Opting out of turnover tax
How a Kenyan small business can elect out of turnover tax in writing, what applies instead, and how to compare tax on sales with tax on profit.
By Achekam · · 5 min read · For Running a business businesses in Kenya
Turnover tax suits a lot of small Kenyan businesses: one figure a month, no expense schedules, no year-end income tax return on that income. But for some it is the wrong fit. A hardware shop with thin margins, a business that has just invested heavily, or one going through a loss-making year can find itself paying tax on sales when there is little or no profit underneath.
Kenyan law does not force an eligible business to stay on turnover tax. KRA says it can choose to leave. This article explains how that choice is made, what replaces turnover tax, which income was never under it in the first place, and how to compare the two before you decide.
Who is in the turnover tax band
KRA says turnover tax applies to resident persons and businesses whose gross turnover is more than Kshs 1,000,000 but does not exceed, and is not expected to exceed, Kshs 25,000,000 in a year of income. It is charged under section 12C of the Income Tax Act, and KRA notes it does not apply to non-residents.
Being inside that band makes a business eligible. It is the starting point for the question this article is about: having qualified, does the business want to stay?
The written election to the Commissioner
KRA says a person eligible for turnover tax may elect, by notice in writing to the Commissioner, not to be taxed under turnover tax. Two things stand out. The choice is the taxpayer's, and it is made in writing. A business that simply stops filing turnover tax returns has not opted out; it has fallen behind.
KRA's turnover tax page states the election rule along with the band, the exclusions and the filing requirements. Read it and confirm with KRA, or with your tax adviser, how and from when an election takes effect before you send the notice. Keep a copy of the notice and any acknowledgement with your tax records.
What applies instead
Once the election is made, KRA says the other provisions of the Income Tax Act apply. In plain terms, the business moves from turnover tax's simple model to the ordinary rules that most larger businesses follow.
That shift has practical consequences:
- Turnover tax is a final tax on gross sales with no deductible expenses. Under the ordinary rules, expenses come into the picture, so a business with high costs is taxed on what is left after them.
- Turnover tax payers do not file an end-of-year income tax return on the income turnover tax covers. Under the ordinary rules, the annual return is back.
- Instalment tax, which does not apply to turnover tax payers, may now apply. The detail is in instalment tax in Kenya.
- The bookkeeping needs to support a profit figure, not just a sales total: expenses, receipts and supporting documents all matter.
Income that never falls under turnover tax
Before comparing, separate out income that turnover tax does not cover at all. KRA says turnover tax does not apply to rental income; management, professional or training fees; or income subject to a final withholding tax, such as qualifying dividends or qualifying interest.
So a consultant earning professional fees, or a landlord earning rent, is not choosing between turnover tax and the ordinary rules for that income. Those streams are taxed under their own rules whatever you decide. The election only changes how your trading sales are taxed.
Gross sales against profit: comparing the two
The decision comes down to margins. A worked example in words: two shops have identical sales. The first buys stock cheaply and has low running costs, so most of each sale is profit. The second sells at a narrow margin and pays high rent. Under turnover tax, both pay the same tax, because both have the same sales. Under the ordinary rules, the second shop's tax is based on a much smaller profit.
The comparison is not purely about tax, though. Leaving turnover tax brings more record-keeping, an annual return and possibly instalments. A business with good books and steady costs may find that a fair trade. One where the owner does everything alone may value turnover tax's simplicity more than the saving.
Questions to answer before electing
- What were gross sales and profit over the last full year?
- Is next year likely to look similar, better or worse?
- Do the books record every expense with a receipt?
- Who will prepare the annual return and work out any instalments?
- Has a tax adviser looked at both calculations?
Management accounts in Achekam to compare
The comparison needs a reliable profit figure, and that is what management accounts give you. In Achekam, management accounts show an income statement for a chosen period beside the period before, and a balance sheet at period end, both added up from the business's own journals. They can be exported as PDF or CSV to share with your adviser.
One detail to watch: the year-to-date preset starts on 1 January, not on the business's own year start. If your year runs differently, choose the dates yourself.
With the profit figure in hand, the tax side is simpler. Once the Kenyan rules in the workspace are approved, Achekam computes Kenyan turnover tax and the other Kenyan taxes it covers, including instalment tax, so you can set the turnover tax figure for a period beside the profit the income statement shows.
Timing the decision
An election made in a hurry, in the middle of a bad month, is rarely the right one. Look at a full year's figures, ask your adviser to run both versions, and decide before the period you want it to apply to. Then plan the change in your bookkeeping as carefully as the tax itself.
If you stay on turnover tax, the monthly routine is set out in filing and paying turnover tax each month. Accountants advising several such clients can find more in turnover tax for small clients.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
