QUESTION ONE
Distinguish between a direct and indirect tax. ( 4 marks) (ii) Is Value Added Tax (VAT) a direct or indirect tax? Explain( 2 marks)
- A direct tax is one whose impact as well as incidence falls on one and the same person while an indirect tax has its impact on one person and incidence is partly or wholly on another person.
- Examples of a direct tax include income tax, wealth tax, gift tax, inheritance tax and corporation tax. Examples of indirect tax include Value Added Tax (VAT), Sales tax, Customs and excise duties.
- Note that impact of tax in the case of direct tax is on the person on whom it is legally imposed and the same person pays the tax. In indirect taxation, however, the tax is legally imposed on one person and through tax shifting, it is paid by another person.
- Direct tax has income as the base while indirect tax is based on expenditure/consumption.
Value Added Tax (VAT) is a multi-stage indirect tax based on the expenditures of individuals as well as legal persons and services on taxable goods and services charged and collected by traders/businessmen acting as agents to the taxing authority. Registered persons are required to charge output VAT on Sales made of taxable goods and services and to recover input VAT charged on purchases they made such that the final consumer bears the final burden of the tax.
What are the rules governing the payment of VAT? Specify the additional tax that may arise from failure to comply with those rules. ( 6 marks)
- The VAT tax period is one month, hence VAT collected for any particular month must be remitted to the VAT department using form VAT 3 by the 20th day of the following month using a bankers cheque addressed to the commissioner VAT or by cash. Where the 20th day of the following month falls on a public holiday or a weekend, then VAT payable must be paid by the last working day before that weekend or holiday. Note that failure to submit a return attracts a default penalty of Ksh.10,000 and additional interest of 2% per month compounded. Failure to pay the tax attracts Ksh.15,000 penalty.
QUESTION TWO
Many farmers in the rural areas are unaware of the benefits accorded to them in form of capital allowances under the Income Tax Act. Write a brief summary on capital allowances which may be available to the farmer. ( 6 marks)
The following capital allowances may be available to the farmer:
- Farm works allowances
- Wear and tear allowances
- Investment deduction and industrial building deduction
- Farm works allowances are granted where a farmer incurs capital expenditure on construction of farm works on a farm for the better performance of farm activities. Farm works include farm houses, labour quarters, fences, dips, drains, water and electricity supply works other than machinery, fish pond, coffee factory, house stable, cowshed, windbreaks, roads, stores, irrigation network, etc. The rate of farm works deduction with effect from 1.1.1985 is 33½%. In the case of farmhouse, only one third of the initial cost of the farmhouse qualities for farm works deduction
QUESTION THREE
- Explain clearly the nature of a public good with specific reference to provision of education in Kenya today and the role taxes play under such circumstances. (10 marks)
A public good is one used by the public, i.e. some members of society cannot be prevented from its consumption. An example would be provision of Education in Kenya. Generally speaking Education is indivisible, it cannot be priced in the market in order to deprive some members of the society from its use or benefits.
An individual cannot refuse the benefit of education or street lighting. Since the exclusive principle cannot be applied to the indivisible goods or services, this creates a problem of raising the necessary finances. Some individuals may argue that if they didn’t pay for education, the supply of education service would still be there. Voluntary payment would be lower (problem of freeriders).
Consequently, provision of such public good/services will be made through compulsory contributions by the members of society for example through taxation. The decisions regarding whether or not education service be provided in Kenya or where or not Kenyans require such good cannot be left to the market forces of demand and supply. Society has to decide the way in which these decisions will be taken and financed and such decisions need not be unanimous.
Government decides whether or not education is necessary and be provided to Kenyan society and how finances have to be raised. Note that education services in Kenya are also provided by the private sector where individuals decide whether or not to pay for such service provided by private institutions.
Government may introduce cost sharing in addition to taxation to ensure that education services are provided to all.
What is the principle of cost sharing and to what extent does it influence the level of taxation?
The principle of cost sharing refers to the requirement for the members of society to share in/or supplement the total cost of provision of public goods and services by Government. This is usually in appreciation of the following facts:
- That there is an ever-increasing requirement for Government to provide goods and services which continually puts greater pressure on limited resources available to the state.
- That members of society view projects for provision of public goods and services as their own such that they cultivate sense of ownership and accountability.
- That whereas public goods are for benefit of all, it would be fair to introduce the element of a charge on or contribution by those directly benefiting from such projects rather than entirely depend on taxation of all.
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- Cost sharing may affect level of taxation such that rather than raise taxes to generate extra funds cost showing is used to target persons directly benefiting from the individual project/service or good. This can only apply where society has enough disposable income left in their hands after taxation. In a situation of general poverty and increasing pressure on Government to provide essential services and goods cost showing would be minimal and as such taxation would still be high or public debt would increase.
( 8 marks)
QUESTION FOUR
List and explain any three deductions that may be available against gains or profits from employment. ( 3 marks)
- Deductions that may be available against gains or profits from employment are:
- Mortgage interest (owner occupied interest) paid on loan to buy or improve a residential house up to a maximum Ksh.100,000 from year 2001. Note that where the mortgage interest paid is less than the maximum, the actual interest paid is claimed. Where actual mortgage interest is higher than maximum only maximum allowable can be claimed. W.e.f 1/1/2006, the maximum allowable interest is Sh. 150,000 p.a (12,500 p.m)
- Actual amount contributed by an employee to a registered pension or provident fund which shall be the lower of (i) Actual contribution or Sh. 240,000 or 30% of pensionable income.
- Contribution to a registered Home Ownership Savings Plan up to Ksh.48,000 p.a., that is Ksh.4,000 p.m.
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- S.S.F of Kshs 200 p.m (Kshs 2,400 p.a)
- Subscriptions to professional associations such as LSK, IATCK etc.
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- (i)Specify the rules relating to payment of Income tax under the Pay As You earn rules.
( 5 marks)
- “Pay as You earn” is deductible from weekly wages, month salaries, annual salaries,
- bonuses, commissions, directors fees (whether the director is resident or non-resident) pensions paid to pensioners who reside in Kenya, where the amount from registered pension funds Kshs. 150,000 p.a. and any other income from an office or employment. W.e.f 1/7/2004, this amount has been increased to Kshs. 180,000 p.a.
- It is the employer’s statutory duty to deduct income tax from the pay of his employees whether or not he has been specifically told to do so by the Department.
- The law requires an employer to remit the income tax deducted from his employee’s pay before the tenth day of the month following the deduction.
- If the total amount of tax deducted, from all employees in any month is less than hundred shillings or when no tax has been deducted, the employer must complete the relevant portions of the top copy of a credit slip and send it direct to his Income Tax office before the tenth day of the following month.
- Where total amount of tax deducted is less than Ksh.100, it should be carried forward to later months until it exceeds Ksh.100 or until December, whichever is the earlier, and then paid-in.
(ii) What are the consequences of failure to deduct and pay tax under PAYE?
( 3 marks)
If any employer fails to comply with the provisions of Section 37 and with the provisions of any rules made under Section 130 which deals with the payment over of tax deducted and the accounting for it to the commissioner, the commissioner may, by order, impose a penalty equal to twenty five per cent of the amount of tax involved or ten thousand shillings whichever is greater, and the provisions of the Act relating to the collection and recovery of the tax shall apply to the collection and recovery of any tax payable and such penalty as if it were tax due by the employer.
QUESTION THREE
Explain the role and functions of a Value Added Tax tribunal. ( 4 marks)
The role of a value added tax tribunal is that of an appeals body for the purpose of hearing and deciding on appeals where a taxpayer is dissatisfied with the ruling by the commissioner for value added tax.
The appeals Tribunal has powers of a subordinate court of the first class to summon witnesses, to take evidence upon oath or affirmation and to call for the production of books and other documents
What are the requirements with respect to any sales made by Pepo Limited?( 5 marks)
