New turnover tax is good for fundis and other consultants

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

17 February 2008

A new income tax system came into force from 1st January 2008 – the so called Turnover Tax. Contrary to popular belief, it is not an additional tax but an alternative (and easier) way of calculating the amount payable to the taxman. The tax is targeted at small businesses whose annual sales are between Sh500,000 and Sh5 million. This group of taxpayers is expected to choose whether to sign-up in the new system or to remain in the old one.

Those who sign-up will be paying income tax from their business activities at the rate of 3 percent of turnover. This will be payable whether or not the business makes any profits. That is the catch of this new system. So how does a business person decide whether to join or not?

Well, as an example, consider my newspaper vendor who sells about 200 copies every day. At Sh35 each, his daily turnover is Sh7,000 or Sh2.555 million annually. Thus he qualifies to register for the new tax system and, if he singed-up, his bill at the end of the year will be 3 percent of Sh2.555 million, which is Sh76,650.

On the other hand, if he chooses to remain in the old tax system, he has to calculate his profit and then work out the tax bill according to the relevant brackets – a complicated process when compared to turnover. Suppose he gets Sh5 from each newspaper; his gross income is Sh1,000 per day or Sh365,000 annually.

Now, the vendor doesn’t have many overheads – no rent for the business, no employees, no transport costs etc. But still, we can allow him Sh15,000 for the few phone calls he makes when his deliveries are delayed and other incidental expenses. His net profit then comes to Sh350,000 per year. The tax payable on this is about Sh52,000. Therefore, he is better off staying in the old tax system.

The reason is that, even though he doesn’t have many overheads, his profit margin is low – less than 10 percent. But for businesses with higher margins (especially those selling services like electricians, mechanics and other fundis), it would be advisable to go the turnover tax way.

A mechanic who makes, say, Sh2,000 per day in total sales has an annual turnover of about Sh600,000. His turnover tax then comes to Sh18,000 (3 percent of Sh600,000) for the year. His overheads are probably less than Sh100,000 per year – mainly “rent” for his open air yard etc. Thus his net profit is about Sh500,000 and the normal tax on this would be Sh91,000.

So, by going the turnover tax route, the mechanic ends up with a lower tax bill than the newspaper vendor, even though he earns 30 percent more. The big problem however, is that the two probably don’t pay any income tax anyway so they won’t go to the revenue authorities to own-up!