Not for Profit Organisations (NPOs) in Kenya face diverse challenges but one that is common to all is resource mobilisation or access to funding. Gone are the days of relying solely on philanthropy or the benevolence of donors. The quest for sustainability demands that NPOs seek to generate at least some of their own revenue. The journey towards self-financing presents a number of interesting legal and tax questions for NPOs.

From a legal perspective, a Non-Governmental Organisation (NGO) is defined in the NGO Coordination Act of 1990 as a private voluntary grouping of individuals or associations not operated for profit or for other commercial purposes. This begs the question whether a registered NGO can embark on profit-generating activities provided that the profits are ploughed back into its social welfare objectives. This next quandary is around whether an NPO can house its for-profit activities in the same legal entity as its non-profit activities. It certainly makes sense to put the trading activities in a limited liability vehicle so as to manage financial risks, for example, around product liability issues, supplier or customer disputes.

From a tax perspective, several issues arise with the foremost being whether the production of income by the NPO invalidates any tax exemptions that it currently enjoys. Tax exemptions are generally premised on an NPO being a not-for-profit entity since the Government’s intention is to maximise the funds of the NPO that are applied to program activities rather than to enrich those who draw the profits.

The tax exemption in the Income Tax Act anticipates a scenario where profits from an NPO’s business are utilised solely for the relief of poverty or distress of the public or for the advancement of religion or education. In such circumstances, the tax exemption is available but there is a crucial rider because the exemption also requires:

  1. The business to be carried out in the course of executing the charitable purpose;
  2. The work of the business be carried on by the NPO’s beneficiaries; or
  3. The business income be generated from rents leasing or letting of land and chattels.

As you can imagine, there are circumstances under which an NPO will fail to meet the exemption requirements above. For example, let’s say that we have an NPO in the educational sector which provides free specialised vocational training to youth.

If that NPO was to use some of the school land to start a high yield farm in order to make a profit from the sale of agricultural produce, then that farming income may end up being taxable at 30% of the profits generated. The result of the tax on such a venture would be to significantly shrink the after-tax returns which are then reinvested in the school’s programs.

If the NPO was to earn a profit of say Ksh. 1,200,000 (US$12000) per annum and this amount could pay for an additional 10 students, then when the profit suffers tax at 30%, the impact is that only an additional 7 students can be accommodated at the school. In short, the inability of the NPO to enjoy the tax exemption has a direct impact on the beneficiaries/ community.

Even for those NPOs that satisfy the exemption criteria, there is a twist as the exemption is not automatic – it has to be applied for and approved by the Kenya Revenue Authority (KRA). Until written approval is received, the correct taxes have to be remitted. It is no exaggeration to say that unforeseen taxes, penalties and interest could substantially erode the self-generated income.

In fact, if an NPO is interested in trading or leasing, then it is vital to understand the tax regime. For example, details of the capital allowances they can deduct in respect of vehicles and equipment (as these allowances are different from the depreciation values in the accounts). In addition, where an NPO is a trading entity, activities performed by its staff in other countries could trigger a taxable presence for the NPO in that foreign country.

Another downside of tax non-compliance is that where NPO’s tax disputes become public knowledge, it could put off potential donors, even where the mistakes were made innocently rather than fraudulently. Furthermore, tax non-compliance would be a red flag for other regulators and could potentially trigger intrusive investigations or endanger the local registration status of the NPO.

In other words, tax exposure carries significant reputational risk for NPOs. This may all sound complex and gloomy but the point is not to avoid tax risk by avoiding business enterprise altogether. It is far better to understand the tax (and legal) risks and to manage them effectively.

Having the right advisors on board is critical and a conscious investment also has to be made to acquire adequate tax resources in the form of qualified personnel and/ or tax technology tools which are correctly configured.

No society can downplay the importance of NPOs. It is perhaps high time that the Government enacted laws to deliberately incentivise NPOs to be self-sustaining. One way to accomplish this would be to enact a provision which creates a tax-free threshold for business income generated by an NPO. In South Africa, for instance, NPOs whose additional trading income does not exceed 5% of the total receipts of the organisation is automatically tax-free. Perhaps a 25% threshold would be more accommodating, provided that there are sound anti-abuse provisions in place. The Government would still get a fair share of taxes whilst at the same time encouraging the NPOs to reduce their reliance on ever diminishing donor funds.

Andrew Wanjiru

Senior Associate,

PwC Kenya

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