Kaimosi Friends University

Directorate of Open Distance and E-Learning

TOPIC SIX

TAXATION

6.0 INTRODUCTION

This topic focuses on the concept of taxation. It introduces you to the principle types of taxes, tax
evasion and suggests remedial measures to tax evasion. Further, the concepts of income tax and
its calculations are discussed.

6.1 OBJECTIVES

By the end of this topic, you should be able to:

1. Differentiate between different types of taxes
2. Describe the principles governing taxation
3. Explain the sources of opportunities for tax evasion and suggest remedial
measures
4. Calculate the income tax of an employee.

6.2SECTIONS OF THE TOPIC

In this topic, we shall cover the following sections:

Section 1: Definition and types of taxes
Section 2: Principles of taxation
Section 3: Tax evasion and its remedial measures
Section 4: Income tax calculations

6.2.1 DEFINITION AND TYPES OF TAXES

Recall how we defined a tax in the topic public finance. We said that a tax is a compulsory
contribution imposed on individual to meet the expenses which are incurred for a common
course. This means that a tax has two main characteristics. Firstly it is a compulsory
contribution whereby everybody must pay and secondly there is no direct service against the
payment of tax. This means that despite compulsorily paying the tax, an individual has no
right to demand for services directed to him or her.

Ensuing from this definition is the fact that all the tax income collected is pooled together
before expenditures are done based on the guiding principles discussed earlier under public

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expenditure. It should be noted that tax revenue constitutes the highest towards public
revenue in country. This is because of its compulsory nature and the different forms that tax
is manifested. The following are some of the types of taxes:

1. income tax- this is tax imposed on income of individuals salaries and other allowances
2. corporate tax - this is tax imposed on profits of public limited companies
3. sales tax- this is tax imposed on sale of commodities and its imposed on businessmen
4. excise tax - this is tax imposed on production of commodities mainly by production
industries
5. Customs duty- this is tax imposed on imports or exports of commodities.

Explain other types of taxes in Kenya.

6.2.2 PRINCIPLES OF TAXATION

The concept of taxation and especially the guiding principles have evolved over the years.
Specifically, the first four principles were by an economist Adam Smith while the others were
developed after Adam Smith and are basically expounds on this first four. Let us now explain
each of these principles.

Equality: This state that the subjects of every state ought to contribute towards the support of the
government in proportion to their respective abilities. This means that individuals must
contribute based on their respective abilities. Thus, the more you have the more you ought to
contribute.

Certainty: This states that the tax which each individual is bound to pay ought to be certain and
not arbitrarily. This means that a proper system should be in place such that individual know
their tax obligation.

Convenience: This states that the tax an individual is supposed to pay should be imposed such
that the time and method of payment is convenient to the payer as much as possible. In fact most
taxes are imposed at source such that the payer does not feel it much. For instance income tax is
paid regularly as the income is paid to the person and is usually done by the employer and
remitted to the government. Also, the price of a commodity is inclusive of the relevant taxes.

Economy: This states that since every tax has cost of collection, this cost should be as minimum
as possible. This means that the tax income should always be more than its cost of collection so
as to generate revenue for the government.

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Productivity: This principle states that the tax system should be able to yield enough revenue for
the treasury to avoid deficit financing. This means that the tax revenue should always provide
sufficient funds for the government so as mitigate any deficits in its revenue.

Buoyancy: This states that there should be an increase in tax revenue even if there is no change
in tax base. This means that the tax system should have an inherent tendency to increase with
national income even if the tax rates and coverage are not revised.

Flexibility: This states that authorities should be able to revise the tax structure (coverage and
rates) to suite the changing requirements of the economy.

Simplicity: This principle states that the tax policies should be simple for people to understand
and easy for the government to administer.

Diversity: This principle postulates that there must be different types of taxes so that the tax
burden is on different groups of the society. This is intended to ensure that every person
contributes towards government revenue through payment of tax.

A good tax system is that which fulfills the maximum possible number of
these principles of taxation. Thus an ideal tax system should meet the majority of this principle.

However, the percentage proportion of tax revenue in relation to the Gross Domestic Product in
less developed countries such as Kenya is lower than those in developed countries. This is
primarily because of high tax rates that are intended to raise more funds for the government. This
means that citizens in these countries are taxed heavily and as a result tend to resort to way to
evade paying their tax liabilities by capitalizing on certain loopholes in the tax system.

6.2.3TAX EVASION

What have you been doing to evade paying a debt?

Tax evasion: This is a situation whereby an individual fails to meet his or

her tax liability as required. This is possible by capitalizing on existing short falls in the tax
system as discussed below.

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Information gap in all levels: There are inappropriate records that are maintained by businesses
that have tendency to conceal factual evidences in the name of small businesses. Such people
pretend to be running small businesses in order to pay less tax yet they are running larger
businesses.

Complicated tax laws: There have been changing provisions in terms of tax rebates (tax
discounts or waivers) which have been restructured in the form of Value Added Tax through
rationalization. It is thus difficult to tell who to give the tax discount or waiver which at times is
given on friendly basis. Also the inclusion of VAT in the price of certain commodities is not
clearly understood to an extend that the consumers rarely know which commodities attract VAT
in their cost hence the charge tax is not remitted to the government.

Concealment of true ownership: This creates a loop hole whereby one invests the property in
another person’s name say a relative. This makes it difficult for one to trace the source of funds
for such investments.

Imperfect tax administration: Tax officials are not efficient and like any other human being there
are emanable to temptations leading to corruption. The tax laws are also complicated for people
to understand.

Donation political parties: Any receipts to political parties and other Non Governmental
Organizations (NGO) are not taxed yet it is an income. Their accounts and those of high profile
personality’s are not audited. Also if you pledge loyalty to the ruling party as a business man you
are awarded by not paying tax.

What other opportunities do you think exist for tax evasion?

Remedial measures to tax evasion: In order to increase tax revenue,

the government needs to check on the loopholes discussed above. Below are some measures that
can be taken to reduce tax evasion.

1. There is need to have appropriate conceptual definitions of income and put appropriate
tax laws.
2. There is need to reduce incentives for tax evasion and put obstacles to evasion. This can
be achieved by

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a. Lowering tax rates so that people earn more hence taxed more.
b. Supplementing income tax with other forms of taxes such as tax on expenditure,
annual income tax etc.
3. There is need to have comprehensive returns on personal accounts.
4. Compulsory auditing of accounts of high income tax payers and assigning code numbers
for each.
5. Donation to political parties to be taxed and all accounts for political parties and other
NGOs to be audited.
6. Penalty for tax evasion should be related to the tax saved rather than the income
concealed. It should also be increased to make it more punitive.
7. Adequate attention to be paid to bracket creeping i.e when there is inflation the
government increases salaries of employees to make them get high salary hence pay
more tax.
8. Also tax brackets should be frequently adjusted to take into account of the price raise
factor.

Suggest other remedial measures for tax evasion.

6.2.4 INCOME TAX

Income tax: This is a tax levied on every person who earns an income
from salaries, wages, commissions, interest on bonds and savings, dividends on share etc. now,
before we look at income tax computation, let us first define some basic terms used under it. This
include:

Gross income: this is the total income earned by an individual in a month or year. It consists of
the basic income basic salary and all the allowances due to the individual.

Relief: this is a tax rebate, discount or waiver given to an individual. It takes the form of
personal or family

Taxable pay: Is the gross income less contribution to registered schemes like pensions or
insurance provided that the scheme is registered with the commissioner of income tax.

Tax liability: this is the actual amount of tax paid by an individual. It is obtained by taking the
tax payable less the relief.

Net income: this is the final amount received by an individual after all deductions have been
made. It is also referred to as the take home package and is calculated as

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Net income = Gross income-(tax paid +contribution to registered schemes + any other
deduction).

Example1

An employee in a certain company drew the following benefits in the month of April 2011: Basic
salary Kshs. 20,000, House allowance Kshs. 15,000, Medical allowance Kshs. 8,000,
Car allowance Kshs. 8,500, Entertainment allowance Kshs. 5,500 and
Responsibility allowance Kshs. 7,200. During the month the employer made the following
payments: Kshs.430 to NHIF, 5% of basic salary to a registered pension scheme,3 % the basic
salary to the cooperative for shares and Kshs.12,000 to a medical chemist for the drags he had
taken. In addition an employee received a tax relief Kshs.1, 056. Using the tax schedule below
calculate the employee’s
a) Gross income

b) Taxable pay

c) Tax charged

d) The net income.

Tax schedule

Income (Ksh) tax rate (%)

1-10,800 10%

10,801-21,600 15%

21,601-32,400 20%

32,401-43,200 25%

43,201 and above 30%

Solution

a) Gross income = basic salary + all the allowances received

Basic salary Kshs. 20,000.00
House allowance Kshs. 15,000.00
Medical allowance Kshs. 8,000.00

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Car allowance Kshs. 8,500.00

Entertainment allowance Kshs. 5,500.00
Responsibility allowance Kshs. 7,200.00
Gross income Kshs. 64,200.00

b) Taxable pay = Gross income - contribution to registered schemes(pension scheme)

Gross income Kshs. 64,200.00

Less pension scheme (5%of20, 000.00) Kshs. 1,000.00
Taxable pay Kshs. 63,200.00
c) Tax charged

We use the tax schedule to tax the amount for taxable pay. This is because the deductions
towards registered schemes shall be taxed at the time of payment.

10
1st 10,800= x10,800 = 1,080.00
100

15
2nd 10,800=  10,800 = 1,620.00
100

20
3rd 10,800=  10,800
100 = 2,160.00

25
4th 10,800=  10,800
100 = 2,700.00

30
5th (63,200 − 43,200) =  20,000 = 6,000.00
100

Total tax =13,560.00

Less Relief = 1,056.00

Tax charged = 12,504.00

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d) Net income = Gross income-(tax charged +pension + all other deductions)

Gross income Kshs. 64,200.00

Less pension scheme (5%of20, 000.00) =Kshs. 1,000.00
Tax charged = Kshs. 12,504.00

NHIF = Kshs. 430.00

Medical Chemist = Kshs. 12,000.00

Shares (3% of 20,000.00) = Kshs. 600.00 Kshs. 25,534.00

Net income Kshs. 38,666.00

Example 2

An employee draws the following benefits in a month: Basic salary Kshs. 37,650.00, House
allowance Kshs. 36,600.00, Subsistance allowance Kshs. 2,900.00, Car allowance
Kshs. 4,400.00, Responsibility allowance Kshs. 800.00 and a non contributory
medical scheme. In a month the employ contribute 10% of basic salary to a registered pension
scheme, Ksh. 320 to NHIF, 15% of basic salary to cooperative society and 400 to the union for
all employees. The employee is however entitled to a personal relief of Kshs. 1,080 per month.
Using the tax schedule provided calculate above, calculate the employees:

a) Gross income per year.

b) Yearly taxable income
c) Monthly tax charged
d) Net monthly income received

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Solution

a) Gross income = basic salary + all the allowances received

Basic salary Kshs. 37,650.00
House allowance Kshs. 36,600.00
Subsistance allowance Kshs. 2,900.00
Car allowance Kshs. 4,400.00
Responsibility allowance Kshs. 800.00
Gross income Kshs. 82,350.00
Gross income per year = Kshs. 82,350.00 p.m X 12 months = Kshs. 988,200.00

b) Taxable pay = Gross income - contribution to registered schemes(pension scheme)

Gross income Kshs. 82,350.00

Less pension scheme (10% of 37, 650.00) Kshs. 3,765.00
Taxable pay p.m Kshs. 78,585.00
Yearly taxable income = Kshs. 78,585.00 p.m X 12 months = Kshs. 943,020.00

c) Tax charged

10
1st 10800= x10,800 = 1,080.00
100

15
2nd 10,800=  10,800 = 1,620.00
100

20
3rd 10,800=  10,800
100 = 2,160.00

25
4th 10,800=  10,800
100 = 2,700.00

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30
5th (78,585 − 43,200) =  35,385 = 10,615.50
100

Total tax =18,175.50

Less Relief = 1,080.00

Tax charged = 17,095.50

d) Net income = Gross income-(tax charged +pension + all other deductions)

Gross income Kshs. 82,350.00

Less pension scheme (5%of20, 000.00) =Kshs. 3,765.00
Tax charged = Kshs. 17,095.50

NHIF = Kshs. 320.00

Union dues = Kshs. 400.00

Shares (15% of 37,650.00) = Kshs. 5,647.50 Kshs. 27,228.00

Net income Kshs. 55,122.00

EXERCISE

Mrs Olive is a personnel manager with a certain company. She has a basic salary of 26,000 per
month, House allowance 20,000; Substance allowance 2,500; Responsibility 4,000; Car
allowance 8,000 and Medical allowance 5,000. She contributes 10% of basic salary to a
registered pension, 320 to NHIF; 200 to NSSF and 500 for service charge. In addition she pays
1000 to her cooperative society every month and she has a personal relief 1,056 per month.

Required: Calculate

a) Gross income per month and for the whole year.

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b) Her monthly and yearly taxable income.

c) Her monthly tax liability.

d) Her monthly tax liability.

e) Her take home package per month.

LEARNING ACTIVITIES

1. List the various measures that you have put in place to maximize your debt collection.

2. Calculate your income tax payment from your pay slip

6.3 SUMMARY

In this topic we have defined taxation and given various types of taxes. We have also learnt
about the principles guiding taxation in any country such as equality, economy, convenience,
certainty among others. Moreover, we have learnt the loopholes for tax evasion and suggested
their remedial measures.

Finally, we have calculated the income tax of an individual.

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6.4 SELF CHECK

SELF CHECK 6

1. Differentiate between tax evasion and tax avoidance (4 marks)

2. Describe any four main tenets of taxation (4 marks)
3. Explain any five measures taken by the Kenya government to increase its tax revenue (10
marks)
4. Mr. Ndegwa, an employee of Cereal Board and Marketing receives a monthly salary of
Kshs. 80,000/= house allowance of Kshs. 35,000/= traveling allowance of Kshs. 15,000/=
(re-imbursed on monthly basis) and entitled to a car allowance of Kshs. 18,000/= which
he has to account for, and a responsibility allowance of Kshs. 18,000/= per month. Mr.
Ndegwa was to pay the following from his monthly remuneration in the month of March
2010.Kshs. 4,000/= pension scheme (registered), Kshs. 320/= NHIF (national Hospital
Insurance Fund), Kshs. 6,000/= Life Insurance Scheme, Kshs. 3,000/= Co-operative
Society Shares and Kshs. 5,000/= House Saving Scheme

Determine:

(i) Tax Liability (Personal Tax Relief being 1,162) (10 marks)

(ii) His net income (2 marks)

6.5 Score Board

Range of marks Level of Performance

25-30 Very good

15-24 Good

11-14 Satisfactory

0-10 Read the topic again

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6.6 LEARNING OUTCOMES

You have now completed the topic on taxation, please tick in the column which reflect your
understanding of the various learning outcome listed below.

No. Learning Outcome Sure Not Sure

1. I can now define a tax

2. I can well discuss the principles of taxation

3. I can now identify the various types of taxes

4. I can now describe the loopholes for tax evasion

5. I Can now suggest remedial measures to tax

evasion

6. I can now calculate the income tax of an employee

If you have put a tick at the “not sure” column, please go back and study that section in the topic
before proceeding.

If you have ticked “sure” in all the rows in all the columns you are ready for the next topic

Congratulations! You can continue to the next Topic

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