnover tax, the government has proposed to replace the turnover tax with a presumptive tax in its continued efforts to draw small and medium-sized enterprises into the tax net, through amendments made to the Income Tax Act by the Finance Act, 2018. The tax is payable by any person whose income from business does not exceed KSh5m ($50,000) of income in a year. The tax will be payable by all persons who are issued a business permit or trade licence by a county government in a year of income, at 15% of the amount payable for the business permit or trade licence. It is a final tax. Similar to the turnover tax, taxpayers subject to presumptive tax can opt out of the regime by submitting a formal application (in writing) to the relevant tax authorities. In such a case, their tax will be assessed in the normal way. The presumptive tax is target towards the informal sector. It is for this reason that incorporated companies cannot opt for this regime.

Personal Taxation

This tax is governed by the Income Tax Act. It entails the taxation of individuals, both residents and non-residents, and unincorporated entities in Kenya. Under the Income Tax Act, residency can arise where an individual has:

• A permanent home in Kenya and was present in Kenya for any period in the year of income under consideration; or

• No permanent home in Kenya, but: i. was present in Kenya for a period(s) amounting to 183 days or more in the year of income under consideration; or ii. was present in that year of income, and in each of the two preceding years of income, for periods averaging more than 122 days. Persons who are residents for tax purposes are taxed on their worldwide employment income, while non-resident are taxable on any income that is derived or deemed to be derived from Kenya.

Employers

An employer is defined under the Income Tax Act to include any resident person responsible for the payment of, or on account of, emoluments to an employee; or an agent, manager or other representative so responsible in Kenya on behalf of a non-resident employer.

The employer is required to deduct tax from the emoluments paid to an employee on a monthly basis. Tax deducted should be remitted to the KRA by the ninth day of the following month. Although it is the employee’s responsibility to obtain a PIN, an employer should ensure that all the employees have the number, since it is an offence to pay an employee who does not have one. The penalty for such an offence is KSh2000 ($19.60) for every payment made.

Taxation of Employment Income

Income tax is charged on all the income of a person, whether resident or non-resident, which was accrued in or derived from Kenya. Income from employment includes wages, salary, leave pay, sick pay, payment in lieu of leave, overtime, commission and any other benefit earned or accrued by virtue of employment.

Any income or benefit that an employee accrues from employment income is chargeable to tax, however, there are some exemptions, including medical insurance provided by the employer to the employee and their dependants; reimbursement of expenses; and non-cash benefits of up to KSh36,000 ($353) per annum.

In addition, against their gross employment income, employees are allowed to deduct contributions to a qualifying house ownership savings plan, owner-occupied mortgage interest up to the set limits and qualifying pension contributions.

Return Filing

Each employee is responsible for filing individual self-assessment tax returns. Under the Income Tax Act, they should be filed with the KRA by June 30 of the following year of income. With the introduction of online tax filing, individuals are required to complete their returns online.

Penalties & Interest

Non-compliance with PAYE rules attracts a penalty of 25% on the unpaid tax. In addition, an interest of 1% per month is also chargeable for the period that tax remains unpaid.

VAT Act

In September 2013 the existing legislation regarding VAT was repealed and in its place the VAT Act, 2013 was enacted. This brought with it drastic changes, including the removal of long lists of exempt and zero-rated supplies. This shift was perhaps indicative of the generalised trend towards consumption-based taxes. The scope and coverage of VAT is broad since it applies to all imports, supplies, manufactured goods and services provided in Kenya, except those specifically listed as exempt. VAT is administered through the act and is chargeable on the supply of goods and services in Kenya, including anything specified by the cabinet secretary as such, and on the importation of goods and services.

VAT Rates

For VAT purposes, goods and services (supplies) are categorised as follows:

• Taxable supplies at the standard rate;

• Zero rated supplies; and

• Exempt goods. VAT is charged on taxable supplies at the specified rates. The exempt supplies are not subject to VAT and are listed in the First Schedule to the VAT Act. Zero-rated supplies are listed in the Second Schedule to the VAT Act and are taxed at 0%. All other supplies are taxable at the standard rate of 16%.

The VAT liability or credit is determined by the difference between VAT charged on the supply of goods and services (output VAT), and VAT incurred on purchases, including imports (input VAT). VAT is payable when the output tax is more than the input tax. There are several restrictions on the deductibility of input VAT, in which case it may be expensed or capitalised. Persons in a VAT-recoverable position arising from the supply of zero-rated supplies are required to lodge a claim within 12 months from the date the tax becomes due and payable.

Withholding VAT has been re-introduced where selected corporate entities, government departments, ministries and parastatals are mandated to withhold VAT at 6% of the taxable value from their suppliers during payment and remit the same to the KRA. They are consequently required to issue withholding VAT certificates to the suppliers. The declaration of VAT withheld and generation of withholding VAT certificates is, however, currently automated.

A taxable person is required to register for VAT as soon as the registration threshold is met. Any person who in the course of business has supplied or expects to supply taxable goods or services or both with a value which is KSh5m ($50,000) or more in a period of 12 months should register for VAT.

Registration Requirements

Upon registration, the person is required to comply with the VAT Act by ensuring that:

• VAT is charged on all taxable supplies made at the specified rates;

• A valid tax invoice is issued on supplies made;

• Monthly VAT returns are filed by the due date, which is the 20th of the following month; and,

• Where the output tax (VAT on sales) exceeds the input tax (VAT incurred on purchases), the difference should be paid to the KRA when filing the monthly VAT return. If the input tax exceeds the output tax, the excess amount is carried forward to be offset against future output tax. However, if an entity is dealing with zero-rated supplies, it would always be in a VAT-refund position. The excess credit would be refunded in line with the existing VAT provisions. It is important to note that only registered traders are allowed to charge VAT on their sales. It is an offence to charge VAT if one is not registered. Export of goods and taxable services are zero rated, that is, taxable at a zero rate. This is, however, subject to the satisfaction of the commissioner that such a supply took place in the course of a registered person’s business.

Imported & Exported Services

As noted above, exported taxable services are zero rated and hence not subject to VAT. Conversely, where imported services are made to a registered person, he is deemed to have a taxable supply. Reverse VAT is payable only to the extent that a registered person is not entitled to a credit for part of the input tax payable, to the extent the registered person’s imported services are incurred for the purpose of generating exempt supplies.

The VAT Act provides the definition of importation and export as follows: “export” means to take or cause to be taken from Kenya to a foreign country or to an export processing zone; “importation” means to bring or cause to be brought into Kenya from a foreign country or from an export processing zone.

Penalties & Interest Framework

Non-payment or late payment of tax attracts simple interest at 1% per month for the period in which the tax remains outstanding, up to a maximum equalling the principal amount. The penalty for late filing of the monthly VAT 3 return is KSh10,000 ($98) or 5% of the tax due, whichever is higher.

Following the enactment of the VAT Act, 2013, the cabinet secretary was to update VAT Regulation, to be in tandem with the act. The cabinet secretary published the updated regulations on March 30, 2017. The updated rulings have not yet taken effect, pending the approval of the National Assembly as laid down in the VAT Act, 2013. In the interim, the subsidiary legislation under the repealed act remains in force, so far as it is not inconsistent with the latter, until subsidiary legislation with respect to this domain is made under the VAT Act, 2013.

Withholding Tax

In Kenya, a resident person or a person having a permanent establishment is required to withhold tax on various payments to both residents and non-residents in line with the Income Tax Act. Withholding tax is applicable on payments such as dividends; interest; commission; royalties; management; professional and training fees; sporting and entertainment income; pension retirement annuities; rent; and agency, consultancy and contractual fees. In addition, real estate rent to non-residents is also subject to withholding tax.

Whether or not payments are subject to withholding tax depends on the nature of the payment and whether it falls under any of the classifications above.

Treaties & Computation

Lower rates of withholding tax are applicable on some payments to residents of countries that have double-tax agreements with Kenya.

The country has entered into a number of similar treaties with the UK, Denmark, Norway, Germany, India, Canada, Sweden, Zambia, South Africa, France, the UAE, Qatar, South Korea and Iran. The treaty rates are as follows:

• 5% applies where the recipient is the beneficial owner;

• 5% applies where the recipient directly or indirectly owns 10% or more of the paying company, 10% in all other cases; and

• 8% applies when the recipient directly holds 25% of the capital of the paying company, or 10% in all other cases. Where the treaty rate is higher than the non-treaty rate, the lower rate applies.

Withholding tax is based on gross fees before other charges, such as VAT. Where the fee is negotiated net of taxes, especially by non-residents, the amount should be grossed up using the appropriate rate of tax that is applicable for the country in which the payments are being remitted.

Tax Payment, Returns & Penalties

The person making the withholding tax payment acts as an agent of the KRA by deducting the tax due and remitting the same to the KRA by the 20th day of the month following the deduction.

Failure to withhold and remit the tax to the KRA attracts a penalty of 10% – subject to a maximum of KSh1m ($9800) – and interest of 1% per month for the period the tax remains outstanding. Interest is restricted to a maximum of the principal tax owing.

A certificate of withholding tax in the prescribed form should be issued to the person for whom tax has been withheld. With the automation of the payment of taxes, a certificate is automatically sent to the withholdee when the withholder pays the amount withheld.

International Trade & Excise Duties

International trade has been on an upward trajectory in Kenya. This is mainly attributable to the developments in the oil and gas industry as well as the expansion of manufacturing entities in both the country and the region.

Customs and excise duties are administered under two principal legislative measures in Kenya; the Excise Duty Act, 2015, for excise duty administration and the EAC Customs Management Act, 2004, for Customs duties administration.

Excise duties in Kenya are managed and administered under the Excise Duty Act, 2015, and are imposed on specified imported or locally manufactured goods and services listed under the First Schedule to Excise Duty Act, 2015.

Goods that are subject to excise duty include wines and spirits, beer, bottled water, soft drinks and cigarettes. Excisable services include mobile and wireless phone services, fees on money transfer services and “other fees” charged by financial institutions, which are defined in the Excise Duty Act, 2015.

The value of imported goods for purposes of levying excise duty is the sum of the value of such goods ascertained for the purposes of import duty and the amount of import duty, suspended duty and dumping duty, if applicable.

Customs

Customs duties include import duty, excise duty, VAT, an import declaration fee and a railway development levy. Customs duties are payable by importers at the point of importation.

Importers are required to correctly compute and settle payment for taxes based on applicable principles including Customs valuation, tariff classification and rules of origin.

When goods are imported the following duties and charges are applied depending on the category of goods and also pertaining to a number of exemption regimes:

• Import duty – 0% to 25% (with some sensitive items attracting 35-100%);

• Excise duty – Various specific (per quantity) duty rates with a few ad-valorem (percentage based on value) rates;

• VAT – 0% or 16%;

• Import Declaration Fee – 2%; and

• Railway development levy – 1.5%. In terms of import duty rates, Kenya and other East African countries employ a tripartite structure:

• Raw Materials – 0%

• Intermediate goods – 10%

• Finished goods – 25% Some raw materials that may also be intermediate or finished goods may be charged more than 0%.

Preferential Rates of Import Duty

Kenya is currently a member of the EAC, as well as COMESA. Any goods imported from member countries of either entity will therefore be taxed at a lower preferential import duty rate. For EAC imports, the duty rate is zero, whereas for COMESA imports the rates are between 0 and 1%.

Transfer Pricing

Kenya continues to attract foreign investment, particularly multinational corporations who are keen to make an entry into the larger East African market. This has presented challenges to the tax authorities who have had to contend with the complicated accounting systems used by these multinationals.

In a bid to ensure that multinational corporations contribute their fair share of taxes from the income derived in Kenya, the KRA has intensified efforts to curb any accounting malpractice that may result in reduced tax liabilities for these entities.

Transfer pricing in Kenya is governed by Section 18 of the Income Tax Act and the Transfer Pricing Rules, 2006. These regulations empower the commissioner to adjust the profits of a person who carries on business inside the country with a related non-resident person, where the business is such that it produces to the resident person either no profits or less than ordinary profits.

The Income Tax Act requires that transactions between the person in Kenya and any related non-resident party are made at arm’s length, i.e, the price charged for the transactions should be the same as what is payable between independent enterprises.

In parallel with the transfer pricing rules, the branch will be under an obligation to prepare sufficient transfer pricing documentation in support of any transaction that they undertake with a related non-resident entity.

This would include transactions with the head office or with other branches. The transfer pricing documentation should, at a minimum, provide details in regard to the following:

• The details of the transaction under consideration;

• The selection of the transfer pricing method and the reasons for its selection;

• The application of the method, including the calculations made and price adjustment factors considered;

• The assumptions, strategies and policies applied in selecting the method; and

• Other important background information that it may be necessary to provide regarding the transaction. The KRA has recently introduced transfer pricing rules for transactions between resident-related entities where one of the related parties is operating within a preferential tax regime.

Recent Developments

The Income Tax Bill, 2018, which proposes to repeal the existing Income Tax Act and introduce fundamental changes to the overall tax framework, was tabled in Parliament for debate in April 2018. Public participation in the bill has already taken place, which is a requirement of the Kenyan constitution, with the new bill expected to come into effect in 2019.

Some of the key changes proposed by the bill include:

• Introduction of a 35% corporation tax rate for taxable income above KSh500m ($4.9m);

• Introduction of 10% branch repatriation tax; and

• Introduction of country-by-country reporting for transfer pricing documentation.