Principles Of Taxation KASNEB Notes

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TOPIC 1

 APPLY TAXATION CONCEPTS AND REGULATIONS IN COMPUTING TAX OBLIGATIONS

 

DEFINITION OF TAX, TAXATION AND TYPES OF TAXES IN KENYA

Dr. Dalton defines tax as a compulsory contribution levied on persons of a state for a common purpose. While Prof. Sallingman, says tax is a compulsory contribution from a person to the government to meet the expenses incurred in the common interest of all without reference to special benefits conferred.

Tax can therefore be comprehensively defined as:

Compulsory/involuntary payment by a tax payer without directly obtaining goods or services (as a “quid pro quo”) in return

In other words, there are no direct goods or services given to a tax payer i.e. no direct benefit in return for the tax paid. The tax payer can, however enjoy goods or services provided by the government like any other citizen without any preference or discrimination

Characteristics of Tax

  1. It is a compulsory contribution from the people to the government hence anyone who refuses to pay tax is punished.
  2. It’s a payment of the people to the government to finance its functions for the benefit of all
  3. It’s not paid for a specific service rendered by the government to the person paying the tax. This means that the person can’t ask the government to provide a service to him for the tax he has paid. And one cannot refuse to pay tax because he does not require the services of the government.

Taxation is the part of public finance that deals with the means and/or a system of raising money to finance government by way of Taxes among other sources. All governments require payment of money – taxes – from people.

Governments use tax revenues to provide goods and services to the public (its Citizens) i.e. pay soldiers & police, build dams & roads, operate schools & hospitals, provided food for the poor & medical care to the elderly, and for hundreds of other purposes. Without taxes to funds its activities, government could not exist.

Generally, Taxation is part of a boarder discussion on public finance while Public Finance is the section of economic theory that deals with public expenditure and revenue.

Whereas Public Revenue is the cash inflow of the government from various sources, which include: –

  • Taxes
  • Fees levied on services provided by the government i.e. Motor Vehicle registration fees, Import licensing fees etc.
  • Fines charged on law brokers
  • State property fees i.e. Entrance fees for Game Reserves
  • Public debts i.e. Treasury Bills
  • Disposal of public investments i.e. Sale of government shareholding in parastatals
  • Donor Aid i.e. IMF, World Bank
  • Grants

 

Public expenditure on the other hand is the allocation of public revenue to the various functions of the government like recurrent expenditure which is day to day operations of the government i.e. salaries and wages of civil servants. Capital expenditure, which includes investment, projects of the government i.e. Building Schools, Roads and Hospitals.

Functions of the Government

Governments world over are expected to carry out certain activities as part of their services to the public. These are divided into four major functions, namely: –

  1. Administration: The government oversees the administration of the country by for instance in the Kenyan scenario, creation of provinces; Districts; Divisions; Locations and Sub-Location.
  2. Protection: A good government must ensure the security of its people from external aggression and internal security must be provided. This is done through The Armed Forces and The Police.
  3. Social functions: The government provides social facilities like Housing, Education and Health care among others
  4. Development functions: It is the duty of the government to develop and maintain transport and communication network, agricultural systems and the economic infrastructure in general.

Principally, the role of governments is to enable us to appreciate the importance of government sector and therefore towards this end in trying to fulfill the above functions modern governments generally undertake the following: –

  1. Security (external & internal) involving military, police & other protective services.
  2. Justice or settlement of disputes
  3. The regulation & control of economy including coinage, weights and measures, the business practices, operation of public sector undertakings
  4. Social and cultural welfare through education, social relief, social insurance, health and other activities.
  5. Conservation of natural resources.
  6. Promotion of the unity of the state by control of transportation and communication.
  7. Administration and financial system, government revenue expenditure and fiscal control.
  8. Education and employment.
  9. Public health.
  10. Uplifting of weaker sections of the society.
  11. Restoration of social justice in the society.

To perform the above functions effectively and adequately, the government needs funds

 

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TYPES OF TAXES IN KENYA

Income Taxes

Income tax is a tax that governments impose on financial income generated by all entities within their jurisdiction. By law, businesses and individuals must file an income tax return every year to determine whether they owe any taxes or are eligible for a tax refund. Income tax is a key source of funds that the government uses to fund its activities and serve the public.

They include among others: Corporation taxes for companies, PAYE for individuals, Capital gains tax, Advance tax, Presumptive tax, Fringe benefit tax, Withholding tax.

Consumption Taxes

A consumption tax, sometimes referred to as a “spendings tax,” is a tax levied on consumption spending on goods and services. The tax base of such a tax is the money spent on consumption. It closely resembles the income tax except that the tax base is spending, not income. The important difference is that the tax base is expenditure rather than income.

They include among others: Value Added Tax, excise duty, Withholding tax

Customs Duties

Customs Duty is a tax imposed on imports & exports. The rates of customs duties are either specific or on ad valorem basis, that is, it is based on the value of goods traded.

Other Taxes, Fees & Levies

These include:

  1. Entertainment tax
  2. Petroleum Development Fund
  3. Import Declaration & Fund (IDF)
  4. Foreign Motor Vehicle Inspection Fee
  5. Road Maintenance Levy
  6. Road Transit Toll Levy
  7. Aviation Revenue
  8. Revenue Stamps
  9. Kenya Bureau of Standards (KEBS) Levy

HISTORY OF TAXATION

World History

Benjamin Franklin (January 17, 1706 to April 17, 1790), a polymath, inventor, scientist, printer, politician, freemason and diplomat best known as one of the Founding Fathers who drafted the Declaration of Independence and the Constitution of the United States once said, “In this world, nothing can be said to be certain, except death and taxes.” Emphasizing on the inevitability of both

Contrary to this popular believe in recent times, taxes haven’t been around forever. Sure, there were taxes in ancient Greek, ancient Egypt, and ancient Roman governments in times of war levied taxes on their citizens to pay for military expenses and other public services. Taxation evolved significantly as empires expanded and civilizations become more structured. But the idea of sales taxes, income taxes, payroll taxes, and other types of taxes is mostly a modern invention.

“The earliest known tax records, dating from approximately six thousand years B.C., are in the form of clay tablets found in the ancient city-state of Lagash in modern day Iraq,” according to a publication on the Association of Municipal Assessors of New Jersey (AMANJ) website. This early form of taxation was kept to a minimum, except during periods of conflict or hardship.

What does the Bible say about paying taxes?

In Matthew 22:17–21, the Pharisees asked Jesus a question: “‘Tell us then, what is your opinion? Is it right to pay taxes to Caesar or not?’ But Jesus, knowing their evil intent, said, ‘You hypocrites, why are you trying to trap me? Show me the coin used for paying the tax.’ They brought Him a denarius, and He asked them, ‘Whose portrait is this? And whose inscription?’ ‘Caesar’s,’ they replied. Then He said to them, ‘Give to Caesar what is Caesar’s, and to God what is God’s.'” In full agreement, the apostle Paul taught, “This is also why you pay taxes, for the authorities are God’s servants, who give their full time to governing. Give everyone what you owe him: If you owe taxes, pay taxes; if revenue, then revenue; if respect, then respect; if honor, then honor” (Romans 13:6–7).

 

Taxation History in Kenya

Initial Stage: Portuguese

This can be traced back to the Portuguese who arrived at the Kenyan coast and took over from the Arabs and signed the first recorded treaty that involved a form of taxation in in 1502. The then Sultan Ibrahim of Malindi was held against his wishes and forced to accept defeat. While being held hostage during negotiations on Vasco da Gamma’s boat, a treaty of surrender was signed with Portugal for an annual tribute of 1,500 meticals of gold.

By the end of the rule of the Arabs and Portuguese along the East coast of Africa the existing balance of taxation that was inherited by the British included a capitation tax payable per head of slave exported and customs revenue shared equally between the Arabs and Portuguese. The tax base was, however, limited to traders only.

Second Stage: British

The British who ruled what is presently Kenya and Uganda together to form British East Africa Protectorate colonial tax policy supported its own economy. This was done initially through the Chartered company concept. However, later in order to encourage rule from within the territory to make it viable after the accidental discovery of arable land in Kenya. They introduced the following taxes:

  • Hut and Poll Tax in 1901, (fee payable by all locals per hut through labor, money, and grain or stock.),
  • Land tax 1908,
  • Income tax 1921,
  • Graduated personal tax 1933

Third Stage: Post independence

Soon after independence Kenya had income tax, corporation tax, trade taxes and excise taxes. Value-added taxes were introduced later. During the first decade and a half of independence, the government mainly dealt with taxation as there was a desperate need.

Fourth Stage: Currently

The new Constitution which was approved by 67% of Kenyan voters was presented to the Attorney General of Kenya on 7th April 2010, officially published on 6th May 2010, and was subjected to a referendum on 4th August 2010. The constitution was promulgated on 27 August 2010.

Article 209 of the Constitution of Kenya 2010 outlines powers to impose taxes or raise revenue for both national government and county government.

 

CLASSIFICATION OF TAXES; TAX SHIFTING AND FACTORS THAT DETERMINE TAX SHIFTING

Classification of taxes can be done in two different ways, namely: –

  1. Incidence of tax (Tax burden)
  2. Rates of tax

 

Classification by Incidence of Tax

Incidence refers to the point or person on whom tax is imposed. Burden on tax refers to bearing of the tax that is he/she who pays tax i.e. when tax (VAT) is imposed on a trader he pays it to the government but he recovers it from the customer through the selling price, in this case the incidence of the tax is on the trader but the burden is on the customer, whereas, when tax (PAYE) is levied on once salary, he/she pays it to the government but cannot recover it from anybody else in which case both the tax incidence and tax burden is on him. Under this classification therefore there basically exist two types of taxes namely: –

  • Direct taxes
  • Indirect taxes

 

Direct Taxes

This refers to the type of taxes whereby both the incidence and the burden is on the same person. That is the person on whom the tax is imposed cannot transfer it to another person. He/she pays it himself/herself. They include Income tax; corporation tax; Capital gains tax; Inheritance tax etc.

 

Advantages of Direct Taxes

  1. Equitable – Direct taxes are based on income hence people pay per ability.
  2. Certainty – Usually the taxpayers knows how much to pay and at what time to pay since incomes is certain. The government also knows how much to collect and when to collect it.
  3. Economical – The cost of collection is usually low since they are deducted and remitted to the government at source, which reduces the government’s cost of collection and the taxpayers’ cost of payment.
  4. Elastic – It is possible for the government to vary the rates of tax from time to time to conform to the needs of the economy.
  5. Simplicity – The tax system is such that it is easy to understand and make returns.
  6. Civic Consciousness – They are the most understood taxes by the public since the public knows that they pay taxes to the government. They therefore take interest in knowing how the government uses the taxes, which promote accountability in government.

 

Disadvantages of Direct Taxes

  1. Discourages Investment and Savings – Direct taxes consume what could have been saved and taxes on interest and Dividends are direct taxes and discourage savings and investments.
  2. Low Coverage – Some people don’t fall under these tax brackets and those who do not earn income do not pay taxes, yet they’ll enjoy the benefits of projects funded with such taxes.
  3. Discourages Production – Companies may reduce production to avoid paying high taxes especially when faced with financial problems.
  4. Prone to Evasion – Taxpayers usually avoid direct taxes by making false statements to reduce their tax liability.
  5. Inconvenient – Persons paying such taxes must undergo the process of registration with many formalities and tax payers must take their own time and resources to make tax returns to the government.

  

Indirect Taxes

These are taxes whose incidence and burden fall on different persons. That is the person on whom tax is levied or imposed can recover the tax so paid from another person. They include, Value Added Tax; Import Duty; Export Duty etc.

Merits of Indirect Taxes

  1. Wide coverage – Since they are based on expenditure they cover all classes of people since everyone must spend.
  2. Elastic – The government can easily vary the tax rates from time to time as per the needs of the economy.
  3. Economical – Those making returns are charged with the responsibility of paying the money to the government hence the governments cost of collection is minimal.
  4. Diversity – These taxes can be levied on a wide variety of goods and services. This diversity increases the revenue collected by the government.
  5. Less Evasion – The person charging the tax acts like an agent of the government he/she collects money from buyers hence such taxes are not a cost to him since the burden falls on the buyer. And because the taxes are included in the prices collect ability is high.
  6. Economic Policy Tool – Indirect taxes can be used to promote exports and discourage imports by taxing imports and making exports tax free hence building the domestic market.
  7. Social welfare – Indirect taxes are levied heavily on harmful commodities like Beer and Cigarettes, which reduce their consumption.

 

Demerits of Indirect Taxes

  1. Uncertainty – Since they are based on expenditure government revenue is uncertain because it’s not easy to tell how much people will spend in any period.
  2. Regressive – The rich and the poor pay tax at equal rates in so doing the poor pay a bigger proportion of their wealth than the rich hence the burden is more on the poor than the rich.
  3. Uneconomical – They can be uneconomical to collect especially for the customs duty. The government must employ officers at all points of entry into Kenya.
  4. Inflation – Indirect taxes are included in the prices leading to high costs of production and high selling prices to consumers hence inflation.
  5. Lack of Civic Consciousness – They are paid in commodity prices therefore the public is not usually aware that they are paying taxes They will not therefore be much concerned with allocation of such funds.

NB: While Direct taxes are based on income and wealth of persons such taxes cannot be passed to another person once paid. Indirect taxes on the other hand are based on expenditure hence can be passed over by he/she who pays to another through commodity prices.

  1. Classification by Rates of Tax

Unlike incidence of tax this classification uses the trend in tax rates to classify taxes as follows: –

  1. Progressive Taxes
  2. Proportional Taxes
  3. Regressive Taxes
  4. Digressive Taxes

 

  1. Progressive Taxes

A 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.

Merits of Progressive Taxes

  • Equitable – High-income earners pay more than low-income earners
  • Productive – It yields more revenue, as the rate of tax is high on higher incomes.
  • Economical – Collection cost will not increase with the increase in tax payable.
  • Better Distribution of Wealth – High-income earners surrender more of their earnings than the low-income earners. This is then used to raise the living standards of the poor.

Demerits of Progressive Taxes

  • Discourages Savings – Since the rate of tax is high on high incomes this may reduce the funds available for savings and investment.
  • Arbitrary – Progressive taxes are based on scales hence complex to understand.
  • Assumption – It assumes that different people get equal utility from equal incomes.
  1. Proportional Taxes

A tax is proportional when the same rate of tax is applied to all tax payers irrespective of their income level, for example the corporation tax which currently stands at 30% for all firms.

Advantage of Proportional Tax Structure

  • It is simple in nature
  • It is uniformly applicable
  • It leaves the relative economic status of taxpayer unchanged

Disadvantages of Proportional Tax Structure

  • Inequitable distribution
  • Inadequate resources: means that the tax for the rich and poor are the same. Hence, the government cannot obtain from the richer sections of the society as much as they can give
  • Inelastic in nature: because the government cannot raise the rate whenever it wants to raise the revenue.

NB: Proportional tax system suffers from the defects of inequitable distribution of the tax burden, lack of elasticity and inadequacy of funds for the increasing needs of the modern government. Hence, it is not particularly and universally accepted.

  1. 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.

  1. Digressive Taxes

These are taxes that call upon the higher income earners to contribute less than their due contribution compared to the lower income earners. i.e.

  1. a) The burden is relatively less since the tax is mildly progressive-the rate of progression is not sufficiently steep, or
  2. b) There is progression up to a certain point beyond which the rate becomes proportional.

 

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