AXATION

Definition:-
1. Taxation can be defined as a “compulsory contribution of the wealth of a person or a body of
persons for the services of the public powers”

Points to note:
a. No body can escape payment of tax if his income has reached the assessable limit. It is a
compulsory contribution imposed by the government against the people who come under
itsr jurisdiction . For this reason, failure to pay taxes is a criminal offence which is
punishable by the law. However taxes are only paid by those people who come under
their jurisdiction.
b. A particular tax is not normally speaking a price for any particular service performed by
the state. A tax is not levied in return of any specific service rendered by the government
and an individual cannot ask for any benefit in return for taxes paid. The essence of a tax
is the absence of a direct “Quid Pro Quo” (something for something) between a taxpayer
and the tax authority. This implies that a taxpayer cannot claim for something equivalent
to the tax paid to the government. A taxpayer cannot refuse to pay taxes on the grounds
that he does not use public services.

c. Tax systems are governed by the law which must be specific and definite enough to
enable an exact sum to be collected.

d. It is a payment made by taxpayers, which will be used by the government for the benefit
of all citizens i.e. in providing social and public goods and services. The state uses the
revenue collected from taxes in the provision of hospitals, schools and public universities
etc that benefit all the citizens of that country.

2. Any leakage from the circular flow of income into the public sector, excepting loan
transactions and direct payments for publicly produced goods and services. Loan transactions
through treasury bills, bonds etc.

Functions of the State

 Protection Function
It is the responsibility of the government to maintain peace, order and security in the
country. The state is charged with the responsibility of defending its citizens and borders
against external aggression. For this purpose the government maintains a police force and
armed forces.

 Administrative Function
The government is responsible for the proper administration of the country. For this
purpose various ministries, departments, sections etc have been set up in the government
to ensure proper and efficient administration.
  Social Function
The government provides social amenities to its citizens such as education, health,
transport and communication, housing, entertainment etc.

 Development Function
The development of the various sections of the country and infrastructure is not possible
without government’s intervention. For this purpose the government undertakes the
development of agriculture, commerce, industry, transport and communication etc. all
such developments significantly contribute to the rapid growth of the economy of the
country.
To perform the above functions effectively and efficiently, the government requires
funding which is primarily sourced from taxation. Taxation therefore becomes a very
important source of revenue to the government. The income that the government derives
from taxes and other sources in known as Public Revenue.

Purpose of Taxation
Taxes are mostly levied with the objective of raising public revenue. However there are other
subsidiary purposes of taxation.

 Economic Stability
Taxes are imposed with a purpose of maintaining economic stability. During inflation,
the government increases the levels of taxation to discourage unnecessary expenditure
and take away excess money supply. In times of depression, the government reduces the
level of taxation to encourage individuals to spend more. In this way, taxes become an
important tool of economic stability.

 Fair Distribution of Resources / Incomes

Taxes are imposed to achieve equality in the distribution of national income. Taxes are
imposed at higher rates on those people with higher disposal income and used to provide
welfare facilities to poor people in this way, taxes become a vehicle for the redistribution
of national resources.

 Protection Policy
Taxes are imposed to implement the protection policy of the government. In order to give
protection to commodities produced in the country, the government raises taxes on
imports. This causes such imports to be more expensive and thus people will resort to
locally manufactured goods that may subsequently boost local infant industries.

 Social Welfare
Taxes are imposed on the production, consumption and importation of commodities,
which are harmful to human health e.g. the customs and excise duties on cigarettes, beer,
cosmetics and other harmful products. This raises their prices and discourages their
production and consumption.
  Higher Levels of Employment
The government imposes taxes in order to initiate, finance and complete development
projects and other public works. All such programs create employment to undertake such
public works. The government is the largest employer in the country and all such
employees are paid from funds derived mainly from taxation.

Principles/Canons of Taxation
 Canon of Equity (Equity/Justice)
This is the most important canon of taxation. In the words of Adam Smith, ‘Every subject
of a state ought to contribute with their respective abilities in proportion to the revenue
that they respectively enjoy under the protection of the state”. It means that every citizens
of a country should pay taxes according to their ability but not necessarily in the same
amount. The rich person should pay more than the person with lower income. This canon
also implies equality of sacrifice i.e. the higher the income the greater the sacrifice one
shall be called upon to make .this canon was put in the forefront of all other canons with
the view that all others have been derived from this one.

 Canon of Certainty
According to Adam Smith, there should be certainty in taxation since uncertainty breeds
corruption. Certainty means that every taxpayer ought to be sure of how much they ought
to pay, the time of payment, the manner of payment, the procedures involved etc. It also
means that the government should be sure as to the amount of tax revenue it should
collect, the time and manner that such amounts shall be received by the exchequer.

 Canon of Convenience
This canon states that both the time and mode of payment of tax should be convenient to
the taxpayer. In the words of Adam Smith, “every tax ought to be designed so as to be
levied at the time or in the manner it is mostly likely to be convenient for the taxpayer to
pay”, e.g. VAT is conveniently paid only when the person has the means to spend. It is
also convent in the sense that it is included in the price of a commodity. PAYE is
conveniently paid when an employee has earned income at the end of the month. Custom
duty is conveniently payable only when a person is able to import.

 Canon of Economy
A good tax system should attain economy in two ways:
- Economy in Collection
Where collection costs of tax outweigh the tax collected by way of salaries,
allowances, administrative and secretariat charges or expenses etc such a tax should
not be levied in the first place.

- A tax should be economical to the taxpayer i.e. a taxpayer should afford to pay all the
taxes levied on him and afterwards have sufficient cash left within him to cater for his
consumption, savings and investment needs. Heavy taxes discourage saving and
investment and end up undermining the productive capacity of a person.
  Canon of Productivity
A tax should be productive in that it should bring in more revenue to the government.
However in its quest for more revenue, the government should not overburden its citizens
with many or heavy taxes since such a move will be counter-productive. One tax that
brings in or revenue is better than a multiplicity of taxes that are expensive to operate and
thus uneconomical.

 Canon of Elasticity
This Canon is closely related to that of productivity. It requires the government should be
able to raise rates of taxes when it needs more revenue. In other words a tax would be
elastic e.g. excise duty can be levied on a number of commodities and their rates can be
increased every year to raise more revenue. However care must be taken to ensure that
the rates are not raised unduly high since they will result in inflationary pressure in the
economy.

 Canon of Flexibility
Flexibility means that there should be no rigidity in the tax system. A tax system should
be changed to meet the revenue requirements of the state while elasticity means that the
revenue can be increase under the existing tax system as a result of changes in tax rates.
However there cannot be elasticity in a tax system without flexibility since some changes
being made on the tax rates may alter the tax structure.

 Canon of Simplicity
A tax system should be simple, plain and intelligible to a common taxpayer. It should be
simple to understand how it is computed and how much is to be paid, when it is to be
paid and where. The forms to be filled in for calculation and payment of tax should be
simple and intelligible to all taxpayers.

 Canon of Diversity
Every tax system should be diverse in the sense that a single or few taxes will neither
meet the revenue requirement of the state nor will they be equitable. An economy should
have a variety of taxes so that all citizens contribute towards state revenue according to
their various abilities to pay. Broadly there should be direct and indirect taxes. However,
a large multiplicity of taxes becomes difficult to administer and uneconomical.

CLASSIFICATION OF TAXES
1. Taxes can be classified on the basis of administrative collection arrangements or (impact
of tax) as:
- Direct taxes
- Indirect taxes
2. Def: Incidence of tax
The person who bears ultimately bears the money burden of the tax, thus, the final resting
place of a tax.
 Def – Impact of Tax
The person who pays the tax in the 1st instance, thus, a tax can be paid by one person who
as impact and then the burden is shifted through a service of transactions to another
person who bears the money burden to another person renown as indecency of tax.

DIRECT TAX
A tax is said to be direct when the person who pays it in the first instance is expected to bear the
burden.

The impact and the incidence are on one person. Examples of direct tax are:-
- Income tax
- Capital gain tax.

ADVANTAGES OF DIRECT TAX

1. The incidence and the yield are easily determinable.
2. The system is easy to understand.
3. The tax – payer knows with certainty what he is expected to pay.
4. Yield increases automatically as wealth and population increase.
5. The direct taxes are in generally progressive.
6. The ability to pay is judged directly. Accordingly there are lesser chances of making an
error of judgment.
7. Direct taxes do not cause at all distortion in the resources allocation of the economy and
that they leave the tax payer better off than do the indirect taxes.
8. These taxes bring about civil awareness and responsibility among the tax payers. They
then try to be more vigilant about how much tax revenue is being raised and to what use
is being put.

DISADVANTAGES OF DIRECT TAX

1. The costs of administration involved are very high.
2. The effect on incentive, enterprise and savings in the case of those with large incomes
may be considerable.
3. The tax is easily evaded by the excess (tax payer) submitting wrong return of income.
4. If taxes are progressive, the rate of progression has to be fixed arbitrarily and if
proportional, they fall more heavily on the poor.

INDIRECT TAXES
An indirect tax is one which is levied on one person in the expectation that he shall indemnify
himself at the expense of another. The impact is on one person and the incidence on another.

ADVANTAGES OF INDIRECT TAX

a) Payment and collection of the taxes are easy and convenient.
 b) The tax-payer does not feel the burden made partly because an indirect tax is paid in small
amounts and partly because it is paid only when making purchases.
c) They cannot be evaded, as they are part of the price of purchases.
d) They check consumption of harmful commodities. This is why tobacco, wine and other
intoxicants arte tax.
e) Incentive and enterprise are not harmed as in the case of direct taxes.

DISADVANTAGES OF INDIRECT TAXES

1. They are always regressive. The rich and the poor pay the same amount which is
obviously unfair.
2. They are uncertain in yield unless necessaries are taxed. In the case of goods with an
elastic demand, the tax might not bring in much revenue.
3. Incidence is not easy to determine.
4. They discourage industries if raw materials are taxed.

CLASSIFICATION BASED ON TAX BASES

The Base of a Tax
The base of a tax is the legal description of the object with reference to which the tax applies. For
example:
The base of excise duty is the production or processing or packaging of specific goods. The base
of income tax is the income of assesses. Examples – income tax, VAT, excise duty etc.

CLASSIFICATION BASED ON RATES

Taxes can be progressive, proportional or regression depending on the rates used with respect to
a given rate.

1. Progressive Tax
Progressive tax is one which with increase in income, the tax liability increases both
absolutely and as a proportion of the income.

The tax rate increases with increase in income. A good example is income tax on
employment income.

2. Proportional Tax
The tax liability increases in the same proportion as the increase in income. The tax rates
remain uncharged with the increase in the income. A good example is income tax on
profit, VAT, exercise duty.

3. Regressive Tax
The tax rate decreases (diminishes) as the income (tax base) increases. This is necessary
to encourage productivity.

4. Digressive Tax
When there is a declining degree of progression as the tax base increases.
.

SHIFTING OF TAX
1. This is the process of transferring tax from the person on whom the tax is imposed
initially to the ultimate tax payer who bears the money burden of the tax.
2. The process of transfer of tax is known as the shifting of the tax while the settlement of
the burden on the ultimate taxpayer is called the incidence of tax.
3. Tax shifting may be forward or backward shifting.

Forward Shifting
1. This is the transfer of the burden whereby the alternate money burden is born by the final
consumers.
2. Thus, the producer in excise duty transfers the burden to the wholesaler; the wholesaler
transfers it to the retailer who finally transfers this to the final consumer.
3. The effect of this is the increase of price due to tax change.
4. A wholly shifted tax is where the price rise due to tax is equal to the amount of tax paid.
5. A partly shifted tax is where the price rise of the commodity is less than the tax charge.
6. The main factor that may lead to partly shifted tax or wholly shifted tax is the price
elasticity of demand.

Backward Shifting
This is when the producer shifts / transfers the money burden of the tax on the supplier of factors
of production by forcing them to accept lower pries for their services.

TAX EVASION
Tax evasion is where the tax payer deliberately tries to avoid tax by any of the following
practices:-
i) Declaring less income
ii) Claiming for allowances to which he is not entitled to
iii) Claiming for reliefs to which he is not entitled to.
This is a crime and if proved quilt the remedies are:
- Payment of tax
- Payment of fine
- Payment of interest
- Imprisonment.

TAX AVOIDANCE
- This is where the tax payer arranges his financial affairs in such a way that he will be
required to pay less tax.
- One can do this by identifying loopholes in the laws and manipulating them to his
advantage.

TAXABLE CAPACITY
Taxable capacity is the ability of individuals and businesses to pay taxes. It is not the ability of
taxing authorities to raise revenue.

THE KENYA REVENUE AUTHORITY

The Kenya Revenue Authority (KRA) was established by an Act of Parliament, Chapter 469 of
the laws of Kenya , which became effective on 1st July 1995 . The Authority is charged with the
responsibility of collecting revenue on behalf of the Government of Kenya.

Role of KRA in the economy

 To administer and to enforce written laws or specified provisions of written laws

pertaining to assessment, collection and accounting for all revenues in accordance with
these laws.
 Advise on matters pertaining to the administration or and the collection of revenue under
written laws.
 Enhance efficiency and effectiveness of tax administration by eliminating Bureaucracy in
Procurement, Promotion etc through Training and Discipline.
 Eliminate tax evasion by simplifying and streamlining procedures and improving tax
payer service and education thereby increasing the rate of compliance.

INCOME TAX IN KENYA

1. Income Tax in Kenya is governed by the Income Tax Act (Cap 470).
2. The Act was enforced on 24 th December, 1973 by an Act of parliament and came into
operation on 1st January, 1974.
3. Prior to that date, Tax matters were ended East African Income Tax Department.
Governed by the provisions of E.A. Income Tax Management Act (Cap 24).
4. Cap 470 contains the rules for the ascertainment of Income Tax, reliefs, assessment and
collection of Tax.
5. The Act has 14 parts, 233 sections and 13 schedules.

THE TAX ASSESSOR

1. They are officers of income tax department who issue return forms and make assessments
based on completed returns submitted by tax payer.
2. They estimate income and assess if not provided with adequate information.
3. They make additional assessment.

TAX COLLECTORS
1. They are officers whose main duty is to ensure that the tax assessed on a tax payer is paid
on the due date.
2. They add 15% interest on tax not paid on due date. This interest is known as late payment
penalty.
THE YEAR OF INCOME
1. The period of 12 months commencing 1st January in any year and ending on 31 st
December in that year. This is the period to which tax is chargeable.
2. Because of some reasons, the commissioner recognizes some a period of 12 months not
ending on 31st December.
3. This period not coinciding with the calendar year is to be taken as the year of income as
follows:-
i) In the case of a company for all chargeable income.
ii) In the case of an individual. For all chargeable income except employment
income which must be shown separately where a person makes up the accounts
for a period shorter or longer than 12 months, the commissioner may subject to
such adjustments as he may consider necessary treat the income of any such
accounting period as income of the year of income in which the accounting period
ends, and tax is charged accordingly.
iii) In the case of a partnership for each partners share of the profit of the partnership
business but the income from employment or service rendered elsewhere will fall
within the normal years of income in which it was earned. Therefore separate
discloser is required.

Note: w.e.f 1998 all incorporated business will have accounting date ending 31st December.

RESIDENCE
Individuals
a. A person who has a permanent home in Kenya and was present in Kenya for any period
in any particular year of income under consideration.
b. Has no permanent home in Kenya but:
i. Was present in Kenya for a period or periods amounting in total to 183 days or
more in such year of income,
ii. Was present in Kenya in such year of income and in each of the two preceding 2
years of income for periods averaging more than 122 days in each such year of
income.

Companies
a. That the body is a company incorporated under a law of Kenya.
b. That the management and control of the affairs of the body was exercised in Kenya in
any particular year of income under consideration.
c. That the body has been declared by the minister for finance by notice in the Gazette to be
resident in Kenya for any year of income.

IMPORTANCE OF RESIDENCE
Individuals
1. Kenya residents pay tax on the income from Kenya and worldwide employment but non-
residents pay tax only on income derived from Kenya.
 2. Kenya residents pay tax on graduated scale on all the taxable income but non-residents
pay tax only on certain specified income at special rates.
3. Withholding tax is deducted at source on all income on non-residents but residents have
withholding tax deducted only on some of their income.

Companies
a) Kenya resident companies are taxed at lower rates than non-residents companies with
branches in Kenya while non-resident companies without branches are taxed on the same
specified income at the special rates applicable to non-resident individuals.
b) Non-resident companies with no branches in Kenya have withholding tax deducted at
source on all their sources of income but resident companies and non-resident companies
with branches in Kenya have withholding tax deducted at source only on income in the
form of dividends.

PERSONS LIABLE TO TAX

1. The term person embraces individuals, and artificial persons both incorporated and
unincorporated.
2. Tax position:
(a) An individual is taxed on his income on himself.
(b) A partnership is not taxed as a business but the individual partners are taxed on their
income from the partnership.
(c) Companies are taxed in their own name.
3. The persons liable to tax:
(a) All persons resident in Kenya whether or not they are Kenyan citizens.
(b) All persons not resident in Kenya but derive income from any property, trade,
profession, vocation or employment in Kenya.
4. Income tax is charged on income that accrues in or is derived from Kenya whether earned
by residents or non-residents. Income arising abroad whether or not it is remitted in
Kenya is no liable to tax unless:
(a) If the business is established in Kenya and has branches in foreign countries, profit
made in foreign countries is taxed in Kenya.
(b) Employment income of resident individuals.

ASCERTAINMENT OF TAXABLE INCOME

Taxable income differ from accounting income due to the following reasons;
i. Some expenses recognized in accounting are not recognized by tax laws
(disallowable expenses)
ii. Some of the taxable expenses are not recognized in accounting (capital allowances)
iii. Reported accounting income may be tax exempt eg foreign investment income.
iv. Some of the taxable income may not be recognized in accounting eg rental income
received in advance.

INCOME CHARGEABLE TO TAX

A tax payer is chargeable taxed on his chargeable or taxable income. Income chargeable to tax
includes:
1. Business profits
2. Income from any employment or services rendered
3. Rent income
4. Dividends income
5. Interest income
6. A pension or annuity or any withdrawal form a payment out of a registered
pension fund or a registered provident fund or a registered individual retirement
fund.
7. Any amount deemed to be the income of any person under the Act.
8. Gains accruing from property computed in accordance with the Eight Schedule.

SPECIFIC INCOME CHARGEABLE TO TAX

1. Sum received under insurance against loss of profits, damages, or compensation for loss
of profit 54 (c )
2. Sum recovered or released from previous years provisions and reserves (54 (d)
3. On the cessation of a business balancing charges which arises (54 (e)
4. Where a non-resident carries on a business with a related company under an agreement
that produces less than the ordinary profit to the resident organization, the difference
between received profit and normal profit will also be taxed (518 (2)
5. A just and reasonable proportion of the profit of a non-resident business of
communication by radio or cable earned on in Kenya (590)
6. A just and reasonable proportion of the profit of a non-resident business of ship owning,
chartering or air transport in the case of ships or aircraft which calls at any part or airport
within Kenya (59(1)
7. The profit of a business of manufacturing, growing, mining, producing or harvesting and
selling of any product outside Kenya carried on by a non-resident and irrespective of
whether the sales contract is made in Kenya or not. (518 (1)
8. Any payment made to non-residents in the form of professional fees, royalties, interest,
rent or entertainment or sporting fees (5-10)
9. The whole of the gains or profits where a business is partly in in Kenya and partly outside
Kenya (54 (a)
10. A foreign exchange gain or losses realized on or after 1 st January 1989 in a business
carried on in Kenya can be considered as a trading receipt (profit) or deductible expense
(loss) (54 (4)
11. Income of export processing zone enterprises (54(3)

EXEMPTIONS FROM INCOME TAX

The part 1 of the 1st schedule of Income Tax Act specifies the Income which the except from
Kenya Income Tax (513)
 1. That part of the Income of the president of the Republic of Kenya that is derived from
salary, duty allowance and entertainment allowances paid or payable to him from public
funds.
2. The income, other than income from investment of a sporting association.
3. Income of agricultural societies from exhibitions or shows and any interest derived from
investing such income.
4. The income of local authorities.
5. Interest on any tax reserve certificate issued by the Kenya government.
6. Income of any registered pension scheme.
7. Income of any registered trust scheme.
8. The income of any registered provident fund.
9. The income of Amateur Sports Association where:-
(i) The association’s role or main objective is to foster or control outdoor sports
activities.
(ii) Its members are amateurs not professionals.
(iii) Its memorandum of association by laws will discontinue any member who turns
professional or ceases to be an amateur.
10. Income of Religious Bodies and charitable organization and Educational Institutions
whereby, such Institution or bodies are:
(a) Public in character to serve the total public or a section of the public.
(b) Set up solely for the purpose of aiding or relieving distress or poverty to society or for
the purposes of advancement of religion or education and that
(c) Its income is expended in Kenya or its expenditure would result in benefit to Kenyans
residents.

In addition business income of such bodies will also be exempted from tax if:
(i) Such business income is solely applied to the above purpose.
(ii) The business is carried on in the actual execution of those purposes;
(iii) That the income is rented income from its properties.
(iv) The work of the business is carried on by the beneficiaries.

11. The income of some parastatal bodies such as:

12. The Income from the Investment of an annuity fund defined in Sec. 19 of the Income Tax
Act of an Insurance Company.
13. Pension of gratuities granted in respect of war wounds or disabilities.
14. Interest on a savings account held with the Kenya Post Office Savings Bank.
15. Interest paid on loans granted by the local Government Loan Authority.
16. The Income of a non-resident person who carries on the business of air transport
provided.

ALLOWABLE EXPENSES FOR TAX PURPOSES

These are expenses recognized by the tax laws. The principle of wholly and exclusive applies
when determining whether an expense is allowable or not. This principle states that, an expense
is allowable if it is wholly and exclusively incurred for the purpose of earning business income
Section 15 of the income tax act states that the following expenses are allowable;
1. Bad debts written off and specific provisions for bad debts.
2. Legal charges and stamp duty in connection with the acquisition of a lease not exceeding
99 years and on issue of shares by a company that is going public;
3. Pre-operational expenses which qualifies to be deducted if they are incurred when the
company is in operation. They should be deducted from the income of the first year of
operation.
4. Capital and revenue expenditure incurred by a farmer for prevention of soil erosion in the
case of a farming business;
5. Interest on money borrowed to earn investment income but this is limited to the
investment income earned in that year;
6. Entrance fees and annual subscription to trade association which has made an election
under section 21(2) of the income tax Act ie to be considered to be taxable;
7. Contribution of revenue or capital nature towards a scientific research related to the
organization whereby the organization is expected to benefit from the findings of the
research.
8. Contribution by the employer on behalf of his employees to a registered pension scheme
or provident fund of the national outlook;
9. Cost of revenue repairs to fixed assets. Note that revenue repairs do not enhance the
carrying capacity, economic life or value of the asset.
10. Patent renewal fees
11. Registration of patent or trademark
12. Insurance premiums
13. Reasonable entertainment for the purpose of earning business income
14. Business removal expenses from one place to another
15. Travelling expenses
16. Reasonable advertising expenses but not installation of permanent signs
17. Salaries, wages and cost of sales and other normal administration and selling costs
18. Subscriptions and donations to institutions of higher learning whose activities are
beneficial to the employees of the business and their dependants such as flying doctor
services.
19. Capital allowances stipulated in the second schedule of the income tax Act
in the case of the owner of premises, any sums expended by him during that year of
income for structural alterations to the premises the expenditure is necessary to maintain
the existing rent;but no deduction shall be made for the cost of an extension to, or
replacement of, those premises
20. Hire expense for equipment and similar items but not of motor vehicles except
commercial vehicles.
"commercial vehicle" means a road vehicle which the Commissioner
is satisfied is-

a. manufactured for the carriage of goods and so used in connection with a trade or
business; or
b. a motor omnibus within the meaning of that term in the Traffic Act; or
c. used for the carriage of members of the public for hire or reward;
 21. The amount considered by the Commissioner to be just and reasonable as representing
the diminution in value of any implement, utensil or similar article, not being machinery
or plant in respect of which a deduction may be made under the Second Schedule,
employed in the production of gains or profits;

22. Any cash donation in that year of income to a charitable organization registered or
exempt from registration under the Societies Act or the Non-Governmental Organizations
Coordination Act, 1990, and whose income is exempt from tax under paragraph 10 of
the First Schedule to this Act, or to any project approved by the Minister for Finance.

23. Expenditure of a capital nature incurred in that year of income, with the prior approval of
the Minister, by a person on the construction of a public school, hospital, road or any
similar kind of social infrastructure.
24. Expenditure of a capital nature incurred in the purchase or acquisition of an indefeasible
right to use a fibre optic cable by a telecommunication operator, provided the amount of
deductions shall be limited to five per cent per annum.

Dis-allowable deductions

1. Any expenditure which is not wholly or exclusively incurred in the production of income
for business
2. Any capital expenditure
3. Personal expenses
4. Any expenditure to earn professional income by a non-resident
5. Any expenditure payable under the contract of hiring.
6. Any loss recoverable under any insurance
7. Any tax paid
8. Any premium paid under any annuity contract
9. Court fines and penalties
10. Donations
11. General provision for bad debts
12. Any loss on disposal of assets
13. Company formation expenses

RATES OF TAX, RELIEFS AND WITHHOLDING TAXES

Rates of Tax
These are given in the Third Schedule of the income tax act (Cap 470). These rates are revised
from time to time. The rates of tax are given separately for individuals and body corporate.

Personal Relief
It is relief claimed and granted to resident individuals only.
A relief is a set-off against taxes payable.
The effect of a relief is to reduce one’s tax burden.

General Application of Relief

 Only resident individuals are eligible to claim personal relief. Therefore non-resident
individuals and corporations do not get personal relief.
 Where an individual dies during the year of income, the relief is given up to the date of
death and not thereafter.
 Where an individual departs from Kenya during the year of income, the relief is given up
to the date of departure.
 Where an individual arrives in Kenya with the intention of being a resident, the relief will
be granted from the date of arrival.

Insurance Relief
A resident individual shall be entitled to insurance relief at the rate of 15% of premiums paid
subject to maximum relief amount of kshs. 5,000 per month (or kshs. 60,000 per annum) if he
proves that:
 He has paid premium for an insurance made by him on his life, or the life of his wife or
of his child and that the insured secures a capital sum, payable in Kenya and in the lawful
currency of Kenya; or
 His employer paid premium for that insurance on the life and for the benefit of the
employee which has been charged to tax on the hands of that employee; or
 Both employee and employer have paid premiums for the insurance:

Provided that:
 No relief shall be granted in respect of part of premium for an insurance which secures a
benefit which may be withdrawn at any time at the option of the insured.
 Premiums paid for an education policy with a maturity period of at least 10 years shall
qualify for relief.
  Only premiums paid in respect of an insurance policy taken on or after 1 st January 2003
shall qualify for relief.

Withholding Taxes
The Income Tax requires withholding taxes or taxes at source to be deducted from the point of
payment and such taxes remitted to the CDT. Examples of incomes whose taxes are deducted at
source are:
 Employment income
 Dividends and interest
 Pension income.
 Insurance commissions
 Farming income subject to presumptive income tax.

This means that the incomes that are subject to withholding tax received by a resident or non-
resident persons will be received net of taxes.

Any tax collected at source whereby the payer of income is required and allowed to deduct the
tax and remit it to the government. Withholding tax is not an additional tax nor a separate tax nor
a special tax, it is a mere administrative procedure of deducting and remitting income tax on
certain incomes and minimizes chances of tax evasion.

Withholding tax rates are as follows;

Resident Payee Notes Non-Resident
Payee
Management fee 5% 1 20%x
Royalties 5% 20%
Leasing equipment 15% 2 15%
Dividend <12.5% voting power 5%x 15%x
>12.5% voting power Exempt 10%
 Interest from financial institutions’ 15%x 3 15%x
and 2 yr. bearer bonds
Interest form bearer certificates 25% 3 25%x
Housing bond interest 10% 3 and 4 15%x
Rents – immovable property 10% 30%x
Pension and taxable withdrawals 10% - 30% 5 5%x
from pension/provident funds
Insurance commissions 10%x 6 20%x
Contractual fees 3% 7 20%
Consultancy and agency fees 5% 7 20%
Consultancy fee to EA Community N/A 15%
Countries
Surplus pension fund withdrawals 30% 30%
Shipping business N/A 8 2.5%
Gross amount of consideration for 3% 9 3%
disposal of property

x Means a final tax

1. Agency fees on export of flowers and from 1.7.2006, on fruits and vegetables, are
exempted. From 1.1.2006, audit fee for analysis of maximum residue limits paid to a non-
resident laboratory or auditor are exempted.
2. Aircraft leasing exempted
3. This applies only to individuals. The non-resident rate is 15%. The resident rate is as
shown but is not a final tax for corporations.
4. Limited to income of ksh. 300,000 per annum.
5. These rates apply only on the graduated PAYE tax rates (for early withdrawal) or in
bands of ksh. 400,000 (for withdrawals after a 15 year period or at 50 years of age).
6. 5% if paid to a resident broker.
7. If fees are in excess of ksh. 24,000 per month when paid to a resident person.
8. For taxable shipping business
9. For capital gains items.
INVESTMENT ALLOWANCES

What are capital allowances?

Capital allowances refer to the amount computed to take into account loss in value of capital
goods used in the generation of profit. This amount will be treated as allowable expenses which
replaces depreciation that is not an allowable expense for tax purposes. Capital allowances are
allowable deductions against the taxable income.

Depreciation is a disallowable expense for tax purposes since it lacks uniformity among different
businesses in terms of the method and the rates of its computation. On the other hand, capital
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:
1. To encourage new industrial enterprises;
2. To allow such deduction as may be just and reasonable as representing the diminution in the
value of fixed assets by reason of wear and tear during a particular year, of any plant or
machinery used for the purpose of a business; and
3. To encourage exportation.

The distinction between capital expenditure and revenue expenditure is quite essential in the
study of capital allowances.

CAPITAL ALLOWANCES-INVESTMENT ALLOWANCES

The Tax Laws (Amendment) Act which was assented to on 25th April 2020 amends various tax
legislations.
The Second Schedule to the Income Tax Act which dealt with capital allowances has been
repealed and replaced with new second Schedule titled ‘Investment Allowance” whose key
highlights are as follows:-
a. The rate of capital allowances has been rationalized to a maximum of 100%
b. Claims to be made on  reducing balance basis
c. Decelerated claims: - 50% in the first year of investment and the residual to be claimed at
different rates (10% or 25%) on a reducing balance.
The rates of deduction are as follows:-
Capital Expenditure Incurred on: Rate of Investment Allowance
(a) Buildings 
 
i)  Hotel Buildings  50% in the first year of use
ii) Buildings used for manufacture  50% in the first year of use
iii)Hospital buildings  50% in the first year of use
iv)Petroleum or gas storage facilities  50% in the first year of use
v) Residual value to item (a)(i) to a(iv)  25% per year, on reducing balance
vi)Educational buildings including student
 10% per year, on reducing balance
hostels
vii) Commercial building  10% per year, on reducing balance

 (b)Machinery 

 i) Machinery used for manufacture  50% in the first year of use
ii) Hospital equipment   50% in the first year of use
iii) Ships or aircrafts   50% in the first year of use
iv)Residual value items (b)(i) to (b)(iii)  25% in the first year of use
v) Motor Vehicle and heavy earth moving
 25% in the first year of use
equipment
vi) Computer and peripheral computer
hardware and software calculators, copiers  25% in the first year of use
and duplicating machines
vii)Furniture and fittings  10% per year, reducing balance
viii)Telecommunications Equipment   10% per year, reducing balance
ix) Filming equipment by a local film
producer licensed by the Cabinet Secretary  25% per year on reducing balance
responsible for filming
x) Machinery used to undertake operations  50% in the first year of use and 25% per year, on  reducing
under a prospecting right balance
xi)Machinery used to undertake exploration  50% in the first year of use and 25% per year on reducing
operations under a mining right balance
xii) Other machinery   10% per year, reducing balance
 (c) Purchase or an acquisition of an
indefeasible right to use fibre optic cable by a  10% per year, on reducing balance
telecommunication operator
 50% in the first year of use and 25% per year, on reducing
 (d) Farmworks
balance

Question 1
Bakari Shoe Company Ltd commenced operations on 1 January 2021 after incurring the
following expenditure:

Sh.
Factory building 6,800,000
Processing machinery 1,600,000
 Furniture and fittings 426,000
Forklift 960,000
Delivery van 3,700,000
Tractor 4,200,000
Lorry (4 tonnes) 3,200,000
Computers 600,000
Staff clinic 1,080,000
Land 25,000,000
Wheelbarrow 36,000

Required:
Investment allowances for Bakari Shoe Company Ltd for the year ended 31 December 2021.

Question 2
Balozi Ltd is a coffee processing company. The company commenced its operations on 4
January 2021 after incurring the following expenditure:

Sh.
Factory building 9,600,000
Coffee milling machinery 2,500,000
Motor vehicle (Toyota Prado) 3,200,000
Furniture and fittings 800,000
Sports pavilion 1,600,000
Delivery vans 2,800,000
Staff canteen 620,000
Parking bay 380,000
Computers 150,000
Land 2,500,000
Mobile forklift 1,200,000

Required:
Investment allowances due to Balozi Ltd for the year ended 31 December 2021.

BUSINESS INCOME

Business refers to any trade, manufacture, vocation, venture or profession whose objective is to
make profit. Businesses may take the form of sole proprietorship, partnerships or companies.
The taxable income includes any gains / profits from business.

Allowable deductions

1. All expenditure, which is wholly or exclusively incurred in the production of the income.
2. Bad debts are allowable when they are actually incurred i.e. actually written off.
3. Capital allowances as specified in the second schedule of the Income Tax Act.
4. The amounts to be deducted under the Ninth Schedule in respect of that year of income.
5. Legal expenses of revenue nature e.g.
a) Legal costs and stamp duties in connection with acquisition of lease for not more than
99 years.
b) Collecting book debts
c) Settling disputes with customers.
6. In the case of owner of the premises, expenditure incurred for structural alterations to the
premises where such expense is necessary to maintain the existing rent income.

7. Any expenditure incurred in connection with any business before the date of
commencement of such business where such expenditure would have been deductible if
incurred after the commencement of the business.
8. The amount considered by the commissioner to be just and reasonable regarding the wear
and tear of implements, utensils or similar articles.
9. Entrance and subscription fees to a trade association
10. Revenue and capital expenditure to a research institution related to the business
11. Any contribution to a pension scheme or fund approved by he commissioner
12. Reasonable adverting and sales promotion expenses, except sign boards and neon signs
13. Tax losses brought forward from previous years
14. Prevention of soil erosion by a farmer and the cost of clearing land for the purpose of
planting permanent and semi-permanent crops.
15. Interest on money borrowed to earn investment income
16. Any expenditure incurred on mining of specified minerals
17. Revenue repairs
18. Patent renewal fees
19. Registration of trade mark
20. Insurance paid
21. Business change expenses
22. Business traveling expenses
23. Cost of sales, salaries and other office expenses
24. Capital allowances.

Dis-allowable deductions

i. Any expenditure which is not wholly or exclusively incurred in the production of income
from business
ii. Any capital expenditure
iii. Personal expenses
 iv. Any expenditure to earn professional income by a non-resident
v. Any expenditure payable under the contract of hiring.
vi. Any loss recoverable under any insurance
vii. Any tax paid
viii. Any premium paid under any annuity contract
ix. Court fines and penalties
x. Donations
xi. General provision for bad debts
xii. Any loss on disposal of assets
xiii. Company formation expenses

Receipts Not Considered Income For Tax Purposes

1. Income from overseas investment

2. Reduction in general provision for bad debts
3. In the case of partnership, any amount transferred from a reserve to profit and loss
account
4. Additional capital introduced by the owner
5. Recovery of general bad debts
6. Incomes exempted from income tax