5.1 Objectives

At the end of this chapter, students should be able to discuss the following concepts:

• Tax planning for individuals and companies

• Employment versus self-employment

• Identifying opportunities to alleviate, mitigate or defer the impact of direct or indirect 

taxation

• Remuneration packages

• Corporate structure and dividend flows

• Anti - avoidance provisions 

• Transfer of real properties 

• Pricing policy 

• Uses of tax incentives 

• Disposal of business operations and restructuring of activities

5.2 Introduction

In the last chapter, we studied the various tax issues affecting cross border transactions. In this 

chapter, we will cover tax planning aspects. Tax planning is the arrangement of the affairs of a 

taxpayer in such a way as to minimise tax liability at lowest cost without contravening any tax 

law or regulations. It is determination, in advance, of the tax effect of proposed business actions 

and requires a deeper understanding of the tax legislation and sound knowledge of case law 

in taxation. Among the many advantages, tax planning helps organisations to fully comply with 

applicable tax laws. In the next topic, we will study the various tax systems and policies.

5.3 Key definitions

Tax planning - Tax planning is the arrangement of the affairs of a taxpayer in such a way as to 

minimise tax liability at lowest cost without contravening any tax law or regulation

Tax avoidance - The reduction of tax liabilities by legal, although possibly artificial means.

Tax evasion - The reduction of tax liabilities by illegal means such as concealing information or 

supplying false information.

5.4 Exam Context

The student is expected to demonstrate an understanding of the taxation laws. This paper 

mainly tests the application of the concepts discussed here. Questions on this topic rarely miss 

in examinations.

5.5 Industrial Content

The student is expected to use his knowledge in taxation to effectively implement tax control 

measures to ensure adherence to tax law. This helps an organisation to control costs hence 

ensuring profitability.

5.6 Tax planning concept

Tax planning is the arrangement of the affairs of a taxpayer in such a way as to minimise tax 

liability at lowest cost without contravening any tax law or regulations. It is determination, in 

advance, of the tax effect of proposed business actions.

Tax planning requires:

- A deeper understanding of the tax legislation; and 

- A sound knowledge of case law in taxation.

Tax consultancy is therefore basically tax planning involving offering tax advice to clients in 

various situations. Tax revenue departments have to ensure the following through proper tax 

planning: -

- Taxpayers comply fully with tax laws and regulations; and

- Revenue collection is maximised.

A careful study of decided cases is important in:

i) Highlighting tax planning schemes;

ii) Provision of judicial interpretation of the legislation;

iii) The judgement in a particular case will show strengths and weaknesses of a particular 

scheme.

Aims of tax planning

1. To achieve compliance with tax laws since non-compliance with tax laws is costly due to 

penalties and interest charges.

2. To ease administration as in working out arrangements, methods of accounting, records to 

be kept, reports to be prepared etc.

3. To achieve the most advantageous financial position out of a business transaction to be 

measured in terms of direct tax savings from planning and financial benefits by way of cash 

flow effects.

5.6.1 Tax planning for individuals

The tax planning measures of an individual would depend on whether they are employed or 

unemployed. The following tax planning measures are allowable for employees.

Owner Occupier Relief

According to Section 15 (3) (b) of the Income Tax Act, interest paid by a person on amount borrowed 

from specified financial institution (includes a bank, insurance company or building society) for 

the purchase of or improvement of premises that he occupies for residential purpose shall be 

deductible against total taxable income of the person. The maximum allowable interest is Kshs 

150,000 per annum (Kshs 12,500 per month). 

An employer should ensure that mortgage interest paid by the employees is allowed for deduction 

in the payroll of all eligible employees. 

Insurance Relief

An employer should notify employees who have taken individual life assurance covers or education 

policies with a maturity of 10 years (with effect from 1 January 2003) and maybe paying out of 

payroll premiums on the same that they are eligible to claim insurance relief and effect the same 

through the payroll. The deductible amount paid is subject to a maximum of Kshs. 60,000 per 

annum (Kshs. 5,000 per month).

Non-cash Benefits

Increasing the non-taxable benefits may reduce tax on employees especially where such benefits 

are allowable for corporate tax purposes. Examples of benefits that the company could consider 

introducing or expanding include the following:-

Medical services 

This entails the reimbursement to staff of medical expenses incurred for self and dependants 

or access to designated hospital facilities where the company holds an account. There is no 

maximum limit of the same under the law.

Staff development and training 

Training costs directly paid to a training institution for an employee in relation to the 

employees’ responsibilities at the work place and for the benefit of the company’s business 

are allowable for corporate and PAYE purposes.

Mileage reimbursement for use of personal car on the company business

This benefit is tax efficient in comparison to the car benefit and provision of staff transport 

which are taxable on the employees.

Meals for low income employees

Meals provided to low income employees on employers premises are a non taxable benefit 

on the employees. A low income employee is a person earning not more than Kshs. 29,316 

per month.

School fees

Generally, where the employer pays school fees for the employee’s child, dependant or 

relative, such payment becomes a taxable benefit on the employee if not already taxed on 

the employer. However, educational fees for dependants of low income employees paid or 

foregone by an educational institutional employer are not taxable on either the employer 

or the employee. A low income employee is defined as one earning not more than Kshs. 

29,316 per month, i.e. employees at income tax bracket of 20% and below. (Effective date: 

13 June 2008)

5.6.2 Tax planning for companies

Companies may lay strategies for tax planning. Some of the reasons companies or entities 

should plan for their taxes are:

- Tax is a major expense in company’s P&L;

- To take advantage of the available tax incentives.

- To minimise tax penalties and interest;

- The KRA aggressiveness in collecting taxes;

- To improve cash management and forecast;

There are many strategies that companies can adopt in tax planning. Some of the tax planning 

opportunities are:

a) Tax compliance

One of the best strategies for tax planning for companies is tax compliance. The company should 

ensure that it complies with its obligation to pay corporate taxes, to deduct advance taxes, to pay 

withholding taxes and to file returns. This will avoid unnecessary penalties and interest being 

levied on the company for non-compliance in case of an audit by the revenue authority.

b) Use of Capital allowances;

The company should explore the provisions of the Income Tax Act on capital allowances. As such, 

the company should always claim the proper capital allowances on the qualifying costs of the 

assets. This will reduce taxable profits of the company and as such lead to a good tax planning 

measure. The company may seek consultancy advice to help utilize the capital allowances.

c) Tax losses used to reduce taxable income

Tax losses or tax deficits of a company can be carried forward to be offset against future income 

from the same source. Following an amendment in the 2009 Finance Bill, the carry forward of tax 

losses is only allowed for the year of income it arose and four subsequent years. The company 

should be able to use tax losses to plan their taxes.

d) Tax refunds used to reduce tax payable;

The company should utilise tax refunds to reduce tax payable. Tax refunds arise from overpayment 

of taxes. It can be overpayment of VAT, corporation tax among others. The refund is allowed 

upon application and approval by the CDT. One can apply to offset a recoverable or a refund from 

one form of tax against tax payable in another form.

e) Lower tax rate on listing at NSE.

Companies can list their shares to make use of preferential tax rates. Companies newly listed on 

any securities exchange approved under the Capital Markets Act enjoy favourable corporation 

tax rates as follows:

• If the company lists at least 20% of its issued share capital, the corporation tax rate 

applicable will be 27% for the period of three years commencing immediately after the 

year of income following the date of such listing.”

• If the company lists at least 30% of its issued share capital, the corporation tax rate 

applicable will be 25% for the period of five years commencing immediately after the 

year of income following the date of listing.”

• If the company lists at least 40% of its issued share capital, the corporation tax rate 

applicable will be 20% for the period of five years commencing immediately after the 

year of income following the date of such listing.

The corporate tax rate applicable to the company may therefore change if the percentage of the 

listed share capital exceeds 20% of the issued share capital. The applicable tax rate will depend 

on the percentage of the issued share capital listed at the Nairobi Stock Exchange.

f) Instalment tax payment

Under the Income Tax Act, companies are required to pay instalment taxes when they expect to 

receive taxable income in that year of income. The payment of instalment tax is a good means 

of cash management since it helps avoid a situation where a company pays a huge tax balance. 

Further, the company can opt to use either the previous year basis or the current year basis while 

estimating instalment tax payable. Whichever method is selected, the company should adopt a 

good approach to the management of cash flows.

g) Application for tax exemptions or remissions

The company can explore the avenue of applying for tax exemptions or tax remissions.

h) Applications for waiver of penalties and interest

The Income Tax allows the taxpayer to apply for waiver of any penalties and interests charged. 

The commissioner can waive up to Kshs 1,500,000 while the Minister of Finance can waive any 

amount upon application. The taxpayer should therefore pay the principal tax and make the 

application for waiver of penalties of interest - it will be upon the commissioner to grant.

5.7 VAT planning

VAT legislation tends to be complex thus making compliance difficult. Penalties resulting from 

non-compliance with VAT law are punitive. Tax losses may result by failure to plan vatable 

transactions. Some of the VAT planning options are:

1. VAT should be loaded on the taxable goods and services and passed on to the 

customer.

2. VAT compliance- payment of VAT by 20th of the following month. 

3. Use of VAT set off where the company is in refund situation and has taxes payable.

4. Use of tax remission scheme such as Tax Remission for Exports Office (TREO)

5. VAT remission on capital investments.

6. Whilst VAT is supposed to be paid even on unpaid invoices, the company may, as a 

cash flow management tool, reduce its debt collection period.

7. VAT is not a cost to the company. The company should ensure that input tax is claimed 

on a timely basis.

8. Claiming for refund of VAT on bad debts. These are debts over three years but not more 

than five years. Evidence of recovery efforts is however required.

5.8 Customs duty planning

Duty planning

Deals with import duty and excise duty. The amount of duty on imports will have a significant 

effect on cost of goods finally exported to say nothing of competitiveness and profitability of the 

business. Excise duty adds to cost of a locally manufactured good ultimately affecting price and 

profit margins.

Customs planning can give opportunities in the following areas:

• Duty Remission

• Customs valuation 

• Duty Suspension

• Classification of goods

• Duty deferral

• Origin of goods

Duty Remission

Investors can apply to the Minister for duty waiver or exemption under special duty rates. Duty 

remissions are also available under the Tax Remission for Exports Office (TREO) programme.

Customs valuation

This involves ensuring that the best valuation method is used. It would be advisable to import from 

a manufacturer rather than a middleman. In practice, the value of the second transaction is used 

to calculate Customs value on import. As such, if one has prior information of first transaction and 

bought directly from the importer or manufacturer, it will result in duty saving. Thus applying “first 

sale” principle can minimise duty by eliminating “middleman markup.”

Duty suspension

The bonded warehouse arrangement can be used to minimise Customs value. A trader in 

Tanzania approaches a Kenyan trader for the first time in order to purchase sports shoes. Had 

the trader imported the sports shoes under a bonded warehouse arrangement they could have 

avoided unnecessary import duties and VAT on the import (enter as transit goods).

Classification of goods

The taxpayer should ensure goods are correctly classified. Incorrect classification of goods may 

lead to payment of either higher or lower duty. If lower duty is paid, there are risks of paying the 

difference after a post clearance inspection. If higher duties are paid, it will result in the pursuit 

of the duties outstanding (Customs duty and VAT) and even fines or interest in arrears on the 

duties and VAT.

Duty deferral

This planning opportunity involves importing goods, storing or further manufacturing the goods, 

then exporting the goods to another country or releasing them to the Kenyan market (pay 2.5% 

surcharge)

Origin of goods

There may be varying amounts of import duty payable depending on the origin of the goods. 

Some imports from certain countries enjoy a preferential import duty. As such, the importer should 

be well versed with rules of origin to make use of the preferential import duty rates. One would 

need to produce a valid Certificate of Origin.

5.9 Employment versus self-employment

There is a distinction between employment (receipts taxable as earnings) and self-employment 

(receipts taxable as trading income). Employment involves a contract of service, whereas self 

employment involves a contract for services. 

Taxpayers tend to prefer self-employment, because:

• The rules on deductions for expenses are more generous.

• Under self-employment, the person would be subject to withholding tax which is usually 

at a lower rate than the graduated scale rates.

Factors which may be of importance include:

• The degree of control exercised over the person doing the work: The higher the degree 

of control, the more likely that the contract of service as opposed to a contract for 

service where there is minimal control from the entity.

• Whether he must accept or provide further work: If the person must accept any further 

work delegated to them, and then the same is a contract of services and not a contract 

for services.

• Whether he provides his own equipment: A person on self employment is expected to 

have his own equipment while providing services. If most of the equipment are provided 

by the employer then it can be construed to be a contract of services.

• Whether he hires his own helpers: If he has the authority and powers to hire his own 

helpers then he is in self-employment as opposed to employment.

• What degree of financial risk he takes: The more the degree of financial independence, 

the more likely that he is in a contract for services.

• What degree of responsibility for investment and management he has: The more such 

responsibilities, the more likely that it is a contract for services.

• Whether he can work when he chooses: If so, then it could be a contract for services.

• The wording used in any agreement between the parties: the agreement can state 

categorically what it is.

Relevant cases include:

(a) Edwards v Clinch 1981

A civil engineer acted occasionally as an inspector on temporary ad hoc appointments.

Held: There was no ongoing office which could be vacated by one person and held by another 

so the fees received were from self-employment not employment.

(b) Hall v Lorimer 1994

A vision mixer was engaged under a series of short-term contracts.

Held: The vision mixer was self-employed, not because of any one detail of the case but because 

the overall picture was one of self-employment.

(c) Carmichael and Anor v National Power Plc 1999

Individuals engaged as visitor guides on a casual 'as required' basis were not employees. An 

exchange of correspondence between the company and the individuals was not a contract of 

employment as there was no provision as to the frequency of work and there was flexibility to 

accept work or turn it down as it arose. Sickness, holiday and pension arrangements did not 

apply and neither did grievance and disciplinary procedures.

A worker's status also affects national insurance. The self-employed generally pay less than 

employees.

5.10 Remuneration packages

Staff costs are significant operational costs. The employer needs to reward labour in the highest 

possible way at lowest cost possible while at the same time observing full compliance with the 

law. Consider lumpsum payments, benefits, expenses etc.

An employee will usually be rewarded largely by salary, but several other elements can be 

included in a remuneration package. Some of them bring tax benefits to the employee only, and 

some will also benefit the employer.

Bonuses are treated like salary, except that if a bonus is accrued in the employer's accounts 

but is paid more than nine months after the end of the period of account, its deductibility for tax 

purposes will be delayed.

The general position for benefits is that they are subject to income tax. The cost of providing 

benefits is generally deductible in computing trading profit for the employer 

However, there are a large number of tax free benefits and there is a great deal of planning that 

can be done to ensure a tax efficient benefits package for directors and employees. The optimum 

is to ensure that the company receives a tax deduction for the expenditure while creating tax free 

benefits. 

There are items which are commonly referred to as income but are not included in the above 

mentioned list of taxable income. A number of such non-taxable incomes come to mind, 

notably:

1. Pension or gratuities earned or granted in respect to disability

2. Monthly or lumpsum pension granted to a person who is 65 years of age or more.

3. That part of the income of the president of the republic of Kenya that is exempt e.g. a 

salary duty, allowances, entertainment allowances paid or payable to him from public 

funds

4. Allowances to the Speaker, Deputy Speaker and Members of Parliament payable to 

them under the National Assembly remuneration

5. Interest up to Kshs 100,000 per individual on housing bonds, account with Housing 

Finance (formerly Housing Finance Corporation of Kenya - HFCK), Savings and Loans 

of Kenya Ltd, East Africa Building Society, Home Loans and Savings. (With effect 

from June 1987, interest up to Kshs 300,000 is qualifying while the excess is non 

qualifying.)

6. Cost of passage to and from Kenya of a non-citizen employee borne by the employer.

7. Employer’s contribution to pension funds or provident funds.

8. Benefits, advantages/facilities of an aggregate value of less than Kshs 36,000 p.a. in 

respect of employment or services rendered.(W.e.f.1.1.2006, non cash benefits are 

taxed if their aggregate value is more than Kshs 36,000 p.a or Kshs 3,000 p.m.)

9. The first Kshs 150,000 per month for persons with disabilities exempt from taxation. ( 

w.e.f. 12.June 2009).

10. Expenditure on amenities by the physically disabled tax allowable up to a maximum of 

Kshs 50,000 per month. (w.e.f. 12. June 2009)

Illustration

Mr Jared Masai, a human resource manager is currently out of employment. However, he has 

received two offers of employment which require him to report on duty on 1st July.. One of the job 

offer is from Mapato Ltd. The company owns a large scale farm in Kitale on which it grows maize 

and rares dairy cows. The other offer is from Watalii Tourist Hotel located in Nanyuki. Mr. Masai 

has approached you as a tax expert, to advise him on which of the two job offers to accept. He 

has provided you with the following additional information. 

JOB OFFER A: MAPATO LTD

Terms of employment

1. A basic salary of Kshs 140,000 per month

2. Free housing for him and his family within the farm , with free water and electricity. The 

water is from a borehole sunk in the farm. The electricity is also generated within the 

farm.

3. Free supply of farm produce subject to a maximum of Kshs 600,00 per month. 

4. Reimbursement of medical expenses incurred on self and family subject to a maximum 

of Kshs 1,500,000 per annum. The reimbursement policy applies only to senior 

managers.

5. Payment of his children’s school fees amounting to Kshs 180,000 per month by the 

employer. The employer would bear the tax on this benefit

6. His annual membersip fee to the local golf club amounting to Kshs 50,000 would be 

paid for by the employer

7. He would be required to register as a member of the Institute of Human Resources 

Managers and pay the initial registration fee of sh. 10,000. The employer would pay the 

annual subscription fee of Kshs 18,000.

JOB OFFER B: WATALII TOURIST HOTEL

1. Terms of Employment

2. A basic salary of Kshs 180,000 per month.

Free housing and meals but only for self.

3. Monthly entertainment allowance of Kshs 15,000

4. Payment by the employer of his medical expenses subject to a maximum of Kshs 

800,000 per annum. The medical scheme covers all hotel employees.

5. Payment by employer of his life assurance premiums amounting to Kshs 60,000 per 

annum.

6. Reimbursement by the employer of annual subscription for the Journal of Human 

Resources Managers amounting to Kshs 2,500 per annum.

7. A one-week fully paid holiday package worth Kshs 150,000 for his wife and children to 

visit him and reside at the hotel once per year. The package will also include visits by 

the family to neighbouring tourist attractions.

Mr. Masai has further provided the following information:

b) (i) Responsibility of employers for the collection of PAYE due from retirees receiving 

monthly pension income.

Pensions or retirement annuities (periodic payments) up to KShs 180,000 p.a received by a 

resident individual are tax exempt so long as the scheme or fund is registered. As such the 

employer will deduct tax on monthly withdrawals in excess of Kshs 180,000. However, if the 

employee is above 65 years of age then the whole withdrawal from a pension fund is tax 

exempt.

NB. Lumpsum withdrawals from a pension or retirement scheme of up to K.shs 480,000 p.a 

received by a resident individual are tax exempt so long as the scheme or fund is registered.

5.11 Identifying opportunities to alleviate, mitigate or defer the impact of direct or indirect taxation

The student should be able to identify opportunities to alleviate, mitigate or defer the impact of 

direct or indirect taxation. Questions on this area will be practical and the student will be expected 

to apply the content learnt in taxation in general.

5.12 Corporate structure and dividend flows

The topic focuses on chargeable income, deductible expenses, capital allowances, available tax 

incentives, treatment of tax losses, dividend policy, transfer pricing, etc.

Forms of decision problem

1. Whether to lease an industrial building or construct one.

2. Whether to invest in office buildings or rent.

3. Whether to operate a partnership or a limited company

4. Determining expenditure tax deductible or non-tax deductible.

1. Capital structure and taxation

By capital structure of a company, we mean the long-term financing normally made up of ordinary 

share capital., preference share capital, reserves (revenue and capital) and debt finance (long 

term, medium and short term loans and debentures).

Capital structure explains the relationship (proportion) between the various sources of finance.

Optimum capital structure is the most ideal capital structure to be maintained and any changes 

to it must affect amounts and not proportions. Optimum capital structure is achieved where, 

among other considerations, the cost of finance is lowest. The capital structure has great impact 

on cost of finance because some finances are cheaper to use than others. Taxation discriminates 

between equity and debt capital. Debt finance is cheaper since interest on debt is tax allowable 

expense and cost is less by the amount of such tax interest. Dividends on equity is not tax 

deductible.

Illustration

Company ABC Ltd. is to pay interest on debt capital of 15% where corporation tax rate of 30%

Required

Compute the true/effective cost of debt capital.

2. Income taxes and project appraisal

XYZ Company Ltd, a manufacturing company in industrial area, Nairobi requires 2,500 units a 

year of a component over a period of 3 years. There are three possible plans of action to be 

considered namely:

Plan A:

To buy the component from a supplier who quotes Kshs 10 per component.

Plan B

To manufacture the component themselves. Equipment needed would cost Kshs 20,000 initially. 

Incremental costs are estimated at Kshs 5 per component. The equipment would be expected to 

have a sale value of Kshs 8,000 after two years; repair costs during the period of use are forecast 

at Kshs 200, Kshs 500 and Kshs 800 for each of the three years respectively.

Plan C:

To manufacture the component using hired equipment which would be maintained by the owner 

without additional charge. The rent of the equipment would be Kshs 5,000 per annum payable 

annually in advance.

The company uses a discount rate of 5% per half year. A wear and tear deduction of 12½% 

would be available on purchased equipment.

Required

Which alternative maximises tax cash inflow? (Take corporation tax rate to be 30%)

5.13 Form of business ownership

There are many tax implications involved in deciding the form of business:

• Company or Business

• Branch or subsidiary

Opening a company or a partnership

• The following are the major tax considerations to take into account in deciding whether 

to operate a partnership or a limited company.

• A partnership is not considered as a separate taxable entity as a company, therefore, 

the taxable income of a partnership is allocated among the partners according to the 

profit/loss sharing ratio. A company is considered to be a separate taxable entity and as 

such it will bear its taxes.

• The partners in a partnership are taxed at the graduated scale rates which are lower than 

the corporate tax rates. The taxable income or loss of a limited company is taxable on 

the company at a flat rate of 30% for resident and 37.5 % for non-resident companies.

• Partner’s salaries are not tax deductible while director’s salaries in a limited company 

are tax deductible.

• The losses made under a partnership are carried forward by the partners individually 

but not the firm while losses in a limited company are carried forward by the company.

• The company will be required to pay withholding tax when it is declaring dividends to 

its shareholders while a partnership does not declare dividends. The partners may 

withdraw and any such withdrawal will be taxed on the individual partner. 

• Companies have compensating tax while partnerships are not subject to the same.

• Currently partnership can pay turnover tax at 3% on gross income if the company 

has turnover of between Kshs500,000 and Kshs5 million within one year. However, 

companies are not subject to turnover tax.

Opening a branch or subsidiary

The following considerations should be made in case of a branch or a subsidiary:

The implications of debt or equity as modes of raising additional capital is as follows:

Corporate form of ownership enjoys legal personality and income is subject to corporate income 

tax rates. Sole proprietorship/partnerships are not separate entities from those forming it for tax 

purposes.

For a corporation, reasonable salaries paid to officers/directors who are also shareholders are 

tax deductible. For sole proprietorships/partnerships no deduction is allowed for owner’s salaries 

or for interest expense on invested ownership capital. 

Corporate profits are subject to double taxation: first corporation tax and secondly dividends 

withholding tax on recipients.

Other considerations:

• Ease of transfer of ownership

• Tax brackets are high or low for owners

• Expected life of business.

Illustration:

2.1.1 Mr. Kamau has two offers for employment in two engineering firms. The details of the 

two offers are as follows:

Pension scheme, which is registered by commissioner of income, and both employer and 

employee contribute 5% of the basic salary for pension scheme.

Required

What offer would you recommend to Mr. Kamau? Explain reasons for your recommendation.

5.14 Anti-avoidance provisions S.23

Under S.23, the Commissioner of Income Tax is empowered to reject certain business transactions 

when he is of the opinion that the main purpose or one of the main purposes for effecting a 

transaction is evasion or reduction of tax liability. He can direct for necessary adjustment on 

taxable income and issue an assessment accordingly. If the taxpayer disputes the adjustment 

and the resulting assessment, the taxpayer can appeal to the Tribunal e.g.

• A director buying a car from the company at a throw away price. He would be taxed 

on the difference between the low price he pays for the car and the market price for the 

car.

• A child paid very high salary for minor duties. The salary helps to spread tax payable but 

the parent controls the child’s income. The Commissioner of Income Tax would disallow 

the salary and tax it.

Tax Avoidance: Principles emerging from case law

Section 23 of the Kenya Income Tax Act empowers the Commissioner to order the adjustment of 

transactions which in his opinion are effected with the main aim of avoiding or reducing liability 

to tax.

Such a direction can only be challenged by appealing to the Income Tax Tribunal. This decision 

of the Tribunal is final and there is no right to further appeal.

However, the Commissioner rarely, if ever, does use such powers. Consequently, there is no 

such litigation in respect of tax avoidance schemes in Kenyan courts.

However, the following principles have emerged from UK Case Law and which may well be 

applied in Kenya:

1. The “Duke of Westminster” Principle.

Lord Tomlin stated: “every man is entitled, if he can, to order his affairs so that the tax 

attaching ... is less than it would otherwise be.

2. The “Ramsay” Principle: This was established in a Capital Gains Tax Case in relation 

to composite transactions.

At the time, the most prevalent scheme to avoid tax (especially Capital Gains Tax) was to 

enter into a series of transactions, which would facilitate the following:

(a) Conceal the sale of property subject to Capital Gains Tax (CGT)

(b) The exchange of shares for shares, which would not have CGT implications.

This interdependent series of transactions would normally be “circular and self cancelling”.

The Ramsay doctrine provides that whether a series of transactions is genuine or artificial 

would be dependent on the end result. Transactions which have no commercial purpose 

are treated as a fiscal nullity. The preordained series of transactions are disregarded if they 

have no business purpose other than achieving the preordained end.

The same principle was extended in CIR vs BURMAH OIL CO. LTD.

3. Francis vs Dawson

Facts of the Case

George Dawson and family owned two private companies which they wanted to sell. If they 

were sold in UK at a gain, it would be subject to Capital Gains Tax.

Dawson wanted to sell to W Ltd a UK company. He was advised to sell by an exchange of 

shares for shares with an offshore company, G Ltd.

G Ltd then sold its shares in the two companies to W Ltd. The scheme succeeded on the 

grounds that the end result led to “enduring legal consequences” and therefore the individual 

transactions had a business purpose and not artificial as in the Ramsay Case.

5.15 Transfer of real properties 

Income from ‘sale of land and buildings’ in Kenya is non-taxable income. It used to be tax on 

gains of sale of property e.g. land and buildings but was suspended with effect from 14.6.1985.

(a) A taxpayer (or a partnership) with Kenya rental income is treated as running a business, 

his Kenya property business'. All the rents and expenses for all properties are pooled, 

to give a single profit or loss. Profits and losses are computed in the same way as 

trading profits are computed for tax purposes, on an accrual basis.

(b) Expenses will often include rent payable where a landlord is himself renting the land 

which he in turn lets to others. 

This is income earned by a person for rights granted to others to occupy his property. Rent 

income is made up of key money or goodwill, normal rent and premium. 

Taxation of rental income depends on whether one is a resident individual or a non resident.

Non residents

They are taxed at a flat rate of 30% on gross rent income and this is the final tax.

No expenses are allowed against gross rent income.

Residents

For residents, rental income will be brought to tax at the graduated scale rates for individuals and 

at the corporation tax rate for companies. However the following points are relevant in arriving at 

the net taxable rental income:

Some of the tax planning measures include:

• Claim the expenses allowable on the rental income.

• If you obtain a mortgage to acquire rental houses, the entire interest will be allowable 

against the rental income for that year of income. As such the mortgage option is 

recommended.

• Compute capital allowances and claim the same accordingly on the capital expenditure 

incurred in the rental premises.

• With the introduction of VAT on commercial rental property, it is important to charge VAT 

on any such properties and issue a valid tax invoice.

5.16 Pricing policy 

The firm or entity should have a tax efficient pricing policy. A tax efficient pricing policy should be 

informed by all considerations including the prices of commodities and the taxes payable for the 

commodities. Further, the taxpayer should consider the risk of transfer pricing.

Transfer pricing

The introduction of transfer pricing documentation requirements in Kenya in June 2006 has 

contributed to increased tax audits by the tax authorities in regard to the same. 

Transfer pricing is important when structuring transactions. Due, in part, to their often complex 

nature and specific characteristics, the transfer pricing aspects of intercompany financing activities 

have had a relatively low profile so far. However, in view of the tax administration’s increasing 

interest in this subject and the pre-eminently ‘affiliated’ nature of shareholder financing, this 

subject cannot be avoided in an M&A transaction.

Documentation requirements

Transfer pricing involves transactions among associated entities at arm’s length conditions, the 

“arm’s length principle”. The fact of not meeting such transfer pricing documentation requirements 

might result in severe penalties in said countries. In addition, discussions about transfer pricing 

might lead to substantial taxation adjustments for both the present and past years which could 

lead to double taxation. In addition to specific, local transfer pricing rules, many countries also 

apply the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 

for consistent application of the arm’s length principle at an international level. 

Intercompany financing transactions and Mergers & Acquisitions ( M &A)

If shareholder loans are granted or other financing transactions are made during an M&A 

transaction or even within the target group, the applied conditions should be at arm’s length and 

sufficiently substantiated. Examples are the substantiation of the (often high) interest charged 

by the investor on shareholder financing; the spread in a back-to-back situation; charging or 

not charging a fee if a group company stands as guarantor for another group company within 

the scope of an overdraft facility; the allocation of the advantage in case of cash pooling; or the 

situation in which external bank financing within the group is on lent at a ‘blended’ rate to all 

group companies, without involving the stand-alone creditworthiness of the various companies 

in the analyses. In principle, a substantiation should be available for each transaction, based on 

its specific characteristics and taking into account the position of the parties involved. 

Loan pricing policy

As said, the arm’s length nature of each loan should be substantiated based on the arm’s 

length principle, transfer pricing legislation and local documentation requirements. Depending 

on the scale and the complexity of the intercompany loans, this may constitute a considerable 

administrative burden. In practice, therefore, substantial loans and high-interest loans in particular 

have only been documented so far. 

In order to ensure that the documentation requirements are nevertheless somewhat met and 

that interest on intercompany loans is determined in a consistent manner, a loan pricing policy 

can be drafted within the scope of (post-deal) structuring. In such loan pricing policy, the credit 

rating of the group companies and the currency and term of the loans must be taken into account. 

Based on this, and on a database with external comparables, a matrix of credit spreads can be 

prepared, to be used to determine the interest and spread on intercompany loans. 

5.17 Uses of tax incentives 

The taxpayer can make use of the various tax incentives as a form of tax planning. Some of the 

tax incentives include:

Capital allowances

The capital allowances available in Kenya are Farm works, Industrial Building, Investment and 

Wear and Tear allowances. These allowances are deductions from taxable income based on a 

percentage of the qualifying cost of investment. They tend to lower the effective price of acquiring 

capital since the initial cost is recovered. 

Export Processing Zone incentives

Enterprises operating in the Export Processing Zones (EPZ enterprises) have got a number of 

incentives. These incentives were provided on the enactment of the Export Processing Zone 

Authority Act “EPZA Act” in 1990 which established the EPZ Authority (EPZA) as a” one-stop” 

centre for facilitating export-oriented investment and administering a number of incentives. The 

incentives offered by the Authority cover trade as well as income taxes. 

The EPZA is also an executing agency since it manages the government-owned free zone parks. 

Most of the parks are, however, owned by private firms. The number of industrial parks that were 

administered by the Authority rose from 7 to 16 between 1993 and 1998. Similarly, the number of 

EPZ firms increased from 13 to 22 within the same period. 

Enterprises operating within EPZ have the following benefits:

• There is a 10- year tax holiday. This is an exemption from corporation tax for the first 

10 years of trading.

• There is a lower corporation tax rate of 25% for the subsequent years after the 10- year 

tax holiday.

• There is an exemption from withholding tax on dividends and other payments to non 

residents during the first 10 years.

• Investment deductions are 100% of the capital expenditure claimable in the 11th year 

after commencement of production.

• Supplies from an EPZ enterprise are zero rated for purposes of VAT

• There is a refund of import duty on raw materials to manufacture exports.

The EPZ companies are allowed to sell up to 20% of their products to the domestic market. 

However, these rules were not rigidly applied during the early years of the scheme, with the 

domestic firms sometimes exceeding 50%. To prevent the EPZ benefits from giving undue 

disadvantage to domestic firms, an additional 2.5% import duty is charged on EPZ sales made 

to the domestic market. 

Another constraint for EPZ operations in Kenya is that because EPZ firms operate outside Kenya’s 

Customs territory, the preferential tariff regime they would have enjoyed in marketing to the 

COMESA countries is blocked. This is considered to be a major disincentive for expansion of the 

scheme since many Kenyan firms target the COMESA market. The EPZ incentives encourage 

the participation of the private sector in the development of the processing zones. Up to now, 

EPZA has gazetted 16 zones but only half of these zones are in operation.

VAT Remission

The Kenyan tax regime incorporates a remission scheme, including VAT targeted at either 

attracting investments or promoting exports. They include the following: 

A duty / VAT remission scheme for firms that import inputs under the Manufacturing Under Bond 

(MUB) and Export Promotion Programmes Office (EPPO); the Minister may also remit the tax in 

the public interest under specific circumstances.

Under the original VAT law introduced in 1990 imports made by MUB are zero rated to avoid the 

payment of VAT up front. The zero rating incentive has since been extended to domestic supplies 

made to MUBs to encourage local firms to sell to those enterprises.

Export processing zone enterprises are exempt from registration under VAT Act because they 

are not considered as local firms. They are also exempt from the payment of excise duties 

as specified in the Customs and Excise Act. The main trade tax incentive schemes include 

export compensation, duty drawback, manufacturing under bond (MUB), and export processing 

zones.

Export compensation schemes

Duty Remission Facility

These are a form of Export Compensation schemes. Materials imported for use in manufacturing 

for export; the production of raw materials for export; or the production of duty free items for sale 

domestically, are eligible for duty remission. Applications for this facility should be made to the 

Tax Remission for Export Office (TREO) administered by the Ministry of Finance.

Manufacture under Bond

The Manufacturing under Bond (MUB) scheme. MUB was established in 1988 to boost exports 

as part of the Srtuctural Adjustments Programmes introduced earlier in 1987. It is a duty or 

tariff deferral scheme under which eligible firms were licensed, placed under bond and allowed 

to import capital items, spares and raw materials without payment of duty. The bonds may be 

established on behalf of the firms by commercial banks or insurance companies. The amount 

of the bond is predetermined for each import, with the Customs authorities, canceling when the 

firms make exports, using the input on which the tax was waived.

A firm must invest up to Kshs 10 million and employ a minimum of 100 people to qualify for 

MUB status. The goods produced can only be sold on the domestic market with the permission 

of the Commissioner of Income Tax. When goods are sold on the domestic market, the firm 

becomes liable for the equivalent import duties waived on the inputs used to manufacture the 

goods. The physical controls that exist for monitoring their inputs and output are similar to those 

used under the excise regimes. By 1993, there were over 70 MUBs that were operating in Kenya, 

exporting mainly garments to the US market. Though the scheme continues, the number of firms 

has declined drastically to about 12 when, in 1994, the US trade authorities revoked Kenya’s 

export quota to that market. They cited the abuse that involved transshipment of cargo from India 

through Kenya as the reason for the revocation order. 

Kenya also offers Duty and VAT remission scheme as a tax incentive. The scheme was introduced 

in 1990 to provide relief for the payment of these taxes on imports on raw materials and other 

inputs that physically form part of the goods exported. Unlike the MUB and EPZ schemes, 

the remission mechanism does not cover taxes paid on capital inputs such as equipment and 

machinery. firms that wish to use the scheme are required to apply to the EPPO of the Ministry 

of Finance.

Double taxation treaties

Kenya has double tax treaties with various governments. In fact, Kenya has signed double tax 

treaties with United Kingdom, Germany, Canada, India, Norway and Zambia. The agreements 

are aimed at eliminating double taxation of income earned by the residents of the respective 

countries. The treaty rates are as shown below:

(a) Interest paid by the government and the Central Bank of Kenya is tax-exempt.

(b) The rate is 12.5% for management and professional fees.

(c) No Kenya tax is due if the dividend is subject to tax in Zambia.

(d) The rate is 17.5% for management and professional fees.

Where the treaty rate is higher than the non-treaty rate, the lower rate applies.

Turnover tax

This is a tax on consumer expenditure introduced in the 2006 Finance Act. It was introduced as a 

measure to improve compliance of small tax payers. It also acts as a tax incentive for the medium 

size businesses with a turnover of less than Kshs 5 million. The imposition of the turnover tax is 

contained in section 12 (c) of the Income Tax Act. It applies to any person whose gross sales is 

more than Kshs 500,000 per annum and does not exceed or is not expected to exceed Kshs 5 

million per annum 

The applicable rate as per the 2006 Finance Bill was 3% of gross sales per annum and it was to 

be a final tax. However, the 2006 Finance Act was not clear on the rate which is applicable and 

also had deleted the charging section. This made it difficult for it to be imposed by 1 January 

2007.

The situation was clarified in the 2007 Finance Bill and the rate was clarified as the resident rate 

for any year of income. Following this amendment, the turnover tax is expected to be effective 

with effect from 1 January 2008.

5.18 Disposal of business operations and restructuring of activities 

The various tax planning opportunities in the disposal of business operations and restructuring 

activities are as follows:

• Application to transfer assets of a going concern without charging VAT

Under paragraph 21 of the 6th Schedule to the VAT Act, where any person disposes of 

a registered business as a going concern to another registered person, both registered 

persons can apply to the Commissioner to transfer the taxable goods without charging VAT. 

For the application to be granted, both registered persons must within 30 days furnish the 

Commissioner with the following information: 

• Details of the transaction,

• Details of the arrangements made for payment of tax due on supplies already 

made

• Description of the transaction 

• Quantities and value of stocks of taxable goods on hand at the date of disposal, 

• Details of arrangements made for transferring the responsibility for keeping and 

producing books and records relating to the business before disposal; 

Unless the Commissioner has reason to believe that there would be undue risk to the 

revenue, and notifies the registered persons accordingly within 14 days of receipt of the 

notification, the stocks of taxable goods on hand may be transferred without payment of the 

tax otherwise due and payable; and

Further, notwithstanding that the business is being disposed of by the registered person as 

a going concern, that registered person shall remain registered and be responsible for all 

matters under the VAT Act in relation to the business prior to its disposal, up to the time of its 

disposal, until such time as the requirements of this Act have been properly complied with. 

• Transfer of assets at the WDV

Under paragraph 13(3) of the 2nd Schedule to the Income Tax Act, in the case of a transfer 

where one of the parties (body of person) exercises control over the other, the body of 

persons can apply to transfer assets at the written down value if the sale would have given 

rise to a balancing charge. In this case, no election will be made in cases where either the 

buyer or the seller is at the time of the sale a non resident person.

- Stamp duty incentives

- Section 95 of the Stamp Duty Act

Section 95 provides some exemptions on stamp duty and a reduction on stamp duty on 

increase of capital. In order for a company to qualify for the tax incentive, the following 

conditions must be met:

• There must be a new company to be incorporated in Kenya or an increase of 

share capital of an existing company. In our interpretation, the company must be 

incorporated under the laws of Kenya. 

• That the absorbing company is either registered or increases its capital with a view 

to acquiring more than 90% of the share capital of the target company. 

• The consideration of the transfer consists of more than 90% of the shares issued 

in the transferee company.

Section 96 exempts from tax instruments in respect to which it is shown to the satisfaction of the 

collector.

(a) That the effect thereof is to convey or transfer a beneficial interest in property from one 

company with limited liability (hereinafter called the transferor) to another such company 

(hereinafter called the transferee); and

(b) That either— 

(i) One of such companies is beneficial owner of not less than ninety per centum of the 

issued share capital of the other company; or 

(ii) Not less than ninety per centum of the issued share capital of each of the companies is 

in the beneficial ownership of a third company with limited liability; 

(c) That the instrument was not executed in pursuance of or in connection with an arrangement 

where under—

(i) The consideration for the conveyance or transfer was to be provided directly or indirectly 

by a person other than a company which at the time of the execution of the instrument 

was associated with either the transferor or the transferee; or 

(ii) The beneficial interest in the property was previously conveyed or transferred directly 

or indirectly by such a person.