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Taxation of Benefits and Allowable Deductions

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Taxation of Benefits and Allowable Deductions

Mr. Otieno is employed as a senior manager at Bidco Ltd. His annual basic salary is KES 2,400,000. He receives the following benefits: a house allowance of KES 300,000 per year; a car allowance of KES 200,000 per year; and a company car for personal use, which cost the company KES 3,000,000. He also receives a loan of KES 1,000,000 from the company at an interest rate of 3% per annum, while the market rate is 10%. The company pays for his life insurance premium of KES 50,000 and his daughter's school fees of KES 150,000. Mr. Otieno contributes KES 200,000 to a registered pension scheme. The company also provides him with a servant who is paid KES 60,000 per year. Calculate Mr. Otieno's taxable income and the tax payable for the year, using the current Kenya tax rates (assume personal relief of KES 28,800 and tax rates: 10% up to KES 288,000; 25% up to KES 388,000; 30% up to KES 6,000,000; 32.5% up to KES 9,600,000; 35% above).

1. Compute Mr. Otieno's taxable employment income, showing all inclusions and exemptions. Justify the treatment of each benefit with reference to the Income Tax Act (Kenya).

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Taxable employment income computation:

  • Basic salary: KES 2,400,000 (taxable).
  • House allowance: KES 300,000 (taxable as employment benefit).
  • Car allowance: KES 200,000 (taxable).
  • Company car: Benefit in kind. The taxable value is the higher of 2% of cost per month or the prescribed rate. For a car costing KES 3,000,000, 2% per month = 60,000 per month, annual = 720,000. Alternatively, the Income Tax Act provides a formula: 2% of cost per month. So annual benefit = 720,000. However, if the car is used for personal use, the whole benefit is taxable. (Note: The Act may have specific rules; assume 2% per month of cost is the taxable benefit.) So include KES 720,000.
  • Loan benefit: Interest benefit = (10% - 3%) × 1,000,000 = 7% × 1,000,000 = KES 70,000. This is a taxable benefit (fringe benefit tax on loan at below market rate).
  • Life insurance premium paid by employer: KES 50,000. Under Kenyan tax law, employer-paid life insurance premiums are taxable benefits unless they are group life policies. For individual policy, it is taxable. So include KES 50,000.
  • School fees: KES 150,000. Employer-paid school fees are taxable benefits. Include.
  • Servant: KES 60,000. Employer-paid servant is a taxable benefit. Include.
  • Pension contribution: KES 200,000. This is deductible from taxable income (subject to limits). The limit is KES 30,000 per month? Actually, the deductible amount is the lesser of actual contribution or 30% of pensionable salary. Pensionable salary includes basic salary only? Typically, pensionable salary is basic salary. 30% of 2,400,000 = 720,000. So 200,000 is fully deductible. So subtract 200,000.

Total taxable income before pension: 2,400,000 + 300,000 + 200,000 + 720,000 + 70,000 + 50,000 + 150,000 + 60,000 = 3,950,000. Less pension: 200,000 → taxable income = 3,750,000.

Justification:

  • House and car allowances are cash benefits, taxable.
  • Company car: benefit in kind taxed at 2% of cost per month (or prescribed rate).
  • Loan: difference between market rate and actual rate is taxable benefit.
  • Life insurance and school fees: employer-paid benefits are taxable unless specifically exempt (e.g., group life).
  • Servant: taxable benefit.
  • Pension: deductible under Income Tax Act, subject to limits.

2. Calculate the tax payable by Mr. Otieno for the year, applying the graduated tax rates and personal relief. Show the tax bands and the final tax liability.

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Tax computation: Taxable income = KES 3,750,000.

Tax bands:

  • First 288,000 @ 10% = 28,800
  • Next 100,000 (288,000 to 388,000) @ 25% = 25,000
  • Next 5,612,000 (388,000 to 6,000,000) @ 30% = but our income is 3,750,000, so the remaining after 388,000 is 3,750,000 - 388,000 = 3,362,000. This falls in the 30% band (up to 6,000,000). So tax on this = 3,362,000 × 30% = 1,008,600.

Total tax before relief = 28,800 + 25,000 + 1,008,600 = 1,062,400. Less personal relief = 28,800. Tax payable = 1,062,400 - 28,800 = 1,033,600.

Workings:

  • First band: 288,000 × 10% = 28,800
  • Second band: (388,000 - 288,000) = 100,000 × 25% = 25,000
  • Third band: (3,750,000 - 388,000) = 3,362,000 × 30% = 1,008,600
  • Total tax = 1,062,400
  • Less personal relief = 28,800
  • Net tax = 1,033,600.

Thus, Mr. Otieno's tax payable is KES 1,033,600.