Kenya has introduced new tax rules to govern donations to charitable organisations and the use of the proceeds given to such institutions, in a move aimed at sealing loopholes for tax evasion.
The new guidelines under the Income Tax (Charitable Organisations and Donations Exemption) Rules, 2024 were gazetted mid last month, replacing the rules that have been in place since 2007.
Charitable organisations are recognised under the Income Tax Act, which exempts from income tax the income of any institution or body which exists exclusively for the relief of poverty, distress of the public or for the advancement of religion or education.
The new guidelines will require all such entities that were exempt before June 18, 2024, to comply with the new rules within 12 months from the effective date to avoid the risk of Kenya Revenue Authority (KRA) revoking their income tax exemption certificate.
They will attach to their fresh application, various details including an impact report of present and future activities in Kenya and the criteria for selecting beneficiaries for their charity work.
Accumulated surplus
Under the new rules, charities will not be allowed to accumulate surplus funds— an excess of income over expenditure in any accounting period—of more than an average of 15 percent of their funds for three consecutive years without using the surplus for their specified charitable purposes.
Law firm Bowmans says in an analysis of the new rules that the restriction will hit those charities that have been holding large sums of money instead of using it for the purposes for which they were registered.
“The surplus funds restriction would mean that the government is seeking to restrict the accumulation of donations and grant income (being the primary sources of tax-exempt income for non-profit organisations) and require their use for charitable purposes,” said Bowmans in a note.
Charities that carry on unrelated business activities with profits and gains will now have to pay tax on income from such activities. Only income from donations and grants will be exempt.
This means that income raised from a business carried on in the course of, or in actual execution of the exempt charitable purposes will be taxed. Charities will be required to obtain a separate tax identification number (PIN) to pay tax on income from such activities.
“This provision would seek to subject the income from business or trade that is not exclusively used by an exempt charitable organisation to support the exempt charitable purposes to income tax,” explains Bowmans.
Under the new rules, charities that exclusively fund, donate or support other charities without carrying out any charitable activities will not be exempt.
Stricter conditions
Bowmans notes that this new rule may force institutions that facilitate charities by providing funding or logistical support without engaging in any charitable activity to restructure their operations if they are to be exempt from tax.
The rules have also introduced stricter conditions for individuals and companies that have enjoyed tax deductions for donations to charities under the Income Tax Act.
The new rules now state that in order to qualify for the deduction, the donation must not be refundable to the donor, there must be no direct or indirect benefit to the donor or anyone associated with the donor, and the donor provides a receipt showing details such as the purpose and amount of the donation. In addition, the rules provide that the donations should not result in a taxable loss.
If the donations are to a related entity, the rules state that they must not exceed 50 percent of the total donations in any year of income.
Bowmans says such provisions allow the KRA to disallow donations made by a taxpayer if the “procedural and substantive requirements” are not met.
“The rules have introduced unfair, unreasonable and onerous restrictions on allowability of donations which would discourage the use of donations to fund charitable activities,” said Bowmans.
Allowability of donations
It adds that the restriction on the allowability of donations as introduced by the new rules is akin to the Cabinet Secretary arbitrarily amending the provisions of the Income Tax Act beyond the CS powers.
According to Bowmans, where donors or founders are related parties, the restriction on the allowability of donations would be a major impediment to charitable organisations and donors would have no incentives to contribute to the advancement of charitable activities.
The rules have also drawn up a checklist of what entities seeking to be exempted from tax will have to provide. The checks include providing proof of the organisation’s purposes and the public benefit.
They also state that if the entity charges a fee for, say, healthcare services or educational activities, it should provide free treatment or school fees to 10 percent of its patients or students, respectively.
The defined scope of what qualifies as charitable work means that entities will have to align to it or lose the tax exemption certificate, which is valid for five years. The rules allow the KRA to revoke the licence and impose tax on any accumulated funds if an entity fails to sustain the criteria for exemption.
Bowmans, however, notes that the KRA would have no legal basis to impose income tax on the accumulated funds if the funds come from donations and grants, as these are not included in the list of income subject to income tax.
