TAX LAW NOTES PRT 1

BY Josiah M.N.

*DISCLAIMER*

The notes below are adapted from the Kenyatta University, UoN and Moi University Teaching module and the students are adviced to take keen notice of the various legal and judicial reforms that might have been ocassioned since the module was adapted. the laws and statutes might also have changed or been repealed and the students are to be wary and consult the various statutes reffered to herein

 

INCOME TAX

Coverage.

Whom do you tax?  What is the basis of taxation?  Is it income in which case you can only tax income earners, Is it Purchase in which case you tax everyone as in VAT?

Who is the most taxed person?  Is it the wage earner who pays 30% on his income?

Ideologies of Taxation

These are 3

1.           Ideology of the ability to pay;

2.           Ideology of the barriers and deterrents;

3.           Ideology of equity.

Ideology of ability to pay:

This ideology is based on the basis that taxes should be apportioned or distributed in accordance with the ability to pay and the ability to pay should be determined by income or wealth.  It should be progressive that is the theory but is it possible to be progressive.  It is not always feasible to have a progressive tax and we do the best we can.  The assumption is that income is ability to pay but is it really? This is not always the case so this ideology is not applicable in full, individuals are not allowed to deduct their cost of production and this way we cannot have a progressive tax as some people have more expenditure and are left with no income whereas others are without a lot of expenditure.  This ideology is not realistic.

Ideology of the barriers and deterrents:

This has 3 concepts

(a)         Progressive rates diminish incentives to work; - when one is earning a salary this really does not matter because either way you still work but for a business person progressive tax might reduce the incentive to work again corporate tax is not progressive and therefore this does not apply in business, whether one earns high or low the tax is the same.  But if done in partnerships, the tax is progressive as it is deemed to be income to one and rises in accordance to ones earning.

(b)         Progressive rates discourage incentives to invest: -

(c)          Progressive rates irreparably impair the sources of new capital - 

Ideology of equity:

 This is the ideology that says you tax those in the same level and the same amount, equality among equals.  Those who earn the same amount should be similarly treated, the more you earn the more you get taxed.  Equals at income should be treated the same.  The principle is supposed to be income based, but in Kenya it is not.  VAT is an unfair tax as here there is no equality, everyone pays the tax irrespective of how much they earn.

GENERAL INTRODUCTION TO TAX

Tax is the only source of self-income to governments i.e. it includes donor income. Tax is their only guaranteed income and under their country.   The richer one is the lower ones income could be in this country.  Income from business is taxed at the level of 12% corporate tax while we tax 30% in income tax.   If the government can get people to earn more, they can lower the level of taxation.  The fundamental purpose of taxation is to raise the revenue necessary to provide government services.

The government has all kinds of taxes but the purpose of taxation for us is among other things to

1.           Finance public expenditure;

2.           Distribute income;  - if the income is progressive, it can be distributed by taxing those who have and giving those who do not have.

3.           It is supposed to enhance government policies one of the policies being to encourage positive behaviour.

The government uses two rationales to impose taxes

1.            Benefit Rationale- the government is a shopkeeper, and people pay for the service, the government taxes and provides services security, health, education etc.  The benefit rationale cannot be achieved 100% although we do expect at least 75% below that people ought to complain.

2.            Ability Rationale – the government taxes people on the basis of their ability to pay.  Where one gets the money, the government has no interest.  In Kenya it seems the government is only using the ability rationale and not the benefit rationale.

Tax is compulsory; there is no tax that is voluntary.  It is a compulsory charge by the state.

Taxes can be classified in 3 categories depending on their impact on the people

1.           Regressive

2.           Proportional

3.           Progressive

Progressive – where the marginal rate of the tax rises with the income then it is progressive.

Proportional – if different blocks are taxed at different levels.   Both progressive and proportional are equitable although progressive is more equitable than proportional.  Corporate tax is a proportional tax.  Takes the same from everyone.

Regressive – tax increases with ones fall of income.  It requires that low and middle-income families pay a higher share of their income in taxes than upper income families.

PRINCIPLES OF TAXATION

Tax is governed by certain principles.

Simplicity and efficiency are principles of taxation.  Taxpayers should be able to understand taxation.  It is meant to be governed by simplicity so that people can understand it.  Taxation can be made complex by inefficiency so simplicity and efficiency go hand in hand.  It should be clear and understandable to the taxpayer.

Cost of complying with the tax laws should be minimal.  The cost is not very high in Kenya although it could be lower.  Communication system should be simplest to lower the cost of tax collection. 

Accountability: - the collector should be accountable to the people for the tax they have collected.  The collector should be accountable to the taxpayer.  In Kenya the government has never been accountable to the taxpayer and this is because of the corruption.  This is one of the principles that is furthest from reality in this country.   May be in future when the people are informed on how their money is being mismanaged, then they will do something about it.                            

PRINCIPLE OF CERTAINTY:

There has to be certainty, it has to be understood to be the same by every taxpayer and every Minister.  Taxpayer must know what they are entitled to pay.  It is supposed to be extensively and adequately publicised and every Finance Act should be publicised in simple language, clearly visible and nothing should be hidden from the taxpayer.  Complicated tax rules make the tax system difficult for citizens to understand.  Complexity also makes it harder for governments to monitor and enforce tax collection.

PRINCIPLE OF EQUITY:

All taxes should treat all taxpayers the same.  People in similar situations should be treated the same in terms of rate, the amount, collection etc.  The interpretation of who is a taxpayer should be the same.  They should be charged in accordance with their economic status and their ability to pay.  Being treated equally.   The terms of tax paid and the achievement from those taxes should be equal.  No one should be allowed to avoid tax while enjoying the benefits that are being taxed for those services.

PRINCIPLE OF NEUTRALITY:

The market economy should not be interfered with.  There should be no practical interference with the market economy.   Taxes should not interfere with market forces.  Business communities are supposed to bear minimum impact on the spending of tax.  The lower the tax the better for the business community.  In the Kenya situation our tax system interferes a lot with the business community and is therefore not neutral.   In Africa, Botswana and South Africa may be the only countries following the principle of neutrality.  VAT is not a neutral tax because it interferes with business; it has been likened to an expenditure tax. 

TAX STRUCTURE:

The tax structure is made of individual elements and it is only through changes of those individual elements that a change in the level of tax can come about.  Each element has a growth rate and base and each of them is related to distinct economic variables.

Tax Base

A tax base of a given tax is the source of revenue and it is that source that is taxable.  Every taxation has to have a source.  The basis available to any country would set the limit for the possible tax structure.  In Kenya like in many poor countries the base of taxation is very narrow.  Our structure here is based mainly on employment and business.  Production is very little and so production tax is very low.  We are traders.

The more agriculture is taxed the more they kill it.  Agriculture is our main source of income but it is very heavily taxed.  In the early stages of our development the tax structure was in itself a reflection of a tax base.  If there was no basis for direct taxation there was more indirect taxation.  Tax has now become a reflection of a political culture i.e. taxes get amended to raise campaign money etc.

The tax handle fee that relates the structure to the base.  The close link of tax structure to tax bases is normal.

1.            At an advanced stage (when we become rich) the problems of revenue collections shift from looking for tax bases to devising means of collecting and yielding tax more effectively.  Tax is not increased but concentration is on collection.  Waweru is increasing the base by sealing the loopholes of tax evasion, he is not increasing taxes.

The income tax lays down certain rules.

(a)         Ascertainment of income – the qualifying conditions for personal allowances rules are laid down,

(b)         The same rules decide which allowances qualify, whether singles relief, medical, personal etc.

(c)          The rules provide for the Procedure of assessment such as self assessment – this is one way where people can avoid tax by assessing themselves on the lower side, avoidance is not illegal evasion is illegal. When one leaves the procedure of assessment to the tax collector they pay more and so the rules must provide for assessments.

(d)         The rules provide for penalties. Income tax penalties can be demobilizing.  Under the Income Tax Act the High Court and the Magistrate courts have no original jurisdiction on tax issues, the original jurisdiction is with the tax department and only facts of law are appealable.  The tax department has denied the courts original jurisdiction on tax matters.

In addition to being revenue device taxation can be used for more, today we use it as a revenue device.   We use tax to encourage or discourage certain kinds of behaviour, we might tax cigarettes more to discourage people from smoking, and taxes are also used to distribute income.  In Kenya we tax because we need the revenue.   In the long run tax can be used not only for tax collection but also for other activities e.g. to encourage education, to encourage investments and so on.

OVERVIEW OF INCOME TAX.

The income tax Act firstly determines what income is; note it does not even define tax as its interest and basis and source of tax.  Out of the income, not all income is taxable. 

What is taxable income?

Income:  

Whose income do we tax?

What is the source of that income?  It has to be income from a specified source.  In Kenya we only tax residents.  Who is a resident for purposes of income tax?

Allowable deductions, every income has deductions so what are the allowable deductions..

Income Tax is payable by

1. Individuals
2. Partnerships – partners are taxed as individuals
3. Corporate Bodies – flat corporate tax
4. Trustees -
5. Cooperative Societies – pay taxes as societies

Income tax is a direct tax.  It is direct because both its impact and incidences mainly fall on the same person.  The impact is on the person who pays the tax to the income tax people or to the authorities while the incidence is on the one who bears the burden.  When one is an employee he is the one who pays the income tax to the income tax person although the employer sends it there.  The burden of any direct tax falls on any person who makes that income.  Gifts are not income and therefore not taxable.  Gift is not a recognised source and is not even defined.

Income tax is generally progressive to a certain level at least in Kenya it is up to 30%.  The marginal rule increases with the income.  If one earns an income of 300,000/- or 300,000,000/- you still pay 30%.  It ought to be progressive all the way but it is not certain that we can afford that.  This progressiveness is not necessarily good as the higher the income, the less tax one pays. 

The base of our income tax is what we call income.  Income for the purposes of our law is not clear,

Section 3 of the Income Tax Act is the definition section but does not define income.  If there is a dispute between what is income between one and the income tax, it would be because income tax is payable on income.  They don’t define income because sources of income keep on increasing.

The Act however defines total income – “total income in relation to a person is the aggregate amount of his income.  Other than income exempt from tax under Part III of the Act.” 

Part III of the Act deals with exemption of taxes.  The law imposes a tax under Part II of the Act Section 3 of the Act creates a Section Charge of Tax and it says that “subject to and in accordance with this Act a tax to be known as the Income Tax shall be taxed on all income of a resident…Total income is chargeable to tax under the law if it is not exempt under Part III.

Part IV deals with ascertainment of total income.

The law presumes that we know what income is.  It is also a legal assumption that one is supposed to know the law is and this is an irrebutable presumption of the law. 

Subject to income, income tax is income of a person.  According to Section 3 it is income of a person and it uses the term sources of income, it does not define income.  Income is not necessarily source and therefore not necessarily taxable.  Income must be recognised as a source before it can be taxed.

INCOME TAX

Section 3 definition – it is based on sources of income

3 (2)   Gains of profits from business, employment, services rendered and rent or rights granted to other persons for rent, dividends and interest, pension, annuity any amount which is deemed to be income of a person under this Act or under any other Act.  Gains from petroleum companies and petroleum service sub-contractors.

3(2)(f)  gains arising out of disposal of depreciable assets

it is assumed that any shares can depreciate in prices so that is why all shares are classified as depreciable interest, so when one sells that stock, that is considered income from which 30% income tax is payable.  The tax is chargeable on a person, not every person pays income tax, there are specific persons who pay income tax they are considered on the basis of residency not citizenship.  Any income which is earned locally or outside the country by a resident is taxable.  Therefore to be taxed one has to be a person and a resident.

Not all persons pay income tax. 

All taxes are payable by individuals in the long run. 

For residents, income they earned abroad while in Kenya is taxable.

NON-RESIDENTS

Non-residents are also liable to tax but only for income derived in Kenya.

Diplomats are residents but they are exempt from tax.

For the purposes of imposing tax, the basis is residence.  What is residence, who is resident?

Section 2 of Income Tax Act – when it is applied in relation to an individual these are the categories

1.            if you have a permanent home in Kenya and you are present in Kenya for any period of time in the year in question.

2.            If you have no permanent home in Kenya but you are present in Kenya for a period or periods

(i)           A period amounting in aggregate to 183 days during the year of income; or

(ii)         Present in Kenya in that year of income and in each of the two preceding years and aggregate the number of days to 122 days in each year.  E.g. 2001 = 122, 2002 = 122 and 2003 = 122

When this is applied to a body corporate, which is not a natural person the management and control of the affairs of that body is supposed to be exercised in Kenya in that particular year of income.

(iii)       The body has been declared by the Minister by a notice in the Kenya Gazette to be a resident; what if the company is not registered under the laws of Kenya but its exercise and management are in Kenya?  That is how the Minister comes in.  Local branches of non-resident firms are classified as resident.  But only for income derived in Kenya; any income derived out of Kenya is not taxable.

A parent company that is based in Kenya is treated as a resident for purposes of income tax and all its income derived from Kenya and outside is taxable.

So in order to pay tax one has to be a resident and people have raised issues at who is a resident.

In the case of Sir George Arnautoglu  V Commissioner of Income Tax

 [1967] EA 312

The Appellant disputed his assessment of his income tax in 1962 on the ground that he was not a resident in the territory in 1962.  The facts were that in 1960 he had a home in Dar-es salaam and was there for a total of 249 days and in 1961 he sold that house but was still present there for a total of 124 days and in 1962 he had no home but was present for 62 days.  On average he was there for 4 months in each of the 3 years.  He argued that in relation to the definition of residence, according to Income Tax Management 1958 he argued that firstly it was not permissible to aggregate the periods of residence with periods of mere presence and secondly that averaging in accordance with (1) paragraph (b) (ii) of that Act it meant in effect that four months presence was required in each of the relevant years.  The definition of residence under that Act for which the construction depended.  They said that it was permissible for purposes of income tax 1958 to aggregate periods of residence with periods of presence.  The court went on and said that first “an individual is defined as residing in the territory if he in fact does so.” And secondly an individual is deemed to reside in the territory if the facts are such that he would not normally be regarded as residing in the territory or there would be doubt as having done so. 

The deeming provisions in Income Tax (deemed to be) according to Justice Charles Newsbold that the deeming provision only come into play if …  (it is like a presumption, you are presumed to be) deemed to be is presumed to be, to bring the presumption into play is by bringing the aggregate period.

BASIC CONCEPTS OF INCOME TAX

Income Tax will be on income only, it is not on assets

The only income which is provided that is taxable is that income which is from sources that are taxable, the income has to come from a classified source, there is no simple and comprehensible definition of income tax but it may be put in 3 broad categories

1.            Income from personal services that are rendered by one person to another; contractual service generally, as long as it earns money it is income and the assumption is that the services have to be legal;

2.            Income from property this is income, which generally when one sells property, one pays various types of tax but when the seller receives the money when declaring income at the end of the year, the proceeds from property must be declared.

3.            Income from profits of a trade, profession or vocation.

Income tax is different from capital but for purposes only of paying tax but it is not always easy to distinguish between capital and income, if you cannot classify any receipt as income, it is generally classified as capital.  Patent Rights in England is charged under income tax, it is capital until one sells it, then it becomes capital. 

The only law that operates retrospectively is

The basic approach is that capital is considered as the tree while income is the fruit.

Liability to Income Tax arises out of

1.            An assessment, to be liable there has to be an assessment as a notice to one as a taxpayer that there is a tax that is due from one.  There can be a self-assessment or the assessment, which is done by the income tax.  Basically all of us except for employment which is assessed in advance, the rest is basically self-assessment as in when one files returns they are assessing themselves.  Where the CIT disagrees he can do his own assessment. 

2.            Amended assessment provided by the Commissioner of yourself

3.            Instalment assessment is only applicable to corporate tax not individual tax.

4.            Deduction:  once you are assessed you will be deducted and the deduction is from the receipt you have already received, e.g. an employee’s PAYE is deduction.  Every employer is termed as an agent of the commissioner for purposes of deducting the taxes. 

Income tax is basically one tax and this was declared in 1901 by Lord Macnaghten in the case of

The London County Council V. Attorney General

(1901) AC  26 at 36

 he defined income tax as “Income Tax if I may say so is a tax on income, it is not meant to be a tax on anything else.  It is one tax not a collection of taxes in every case the tax is a tax on income whatever may be the standard by which the income is measured.”  It means it does not matter how you measure income but it has to be income and if it is not classified as income then one cannot pay income tax on it.  Profit is basically income for purposes of tax, the gross turnover is not income for purposes of tax but once you get your net income, it is income for purposes of tax. In Kenya it is an annual tax.  It is not possible to make an assessment in the current year, as one has to wait until the year is over and then audit their accounts.  Although the returns are filed the following year, we still call it current year of income.  It is based on the source from which it comes.

One can reduce their tax as a payer either legally by an allowance or by a tax relief or by an exemption like the church gets.  Or one can actually avoid tax.

Tax avoidance involves one of the following things:

1.            One can claim that certain receipts do not constitute income;

2.            Arguing that you were not resident in that year of income;

3.            You can claim that you have deductible costs, when they agree, you increase the costs;

4.            Increase the number of personal reliefs that one is claiming, if they are accepted the tax is reduced

5.            Transfer income to another person, you for example transfer income to your spouse who earns less and thereby reducing the tax burden.

6.            Transfer deductions from one year to the other year,

All these are ways of tax avoidance, which is not illegal, if not genuine one may pay penalties but it is not illegal.

The difficulty of assessing any one individual income is also very difficult in developing countries, even fixing rates in countries where people are already overtaxed is difficult.

Tax falls under income which excludes by general rule gains and losses, losses only for purposes of business not for purposes of employment and it is expected to be progressive until it reaches a certain level except corporate tax where all are taxed at the same rate.  Tax falling on income is what is called a definitive principle, when we say progressive that will be the equitable principle, the one upon whom the income falls is not equitable. 

The second principle is based on a current social consideration of justice.  Corporate tax do not have this principle as they all pay a fixed amount but we assume that since everyone pays a fixed amount there is no progression but lets remember corporates pay dividends to individuals that are tax and are progressive.  The progression ends at 30% where after everyone pays the same amount.

People have a heavier burden to carry when it comes to income tax if they are rich.  The first aspect is the ability to arrange the income tax arrangement.  You pay a professional to arrange them in such a way that you pay the least, sometimes you pay only on your ability to arrange, when you have a better arrangement to arrange tax, you pay less although your income could be the same as with someone who earns the same.

INTERNATIONAL ASPECTS OF INCOME TAX

1.   Competitiveness

International competition in business does pressurize our policy makers in the way they organise their tax systems.  We grant tax rebates, give exemptions so that we are able to compete in the international market because taxes are an expense.    Both direct and indirect taxes are used.  The Export Processing Zone is a good example where tax exemptions are offered to encourage exports.

2.   Reliability

The taxation and revenue should be reliable.  Rules should be reliable and adequate.  Income tax or taxation in general is the State diet without which the State would starve.  It is vital to the economy and therefore the flow should be reliable, we should be able to know when it flows and how it flows and how much of it is there since we rely on it for services.  Government expenditure ought to be anticipated so that we can hinge our tax assessment on the anticipation.

3.   Interpretation

When we interpret law, the interpretation is required to be very strict.  Where there are two interpretations, we take the interpretation that is most favourable to the taxpayer.  You can only go to court on a question of law or on a question of mixed facts and law, on a question of fact you cannot go.  In the case of T M Bell V Commissioner of Income Tax (1960) EA 224

Income Tax V Holdings Limited

 (1972) EA 128

The general rule is that a taxpayers business or other ventures are considered together as one (your income is your income does not matter from what source) chargeable income should be arrived at by aggregating all the taxpayers income and then deducting all expenditure incurred from the production of this income.

In interpreting the Section (58) or any section the whole Act must be considered in relation to the particular section and especially with reference to the interpretation section and the methods set out in the Act in this case our Income Tax Act Cap 470 to arrive at what is chargeable income.  One must consider the provisions of the Act and if the Act provides on what to consider as chargeable income, then you consider that if not, you look elsewhere.  It does not matter how harsh the Act is, it must be followed.  This is the theory, assuming that the taxpayer goes to court.  The theory is that the law is pro-taxpayer but in reality, the law is pro commissioner of income tax.

ADMINISTRATION AND JUDICIAL ORGANIZATION OF INCOME TAX

TAX LAW LECTURE 4                                   

JUDICIAL ADMINISTRATION OF TAX

Income Tax Collection falls in two levels

1.            Administrative level or main level where the bulk of the calculation is done

2.            Judicial Level wherever there is a dispute one is supposed to go to court

Administration aspect falls into 3 categories

1.            General Administrative Management.  They have to establish who ought to pay income tax and where they are.  There is a legal definition of who is supposed to pay tax i.e. who falls within that definition; they also trace to find out where the taxpayers are. Where are the taxpayers?  Administratively the tax collectors are supposed to establish where the taxpayers are.

2.            Ascertaining the amount payable by each taxpayer by assessing the income.

3.            Collecting Data – they have assessed, ascertained how much then they go ahead and collect it.

Judicial Elements are brought about by the above 3 administrative elements where disputes arise whether one is a taxpayer, whether what is being taxed is income and the amount to be collected.

The revenue department falls

Assessing and collecting taxes is what brings most arguments, it is the most complex because we have very few tax collectors.

TAX ASSESSORS

The Assessors are the people who identify one as a taxpayer and then proceed to send one their tax returns so that they can file tax.  The returns are sent to the taxpayer to show that they have paid tax and also if there is any extra income that has not been paid for under the PAYE then one has to pay for it.  Normally the assessors do no assess businesses and they will request that they be told what one has done, only after which they will do their own assessment.  Secondly they receive the returns and then they assess the amount of tax due to one in accordance with the returns.  It is the assessors who receive the appeals where there are appeals (referred to as objections) and deal with them and they are the ones who produce the Commissioner’s case to the committee and also to the courts.

TAX COLLECTOR

Done by tax collector.  They receive the money that comes in and follow-up the defaulters.  In the process of doing this they issue one with notices and charge penalties and interests for non-payment.  They issue receipts for all the monies paid, if you have overpaid, they issue a credit note or a cheque.

JUDICIAL PART

Anywhere there is a dispute that went beyond the tribunal and went to court, it becomes official.  It is not a criminal matter unless it is a matter of tax evasion but disputing is not an offence.

SOURCES OF TAX LAW IN KENYA

Tax law in Kenya is all based on statutes, it’s all statutory, and not just income tax but every tax is provided for by statutes.  Wherever there is a dispute, then the courts come in to interpret the statute.  The courts interpret the statutes but do not establish the taxes themselves.  It is to be found in our law in Cap 470 Income Tax Act.  There is no general power to delegated legislations to create any taxes.  They show how exemptions are created.

There are certain areas where the law will grant the minister some powers to deal with the income tax Sec. 41 deals with Double Taxation.  Where the Act imposes tax to exempt one by way of double taxation he can only do this under the power granted by the financed

Income tax is imposed each year although once it gets here it is permanent.  We have provisional Acts that are created to increase rates.  Section 3 of the Income Tax – Imposition of Tax (1) Income Tax from businesses, exemption falls under Part III of the Act which starts with Section 17, then we go to collection and objections.  Local committees and tribunals do not have judicial binding decisions although they are followed.

OBJECTIIONS & APPEALS

PART X of the Income Tax Act  -

Objections and appeals are provided for in Section 82.  The committees and tribunals appointed by the Minister hear the objections and their decisions are not final but their findings on facts are final.    The decision of a court of law on a point of law is binding and final and no one can argue against it, neither one or the commissioner can argue against it even if it is wrong unless one seeks a review.

Interpreting tax law certain principles are used.  These are principles established by English courts, which we have been following and our law is based on them

1.            The onus or burden of proof is on the State to prove that there is a valid tax law which imposes the tax and that that law covers the taxpayer in question; to quote Pennyquick in the case of

Reed and International Ltd V CIR [1974]

1 All ER 385, 390

he said duty is chargeable on any particular subject matter or if that subject matter falls within the words of that statute.

2.            The taxing statute must be construed or interpreted strictly by reference to its actual words.  This has a lot of case law and one of the earliest case is

Partington V Attorney General

(1869) L.R. 4 H L 100, 122

 he said “if the person sought to be taxed comes within the letter of the law he must be taxed however great the hardship but appear to the judicial mind.  However apparently within the spirit of the law the case might appear to be … a construction is not admissible in a taxing statute…” there is no question of equitableness.  It looks strictly at the letter and does not care about being inequitable.  In the case of

 Cape Brandy Syndicate V IRC

[1921] 1 K.B. 64 71

  Rowlett J. said “.. In a taxing Act one has to look merely at what is clearly said.  There is no room for any internment, there is no equity about tax, there is no presumption as to a tax, nothing is to be read in, nothing is to be implied, one can only look fairly at the language imposed.”  Courts have been looking at Substance rather than form.  Looking at form requires a literal translation while looking at substance …it is more likely that if there is an ambiguity in any section that carries weight against the taxpayer, that ambiguity will be used in favour of the taxpayer or the ambiguity will be removed in favour of the taxpayer.  The court has to give a clear meaning to the ambiguity however unreasonable it is.  It is not for the court to clear the ambiguity.

3.            The Object of the construction of a statute is to establish the will of parliament and so it should be presumed that neither injustice nor absurdity was intended. If interpretation will produce absurdity or injustice and the language admits such an interpretation, which would avoid it, then such an interpretation may be adopted.  This means that the language of parliament has not excluded that kind of interpretation.

4.            The history of an enactment like the Income Tax and the reasons that led to its being passed may be used as an aid to its construction. So one can look at the history of the Act to see why it was enacted and use that to interpret it.    Mangin V IRC [1971] AC 73 CH 746 Lord Donovan said “…

PRINCIPLE OF RETROSPECTIVITY

The law can be retrospective in various ways

1.            It may impose a tax on income that was acquired before the law; this type of retrospectivity has been enforced but it has been classified as “improper and immoral”  nobody said that the law should be proper or moral and in tax law, it can be done.  Income tax, your income can precede that law unless in the case of Kenya if the matter ever comes to court, it’s a law that needs to be changed.  If the Constitution says it cannot do that then it would be unconstitutional but at the constitution declares that parliament can make any law.

James V I.R.C

[1977] STC 240

 The taxpayer (James) challenged the validity of Section 8 of the Finance Act of 1974 it increased the rate of surcharge Retrospectively for the year of assessment 1972-73, the taxpayer was saying that the Crown had set that rate and in some cases had even collected the Tax, it was therefore contrary to common law and natural justice for that rate to be subsequently valid as it amount to reopening the transaction.  Slade J dismissed the Case.  Although he sympathised with it and he actually described that Section as retrospective legislation of extreme kind which would operate harshly on taxpayers.  However he did not agree that it was illegal and this is what he said “…it is in my judgment that as the constitutional law of England stands today parliamentarians have the power to enact by-statute any fiscal law whether of a prospective or a retrospective nature and whether or not it may be thought by some persons to cause injustice to individual citizens and note.. If the wording of the legislation is clear the court must give effect to it even though it may have or will have a retrospective effect.  It has no power to refuse to give effect to it on the ground that the protection private citizen required.”  In the case of

Ingle V Farrand

[1927]11 TC 446

Where they were interpreting whether it was public office or employment in the case of Great Western Rly & Co. also and later parliament passed a law which changed that interpretation retrospectively.   There was nothing they could do and the courts went ahead and enforced it.

A statute can change provisions that may have been announced in a provisional collection of taxes Act.  Our Act is Cap 495 and the Finance Act when it comes can change that, this is changing the law retrospectively and the things is our law allows that assessment be made can be changed by the Finance Act that is Section 2 which says that in relation to any year of income in respect ….  Under the provision collection of taxes and duties Act..  Cap 470 can change any assessment set out in the provisional, this is legal retrospective.

A retrospection may be introduced to reverse a decision of a court i.e. an Act may be changed retrospectively to reverse the decision of a court.  An example cited in England is Section 62 of the Finance Act 1987 was introduced to reverse the case of the decision of Padmore V I.R.C.  S [1987] STC 36. 

Law can be introduced retrospectively to clarify an old law or some confusion in a past law.

When it comes to interpretation of taxation, the consequence of a transaction one either uses form or substances but there are questions to be asked i.e. is the law being interpreted relating to a specified transaction or literally or using the rationale rule of interpretation.  Do you try and read the intention of Parliament in the words, the style or form.  If you use the style it means you don’t.  Refer to the case of I.R.C. V Westminster (1936) C 1  - he was trying to create a trust for his employees for future payments and the question was if those people had asked for the money that he had created a trust for, could he have been taxed that amount? Was it an income or future income?  It was contentious issues and according to the law they were saying no, that the law should have been interpreted using the substance doctrine and..  The special commissioners at that time held that they were wages and therefore taxable.  This decision was accepted by Finley J. in the High Court who said that looking at the substance and not the form it must be regarded as the case of someone remaining in the Duke’s employ and therefore wages.  The Court of Appeal reversed the decision and the House of Lord held that the C.A. was right.  The document said that they were created for trust saving for after service and that is what they were, they were not wages, look at the substances.  The House of Lord said Lord Atkin dissented “… I do not myself see any difficulty in view taken by the Commissioner and Finley J. that the substance of the transaction was that which was being paid was remuneration so construed the correct interpretation appears to be that they were wages but the other members of the House of Lords overruled him saying that they could not accept the substance approach.

C J CLARK LIMITED V IRC

[1973] 50 T.C 103

 This case was talking about “… when parliament sweeps away one provision in amending act enacts in its place another provision which is drafted rather differently … he who says yes and later changes his mind and says no does not demonstrate for him yes means no.   One is allowed to use a rational interpretation rather than a literal interpretation.

Consolidation Act – Finance Act, which comes out every year

Lord Diplock – the only mischief a consolidate is supposed to remove is a peace-meal Act.  In the case of IRC V Joinder [1975] 50 TC 449

Any Act consolidating any law are not to be interpreted differently it is the original Act that matters, the consolidated Act.

PRINCIPLES OF STATUTORY CONSTRUCTION

The Ramsay Principle – it is important to interpret how far it is permissible when one comes to the Act they have to look at the substance of the Act as opposed to the Form. 

In 1936 the House of Lords held that the Inland Revenue Authority could not invoke the supposed doctrine of substance in income tax.  According to them you interpret it formally.  They said that one could not invoke the substantive doctrine of interpretation so as to uphold the legal rights and interests of the parties.  The legal rights of the taxpayer are to pay in accordance with the income tax law.  They went on to say that the only situation in which a document could be disregarded for tax purposes was to find out whether or not it was bona fide or intended to be acted upon.  They said “any attempt to pray aid in the so called doctrine of substance was merely an attempt to make a man pay tax not withstanding that he has so ordered his affairs that the amount of tax sought from him is not legally claimable.  They are saying that if you have filed your returns correctly, and you have not cheated but the way they are organised has resulted in the lowest profit, they are saying that using this doctrine, one would pay more than he is legally entitled to pay.”  How one uses information may make a big difference.

In our case Section 110 of the Income Tax Act – incorrect returns “ a person shall be guilty of an offence if he without reasonable cause makes an incorrect statement in a return of income by omitting or..  It makes it a criminal offence to file an incorrect return.   If you tailor it in such a way that you save money, this is not an offence.  What is wrong information?   As far as income tax is concerned, one looks at form and not substance.

In the case of the

Duke of Westminster

it was held that every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it would otherwise be.  If he succeeds then, however unappreciative the commissioner of Inland Revenue or his taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax.  Lord Tomley

The subject cannot be taxed by inference but only by strict interpretation of the law.  This doctrine was looked at in the case of

Ramson V Higgs

[1974] 50 TC

 and then it went on to become what we live on today which is the Ramsay Principle. 

W T Ramsay Ltd V IRC

[1981] 54 TC 101

                                

RAMSAY PRINCIPLE

1.            The principle is a principle of construction for words involved in taxes and

2.            Secondly tax avoidance par se does not bring the Ramsay Principle into play.  It is not part of the judicial function to nullify any step that one as a taxpayer chooses to organize their tax affairs although they are supposed to modify the Westminster principle.  One can organize their matters so that they can avoid tax and it is not for the courts to go behind ones style to prove that one is avoiding tax unless there is a specific provision avoiding tax avoidance. 

3.            Thirdly a tax avoidance motive of a prior transaction does not enable it to be treated as one with a subsequent transaction i.e. tax avoidance is not an authority; one has to look at the current transaction independent of the previous transaction. 

4.            Fourthly, they say that there is no moral dimension to the Ramsay Principle i.e. they don’t do it for moral purposes.  According to them any idea that the principle in Ramsay is a moral principle or that it is supposed to catch tax avoiders is wrong and it is defeated by the interpretation that there are, Ramsay Principle is a principle of statutory construction and not a moral principle. 

5.            Fifthly the principle is only concerned with ascertaining what is the reality of the transaction 

6.            The Ramsay Principle is not a substance doctrine; and it’s a formal interpretation

7.            The basic approach where Ramsay applies was that it is not that the court looks at the behind returns but the returns were not properly done.  They did not prepare a proper return.

PRINCIPLES OF STATUTORY INTERPRETATION

Principles of tax statutes interpretation.  As set out in the case of Ramsay

1. A subject or taxpayer should only be taxed on clear words of the statute not in accordance with any intendment or intention;

2. A taxpayer is entitled to organize his returns in such a manner that he reduces his liability to tax as much as possible.

3. It is for the fact finding commissioners to find whether the document is genuine or not, if it is genuine they argue with it and if they find that it is a sham, that is the information they bring to court.  The court can go behind the document to determine whether the document is a forgery or not.  The justification of a court will only be to look behind that document only if the commissioner raises the point

4. Given that a document is genuine the court will not go behind it to look at underlying substance.

JURISDICTION OF OUR LAW

Parliament in Kenya has jurisdiction to make law.  Income Tax Act applies to all Kenya including Kenya’s continental shelf.  Outside Kenyan territory by exclusion one is not bound.

On the 1^st January 1974 the East Africa Tax became the Kenya Income Tax Act Cap 470.  It is only effected to persons who are found within its jurisdiction in accordance with its definition.  Its definition includes some elements of Kenyan residence not Kenyan citizenship.  It creates territorial limits, which are

1. Person to be taxed is either resident or non-resident
2. Income to be taxed – the income that should be derived from all accrued to one in Kenya
3. It is annual

Section 3 tells us how income tax is effected, annual, upon income of a person, whether resident or not that accrues to or is derived in Kenya.  The type of tax, the period, the geography and the source.

The person who is to be taxed is not determined either by residence or anything but by income, without income, income tax has no interest in one.  The income chargeable is provided for under Section 3(2) of the Income Tax Act.  Any income that does not fall under that section is not income for the purposes of this Act.  The person to be taxed is defined under Section 3(1).

What type of tax in subsection 2, is it gains or profits from business?  From whatever period of time as far as business is concerned.  From dividends or interests, from a pension?   Definition in 3(2) a person does not include a partnership.

Section 10 gives details of what type of income, details of what gains and profits are.

What is a year of tax – 12 months from 1^st January to 31^st December …

A foreigner has to be in Kenya for 183 days in a year or for an average of 122 days for 3 years.

Who is a residence, can one be a resident if they have not been in Kenya for several years, according to English Law, yes one can, you can be held to be a resident although physically absent.

In the case of

Rogers V. IRC

(1879) 1 ITC 225

 – Mr Rogers went out of the UK for a whole year.  He was a commander of a ship and left his wife and children in England.  The income tax people wanted him and he argued that he was not a resident and therefore not liable to tax and the court said no that he was a resident not on the basis of a wife but “… every sailor has a residence on land” it is a presumption which is correct.  His evidence was his wife and children.  They used the substantive principle and reversed their own principle of using only formal interpretation; to be resident you have to be there physically or legally declared to be resident.

In Kenyan practice the average period spent counts to be a resident, a visit to Kenya and a permanent home counts.  If you don’t have a permanent home and you make a visit, you have to have stayed for a 183 days.  Rogers had a permanent home in England but had not visited.

The purpose of the visit is immaterial Section 3.  If the income is derived in Kenya the purpose of the visit if immaterial.  Section 5 will require that income (1)(a) – an amount paid to a person who is or was at the time paid the amount for services rendered …

It is not where you are paid but where you are.  (2) Gains of profit – includes all that  a, b, c, d, e, f.  One can make a permanent visit here but the work is not being done here.

I R C V. Zorah

(1926) 11 TC 289

Zorah was a retired British worker (member of Indian Civil Services) who visited the UK for 6 months with the sole object of seeing friends.  The Commissioner tried to tax him, the matter went to court and he was held not to be a resident in the UK for the purposes of Income Tax..

Where one is resident in Kenya but not of his own free will, he will still be held as resident.

In the case of

IRC V Lysaght

(1928) AC 234

Lord Buck master stated “I understand the judgment of the Court of Appeal to mean this that they regard the objects of his visits to show that he could not be regarded as a resident.  They said that it was not of his own free choice but in obedience to the necessities of his position in relation to the company that he was over there.  The CA considered that as very important, the fact that he was not there.  A man might well be compelled to reside here, completely against his will.  The exigencies of business often forbid the choice of residence.  He went on to argue that a man may have his home somewhere else and stay in England because business compelled him.  But according to the House of Lords the periods of which and the conditions under which he stays are such as may be regarded as constituting residence and so he was a resident.  The court went to the formal interpretation.

When it comes to the interest of the taxpayer, courts have no other business but looking at the substance but when it comes to looking at the interests of the commissioner to look at it formally.

Permanent home is not defined in the Act.   We go by English decisions of ownership of accommodation.  You don’t have to own any accommodation in Kenya going by authorities in order to own a home.  For purposes of income tax all that is necessary is that an individual has access to the property whenever he/she wishes, it does not have to be permanent.

 This was decided in the case of

Lowenstein V de Salis

(1926) 10 TC 424

This man was Belgian and used to visit the UK every year where he stayed no more than six months and he stayed in a hunting box and that box belonged to a company where he was a director. Not only was he a director in this company but owned 90% of the shares so he had a place to stay in England, it was old.  The court here looked at substance although we are told that substance is not applicable in income tax, the court held that the hunting box was available de facto to him whenever he came to the UK although he was neither the owner or the lessee but he had access to it whenever he wanted to and for that reason he was resident in England because he had a permanent home.  The commissioners in England came to a conclusion that where a person residence turns on whether or not he has accommodation, for this purpose, ownership is immaterial.  The opposite is also true that if you have a house, which you own but you have leased it out but have no access to it, then you have no home.  They seem to be extending the definition of ownership.  In addition the English if one has a spouse who lives some where, where she lives will be considered to be available by the Act unless of course you are separated but when you are still husband and wife whether it is owned by the wife, you still have access, a partner’s home is his/her home.  We talk of permanence because in Kenya if you have a permanent home, you don’t have to be here for 183 days you just have to be here and it is enough, you are entitled to pay tax.

In England they have a rule that we have not provided i.e. if the place being rented is being rented for 2 years and it has furnished accommodation or less than one year but unfurnished accommodation then it is permanent.

INCOME FROM EMPLOYMENT

Income from employment;

We are studying income tax for the natural and artificial person.

A natural person can be employed but an artificial person cannot be employed and thus a natural person’s income comes from employment and artificial persons income comes from business.

The business a natural person does would always be individual business unless it is a partnership and unless it is a company.

An income from office can be from an individual or income from employment.

The history goes back to 1918 when Public offices and employment were charged and income tax law does not define its terminology it leaves it open so that everyone could fit in.

1922 they transferred employment charges from schedule D to E.

However it does not matter under which schedule you are charged

1956 Act charged income from all employment in schedule E and our law today charges from sources of income under part II of the Act, and this is a very important part because it affects you and imposes taxes on all incomes.

Part – II is actually called imposition of tax and they base it on all income the most famous section 2(1)

Income tax does not know citizenship whether you are an Australian you can be liable to Kenyan income tax.

Income tax is chargeable on an annual basis and it is taxed separately independently, and it is upon income it is not from anything else. But if you look at the section of the Act there is no definition of income and yet that is what you pay tax on.

You are required to pay tax as a resident and not as a Kenyan.

Section 3 (2);

What is income?

They don’t tell you but they tell you “ income upon which tax is chargeable” subsection 2 says, “gains and profits from the following:

a)   Business for whatever period of time carried” even if you carry business for half a day in a year you will be taxed on it;

b)   Income from employment or services rendered;

c)    A right granted for another person for use or occupation of a property (this is for the landlords and the right they are taking for granted to another person is meant a tenant” if it is ex gracia then there is no income

d)   The second item they classify is dividends and interest

e)   A pension charged or annuity

f)     An amount deemed to be an income of a person under this Act

g)    Any gains accruing in the circumstances and ...in the 8^th Schedule;

h)   For the purposes of this section person does not include a partnership (so that they tax you as a person on gain from your partnership and then they charge you as a partnership being a company)

 When they say annual income that does not mean that you have to work for a year, what it means is that income for whatever periods in a year.

From the income of employment they charge you under section 5 you look at part – II, again you assume that it is well defined. This section has A and B

Two things have to be address:

1)    Whether you are taxable and

2)    To what extent you are taxable

You may even be exempt from paying tax on a particular transaction such as Ndwiga.

When you are exempt from tax there are times when you as individual may be exempt from tax including even customs say when you an Ambassador, even if you are a resident in Kenya but your income does not come from Kenya. However if you are to buy from Uchumi you are not exempt even if you an Ambassador if you want tax free items you have to go to a duty free shop, but if you are a Kenyan then you will be given an identity to buy from a duty free shop.

In order to decide whether you are a taxpayer you have to look at the following:

1)    Do you hold an office or employment;

2)    Is that income from that office taxable

3)    You have to look whether that taxable income falls within any income provisions;

4)    What deduction you have to make (you are not the one making a deduction that is why you are asked to file returns and you tell them that this is what I have earned and this is my tax)

5)    Then you have to look at section 5 and that is what charges you.

Under Part – II – imposition of tax subject to Income Tax Act income refers to gains and profits from employment or services rendered. However there is no definition in the Act for the term employment and even in England there was no statutory definition of the term office. But you get some definition in cases. Look at the case of

Great Western Railway Co v. Bater

(1920) 8 TC @231

Rowlatt J SAID:

“ That definition is something which is a subsisting permanent substantive position, which had an existence independent of the person who filled it, and which went on and was filled in succession by successive holders” This is the definition of the term office by Rowlatt.

However Gachuki does not agree that the office has to be permanent, but he does agree that it has to be independent of the person who is occupying it even if you retire, die or fall sick the position remains.

This definition went on until it was looked upon in the case of Edward v. Clinch (1981) 56 TC @367

In this case where a person was regularly appointed to act as an inspector of public inquiries. This was an office created by a statute but it was not a permanent job only when it was necessary.

When he was appointed the issue arose whether that office was an office within Schedule E subject to income tax.

The House of Lords decided that it is open to the courts and it is also right for the courts to consider the Rowlett definition (because this was not a dictionary definition).

According to them it was still appropriate and that they could continue using the term office under Schedule and Rowlett definition was correct except that rigid requirement of permanence cannot be accepted. And when it comes to question of continuity it does not exist even they went on to say that the terms trade or vocation they are the same as employment and office.

Although in Kenya the most used term is employment.

According to their view the continuity is not necessarily permanent and it has to be independent of the employee so that any person appointed to that position may leave it and the position still remains the same.

In their case every appointment had to be personal to a taxpayer for the purposes of tax, it has to have an independent existence and has to be continuous.

If you look at these provisions and then you look at the office say the Office of the Vice – Chancellor, you will see that the office is continuous but should the University of Nairobi cease to exist the continuousness ends and the statutes provides for it and there will be no Vice – Chancellor of the University of Nairobi however, Makogha as a person will still exist.

If I sit in Makhogha’s office and I earn twice as much I will pay more tax than Makhoga paid because the tax is personal to me and even if I am exempt from tax I will not pay tax because the tax is personal to me notwithstanding that Makhoga did pay tax sitting in that office based on his employment.

The term employment is more extensive than the term office because every office including casuals are employed and they don’t hold office however they are employed – this is as per Gachuki.

Employment can exist where there is no office – such car wash on the street, however in that case the judges decided differently.

The leading case in this is

Davies v. Braithwaite

(1931) 18 TC @109

The facts of the case there was an actress, she contended that one of her separate theatrical clearances was.. And each separate appearance was a contract of employment and thus should be taxed as income from employment (perhaps tax from business was higher than it is today).

But Rowlett rejected this argument saying that

“When the legislator used the term employment in Schedule D and then shifted it to Schedule E, alongside offices the legislature had in mind employments which were something like offices. And I thought of the expression posts. He moved on to say that as far as he was concerned where there was any method of earning you earn of livelihood from a method and its not from a post (as you find in an office)  and it is a series of engagement.  Then it means that moving from one engagement to another should not be considered as employment”.

In employment the Schedule was thought to be something like office - they were similar and schedule E was where they were charging employment and Schedule D

The term employment was in Schedule E together with term office

Two factors can be taken into account when you determine whether you are employed or you are carrying out a business:

1)    Whether or not the services are those of a professional and that is what you refer to as vocational services;

2)    You look at whether there are a number of different engagements that that person has undertaken over a period of time;

3)    However there are no conclusive decisions and this was decided in the case of

I.R.C. V. Brander and Cruinkshank

( 1971) 46 TC @574

This was a firm of advocates and carried on legal services and at the same time they acted as registrars to a client and they would register a company occasionally.

They did two cases and they charged 2, 500 Pounds. The Commissioner argued that that money that they received was income to their firm or profession or business.

The House of Lords rejected saying that that was more of an office than the profession.  And according to them they were saying that where you have a selected or an appointed person appointed to a position where he has to perform some type of work rather than where you have a category of a person who is appointed to carry out a particular task which is a profession and that is business. According to them one of the jobs is not employment. In Kenya there are professional servers instead of keeping a court clerk they offer services of a court clerk to perform service but they are not employed by anybody. However, there are certain services that can only be performed by professionals, those services are performed for the hospital to the patients

In tax law courts are very resistant to taxation.

Look at the case of

Market Investigations Ltd v. Minister of Social Services

(1969) Vol II, QB, @`73

Where the court rules:

“The fundamental test to be applied in distinguishing between a contract of service and a contract for services is this person who has engaged himself to perform these services performing them as a person in business on his own account? If the answer is yes then it is a contract for services. If the answer is no then it is contract of service. And the court tells you to have regard to the following things:

1)    The terms of services and if you find that those terms allow that person to exercise control of the work carried out and the manner in which it is carried out then it will be a contract for services because it is business.

2)    But if the control of the work carried out and the manner in which the work is carried out is by the person who is recipient of services then it is a contract of service.”

Part timers in Gachuki’s view are providers of professional services generally.

Fuge V. Mc Claelland

(1956)VOL 36 TC 1

Taxpayer was married and his wife was a full time teacher during the day then she agreed to teach the evening classes and the pay for the evening classes was under a different contract. The question was whether the pay for the evening classes income from employment or a business. If it s income from employment then the husband will pay or whether it is a business and then he will not have to pay.

For the some reason court said that it was income from employment.

Tax from Employment:

Lindsay V IRC

[1964] TR 167 –

There was a man who held a fulltime post as a radiologist in a certain hospital.  At the same time he delivered lectures in the same hospital not as a radiologist but as a different kind of job.  The Income Tax argument was that the fee he received, as a teacher was taxable although according to our Income Tax Act it is any income received from employment or for services rendered so we can consider this as services rendered.  The court held that this income was taxable as the argument was that it was not part and parcel of his employment income.

Walls v Sinnet

(1987) STC 236 –

A taxpayer who was an employee worked for 4 days per week for a college.  The college was owned and ran by a local authority.  He worked for them and they did not control him at all.  The local authority did not exercise control over the way he carried out his duties at the college. The argument was since the so called employer did not exercise any control over this employee, then his income was not taxable as income under Schedule E in England and in Kenya Section 3 …

The commissioners ruled in the first place that it was taxable, then he went to the local commission and appealed and the commissioners decided that it was not employment, it was schedule D, then the matter went to court and overturned the decision saying that although no control was exercised over him on how he performed and he had income from other sources during that time, it was still taxable.  So the rule is and it has been adopted here in Kenya, that one has to bring any other source of income plus the employment income so it can be taxed together as employee income.  The argument is that although nobody exercises control it is tax as income from employment.

One can be held to be employed full time and at the same time carrying a professional job, it does not Matter.  This was decided in the case of

Mitchell Edon v Ross

(1962) 40TC56

The taxpayer was in private practice and also held a job on which he was paid a salary under the National Health Scheme.  His argument was that his private practice would not have been successful without his employment and therefore his employment should be treated as part of his profession.  He wanted his income treated as business income, rather than employment income.  He argued that it should be included under Schedule D but the Court refused to do that.  Whether income is from employment or from professional may not be learnt easily.  One has to bear certain considerations like firstly, does the taxpayer occupy an office, and the next to consider is “do you undertake any employment under that office, Do you merely render services in the course of the exercise or practice of his profession, or the office he occupies or does he only render services in the course of the private profession. 

Income tax is taxable on a current year basis and that is how it is assessed so that the taxpayer in any year of assessment will be charged all the income for that year in relation to employment or services rendered.

Section 3 (2) (a) (i) Subject to this Act income which is chargeable under this Act …  Section defines an employer as including any resident persons responsible for …  employee is not defined neither is the definition of employment.

Heaton v Bell

[1969] L46TC 211 –

The court in this case defined liability to tax of a taxpayer   “it is well settled that a taxpayer or tax or liability ….

The meaning is that one is taxed on their earnings and not on net received.  Income to be earned is not taxable.  Even where one gives part of their earnings to charity, they are taxed on their taxed earnings.

Section 5(2)  Gains or Profits from employment or services rendered for purposes of section 3 (a) (ii) gains or profits include wages, salary, leaves paid, payment in lieu on leave, fees, commission, gratuity or allowances.

Section 15 disallows donations exemptions donations are not allowed as a deduction

Section 16 – donations are expressly disallowable since they are personal and the decision is the employee’s. 

Section 5 – 3 methods under which amounts payable by virtue of contracts being terminated.  Where there is a contract that defined what is to happen in case of breach, where there is no contract and where there is no provision at all depending on these 3 situations, taxation of income arising out of the time a contract has ended that that amount is taxed.

In our case all income is taxed under Section 3(2) (a) (ii) – profits from employment including pension, which is earned as income.  For it to be termed as tax it must be derived from that office or employment, if it is income from a harambee for example, it is not earnings and therefore does not fall anywhere and is thus not taxable.

The general principle was provided for in the case of

Hochstrasser v Mayes

(1959) 38 TC 673

 IN this case Upjohn J. decided and gave the authorities and summarised them saying they seemed to have answered the question that in the light of every particular fact, every case whether or not particular payments are made or is not from employment.  Not all payments made to any employee as gains or profit to an employee, the authorities said that that profit must have been in reference to the services rendered in that employment.  If it was not income made in relation to services rendered in that office, then it is not taxable.  It must be in the nature of a reward for services.  The Court of Appeal agreed with that and it is the current definition.  In Kenyan case where income tax is on earnings or for services rendered, you pay tax on it. 

Payment in respect of employment or services only for an employee, services which are rendered in Kenya or outside Kenya in the case of a resident person or if the payment is made to a non-resident, all of this may be taxed but only on the following condition, if the non-resident is employed or rendering services to an employer who is resident is Kenya, his income is taxable or if he is rendering services to a non-resident who has a permanent resident in Kenya for which one works, for example if he has a company here. Which means that even if one works for World Bank but they are resident in Kenya they will be taxed.

In case of a non-resident a person is chargeable to tax only on income that is accrued or derived from Kenya.  There are cases in the English system where employee’s income has been held not to be taxable.  There are 3 situations

1.            Where you have paid a gratuitous payment to an employee i.e. it is a gift or any other voluntary payments;

2.            Where an employee has received payment under a contractual right which is considered to be outside the scope of his employment;

3.            Where an employee receives payment after his employment has ceased or after it has come to an end.

The first category of gift and other voluntary payments – the case of

Seymour v Reed

(1927) 11 TC 625

 In this case the House of Lords summarised the general principle in relation to income tax or chargeability of gifts to income tax as follows “it must be settled that the words salary, wages, fees … whatsoever (Section 5(2) (a) according to the judge One these profits include payments made to the holder of an office by way of remuneration for his services even if those services are voluntary so long as they are made as payment by way of remuneration for services rendered.  But these do not include a mere gift or present.  There are two types of voluntary gifts, when employer makes a gift to an employee; this is made on a personal ground and not by way of payment, secondly where someone other than the employer makes the gift to an employee.  In the case where the gift if made by employer to employee the court went to say that they would have to be very exceptional circumstances for the gift not to be taxable, for example if one was to give their employee money to pay an ambulance for a spouse, that is a personal payment and is not a remuneration for services rendered, it is a gift being given for an employee but not in remuneration for services rendered.  The other example is where an employer gives a donation for burial for an employee’s kin as a harambee, this is a free gift given not in relation to services rendered but on personal grounds.  It is not in the contract.

Ball v Johnson

 (1971) TC 155

In this case the taxpayer was a bank clerk and his contract of employment required him to sit for some examinations referred to as examinations of the institute of bankers, which was a condition. He fulfilled that and he studied sat for the exam and passed.  He was doing this at his own time not at his employer’s time.  After that the employer gave him £130 pounds, which was normal and was a gift stated in the handbook as a gift.  Was this a gift in relation to employment when he had done this examination at his own time, the employee was only fulfilling a term of the contract which does not mean rendering services.  The Judge held that that was not income that had arisen from his employment and therefore was not taxable.  Not all judges decide this for example in

Laidler v Perry

(1966) 42 TC 351 –

In this case a group of companies gave each of their employees that had worked for them for more than a year a gift voucher of 10 pounds as a Christmas present.  They could use the voucher in a shop of their choice.  Was that income for services rendered?  The matter went all the way to the House of Lords and they decided that the vouchers were taxable under Schedule E as income from employment in our case Section 3(2) (a) (ii).  However the court went on to say that a gift by an employer on purely personal grounds and not by way of payments for the employee’s services is not taxable for example a bonus paid to a single employee for exemplary service rendered.  It is not a contractual right and it is just a gift.  If it is given to one person it is a personal gift, given to all employees it is not personal.  Some of the courts went on to say that even tips are taxable.  If an employer gives employee money under pure benevolence, that income is not taxable.  The general rule is that gifts to an employee by his employer are taxable we have not reached there maybe because we are incapable of chasing those gifts. 

Where a person who is not an employer makes gifts – it raises two problems, where rewards are given as a result of services rendered but as voluntary gifts by people who are not employers.  Sometimes these are taxable, if earned by virtue of employment but where the gifts are given personally and on personal grounds irrespective or whether or not services have been rendered is not taxable.  Good case in point is that Wangari Mathai’s gift of 110 million is not taxable.

In the case of Calvert v Wainwright (1947) 27 TC 475 – A famous good Judge Lord Atkinson held that the tips that are received by a Taxi Driver in the ordinary course of business are taxable.  In Wings v O’Connell (1927) IR 84 It was held that the presents that a jockey wins are taxable.  In Blakiston v Cooper (1909) STC 347 it was held that a Parson’s Easter offerings to the Church of England were taxable.

Taxability of gifts may depend on the frequency or regularity in which they are given, if they are given frequently and regularly then they may be considered as income for services rendered.  Lord Jenkins in the case of

Moorehouse v Dooland

(1955) 36TC 1

 Summarised it as follows: 

1. That income which is voluntary or the voluntary gift should be looked at as to whether it is by virtue of his office or employment,
2. If the recipient of the gift in his contract of employment entitles him to receive that payment, in that case it will be most likely to be held that it arose out of rendering services. 
3. The fact that the payment is of a periodic or recurrent character may also support taxability although that would not by itself lead to a conclusion that it is taxable.
4. Any voluntary payment which is given by way of a present on personal grounds may lead to a likely conclusion that it is not a profit accruing from employment and therefore not taxable.

CONTRACTUAL RECEIPTS NOT ARISING FROM EMPLOYMENT:

Under the common law it is possible to receive from an employer payment which one is entitled to not as payment for services rendered.  The best example is one given by Lord Denning in the case of

Jarrod v Bousted

(1964) 41 TC 701

 in this case he gave the example as follows:  “ suppose there was a man who was an expert organist but who was very fond of playing golf on Sundays and asked to become an organist for a church for the 7 months that would follow at a salary of £10 pounds a month but this church expressly provides that he would never play golf on Sunday for those months he was working for them.   The organist said that if he had to give golf on Sunday they would have to give him an extra £5 pounds for not playing golf on Sunday and they obliged.  Lord Denning asked if the £5 pounds is payment for him as organist?  Is it income for services rendered?  Lord Denning said that this was not payment for services rendered to the church as an organist but a payment for relinquishing what the organist considered to be an advantage to him.  On the basis of this reasoning, the Court of Appeal held in that case that a signing on fee for an amateur rugby player to a professional rugby player, the signing on fee is a fee for turning professional and for agreeing to pay for that particular club.  It was not income but a capital sum, which is compensation for his giving up the amateur status and not income for services rendered.

A different case decided otherwise in

Riley v Cogland

(1964) 44 TC 481

 Ungoed Thomas J. held that signing on fee of a Rugby player was taxable because according to him it was paid into consideration of the taxpayer playing for the club for the rest of his career.  This was in the High Court in 1964.

The House of Lords has also held that the fact that any payment would not have been made to an employee unless he was an employee is not enough to make any income taxable, one must have been paid because of that employment to be taxed the employment must be the cause of the payment for services rendered.

There are substituted forms of remuneration and an example was given in the case of

Holland v Geoghegan

(1972) 48 TC 484

 Here this taxpayer was on strike with his colleagues and the employer paid him £450 pounds so that he can go back to work, there was no requirement in his contract because under contract he could only remain at work for 7 days and so the £450 pounds was meant to make him to leave his trade union friends and come back to work. The judge held that the main reason for payment of that money was to get the employment back to work and that when he received that money it is by way of a substituted form of remuneration and therefore it was taxable.