New Tax Exemption Rules for Charitable Organisations

The Income Tax (Charitable Organisations and Donations Exemption) Rules, 2024 were issued by the Cabinet Secretary for the National Treasury and Economic Planning via Legal Notice No. 105 of 2024 published in the Kenya Gazette on 28 June 2024 under Supplement No. 122 dated 18 June 2024. The Rules repeal the Income Tax (Charitable Donations) Regulations, 2007 which have been in place for nearly two decades. The publication of the Rules follows the coming into force of the Public Benefits Organizations Act, 2013 in May 2024, adding to the legislative changes that have been rolled out in the charitable organisations sector.

The Rules prescribe the criteria for a charitable organisation to qualify for income tax exemption, the procedure for application, processing, and grant of the exemption, and the determination of deductibility of donations for tax purposes.

Key Highlights of the Rules????????

Requirements for Tax Exemption

The income of a charitable organisation is eligible for exemption from tax if that income is to be expended in Kenya or used for charitable purposes for the benefit of the residents of Kenya. The exemption does not extend to income from business, unless:

a)??the income is applied solely to the charitable purposes of the charitable organisation; and

b)??the business is carried on in the course of the actual execution of the charitable purposes of the organisation, the business is mainly carried on by beneficiaries of the charitable organisation or the gains or profits consist of rents received from the leasing or letting of land.

These requirements are in line with the criteria set out under Paragraph 10 of the First Schedule to the Income Tax Act.

Qualifications of a Charitable Organisation

An entity qualifies as a charitable organisation for tax exemption purposes if it meets the following three tests:

• Organisational test: The charitable organisation should be organised exclusively for one or more of the charitable purposes. To demonstrate this, the governing document of the charitable organisation is required to expressly limit the objects of the charitable organisation to charitable purposes only, prohibit the charitable organisation from providing private benefits, not allow the charitable organisation to engage in activities which are not in furtherance of the charitable purposes, and upon dissolution, requires the charitable organisation to transfer its assets to another charitable organisation with similar objects. ?
• Operational test: The operational test requires charitable organisations to engage primarily in activities which accomplish the charitable purpose for which they were founded and not engage or take part in any unlawful activities.
• Public benefit test: The charitable purposes of the organisation must be directed towards the benefit of the public, being, the general public (any resident of Kenya without limitation) and a sufficient section of the public (based on specific charitable needs or reasonable geographical limitations). A charitable organisation would not meet the public benefit requirement if the criteria used for determining beneficiaries is irrational or without good reason, excludes the poor from benefiting, is based on a personal connection, or benefits numerically negligible number of persons.

Charitable organisations should therefore review their governing documents and operations to ensure that they are compliant with the organisational test, the operational test and the public benefit test.

Qualifying Charitable Purposes

Paragraph 10 of the First Schedule to the Income Tax Act prescribes charitable purposes that qualify for income tax exemption. They are:

a) relief of poverty

b) the relief of distress of the public;

c) the advancement of religion; or

d)?the advancement of education.

The Rules have expounded the activities that constitute qualifying charitable purposes. This has provided the much-needed clarity on the activities that qualify for tax exemption as the Income Tax Act and the Repealed Regulations did not elaborate on the qualifying activities. Previously, the Commissioner of Domestic Taxes had the discretion of determining, on a case-by-case basis, the activities that constitute the qualifying charitable purposes when reviewing an application for tax exemption, which posed the challenge of subjective and restrictive interpretation.

We have highlighted the charitable purposes below.

a) Relief of poverty

The Rules describe relief of poverty as the provision of aid to those lacking the ability to acquire basic necessities or amenities considered essential for a modest, but adequate, standard of living. To qualify for an exemption, a charitable organisation established for this purpose must prove that its activities directly benefit those in poverty and must have clear criteria for defining and selecting its beneficiaries. The Rules set out a list of activities which comprise relief of poverty which include provision of community-based support to help the poor and needy persons generate sustainable income or be self-sufficient.

b) Advancement of Religion

Charitable organisations focused on the advancement of religion are required to demonstrate that they promote religious activities including raising awareness and understanding of religious beliefs and practices, or any other religious activity.

c) Advancement of education

Advancement of education involves promotion of education including provision of basic education, university education, bridging courses as well as technical and vocational training and undertaking ancillary activities to education such as building schools and libraries. Educational services must be accessible to the poor and needy, and the organization should cater to the educational needs of persons with disabilities and abandoned children. Fee-charging educational institutions are required to grant full scholarships to at least 10% of their student population from poor and needy backgrounds to qualify for tax exemption.

d)?The relief of distress of the public

To qualify as a charitable organisation established for the relief of the distress of the public, the organisation must demonstrate that it is involved in activities related to this purpose which may include disaster relief, conflict resolution and environmental preservation, child welfare, addiction rehabilitation, elderly and disability support, community development, prisoner rehabilitation, among others.

The Rules require charitable organisations providing healthcare services and charging fees to adhere to additional requirements which demonstrate a public benefit and non-profit making objective to qualify for tax exemption.

Application for Income Tax Exemption

The Rules provide a more detailed application process for charitable organisations seeking a tax exemption certificate for the first time and renewal. The Rules prescribed various information that is required to be submitted to the Commissioner for review, including the organisation’s governing documents, financial statements, bank statements, criteria for defining and selecting beneficiaries, tax compliance certificate and report on how the activities have benefited the residents of Kenya.

First-time applicants are required to have been in operation for at least one year while an application for a renewal of exemption is required to be made at least 6 months before the expiry of the existing exemption.

Where an application complies with all requirements, the Commissioner is required to issue a tax exemption certificate within 60 days of receiving the application. The tax exemption certificate is valid for five years from the date of approval of the exemption for new applications or where it is a renewal, from the date of application or expiry of the earlier certificate, whichever is later.

The Commissioner is empowered to revoke the tax exemption certificate where the charitable organisation has in any material way or repetitively failed to comply with the Rules. .

Appropriation of Income and Accumulation of Surplus.

Charitable organisations are restricted from distributing their income, directly or indirectly, to any person, except payment for services rendered or goods supplied such as salaries, professional fees, director's remuneration, among others.

The Rules also restrict a charitable organisation from accumulating and retaining more than an average of 15% of its funds in a period of 3 succeeding years without applying the surplus funds to their charitable purposes. The retained surplus funds do not include gains and profits arising from business activities and we understand that business profits would be treated separately from grant income when calculating the accumulated surplus.

We point out that a charitable organisation with a tax exemption is required to obtain a separate tax PIN for any unrelated business. The tax exemption would not apply to gains and profits from an unrelated business and such income should be accounted for separately.

Tax Deductibility of Donations Made to Charitable Organisations

The Rules require donations to a charitable organisation to be made from the donor’s taxable income. The donation should not lead to a taxable loss for the donor and not more than 50% of the donations in any year should be made to unrelated entities.

To qualify for a tax deduction under the Income Tax Act, donors must provide proof of the donation, which includes evidence of receipt of the donation by the charitable organisation, project proposals and budgets submitted by the charitable organisation and approved by the donor, a copy of the charitable organisation’s exemption certificate, and a declaration from the charitable organisation confirming that the donation will be used exclusively for charitable purposes. Some of the evidence required would make it onerous for donors to claim a deduction in respect of donations.

The donations may be in cash or in kind and cannot be repayable, revoked, refundable, or returnable to the donor under any circumstances. Additionally, donations must not confer any direct or indirect benefit to the donor or any person associated with the donor.

Conclusion

The Rules have introduced significant changes to the tax landscape for charitable organisations in Kenya. While the Rules aim to provide clearer guidelines, some provisions remain ambiguous and onerous and may give rise to disputes with the Kenya Revenue Authority. Charitable organisations must therefore review their governing documents and operations to ensure compliance with the Rules. A charitable organisation exempted from income tax prior to coming into operation of the Rules is required to comply with the Rules within twelve months from the date of coming into operation of the Rules, being the date of publication of the Rules highlighted above.

Not-for-profit organisations that did not qualify for exemption in the past or whose applications for exemption were rejected due to restrictive interpretation of the relevant provisions of the Income Tax Act may need to reconsider whether they would now qualify for tax exemption under the Rules.

This article was prepared by Dennis Chiruba , Faith Siteyia and Abdulrahman Faiz

The information provided in this article is for general informational purposes only and should not be construed as professional advice. Please consult your legal and tax advisor to obtain advice tailored to your specific situation before taking any action based on the information contained in this article.