Tax Planning pt 2: Individual Tax Planning


There are a limited number of methods, vehicles and techniques by which individuals can avoid taxes. These are highlighted below.

1. Tax Deductible Contributions to Retirement Benefit Schemes

Income tax laws have for the last 17 odd years provided that contributions to registered retirement benefit schemes can be deducted from gross income before taxable income is determined. The tax deductible contribution is currently set at a maximum of Ksh 20,000/= per month (Ksh 240,000/= per annum). These contributions achieve the twin aims of building retirement savings and reducing taxes paid.
It should be noted that upon reaching the set retirement age, the retirement savings are still taxable under certain conditions. When the individual desires to receive his retirement savings as a lump sum, a sum of Ksh 48,000/= per full year worked subject to a maximum of Ksh 480,000/=, is deductible from the lump sum before the balance is taxed under applicable tax bands for individual income. In addition, individuals who retire after 50 years or retire on medical grounds are liable to tax on the balance of the lump sum at wider tax bands, effectively reducing the tax rate. Overall, the option of accessing retirement savings as a lump sum may therefore significantly reduce the tax savings received from contributions made during income earning years.
Members of pension schemes, or members of an individual retirement scheme who opt to use their retirement savings to purchase an annuity (which will generate a periodic pension), will have various advantages. The first Ksh 180,000/= of the total pensions or retirement annuities received annually are tax exempt. Secondly, personal relief is applied to reduce the taxable income. Further, and as a result of changes brought about by the Finance Bill 2007, pensions for persons over 65 are now totally tax exempt.

2. Contributions to a Registered Home Ownership Savings Plan

The Income Tax Act has for some time provided that contributions to registered schemes designed and established to enable savings for purchase of residences can be deducted from gross income up to a maximum of Ksh 4,000/= per month (Ksh 48,000/= per annum). This has been enhanced by making interest earned on deposits of up to Ksh 3 million into such a scheme tax free. This avenue for savings and tax mitigation still remains relatively unattractive, however, since the enabling rules and regulations are difficult for banks to abide with. As a result, so far only one financial institution, Housing Finance, has launched a savings product for this purpose.

3. Mortgage Interest Deduction

Interest incurred on personal mortgages is deductible from gross income before arriving at taxable income, subject to a limit of Ksh 12,500/= per month or Ksh 150,000/= per annum.

4. Individual Investment in Various Assets so as to Avoid Taxes on Gains

The suspension of taxation of capital gains for more than two decades has meant that individuals have not been subjected to taxes on gains made on acquisition and subsequent disposal of assets such as immovable property, equities, and fixed income securities. When the same investments are made through a corporate entity, the gains can lead to taxable profits at corporate tax rates. An attempt in 2006 to reintroduce tax on capital gains realized on sale of immovable properties was unsuccessful after Parliament rejected the enabling provision of the Finance Bill.
It should be carefully noted that tax exemption is where the acquisition and disposal of assets is not a business activity carried on under the guise of personal investments. Section 3(2)(a) of the Income Tax Act provides that income tax is chargeable upon gains or profits from a business. In the definitions section of the Act “business” is defined to include any trade, profession or vocation, and every manufacture, adventure or concern in the nature of trade. This clearly captures regular personal trading in assets of whatever nature.
This exemption can be enjoyed by investment through Unit Trusts or other Collective Investment Schemes such as mutual funds. Such investment vehicles are subject only to withholding tax on dividends and interest income that they receive, with subsequent distributions from such entities to members being tax exempt.

5. Conducting Business Using a Corporate Entity so as to Enable Comprehensive Deductions of Business Expenses

While expenses legitimately incurred in the production of income are tax deductible regardless of the form of business, conducting business using a corporate entity enables clearer segregation of business and personal expenses, thus enhancing the deduction of certain expenses. This is especially in light of the fact that the Domestic Taxes Department will carefully scrutinize expenditure in the course of audits to determine if it was of a personal nature or not.
Individuals engaged in various professions, including entertainment can set up companies, labeled Personal Service Companies, to which they direct their income. This enables them to reduce taxable income by charging their gross income with certain tax deductible expenses they most probably would fail to deduct if they conducted their business as individuals.

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