The items of expenditure listed below must be disallowed where charged against taxable income: a The amount of capital expenditure, loss, diminution or exhaustion of capital e. These are disallowed unless speciically allowed in the Income Tax Act. Other taxes may be allowed.
The income is taxed gross at source at non- resident rates of tax. The expression "permanent establishment" is deined in the Act as a ixed place of business in which that person carries on business. A ixed place S T U D Y of business means a building site, or a construction or assembling project, which has existed for six months or more in relation to a person. This is business not carried on with a view to making proit e.
The issue of losses from hobby business has been weakened by the concept of speciied sources of income. The lease hire agreement entered into before the above date was allowable. These are not business expenditure incurred. It should be noted that the provision for speciic trade bad debts is speciically stated to be allowable expenditure.
Where a sum is paid by a person after the cessation of his business, which if it had been paid prior to the cessation, would have been deductible in computing his gains or proits from that business, it shall be deducted in ascertaining his total income for the year of income in which it is paid. As such, a tax deicit is carried forward indeinitely in the following T E X T period s. Note that the tax loss or deicit is carried forward on the basis of speciied sources until the person makes a proit to off-set the loss.
Please note that for petroleum companies, tax deicits in the year the petroleum company closes its business is carried backwards for a maximum of three years. The income tax computation involves: a.
Determining computing income or loss to be taxed. The Income is taxed and losses are carried forward for each speciied source of income to the next year of income and so on until there is income to off-set it. Reviewing various incomes appearing in the accounts to determine whether they are S T U D Y taxable or not. Reviewing the various expenses appearing in the accounts to determine whether allowable against income or not. The adjustments are necessary because: a.
Income Income is either: a. Allowable or deductible can be deducted against income e. Not allowable or not deductible against income e. The allocation is explained in the section dealing with partnership return of income. Matata wrote-off amounts payable to her by Mr. Walia of S 4, The amount is included in drawings. Cost of a bicycle used in the shop bought in May for Sh 3, Alimony paid to a former wife he divorced Sh 2, Subscription of Sh 1, to Matumbo Welfare Association of which he is a member.
Depreciation of assets Sh 2, iv He paid with amounts drawn and included in his drawings accounts: a. Insurance premium of Sh 2, against ire in respect of trading stock. Painting of business premises Sh Stationery Sh Required Compute the taxable income for the year ended Review the items of expenditure and add back or deduct in the income tax computation as per the rules explained above. Review the items of income and add back or deduct in the income tax computation as per the rules explained above.
The items added back are listed together and the items deducted are listed together. Briely indicate why an amount has been added back or deducted in the income tax computation. Mambo Walia Taxable Income for the year ended All amounts added back to net proit are listed together whether they are income or expenditure items, likewise all deductions are listed together whether income or expenditure items.
Capital deductions namely wear and tear deduction, investment deduction, industrial building deduction, and farm works deductions are, where calculated, deducted in the income tax computation. Subscriptions to clubs are allowable. Back-duty refers to collection of all kinds of tax in arrears. The Income Tax Act requires every person assessable to tax to notify his liability within four months after the end of the year of income.
Tax arrears normally arise under the following conditions: 1. Under declaration of income incomplete and incorrect returns 2. Non-declaration of income 3. Taxpayer claims expenses, allowances, reliefs he is not entitled to. T E X T An offence will have been committed by a taxpayer under the above mentioned circumstances and his affairs will be dealt with as a back-duty case i.
Penalties may be charged including interest charges. Determination of Income through Back-duty cases 1. The taxpayer can declare income acceptable to the department supported by accounts and other relevant documentation. A capital statement consists of details of assets and liabilities as at a given date or period.
This would show changes in total worth of a taxpayer between two or more periods. The capital statement also considers capital losses or gains, living expenses, income tax paid etc.
Deduct all liabilities both personal and business used to inance the assets. This represents additional assets that the taxpayer acquired or disposed in the time period. The net igure would represent Net Business savings. Add also personal expenses such as food, services, clothing, T E X T toiletries, medical expenses, house servant, holidays, amusements, private motor vehicle running and maintenance costs, harambee contributions, donations and any cash stolen from house or shop etc.
Further Procedures Determine the capital at the beginning and end of the period. An increase in capital may be due to: - a Fresh capital introduced not income. ADD: Taxes paid, gifts or donations made, non-allowable losses e. Are there other expenses not deductible? Does the taxpayer have any other income source? Does the taxpayer lease the freehold land or does he farm it and what is the income?
Why has the taxpayer not claimed capital allowances? Does the taxpayer have a life insurance policy with a Kenyan company? If so, how much are the premiums he pays? Employment is not legally deined but covers any relationship between master and servant arising from a contract or agreement. The scope of S. The appellant had never previously negotiated the sale of any property.
The appellant was assessed to income tax on the commission. He appealed to the Local Committee on the grounds that the commission was not a taxable receipt as it arose from services rendered and not either from business or employment. The appeal went up to the Court of Appeal for Eastern Africa. Held: 1. The Commission was gains or proits from a business and was taxable. The Commission was also gains or proits from employment. It states: S T U D Y "For the purposes of subparagraph a ii of subsection 2 of Section 3 of this Act, "gains or proits" includes- a any wages, salary, leave pay, sick pay, payment in lieu of leave, fees, commission, bonus gratuity, or any subsistence, travelling, entertainment or other allowances received in respect of employment of services rendered, and any amount so received in respect of employment or services rendered in a year of income other than the year of income in which it is received shall be deemed to be income in respect of such other year of income".
This implies the amounts shown above are charged on an "earnings" basis and not on a "receipts" basis. For example if a bonus is earned in and is actually paid in it will be assessed in the year of income The value of a beneit is usually the cost to the employer. Some beneits may not entail a cost to the employer but are still chargeable to tax e. The important criterion is that the beneit has some monetary value. Held: Although the employee did not sell any of the shares, there was no restriction to do so if he wished.
The privilege represented money's worth for services rendered to the company equivalent to the difference between the par and market value was accessible. This rule applies to personal gifts e. However if a gift is received by virtue of an employment or services rendered it is a gain from employment and it is taxable e. This also includes gifts made to employees as "Christmas gifts" or "Long-service awards". Not a personal gift; 2. The sum is an emolument by way of bonus and because the employee had not left employment the gift was from the employer and therefore assessable.
The reason for the payment was not services rendered but the personal success of the employee in passing examinations and not remuneration for services.
The payments were not taxable. Year of income means the period of twelve months commencing on 1st January in any year and ending 31st December in that year. Where the accounting period of a person does not coincide with the year of income as deined, then, for the purposes of ascertaining his total income for a year of income, the income of an accounting period ending on that other date, say This will not apply to individuals earning employment income only.
Business includes any trade, profession, or vocation and every manufacture, adventure and concern in the nature of trade, but does not include employment. This will include business carried on partly in Kenya and partly outside Kenya by a resident person. Question Two Persons liable to tax 1. An individual i. A legal person e. As such, a tax deicit is carried forward indeinitely to the following period. Such a or before 11th June This beneit is beneit is taxable on the employer at taxable on the employee the corporation Tax Rate.
Ongera works with Anga Ltd. Pension from previous employment Sh. Salary sh. Ongera and her husband own a company whose taxable income was agreed at Sh. Ongera in South B where rent of similar houses was Sh. Ongera works over-time and her over-time income averages Sh. Ongera enjoyed medical beneit of Sh. She is a senior manager and the company has medical cover for all its employees. She obtained free consumables from the company as a Christmas gift worth Sh.
Ongera owns rental property at Komarock Estate and receives Sh. During the year, She incurred Sh. She had obtained a mortgage loan from Housing Finance Company amounting to Sh 3,, She paid Sh , during the year of which Sh , was principal. Ongera did not ill her self assessment return form for Justify your comment in each case.
Charles Owino has a permanent home in Kenya. He works for a company based in the United Kingdom UK where he lives. He came to Kenya for a one- month holiday on 1 September but had not returned to the UK by 31 December The company opened a branch in Kenya on 1 March Frida Aloo, a Kenyan citizen, is married to a citizen of Canada. Was registered in Kenya where the company operated until 15 July The company thereafter relocated its operations to Kampala, Uganda.
He has provided you with the following information on his income for the year ended 31 December 1. He is paid a basic salary of Sh. He is housed by the employer in a house leased at Sh 30, per month. The house was furnished by the employer at a cost of Sh , He is a member of a golf club where the employer contributes Sh 5, per month for him.
He holds a life assurance policy with Maisha Assurance Company Ltd. The employer paid the premiums on the policy for year amounting to Sh 48, He is a member of a registered collective investment scheme. During the year, he earned an income of Sh. The scheme invests in shares and ixed deposit accounts. He separated with his wife on 1 October With effect from 31 October , he has been paying alimony of sh20, per month to his wife as required by a court order. He is provided with a motor vehicle cc by the employer which was purchased on 1 January at a cost of Sh1,, He contributed Sh 25, per month towards a registered pension scheme.
On 1 December , his monthly salary was increased by ten per cent backdated to 1 July He owns a pig-rearing farm in Limuru. The farm reported revenue of Sh 1,, for the year ended 31 December before deducting the following costs: Sh Salary to farm manager , Wages to farm labourers , Construction of pig stays 48, Purchase of a plastic water tank 22, Purchase of pig feed , Cost of renovating the farmhouse , 1,, Required: i Taxable income of Mr.
Joel Kivu for the year ended 31 December He provided the following information relating to his income and that of his wife for the year ended 31 December 1.
His monthly basic salary is Sh. He lives in a company house and pays a nominal rent of Sh. The market rental value of the house is Sh. The company reimburses him for all out-of- pocket expenses incurred on the oficial use of his car. In the year , the amount reimbursed was Sh. The education fees for his two children amounting to Sh.
He earned a net interest income of Sh. He is contemplating purchasing a house for his residence in the near future. In the year , he invested Sh. He has a farm which generated a surplus of Sh. A tax of Sh. His wife has invested in the shares of a quoted company. She received a dividend of Sh. Required: i Compute the total taxable income of Alex Kipkoech for the year ended 31 December Investment income: Sh.
Directors remuneration: Sh. Directors fees , Travelling expenses — directors , Payment to directors pension scheme , Compensation to a former director for , wrongful termination contract 1,, 3. Interest expenses Sh. Interest on bank overdraft , Interest on loan from a foreign bank 50, Interest on loan to purchase investment 72, shares , 4.
Audit fees 68, Tax appeal against assessment 32, Book-keeping fees S T U D Y 48, Audit expense paid in relation to a 68, discontinued business line , 5. Bad debts: Sh. Embezzlement by staff 21, Insurance compensation on embezzlement 12, Bad debts written off 28, General provision for bad debts , , 6. Miscellaneous expenses: Sh. Acquisition of a year lease on business 28, premises Directors Christmas party 24, 30, Subscription to a trade association A.
They have presented the following proit and loss account for the year ended 31 December Income: Sh. Included in sales revenue were goods valued at Sh. These goods had cost Sh. Insurance premiums include Sh. Bad debts comprise: Sh. Increase in general provisions 20, Increase in speciic provisions 41, 61, 4. Interest on loan and legal expenses relate to a mortgage acquired by Ali for purchase of his house. Salaries to partners comprise: Sh.
Ali , Salama , ,00 6. Required: i The adjusted partnership proit or loss for the year ended 31 December T E X T 10 marks ii An allocation of the adjusted proit or loss between the partners.
We also studied the speciied sources of income but in a summary basis. In this chapter, we have covered the speciied sources of income in detail together with their various tax implications. The various aspects of the topic may be examined separately or as part of a tax computation question. It should be noted that if one does not appreciate the various taxation rules in this topic, there is a risk of non compliance to tax. Dividend paid by resident companies to the individual share holders are taxable income.
In comparison to employment income which is brought to tax in the year it is earned, dividend income is taxable in the year it was paid out. Dividend in this case shall be higher of the nominal value or Redeemable value. Kiambu Farmers Coop society b. Kariokor Women Coop society c. It is an additional tax imposed on companies and arises if a company pays dividends from untaxed proits. Untaxed proits would occur in cases where the company declares dividends out of proits arising from sale of ixed assets, investments or other gains that are not taxable.
Note that capital gains tax was suspended in and stands suspended to date. According to the Income Tax Act, the initial balance in the dividend tax account will be either:- a Zero; or b Sum of the total taxes paid and tax on dividends received, less tax on dividends distributed and tax refunded by the company with respect to to years of income. Where the tax is paid in a given year the balance carried forward to the next year is zero.
The tax is due for payment by the last day of the 6th month following the end of the accounting period. During the year , the company paid tax of Sh.
It distributed dividend of Sh. Compute the compensating tax payable if any for the year For tax purposes, it is deined as interest payable in any manner in respect of a loan, deposit and other debts or obligations. When is interest taxable? Compute Interest taxable for years and Interest arising from tax reserve certiicates- These are certiicates sold or issued by the government and for the time being they are held by the government.
Interest accrues which is fully exempt from taxation. These certiicates will then be used to pay taxes when tax becomes due. Interest arising from government stocks and Nairobi City council stocks in the case of a non resident only. Interest on East Africa High Commission in the case of non residents only. Interest arising from a registered retirement Fund. Interest accrued or earned outside Kenya. Interest paid by other persons not inancial institutions is fully taxable.
Omoding deposited Sh 3,, in Housing Finance development Bonds in year and earned gross interest of Sh , Non qualifying Interest Non qualifying interest is the interest that is taxed further i. It is aggregated with other incomes of that person and any withholding tax suffered will be allowed as asset off tax. Rent income is made up of key money or goodwill, normal rent and premium. Taxation of rental income depends on whether one is a resident individual or a non resident. No expenses are allowed against gross rent income.
However the following points are relevant in arriving at the net taxable rental income: T E X T Allowable deductions against Rent S T U D Y The generate principle is that expenses allowed as deductions from incomes where they are wholly and exclusively incurred in the production or generation of the chargeable income. Expenses incurred prior to period of production are not allowable Allowable expenses include: 1. Interest on an overdraft or mortgage where funds have been raised to purchase the property.
Interest is allowable in full irrespective of the source of the loan provided that the premises have been rented for 12 months. If let for less than 12 months, the amount is apportioned accordingly. Structural alterations to maintain existing rents. Capital allowances e. Diminishing in value of any implements, utensils or similar articles if included in the rentals. Wear and tear, industrial building allowance, investment etc may be allowed as deduction. Legal costs and stamp duties on acquiring a lease of not more than 99 years.
Any reasonable advertising and promotional costs. Municipal water rates, land and ground rates. Repairs, renewals and replacements in order to maintain the existing rent e. Cost of valuation for insurance of the building and its contents as well as insurance premiums paid. Expenses incurred during regular or normal inspection by the agent. Note a Cost of structural extension cannot be allowed as a deduction.
Expenses relating to a whole year are apportioned if the property is rented for a period of less than 12 months 3. These are incomes arising from rights granted to other persons for the use of intellectual property.
Royalties means a payment made as a consideration for the use of: a A copyright of literary, artistic or scientiic work. Taxation of royalties Taxation of royalties depends on whether one is a resident individual or a non resident. This is a withholding tax which is a inal tax. No expenses are allowed against the gross income.
Expenses are allowed against gross royalty income to arrive at the taxable royalty. Expenses incurred prior to the period of production of royalty income are not allowed e. The net royalty income will be aggregated with other incomes of that resident individual and assessed on him using graduated scale rates in the case of an individual and corporation tax rate in the case of a body corporate.
Provident fund would normally cease upon ceasing employment Are of 2 categories: A. Beneit as a contributor B. Beneit after employment Beneit as a contributor Contribution may be under; a Contributory scheme-both employer and employee contributes. The combined employer-employee contribution to a registered or approved fund or scheme on behalf of a member is unlimited.
Before 1. Note, the irst 1. However, Where an employee is a member of a pension scheme or fund and at the same time the National Social Security Fund NSSF the maximum allowable contributions should not exceed Sh 20, per month in aggregate. Question Two List four dividend incomes exempt from Taxation in Kenya Question Three List the allowable expenses against rental income. These properties include: i. Copyright, Literary, artistic or scientiic works.
Cinematograph including ilm or tape used in radio or any other form of broadcasting. Patents, trademarks, designs, model, plan or formula. Any industrial, commercial or scientiic equipment or information concerning industrial commercial or scientiic equipment. Expenses will be allowed as long as they were incurred wholly and exclusively in earning such income. No expenses are allowed. It is then deducted from gross tax liability of the resident individual as a tax credit.
Question Two Dividends exempt from tax; i. Dividends from outside Kenya or from non-resident companies ii. Dividends received by a resident insurance company from its investments income of the life insurance fund iv.
In determining the taxable rent income, all expenses incurred wholly and exclusively in earning such income are allowed deducted against such income. These expenses include the following: a Bad debts and rental losses. Note 1 Any cost incurred with the intention to increase rent will be disallowed.
Gross proit 5,, Other incomes: Dividend from a subsidiary company , Interest from foreign bank accounts 4, Discount received 28, Refund of VAT 12, Gain on sale of motor vehicle 14, , 5,, Expenditure: Salaries and wages , NHIF contribution 30, Subscription to a trade association 50, Hire purchase interest 15, Bad debts written off 60, T E X T General expenses 80, Depreciation 25, Legal expenses 40, Insurance premiums , S T U D Y Rent 66, Electricity 34, Purchase of furniture 26, 1,, 4,, Additional information: 1.
Capital allowances were agreed with the Revenue Authority at Sh. Included in bad debts is a loan of Sh. Legal expenses include Sh. The company paid stamp duty of Sh. This payment is included in the rent expense for the year ended 31 December Required: i Compute the adjusted taxable proit or loss of Mali Limited for the year ended 31 December We noted that capital allowances are among the expenses that are deductible.
In this chapter, we shall study in detail the principles regarding the capital allowances. By the end of the chapter, one should be able to compute the capital allowances available. The deduction is made against income Farm works deduction: This is a capital deduction granted only in respect of capital expenditure on agricultural land.
Questions on this topic do not miss in the examinations. The student should also be keen on the application of these rules in the computations.
The chapter would be helpful in understanding the incentives and as an investor focusing your efforts to areas that have higher allowances. The chapter would also form a basis for advocating for allowances in other sections that may not have been covered. S T U D Y While discussing allowable expenses above, the deductions or allowances on some machinery and buildings used for business were stated to be some of the expenses speciically allowed against taxable income. The deductions or allowances are at standard rates for all taxpayers depending on the nature of the capital expenditure incurred.
The capital deductions are important because: a Some offer incentives to business by allowing capital expenditure otherwise not claimable. The depreciation and similar charges are not allowable expenses against taxable income. The manner of calculating and computing the various capital deductions or allowances is given below. The deduction is made against income. As we shall see later, the deduction is made in the income tax computation or in arriving at the taxable income or loss for the year after disallowing any depreciation and similar charges against taxable income.
As noted earlier any capital loss, diminution, exhaustion of capital, such as depreciation, amortisation, loss on sale of assets, obsolescence, provision for replacement, are not allowable expenditure against income. But the Income Tax Act recognises the loss of value of assets used in business through usage, passage of time or obsolescence and so grants the wear tear allowance.
Owned by a person, and ii. Used by the person for business anytime during the year of income. The irst step is to identify the machinery which qualiies for wear and tear deduction. The machinery for wear and tear deduction has a wide meaning and includes tractors, lorries, motor cars, plant and machinery, furniture, aircraft, ship, etc. It is important to note that implements, utensils, tools and similar articles, qualify for diminution or reduction in value. See speciic deduction allowable in the previous lesson.
The machinery which qualify for wear and tear are classiied as follows: Class I This is a class for heavy earth moving equipment and heavy self-propelling producing own power to move machinery e. Class II This is a class for ofice equipment bought on or after 1. Class IV This is a class for other machinery including ships e.
The third step in the procedure for wear and tear deduction is that an appropriate percentage rate on the balance of machinery of each class is allowed as a deduction— Class I Written down value start 1. Sometimes there is no balance brought forward from previous accounting period. There would be a sub-total for each class. There would again be a sub-total for each class involved. As will be seen later, the amount of wear and tear deduction calculated as above is deducted in T E X T the Income Tax Computation as a deduction against taxable income or loss.
The concept of the Income Tax Computation will be explained later in this lesson. S T U D Y Commercial and non-commercial vehicles for wear and tear deduction The motor vehicles as machinery for wear and tear deduction may fall under either Class I or Class III depending on the nature of the motor vehicle. For the vehicle under Class III, the value for additions as well as the value for disposal is restricted if the vehicle is a non-commercial vehicle.
The Income Tax Act deines a commercial vehicle as a road vehicle which the Commissioner of Domestic Tax is satisied: a Is manufactured for the carriage of goods and is so used in connection with trade or business e. Lorry, pick-up, van etc; or b Is a motor omnibus within the meaning of that term in the trafic act e. All public service vehicles PSV vehicles like buses and matatus, or c Is used for the carriage of members of the public for hire or reward e. Any vehicle which does not it the deinition of a commercial vehicle is referred to as a non- commercial vehicle.
For the purpose of wear and tear, the value of addition of any non-commercial vehicle is restricted to Sh. The old safe was valued at Sh 20, and the company paid the balance of Sh,20, to acquire the new safe. The net book value of the old safe was Sh 22, at Required Calculate the wear and tear deductions due to the company for the year LTD Wear and tear computation for the year ended Mercedes Benz sports car is not a commercial vehicle and its cost for wear and tear deduction is therefore restricted to Sh.
The trailer is occasionally pulled by the tractor and is detached and not part of the tractor and therefore falls under Class IV Note that a trailer permanently pulled by lorry is part of the lorry and falls under Class I together with the lorry. Computers and computer hardware, calculators, copiers and duplicating machines bought on or after 1.
The purchase price of the safe is Sh. The car sold is not a commercial vehicle which means that it was restricted to Sh 2,, as addition in Trading receipt arises in a continuing business where the sale proceeds in a class of wear and tear machinery exceeds the written down value as has happened in Class I in our example.
Note that the tractor is still owned and used and does not prevent trading receipt being recognised. Where business is continuing and all the assets in a Class of wear and tear are sold for less than the written down value, the result is a trading loss. Where business has ceased, the trading receipt is referred to as a balancing charge, and trading loss is referred to as balancing deduction.
They are taxable income and allowable expense respectively, as will be explained later. Addition for Wear and Tear The cost of assets which qualify for wear and tear additions are: a The historical cost of qualifying assets whether new or old and whether made in the business or purchased. In other words, the full value of an asset acquired is taken as an addition for the respective class of wear and tear as in the case of the safe in the above example.
The hire purchase interest is charged in the proit and loss account and is allowed for tax. T E X T e For assets brought into the business without being purchased, the most likely open market price of such assets is taken as the value for addition. S T U D Y The Commissioner of Domestic Taxes has normally accepted taxpayers' own valuation of assets brought into the business unless such values are unreasonable.
The investment deduction is explained later in the lesson. Disposal or Sales for Wear and Tear. Some details of sale proceeds which qualify as sales for wear and tear: a. Presenting high quality research about developing economies, construction, education and sustainability, this proceedings will be of interest to academics, postgraduate students, and industry professionals.
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