In Kenya, charitable activities can be carried out through vehicles such as companies limited by guarantee, charitable trusts, non-governmental organisations (NGOs), and societies. Despite serving a common purpose, each of these is subject to a distinct manner of incorporation and compliance requirements.

In this alert, we focus on their tax treatment. We also highlight the salient features of the draft Income Tax (Donations and Charitable Organisations Exemption) Rules, 2023 (Rules), whose public participation phase closed on 29 December 2023.

The Rules are meant to repeal the Income Tax (Charitable Donations) Regulations, 2007, and provide clarity on the criteria for tax exemption for charitable organisations. Additionally, they specify the criteria for allowing donations made to charitable organisations as tax deductions.

Current tax treatment

Income tax

The general rule in Kenya is that income earned by a charitable organisation is exempt from tax. The criteria to be met is that the organisation should serve a charitable purpose, for the benefit of Kenyans. It should also be established in Kenya, or have its regional headquarters situated in Kenya.

An exemption is obtained by way of application to the Commissioner who, once satisfied, will issue the exemption. It is valid for five years with the possibility of renewal. However, it may be revoked by the Commissioner before the lapse of the five-year period where there is a just cause.

Donations made to charitable organisations are also deductible when computing taxable gains or profits of a person. We have discussed this in more detail in our analysis of the draft Income Tax (Donations and Charitable Organisation Exemption) Rules, 2023

Withholding tax

Charitable organisations are obligated to deduct withholding tax on payments made for specified services that trigger withholding tax. These include management or professional fees, agency fees, training fees, commission, and consultancy fees. Withholding tax rates vary depending on the nature of the transaction and the residency status of the payee. 

Value-added tax

The Value Added Tax Act, 2015 (VAT Act) exempts social welfare services provided by religious, educational, welfare, and charitable organisations. The exemption, however, does not apply where such services are rendered by way of business.

The Public Benefits Organisations Act, 2013 (PBO Act) also provides for preferential treatment for public benefit organisations (PBOs) under the VAT Act as well as customs duties in relation to imported goods or services that are used to further their public benefit purposes.

It is important to note however, that the PBO Act is yet to take effect as it will come into operation on a date appointed by the Cabinet Secretary by notice in the Kenya Gazette. There have been several High Court judgments ordering the Cabinet Secretary to gazette the commencement date of the PBO Act. However, the Cabinet Secretary is yet to do so.

Employment taxes and statutory deductions

Employees of charitable organisations are not exempt from tax. Pay-as-you-earn (PAYE) on their earnings is deducted and remitted to the Kenya Revenue Authority by the ninth day of each month. Charitable organisations also deduct and remit mandatory deductions such as the National Social Security Fund, National Industrial Training Authority levy, National Hospital Insurance Fund, and the housing levy.

It is important to note that the National Hospital Insurance Fund Act, No. 9 of 1998 was repealed in 2023 following the enactment of the Social Health Insurance Act, 2023, which establishes a new health fund – the Social Health Insurance Fund (SHIF). Once the enactment of its associated regulations is completed, charitable organisations will be responsible for deducting the specified portion of their employees’ income and remitting it to the SHIF.

It is also important to highlight that charitable organisations are not exempt from the housing levy that is currently being challenged in court.

The draft Income Tax (Donations and Charitable Organisation Exemption) Rules, 2023

According to section 15(2) (w) of the Income Tax Act Cap 470, any donation made to a qualifying charitable organisation is an allowable deduction when computing taxable income or gains. Claims for such donations are made to the Commissioner, accompanied by proof, i.e. the receipt issued and certified by the recipient of the donation. The receipt should contain the recipient’s details, including its Personal Identification Number, the date, as well as the purpose of the donation.

The Rules aim to shed light on how to determine whether an organisation has been set up for charitable purposes, thereby qualifying it for tax exemption and whether a donation to a charitable organisation qualifies for a tax deduction.

An organisation will be deemed to have been set up for charitable purposes if: (i) it is organised and operated solely for charitable purposes; and (ii) its charitable purpose is directed towards public benefit. In this respect, a charitable organisation that excludes the poor or is based on personal connections such as family would not qualify for an exemption.

Organisations that engage in illegal activities such as terrorism, money laundering, tax avoidance, or fraud will also not be exempt.

It is important to note that the Rules propose to limit the amount of funds that a charitable organisation may hold over a three-year period. Specifically, a charitable organisation cannot retain more than an average of 15% of its funds over three consecutive years without directing them towards a charitable purpose.

Obtaining an exemption

The process will entail making an application to the Commissioner in the prescribed form, accompanied by the required documents, which include the organisation’s constitution, trust deed, and certified copy of registration documents, among others. Upon compliance with all registration requirements, the Commissioner will issue a tax exemption certificate valid for a period of five years. Where declined, the applicant will receive a written notification along with the reasons for the decision.

All decisions in this regard will be appealable to the Tax Appeals Tribunal.

It is important to note that an organisation will need to have been in operation for a minimum of one year to apply for an exemption. Renewal applications, on the other hand, will be submitted at least six months before the expiry of the existing certificate. 

Allowability of donations made to charitable organisations

To qualify for a tax deduction, donors will be required to provide the Commissioner with proof of the donation and utilisation by the recipient. Donations should further take the form of non-refundable cash to the donor and should not confer any form of benefit on the donor, or any person associated with them.

Importantly, donations will not be revoked once conferred upon a charitable organisation unless approved by the Commissioner. In such a case, the tax arising shall be due and payable.

Commentary and conclusion

The Rules are welcome, as they seek to clarify the criteria for eligibility of a charitable organisation for tax exemption. They explicitly outline the factors to be considered in evaluating whether an organisation aligns with charitable purposes for public benefit and clarify the qualifications that a donation should meet to be allowed as a deduction for purposes of computing a person’s taxable income. They further clarify the procedure and documentation required when seeking an exemption.

In an attempt to mitigate tax avoidance within the charitable sector, the Rules also mandate the substantiation of claims of donations or activities related to charity.

We note the intended limitation of the amount of funds that a charitable organisation may hold over a three-year period, and hold the view that such limitation may hinder organisations from building up surplus funds for future use.

We will wait to see whether any revisions will be made to the final version of the Rules.