What is Rental Income?
Rental Income is any income earned from permitting another to use property that one owns or has rights over. It arises from the renting of a house, apartments, rooms, space in an office building, or other real or moveable property.
The earning of rental income can be the core business of a person or can be incidental to their core business
1.1.1. Tax treatment of Rental Income.
Rental Income is taxable on anyone in receipt of rental income unless they are tax-exempt.
Section 3(2)(a)(iii) of the Income Tax Act (ITA) provides that income arising from a right granted to another person for the use or occupation of property constitutes income chargeable to tax. The Section reads as follows:
3. Charge of tax
(1) Subject to, and in accordance with, this Act, a tax to be known as income tax shall be charged for each year of income upon all the income of a person, whether resident or non-resident, which accrued in or was derived from Kenya.
(2) Subject to this Act, income upon which tax is chargeable under this Act is income in respect of—
(a) gains or profits from—
(i) any business, for whatever period of time carried on;
(ii) any employment or services rendered;
(iii) any right granted to any other person for use or occupation of property;
Where a person has several sources of income, the ITA provides for the taxation of rental income as a separate source of income.
Section 6(1) of the ITA provides for the taxation of rental income: ‘gains or profits’ includes a royalty, rent, premium or similar consideration received for the use or occupation of property.
Expenditure incurred in the production of rental income is an allowable deduction under the ITA.
Section 15 provides that – for the purpose of ascertaining the total income of a person for a year of income there shall…be deducted all expenditure incurred in that year of income which is expenditure wholly and exclusively incurred by him in the production of that income Tax
1.1.2. Allowable expenses on rental income\ rental tax in Kenya
The allowable deductions for rental income include:
- For the owner of premises, any amounts used for structural alterations to the premises necessary to maintain the existing rent (S15(2)(f));
- Expenditure incurred by a lessee in the case of a lease or similar transaction (15(2)(t);
- Interest paid in respect of money borrowed wholly and exclusively for production of investment income (15(3)(a));
- Land rent and rates
- Agent fees
- Grounds keepers expenses or
- Insurance
Non-residents cannot claim any of the above expenses – income taxed as a WHT at 30%
1.1.3. Non-allowable expenses
Any expenses that are not incurred wholly and exclusively in the production of rental income are not allowable i.e.
ü Principal loan repayment
ü Cost of construction – Commercial building allowance
ü Any expenditure of a personal nature
1.2. Requirements at the end of the accounting period
· Preparation of the rent schedule for all let property indicating the number of the properties, gross rent received and all expenses incurred on the properties;
· Deduction of allowable and supported expenses to arrive at chargeable rent
· A completed tax return including the rent schedule as support
· Submission of the self-assessment return (SAR) within six months after the end of the accounting period
1.3. Residential and Commercial Rental Income Tax in Kenya
There is a distinction between ‘commercial rental income’ and ‘residential rental income’ for tax purposes
Commercial rent attracts VAT while residential rent does not
The Finance Act 2015 introduced special provisions relating to taxation of residential rental income in a bid to make more taxpayers declare residential rental income
1.4. Measures to Improve Rental Tax in Kenya
Kenya Revenue Authority commenced an aggressive tax compliance campaign targeting real estate sector in July 2012.
During this period, landlords raised concerns to be addressed by government, including the need for;
a) Tax amnesty
b) Simplified tax regime on rental income
c) Reduced tax burden
d) Reduced cost of compliance
The government addressed these concerns during the National Budget in June 2015. The govt. thro’ the Finance Act 2015 has approved implementation of 3 key tax measures on rental income;
a) Tax Amnesty on rental income for Landlords (individual/company), effective 1st July 2015 to 30th June 2016.
b) Introduction of simplified flat tax rate regime on rental income (i.e. Residential Rental Income Tax), effective 1st January 2016.
Withholding Tax Regime for Rental Income, effective January 2017.
1.4.1. Amnesty – The Finance Act 2015
The Finance Act 2015 introduced amnesty for landlords in order to reduce the tax burden and cost of compliance
With effect 1st July 2015, the Commissioner, will refrain from assessing or recovering taxes, penalties or interest in respect of any period before or during 2013 year of income and any penalties or interest for 2014 and 2015 on rental income
Amnesty will benefit landlords who voluntarily disclose undeclared rental income for 2014 and 2015 between 1 July 2015 and 30 June 2016 and who submit their tax returns online via iTax and pay all principal taxes due. The amnesty extends to both individuals and corporations
In order to qualify for amnesty, applicants should download and fill the form from the KRA website
Once application has been submitted there is no requirement to apply for a waiver of the penalties or interest.
The tax due shall be computed as follows:
I. Calculate the gross rental income and deduct all allowable expenses to obtain net taxable rental income
II. In event of expense records not being available, deduct 40% of gross rent
Note – the 40% is allowed by law to apply ONLY to amnesty cases from July 2015 to June 2016 and years of income 2014 and 2015.
III. Apply the relevant tax rates to net rental income to compute tax due (individual rates and corporation rates)
1.4.1.1. Key Benefits of Amnesty to the Taxpayer
a) For 2013 and prior, 100% tax amnesty on principal taxes, interest and penalties shall be granted.
b) For 2014 and 2015, landlords shall only pay principal taxes and qualify for 100% tax amnesty on any interest and penalties arising.
d) Where expenditure records are not available, landlords will enjoy a deduction of 40% of gross rental income as expenditure. Taxpayer will not be subjected to further tax compliance checks, audit or investigation for 2013 and prior, 2014 and 2015 if they fully disclose undeclared rental income.
e) Taxpayers unable to pay the declared tax (at once), will be allowed to pay at agreed instalment.
f) After eliminating past tax baggage thro’ amnesty, landlords will enjoy reduced tax burden with implementation of simplified flat tax rate of 10% on gross rent, effective, 1st Jan. 2016.
1.4.2. 2016 Onwards: Simplified Regime on Rental Income (MRI) (Rental tax calculator in Kenya)
The Finance Act 2015 approved the implementation of a simplified tax regime on rental income known as residential rental income tax .It will be payable by a resident person (individual or company), effective 1st January. 2016.
It applies to rental income that has accrued or derived from Kenya for the use or occupation of residential property. Applicable only to those earning annual rental income above K.shs.144, 000 (K.Shs. 12,000 per month) but does not exceed K.Shs. 10M (K.Shs. 833,333 per month).
The rate of tax shall be 10% on gross rent received. Therefore, no expenses, losses and personal relief shall be allowed. This tax shall be a final tax and shall be paid for on monthly basis.
Tax point is when landlords receive rent from their tenants – monthly, quarterly, semi annually or annually. Therefore, those receiving rent quarterly, semi annually or annually will be expected to pay when they receive rent and file nil returns during the intervening period.
1.4.2.1. Exceptions to the Simplified Tax Rate Regime
The simplified tax shall not apply to;
· Non resident landlords : They will continue being subjected to the current income tax regime i.e. tax rate of 30% on gross rental income.
· Landlords earning residential rental income of less than Kshs. 144,000 per year Note:Where rent income is less than Kshs 12,000 per month, one is required declare the rental income in their annual return.
· Landlords earning residential rental income of more than Kshs. 10 million per year.
· Rental income from commercial property.
Where a person who would otherwise pay tax under this regime elects by notice in writing to the Commissioner NOT to be subjected to the Residential Rental Income Tax.
1.4.2.2. Benefits to the Taxpayer
- No production of records on expenses
- Reduced compliance costs to taxpayer.
- Easy to comply.
- Reduced tax burden to the taxpayer (i.e.10%)
- A final tax thus no requirement to file annual returns if the landlord does not have other incomes.
1.5. Offences and Penalties.
Failure to file return by due date ( 20th of the following month) – K.Shs. 20,000 or 5% of principal amount due, whichever is higher
Any tax not paid by the due date will attract;
a. Penalty at 20% of the tax payable, and
b. Interest of 1% per month
1.6. Introduction of Withholding Tax Regime on Rental Income – w.e.f 1st January 2017
Finance Acts 2015 & 2016 have empowered KRA to implement a withholding tax (WHT) regime for rental income to promote compliance.
WHT agents shall be required to deduct and remit withholding tax on gross rent paid to resident landlords. The tax will apply for rent payable for both residential and commercial property. The rate is 10% on gross rent. The tax point is upon payment of rent.
1.6.1. Why WHT on Rental Income?
- Broadening the tax base.
- Facilitating the normalisation of the tax affairs by all landlords.
- Increasing and improving the tax compliance culture.
- Facilitating participation of public corporations and private firms in revenue enhancement.