The draft Income Tax (Donation and Charitable Organisation Exemption) Rules, 2023 (the Draft Rules) propose rules on the eligibility of charitable organisations for an income tax exemption and eligibility of persons donating to an exempt charitable organisation for a tax deduction under the Income Tax Act, Chapter 470 of the Laws of Kenya (the Income Tax Act). The Draft Rules propose to repeal the Income Tax (Charitable Donations) Regulations, 2007).

What documents will be required when applying for the income tax exemption certificate

The KRA will require an application for exemption to be accompanied by certain documents including the following:

• certified copy of the governing documents of the charitable organisation such as the rules, constitution, trust deed, and memorandum and articles of association;
• certified copy of the charitable organisation’s registration documents;
• audited financial statements for the three (3) years preceding the making of the application. An entity applying for an exemption for the first time is required to have been in operation for at least one (1) year when making the application. Therefore, it is presumed that such an organisation will submit the financial statements for that one (1) year; and
• original introduction letter from the County Commissioner where the principal activities are carried out.

Other documents required include original bank statements for three (3) years, a schedule of assets and values, an impact report of present and future activities in Kenya, beneficiary selection criteria, an itemized summary of payments showing the payee, amount, and purpose, identification documents of the officials, physical address proof, and letters from the charitable organisation’s representative.

Should the documents submitted contain any specific information?

The Draft Rules set out in detail the required scope of objectives for charitable organisations established for the relief of poverty, distress of the public and advancement of religion and education (the Restricted Charitable Purposes) to qualify for an income tax exemption.

The governing document should limit the objects of the organisation to one or more of the Restricted Charitable Purposes. This requires that the founding documents clearly state: (a) its primary charitable purpose being the relief of poverty, distress of the public, advancement of religion, or advancement of education; (b) the specific charitable activities it intends to carry out to achieve its charitable purpose such as projects to be undertaken; and (c) the targeted beneficiaries including the criteria for selecting the beneficiaries.

The governing document should also prohibit the use of funds and assets for non-charitable purposes such as providing private benefits to persons associated with the management and ownership of the organisation. The governing document should provide that upon dissolution of the organisation, the entity would transfer its assets to another charitable organisation with similar charitable purposes as the organisation being dissolved.

Depending on the charitable purpose, the governing document may be required to contain additional provisions. For example:

• if the purpose of the organisation is the relief of poverty, the governing document should have provisions for identifying beneficiaries who cannot acquire the necessities of life or simple amenities that would be reasonably regarded as necessary for a modest and adequate standard of living;
• where the charitable organisation is seeking to advance education but charges a fee for the education, the KRA will require proof that full scholarships would be granted to at least ten per cent (10%) of the students from poor and needy backgrounds; or
• relief of distress of the public has been defined to include providing relief to victims of natural disasters, children in need of care and protection, and persons living with disabilities and accordingly if an organisation is established for this purpose, it should expressly include the above in its governing documents. An organisation providing healthcare services as a means of relief of distress of the public would be required to, among others, offer free emergency treatment at an active emergency room and free specialised medical equipment not available at local hospitals.

What are the prohibited activities for charitable organisations seeking an income tax exemption?

A not-for-profit organisation should not:

• take part in illegal activities such as terrorism, fraud, money laundering and any tax avoidance schemes;
• distribute the income of the charitable organisation directly or indirectly to any person except as reasonable remuneration for services rendered; and
• retain more than an average of fifteen per cent (15%) of its surplus funds in a period of three (3) succeeding years without using the funds for its charitable purposes. When determining the surplus funds to be retained, the organisation would not take into account the gains or profits from the business. The exclusion of such business income would mean that the government is seeking to restrict the accumulation of donations and grant income (being the primary sources of tax-exempt income for non-profit organisations) and require their use for charitable purposes.

What are the timelines for the issuance of an income tax exemption certificate?

The KRA is required to issue a decision on granting an income tax exemption certificate within sixty (60) days of all the application requirements being met. Such an exemption certificate would be valid for five (5) years and may be renewed by an application to be made at least six (6) months before the expiry of the existing certificate.

A charitable organisation is entitled to appeal a decision of the KRA to reject an application for the exemption certificate or if an exemption certificate that had been granted is revoked. The appeal must be filed with the Tax Appeals Tribunal within thirty (30) days of the organisation receiving the written decision of the KRA, after giving the KRA notice in writing of the intention to appeal the decision.

After receiving the exemption certificate, the charitable organisation would be required to submit an income tax return on an annual basis to the KRA.

What are the rules on the allowability of donations to charitable organisations as a tax deduction for the donor for income tax purposes?

Pursuant to section 15(2)(w) of the Income Tax Act, persons making donations to a charitable organisation with an income tax exemption certificate or to a project approved by the Cabinet Secretary responsible for matters relating to finance qualify for a tax deduction on the donation.

To qualify for the tax deduction under the Draft Rules, the donation must:

• be in cash and not be refundable or repayable to the donor;
• not confer any direct or indirect benefit on the donor or any person associated with the donor;
• not be revoked by the donor once paid to the organisation unless approved by the KRA, in which case, tax would be due and payable.

Further, the donor must obtain a receipt showing the full name and address of the recipient organisation, the tax personal identification number of the recipient organisation, the date of the donation, the purpose of the donation, and the amount of the donation.

Notably, the Draft Rules propose to require that the donor obtain proof of utilisation of the funds from the non-profit organisation. This would include the approved project proposals and budgets submitted by the charitable organisation and approved by the donor, a copy of the exemption certificate of the organisation or the Cabinet Secretary’s approval of the project and a declaration from the recipient that the donation shall be used exclusively for charitable purposes.

The Draft Rules propose to repeal the Income Tax (Charitable Donations) Regulations, 2007.

Our comments

The Draft Rules provide clarity on the key considerations that the KRA will use to evaluate applications for an income tax exemption certificate and allowability of donations for income tax purposes. Charitable organisations and donors will be able to prepare their applications to the KRA with a clear understanding of the documents and information required. However, we note that some of the requirements are too prescriptive.

The attempt to limit the surplus funds that non-profit organisations may hold over a three-year period may discourage fundraising efforts by organisations seeking to accumulate funds to support long-term (over three (3) years) activities since the definition of surplus funds does not exclude common sources of funds such as donations or grants.

In attempting to set out the scope of activities that constitute the relief of poverty or distress of the public, or for the advancement of religion or education, the Draft Rules provide a closed list of activities, which may not be exhaustive.

Further, the Draft Rules introduce additional requirements that limit the number of eligible entities. For example, an organisation providing healthcare services as a means of relief of distress of the public would be required to, among others, offer free emergency treatment at an active emergency room and free specialised medical equipment not available at local hospitals.

The requirement for a person to obtain proof of utilisation of funds to qualify for an income tax deduction for donations to an exempt charitable organisation would impose an additional compliance burden on the donor. The charitable organisation would have to provide the donor with the required documentation including budgets, proposals, the exemption certificate, and a declaration that the funds will be used exclusively for charitable purposes.

The deadline for submission of comments to the KRA was 29 December 2023. We will continue to monitor developments on the Draft Rules and share updates on the same.