While individuals who are employed traditionally have their income tax withheld from their paychecks, individuals in business and entities must proactively estimate and pay their income taxes. Payments are typically made quarterly. A taxpayer whose income tax is payable by instalments is required to submit a statement of tax estimate (“provisional income tax return”) for the year of income to the tax authority and pay the first instalment by the end of the first quarter of the year of income.
So, if you or your entity has 31st December as its year-end, it means for the year 2021, you have less than two weeks to hand in your annual income tax estimates for the year. And what is new this year is that the filing must be done online. If you estimate that some tax will be payable, then the first of four instalments is also payable by 31st March 2021.
Section 75 of the tax administration law (The Tax Administration Act, Cap 438), essentially, requires that taxpayer’s estimates for income tax be at least 80 per cent accurate. There is a penalty (“interest”) for underestimation. The penalty will apply at a statutory rate compounded monthly from the due date of the first instalment to the due date of the final tax return. So, the question is what happens if, for any reason, the bases for your estimate changes during the year? The answer is simple. You can always review your estimates during the year to ensure that at least 80 per cent accuracy is achieved. So, if there are reasons to amend the estimates, the tax law allows such amendments at any time during the year. And thanks to technology, the amendments can now be done online.
But the accuracy of tax estimate, now than ever, poses a significant risk to taxpayers if it is not managed properly. In the past, underestimation interest would be computed based on the difference between 80 per cent of the correct income tax and the estimated amount paid by instalments during the year of income. That is if the correct income tax is finally determined to be shillings 100 million, but your estimate was shillings 79 million, then interest would be computed on shillings 1 million (i.e. 80 per cent of 100 million less 79 million estimates). But this was changed by the Finance Act, 2017.
From 2017, if your tax estimate is less than 80 accurate, then underestimation interest will be computed based on the difference between the correct income tax and the estimated amount paid by instalments during the year of income. If the correct income tax for the year 2021 will be finally determined as shillings 100 million, but your estimate is shillings 79 million, then underestimation interest will be computed on shillings 21 million (i.e., the correct 100 million less the estimate of 79 million). You will notice, as this example depicts, the interest computed on shillings 21 million will surely be significantly higher than interest computed on shillings 1 million.
Whilst the 20 per cent range of accuracy may seem so wide for you to miss, in practice, it may easily be missed if there are no adequate internal controls for tax. The income tax estimate is essentially a by-product of your estimates of incomes and expenses. If you get either or both two wrong, your tax estimate is also likely to be wrong. So, after filing your estimates for the year 2021 by the end of March, you need to review your business and financial plans periodically throughout the year to test the validity of your financial and tax estimates. This is important even if the exercise does not lead to revising your original estimate.
By Shabu Maurus, Tax Partner, Auditax International.