Why start-ups should have minimum tax grace period
Robert Maina and Issa Zuberi
Kenya has over the past few years been grappling with a significant growth in its revenue needs amidst a below optimal growth in tax collections.
The growth in revenue demands has been driven by the need to finance various mega infrastructure projects, repayment of debts and funding county governments, among other competing needs.
On the other hand, efforts by the National Treasury through Kenya Revenue Authority to grow its tax collections have not met the expectations of the government.
This has been partly blamed on taxpayers who are deemed not to be contributing their fair share to the tax kitty either through reporting of perpetual losses or paying income taxes which are deemed to be below the expectations of the government.
In a bid to plug this gap, the government through the Finance Act, 2020 introduced minimum tax.
This is a tax which is payable by all persons where the tax payable (if any) on their income is less than 1 per cent of their annual gross turnover.
It also applies to persons who are currently not paying income tax as a result of their businesses not being profitable.
But what does the introduction of minimum tax mean to persons who are operating micro, small and middle enterprises (MSME’s)? Owners of MSME’s should be concerned about minimum tax if they meet the following criteria.
Annual turnover
First, they currently do not pay tax on their income or are paying income tax which is less than 1 per cent of their annual turnover despite having active businesses.
Secondly, they are not enrolled and are currently paying tax under the turnover tax regime. Thirdly, their income is not exempt from tax.
Fourth, their income does not consist of residential rental income that they declare under the monthly residential rent income tax regime.
Fifth, their income does not comprise a capital gain. Minimum tax is also not applicable on employment income, persons who are engaged in businesses whose retail price is controlled by the government such as oil marketing companies e.g. petrol stations, and persons who are engaged in insurance business.
Persons who are eligible to pay minimum tax are required to make payment on or before the 20th day of each period ending on the fourth, sixth, ninth and 12th month of the year of income.
What this means is that for a business owner with total revenue of Sh10,000,000 per year, their minimum tax will be 1 per cent of the Sh10,000,000, which is Sh100,000.
This is where the income tax they would have paid on their taxable profit, that is, after deducting allowable expenses would be below Sh100,000 in that year of income.
For such a business, if their financial year ends on December 31, they will be required to make their first payment on or before April 20, 2021.
Negative effects
In some instances, businesses incur losses due to circumstances beyond their control.
For instance, under the current Covid-19 pandemic, many businesses are likely to incur losses for 2020 year of income and probably the next few years. Imposing an additional burden in the form of minimum tax on such businesses is likely to worsen their current situation.
Most start-ups, especially capital-intensive ventures such as manufacturing companies incur heavy initial investment costs in the initial years of operation while recording sluggish sales.
Capital injection
It is unlikely that such businesses would report a profit during this phase and hence they will be paying minimum tax from their capital injection.
Such fledgling start-ups should be cushioned by being granted a grace period during which minimum tax should not apply.
This logic informed the change in the case of Nigeria, where, effective January 2020, companies that have been in business for less than four calendar years are exempted from minimum tax.
This is also the case in other countries where minimum tax applies on companies that have been in a loss position for a prescribed number of consecutive years.
— Robert Maina is a Senior Manager while Issa Zuberi is a Senior Consultant in Ernst & Young LLP. The views expressed herein do not necessarily represent the views of Ernst & Young LLP
