Purpose of Taxation

1. To raise public revenue

DIPLOMA IN BUSINESS MANAGEMENT
DFM 100: PRINCIPLES OF TAXATION
TOPIC: INTRODUCTION TO TAXATION
Definition of Tax:
A tax is a compulsory contribution to the government from its citizens that
is used to pay for expenses incurred for the common interest of all persons
without reference to any special benefit being conferred to the payers.
Characteristics of Tax:
 It is a compulsory contribution.
 The fact that tax is a contribution implies the idea of a sacrifice
involved on the part of the contributor.
 Tax payment is a personal obligation.
 A tax is levied according to certain legal requirements.
 The amount of tax is not fixed with reference to the exact benefit
which a taxpayer receives from public service.
 A tax is paid out of the income of the taxpayer.
 The power of taxation is mainly to be used for collecting revenue to
the state.
2. Ensure and maintain Economic stability
3. Fair distribution of resources and income
4. Protection policy – Taxes are imposed to protect the local industries.
5. Social welfare – Taxes on the production, consumption and
importation of commodities are harmful to human health e.g. customs
and exercise duties on cigarettes and beer.
6. Higher levels of employment – the government imposes taxes in order
to initiate and complete development projects and other public works.
Canons/Principles of Taxation
Adam Smith has given the following four canons of taxation:
1) Canon of equality: The amount of tax must be in proportion to the
ability of the tax payer, i.e., progressive taxation should be followed.
2) Canon of certainty: The time of payment, the manner of payment, and
the quantity to be paid should be made clear to the tax payer well in
advance and arbitrary fixation of taxes should not be there.
3) Canon of convenience: Tax payment should be made convenient to the
tax payer. The time of payment and the manner of payment should be made
convenient to the tax payer. Land revenue can be paid in installments after
the harvest of crops.
4) Canon of Economy: Cost of tax collection should be very low. Cost of
tax collection should be a small portion of the actual amount of tax
collected.

1
Other canons
1. Canon of productivity
A tax should be productive in that it should bring in more revenue to
the government. However in this quest for more revenue it should not
overburden its citizens with many or heavy taxes since it can be
counter-productive. One tax that brings in more revenue is better than
a multiplicity of taxes that are expensive to operate.
2. Canon of Elasticity
The government should be able to adjust the tax rates when it needs
more revenue. A tax should be elastic and flexible.
3. Canon of Simplicity
A tax system should be simple, plain and intelligible to a common tax
payer.
The tax payer should be able to understand how to compute the tax
and how much is to be paid, when and where it is to be paid.
4. Canon of diversity
Every tax system should be diverse in the sense that a single of few
taxes will neither meet the revenue requirements of the state neither
will they be equitable.
An economy should have a variety of taxes so that all citizens
contribute towards state revenue according to their various ability to
pay.
Broadly there should be direct and indirect taxes.
2
TAX IMPACT, INCIDENCE AND SHIFTING
Tax impact- The term impact is used to express the immediate result of or
original imposition of the tax. The impact of a tax is on the person on whom
it is imposed first. Thus, the person who is to pay the tax to the government
bears its impact.
Tax incidence- This is the final resting point of a tax. It is upon those
economic units which finally bear the money burden of the tax. It is on the
economic units where tax money comes from.
Tax shifting- It is the process of transferring the tax burden from one unit
to the other. There are two aspects of tax shifting:
i) Forward tax shifting- This is the transfer of the tax burden from
a trader to the customer. Usually it is by increasing the selling
price of a given product it is by inclusion of the tax element in the
product price e.g. VAT,
ii) Backward tax shifting- This occurs when the producers shift the
money burden of the tax to the suppliers of factors of production.
E.g. urging them to accept lower wages/for services provided or
materials supply.
Factors influencing Tax shifting
1. Elasticity of demand and supply- Where the demand is elastic
the tax cannot be shifted forward. Where the demand is
inelastic forward shifting can apply. Where the supply is
elastic the tax can only be shifted forward. In case of inelastic
supply the tax can be shifted backwards.
 2. Nature of markets - In a monopoly the tax can easily be
shifted forward. In a competitive market the tax can be shifted
backwards or absorbed by the trader.
3. Time available for adjustment- The person either the buyer or
the seller who can adjust will be able to shift the tax. If the
buyer can shift to substitute products then the seller will bear
the tax burden.
4. Geographical location- If taxes are imposed in certain regions
it is hard to shift to consumers since they will move to regions
of low tax.
5. Government policy on pricing In case of government price
control it will be impossible for the supplier to increase prices
hence impossible to shift the tax burden to the buyers.
6. Nature of tax whether it is a direct or indirect tax. Direct tax
cannot be shifted while indirect taxes can be shifted.
7. Rate of tax- If the tax rate is too low the producer may absorb
it and retain his customers. If it is too high it can be partially
or fully shifted to consumers.
Taxable Capacity
Taxable Capacity refers to the maximum capacity that a country can
contribute by the way of taxation both in ordinary and extra ordinary
circumstances. In other words, it refers to the maximum capacity of the
people of a country to bear the burden of taxation without much hardship. It
is nothing but the maximum limit that a government can tax the people.
3
Types of taxable capacity
1. Absolute Taxable Capacity: Absolute taxable capacity refers to
whatever could be taken away by the State after allowing for the barest of
subsistence to the citizens. The indicator of absolute taxable capacity is that
if it does not increase the revenue of the State, it then indicates that the
absolute taxable capacity of the people has already been reached.
2. Relative Taxable Capacity: Relative Taxable Capacity refers to the
respective contribution made by two communities for the common
expenditure of the government. In other words, it is the capacity of one
community to some common expenditure in relation to the capacities of
other communities. For example, there are two communities, namely the
rich and the poor communities. The rich-people can be made to contribute
more to a common expenditure than the poor people. The rich people have
the ability to pay in view of their higher income
Factors influencing taxable capacity in a country
1) The population – the higher the population the higher the reve3nue.
2) The level of economic development.
3) The level of employment.
4) Literacy levels.
5) The popularity of the government/psychological effects of
the residents towards the government.
 CLASSIFICATION OF TAXES Disadvantages of direct taxes
CLASSIFICATION OF TAXES BY EFFECT. 1. They violate the principle of convenience since they are paid in lump
a) Direct Taxes sum.
This is a tax that requires the tax payer to remit the tax to the tax authority 2. It discourages people to work for extra hours since the higher the
directly. It is levied on persons and can vary with the status of the tax income the higher the tax and thus it reduces availability of labour.
payers. Its impact and incidence fall on the same person i.e. the tax cannot 3. It is not easy to attain the principle of vertical equity.
be shifted e.g. PAYE, corporation tax. 4. It discourages capital assumption thus reducing the savings ability.
Advantages of direct taxes 5. They are easy to evade.
1. They are related to the ability to pay since the tax rates are chosen with 6. It is expensive to collect since there are many collection points.
respect to tax payers’ ability. Consequently they are suitable in b) Indirect taxes
achieving income and wealth re-distribution. This is a tax imposed on a “thing” and paid by a person by virtue of his
2. Direct taxes fulfill the central authorities need for social and association within that thing. The impact is on one person and the incidence
community goes up the tax yield also goes up. is on another person through tax shifting. The tax is usually included in the
3. Direct taxes fulfill the central authorities need for social and economic product price and it is known by the tax payer. An example is VAT.
justice since tax payers are taxed fairly with continued change in their Advantages on indirect taxes
incomes. 1. It has fewer collection points and therefore it is cheap to collect.
4. Direct taxes do not cause distortions in resource allocations thus 2. It is not easy to evade since it is included in the product price.
receiving the tax payers better off than indirect taxes. This is a suitable 3. It has no difficulty in definition and the tax base cannot be
attitude towards resource allocation since it leaves the tax payers manipulated.
neutral. 4. It is related to consumption of luxury goods thus it is an incentive to
5. Direct taxes inculcate the spirit of civic responsibility among the tax save and consume less.
payers. 5. It is convenient since it is paid in several installments.
6. It can be applied selectively to achieve a given economic objective.

4
7. Indirect taxes can be used as an economic tool to influence production a) Progressive taxes
and economic activities. These are taxes that take a larger proportion of people’s income when their
Disadvantages of indirect taxes income increases.
1. It goes against the principle of ability to pay since they are applied It is a tax where with increased income the tax increases both in absolute
to cover products generally consumed by the poor. terms and also in relative terms. E.g. the PAYE system in Kenya.
2. They are against the objective of least aggregate sacrifice. Advantages
3. They promote inflation since they start by increasing the prices of 1. They conform to the canon of ability to pay (equity).
goods and services without corresponding increase in purchasing 2. They help in achievement of social and economic justice.
power. 3. It helps to redistribute wealth and economic resources by taxing the
4. They don’t promote civic consciousness. rich heavily and applying their excessive wealth in providing services
CLASSIFICATION OF TAXES BY RATES to the poor.
A tax rate is the amount payable per unit of tax base. 4. It discourages the rich from mis-using economic resources on luxuries
A tax base is the legal description of the object to which the tax applies and non-essential goods and services that do not have productive
such as income, output expenditure benefits to the society.
5. It helps the economy to have a stable demand because the rich are
heavily taxed during the boom period and they also get high tax credits
during the depressed period.
6. They are administered conveniently resulting in less or lower
administrative and collection cost.
Disadvantages
1. They discourage people to work harder since the higher the income the
higher the tax.
2. They reduce the savings ability since the rich save from their
excessive wealth which facilitates capital accumulation.

5
3. Lower Government Revenue- Depending on how progressive the tax
system is, it could actually lead to lower levels of government Disadvantages
revenue. 1. It is heavy on the poor leaving the rich to pay little tax in continued
4. High Administrative Costs- A truly progressive tax will increase increase in their wealth.
gradually alongside income. However, this can create a large number 2. It does not follow the principle of ability to pay or the least aggregate
of brackets sacrifice.
5. Discourages Wealth creation- By taxing the rich disproportionately 3. Proportional taxation cannot bring social justice.
more than those on lower incomes, a discouragement is created. 4. It widens inequality in the distribution of income and wealth as the
b) Proportional taxes burden of this tax is borne mostly by the poor people.
This is a tax that takes the same percentage of people’s income irrespective 5. It is inelastic and, therefore, less productive. In other words,
of the levels of income. The tax increases in the same proportion as the proportional tax contributes little to the state
increase in income e.g. corporation tax of 30%. c) Regressive taxes
Advantages People who earn low income are taxed heavily than those who earn higher
1. It is simple to administer and compute since it does not require income. In relative terms it means taxes increase at decreasing rates with
complicated rates. increase in income.
2. It does not change the relative position of different tax payers since Advantages
each of the tax payers is subjected to the same proportion of tax. 1. It encourages the poor to work harder and enter higher income
3. Since it is difficult to determine the correct degree of progression it is brackets where the tax rates are lower.
considered to be better than progressive taxes. 2. It forces the accumulation of capital and savings which the poor would
4. since all people pay taxes at the same rate there is no ambiguity as to not otherwise saved since they have a higher propensity to consume.
rate of taxation 3. It results in increased government revenue since the tax base and
5. proportional tax is that it simple to understand by both tax authorities wider being based on the majority poor.
as well as tax paying individual 4. Wealth is left with the rich to save and invest in strategic enterprises.
This promotes the private sector and promotes employment.

6
5. Regressive taxes are easier to administer and calculate than
 The people with higher income and consumption pay less tax than
progressive taxes. the people with less income and consumption.
6. Regressive taxes may be less likely to cause economic distortions than TAX SYSTEMS
progressive taxes. There are 2 types of tax systems
Disadvantages 1. Single tax system
 It goes against the principle of equity. A regressive tax imposes a This is where only one type of tax is applied usually the direct tax.
higher tax burden on those with lower incomes than those at higher Advantages
incomes. 1. It is easy to administer.
 It is less practical. 2. It has row cost of collection
 Regressive taxes can lead to increased income inequality. 3. It is simple for tax payers to understand
 Regressive taxes can place a greater financial burden on low- 4. It enhances certainty to the tax payers since they pay only one
income earners. type of tax which has specific rates.
 Regressive taxes may cause people to spend less money, which can Disadvantages
lead to decreased economic activity. 1. It does not promote the canon of equity since it considers only one
 Regressive taxes may be less politically popular because they are sector of the economy.
seen as “unfair.” 2. It leads to low government revenue.
d) Digressive taxes 3. It lacks diversity and elastic.
The tax rates increases at decreasing rates. The tax is mildly progressive. 2. Multiple tax system
Disadvantages This is a system that uses several types’ taxes covering both direct and
 This kind of tax puts more burden on the poor and relieves the rich. indirect taxes.
 The rate of tax is disproportionate to the ability of payment of Advantages
taxpayers. 1. It promoted equity since all residents are covered by different
taxes.

7
 2. It leads to higher revenue for the government since there is a wider TYPES OF TAXES IN KENYA
tax base. 1. Income Tax-
3. It promotes diversity of taxation. Income tax is a tax charged for each year of income, upon all the income of
4. It is economical to the government since it collects more revenue. a person whether resident or non-resident, which is accrued in or was
Disadvantages derived from Kenya. Income Tax is imposed on;
1. It is complicated for the tax payers.  Business income from any trade or profession
2. It leads to higher cost of collection and administration.
 Employment income
3. It may be too heavy for the tax payer since there are too many
 Rent income
taxes.
 Dividend and Interests
4. There is lack of certainty since the taxpayer is not aware of all the
 Pension income
taxes.
 Income from a Digital Marketplace
Factors to consider when developing or when introducing new tax
 Natural resource income among others
system
There are different methods of collecting income tax from companies &
1. The cost of collection of the taxes. It should always be lower than
partnerships, based on their sources of income. These methods include:
revenue collected.
a. Corporation Tax- This is a form of Income Tax that is levied on
2. Whether the tax will lead to equity in taxation.
corporate bodies such as Limited companies, Trusts, and Co-
3. The effect of the tax in the economy.
operatives, on their annual income. Companies that are based outside
4. The flexibility of the tax such that the tax can be adjusted depending
Kenya but operate in Kenya or have a branch in Kenya pay
on the economic conditions.
Corporation Tax on income accrued within Kenya only.
b. Pay As You Earn (PAYE)- This is a method of collecting tax at
source from individuals in gainful employment. Companies and
Partnerships with employees are required to deduct tax according to
the prevailing tax rates from their employees' salaries or wages on

8
 each payday for a month and remit the same to KRA on or before the
9th of the following month.
c. Withholding Tax (WHT) -This is a tax that is deductible from certain
classes of income at the point of making a payment, to non-employees.
WHT is deducted at source from the following sources of income:
 Interest
 Dividends
 Royalties
 Management or professional fees (including consultancy,
agency or contractual fees)
 Commissions
 Pensions
 Rent received by non-residents
d. Advance Tax- This is a tax paid in advance before a public service
vehicle or a commercial vehicle goes for the annual inspection.
e. Installment Tax- Installment tax is paid by persons who have tax
payable for any year that amounts to KShs. 40,000 and above.
2. Rental Income Tax
This is a tax charged on rental income received from renting out property.
Taxation of rental income depends on how the rented property was used for
residential or commercial purposes. All people’s individuals, partnerships
and companies that rent out property to other persons for either residential
or commercial use are required to pay income tax on rent received. To
9
facilitate compliance, KRA appoints agents to withhold and pay, a
percentage of the gross rent as tax. These agents can be verified via the
agent checker on iTax.
3. Value Added Tax (VAT)
Value Added Tax is charged on supply of taxable goods or services made
or provided in Kenya and on importation of taxable goods or services into
Kenya.
While companies & partnerships can voluntarily register for VAT they
MUST register if their annual revenue exceeds KShs. 5,000, 000. To
facilitate compliance, KRA appoints agents to withhold and pay, VAT on
supplies made. These agents can be verified via the agent checker on iTax.
4. Excise Duty
This is a duty of excise imposed on; goods manufactured in Kenya, or;
imported into Kenya and specified in the 1st schedule to Excise Duty Act,
2015. Companies and Partnerships dealing in excisable good and services
are required to pay excise duty. The List and types of Excisable goods and
services are listed in the Customs and Excise Act, CAP 472 Laws of Kenya.
They includes;
 Mineral water
 Juices, soft drinks
 Cosmetics and Preparations for use on hair
 Other beer made from malt
 Opaque beer
  Mobile cellular phone services
 Fees charged for money transfer among others
5. Capital Gains Tax (CGT)
This is a tax chargeable on the whole of a gain which accrues to a company
or an individual upon transfer of property situated in Kenya, whether or not
the property was acquired before 1st January, 2015. It took effect on 1st
January 2015.
6. Agency Revenue
This is a type of payment that KRA collects on behalf of various revenue
collection agencies in Kenya. The two types of Agency Revenue include;
a. Stamp Duty- Stamp duty is a tax charged on transfer of properties,
shares and stock. It is collected by the Ministry of Lands, which has
seconded the function to Kenya Revenue Authority (KRA).
b. Betting Tax- Betting Tax is chargeable on the gross gaming revenue
(GGR) of a bookmaker at the rate of 15% as provided by Section 29A
of the Betting, Lotteries and Gaming Act, 1966. Betting, gaming and
Lottery businesses are required to withhold as tax and remit to KRA
20% of the winnings being paid out to winners. Excise Duty on
Betting is chargeable at the rate of 20% of the amount wagered or
staked, commencing 7th November, 2019.
TAX EVASION AND TAX AVOIDANCE
Tax evasion is an illegal means employed by a taxpayer in order to reduce
his tax liability. This may be carried out by fraudulent or false tax,
10
smuggling, hiding or non-declaration of incomes, claiming expenses or
relief one is not entitled to, etc. The Tax Act usually states the penalties to
be applied in case of evasion of tax. Some of the reasons for tax evasion
includes;
• The very structure of the countries’ tax system.
• Chaotic distribution of powers among the
different government levels.
• Low educational level of the population.
• Lack of simplicity and accuracy of the tax
legislation.
• High Inflation leading to high cost of living
• Tax pressure – high rates.
• A significant informal economy
• Possibility of failing to comply without greater
risks.
• Lack of dissemination regarding the use of
resources originating from taxes.
• Lack of citizens’ tax integrity.
• Inefficiency of the Tax Administrations
• Presence of multinational enterprises with
aggressive tax planning.
• Tax havens – jurisdictions of null or low
taxation or as it is said in many countries, non-
cooperating jurisdictions.
 • creation of special tax regimes for attracting
investments
• Difficulty to control the transfer prices of
related multinational enterprises
• Digital economy, with the significant
technological development.
Tax avoidance on the other hand is where a taxpayer uses methods to
reduce tax liability but within the law. This could be done by studying the
Tax Act and detecting loopholes in it to be exploited to the full advantage
of the taxpayer. For example a taxpayer could operate business as a
company or sole proprietorship or partnership whichever gives the best
advantage. Pressure groups could be formed to influence legislation in
taxpayers favour. Note that tax avoidance (tax planning) may or may not
lead to loss of revenue to the government and is not punishable.
Taxpayers can engage in tax avoidance through tax planning activities such
as:
- buying assets to enjoy capital allowances instead of
leasing
- engaging in exporting business where exports are zero
rated instead of domestic sales
- Use of debt capital where interest is tax allowable
instead of equity capital
11
- Being granted low interest loan to purchase a house
(employer pays Fringe Benefit Tax) instead of being
granted a house (taxable housing benefit)
- Mortgage relief
- Pension with a registered retirement benefits scheme
- House Ownership Savings Plan (HOSP)
- Life Insurance
- Investing in tax free instruments
- Disability relief
STATUTORY DEDUCTIONS
a) Pay As You Earn (PAYE) - Employers are required to
deduct PAYE from monthly salary paid to their employees
and remit the same to the Kenya Revenue Authority
(KRA). Employers are required to remit PAYE deducted
from salaries paid to their employees on or before the 9th
day of the succeeding month.
b) National Social Security Fund (NSSF)- National Social
Security Fund (NSSF) is the statutory retirement benefits
scheme and operates as a public trust. It provides
retirement benefits for employees in the formal and
informal sectors. Employers are required to remit NSSF
contributions deducted from salaries paid to their
 employees on or before the 15th day of the succeeding
month.
c) National Hospital Insurance Fund (NHIF) - National
Hospital Insurance Fund (NHIF) is a State Corporation
which provides limited in-patient medical insurance cover
at accredited health facilities to eligible members from both
the formal and informal sectors. Employers are required to
remit NHIF contributions deducted from salaries paid to
their employees on or before the 9th day of the succeeding
month. However, some employers provide their employees
with private medical insurance cover in addition to the
NHIF medical scheme.
d) National Industrial Training Authority (NITA) Levy-
the National Industrial Training Authority (NITA) is a
State Corporation whose mandate is to promote the highest
standards in the quality and efficiency of industrial training
in Kenya and ensure an adequate supply of properly trained
manpower at all levels in industry. Employers are required
to register with NITA as training levy payers, pay KES 50
per month per employee at current rates and remit the same
on or before the 9th day of the succeeding month.
Employers who are levy-compliant are reimbursed in part
or full for training costs incurred on employees based on
levy terms and conditions.
12
e) Higher Education Loans Board (HELB)- It is a
requirement for employers when recruiting and onboarding
a new employee to ascertain if the employee is a
beneficiary of HELB and inform HELB accordingly.
Employers have three obligations to HELB, namely, to
disclose, deduct and discharge payments to HELB.
Employers are required to remit HELB contributions
deducted from salaries paid to their employees on or before
the 15th day of the succeeding month.
PSEUDO TAXES
Refers to other form of levies that are not grouped in the main taxes
instituted by government in form of fees, levies etc. They include;
1. Stamp duty - This is a tax levied on legal instruments such as
cheques, receipts, military commissions, marriage licenses, land
transactions and shares.
 Non-payment of the duty results in the invalidity of the relevant
transaction and any agreement signed between the parties
become null and void, and the same is inadmissible in a Court
of Law as evidence.
 If Transaction instruments that are prepared locally, the tax
should be paid within 30 days after assessment.
  Documents executed abroad and sent for registration locally, source revenue include (land) rates, single business permits, parking fees,
Stamp Duty must be paid within 30 days of receiving the building permits, and fees from billboards and advertisements.
documents
 Failure to pay the duty and or assessed amounts leads to a fine
that is assessed at five percent (5%) of the principal assessed
stamp duty for every quarter from the date of the Instrument
2. Airport tax-Tax charged on departure or arrival of passengers in
the Kenyan airports.
3. Tourism levy- The tourism levy is payable to the Tourism Fund by
establishments dealing in tourism activities and services as listed in
the Tourism Act at a rate of 2% of turnover.
4. Railway development levy (RDL) - The RDL is now payable on
all imports into the country at 2% on the customs value of the
goods. However, the rate will apply at 1.5% for (i) raw materials
and intermediate products imported by approved manufacturers and
(ii) inputs for the construction of houses under the affordable
housing scheme approved by the government.
Charges and fees of county governments
According to Kenya constitution a county may impose--
(a) Property rates;
(b) Entertainment taxes; and
(c) Any other tax that it is authorised to impose by an Act of Parliament
The county governments can also impose charges for any services they
provide in accordance with the stipulated laws. Some types of these own

13