QUESTION ONE (a) State and briefly explain four factors which influence the taxable capacity in a country. ( 6 marks) (b) Governments in developing countries tend to overtax individuals in formal employment. (I) Using suitable explain why Governments find it convenient to continually raise higher taxes on earnings from formal employment. ( 6 marks) (ii) Suggest and explain one proposal on how the Government can be able to generate tax revenue from the informal sector. ( 2 marks) (c) Normally in Kenya a trader is required to pay for a variety of licences in order to conduct trade. (i) Do you consider a licence to be a tax? Explain. ( 1 mark) (ii) Specify four of such licences. ( 4 marks) (iii) In Kenya there is a proposal for the Government to issue a single licence to a trader in preference to the practice of issuing a variety of licences. Would you support this proposal? Why ( 1 mark) (Total: 20 marks) QUESTION TWO Mrs. S. Nkuraru is the owner of a supermarket in Nairobi East. Her accounts clerk has submitted to you the following trading profit and loss account for the year ended 31 December 2005: Opening stock Purchases Salaries and wages Donations to Kenya Chamber of Commerce Redundancy payments Contributions to registered pension fund Rent, rates and taxes Insurance Legal and professional fees 8,640,000 96,000,000 1,500,000 100,000 600,000 100,000 110,400 14,880 109,200 Closing Stock Sales Proceeds from sale of land allocated to her by the Government Gain on sale of shares Gain on sale of residential plot General bad debts recovery Dividends (Net) 1,004,000 110,000,000 500,000 200,000 400,000 36,000 43,200
Depreciation Advertising Value Added Tax Customs duty 2005 Income tax for 2004 Medical expenses Mrs. S. Nkuraru Interest on bank overdraft Purchase of equipment Christmas gifts to customers General bad debts Household expenses Stationery and postage Net profit 363,840 166,800 247,200 700,000 312,000 28,800 49,920 25,200 20,160 55,200 100,800 33,120 2,905,680 112,183,200 The following additional information is provided: 112,183,200 1. Rent, rates and taxes include sh.20,400 being customs duty for the purchase of equipment. 2. Sales include a sum of 120,000 representing the value of goods withdrawn for use by Mrs. S. Nkuraru and her children. These goods had been purchased at a cost of 96,000. 3. Opening stock as well as the closing stock are consistently overvalued by 20% above cost price. 4. The legal and professional fees are analysed below: Appeal to local committee against tax assessment Renewal for 5 year lease Defending a suit for breach of trade agreement Court fines Miscellaneous (allowable) 24,000 25,200 36,000 20,400 3,600 109,200 5. Wear and tear allowances were agreed at 259,200. 6. Included in advertising expenses is a sign board erected at the road junction leading to the supermarket at a cost of 24,000. Required:
(a) Mrs. S. Nkuraru s chargeable profit for the year of income 2005. (14 marks) (b) The tax payable on chargeable profit and state when it is payable. ( 4 marks) (c) State the tax position if the tax payable is not paid on the due date. ( 2 marks) (Total: 20 marks) QUESTION THREE Professor Ujuzi, a Kenyan, came back to Kenya from USA on 1 August 2005 to take up an appointment as a managing director of Good Metal Limited after a 15 year absence from Kenya. The letter of offer sent to him from the Good Metal Limited indicated that he would: 1. receive a monthly basic salary of 200,000. 2. be provided with a company car for his own personal use of 2,000cc rating. The company had bought the car for sh.2,000,000. 3. be provided with school fee support for his two children in America. The company is to spend sh.300,000 per annum for this purpose. 4. have his baggage moved from America to Kenya by Express Cargo who were paid 1,500,000 to move the four containers of personal effects and the air tickets for Professor Ujuzi, his wife and children. 5. buy 10 per cent of the share capital of the company at US$50,000 (3,000,000). For the year ended 31 December 1998, the company paid him 400,000 (gross) as dividends. Withholding tax for the dividends were paid by the company. 6. be covered by the company on his life with Fedlife, an American Insurance Company based in New York. Premium of 60,000 was to be paid for a sum insured on death of 6,000,000. Upon arrival in Kenya on 1 August 2005, Professor Ujuzi purchased a house in Runda Estate using a loan from Housing finance Company of Kenya. The loan advanced was for 2,000,000 at 25 per cent interest rate. All instalments in the year were paid. He lived in the house from 1 August 2005 to 31 December 2005. The
wife did not like the house and on 31 December 2005, they sold the house and made a gain of 400,000. The wife, Mrs Ujuzi enrolled for the external degree programme at the University of Nairobi. While there, she was requested to teach American English. The University paid her a honoraria of 2,000 per hour for 60 hours. She did not receive the money in cash but the amount was used to offset her fees as an external student. Required: (a) (i) Comment briefly on the tax implications of Professor Ujuzi s return to Kenya, using the Income Tax Act, the Customs and Excise Act. ( 4 marks) (ii) According to the Customs and Excise Act, are the personal effects chargeable to tax? ( 1 mark) (b) Analyse the income tax effects of each item in Professor Ujuzi s employment contract. ( 6 marks) (c) Determine the taxable income of Professor and Mrs Ujuzi for the year of income 1998. ( 7 marks) (d) Calculate the tax payable by Professor Ujuzi and Mrs. Ujuzi. ( 2 marks) (Total: 20 marks) QUESTION FOUR Kamene, Mutinda and Mwende have been trading in partnership as Meka Associates making water tanks for the last 5 years. They share profits and losses in the ratio 2:2:1 respectively. For the year ended 31 December 2005, Meka Associates made a profit adjusted for income tax purposes of 60,498,500 before capital allowances. On 31 December 2004, Meka Associates acquired in whole the business of Nithi Brothers, a tea processing firm. Information given below relates to the business when it was owned by Nithi Brothers.
Nithi Brothers had purchased a building on 1 January 2004 for 42,000,000 (including land valued at 6,000,000). It was brought into use on the same day. The sellers construction costs comprised: Land Construction costs: Factory Offices Levelling land Architects fees 30,800,000 3,200,000 4,000,000 34,000,000 1,200,000 800,000 Meka Associates continued with the same business of processing raw tea. following amounts were paid for assets purchased from Nithi Brothers: The Motor vehicle Goodwill Land and buildings Milling machines Tractor and lorry 4,000,000 200,000 80,000,000 36,000,000 32,000,000 Meka Associates incurred the following additional costs: Extension to building Security wall Fixtures and fittings Installed machinery Additional boiler Volvo saloon Nissan urvan 16,000,000 2,000,000 12,000,000 24,000,000 20,000,000 2,000,000 3,000,000 The following transactions took place in 2005: 1.8.2005 Sold milling machines for 4,000,000 and one faulty photocopier for sh.80,000
1.10.2005 Sold damaged fixture and fittings for 160,000 and disposed of a lorry for 3,600,000 3.10.2005 Disposed of the motor vehicle for 3,000,000 The terms of the partnership agreement were as follows: 1. Kamene and Mutinda to receive salaries of 480,000 each per annum. 2. Interest of 2,000,000 and 1,320,000 to be paid to Kamene and Mutinda respectively on their fixed capital accounts. 3. Mwende was to draw a salary of 2,400,000 per annum. 4. The remaining profits or losses to be shared according to the existing profit/loss sharing ratio. The following additional information is provided: Kamene and Mutinda are married while Mwende is unmarried. Kamene has a mortgage for a residential house and paid interest amounting to 600,000 during the year 2005 to Savings and Loan (K) Ltd. Mutinda received 400,000 as interest on 4,000,000, city council stocks which he has held for many years. The partners had no other income. Required: (a) The capital allowances due to Meka Associates in 2005. (10 marks) (b) Allocation of partnership profits/losses for 2005. ( 8 marks) (c) Taxable income for each partner. ( 4 marks) (Total: 22 marks) QUESTION FIVE (a) What are the partners responsibility with respect to the following VAT matters? (i) Exempt supplies in relation to their business. ( 2 marks) (ii) Zero rated supplies in relation to their business. ( 2 marks) (b) Discuss the tax implications of the following independent transactions: (i) 16% VAT paid on a new factory building constructed on behalf of Wema Ltd. VAT of 60,000 due on the invoice to Disaster Limited which has remained unsettled by them for 6 months.
Transfer of a building worth 5,000,000 from a father to a daughter for a nominal sum of 1,000,000 in an urban area. Custom bond executed by Watu Insurance Company on behalf of Barm Limited for sugar worth 100 million which was not re-exported as promised. (12 marks) (Total: 18 marks)