Income Tax (Donations & Charitable Organizations) Rules, 2024 Analysis.

A New Tax Regime for Charitable Organizations- An Analysis of the Income Tax (Donations & Charitable Organizations) Rules, 2024.

A charitable organization is a non-profit entity set up for the benefit of the general public. A charitable organization can take different legal forms including Public Benefit Organizations registered under the Public Benefits Organisation Act, 2013, Charitable Trusts incorporated under the Trustees (Perpetual Succession) Act, 2010 and Companies Limited by guarantee incorporated under the Companies Act, 2015. The Income Tax Act exempts from corporate income tax the income of charitable organizations that have been established in Kenya solely for the purposes of the relief of the poverty or distress of the public, or for the advancement of religion or education.

On 18^th June 2024, the Income Tax (Donations & Charitable Organizations) Rules (the “Rules”) were gazetted ushering in a new era for the taxation of charitable organizations and donations. The Rules bring more clarity on the requirements to be met by a charitable organisation to qualify for a tax exemption on its income generated as well as providing for the procedure for determining the allowability of charitable donations for income tax purposes. In this article, we summarize key provisions in the Rules and discuss how they will affect the operations of charitable organizations.

The Test for a Charitable Organization

The Rules require an organization to satisfy four requirements for it to qualify as a charitable organization for purposes of taxation:

Test One

Charitable Purpose Test

 First, the organization should be established in Kenya for a charitable purpose being relief of the poverty or distress of the public, or for the advancement of religion or education. The Rules outline the requirements for organizations to meet the charitable purpose test. For instance, charities established for the relief of poverty should be organised and operated solely for the relief of poverty which extends to providing training, support or assistance to persons experiencing poverty to develop skills that help them generate sustainable income.

Under the Rules, charitable organizations may charge fees for their services and still meet the charitable purpose test. However, a proportion of the target groups should be offered the services for free. For example, charitable organizations established for advancement of education may charge fees but should ensure that full scholarships are granted to at least ten percent of its student population who must be from poor and needy backgrounds. Similarly, organizations offering healthcare services should offer free outpatient and inpatient treatment to at least ten percent of the total patient population, who should be from the poor and most vulnerable members of the society.

Test Two

Organizational Test

The Rules requires the charitable organizations’ governing documents to limit the activities of the organization and clearly state its primary charitable purpose and the activities it intends to conduct to achieve the charitable purpose. The governing document should further prohibit the charitable organisation from providing private benefits, directly or indirectly to any person including the founders and their family members.

The Rules also require the use of the assets of the charity to be restricted to the charitable purpose and not private use. The governing document is further required to provide for the transfer of the trust’s assets to another charitable organisation with similar objects upon its dissolution. The effect of this provision is to ensure the assets of the charities are not exploited for private gain by its founders or their families by clearly prohibiting the same in its governing documents. The charitable organizations will also be required to notify the Commissioner-General of the Kenya Revenue Authority of any change to the governing document within thirty days.

Test three

Operational test.

To satisfy the operational test, the charitable organisation is required to engage primarily in activities which accomplish the charitable purpose for which it was founded and the not to engage or take part in any unlawful activities. This will ensure the charitable organizations do not redirect their income or use their assets in other activities that do not advance the charitable purpose.

Test four

Public Benefit test

The Rules outline stringent requirements for an organization to satisfy the public benefit test. First the beneficiaries of the charity should be identifiable and can attest to the said benefits when required. Additionally, the charitable organisation’s purpose and activities should benefit the specified target groups or the public in general. The people living in poverty should also be allowed to benefit from the charity.

The charity is required to specify the criteria for identifying the target beneficiaries in an open and needs-based manner. Whereas the charity may restrict the benefit to a class of persons or a geographical area, the restrictions should be reasonable and justifiable. However, the restriction cannot be for the benefit of the members or their families.

Test five

Rules on Donations by Charities

The Rules provide that the donations by charitable organisations may be paid out of their taxable income provided that the donation shall not result to a taxable loss and not more than fifty per cent of the donations in any year of income shall be to unrelated entities.

The donations will only qualify for tax deductions if the organization provides proof of the donation through a receipt of the donation; approved project proposals and budgets submitted by the charitable organisation and approved by the donor; a copy of the exemption certificate; approval by the Cabinet Secretary, where the project requires such approval; and a declaration from the done that the donation shall be used exclusively for charitable purposes.

Test six

Treatment of Surplus Funds

The Rules permit a charitable organization to accumulate surplus funds as desired. However, the charitable organization may not retain more than an average of fifteen per cent of its funds in a period of three succeeding years without applying the surplus funds to its charitable purposes. This will ensure proper planning by charitable organisations to ensure that funds are utilized, and the charitable purposes of the organisation are met.

Application for Exemption

Procedure for application for exemption from income tax

A charitable organisation is required to make the application for exemption to the Commissioner-General of the Kenya Revenue Authority (the “Commissioner”) in the prescribed form accompanied by the following documents:

1. A certified copy of the governing documents of the organisation;
2. A certified copy of the organisation’s registration documents;
3. Audited financial statements of the organisation for preceding three years;
4. A schedule of assets of the organisation and their values;
5. Certified copies of bank statements of the applicant for the preceding three years;
6. An introduction letter detailing the name, nature, and principal activities of the applicant from the office of the County Commissioner where the head office of the organisation is located;
7. The charitable organisation’s impact report describing in detail its past, present and future activities and how the activities are intended to or have benefited the residents of Kenya;
8. The applicant’s criteria for defining and selecting beneficiaries;
9. An itemised summary of the payments made by the applicant showing the payee, amount, and purpose of payment;
10. Ccertified copies of identity documents of all the relevant office bearers of the applicant;
11. proof of the applicant’s physical address;
12. A copy of a valid tax compliance certificate and, in the case of an application to renew an exemption, a copy of the previous tax exemption certificate of the applicant; and
13. A letter of authority, power of attorney or appointment letter for the representative of the applicant.

The Income tax exemption certificate.

After confirming that the charitable organization has satisfied the requirements of the Rules, the Commissioner can issue a tax exemption certificate to the organization. The exemption certificate is valid for five years from the date of issuance. Notwithstanding the issuance of a tax exemption certificate, a charitable organization is still expected to file income tax returns at least once a year. This is to ensure that there is separation of any income generated from related and unrelated business of the charitable organization.

The exemption certificate may be revoked by the Commissioner where the Commissioner is of the opinion that the organization has failed to comply with the provisions of the Rules or the governing document. The Commissioner is required to serve a notice of intention to revoke the exemption certificate to the organization stating the reasons for the revocation. The organization may respond to the Commissioner within thirty days. If the organisation does not respond or the Commissioner is not satisfied with the Organisation’s response, the Commissioner may revoke the exemption certificate in writing. An organisation aggrieved by the Commissioner’s decision may appeal to the Tax Appeals Tribunal.

Conclusion

The Rules provide for clarity on the requirements a charitable organization needs to satisfy to enjoy exemptions from payment of income tax in Kenya. Furthermore, there are clear guidelines on donations by the charitable organization to other entities and strict rules on how organizations can prove the donations.

The Rules are aimed at curtailing irregular income tax exemptions enjoyed by organizations that may be conducting business activities under the guise of charitable activities and further control deductions claimed by such organizations and passed off as donations.

Contact Esther Omulele – [email protected]

Billy Otieno – [email protected]  for expert legal advice and support.