SACCOs Now Offering Front Office Activities

By CPA Andrew Kubo Mlawasi

Blurred Regulatory and Taxation Framework in Financial Services

 Savings and Credit Co-operative Societies (SACCOs) have played a pivotal role in offering financial services in Kenya, providing members with credit and savings opportunities. Traditionally, SACCOs operate in a cooperative model where the primary focus is to serve members by pooling resources for mutual benefit. However, in recent years, many SACCOs have diversified their services to include what are known as Front Office Service Activities (FOSA). These activities are akin to those offered by commercial banks, including deposit-taking, issuing loans to the general public (non-members), and providing payment services.

This expansion into banking-like services has led to complexities, especially regarding the taxation of SACCOs. A prominent case that highlighted the taxation issues was Nyeri Teachers SACCO vs. Commissioner of Domestic Taxes. This article examines the implications of SACCOs offering Front Office Services, their taxation under the Income Tax Act, and the challenges that arise from their dual role as cooperative societies and quasi-commercial banks.

Front Office Service Activities (FOSA) by SACCOs

Front Office Services in SACCOs were initially introduced to offer members more accessible, banking-like services. These services include:

1. Deposit-taking services: Similar to commercial banks, SACCOs allow members and sometimes non-members to open deposit accounts.
2. Issuing loans: SACCOs extend loans to their members, often at lower interest rates than commercial banks.
3. Payment services: Services like salary processing, standing orders, and direct debits.
4. ATM and mobile banking services: SACCOs have embraced technology, providing digital platforms for easy access to savings and loan services.

Challenges with FOSA and Commercial Banking-Like Activities

While these services have enhanced financial inclusion and provided members with more options, they have also blurred the line between SACCOs and commercial banks. The regulatory and taxation framework for SACCOs was traditionally designed for non-profit, member-oriented entities. However, with SACCOs engaging in activities similar to those of commercial banks, a number of challenges have arisen:

1. Regulatory Supervision: The Sacco Societies Regulatory Authority (SASRA) was established to regulate deposit-taking SACCOs. However, FOSA activities often push SACCOs into operating like commercial banks, leading to overlapping regulatory oversight between SASRA and the Central Bank of Kenya (CBK), which governs traditional banking institutions.
2. Taxation: SACCOs are subject to taxation under the Income Tax Act, specifically with regard to profits generated from non-member activities. However, defining and segregating member and non-member income becomes problematic, especially for SACCOs heavily engaged in FOSA. This brings us to the case of Nyeri Teachers SACCO vs. Commissioner of Domestic Taxes.

Nyeri Teachers SACCO vs. Commissioner of Domestic Taxes

The landmark case of Nyeri Teachers SACCO vs. Commissioner of Domestic Taxes brought to light the complexities surrounding the taxation of SACCOs offering FOSA services. The key issues revolved around the interpretation of taxable income for a SACCO that engaged in both traditional cooperative activities and banking-like FOSA services.

Case Background

Nyeri Teachers SACCO, like many other SACCOs, had diversified its offerings to include FOSA. This allowed the SACCO to attract non-members, who were permitted to open accounts and access loans, creating income streams outside the traditional cooperative model. The SACCO argued that the profits derived from such activities should be exempt from taxation under the provisions of the Income Tax Act, which grants tax exemptions for SACCOs on income earned from member contributions.

However, the Commissioner of Domestic Taxes held a different view. They argued that the income generated from non-member activities should be subject to taxation, as it fell outside the scope of the tax exemptions granted to SACCOs. 

The Commissioner stated that if a SACCO provides services to non-members like a commercial bank, it should be taxed the same way as a commercial bank.

Court’s Findings

The court ruled in favor of the Commissioner of Domestic Taxes, stating that while SACCOs are granted certain tax exemptions, income derived from non-member activities should indeed be taxed. The court noted that SACCOs should maintain a clear distinction between member-based and non-member-based activities for tax purposes. The ruling underscored the importance of transparency in SACCO operations, especially those engaged in FOSA.

Taxation of SACCOs under the Income Tax Act

Under the Income Tax Act (Cap 470), SACCOs are granted specific exemptions on income derived from transactions with their members. Section 19A of the Act provides that income received from members by a SACCO, including savings, dividends, and interest from loans, is exempt from taxation. This is in line with the cooperative principle that SACCOs are member-owned and exist primarily to serve their members.

However, when SACCOs engage in FOSA and generate income from non-member activities, this income falls under the taxable bracket. Specifically:

• Interest income from non-member loans: Taxable under the Income Tax Act.
• Income from fees and commissions: Any fees charged to non-members for services like ATM withdrawals, payment processing, or account maintenance are taxable.
• Income from investments: If a SACCO invests its surplus funds in non-member ventures, the income generated is subject to tax.

Challenges with Taxation of FOSA Activities

The ruling in the Nyeri Teachers SACCO case highlights several key issues that arise when SACCOs offer banking-like services:

1. Segregation of Member vs. Non-member Income: One of the major challenges is accurately distinguishing income generated from members and non-members. SACCOs must have robust accounting systems to track these transactions separately.
2. Regulatory Complexity: SACCOs that offer FOSA services find themselves under both SASRA and CBK scrutiny, adding to the regulatory burden. Balancing compliance with both regulators, especially regarding financial reporting and taxation, can be onerous.
3. Competitive Pressure: SACCOs offering FOSA services face competition from commercial banks. This pressure may push SACCOs to adopt more aggressive commercial practices, which further complicates their tax obligations.
4. Potential Loss of Cooperative Identity: With SACCOs engaging in commercial-like activities, there is concern that they may lose their cooperative identity and principles. This shift could lead to increased taxation, reducing the benefits traditionally enjoyed by SACCO members.

The case of Nyeri Teachers SACCO vs. Commissioner of Domestic Taxes sheds light on the evolving nature of SACCOs in Kenya and the challenges they face as they expand their service offerings. SACCOs must be vigilant in maintaining clear boundaries between member-based and non-member-based activities to ensure compliance with the Income Tax Act. As SACCOs continue to offer Front Office Service Activities akin to those of commercial banks, they must navigate the delicate balance between serving their members, adhering to cooperative principles, and meeting their tax obligations.

This case also serves as a cautionary tale for other SACCOs that are diversifying into banking-like services. While the expansion of services provides opportunities for growth, it also brings new regulatory and tax challenges that must be carefully managed to avoid costly legal battles and potential tax liabilities.

The writer is a Public Financial Management (PFM), public policy, Governance and Tax consultant. He is currently on a consultancy assignment with the Institute of Public Finance (IPF). He is a PhD Finance student at the Jomo Kenyatta university of Agriculture and Technology and is also studying Advanced Diploma in Tax Administration at the Kenya School of Revenue Administration. He has over 14 years working experience in the public sector.

mlawasikubo@gmail.com