Turnover is a form of income tax charged on small businesses with an annual turnover of up to Sh5 million. The tax was first introduced in Kenya in January 2007 with the aim of increasing revenue collection by bringing small businesses to the tax net. However, the administration of the tax failed spectacularly in the succeeding years, mainly due to the nature of small businesses which typically operate in the informal sector, and lack of proper documentation of transactions.
In 2018, turnover tax was replaced with presumptive tax which is payable at the time of renewing business permits from County Governments at the rate of 15 percent of business permit fees. Notwithstanding the structure of presumptive tax, its administration did not meet the projected revenue targets.
As a result, turnover tax was reintroduced in January 2020 to increase revenue collection by supplementing presumptive tax. Presumptive tax was retained as an advance payment of turnover tax. As such, the presumptive tax paid in the beginning of the year is offset against the turnover tax accruing in the course of the year.
The reintroduction of turnover tax has increased the tax and compliance burden to small businesses. Key to note, while income tax is payable on gains and profits, turnover tax is charged on the gross turnover of the business.
In arriving at the taxable income of any business, the expenses incurred in generation of the income are deducted in order to determine the net gain. However, turnover tax has completely disregarded this important principle of taxation, and instead the tax is levied on the gross sales. Small businesses are thus forced to pay the tax, whether they make a profit or not.
In addition, while businesses not subject to turnover tax are allowed to declare and carry forward losses for a period of nine years, the turnover tax regime does not allow declaration of losses or carrying forward of losses to the subsequent years for tax purposes. In fact, losses incurred by the business do not have any impact on the taxes payable.
Turnover tax is also more punitive than corporation tax which would be applicable to bigger businesses with a turnover of more than Sh5 million. For instance, assuming an ambitious gross profit margin of 20 percent, it would mean the business bought goods worth Sh4.2 million in a year to makes sales of Sh5 million in that year. This would translate to a gross profit of Sh840,000 and a net profit of Sh420,000, assuming minimum operating expenses of 50 percent of the gross profit. Therefore, the business would pay a lower corporation tax of Sh126,000 compared to turnover tax of Sh150,000 on equal sales.
Also, unlike corporation tax which is payable annually with four equal instalments remitted throughout the year, turnover tax is payable monthly. This increases the compliance cost and may lead to cash flow constraints for small businesses, which are already burdened with licence fees, business permit fees, among other government levies.
Businesses under the turnover tax regime are also required to submit a monthly return within the same timeline as the payment of the tax due. This contrasts with corporation tax for bigger businesses where returns are filed only once a year. The monthly returns pose a big challenge to small business which are mainly family-owned and informal. Filing of tax returns requires access to a computer, Internet connectivity and computer literacy which may not be within the reach of majority of small businesses.
The obligation of keeping documents for a period of five years may also be difficult to observe for the many small businesses that do not have a fixed place of operations or the necessary resources to comply. Most sales by small businesses are also made in cash with little or no documentation.
Turnover tax is regressive in nature and has failed the equity and economy test of the canons of taxation. The cost of enforcing the tax is also high due to the lack of documentation and fixed place of business for small businesses. Considering that the informal sector is the largest “employer”, the government should be facilitative of the environment in which small businesses operate.
One of the ways which the government may explore to mitigate the burden occasioned by administration of the tax would be to reduce the tax rate and have the tax paid quarterly in a year. That way, the tax and compliance burden would reduce significantly.
Alternatively, due to the volatile nature of the informal sector, the government may consider doing away with turnover tax, and instead revamp the presumptive tax which is easier to administer. Revamping the administration of presumptive tax would include spreading the payment into several instalments throughout the year.