Principles of Taxation PDF

Principles of taxation  A brief history of taxation About 5,000 years ago, we see the first record of taxation in ancient Egypt, where the Pharaoh collected a tax equivalent to 20 percent of all grain harvests. At the time, Egypt was without coined money, so grain represented a tangi...

Principles of taxation  A brief history of taxation About 5,000 years ago, we see the first record of taxation in ancient Egypt, where the Pharaoh collected a tax equivalent to 20 percent of all grain harvests. At the time, Egypt was without coined money, so grain represented a tangible store of value that could easily be collected, traded, and redistributed throughout society. As with many modern innovations, the Greeks were responsible for taking the idea of taxation and spreading it throughout the developed world, as they expanded their realm and civilization evolved. It was Benjamin Franklin, the US Founding Father and statesman, who famously said that in this world nothing is certain except death and taxes. He was speaking over 200 years ago yet the adage is as true today as it was then. This article shows how governments since ancient times have raised taxes in times of war or emergency. Taxation has its historical roots in the first years of record-keeping: the earliest signs are recorded on clay tablets found in Sumeria in southern Mesopotamia, part of modern-day Iraq. Tax records there date from around 3300 BC. Archaeology confirms that Egypt employed one of the first tax systems: between 3000 and 2800 BC, Egyptian pharaohs employed collectors or scribes to impose levies on a range of goods and produce, such as cooking oil. Tax was collected twice a year and provided revenue primarily to fund government activity, to support the head of state and to finance the conduct of wars. Ancient Greece and Rome are often cited, too, among the earliest regimes attempting to raise taxes in an effort to generate funds for government expenditure. Greek city states imposed taxes on commodities when wars were fought or when there was an emergency, but (where some form of democracy applied) usually direct taxation only applied to the part of the population entitled to vote. In times of peace, the state governors sometimes paid back revenue no longer required for military conflict. In the Dark Ages, after the Roman Empire collapsed in Europe, Europe returned to less sophisticated tax systems that varied from kingdom to kingdom. Karl Marx saw the feudal network as he understood it as muddled and uncoordinated, taking a toll on the development of European economies. Feudal taxation was highly indirect: large classes were expected to give their labour and its fruits to the overlord and monarchs occasionally brought in levies to cover military engagements (or extravagance), which were resented by the populace. These were generally on assets, like the famous Window Tax introduced under William and Mary and only repealed 150 years later. By the 18th century, the intelligentsia began to discuss the purpose of government. Industrialization led to calls for political and economic reform and for the tax system to tackle the accompanying expansion and growth: rich merchants reaped extensive profits from colonies in Africa, Asia and elsewhere. In Europe, income tax was introduced in the eighteenth century, as in ancient times, to cover foreign wars. Monarchs’ ruthless demands on their taxpayers sometimes led to revolutions. The evolution of taxation is attributed to the development of the modern state, which led to increased expenditure for infrastructure and public services. Tax is the price we pay for civilization, which goes hand in hand with organized society. For society to be organized, it needs a well-financed administrative structure. Therefore, taxation in its different forms has existed as long as society had the minimum elements of government. History of Taxation in East Africa Taxation as understood today was introduced in East Africa by the early British colonial administrators through the system of compulsory public works such as road construction, building of administrative headquarters and schools, as well as forest clearance and other similar works. Theory of taxation The economists have put forward many theories or principles of taxation at different times to guide the state as to how justice or equity in taxation can be achieved. The main theories or principles in brief, are: (i) Benefit Theory: According to this theory, the state should levy taxes on individuals according to the benefit conferred on them. The more benefits a person derives from the activities of the state, the more he should pay to the government. This principle has been subjected to severe criticism on the following grounds: Firstly, If the state maintains a certain connection between the benefits conferred and the benefits derived. It will be against the basic principle of the tax. A tax, as we know, is compulsory contribution made to the public authorities to meet the expenses of the government and the provisions of general benefit. There is no direct quid pro quo in the case of a tax. Secondly, most of the expenditure incurred by the slate is for the general benefit of its citizens, It is not possible to estimate the benefit enjoyed by a particular individual every year. Thirdly, if we apply this principle in practice, then the poor will have to pay the heaviest taxes, because they benefit more from the services of the state. If we get more from the poor by way of taxes, it is against the principle of justice? (ii) The Cost of Service Theory: Some economists were of the opinion that if the state charges actual cost of the service rendered from the people, it will satisfy the idea of equity or justice in taxation. The cost of service principle can no doubt be applied to some extent in those cases where the services are rendered out of prices and are a bit easy to determine, e.g., postal, railway services, supply of electricity, etc., etc. But most of the expenditure incurred by the state cannot be fixed for each individual because it cannot be exactly determined. For instance, how can we measure the cost of service of the police, armed forces, judiciary, etc., to different individuals? Dalton has also rejected this theory on the ground that there s no quid pro qua in a tax. (something for something). iii) Ability to Pay Theory: The most popular and commonly accepted principle of equity or justice in taxation is that citizens of a country should pay taxes to the government in accordance with their ability to pay. It appears very reasonable and just that taxes should be levied on the basis of the taxable capacity of an individual. For instance, if the taxable capacity of a person A is greater than the person B, the former should be asked to pay more taxes than the latter. It seems that if the taxes are levied on this principle as stated above, then justice can be achieved. But our difficulties do not end here. The fact is that when we put this theory in practice, our difficulties actually begin. The trouble arises with the definition of ability to pay. The economists are not unanimous as to what should be the exact measure of a person's ability or faculty to pay. The main view points advanced in this connection are as follows: (a) Ownership of Property: Some economists are of the opinion that ownership of the property is a very good basis of measuring one's ability to pay. This idea is out rightly rejected on the ground that if a persons earns a large income but does not spend on buying any property, he will then escape taxation. On the other hand, another person earning income buys property, he will be subjected to taxation. Is this not absurd and unjustifiable that a person, earning large income is exempted from taxes and another person with small income is taxed? (b) Tax on the Basis of Expenditure: It is also asserted by some economists that the ability or faculty to pay tax should be judged by the expenditure which a person incurs. The greater the expenditure, the higher should be the tax and vice versa. The viewpoint is unsound and unfair in every respect. A person having a large family to support has to spend more than a person having a small family. If we make expenditure. as the test of one's ability to pay, the former person who is already burdened with many dependents will have to' pay more taxes than the latter who has a small family. So this is unjustifiable. (c) Income as the Basics: Most of the economists are of the opinion that income should be the basis of measuring a man's ability to pay. It appears very just and fair that if the income of a person is greater than that of another, the former should be asked to pay more towards the support of the government than the latter. That is why in the modern tax system of the countries of the world, income has been accepted as the best test for measuring the ability to pay of a person.  It is also reasonable to demand certain other things of a tax system – for example, that the amounts of tax individuals pay should bear some relationship to their abilities to pay… Good taxes meet four major criteria. They are (1) proportionate to incomes or abilities to pay (2) certain rather than arbitrary (3) payable at times and in ways convenient to the taxpayers and (4) cheap to administer and collect. In modern public-finance literature, there have been two main issues: who can pay and who can benefit (Benefit principle). Influential theories have been the ability theory presented by Arthur Cecil Pigou and the benefit theory developed by Erik Lindahl. There is a later version of the benefit theory known as the "voluntary exchange" Under the benefit theory, tax levels are automatically determined, because taxpayers pay proportionately for the government benefits, they receive. In other words, the individuals who benefit the most from public services pay the most taxes. Here, two models adopting the benefit approach are discussed: the Lindahl model and the Bowen model  Lindahl's model Lindahl tries to solve three problems:  Extent of state activity  Allocation of the total expenditure among various goods and services  Allocation of tax burden Government Systems government (central or local government) provides some goods and services to the public. The goods and services provided to the public cost money which means that the government must incur expenditure in providing them. This is referred to as the government expenditure. On the other hand, the government cannot incur any expenditure unless it first obtains money in form of government revenue or income. The major source of government income is taxation. Taxation may be referred to as the revenue raising activity of the government. Taxation is part of public finance. Public finance is the study of the spending and revenue raising activities of the government. ACTIVITIES OF THE GOVERNMENT A government is expected to carry out some activities as part of its service to the public. These activities are generally of universal application, but where applicable, a Kenyan example is given to drive the point home. These activities are: 1.To maintain internal security and external defence and carry out general administration. In this respect, it will incur expenditure relating to:  The cost of police and judiciary for maintenance of law and order.  The cost of the armed forces such as the army, navy and air force for defence against external aggression  Cost of provincial administration and general administration of law and order. 2. To provide infrastructure and communication such as: Cost of constructing roads, railways, airports and harbours. Cost of constructing electricity and telephone networks, television and radio systems etc. 3. To provide basic social services such as the cost of: Medical services and medicine in hospitals. Education in schools, colleges and universities. Water supply and sewerage. Sports and cultural activities. Entertainment and information on radio and television. 4. To participate in the production and marketing of commercial goods and services: Cost of establishing public enterprises such as parastatals. Combining with private business through purchase of shares in commercial enterprises. There is pressure all over the world for government to divest or privatise business enterprises. Providing in form of easy loans not obtainable in financial institutions, and providing cheap business premises such as the industrial estates , export processing zones etc. Guaranteeing markets through protection from competition and preferential purchases. 5. Influencing and guiding the level and direction of economic activities through various regulations: Monetary policy (relating to interest and money supply); Fiscal policy (deliberate manipulation of government income and expenditure so as to achieve desired economic and social goals). 6. Redistributing income and wealth through taxation and public spending: Taxing the rich and those able to afford tax. Cost of providing basic needs to the poor such as free education, medical care and housing. Cost of relief of famine and poverty which may arise from unemployment, sickness, old age, crop failure, drought, floods, earthquakes etc. To perform the above functions effectively and adequately, the government needs funds. Taxation is an important source of government income. The income of the government from taxes and other sources is known as public revenue.  PUBLIC REVENUE Public revenue is all the amounts which are received by the government from different sources. The main sources of public revenue are as follows: 1.TAXES Taxes are the most important source of public revenue. Any tax can be defined as an involuntary payment by a taxpayer without involving a direct repayment of goods and services (as a "quid pro quo") in return. In other words, there is no direct goods or services given to a taxpayer in return for the tax paid. The taxpayer can, however enjoy goods or services provided by the government like any other citizen without any preference or discrimination. The following features are common in any tax system: Taxing authority—This is the authority with the power to impose tax e.g. the central government or a local authority. The taxes are received as public revenue. The taxing authority has power to enforce payment of tax. Taxpayer—The person or entity that pays the tax e.g. individuals, companies, business and other organizations. The amount of tax is compulsory and there is punishment for failure to pay. Tax—The amount paid to the taxing authority as direct cash payment or paid indirectly through purchase of goods or services. The tax is not paid for any specific service rendered by the tax authority to the taxpayer. The tax paid becomes revenue and is used to provide public goods and services to all citizens. In addition to the above common features of tax, the definitions of tax by some tax experts as listed below are important: A) A compulsory contribution to a public authority, irrespective of the exact amount of service rendered to the taxpayer in return. B) A compulsory contribution from a person to the government to defray the expenses incurred in the common interest of all. C) A compulsory contribution of wealth by a person or body of persons for the service of the public. There is a portion of the produce of the land and labour of country that is placed at the disposal of the government for the common good of all. THERE ARE DIFFERENT KINDS OF TAXES: 1. Income tax—this is tax imposed on annual gains or profits earned by individuals, limited companies, business and other organisations. The income tax will be explained in lessons 2 to 6. 2. Value added tax (V.A.T.)—This is tax imposed on sale of commodities and services introduced in Kenya with effect from 1.1.90. The V.A.T. 3. Sales tax—This is tax imposed on sale of commodities which was abolished in Kenya on 31.12.89 and replaced with value added tax. 4. Excise duty—This is tax imposed on commodities produced locally. 5. Customs duty—This is tax imposed on import or export of commodities. 6. Stamp duty—This is tax imposed on the transfer of property 7. Land, rent and rates—This is tax imposed on property. Rent is paid to the central government on some land leases while rates are paid to the local authority based on the value of property. 2. FEES Fees is an amount which is received for any direct services rendered by the central or local authority e.g. television and radio fees, national park fees, airport departure fee, airport landing and parking fee, port fee by ships, university fee, etc. 2. PRICES Prices are those amounts which are received by the central or local authority for commercial services e.g. railway fare, postage and revenue stamps, telephone charges, radio and television advertisement etc. 3. EXTERNAL BORROWING This is done from international financial institutions such as World Bank and IMF. Other foreign government are also lenders. 4. FINES AND PENALTIES, If individuals and firms do not obey the laws of the country, fines and penalties are imposed on them. Such fines and penalties are also the income of the government. 6. STATE PROPERTY Some land, forests, mines, national parks, etc. are government property. The income that arises from such property is also another source of public revenue. The income will arise from payment of rents, royalties, or sale of produce. 7. INTERNAL BORROWING The government usually raise revenue through issue of treasury bills and treasury bonds in the local market. THE PURPOSES OF TAX The raising of the revenue is not the only purpose for which taxes are levied. The taxes are levied for various purposes as follows: 1. Raising Revenue the main purpose of imposing taxes is to raise government income or revenue. Taxes are the major sources of government revenue. The government needs such revenue to maintain the peace and security in a country, to increase social welfare, to complete development projects like roads, schools, hospitals, power stations, etc. 2. Economic Stability Taxes are also imposed to maintain economic stability in a country. In theory, during inflation, the government imposes more taxes in order to discourage the unnecessary expenditure of the individuals. On the other hand, during deflation, the taxes are reduced in order to encourage individuals to spend more money on goods and services. The increase and decrease in taxes helps to check the big fluctuations in the prices of goods and services and thus maintain the economic stability.  3. Protection Policy Where a government has a policy of protecting some industries or commodities produced in a country, taxes may be imposed to implement such a policy. Heavy taxes are therefore imposed on commodities imported from other countries which compete with local commodities thus making them expensive. The consumers are therefore encouraged to buy the locally produced and low priced goods and services. 4. Social Welfare Some commodities such as wine, alcoholic drinks, tobacco, cigarettes, etc. are harmful to human health. To discourage wide consumption of these harmful commodities, taxes are imposed to make the commodities more expensive and therefore out of reach of as many people as possible.. 5. Fair Distribution Of Income In any country, some people will be rich and others will be poor due to limited opportunities and numerous hindrances to becoming wealthy. Taxes can be imposed which aim to achieve equality in the distribution of national income. The rich are taxed at a higher rate and the amounts obtained are spent on increasing the welfare of the poor. That way, the taxes help to achieve a fair distribution of income in a country  6. Allocation Of Resources Taxes can be used to achieve reasonable allocation of resources in a country for optimum utilization of those resources. The amounts collected from taxes are used to subsidise or finance more productive projects ignored by private investors. The government may also remove taxes on some industries or impose low rates of taxes to encourage allocation of resources in that direction. 7. Increase In Employment Funds collected from taxes can be used on public works programs like roads, drainage, and other public buildings. If manual labour is used to complete these programs, more employment opportunities are created POWER TO TAX The laws of a country will authorise the government (central or local authority) to levy taxes. The taxes imposed are legally enforceable and must be paid by all those individuals and organisations that come within the jurisdiction of the taxing authority. There are fines and penalties for failure to pay taxes. The parliament and local councils have the power to pass laws and by-laws, respectively, that govern taxes. As people's representatives sit in parliament and councils, the final power to tax rests with the people. In our country, the Central Government and the Local Authorities (municipal, town, urban, and county councils) are authorised to impose taxes. Every year in June, the Minister for Finance presents the budget before Parliament (National Assembly). Briefly, the budget is a statement of the government expenditure and the sources of funds to finance the expenditure. The Local Authorities must also present their annual budgets. The purpose of presenting budgets which have to be approved by the relevant authorities is that all taxes that are imposed must be approved and authorised. The main taxes of the Central Government are usually value-added tax, income tax, custom duty, excise duty, stamp duty, etc. The main taxes of a local authority are usually rates, poll tax, fees, service charge, etc PRINCIPLES OF AN OPTIMAL TAX SYSTEM The principles of an optimal tax system, what are known as Canons of taxation were laid down by Adam Smith. 1. Simplicity A tax system should be simple enough to enable a taxpayer to understand it and be able to compute his/her tax liability. A complex and difficult to understand tax system may produce a low yield as it may discourage the taxpayer's willingness to declare income. It may also create administrative difficulties leading to inefficiency. The most simple tax system is where there is a single tax. However, this may not be equitable as some people will not pay tax. 2. Taxable Capacity This refers to the maximum tax which may be collected from a taxpayer without producing undesirable effects on him. A good tax system ensures that people pay taxes to the extent they can afford it. There are two aspects of taxable capacity. A) Absolute taxable capacity B) Relative taxable capacity Absolute taxable capacity is measured in relation to the general economic conditions and individual position e.g. the region, or industry to which the taxpayer belongs. If an individual, having regard to his circumstances and the prevailing economic conditions pays more tax than he should, his taxable capacity would have been exceeded in the absolute sense. Relative taxable capacity is measured by comparing the absolute taxable capacities of different individuals or communities. 3.Administrative Efficiency A good tax system should be capable of being administered efficiently. The system should produce the highest possible yield at the lowest possible cost both to the tax authorities and the taxpayer. The tax system should ensure that the greatest possible proportion of taxes collected accrue to the government as revenue. 4. Neutrality, Neutrality is the measure of the extent to which a tax avoids distorting the workings of the market mechanism. It should produce the minimum substitution effects. The allocation of goods and services in a free market economy is achieved through the price mechanism. A neutral tax system should not affect the taxpayer's choice of goods or services to be consumed. 5.Certainty The tax should be formulated so that taxpayers are certain of how much they have to pay and when. The tax should not be arbitrary. The government should have reasonable certainty about the attainment of the objective(s) of that tax, the yield and the extent to which it can be evaded. There should be readily available information if taxpayers need it. Certainty is essential in tax planning. This involves appraising different business or investment opportunities on the basis of the possible tax implications. It is also important in designing remuneration packages. Employers seek to offer the most tax efficient remuneration packages which would not be possible if uncertainty exists. 6. Convenience The method and frequency of payment should be convenient to the taxpayer e.g. PAYE. This may discourage tax evasion. For example, it may be difficult for many taxpayers to make a lump-sum payment of tax at the year-end. For such taxes, the evasion ratio is quite high. 7. Equity A good tax system should be based on the ability to pay. Equity is about how the burden of taxation is distributed. The tax system should be arranged so as to result in the minimum possible sacrifice. Through progressive taxation, those with high incomes pay a large amount of tax as well as a regular proportion of their income as tax. Equity means people in similar circumstances should be given similar treatment (horizontal equity) and dissimilar treatment for people in dissimilar circumstances (vertical equity). There are three alternative principles that may be applied in the equitable distribution of the tax burden. A. The benefit principle B. The ability to pay principle C. The cost of service principle A. The Benefit Principle This dictates that tax is apportioned to individuals according to the benefit they derive from government activity and spending. The state is regarded as a market and taxes are treated as a payment for the goods and services provided by the state. According to the principle, the provision of government goods and services, will, like the provision of private goods and services be dictated by market demand. This provision is inadmissible as it goes against the aims of taxation, which are also the duties of the government in a market economy, namely the redistribution of income and the clearing of market imperfections. In addition, the principle may have application in limited areas where a close relationship between government expenditure and benefit to the taxpayer can be identified. For example road licenses charges are paid by the owners of vehicles who are the road users. However, even in such instances, the road users may not obtain benefit from such payment if the revenue so raised is not applied for the benefit of road users. B. The Ability to Pay Principle This is concerned with the equitable distribution of taxes according to the stated taxable capacity of an individual or to some criterion of ability to pay. This is in keeping with one of the principal aims of taxation, namely the distribution and stabilization objectives. The difficulty in the application of this theory is in determining the criterion of the ability to pay. Three propositions have been advanced; income, wealth and expenditure. Should individuals be taxed according to their income, wealth or expenditure? A wealth-based tax may be useful in the redistribution of income and wealth but may not provide sufficient revenue by itself. An expenditure tax ensures that both income and wealth are taxed, when they are spent. Most tax regimes would, therefore, be partly income-based and partly expenditure based. C. The Cost of Service Principle This is the cost to the authority of the services rendered to individual taxpayers. Tax is a payment for which there is no "quid pro quo" between the tax authority and the taxpayer; the taxpayer does not necessarily have to receive goods and services equivalent to the tax paid. For this reason, the principle cannot be applied in relation to services rendered out of the proceeds of taxes e.g. police, judiciary and defence. Rather, it may be applied for such services as postal, electricity, or water supply where the price of these services are fixed according to this principle, i.e. the price paid for postal services is the cost incurred in providing the service. It can therefore be stated that this principle may have limited application areas. THE INCIDENCE OF TAX AND TAX SHIFTING Tax Shifting This is the transfer of the burden of a tax from the person on whom it is legally imposed to another person. Illustration K Creameries Ltd. buys milk from dairy farmers at Shs 5 per litre and after processing sells it at Shs 10. Assuming that a tax of 20% is imposed on every litre of milk sold, how can it be shifted? 1. If K Creameries Ltd. bears the whole tax i.e. it does not change the buying price or the selling price, there will be no tax shifting. 2. If K Creameries Ltd. transfers the whole tax to the consumers by raising the selling price by Shs 2 to Shs 12 i.e. 20% of Shs 10, it is referred to as forward shifting. 3. K Creameries Ltd. could transfer the whole burden to dairy farmers so that the buying price of milk is lowered by Shs 2 to Shs 3. This is referred to as backward shifting. 4. The tax could be shifted partly forward to the consumers and partly backwards to the farmers. 5. K. Creameries Ltd. could bear part of the tax shift forward partly and shift backwards partly. Tax Burden There are four aspects of tax burden, namely: A. The direct burden; B. The indirect burden; C. The money burden; D. The real burden.  1. The total direct money burden of a tax is its yield to the government. For every shilling of tax received by the treasury there corresponds a shilling of direct money burden upon someone. 2. The payment of tax constitutes a sacrifice of economic welfare or utility to the taxpayer. The sacrifice is relatively greater, for example, to a poor man who parts with a shilling than to a rich man paying the same amount. This is referred to as the direct real burden of tax. 3. A tax on commodity which is shifted forward to the consumers has the effect of raising its price. This may force the consumers to partake less of that commodity. The reduced consumption is the indirect real burden of the tax. 4. In the illustration above, the dealer would pay the tax to the government even before the commodity is sold and the tax recovered from the consumers. Some time will elapse, occasioning an opportunity cost to the dealer equivalent to the interest he could have earned on the money paid to the tax authorities. This constitutes the indirect money burden of the tax. Other examples of indirect money burden of tax would include tax consultancy fees, and the cost of remitting tax. Tax Incidence The incidence of a tax is the direct money burden of the tax. It deals with who ultimately pays the tax. From the illustration given above the incidence of the tax collected from the dealer is: A) wholly on the consumer if, as a direct result of the tax, the price of the commodity rises by at least the full amount of the tax; B) wholly on the dealer if the price does not rise at all; C) partly on the dealer if the price rises by an amount less than the full amount of the tax. The Importance of Tax Incidence There are numerous objectives of taxation. An efficacious tax system must be designed having regard to the possible incidence of the taxation. For example, if a tax is imposed on cigarette sales in order to discourage smoking and hence cut expenditure on health, it must be ascertained whether the smokers will be affected "adversely" by the tax. CLASSIFICATION OF TAXES 1.Direct Taxes A direct tax is one whose impact and incidence are on the same person. The impact of a tax is its money burden. A tax has impact on the person on whom it is legally imposed. The incidence of a tax is on the person who ultimately pays the tax whether or not it was legally imposed on him. Therefore a direct tax is one which is paid (incidence) by the person on whom it is legally imposed (impact). Examples are income tax and corporation tax. 2. Indirect Taxes Indirect tax is one whose impact is on one person, but paid partly or wholly by another. An indirect tax can be shifted or passed on, as opposed to a direct tax which cannot. Examples are taxes on commodities such as a sales tax, duty and excise tax. A tax is not held to be indirect merely because it is collected from one person and paid by another. For example, tax on employment income, Pay As You Earn (PAYE) which is collected from the employees and paid by the employer. Taxes are also classified according to how the marginal rates of tax vary with the level of income. 1.Progressive Taxes tax is progressive when the marginal rate of tax rises with income. A good example of a progressive tax in Kenya is the income tax on individuals. Individual income tax rates for Kenya in 2005 Annual taxable pay (Shs.) Rates of tax % in each Shilling 1 – 121,968 --------------------------------------------10% 121,969 – 236,880-------------------------------------15% 236,881 – 351,792--------------------------------------20% 351,793 – 466,704--------------------------------------25% Over - 466,704------------------------------------------30% Personal relief Sh. l, 162 per month (Sh.13,944 per annum) 2.Proportional Taxes A tax is proportional when the same rate of tax is applied to all taxpayers, for example the corporation tax which currently stands at 30% for all firms. 3. Regressive Taxes A regressive tax is one where the rate of tax falls as income rises. Here, the poor are called upon to make a greater sacrifice than the rich. Illustration: Tax versus base of tax Taxes can be classified on the basis of the object of taxation i.e. the tax base. For example: Income tax - tax based on income Sales tax - tax based on expenditure Wealth tax - tax based on wealth. Progressive taxes are favoured for their redistribution of income. Progressive taxes take a larger proportion of an individual's gross income, the larger his/her income is. In a free market economy, the allocation of goods and services is achieved via the price mechanism, (according to demand which is backed by purchasing power). The price mechanism fails because production of goods and services is not raised to the socially desirable level. Individuals would not be able to satisfy even their basic wants if they do not have the ability to purchase those goods. For example, no entrepreneur will set up private schools or hospitals in remote poverty stricken areas because of lack of demand. The government intervenes to correct the market imperfection by taxing heavily the relatively affluent via a progressive income tax system, in order to fund the provision of essential goods and services at subsidized rates or at zero prices to all. However, a steeply progressive tax system may discourage enterprise. This will be examined later under the effects of taxation. Advantages of Direct Taxes As Opposed To Indirect Taxes 1. They are economical in collection. For example, with income tax the collection is done through employers who are unpaid "tax collectors". 2. Direct taxes, if progressive, can be made to fall equitably on all taxpayers having regard to their relative abilities to pay. Indirect taxes tend to be regressive; i.e. they take more from the poor and relatively less from the rich. 3. Direct taxes are relatively more certain in quantity as opposed to indirect taxes e.g. a sales tax whose yield would depend on the elasticity of demand for the goods taxed. 4. They are usually less inflationary than indirect taxes. Usually indirect taxes are imposed on goods thus raising the price of goods (through forward shifting). The cost of living rises and this may trigger off serious confrontations between workers and employers, as the workers seek salary increases. If the employers grant such increases, it will lead to higher costs of production and prices. Higher prices will affect workers leading to a damaging wage-price spiral. Disadvantages of Direct Taxes As Compared To Indirect Taxes 1.They are costly to administer, for example, every individual liable to income tax would have to be assessed independently depending on his/her taxable capacity. Indirect taxes have fewer collection points leading to administrative efficiency. 2.They are not flexible hence not adaptable to differing circumstances. They cannot be varied so quickly as indirect taxes and therefore, it takes longer for changes to take effect in the economy. 3.Indirect taxes as opposed to direct taxes lack announcement effect i.e. people are often unaware that they are paying tax or even how much they are paying. Direct taxes have direct effect on income and therefore may act as a deterrent to effort and enterprise. On the other hand, indirect taxes, although resulting in higher prices, encourage enterprise as people are induced to work harder so as to afford articles desired. 4.Higher levels of income tax reduce the incentive to save. On the other hand, high levels of indirect taxes, may encourage saving when goods become unaffordable, and purchasing of goods is delayed in the hope that tax will later be reduced. 5.Some forms of direct taxes are paid annually as a lump sum. It may be difficult for the taxpayer to find a lump sum and it gives opportunities for evasion by the submission of fraudulent returns of income. THE ECONOMIC EFFECTS OF TAXATION The quality of a tax system will depend on the effects produced. The best tax system is one which produces the least undesirable effects. The effects of taxation can be examined under two headings: 1.Effects on production 2.Effects on distribution Effects on Production There are two aspects of the effects on production A) Ability to work and save B) Desire to work and save  A) Ability to work and save Taxes have adverse effects on the ability to work if they lower efficiency of the workers. Any person's ability to work will be reduced by taxation which reduces efficiency. This argument applies to the taxation of small incomes and necessities. It also applies to taxes on commodities. Some commodities, which are not strictly necessities, but their consumption contributes to efficiency These will be treated by the workers concerned as "conventional necessities" whose demand is comparatively inelastic. If a tax is imposed on such commodities, and hence an increase in their price will cause an increase in the expenditure upon them. Little income will be left for real necessities leading to lower consumption as if it were the real necessities taxed. The ability to save is reduced by all taxes on those who have any margin of income out of which saving is possible. This happens when a person maintains the same standard of living after the imposition or increase in taxes and does not reduce his expenditure on goods accordingly.  B) Desire to work and save Taxes, especially direct taxes are argued to be a disincentive to work. It is argued that if taxes are cut this will increase incentives because people will receive more from their efforts. The process can be illustrated as follows: Greater incentives will lead to hard work and higher productivity and as the economy expands, create more employment. This will lead to a rise in the level of real national income and a higher yield from taxation. On the other hand, it may be argued that an increase in taxes will induce people to work harder to raise their disposable incomes. After all, at the end of the month they have to find the money to pay rent, debts, school fees, buy food and so on and are thus forced to work harder. It follows that increase in taxation may or may not be a disincentive to work. The effect upon the taxpayer's desire to work and save would depend partly on the nature of the tax and partly on the individual's reaction to taxation. These factors are examined below. A) Nature of taxes An unexpected tax or a temporary tax may not have any effect at all. For example a tax on windfall gains, (unexpected gains), which is unexpected, and will not continue in future may not produce any effects on the desire to work. B) Nature of individual's reaction to taxation The individual's reaction to taxation is largely governed by the elasticity of his/her demand for income, in terms of the efforts and sacrifices which he/she makes in order to obtain his/her net income. Increased taxation lowers the net income earned although the efforts and sacrifice remain the same. If the elasticity of his/her demand for income is small, he/she will desire to work harder. Effects on Distribution A person who owns resources, or by himself/herself embodies resources which in their actual employment are subject to taxation may seek to escape taxation by diverting these resources to other employment in which they will either be untaxed or taxed less heavily. A tax is considered to have adverse effect if it diverts resources from their "natural channels". Conversely, a tax is considered to produce desirable effects on distribution if it helps encourage the flow of resources along their "natural channels". The resources therefore tend to flow in the tax- free direction or where there is less punitive taxation or where generous tax concessions are available. For example, steeply progressive taxation on income may lead to an outflow of high achievers to other countries with lower marginal tax rates at high levels of income. This leads to a loss of their contributions to the economy and such a "brain drain" hinders economic growth and their tax contribution to the exchequer are also lost.  CHAPTER TWO TAXABLE PERSONS, INCOME, RATES OF TAX AND RELIEFS  DEFINITIONS Imposition (charging) of income tax Income Tax, or the tax on income, is charged on income of a person for each year in accordance with section 3(1) of the Income tax Act. It is worth examining the charging section in detail. S 3(1)’’..... a tax to be known as income tax shall be charged for each year of income upon all the income of a person, whether resident or non-resident, which accrued in or was derived from Kenya.’’ The words and phrases highlighted above are crucial in the taxation of income and it is important to understand their meaning in detail. Year of income Year of Income is a period of 12 months commencing 1 January and ending on 31 December in each year. It is the same as calendar year. Income tax is charged for each year of income. The year of income should be distinguished from the accounting year. There is a date to which accounts of a business are prepared each year, and this date would indicate the accounting year end. The accounting year ending on 31 December would coincide with the year of income. Other accounting year-ends would however fall in a given year of income and the profit or loss per the accounts would be for that year of income. For example, an accounting date ended 30 May 1999 would fall to be treated as the year of Income 1999. (Taxable) income The Act does not defined income, but taxable income is said to include gains or profit from various sources, for example:  business profits; employment salary, wages, bonus, commission etc; investment income e.g. interest and dividend income; (Taxable) person A person whose income is taxed is either: A) an individual i.e. a natural person; or B) a legal person e.g. a company. The company here includes a Trust, Co-operative Society, Estate, Club, Trade Association etc. A taxable person does not include a partnership. A partnership is not taxed on its income, but the partners are taxed on their share of profit or loss from the partnership. Resident and non-resident persons There are conditions for being a resident in case of an individual and also in case of a body of persons. A) Resident in relation to an individual means that the individual: i)has a permanent home in Kenya and was present in Kenya for any period during the year of income under consideration; or ii)has no permanent home on Kenya but was present in Kenya for a period or periods amounting in total to 183 days or more during the year of income under consideration; or iii)has no permanent home in Kenya but was present in Kenya for any period during the year of income under consideration and in the two preceding years of income for periods averaging more than 122 days for the three years. Example Mondo and Titi visited Kenya between 2003 and 2005 as follows. Days in Kenya Year Mondo Titi 2003 365 364 2004 1 1 2005 3 1 Total days 369 366 divide by 3 divide by 3 Average for the three years 123 days 122 days Mondo was a resident in 2002 as the average days for the three years is more than 122 days. Titi was not a resident in 2002 as the average days for the three years at 122 is not more than 122 days. Kenya includes the air space which is a distance up in the sky considered to be part of Kenya. It also includes the Territorial waters which is a distance into the sea considered to be part of Kenya. B) Resident in relation to a body of persons means that: i) the body is a company incorporated under the laws of Kenya; or ii) the management and control of the affairs of the body was exercised in Kenya in the year of income under consideration; or iii)the body has been declared, by the Minister for Finance by a notice in the Gazette, to be resident in Kenya for any year of income. C) Non-Resident: Means any person (individual or body of persons) not covered by the above conditions for resident. Note Residents have some tax advantages over non-residents which relate to tax reliefs, rates of tax, and expenses allowable against some income. (Income) Accrued in or Derived From Kenya The income which is taxable is income arising from or earned in Kenya. Under certain conditions, some business and some employment income derived from outside Kenya is taxable in Kenya. TAXABLE INCOME Some items of income are subject to tax and others are not. The Act has listed the income upon which tax is charged. The income which is taxed is income in respect of: A) gains or profits from business; B) gains or profits from employment or service rendered; C) gains or profit from rights granted to other persons for use or occupation of property e.g. rent; D) dividend and interest; E) pension, charge or annuity, and withdrawals from registered pension and provident funds; F) an amount deemed to be income of a person under the Act or rules made under the Act; Any person (individual or legal person) who receives all or some of the above income in a given year of income is taxed on the income. Each item of taxable income will be examined in detail to see the various components that make up the particular item of income. There are items which are commonly referred to as income but are not included in the above list of taxable income. A number of such non-taxable incomes come to mind such as dowry, lottery winning, post office premium bond winning, gifts, horse race winning, harambee collections, donations received, foreign income, betting's winning, inheritance, and profit on sale of isolated assets unless dealing in them as a business. This list is not exhaustive. We will now look at the items of taxable income in more detail. Gains Or Profits From Any Business, For Whatever Period Of Time Carried On. The Income Tax Act has defined business to include any trade, profession or vocation, and every manufacture, adventure and concern in the nature of trade, but does not include employment. Trade means buying and selling for gain; Profession means professional practice such as by a doctor, lawyer, accountant etc; Vocation means a calling or career; Adventure would include smuggling and poaching; Concern would mean any commercial enterprise. Business may be carried on for a short time or a full year. The period a business is carried on is irrelevant in taxing the income (gains or profits) and so the use of the phrase "for whatever period" of time (business is) carried on. The Act charges tax on gains or profits from any business. One person may carry on illegal business and another one may carry on a legal business. Both would be taxed on gains or profits from business as the Act is not concerned with the legality of the business when it comes to taxing the business income (gains or profit). The following items whenever they arise will form part of the gains or profits from business: 1)An amount of gains from ordinary business arising from buying and selling as a trade e.g. butchery, grocery, manufacture, transport etc. 2)Where business is carried on partly within and partly outside Kenya, by a resident person, the gains or profits are deemed to be derived from Kenya. A good example of this is a transporter who transports goods from Mombasa to Kigali (trading in Kenya) and then transports goods from Kigali to Kampala and to Mombasa (trading outside Kenya). 3)An amount of insurance claim received for loss of profit or for damage or compensation for loss of trading stock. 4)An amount of trade debt recovered which was previously written off. 5)An amount of balancing charge. This arises where business has ceased and the machinery in a class of wear and tear is sold for more than the written down value. For example: Wear and tear computation Class III Shs Sale proceeds (business ceased) 35,000 Written down Value 30,000 Balancing Charge (taxable income) 5,000 when dealing with the calculation and claim for wear and tear deduction, which at this point may be viewed as the standard depreciation for tax on machinery used for business. 6) An amount of trading receipt. This arises where business is continuing and all the machinery in a class of wear and tear is sold for more than the written down value. For example, the same figures as in 5 above can be used: Wear and tear computation Class III Shs Sale proceeds (business continuing) 35,000 Written down Value 30,000 Trading receipts (taxable income) (5,000) 7. An amount of realized foreign exchange gain. If the foreign exchange gain is not realized, it is not taxable. Gains or Profits from Employment or Service Rendered An employee can be said to be a holder of a public office or other appointment for which remuneration is paid. The remuneration is the reward or pay for work or service rendered, for example, in the case of a minister, civil servant, company directors, company secretary, accountant, clerk, engineer, and all those commonly referred to as employees. An employer will include: A) the person having the control of payment of remuneration; or B) any agent, manager or other representative in Kenya of a branch of an overseas company; or C) any paying officer of the Government or other public authorities. The above definitions are particularly important in relation to Pay As You Earn (PAYE) operations. This is the system of deducting tax, monthly, when the employer is paying emoluments. Gains or profits from employment or service rendered will include cash as well as non-cash payments. 1. Cash payments to employees will include: A)Wages, salary, leave pay, sick pay, payment in lieu of leave, director's fees, overtime, commission, bonus, gratuity, compensation for the termination of any contract of employment or service etc. B)Cash allowances and all round sum expense allowances, for example, house or rent allowance, cost of living allowance, clothing allowance, etc however named. C)Employees' private expenditure paid by employer. The bills in this case would be in the name of the employee who is responsible for meeting the expenses. The examples of such expenses would include house rent, grocery bill, electricity bill, water bill, school fees, insurance premium etc. D)An amount of subsistence, travelling, mileage, and entertainment allowance. When these are paid to employees as mere reimbursements (refunds) of expenses of employer, they are not taxable employment income. As reimbursement (refund) they must be documented, that is claimed with supporting documents.  E) Amounts deemed to be gains or profits from employment derived from Kenya: I) an amount paid to resident person for employment or service rendered inside or outside Kenya if resident at the time of rendering service. A resident is therefore taxed on worldwide employment income. II) an amount paid for employment or service rendered to an employer who is resident in Kenya or with a permanent establishment in Kenya. A non-resident person is therefore taxed on income from service rendered to a resident person. 2. Non-cash Employment Income will include: A) The benefit, advantage, or facility arising from employment. These are taxed if they aggregate (total) in value to (Kshs 36,000) or more in a year of income. The benefits that are taxed are: (i)Facilities e.g. free lunch, transport, gift by employer etc. (ii)Servants provided by employer, for example house servants, cooks, watchman (day and/or night), ayah, and gardener. The Commissioner of Income Tax has quantified the value of the benefits as shown below. An employee is taxed on the cost of providing the benefit or the quantified value of the benefit, whichever is higher. (iii)Services provided by employer, for example, water, telephone, electricity, furniture, and radio and electronic alarm system. The Commissioner of Income Tax has quantified the value of some benefits as shown below. The employee is taxed on the market value or the cost of providing the service, whichever is the higher, except in the cases of telephone, furniture, and electricity from a generator to agricultural employees. IV) Motor car provided by employer. The Commissioner of Income Tax (CIT) has quantified the value of the benefit on the basis of the engine capacity rating. Employees are taxed at the quantified value or 24%p.a. of the initial expenditure on the motor vehicle, whichever is higher. If the motor vehicle is leased/hired by the employer, the taxable benefit on the employee shall be the higher of: 1) 24% p.a. of cost or 2) Hire charges paid. VALUE OF TAXABLE BENEFITS PRESCRIBED BY CIT (YEAR 2005) Taxable Employment Benefits - Year 2005 RATES OF TAX (Including wife’s employment, self-employment and professional income rates of tax). Year of income 2005.  Monthly taxable pay Annual taxable pay Rates of tax % in each (shillings) (shillings) shilling 1 - 10,164 1 - 121,968 10% 10,165 - 19,740 121,969 - 236,880 15% 19,741 - 29,316 236,881 - 351,792 20% 29,317 - 38,892 351,793 - 466,704 25% Excess over - 38,892 Excess over - 466,704 30% NB. Personal relief Shs. 1,162 per month (Shs. 13,944 per annum) Commissioner’s prescribed benefit rates Services Monthly rates Annual rates Sh. Sh. (i) electricity (Communal or from a generator) 1,500 18,000 (ii) Water (Communal or from a borehole) 500 6,000 (iii) Provision of furniture (1% of cost to employer) If hired, the cost of hire should be brought to charge (iv) Telephone (Landline and mobile phones) 30% of bills Agricultural employees: Reduced rates of benefits (i) Water 200 2,400 (ii) Electricity 900 10,800 Low interest rate employment benefit: The benefit is the difference between the interest charged by the employer and the prescribed rate of interest. Other benefits: Other benefits, for example servants, security, staff meals etc are taxable at the higher of fair market value and actual cost to employer. Note Range Rovers and vehicles of a similar nature are classified as Saloons.  B) Housing Benefit. – Section 5 (3) A housing benefit arises where an employee is housed by the employer. The employer may own the house or lease it from other parties. To determine the amount of housing benefit, the employees are classified into six groups and the value of the housing benefit will depend on this classification: Ordinary Employee 15% of his gains or profits from employment (i.e. monthly cash pay plus benefits); excluding the value of those premises, minus rent charged to the employee; subject to the limit of the rent paid by the employer if that is paid under agreement made at arm’s length with a third party. Agricultural employees Including a whole-time service director) who is required by terms of employment to reside on a plantation or farm: - 10% of his gains or profits from employment – (i.e. monthly cash pay plus benefits), minus amount of rent charged to the employee. This is subject to employer obtaining prior approval from Income Tax Office – Note also reduced rates of benefits for agricultural employees – (Page 6).  Director, Fifteen per cent (15%) of his total income; excluding the value of those premises minus amount of rent charged to the director; PROVIDED THAT: - A) If employer pays rent under an agreement not made at arm’s length with a third party; the value of quarters shall be; the fair market rental value of the premises in that year or rent paid by employer, whichever is higher, OR B) Where premises are owned by the employer, the fair market rental value in that year is to be taken.   Whole-time Service Director 15 per cent of gains or profits from his employment, excluding the value of those premises, minus amount of rent charged to the director, PROVIDED THAT: - A)If employer pays rent under an agreement not made at arm’s length with a third party, the value of the quarters shall be; the fair market rental value of the premises in that year or rent paid by the employer; whichever is higher, OR B)Where the premises are owned by employer; the fair market rental value of the premises in that year is to be taken. This means therefore that directors and whole-time service directors will be subject to the new provisions irrespective of their level of earnings. The new provisions are effective from 11th June, 1998. Notes: - In calculating the housing benefits the employer is required to deduct rental charges recovered from the employee or director. The amount remaining is the chargeable value to be included in the total taxable amount. - If the premises are occupied for part of the year only, the value is 15% of employment income relative to the period of occupation less any rental charges paid by employee/director. - Any employee who provides other than normal housing to an employee should consult his local Income Tax office regarding the value of such housing. - Whole-time service director is a director who is required to: - A) devote substantially the whole of his time to the service of the company in a managerial or technical capacity; and B) does not own or control, directly or indirectly, more than 5% of the share capital or voting power of such a company. Shares owned by spouse or own shares in the company are included in computing the 5% control.   Accommodation and Meals Provided If an employee is accommodated within the employer’s premises and is also provided meals, the value of the benefits shall be 10 per cent of the gains or profits from employment for accommodation and 10 per cent representing meals making a total charge of 20%. In situations other than where accommodation and meals are provided to employee, the taxable value of the benefit should be determined as is explained in paragraph 5 (e) of the Guide Book. Note The value of housing in this case will only apply where an employee’s gains or profits from employment do not exceed Kshs.50,000 per month (i.e. Kshs.600,000 per annum)  Valuation of Quarters – Section 5 (3) Proviso Where gains or profit from employment of an individual exceed Kshs.50,000 per month (i.e. Kshs.600,000 per annum) excluding the value of the premises; the value of the quarters shall be: - Rent paid by the employer to a third party under an agreement made at arm’s length. Fair market rental value of the premises in that year or rent paid by the employer to a third party under an agreement not made at arm’s length; whichever is higher, OR Fair market rental value of the premises in that year is to be taken in case the premises are owned by the employer. Note Fair market rental value should be taken to mean the amount of rent the premises would attract if it were floated in the open market for the purposes of leasing. The valuation should be carried out by an independent registered land valuer (i.e. No relation with the employer). Any cases of doubt should be referred to the local Income Tax Office for advice. Example – Section 5 (3) (C) A whole-time service director who earns basic salary of Kshs.56,000 per month plus other benefits – (e.g. Motor Car, House Servants etc.) – Ksh.9,900 is housed at Runda Estate – Nairobi. Employer pays the Landlord Shs.35,000 per month (i.e. Shs.420,000 per annum) under an agreement made at arm’s length. Calculation for Quarters Basic Salary - Kshs.56,000 Add: Benefits - Ksh.9, 900 Total - Kshs.65, 900 15% of the value quarters 65,900 X 15 = 9,885 100 Rent paid by the employer Kshs.35,000 per month is the amount to be brought to charge and not 15% of value of Quarters. Total taxable income =65900+35000=100900 p.m.  LOAN TO EMPLOYEES If an employee acquires a loan from his employer at a rate of interest that is lower than the prescribed rate of interest, then the difference between the prescribed rate of interest and employer’s interest is a benefit from employment. This benefit can be brought to charge as follow: A) Low Interest Rate Benefit: This benefit arises from the difference between the prescribed rate and the interest rate charged by the employer for loans provided by the employer on or before 11th June 1998. This benefit is taxable on the employee. - Loan provided Ksh. 500,000 - Employer’s Loan Interest Rate 2% - Prescribed Rate 10% Low Interest Benefit: = (10% - 2%) x 500,000 = Kshs. 40,000 p.a B) Fringe Benefit This benefit arises from the difference between the Market Interest rate and the employer’s interest rate for loans provided after 11th June 1998 or loans provided on or before 11th June 1998 whose terms and conditions have changed after 11th June 1998. Such a benefit is taxable on the employer at the corporation Tax Rate. The Tax on Fringe Benefits is known as Fringe Benefit Tax. Example Loan Amount Kshs. 800,000 Interest Rate charged by Employer 2% Market Interest Rate for the month 12% Fringe Benefit (12% - 2%) x 800,000 = Kshs. 80,000 p.a. Fringe Benefit Tax = 80,000 x 30% = Kshs. 24,000 p.a. or Sh. 2,000 p.m. COMPENSATION FOR TERMINATION OF EMPLOYMENT This refers to payment, whether voluntary or obligatory made to a person to compensate him for termination of employment or services. Such a contract could be written or verbal. Such payment is taxable on the person receiving it with effect from 1st july 2004, this compensation is taxable in full A) Where the contract is for a specified term: The amount to be taxed in this case shall spread evenly over the un-expired period using the employee’s rate of earning at the ate of termination until it is exhausted. Example A contract for four years is terminated on 31.12.2005 after it has ran for 2 years. A compensation of ksh.1, 000,000 is received. The employee was earning ksh. 400,000 per annum at the time of termination. The compensation will be spread as follows: Year Taxable Amount (Kshs) 2006 400,000 2007 400,000 2008 200,000 Total 1000,000 B) Where the contract does not specify the term (period) but it provides for a compensation, the compensation received shall be spread using the employee’s rate of earning at the time of termination until the whole amount is taxed. A contract for an unspecified term provides for a payment of Sh. 900,000 on termination. The contract is terminated on 31.12.2005 when the employee was earning Ksh. 400,000 per annum. The compensation will be spread as follows: Year Taxable Amount (Kshs.) 2006 400,000 2007 400,000 2008 400,000 2009 100000 1300,000  C) Where the contract does not specify the term and does not provide for terminal payments the compensation shall be spread forward but it should not exceed the employees 3 years earnings. Example: A contract for an unspecified term and which provides for no terminal payments is terminated on 31.12.2005. A compensation Kshs. 1,300,000 is paid. The employee was earning Ksh. 400,000 at the time to termination. The compensation will be spread as follows: Year Taxable Amount (Kshs.) 2006 400,000 2007 400,000 2008 500,000 1,300,000 Note: The above treatment of compensation for the termination of contracts apply to all employees and whole-time service directors. LIMITING OF BENEFITS Where a benefit is enjoyed for a period of less than a year, the taxable value of the benefit is proportionately reduced to the period enjoyed. For example, if an employee was provided with furniture for three months in 2005, he would be taxed on one quarter of the benefit as follows: Assuming the price of the furniture was sh 800,000 Taxable benefit=12% x 800,000 x3/12 = 24,000 Benefits excluded from Employment Income (Tax free employment benefits): 1. Expenditure on passage for expatriates only. This is expenditure on traveling between Kenya and any other place outside Kenya borne by the employer for the expatriate employee and family. Conditions for qualifying for passage: (i)The employee must not be a citizen of Kenya. (ii)The employee must be recruited or engaged from outside Kenya. However, an expatriate employee does not lose the free passage by changing jobs in Kenya. (iii)The employee must be in Kenya solely for the purpose of serving the employer. The expatriate may fail to qualify for passage if he engages in commercial activities in addition to employment. (iv)The employer obtains tickets or reimburses the expatriate for employee the passage cost. Where cash is paid for passage and the employee may not travel and could in fact use the money for personal expenses, then the cash sum is taxable on the employee.  2. Medical Expenses: Where an employer has a written plan or scheme, or by practice provides free medical services to all the employees (non- discriminative), the value of such medical expenses is a non- taxable benefit for employees and whole time service directors. Where there is no medical scheme or plan for all employees, the payment of any medical bills is a taxable cash payment to the beneficiary. It is permissible to have different schemes for different categories of employees. 3. Fringe benefit 4. Benefits in kind whose value does not exceed Kshs. 36,000 p.a. (3000 p.m). Note: A director other than whole time service director is excluded from any tax free medical scheme. However, w.e.f 1/1/2006, medical benefits received by such directors is tax free as long as it does not exceed Kshs. 1,000,000 p.a. 5. The amount of contribution by an employer, on behalf of an employee, to a pension fund or scheme whether the fund is registered with the Commissioner of Income Tax or not. 6. With effect from 12.6.87, the amount contributed by an employer, on behalf of an employee, to a provident fund which is registered with the Commissioner of Income Tax. 7. Educational fees paid by the employer for the employee as long as such fees is taxed on the employer (disallowable expense). The following employment incomes are not taxed as they are exempted from taxation: 1.Employment income of foreign embassy staff excluding locally recruited staff. 2. Employment income of Organization of African Unity(OAU) staff, foreign and locally recruited. 3. Employment income of United Nations Organization (UNO) staff, foreign and locally recruited. 4. Allowances payable to the Speaker, Deputy Speaker, Vice-President, Ministers, Assistant Ministers, and Members of Parliament. The salaries are however taxed. 5. Salaries, allowances, and benefits paid from public funds to the President of Kenya. 6. Foreign allowances paid from public funds to Kenya officers serving abroad. Gains or profits from any right granted to any other person for use or occupation of property. This is consideration received for the use or occupation of property and includes: Royalty for copyrights, patents, trademarks etc. Rent which is the tenant's periodic payment for the use of land, building or part of the building etc. Rent premium or key money being inducement to lease out a property. Income In Respect of Dividend and Interest Dividend: Dividend is the amount of profit of a company which it pays to its share-holders in proportion to their shareholding in any particular year. It is income in the hands of the recipients. The following are deemed to be payments of dividend to those receiving: A) In a voluntary winding up of a company, amounts distributed as profits whether earned before or during winding up, whether paid in cash or otherwise. B) Issue of debentures or redeemable preference shares for no payment. The dividend is taken to be the greater of nominal or redeemable value e.g. nominal value Kshs. 100 redeemable value Kshs. 110 The following dividends received by a resident company are not taxed on the company: 1. Dividend received by a company which owns or controls 12½ % or more of the voting power(shares) of the paying company. 2. Dividend received as business income by specified financial institutions, subject to a pro-rata disallowance of relevant expenses. Note:  Foreign dividends not earned in Kenya are not taxable. Dividends are subject to withholding tax (tax at source) at 5% which is deducted by the person paying and remitted to the Income Tax Department. This constitutes the final tax i.e. no further tax is chargeable for Kenya residents. Dividends are treated as income of the year in which they are received. Interest This means interest payable in any manner in respect of any loan, deposit, debt, claim, or other rights or obligations, e.g. loans by banks and financial institutions, deposits to banks and financial institutions etc. Interest is assessed on an cash basis, which means that it is taxed when received not when earned if not paid. Interest income exempted from taxation: A) Interest from Post Office Savings Bank Account. The Post Office Savings Bank does not accept deposits of more than Shs.500,000. The interest from Fixed Deposit with the Post Office Savings Bank is exempted from taxation. B) Part exemption: The interest of up to Shs.300,000 from housing development bonds called the "qualifying interest' is partly exempted from taxation, i.e. the first Kshs.300,000 of interest on housing bonds is subject to 10% withholding tax as final tax. The "qualifying interest" here means interest received by an individual which does not exceed Shs.300,000 in any year of income in respect of housing development bonds held by that individual with a financial institution licensed under the Banking Act or a Building Society registered under the Building Societies Act and which has been approved to issue housing development bonds. The housing development bonds are issued by a financial institution on payment of money and the money earns interest. The money raised through issue of housing development bonds is supposed to help in housing development. The qualifying interest is taxed at the "qualifying interest rate of tax" which is the resident withholding tax of 15%. Income In Respect Of Pension, Charge Or Annuity, And With Effect From 1st January 1991, Any Withdrawals Or Payments From Registered Pension Fund Or Registered Provident Fund. A pension fund is created by contributions from employer, or from employees, or both. An employee receives pension from this fund when he/she retires because of old age or for any other reason. Normally, the retiring employee is paid a lump sum on retirement, and thereafter, a stated amount per month for life or for a stated period. A provident fund is also created by contributions from employee or from employer or both. An employee, on leaving employment is paid a lump sum from the fund depending on the contributions made to the fund. (i)Pension is received for past service and after retirement. (ii)Pension of up to Kshs. 180,000 p.a is exempted from taxation where received by a resident individual. (iii)Lump sum payments from registered pension fund and registered provident fund by resident individuals are exempted from taxation as follows: First Kshs. 480,000. (i) Any amount received in excess of exempt amounts is taxed as follows above Kshs. 480,000 tax exempt. 1st Kshs. 400,000 @ 10% Next Kshs. 400,000 @ 15% Next Kshs. 400,000 @ 20% Net Kshs. 400,000 @ 25% Excess of Kshs. 1,600,000 @ 30% (i) Pension received by a non-resident is not exempted from taxation and is in fact subject to withholding tax of 5% of Gross Income. No portion of the income is exempted. Income of a Married Woman The income of a married woman living with her husband is deemed to be the income of the husband and self-employment is taxed on the husband. However, when calculating the tax on the husband, the wife's employment income, and the wife's professional income have specified treatment. The wife's income can be from any source e.g employment, rent, business, profession, dividend, interest etc. A married woman will be treated as living with her husband and her income taxed on the husband unless: A)They are separated under an order of a court or written agreement of separation; B)They are separated in such circumstances that the separation is likely to be permanent; Note A husband working in Nairobi and wife living in the rural home is not separation; C) She is a resident person and the husband is non-resident. Wife's Employment Income and self-employment income. For purposes of calculating tax payable, wife's employment and self- employment income qualifying for separate taxation is segregated from the husband's income and the tax on it separately calculated at wife's employment income rate, which is the same as individual rate of tax. The wife's income will not qualify for separate taxation if she is employed by any of the following: A) a partnership in which her husband is a partner; B) her husband; C) a company where the husband and/or wife or both jointly control 12 ½% or more of the voting power directly or indirectly, of the company; D) a trustee or manager of a trust created by her husband. The wife's employment position is then said to be not at arm's length and, therefore, the income is not separately taxed. Note: Self-employment income for a married woman means business by the wife where husband is not a partner nor employs the wife. Wife's Professional Income. Wife’s professional income is also segregated from the husband’s income and the tax on is separately calculated at "wife's employment and wife's professional income rate which is the same as individual rate of tax. The professions whose income qualify for separate taxation are accountancy, medical, dental, legal, survey, architecture, veterinary medicine and engineering. Those who qualify are the professionals registered under the respective professional bodies e.g. doctors, engineers, lawyers, accountants, veterinary, doctors, architects, quantity surveyors etc. The wife's professional income will not qualify for separate taxation if it is from a partnership where her husband is a partner. The wife's loss is also deemed to be the loss of the husband. The deficit at the time of marriage becomes the husband's deficit to be off-set against future income of the wife which is taxed on the husband. In case of more than one wife, income is still deemed to be the husbands. Where the husband fails or is unable to pay tax due, the Commissioner of Income Tax can collect a portion of the tax from the wife which relates to her income taxed on the husband. RATES OF TAX After determining the taxable income, also referred to as assessable or chargeable income/loss of a person, the person is taxed. The tax is always expressed in KShs and the income is always expressed in K£. A) Loss is carried forward on the basis of specified sources until the person makes a profit to off-set the loss. The loss from one specified source can only be off-set against future income from the same specified source. B)Income is taxed at the prescribed rates of taxation. There are Corporation rates of tax applicable to companies (legal persons) and there are individual rates of tax applicable to individuals (natural persons). Corporation Rates of Tax The corporation rates of tax apply to legal persons such as companies, trusts, clubs, estates, co-operatives, associations etc. 1. Corporate rate of tax from years 2000 to date is 30% for resident corporations. 2. From year 2000 to date, a non-resident company with a permanent establishment in Kenya is taxed at 37½%. Individual Rates of Tax An individual is taxed at graduated scale rates such that the higher the income, the higher the tax as follows: 2002 - 2004 Bands of taxable Taxable income Tax rate on band Tax on band Cumulative tax on income income KShs KShs % KShs KShs First 116,160 116,160 10 11,616 11,616 Next 109,440 225,600 15 33,840 45,456 Next 109,440 335,040 20 67,008 112,464 Next 109,440 444,480 25 111,120 223,584 OVER 444,180 30 2005 Bands of taxable Taxable income Tax rate on band Tax on band Cumulative tax on income income KShs KShs % KShs KShs First 121,968 121,968 10 12,196.8 12,196.8 Next 114,912 236,880 15 17,236.8 29,433.6 Next 114,912 351,792 20 22,982.4 52,416.0 Next 114,912 466,704 25 28,728 81,144.0 OVER 466,704 30 Withholding Tax or Tax at Source The Income Tax Act requires that withholding tax or tax at source be deducted at the point when payment is made in respect of interest, dividend, insurance commission, employment income, pension and farming income subject to Presumptive Income Tax (PIT), etc. The income subject to withholding tax may be received by a resident or non-resident person. The importance of deducting withholding tax is that it makes tax collection easy and it also ensures that some incomes do not escape taxation. The withholding tax should be viewed as income tax paid in advance. A person making payments of incomes subject to withholding tax is legally required to deduct the withholding tax or the tax at source at appropriate rates before effecting the payment and: A) remit the tax so deducted to the Income Tax Department; B) pay the payee the amount net of tax; and C) issue the payee with a certificate of the withholding tax or tax paid at source e.g. interest certificate or a dividend voucher. For any given year of income, the payee is assessed on gross income and is given credit for the tax paid at source except in cases where the withholding tax is the final tax. Employment income The employment income is taxed at source monthly under the Pay as You Earn (PAYE) tax deduction system. The tax is referred to as PAYE tax. It will apply to salaries, wages, directors’ fees, benefits, etc. paid monthly to any employee. Every employer is legally required to operate a PAYE tax deduction system. The main features of the PAYE system are: (i)The employers deduct PAYE tax monthly on all employment income they pay to their employees; (ii)A PAYE tax deduction card (form P9) is maintained for each employee, showing monthly gross pay, benefits, allowed deductions, PAYE tax deducted, personal relief and net pay; (iii)The details above must be given to every employee by the employer per month, i.e. the pay slip or pay advice; (iv)The PAYE tax deducted must be paid to the Income Tax Department (banked using credit slip paying-in-book called P11) by the 9th day of the month following the one in which PAYE was deducted; (v)The employer is required to issue a certificate of pay and tax (form P39) at the end of each calendar year or whenever an employee leaves employment; At the end of each calendar year, every employer is required to submit the PAYE end-of-the-year documents as follows: A) the tax deduction cards (form P9) for all employees; B) personal relief claim forms duly signed (forms P1, 2 and 4) for all employees concerned; C) certificate showing total monthly PAYE tax deducted for the year (form P10); D) List of employees and total PAYE tax deducted from each for the year of income (form P10A). (You are advised to study the PAYE rules in the Income Tax Act.) PERSONAL RELIEFS The personal relief is claimed and granted only to resident individuals. The relief reduces tax payable by an individual. General Application: 1)The personal relief reduce tax payable by a resident individual only. 2)Any resident individual is entitled to claim personal relief. The relief does not apply to non-resident individuals or to companies. 3)The personal relief is currently Kshs. 13,944 p.a (1,162 pm) granted on the basis of number of months worked during the calendar year. RENT INCOME This is income earned by a person for rights granted to others to occupy his property. In determining the taxable rent income, all expenses incurred wholly and exclusively in earning such income are allowed (deducted) against such income. These expenses include the following: a)Bad debts and rental losses. b)Advertising and promotional costs of revenue nature. c)Legal costs and stamp duty on acquiring a lease of less than 99 years. d)Water and rates e)Management and Agency fees. f)Insurance g)Staff wages and salaries. h)Repairs and maintenance i)Structural alterations on the building necessary to maintain existing rent. j)Heating and lighting. Note 1) Any cost incurred with the intention to increase rent will be disallowed. 2) Any cost in respect of extension or replacement of the building or part thereof is not allowable. 3) All costs of a capital nature are not allowed. 4) For non-residents the income is taxed at a rate of 30% with- holding tax which is a final tax. No expenses are allowed. ROYALTY INCOME: This is income earned by a person for rights granted to others to use his intellectual properties. These properties include: i) Copyright, Literally, artistic or scientific works. ii) Cinematograph including film or tape used in radio or any other form of broadcasting. iii) Patents, trademarks, designs, model, plan or formula. iv) Any industrial, commercial or scientific equipment or information concerning industrial commercial or scientific equipment. Expenses will be allowed as long as they were incurred wholly and exclusively in earning such income. Note For non-residents the income is taxed at 20% with-holding tax which is a final tax. No expenses are allowed. For residents, a 5% withholding tax is first deducted before determining net royalty income. It is then deducted from gross tax liability of the resident individual as a tax credit.  CHAPTER THREE CAPITAL DEDUCTIONS/ALLOWANCES the deductions or allowances on some machinery and buildings used for business were stated to be some of the expenses specifically allowed against taxable income. The deductions or allowances are at standard rates for all taxpayers depending on the nature of the capital expenditure incurred. The capital deductions are important because: A)Some offer incentive to business by allowing capital expenditure otherwise not claimable. B)Some act as standard depreciation for income tax purpose. The manner of calculating and computing the various capital deductions or allowances is given below. 1. Wear And Tear Deduction (Allowance) The wear and tear deduction is a capital deduction on machinery used for business. The deduction is made against income. the deduction is made in the income tax computation (or in arriving at the taxable income or loss for the year) after disallowing any depreciation and similar charges against taxable income. As noted earlier any capital loss, diminution, exhaustion of capital, such as depreciation, amortisation, loss on sale of assets, obsolescence, provision for replacement, are not allowable expenditure against income. But the Income Tax Act recognises the loss of value of assets used in business through usage, passage of time or obsolescence and so grants the wear tear allowance. Wear and Tear deductions (allowance) As per paragraph 7 of the Second Schedule to the Income Tax Act... "where during a year of income machinery owned by a person is used by the person for the purpose of his business, there shall be made in computing the person's gains or profits... a deduction... referred to as a 'wear and tear deduction’.” 'It tearshould be noted deduction where:that machinery qualifies for wear and A. owned by a person, and B.Used by the person for business anytime during the year of income Procedure for Wear and Tear Deduction 1.The first step is to identify the machinery which qualifies for wear and tear deduction. The machinery for wear and tear deduction has a wide meaning and includes tractors, lorries, motor cars, plant and machinery, furniture, aircraft, ship, etc. It is important to note that implements, utensils, tools and similar articles, qualify for diminution or reduction in value  2. The machinery which qualify for wear and tear are classified as follows: Class I equipment This is a class for heavy earth moving and heavy self-propelling (producing) (37.5%) own power to move) machinery e.g. tractors, combined harvesters, tippers, lorries of load capacity of 3 tons and over, buses, loaders, graders, bulldozers, mounted cranes etc. Class II This is a class for office equipment bought on or after 1.1.'92 e.g. computers, printers, (30%) electronic calculators, adding machines, photocopiers, and duplicating machines. Class III This is a class for other self-propelling vehicles including aircrafts, examples include (25.0%) pick-ups motor cars, aircraft, motor cycles, lorries of less than 3 tons load capacity, vans. Class IV This is a class for other machinery including ship e.g. factory plant and (12.5%) machinery, fixtures and fittings, bicycles, partitions (temporary or movable), shop counters and shelves, safes, typewriters, sign boards, fridges, freezers, advertisement stands etc. 3. The third step in the procedure for wear and tear deduction is that an appropriate percentage rate on the balance of machinery of each class is allowed as a deduction—Class I (37.5%), Class II (30%), Class III (25%), and Class IV (12½%). Commercial and non-commercial vehicles for wear and tear deduction The motor vehicles as machinery for wear and tear deduction may fall under either Class I or Class III depending on the nature of the motor vehicle. For the vehicle under Class III, the value for additions as well as the value for disposal is restricted if the vehicle is a non- commercial vehicle. The Income Tax Act defines a commercial vehicle as a road vehicle which the Commissioner of Income Tax is satisfied: A) Is manufactured for the carriage of goods and is so used in connection with trade or business e.g. Lorry, pick-up, van etc; or B) Is a motor omnibus within the meaning of that term in the traffic act e.g. All public service vehicles (psv vehicles) like buses and matatus, or C) Is used for the carriage of members of the public for hire or reward e.g taxi and tour operator vehicles Any vehicle which does not fit the definition of a commercial vehicle is referred to as a non-commercial vehicle. For the purpose of wear and tear, the value of addition of any non- commercial vehicle is restricted to Sh.1million w.e.f 1/1/2006, the restricted value will be Sh. 2 million. 2. Investment Deduction/Allowance The investment deduction is another capital deduction given on cost of buildings and machinery which are used for manufacture, on cost of a ship, and on cost of a hotel building. There are four types of investment deduction: A)Investment deduction in respect of buildings and machinery used for ordinary manufacture. B) Investment deduction in respect of building and machinery used for manufacture under bond, that is, goods manufactured for export only. It was introduced 1988. It is commonly referred to as Investment Deduction Bonded Manufacture (IDBM).  C) Investment Deduction in respect of a hotel building certified by the Commissioner of Income Tax to be an industrial building. D) Shipping Investment Deduction (S.I.D) in respect of a ship. The investment deduction on buildings and machinery is intended to encourage new investments in the manufacturing sector. Previously, the government wished to attract investments outside Nairobi and Mombasa by offering higher rates of allowance. With effect from 1.1.'95 there is a uniform rate of 60%. The investment deduction is deducted in the income tax computation, or in arriving at the taxable income/loss and is given once and for all when the building and machinery are used, that is, in the "year of first use" of building or machinery. 3. Shipping Investment Deduction—S.I.D. 1. The shipping investment deduction is given where a resident shipowner incurs capital expenditure: a. on the purchase of new, power-driven ship of more than 495 tons tare weight; or a. on the purchase and subsequent refitting for the purpose of shipping business of a b. used power-driven ship of more than 495 tons tare weight. The rate of shipping investment deduction is 40% (2/5) of qualifying cost. The deduction is made in computing the taxable income/loss of a person for the year of income in which the ship is first used for business, that is, the year of "first use of the ship". With effect from 1.1.'87, the wear and tear deduction for a ship is calculated on the qualifying amount net of shipping investment deduction. Limitations on shipping investment deduction. 1. A given ship can only get one shipping investment deduction in its life. 2. If a ship is sold within 5 years after the year of income in which shipping investment deduction is given, the shipping investment deduction is withdrawn and the deduction treated as income of the year of income in which the sale takes place e.g. Shipping investment deduction given Shs 2.5. million in 1985 Ship sold in 1990. The shipping investment deduction of Shs 2.5 million is withdrawn in 1990*. The ship would have to be sold in 1991 and after for shipping investment deduction to hold. *In its place Wear & Tear Team allowance Class IV would be granted for Year ’85 to ’89. the balance of the shipping investment deduction is taxed in 1990. 4. Industrial Building Deduction (Allowance)—I.B.D. This is a capital deduction or allowance given in respect of capital expenditure on an industrial building as per paragraph 1 to 6 of the Second Schedule to the Income Tax Act. ".... where a person incurs capital expenditure on the construction of an industrial building, and the industrial building is used for business carried on (by the person) or a lessee.... a deduction called industrial building deduction shall be made in computing (the person's) gains or profits from the business." The amount of industrial building allowance is deducted in the income tax computation or in arriving at the taxable income/loss for year or period. The rates for industrial building deduction are: A. The standard rate of 2.5% (1/40) of the qualifying cost per year for 40 years, except in two cases below. The life of an industrial building is deemed to be 40 years. B. A rate agreed with the Commissioner of Income Tax. Where a taxpayer considers that the life of an industrial building is less than 40 years, the taxpayer can apply for a greater rate than 1/40 and if the Commissioner of Income Tax agrees, that will be the agreed rate of industrial building deduction. The life of an industrial building may be shorter than 40 years due to the type of construction or the use to which the industrial building is put. C. In the case of a hotel building which is certified by the Commissioner of Income Tax to be an industrial building, the industrial building deduction rate is 4% (1/25) of qualifying cost per year for 25 years. NB. It is important at this point to know what is an industrial building which qualifies for the industrial building deduction. Industrial Building means A) a building in use i)For the purpose of a business carried on in a mill, factory or other similar premises e.g. bakery, saw mill, soap factory, posho mill, etc. ii) For the purpose of a commercial undertaking of transport, dock, bridge, tunnel, inland navigation, water, electricity, or hydraulic power e.g. old Nyali bridge, old Karen water supply, repair dock in Mombasa, Kenya Bus Depot at Eastleigh etc. ii) For the purpose of a business of manufacture of goods or materials, or the subjection of goods or materials to any process e.g. East African Industries, Kenya Breweries, BAT Kenya Ltd etc. ii) For the purpose of a business which consists in the storage of goods or materials which are raw materials for manufacture of other goods or materials, finished goods, or on their arrival by sea or air into any part of Kenya. ii) For the purpose of agricultural services e.g. ploughing, cultivation, threshing of crops etc. on agricultural land but not owned by the farmer. This is normally buildings used by agricultural contractors. For the purpose of a business declared by the Minister for Finance by a notice in the Gazette as qualifying for industrial B) A prescribed dwelling-house e.g. dwelling-house constructed for and occupied by employees e.g. Tusker Village for Kenya Breweries employees and BAT Shauri Moyo houses. C) A hotel building or part of a hotel building which the Commissioner of Income Tax has certified to be an industrial building, including any building directly related to the operations of the hotel such as kitchens, staff quarters and entertainment and sporting facilities. D) A building used for the welfare of workers employed in any business or undertaking referred to in (a) above e.g. canteen, sports-house etc. E) With effect from 1.1.'95 where a building is an industrial building, the following civil works or structures on the premises of the building shall be deemed to be part of the building where they relate or contribute to the use I) roads and parking areas; II) railway lines and related structures; III) communications and electrical posts and pylons and other electricity supply works; IV) water, industrial effluent and sewage works; and V) security walls and fencing. The following costs do not qualify for industrial building deduction: 1. The cost of acquisition of land on which the industrial building is constructed, and other incidental costs on acquisition such as stamp duty and legal fees. 2. The costs of items treated as machinery for wear and tear e.g. partitioning, shelves, counters etc. 3.The cost of retail shop, showroom, office, dwelling house etc EXCEPT where the cost is not more than 10% of the total capital expenditure (the industrial building plus shop, office etc.) 5. MANUFACTURE UNDER BOND: (MUB) This is a programme by the government to encourage the production of goods for exports. In this programme, the Manufacturer of the goods writes a Bond to cover the goods being manufactured. Bond: This is a promise (agreement) by a person to pay to the commissioner of Customs and Excise an amount of money if the conditions of the manufacturing agreement are not met. Goods manufactured and exported will not be charged any duty. However, if such goods are not exported, then duty must be paid. Such duty is secured by the Bond. INVESTMENT DEDUCTIONS FOR MUB This is granted to firms operating in the MUB programme. It is granted in the first year the building and machinery are brought to use. It is based on capital expenditure incurred in building and installation there in of new machinery. Such building and machinery must be used for MUB. MUB Conditions: Where a person who has been granted Investment deductions for MUB ceases to manufacture under Bond within 3 years from the date of commencement, then the investment deduction for MUB is withdrawn and treated as income in the year of income in which he ceases to manufacture under Bond. However, he is granted Wear and Tear Deductions and IBD for the years he has operated. 6. MINING DEDUCTIONS This refers to capital allowances granted to a person carrying on the business of mining. Qualifying Costs: 1) Cost of exploring and prospecting the mine. 2) Cost of acquiring rights over the mine and minerals but does not include cost of land/site. 3) Cost of buildings and machinery (mining equipment's) which will have little or no value if mining ceased, 4) Cost of development and general administration and management incurred prior to commencement of production or during a period of non-production (temporary stoppage NB 1) If a mining operation is transferred during a year of income, then the deduction will be apportioned between the new and old owner on time basis. 2) If someone operates many mining operations that are not related then each mining operation is treated separately and granted its own deductions. 3) When a person incurs qualifying expenditure in relations to a m