QUESTION ONE (a) Taxable capacity of the people refers to the extent of their ability to pay tax. Four factors affecting/influencing taxable capacity in a country are: Number of inhabitants: The larger the number the greater is the taxable capacity of the community to contribute towards the expenses of the Government. Distribution of wealth: Where wealth is more equally distributed, the taxable capacity will be correspondingly reduced. If accumulations of wealth in a few hands then the Government has to tax the rich highly to help the poor. Method of taxation: A tax system composed of various types; direct and indirect will ensure a larger yield. Purpose of taxation: If the purpose of taxation is to promote welfare of the people, they will be more willing to pay tax for popular causes. If tax revenue is used to finance war, maintenance of armed forces, a costly civic service them taxable capacity will reduce. Others: Psychology of taxpayers, stability of incomes, rate of inflation etc. (b) (i) Formal employment has the following characteristics that make it convenient to raise taxes: o Income in formal employment is certain since those in employment are expected to be in work over a long period of time before retirement. o Collection of such tax is less costly since employers are agents to the Government who charge, collect and remit tax to the state without payment. o Elasticity of demand for income in formal employment is inelastic in face of rise in tax since incomes informal employment tends to be higher than would be the case in informal sector. o It is not easy to evade taxes on formal employment.
Others: o The tax authority does not have sufficient capacity to enforce/collect tax from informal sectors. (ii) Oneway the Government can be able to generate tax revenue from informal sector is designating areas of informal sector operations so as to make easy registrations and collection of tax/charges from such operators. Introducing indirect tax on items used by informal sector operations. Introduce direct tax on informal operations. (c) (i) A licence is not strictly a tax but authorization for one to conduct a particular business or a line of business. (ii) For such licences include: Trade licence for authority to conduct business Driving licence authorizes one to drive an automobile Import/export licences authorizes one to import or export Practice licence authorizes one to practice in a particular profession as a professional. Others: Transport licensing board permit Liquor licences, etc. (iii) Issuing a single licence to a trader rather than a variety of licences would reduce costs involved in acquiring a number of licences from different points hence convenient to trader. However this would not check abuses by traders wishing to carry out trade in various trade activities requiring proof of eligibility. It would also reduce revenue collection by the government. QUESTION TWO (a) MRS. NKURARU CHARGEABLE PROFIT FOR 2005 Net profit as per account Add disallowable expenses Sh. 000 Sh. 000 2,905.68
Over valuation of opening stock (20/120 x 8,640) Rent, rates and taxes customs on equipment to capitalize Legal and professional fees: Tax appeal Breach of trade agreement Court fines Depreciation Advertising sign board (capital) Value added tax Customs duty for 2005 Income tax for 2004 Medical expenses Mrs. Nkuraru (private) Purchase of equipment General bad debts Household expenses Less nontaxable income, capital allowances, etc Over valuation of closing stock (20/120 x 1,004) Unrealised profit on drawings (Sh.000, 12096) Proceeds from sale of land Gain on sale of shares Gain on sale of residential plot General bad debt recovery Dividends (net) assumed qualifying type Wear & Tear allowances Chargeable profit 1,439.999 20.4 24 36 20.4 363.84 24 247.2 700 312 28.8 25.2 55.2 100.8 167.333 24 500 200 400 36 43.2 259.2 3,397.889 6,303.519 1,629.733 4,673.786 (b) Tax payable Ksh.121,968 @ 10% Ksh.114,912 @ (15% + 20% + 25%) (Ksh.4,673,786 466,704) @ 30% Gross tax liability Less personal relief Net tax liability 12,196.8 68,947.2 1,262,125.0 1,343,269.0 (13,944.0) 1,329,325.0 Tax is payable through self assessment on or by end of the 4 th month after accounting year i.e 30 th April 2006. QUESTION THREE
(a) (i) Having taken up appointment as managing director of Good Metal Limited from 1 st August 2005, Prof. Ujuzi becomes resident individual for year 2005; (i.e. from 1 st August 31 December 2005) since he has a permanent home in Kenya. His salary and benefits will be taxed on him as a resident and will be entitled to 5 months personal relief. He will also be entitled to mortgage interest to the lower of (Sh.2,000,000 x 25% x 5/12) Sh.208,333 or set limit of Ksh.100,000 p.a x 5/12 = Ksh.41,667 (allowable amount) (ii) He will be exempted from customs duty on personal belongings as returning resident subject to nature and quantities of items involved. (b) For income tax purposes the following would be the implications of his employment contract: tax. Monthly salary of Sh.200,000 is employment income and chargeable to income School fees of Sh.300,000 will be taxable on him unless Good Metal Limited treat this expense as disallowable (taxed on the employer). Provision of a car of 2,000 c.c rating gives rise to taxable car benefit equal to the higher of c.c. rating of Sh.(36,000 x 5/12) = 15,000 p.a. or 2% per month multiplied by cost of car, i.e. (Sh.2,000,000 x 2% x 5months) = Sh.200,000. Therefore taxable car benefit will be Sh.200,000 for the year. Baggage and air travel costs are not taxable benefit on Prof. Ujuzi who is coming to Kenya having been appointed outside Kenya on a first appointment in Kenya; Sec.5(4)(a). Dividend is not employment income and is taxed at source. However tax paid on dividend by the employer on his behalf is taxable income on him and will be added to his income and taxed as such. Premium paid on his behalf by employer is a taxable benefit on him. (c) PROFESSOR UJUZI TAXABLE INCOME YEAR 2005 Employment income: salary (Sh.200,000 x 5 months) Benefits: Company car take the higher of 2000 c.c rating Ksh. p.a. 100,000
(Sh.36,000 x 5/12) = Sh. 000 15 or 2% x 2,000,000 x 5 months) = Sh.000 200 Dividend tax paid at source by employer Premium on life paid for by employer Less interest on owner occupied property the lesser of actual Sh.208,333 or max. 41,667 for 5 months Taxable income 200,000 20,000 60,000 (41,667) 1,238,333 Tax liability (Ksh.121,968 @ 10%) + (114,912 @ 60%) (Ksh.1,238,333 466,704) @ 30% Gross tax liability Less personal relief 1,162 p.m x 5 Net tax liability 81,144 231,489 312,633 (5,810) 306,823 Notes: 1. Honoraria to wife is not strictly employment income neither is it business and therefore not taxable on her. 2. Personal relief to Prof. Ujuzi is for 5 months only of employment during the year. QUESTION FOUR (a) MEKA ASSOCIATES CAPITAL ALLOWANCES YEAR 2005 (I) INVESTMENT DEDUCTION ASSET Building extension Security wall Machinery QUALIFYING COST 16,000 2,000 24,000 20,000 I.D @ 100% 16,000 2,000 24,000 20,000 RESIDUE FOR IBD & WTA
Boiler 62,000 Note that Nithi Brothers had claimed I.D on factory building and machinery. (ii) INDUSTRIAL BUILDING DEDUCTION NATURE OF BUILDING Factory building (2004) QUALIFYING COST RESIDUE B/FWD 14,400 14,040 360 360 IBD @ 2½% RESIDUE C/FWD 13,680 (iii) WEAR & TEAR ALLOWANCES CLASS I @ 37½% WDV as at 1/1/2005 Additions Fixtures & fittings Volvo saloon Nissan Urvan Milling machines Tractor & lorry Motor vehicle Disposals: Milling machines Fixtures and fittings Lorry Motor vehicle Photocopier WTA Trading receipt WDV 31/12/2005 Nil 32,000 (3,600) 28,400 (10,650) 17,750 II @ 30% SH 000 Nil (80) (80) T.R 80 Nil III @ 25% Nil 1,000 R 3,000 1,000 R (750) R 4,250 (1,062.5) 3,187.5 IV @ 12½% NIL 12,000 36,000 (4,000) (160) 43,840 (5,480) 38,360 Total WTA = 17,192.5
SUMMARY OF CAPITAL ALLOWANCE INVESTMENT DEDUCTION INDUSTRIAL BUILDING WEAR & TEAR ALLOWANCE TOTAL CAPITAL ALLOWANCES 62,000,000 360,000 17,192,500 61,372,500 MEKA ASSOCIATES COMPUTATION OF TAXABLE INCOME Net profit as per accounts Less capital allowances Add trading receipt Sh. 000 60,498,500 (80,552,500) 80,000 (19,974,000) (b) ALLOCATION TO PARTNERS PARTNERS Salaries Interest Share of loss Net profit share KAMENE 480 2,000 (10,661.6) (8,181.6) MUTINDA SH 000 480 1,320 (10,661.6) (8,861.6) MWENDE 2,400 (5,330.8) 2,930.8 TOTAL 3,360 3,320 (26,654) (19,974) (c) TAXABLE INCOME FOR EACH PARTNER Net profit from partnership Less mortgage interest (maximum) Interest on city council Chargeable income KAMENE (8,181.6) (100.0) (8,281.6) MUTINDA SH 000 (8,861.6) (8,861.6) MWENDE 2,930.8 2930.8 Notes: 1. Interest on city council stocks suffers withholding tax as final tax. 2. W.e.f 1 January 1995 any civil works or related structure to an industrial building is taken as
part of the building and will qualify for investment deduction. QUESTION FIVE (a) (i) Exempt supplies: Partners need not register for VAT and consequently cannot claim input tax suffered on purchases. (ii) (iii) Zero Rate Supplies: Partners need to register for VAT, to charge VAT but at zero rate can claim input tax suffered on purchases. NonRemittances of VAT: The following actions, penalties are available to the commissioner: (a) (b) (c) (d) (e) Seizing goods of taxable person in question Collecting the money from debtors of the taxpayer out of sums due to the taxable person. Property of the taxable person can be distained. Taxpayer could be sued for the amount in a court of law Late payment penalty of Ksh.15,000 and interest charge of 2% per month. (b) (i) The VAT suffered on new building constructed on behalf of Wema Ltd. is capital in nature and therefore not deductible as input tax rather it is included in total factory building cost for the purpose of claiming capital allowances. (ii) (iii) (iv) VAT is payable on total invoices amount by 20 th of the following month whether sales were on cash or credit basis. Stamp duty is payable on such transfer based on market value of building i.e. Sh.5,000,000 x 4% = Sh.200,000. Since goods have not been reexported as required then the customs department will require the Watu Insurance Company to pay up the sum guaranteed. The customs bond is a guarantee of performance by the insurance company, however the Insurance Company may then recover the amount from Barm Limited.