TAXATION & TAX ADMINISTRATION

TAXATION & TAX ADMINISTRATION

1. Introduction to taxation
- History of taxation
- Principles of an optimal tax system
- Single versus multiple tax systems
- Classification of taxes and tax rates
- Impact incidence and tax shifting, Lax shifting theories
- Taxable capacity
- Budgetary and fiscal policy tools.: General definition of budgets terms ,Budget surplus and
deficits
- Role of budget officers in budget preparation and execution
- Responsibilities of the national and county treasury in relation to budget preparation
- Budget process for both national, county and Public entities
- Revenue Authority — History, structure and mandate

2. Taxation of income of persons Taxable and non taxable persons

- Sources of taxable incomes
- Employment income;
 Taxable and non taxable benefits
 Allowable and non allowable deductions
 Tax credits (Withholding tax, personal and insurance relief etc)
 Pension Income
- Business income:
 Sole proprietorship
 Partnerships (excluding conversions)
 incorporated entities (excluding specialised institutions)
 Turnover tax
- Income from use of property- rent and royalties
- Farming income
- Investment income
- Capital gains tax

3. Capital deductions
- Rationale for capital deductions
- Investment deductions: ordinary manufacturers
- Industrial building deductions
- Wear and tear allowances
- Farm works deductions
- Mining allowance
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- Shipping investment deduction
- Other deductions
4. Administration of income tax
- Overview of the income tax act
- Identification of new tax payers
- Assessments and returns
- Operations of PAYE systems: Preparation of PAYE returns, categories of employees
- Notices, objections, appeals and relief of mistake A
- Appellant bodies
- Collection, recovery and refund of taxes
- Offences, fines, penalties and interest
- Application of ICT in taxation: iTaxi Simba system

5. Administration of value added tax

- Introduction and development of VAT
- Registration and deregistration of businesses for VAT
- Taxable and non taxable supplies Privileged persons and institutions
- VAT rates
- VAT records
- Value for VAT, tax point
- Accounting for VAT
- VAT returns
- Remission, rebate and refund of VAT
- Rights and obligations of VAT registered person
- Offences fines, penalties and interest
- Enforcement
- Objection and appeals: Requirements and procedure
- Challenges in administration of VAT

6. Customs taxes and excise taxes

- Customs procedure
- import and export duties
- Prohibitions and restriction measures
- Transit goods and bond securities
- Excisable goods and services
- Purposes of customs and excise duties
- Goods subject to customs control
- Import declaration form, pre-shipment inspection, clean report of findings
- Other revenue sources
6.12 Emerging issues and trends

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TAXATION

TAX RATES: INDIVIDUALS, COMPANIES, WITHHOLDING TAXES

INDIVIDUAL RATES OF TAX

RATES OF TAX (Including wife’s employment, self employment and professional income
rates of tax)
Year of Income 2011

Monthly taxable pay Annual taxable pay Rate of tax

(Shillings) (Shillings) % in each shilling
1 - 10,164 1 - 121,968 10%
10,165 - 19,740 121969 - 236,880 15%
19,741 - 29,316 236,881 - 351,792 20%
29,317 - 38,892 351,793 - 466,704 25%
Excess over -38,892 Excess over - 466,704 30%

Personal relief Sh.1,162 per month (Sh.13,944 per annum)

COMMISSIONER’S PRESCRIBED BENEFIT RATES

Monthly Annual
rates rates
Services Sh. Sh.
(i) Electricity (Communal or from a generator) 1,500 18,000
(ii) Water (communal or from a borehole) 500 6,000

Agricultural employees: Reduced rates of benefits

(i) Water 200 2,400
(ii) Electricity 900 10,800

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PRESCRIBED BENEFIT RATES OF MOTOR VEHICLE

PROVIDED BY EMPLOYER

Monthly Annual Rates

Rates (Sh.)
(Sh)
i. Saloons, Hatch Back and Estates
Up to 1200cc 3,600 43,200
1201 1500cc 4,200 50,400
1501 1750cc 5,800 69,600
1751 2000cc 7,200 86,400
2001 3000cc 8,600 103,200
Over 3000cc 14,400 172,800
ii. pick-ups, Panel Vans
(unconverted)
Up to 1750cc 3,600 43,200
Over 1750cc 4,200 50,400

iii. Land Rovers/ Cruisers 7,200 86,400

CAPITAL ALLOWANCES:
WEAR AND TEAR ALLOWANCES
Class I 37.5%
Class II 30%
Class III 25%
Class IV 12.5%
Software 20%

INDUSTRIAL BUILDING ALLOWANCE:

Industrial buildings 10%

Hotels 10%
Hostels/Education buildings 50%
Farm works allowance 100%
Investment deduction allowance 100%
Shipping investment deduction 40%
Mining allowance:
Year 1 40%
Year 2-7 10%

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WITHHOLDING TAX:
Resident Non- Resident
Income Income Withdrawing Income Withdrawing
Tax Tax Tax Tax
Business / Trade (1) N/A (1) N/A
Employment / services rendered (1) N/A(2) (1) N/A(2)
Management / Professional fees (1) 10%(7) N/A 20%(3)
Entertainment & sporting fees (1) N/A N/A 20%(3)
Royalties (1) 5% N/A 20%(3)
Rents (1) N/A N/A 30%(3)
Equipment hire (1) N/A N/A 15%(3)
Telecommunication 5%(3)
Dividends N/A 5%(3) N/A 5%(1) /
10%(3)
Interest from financial institutions N/A 15%(3) N/A 15%(3)
and government bearer bonds of
more than two year duration
Interest on bearer certificates N/A 25%(3) N/A 25%(3)
Interest on bearer bonds with N/A 10%(3) N/A N/A
maturity of 10 years and more
Interest on housing bonds (1) 10%(4) N/A 15%(3)
Pension payment / withdrawal N/A (5) 5%(3) 5%(3)
Retirement annuities N/A N/A 5%(3) 5%(3)
Insurance commissions (1) (6) N/A 20%(3)
Presumptive income tax - 2%(7) - 2%(7)
Consultancy / Agency fees N/A 5% - 20%(8)
Contractual fees N/A 3% - 20%(8)

Notes:
(1) Final tax
(2) Limited to income of Sh. 300,000 per annum.
(3) •Withholding tax is deductible from insurance commissions paid at the rate of 5% from
amounts paid to brokers and 10% from amount paid to agents.
• From 1st January 2004, commission or fees paid by an insurance company to another for
provision of insurance cover is not subject to withholding tax.
(4) The rate for presumptive income tax (PIT) has remained while section 17A dealing with PIT
was repealed on 15% June 2000.

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(5) Special provisions may apply in relation to the petroleum industry, mining and resident life
assurance companies.
(6) Prior to 11th June 2010, lease rentals paid to residents were subject to 3% withholding tax.
(7) Prior to 9th June 2011 management and professional fees were subject to 5% withholding tax.
(8) Withholding tax on winnings from betting and gaming, is effective from 1st

COMPANIES
Resident Non- Resident Non – resident
With Kenya branch No Kenya branch
Income Incom Withholdin Income Withholding Incom Withholdin
e g Tax Tax e g
Tax Tax Tax Tax
Business / Trade 30% N/A 37.5% N/A N/A N/A
Management, Professional 30% 10% (7) 37.5% N/A N/A 20%(1)
& training fees
Entertainment & sporting 30% N/A 37.5% N/A N/A 20%(1)
fees
Royalties 30% 5% 37.5% 5% N/A 20%(1)
Rents 30% N/A 37.5% N/A N/A 30%(1)
Equipment hire 30% N/A 37.5% N/A N/A 15%(1)
Telecommunication 5%(1)
Dividends N/A 5% N/A 5% N/A 10%(1)
Interest from financial 30% 15% 37.5% 10% N/A N/A
institutions and
government bearer bonds
of more than two year
duration
Interest on bearer 30% 25% 37.5% 20% N/A 25% (1)
certificates
Interest on bearer bonds 30% 10% 37.5% 10% N/A N/A
with maturity of 10 years
and more
Interest on housing bonds 30% 15%(2) 37.5% 15% N/A 15% (1)
Insurance commissions 30% (3) 37.5% (3) N/A 20%(1)(3)
Presumptive income tax - 2%(4) - 2%(4) N/A N/A
Contractual fees 30% 3% 37.5% N/A N/A 20%(1)
Consultancy & agency fees 30% 5% 37.5% N/A N/A 20%(1)
Lease rentals 30% N/A(6) 37.5% N/A N/A 15%(1)
Winnings from betting and 30% 20%(8) 37.5% N/A N/A N/A
gaming

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Notes:
1. Final tax
2. Limited to income of Sh. 300,000 per annum.
3. •Withholding tax is deductible from insurance commissions paid at the rate of 5% from
amounts paid to brokers and 10% from amount paid to agents.
a. From 1st January 2004, commission or fees paid by an insurance company to another
for provision of insurance cover is not subject to withholding tax.
4. The rate for presumptive income tax (PIT) has remained while section 17A dealing with
PIT was repealed on 15% June 2000.
5. Special provisions may apply in relation to the petroleum industry, mining and resident life
assurance companies.
6. Prior to 11th June 2010, lease rentals paid to residents were subject to 3% withholding tax.
7. Prior to 9th June 2011 management and professional fees were subject to f5% withholding
tax.
8. Withholding tax on winnings from betting and gaming, is effective from 1st

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INRODUCTION TO TAXATION

HISTORY AND PURPOSE OF TAXATION

Before 1897, Kenya was made up of multifarious tribal-based societies each with its own
geographical and sociological background. These societies were communist/socialist in the sense
that property was communally owned by all the members of a particular social setup. Upon
amassing wealth in form of harvests, part of it was required to be submitted to the community
leaders in form of tithe. This “tithe” was to be used in future to assist those who didn’t have
enough property to sustain them or even to assist those who were hit by calamities. In a sense, this
was a form of taxation because the percentage that was submitted to the community leaders was
used to help others in future.

The principles and systems of taxation that existed in most African Kingdoms during this period
were therefore informal. It was only upon the influx of foreigners that some form of formal
taxation started. The Arabs who entered Kenya in the seventh century for example taxed the
coastal region on the basis of Islamic Law. Islamic law upholds the right of leaders to tax their
subjects within bearable limits and therefore taxation is not forbidden. Capitation of such tax was
done by charging a fixed amount for each and every slave that was to be exported from the
Sultanate of Oman. Custom duties were also charged on other exports like ivory, cloves and beads.

The Portuguese arrived at the Kenyan coast and were now taking over from the Arabs. The first
recorded treaty that involved a form of taxation in this period was in 1502. The then Sultan
Ibrahim of Malindi was held against his wishes and forced to accept defeat. While being held
hostage during negotiations on Vasco da Gamma’s boat, a treaty of surrender was signed with
Portugal for an annual tribute of 1,500 meticals of gold.

However, the Portuguese were violent and thus this led to a complete failure to use equity in the
creation and levy of taxes there were riots (you thought riots started the other day?) were
punctuated with civil disobedience and widespread cases of tax evasion and avoidance.

By the end of the rule of the Arabs and Portuguese along the East coast of Africa the existing
balance of taxation that was inherited by the British included a capitation tax payable per head of
slave exported and customs revenue shared equally between the Arabs and Portuguese. The tax
base was, however, limited to traders only.

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Exit Portuguese and Arabs, Enter The British

Next were the British who ruled what is presently Kenya and Uganda together to form British East
Africa Protectorate. British colonial tax policy developed mostly on the grounds that Britain
needed to support its own economy by creating foreign markets and sources of raw materials for
its industries, thus obtain maximum gains with minimum input. This was done by initially through
the Chartered company concept. However, later in order to encourage rule from within the territory
to make it viable after the accidental discovery of arable land in Kenya.

British Taxes

Hut and Poll Tax: The 1901 Hut Tax Regulation imposed a tax of one rupee, payable in kind or
through labour, upon every native hut in British East Africa. Hut tax or poll tax was increased to 5
rupees in 1915 and again in 1920 to 8 Rupees.

Land Tax: The levying of a graduated land tax on individual holdings was introduced by the
British as a sound basis for land policy in East Africa. The protectorate government in East Africa
argued in early 1908 for preserving the means of obtaining some share of any future appreciation
in the value of the land, particularly because much of the land acquired by settlers was not being
developed.

Graduated Personal Tax: The Graduated Personal Tax was introduced in 1933. The Act
was modeled on the Colonial Income Tax Ordinance which itself was a ‘simplified synthesis’ of
the United Kingdom Income Tax Act of 1920. Now graduated taxes on global income would have
been considered revolutionary because non-Africans were liable to a fl at poll rate and an
Educational Tax. This tax was applied for the fi rst time in 1934 at rates graduated according to the
taxpayer’s income with certain amendments.

Income tax: It was first introduced in Kenya in 1921, and in 1954, the rates of personal income
tax were set at 20 shillings for anyone earning less than £60, for earnings between £ 60- 120
charge of 40 shillings and for earnings over £120 a charge of 60 Shillings. In 1956, a
Commission of Enquiry into the Administration of Income was established and was chaired by
Sir Erick Coates.

Kenya’s taxation system and policy after independence

The first post-independence strategy on matters taxation and policy was set out in Kenya’s earliest
planning document entitled Sessional Paper No. 10 of 1965 on African Socialism and its
Application to planning in Kenya. The main purpose of the paper was to guarantee all citizens
equal political and economic rights. The paper stated that the economic approach of the
government was to ensure Africanisation of the economy and also the public service16. The

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government would concentrate investment in places where it was likely to maximize returns which
would subsequently be distributed to the rest of the country.
The paper laid down the foundation for the country’s fiscal policy framework. By the year 1972,
the economy of the country expanded and this saw the introduction of Sales Tax in 1973 which,
coupled with the first oil crisis of 1973, led to an economic shock and an increasing debt problem.
The resultant fiscal reforms included 20% withholding tax on nonresident entrepreneurs, capital
allowance restricted to rural investment, a new tax on the sale of property, taxes on shares, the sale
of land and a custom tariff of 10% on a range of previously duty-free goods.
Kenya later came up with its own income tax department as a department of treasury and also
came up with its own income tax legislation known as the Income tax Act which commenced on
1st January 1974 and it was codified as Chapter 470 of the laws of Kenya. The preamble to this
Act reads as follows, “An Act of Parliament to make provision for the charge, assessment and
collection of income tax: for the ascertainment of the income to be charged; for the administrative
and general provisions relating thereto; and for matters incidental to and connected with the
foregoing”. The preamble gives us the scheme or the various components with which this law has
dealt with.

PURPOSE OF TAXATION

1. Raising public revenue to meet public expenditure for a common cause.

2. Protection of the health of citizens. Heavy taxes are imposed on goods that are considered to
be harmful to the health of citizens if consumed in large quantities such as beer and cigarettes.
3. Protection of local industries. Heavy taxes are imposed on imported goods which are
substandard or goods that are available locally in plenty.
4. Encourage exportation and hence the generation of foreign currency e.g. Exports are zero
rated for VAT purposes, i.e. VAT paid on purchases used for processing exports is refundable.
 Export processing zones (EPZ). These are designated areas where the industries located are
granted attractive tax incentives in exchange of exporting manufactured goods e.g.
- Corporation tax is not payable during the first ten years of operation.
- Corporation tax is payable at a rate of 25% from the 11th to 20th year of operation.
- Capital expenditure or machinery and factory building is deductible at 100% cost known
as investment deduction.
 Manufacturers under bond (MUB). These are manufacturers that are licensed by the customs
department to manufacture for export purposes for at least three years. Such manufacturers are
granted 100% investment deduction on capital expenditure incurred on machinery and factory
buildings.
5. To encourage savings for retirement.

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 As a contributor: contributions to a registered pension scheme are exempted from tax up

to a maximum of Sh. 240,000 p.a. (20,000 per month)

TYPES OF TAXES

 Income tax
This is the tax imposed on income derived by individuals, (i.e. Pay as You Earn) and
businesses (i.e. Corporation Tax).
 Value Added Tax (VAT)
This is the tax imposed on goods and services supplied in Kenya and goods and services
imported into Kenya.
 Excise duty
This is tax imposed on locally manufactured goods such as textiles, shoes wines and spirits.
 Custom duty
This is tax imposed on imported goods such as machinery, cars, Electronics e.t.c.

TAXES CHARGED ON SPECIFIC ITEMS

1. Petroleum levy
This is the tax that is imposed on the prices of petroleum products. The revenue collected is
used to maintain roads in the country.
2. Airport tax
This is the tax imposed on air tickets through various airlines. The amounts collected are used
to improve or maintain airport facilities such as the run-ways.
3. Stamp duty
It is imposed by the government on the transfer of properties and on certain instruments or
legal documents. The purpose of stamp duty is to ensure that the transactions are legalised.
4. Catering levy
This is a tax imposed by the government on services and food supplied in certain hotels. The
amounts collected from catering levy are used to improve tourism industry e.g. maintaining of
institutions offering courses in hospitality such as Utalii College.

TAXES BY LOCAL AUTHORITIES

1. Rates
These are charged by local authorities on property owners e.g. land and buildings within the
local authority.
2. Cess
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This is the levy imposed by the rural local authorities on certain products such as sand, stones
etc. The amounts collected are used to develop roads, hospitals, schools and provision of water
within the local authorities.

SUB-TAXES

1. Presumptive tax
This is tax that is levied on farm produce at the rate of 2%. Such produce include wheat, tea,
coffee, maize e.t.c
2. Withholding tax
This is tax deducted at source i.e. income is paid net of withholding tax e.g. incase of dividends
withholding tax is 5% of income received.
3. Advance tax
It is charged in advance on commercial vehicles before granting road licenses. Commercial
vehicles include Lorries, vans, matatus, pickups e.t.c.
Advance tax is payable annually in respect of all commercial vehicles at the following rates:-
 For vans, pick-ups, trucks, lorries with effect from 11 June 2010, prime movers and trailers
but excluding tractors and trailers used for agricultural purposes; Sh. 1,500 per ton of load
capacity p.a. or Sh. 2,400 p.a. whichever is higher; and
 For saloons, station-wagons, mini-buses, buses and coaches; Sh. 60 per passenger capacity
p.m. or Sh. 2,400 p.a. whichever is higher.
Prior to 11 June 2010 advance tax was applicable on all public service vehicles.

4. Turnover Tax
Turnover tax was introduced with effect from 1 January 2007 for businesses with a turnover of
less than Sh. 5 Million p.a., but exceeding sh. 500,000 p.a. The applicable rate is 3% of the
gross receipts of the business.
Turnover Tax shall not apply to:
 Rental income and management or professional or training fees;
 The income of incorporated companies; and
 Any income which is subjected to a final withholding tax

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STATUTORY DEDUCTIONS

These are mandatory deductions made from employees salaries and wages by the employers
who remit the amounts deducted. Statutory deductions include:-

P.A.Y.E
It is a statutory duty of all employers to deduct income tax from the wages or salaries paid to
the employees. This provision also applies to the Government. The P.A.Y.E. system does not
apply to the case of casual employees.
P.A.Y.E is not a tax; it is a system of collecting tax from the income of the employees. Under
this system, tax is deducted from the salaries and the net amount paid to the employees. If the
employee does not have any other taxable income, the tax deducted under P.A.Y.E. will be
enough to cover his tax liability and he will not be required to pay any extra tax at the end of
the year. The normal P.A.Y.E. year runs from 1st January to 31st December.
It is the employers’ statutory duty to deduct income tax from the pay of his employees. If an
employer fails to deduct tax from salaries paid to his employees (or remit the money so
deducted) to the income tax department, the Commissioner of Domestic Taxes has the power to
impose penalty not exceeding Sh. 10,000 and require him to pay the tax which he should have
deducted from his employees’ income.

NATIONAL SOCIAL SECURITY FUND (NSSF)

The contributions are at 12% of the monthly employee's pensionable pay, with 6% deducted from
the employee and 6% contributed by the employer. The is deducted in a two Tier contributions
system i.e.; Subject to an upper limit of the Sh2,160 for employees earning above Sh18,000. The
lower earnings limit being Sh6,000.

Contributions for people earning above Sh18,000 are however divided into two levels of accounts
which are referred to as Tier I and Tier II.

In Tier I account, contributions are up to Sh720 while in Tier II is the balance of the contributions
of earnings between the minimum and up to the maximum which is Sh1,440

Voluntary Contributions

That under the National Social Security Fund (NSSF) Act, you can make your contributions even
if you are not formally employed

Voluntary contributors will remit into the Provident Fund;

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 A minimum of 200 shillings in a month or 4, 800 shillings in a year

THE FOLLOWING BENEFITS ARE PROVIDED UNDER THIS SCHEME:

 Age benefits – This will be paid to a member at age of sixty or when he ultimately
retires from paid employment, whichever is later.
 Withdrawal Benefit – This will be paid to a member who is at least fifty-five years of
age and has not engaged in paid employment during the previous three months
 Invalidity Benefit – This will be paid to a member who is permanently incapable of
work because of physical or mental disability.
 Survivors Benefit – This will be paid to the dependants of the deceased member.
 Emigration Grants – This will be paid to a member who is permanently emigrating
from Kenya.
 As a person in the service of any University or College who is entitled to receive
benefits under superannuation scheme other than the Superannuation Scheme for
Universities.

NATIONAL HOSPITAL INSURANCE FUND (NHIF)

This is a statutory deduction made under the National Hospital Insurance Act. The Act requires
every employee to contribute some amount per month towards this fund

The rates are as follows:

Gross Income (Ksh) Monthly NHIF Premium (Ksh)

0-5,999 150
6,000 – 7,999 300
8,000 – 11,999 400
12,000 – 14,999 500
15,000 – 19,999 600
20,000 – 24,999 750
25,000 – 29,999 850
30,000 – 34,999 900
35,000 – 39,999 950
40,000 – 44,999 1,000

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45,000 – 49,999 1,100

50,000 – 59,999 1,200
60,000 – 69,999 1,300
70,000 – 79,999 1,400
80,000 – 89,999 1,500
90,000 – 99,999 1,600
100,000 and above 1,700
Self Employed (special) 500
Members or contributors and their families (husband, wife or children) enjoys both inpatient and
outpatient services.
Key Term
Tax – It is a compulsory contribution made by citizen to the state for it to meet its expenses for a
common cause.
Charge – It maybe compulsory or voluntary but related to the enjoyment of a certain benefit or
privilege
QUESTION:

Mr. KK was paid a salary of sh.22, 000 per month. He contributed Sh. 4,000 per month to a
registered pension scheme. Calculate his taxable income

ANSWER:

Sh.
Basic salary 22,000
Less contribution to pension:
Actual 4,000
Set limit 20,000 (4,000)
30% gains from employment 6,600
(30% x 22,000)

Taxable income 18,000

 On retirement: Incase pension is received in lumpsum the first Sh. 600,000 is exempted
from taxation. However, where pension is received in periodic amounts, the first sh.300,000
received per annum is exempted from taxation.

QUESTION:

Mrs. Chagua received pension of Sh. 1,200,000 out of which sh. 350,000 was annual entitlement.
Calculate her taxable income.

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ANSWER:

Sh.
Pension-Lump sum 850,000
Less exempt (600,000)
250,000

Periodic 350,000
Less exempt (300,000) 50,000
Taxable income 300,000
6. Encouragement of citizens to acquire residential property
 The interest paid on a loan acquired to purchase a residential house which is owner occupied is
allowable deduction from income up to a maximum of sh. 150,000 per annum.

QUESTION:
Mr. Ali was paid a salary of Sh.550, 000 during the year 2011. He obtained a loan from HFCK of
Sh.4, 000,000 which he used to purchase his residential house. He paid interest on the loan
amounting to sh. 210,000during the year. Calculate his taxable income.

ANSWER:
Sh.
Basic salary 550,000
Less mortgage interest
Actual 210,000 (150,000)
Set limit 150,000
Taxable income 400,000

 Savings to a registered home ownership savings plan is allowable as a deduction up to a

maximum of sh.4,000 (sh.48,000 per annum)

QUESTION:

Mr. Najibu received a salary of Sh.600,000 during the year 2011. He contributed 25% of his salary
to the company’s registered pension scheme and 10% of his salary to a registered home ownership
savings plan. Calculate his taxable income

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ANSWER:
Mr. Najibu
2011 computation of taxable
income Sh.

Basic salary 600,000

Less contribution to pension:
Actual 25% x 600,000 150,000
Set limit 240,000 (150,000)
30% gains from employment 180,000

Less contribution to Hosp:

Actual 10% x 600,000 60,000 (48,000)
Set limit 48,000

Taxable income 402,000

7. Taxes are used to stabilize the economy.
During inflation i.e. when price levels increase due to increased demand, taxes are levied
heavily in order to reduce the money in circulation. During deflation when activities in the
economy are low, taxes may also be reduced to improve demand, increase economic activity
and employment in the economy.

8. Redistribution of income
Persons with more income i.e. for both individuals and companies are taxed more than those with
lower incomes and the revenue collected is used to develop all the under-developed areas.

9. To encourage the development of industries.

Capital expenditure incurred on purchase of machinery and factory buildings is allowed as a
deduction at the rate of 100% referred to as investment deduction.

Key Terms
Inflation – this is defined as a situation of increasing price levels due to an increase in money in
circulation
Deflation – This is defined as a case of lack of demand for goods and services due to high level
of interest rates hence increased cost of borrowing.

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PRINCIPLES OF AN OPTIMAL TAX SYSTEM

These refer to the rules or standards established by economic scholars for an optimal tax system.
The principles guide the formulation of tax systems by the government.
Adam smith was the first economic scholar to state four principles of taxation. Other economic
scholars proposed 5 additional principles.

The major principles of taxation include:

1. PRINCIPLE OF EQUITY

Adam smith stated that every taxpayer should pay tax according to his ability in proportion
to his income. Persons with high incomes should pay more tax than the persons with lower
incomes.
In Kenya the principle of equity is achieved in two ways i.e.:

 By adopting the graduated scale rates.

In 2011 the graduated scale is as follows:
Income Sh. P.a
Excess above 466,704 30%
351,793 – 466,704 25%
236,881 – 351,792 20%
12,969 – 236,880 15%
1 - 121,968 10%

 Employment income of up to sh.11, 135 p.m. is exempted from income tax under the PAYE
system.

2. PRINCIPLE OF CERTAINTY

Adam smith also stated that the tax which every person should pay must be certain and not
arbitrary.
This principle facilitates planning by both the government and the taxpayers.
In case of the taxpayers, they need to be certain about the dates and the amount of tax to be paid,
the methods and the rates of tax used in order to plan their cash flows.
In case of the government, it should be certain about the amount of public revenues and the time it
is expected to flow to the exchequer.

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In the Kenyan tax system certainty is achieved as follows:

 VAT is paid on the 20th day of the following month after the month of transactions.
 Corporation tax is charged at the rate of 30%.
 Withholding tax on dividend is 5% and 15% on interest income.

3. PRINCIPLE OF CONVENIENCE

Every tax should be levied at the time or in a manner that is most likely to be convenient to the
taxpayers.
This principle encourages tax compliance by the tax payers e.g. a tax payer may pay installment
tax in 4 equal installments during the year.
Income tax on employment income is paid at the end of the month i.e. when the employees have
the means of payment after receiving their salaries.

NB: VAT may be inconvenient to a person in case of supplies of goods and services which are
made on credit. This is because VAT has to be paid by the 20th day of the month after the month of
transactions, whether cash has been received from the debtors or not.

4. PRINCIPLE OF ECONOMY
The tax system should be economical to both the taxpayer and the state. In the case of the tax
payer, he should be left with some income after paying tax both for his needs and for saving and
investments. A very heavy tax will discourage saving and investments, thus have a negative
impact on the economy
In case of the government, the cost of tax collection, administration and carrying out indepth
investigation should not exceed the tax revenue to be collected. In the Kenya tax system the tax
payers are granted tax relief i.e. Personal relief of sh.13,944 p.a is deducted from tax liability for
every tax payer.
In addition income of up to Sh.11, 135 p.m. is exempted from income tax in Kenya.

The other principles are:

5. PRINCIPLE OF SIMPLICITY

The tax system should be simple to understand by ordinary tax payers, Complexities in the tax
law, multiple taxes and rates should be streamlined to encourage tax compliance. Additionally, the
government should not face administrative challenges in implementing the tax system. In Kenya
simplicity has been achieved by:

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- Online filing of tax returns.

- Tax payment through Commercial Banks.
- Few documents required in filing of tax returns.
- Ease in calculating taxes e.g. turnover tax at the rate of 3% of turnover

6. PRINCIPLE OF ELASTICITY

The tax system should be responsive to changes in the economy.

More revenue should be collected in time of economic prosperity while taxpayers should be
cushioned in times of economic depression to sustain demand and employment. The system
should provide tax relief for large tax payers during difficult economic times. In addition the
government should be able to increase or decrease the rates of tax according to the revenue
requirements of the state e.g. the VAT rate was 15% in 1990 and was subsequently increased to
18% and is currently 16%.

7. PRINCIPLE OF FLEXIBILITY

There should be no rigidity in the tax system and the tax legislation. The tax provisions and
sections should be easily adjusted, amended or abolished if necessary to meet the revenue
requirements of the state.
In 1998 section 12B of the income tax Act was introduced. This was an amendment to the
income tax Act, which deals with fringe benefit tax (FBT) charged on loans granted to
employees at an interest rate that is lower than the market interest rate. Before 12th June 1998
the tax was known as low interest benefit tax.
Fringe benefit tax is paid by the employer at the corporation tax rate.

8. PRINCIPLE OF PRODUCTIVITY

The tax system should yield substantial amounts of revenue to the government. A few taxes
that yield much revenue are better than a variety of taxes yielding small amounts of revenue.
Any system that does not yield sizeable amounts of revenue should be discarded and replaced
with more productive taxes. In Kenya certain taxes have been abolished over the years
e.g.

- Capital gains tax

- inheritance tax abolished in 1985 and replaced with increased stamp duty
- gift tax
- Sales tax

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- Accommodation tax absorbed in VAT in 1990

- Telephone and electricity tax

9. PRINCIPLE OF DIVERSITY
A single or very few types of taxes may not meet the revenue requirements of the state or
satisfy the principal of equity. It is required to have a variety of taxes to enable citizens to
contribute towards public revenue according to their ability. However, there should be an
optimal number of taxes so that it is economical for the government to administer.

Key Term
Elasticity- It refers to how the tax system responds to changes in the economy e.g. it is
expected that tax revenue should increase in times of economic boom
Flexibility – It refers to the sections of the tax law which should be possible to change or
amend or discard.

CLASSIFICATION OF TAXES

1. BY EFFECTS
The effect of tax may be considered through its impact and incidence;

 The impact of a tax is on the person on whom it is imposed i.e. the person with the ultimate
responsibility to account for the tax to the authorities.
 The incidence of a tax refers to the money burden or where payment of tax is made.

In this case a tax may be classified as either a Direct or Indirect tax. In case of a direct tax, both
the impact and the incidence of tax are on the same person i.e. the tax cannot be shifted to
another person e.g. income tax, corporation tax e.t.c
In case of an indirect tax, the impact is on one person while the incidence is on another person.
It means that the tax can be shifted e.g. VAT where it is imposed on the suppliers of goods and
services but paid by the consumers.

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MERITS AND DEMERITS OF DIRECT

TAXES MERITS

Direct taxes possess the following merits:

a) Equitable
Direct taxes are based on the canon of equity. Tax burden is equitably distributed as they
are progressive in nature. As the income of a person increases, the rate of income tax also
increases. So all direct taxes fall heavily on the people whose income and wealth increase.
The poor are not affected by such taxes.

b) Certain
Direct taxes satisfy the canon of certainty. The tax payer is certain as to the time and
manner of payment, and the amount to be paid in the case of these taxes. Similarly, the
government is also certain as to the revenue it shall receive from these taxes.

c) Economical
These taxes also satisfy the canon of economy. The cost of collection of direct taxes is low.
In the case of income tax, it is deducted at the source from salaried persons. The
assessments of wealth, incomes, inheritances, gifts e.t.c. can be made by the same officers.
No separate staff is needed for each. Such taxes are also economical to the tax payers who
make payments directly into the treasury.

d) Elastic
Direct taxes satisfy the canon of elasticity. The government can increase or decrease the
rates of direct taxes according to the requirements of the economy. In case of war, natural
calamities, or emergency, the state can raise the rates of taxes in order to have larger tax
revenue. During a depression, it can reduce rates of taxes considerably.

e) Simple
Direct taxes are simple and easy to understand.

f) Desirable
These taxes do not involve general opposition from the public because they are paid by
those persons or firms who come under the jurisdiction of income tax or corporation tax.
Thus, they are based on the canon of equity.

g) Reduce inequalities

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These taxes help to reduce income and wealth inequalities because of their progressive
nature. The rich are taxed heavily through income tax, property rates, expenditure tax,
corporation tax, etc. The poor and the income groups which lie below the minimum tax
limit of Sh.11,135 p.m. are exempted from income tax.

h) Civic consciousness
Direct taxes create civic consciousness among the taxpayers. They are conscious that they
are paying taxes to the government and take interest in the activities of the state as to
whether public expenditure is incurred on public welfare or not. Such civic consciousness
puts a check on the wastage of public expenditure in a democratic county.

DEMERITS

Direct taxes have the following demerits.

a) Pinch
Direct taxes pinch the tax payers because they have to pay directly out of their incomes or
salaries. They are, therefore, unpopular.

b) Inconvenient
These taxes are inconvenient in nature because traders, businessmen, producers, etc., have to
comply with a number of formalities relating to their sources of income and expenditure
incurred in earning that income. Often the details are incomplete and the various sections of the
Act so complicated that the tax payers have to use the help of tax consultants hence incurring
additional cost for tax compliance. Moreover, these taxes are payable in advance and in lump
sum, except in the case of salaried persons. Hence they are inconvenient.

c) Arbitrary
Direct taxes possess an element of arbitrariness in them. They leave much to the discretion of
the tax authorities in fixing the rates of taxation and in interpreting them.

d) Evasion
Since direct taxes pinch every tax payer, tax evasion is perpetrated by filing wrong returns and
engaging tax consultants. Thus such taxes encourage dishonesty and result in loss of revenue to
the government.

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e) Not imposed on all

Direct taxes are not imposed on all income groups. Low income groups do not come under the
purview of these taxes. Such groups, therefore, do not contribute anything to state exchequer
through direct taxation.

f) Discourage saving and investment

Direct taxes adversely affect saving and investment. When people are aware that with increase
in their income and wealth, more tax is paid, they are reluctant to increase their saving and
investment. This adversely affects the will to work, save and invest.
g) Discourage production
Corporation taxes discourage those industries and firms which produce essential goods.

MERITS AND DEMERITS OF INDIRECT TAXES

MERITS

Indirect taxes possess the following merits:

a) Convenient
Indirect taxes are convenient and less burdensome e.g. these are paid only when a commodity
or a service is bought. Therefore the amounts paid are small rather than in lump sum. Since
these taxes are included in the prices of commodities, buyers do not feel the burden. Such taxes
are like sugarcoated pills.

b) Wide coverage
These taxes reach the pockets of all income groups – low, middle and high. The taxes are
levied on different types of goods e.g. necessaries, comforts and luxuries. Thus such taxes have
a wide coverage and every consumer pays to the state exchequer according to his ability to pay.
Thus they are equitable.
c) Elastic
Indirect taxes are also elastic in nature. The government can reduce or increase the rates of tax
e.g., excise duties or custom duties according to its requirements. But care should be taken in
order to avoid imposing high rates on necessaries which are mostly consumed by the poor.
d) Economical
These taxes are economical in the sense that the cost of collection is reduced because the
producers and sellers deposit the amounts collected with the government.

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e) Diversity
Indirect taxes satisfy the canon of diversity. These can be levied on a variety of commodities
and services. So the government can be sure of continuous and sufficient revenue, even if it is
required to reduce the rates of taxes on certain commodities due to the fall in demand.
f) Less evasion
There is less possibility of evasion in the case of indirect taxes since these are included in the
prices of commodities. As these taxes are transferable to the ultimate consumers, the producers,
the wholesalers and the retailers do not mind paying them. The consumers can evade them only
if they decided not to buy the taxed commodities. However, these taxes are generally evaded
by producers when they sell their products to the wholesalers and retailers without entering the
goods in their stocks and without issuing cash receipt for the same.
g) Check the consumption of Harmful Goods
Indirect taxes have the great merit of checking the consumption of harmful goods like wine,
cigarettes and other intoxicants. The state levies heavy duties on goods which are harmful to
the health and efficiency of the citizens if consumed in large quantities. As a result, their prices
rise and their consumption is reduced. The state also earns substantial revenue.

h) Powerful tool of economic policies

Indirect taxes can be used as a powerful tool for implementing economic policies by the
government. If the government wants to protect domestic industries from foreign competition,
it can levy heavy import duties. This will help to develop domestic industries. If the
government wants to encourage one industry on priority basis, it may not levy any taxes on its
products but continue the taxes imposed on other industries. The government may do so in
order to encourage a particular technology or employment in a particular industry.

DEMERITS

a) Uncertain Revenue
The revenue from indirect taxes is uncertain because it is not possible to accurately estimate the
effect of such taxes on the demand for products. If heavy excise duty is levied on some luxury
goods, the price will rise. Since the demand for luxury goods is elastic, sales may be adversely
affected by a fall in demand and the state revenue may actually decline.

b) Regressive
Indirect taxes are charged on necessities, which are consumed by the poor. This makes them
regressive in nature. The rich and the poor are required to pay the same amount of tax on
commodities such as matches, kerosene, toilet soap, washing soap, tooth paste, razor blades,

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shoes etc., but the burden is heavier on the poor than on the rich. Thus these do not satisfy the
canon of equity.

c) Uneconomical
These taxes are uneconomical in that the cost of collection to the state is heavy. The state has to
appoint inspectors to check the accounts and stocks of producers, wholesalers, and retailers in
order to find out whether they are paying taxes or not. Thus they are more expensive than direct
taxes.

d) Bad effect on production and employment

Sometimes, these taxes adversely affect production of commodities, and even employment.
When the price of a commodity increases with the levy of a tax its demand falls (if it happens
to be a commodity with elastic demand). As a result, its production falls, and so does
employment.
e) Feed inflation
Imposition of these taxes tends to raise the prices of commodities, thereby leading to higher
prices. Thus price-wage-cost spiral sets in the economy, which feeds inflation.
f) Lack of civic consciousness
A person who buys a commodity does not know that he is paying a tax to the government in
the price of the commodity. Therefore, such taxes do not create civic consciousness among the
majority of tax payers who are ignorant of the fact that they are contributing tax to the state
exchequer.
2. By tax bases
The tax base is the object that is subjected to the rates of tax to determine the tax payable. In
this case taxes may be classified as:
 Income tax
The tax base is the income derived by an individual.
 Corporation tax
The tax base is the profit derived by a company.
 VAT
The tax base is the value of supplies of goods and services.
 Import duty
The tax base is the value of imported goods.
 Excise duty
The tax base is the value of locally manufactured goods.

3. By rates
The rate of a tax is the percentage or proportion of the tax base. Rates of tax can be:
 Progressive

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 Degressive
 Regressive
 Proportional

PROGRESSIVE RATES

In this case the rates of tax increase as income increases. This form of taxation affects the rich
more than the poor and is widely used all over the world.
In Kenya progressive rates are used to determine the tax liability of individuals’ e.g. the graduated
scale rates for 2011 are as follows:
Income (Sh.) p.a

Excess above - 466,704 30%

351,793 – 466,704 25%
236,881 – 351,792 20%
121,969 – 236,880 15%
1 - 121,968 10%

Personal relief is Sh.13,944 p.a.

DEGRESSIVE RATES
These are similar to progressive rates of taxation in that the rates of tax increase as income
increases. However in the case of degressive taxes, the rate of progression is not as steep as in the
case of progressive rates e.g. comparing 1980 graduated scale rates to those of 2011 shows the
1980 rates as degressive.

1980 Graduated Scale Rates

1K£ = sh.20
Income (K£) p.a
Excess above - 8,400 Sh.13
7201 - 8,400 Sh.11
6001 - 7,200 Sh.9
4801 - 6,000 Sh.7
3601 - 4,800 Sh.5
2401 - 3,600 Sh.4
1201 - 2,400 Sh.3
1 - 1,200 Sh.2
Personal relief is Sh. 7,820 p.a.

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REGRESSIVE RATES

The rates of tax reduce as income increases, it means that those with lower incomes are taxed at
higher rates than those with higher incomes.
The main purpose of taxation is income redistribution; therefore regressive rates cannot achieve
that purpose. Regressive rates are not commonly used in many countries, however VAT may be
said to be regressive in nature since both the rich and the poor pay VAT at the same rate of 16%,
hence the tax burden is heavier on the poor than on the rich.

PROPORTIONAL RATES

In this case the same rate of tax is applied at all levels of income e.g. corporation tax rate is 30%
for all companies regardless of the level of profit.

QUESTIONS:
1. Bidii company Ltd, reported a profit of Sh. 12,000,000 in 2011
Calculate the tax payable.
2. Swift Kenya Ltd is a branch of Swift International Co. of USA. Swift Kenya Ltd
reported a profit of Sh.8, 000,000 in 2011. Calculate the tax payable.
3. Jaza company Ltd reported income in 2011 was follows:
- Business income Sh.3, 000,000
- Rental income Sh.8, 000,000
- Farming loss Sh.2,800,000
Calculate the tax payable.
ANSWERS:

1. Corporation tax payable

30% x Sh. 12,000,000

= Sh.3, 600,000

2. Corporation tax payable

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37.5 x 8,000,000

= Sh. 3,000,000

3. Corporation tax payable

(3000, 000 + 8,000,000) x 30%

= Sh. 3,300,000

N/B. Farming Loss is carried forward to be offset against future profits from the same
source

IMPACT AND INCIDENCE OF A TAX

 The impact of a tax is on the person on whom it is imposed i.e. the person with the ultimate
responsibility to account for the tax to the authorities.
 The incidence of a tax refers to the money burden or where payment of tax is made.

In this case a tax may be classified as either a Direct or Indirect tax. In case of a direct tax, both the
impact and the incidence of tax are on the same person i.e. the tax cannot be shifted to another
person e.g. income tax, corporation tax e.t.c
In case of an indirect tax, the impact is on one person while the incidence is on another person. It
means that the tax can be shifted e.g. VAT where it is imposed on the suppliers of goods and
services but paid by the consumers.

TAX SHIFTING

This refers to the transfer of the money burden of tax to another person. Tax shifting is carried out
through the revision of price .Tax may be shifted forward, backward or partly forward and
backward.
Incase of forward shifting of tax a supplier is able to pass additional tax to the consumer through
the increase in price of a commodity.
Forward shifting of tax is possible where the demand of a commodity is inelastic i.e. the
responsiveness of demand to changes in price is proportionately lower e.g. incase of goods such as
beer wines and spirits or cigarettes.
Backward shifting of tax occurs where the producer is unable to pass an increase of tax to his
consumers but instead he negotiates lower purchase prices with the suppliers of factors of
production.

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Backward shifting of tax occurs where the demand of a commodity is elastic i.e. the
responsiveness of demand to changes in price is greater proportionately e.g. incase of goods with
substitutes such as soaps, detergents, cooking fat, milk e.t.c

FACTORS THAT INFLUENCE TAX SHIFTING

 Elasticities of demand and supply

The higher the elasticity of demand, the lower the incidence of tax on the consumer. The
higher the elasticity of supply, the higher the incidence of tax on the consumer
 Nature of markets
In an oligopolistic market (few sellers and many buyers) tax shifting to the buyers is high
since the few sellers can team up to determine the market price. For many sellers and many
buyers, a large portion of tax will be borne by the sellers. For a monopolistic market, the
entire tax burden falls on the shoulders of the buyers.
 Time available for adjustment
The person who can adjust faster (buyer or seller) will be able to shift tax e.g. if the buyer
can shift to substitute goods, the seller will bear the tax burden.
 Government policy on pricing
Incase of Government price control, the supplier cannot increase price hence cannot shift
tax burden to buyers.
 Geographical location
If taxes are imposed only on certain regions, it is hard to shift them to consumers because
consumers will move to regions of low tax.
 Nature of tax (direct or indirect)
Direct taxes e.g. income tax cannot be shifted whatsoever, while indirect taxes can be
shifted through increase in prices.
 Rate of tax
If too high, shifting can occur backwards or forwards.
If too low, it can be absorbed by the manufacturer.

Key Terms
Impact of tax – It is the person on whom tax is imposed
Incidence of tax – It is the person on whom the money burden of tax rests i.e. payment

TAXABLE CAPACITY

This refers to the maximum tax which may be collected from a person without producing
undesirable effects on him.

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A good tax system ensures that a person pays tax to the extent that they can afford it. There are
two aspects of taxable capacity. i.e.
 Absolute taxable capacity
 Relative taxable capacity

Absolute taxable capacity

It is measured in relation to the general economic conditions and circumstances of a person e.g. the
industry to which a person belongs and the economic environment. Incase an individual having
regard to his circumstances and the prevailing economic conditions pays more tax than he should,
his taxable capacity would have been exceeded in the absolute sense.

Relative taxable capacity

It is measured by comparing the absolute taxable capacities of different persons or companies.

FACTORS THAT INFLUENCE TAXABLE CAPACITY

1. Number of inhabitants
The larger the number of inhabitants of a country the greater the capacity to pay tax
2. Distribution of income and wealth. If income and wealth are more equally distributed in
the country, taxable capacity is reduced. However, if there are large disparities of income
and wealth distribution in the country, taxable capacity is increased.
3. Methods of taxation used
A tax system that is modernized to include ICT and electronic equipment would increase
taxable capacity. However, a tax system with complex laws and administrative difficulties
for the government would reduce taxable capacity of the country.
4. Purpose of taxation
Incase public revenue is utilized to promote the welfare of citizens through provision of
goods and services, taxable capacity is increased. However if public revenue is used to pay
a huge wage bill for the civil servants and Members of Parliament including other factors
such as loss of revenue through corruption, taxable capacity is reduced.
5. Psychology of the tax payers
This refers to the citizen’s perception of the government. Incase citizens feel patriotic
towards the country and they identify positively with the government activities, taxable
capacity is improved.

6. Economic stability
Incase of a stable economy and increased employment opportunities taxable capacity is
increased.

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During economic depression which causes unemployment due to reduced economic

activities, taxable capacity is reduced.
7. Inflation This is a situation of increasing price levels caused by increased demand. It
reduces the purchasing power of money and also the taxable capacity of the country.

BUDGETARY OBJECTIVES AND FISCAL POLICIES

Budgetary and fiscal policy measures are adopted by the government to maintain economic
stability in the country and to increase the rate of economic growth.
The main aspects of budgetary and fiscal policy include:

THE BUDGET

 A budget is a statement, which contains the government revenue and expenditure estimates for
one particular year.
 If the government expenditure is greater than the revenue then it is known as a deficit budget.
 If the government revenue is greater than the government expenditure, it is known as a surplus
budget.
 Where the government expenditure is equal to the government revenue it is known as a
balanced budget.
 Budgets may be of two kinds;
1. A revenue budget
2. A capital budget
 A revenue budget relates to normal income and expenditure items.
 In a revenue budget the main sources of public revenue are:
1. Custom duty
2. Excise duty
3. Income tax
4. Corporation tax
5. Income from sale of state property or assets
6. Income from fees and court fines
The main expenditure heads of a revenue budget are:
1. Internal and External Defence
2. Administration
3. Education
4. Health
5. Collection of taxes
A capital budget relates o development projects. The main sources of income for a capital
budget are loans and grants obtained by the government.
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The main expenditure heads of a capital budget are:

1. Development projects.
2. Establishment of new industrial and agricultural projects.

BUDGETARY POLICY

 The budgetary policies are measures designed to achieve clearly defined budgetary objectives.
 Budgets are annual plans designed by the Government to achieve the economic objectives of:
1. Price stability
2. Capital accumulation
3. Economic growth
4. Equitable distribution of income
5. Raising of government revenue for provision of services
 It is the major means by which the government regulates the economy.
 The government uses both fiscal and monetary instruments to achieve budgetary objectives.

The budget as an instrument of planning

The following facts indicate the importance of budgeting as an instrument of planning:
 The budget in the framework of economic planning is an overall regulator of all the
determinants of economic growth.
 The budget can play a fundamental role in increasing the rate of capital accumulation and
economic growth.
 With the increased responsibility of the government for adequate spending in a planned
economy, the theory of sound finance and balanced budget may not be applied.
 The above facts indicate that the budget is an important instrument in the hands of the
government to achieve the objectives of fiscal policy.

Key Terms
Budgetary policy – These are measures designed by the government to achieve specific economic
objectives. The government uses the budget as a means of implementing budgetary policy.
Budget – It is a statement of estimated government revenue and expenditure for a particular year

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ROLE OF TAXATION IN ACHIEVING BUDGETARY OBJECTIVES

FISCAL POLICY

a) Fiscal policy is a combination of deliberate changes in expenditure programs, revenue and

tax programs and debt management policy.
b) The main objectives of fiscal policy are the following:
 The achievement of a desirable price level.
 The achievement of a desirable consumption level.
 The achievement of a desirable employment level.
 The achievement of a desirable income distribution.
c) The maintenance of a desirable general price level means that prices must not fall because
incomes of the producers will be minimized.
d) Similarly the prices must not rise because fixed incomes are greatly decreased in value.
e) The general stability of prices is associated with the stability of the economy
f) The second main objective of fiscal policy is to attain a desirable level of consumption.
g) To achieve this, consumption patterns are evaluated on the following bases;
 The degree to which satisfaction is maximized.
 The effect on the quantity of savings
 The effect on the efficiency of human productive activity
h) A good quantity and distribution of consumption must fulfil the three requirements.
i) The efficient employment of all productive persons is the most important factor in
determining the standards of living of individuals in any economy.
j) The concept of full employment is considered a necessity for political stability and for
maximising of production.
k) The distribution of income largely determines the type of economic activity and the amount
of saving which are closely related to prices, consumption and productivity of human
resources.

FISCAL POLICIES IN UNDERDEVELOPED COUNTRIES

a) An under-developed economy is one in which the output per capita is relatively low and
productive efficiency is increased very slowly.
b) The main reasons for slow increase in the productive efficiency is lack of capital.
c) Capital formation is the main objective of fiscal policy.
d) The main objectives of fiscal policy for under developed countries like Kenya are the
following.
 To increase the rate of investment by checking consumption.

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 Encouraging the flow of investment into channels which are most desirable from the
point of view of society.
 To regulate the flow of purchasing power in accordance with the requirements of the
plan.
e) The instruments of fiscal policy are the following:
 Public expenditure
 Public revenue
 Public debt
f) When a country faces the threat of inflation, the government raises taxes and cuts on public
expenditure.
g) During deflation the government increases its expenditure and reduces taxes so that
unemployment may be decreased by increasing effective demand.
h) Economic stability can be maintained by utilizing public loans on productive programmes.

EFFECTIVE TAX POLICY FOR A DEVELOPING COUNTRY

a) A developing country must have a different tax policy from a developed country because:
 Its Primary objective is to achieve a high level of economic development not merely
economic stability.
 Greater attention has to be paid to the maximization of revenue and not to the ability to
achieve equity.
 It has to follow a policy of active intervention in economic affairs and not Laissez faire.
 It aims at accelerating economic growth and not to reduce economic inequalities.
b) A developing country must aim at raising the rate of savings by taxing the big industrialists
and landlords and diverting consumption to productive enterprises.
c) The tax policy must mobilise economic surplus i.e. excess of current output over essential
consumption, for accelerating economic growth.
d) In under- developed countries, greater attention needs to be paid to indirect taxes, because
 These promote development by checking conspicuous consumption.
 Mobilise resources for the public sector.
 Increase the savings ratio.
e) The aim of a suitable tax policy for under developed countries must be to direct resources
from:
 The private to the public sector.
 Consumption goods industries to investment goods industries.
 Import goods to export goods.

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FISCAL POLICY REFORMS AND THEIR IMPACT ON GOVERNMENT REVENUE,

EXPENDITURE AND ECONOMIC ACTIVITIES

The reasons why the tax authority has undertaken major reforms in the Kenyan tax systems are:
 To simplify the current tax systems.
 To minimize political interference.
 Current tax systems my not create the necessary economic impact.
 To be able to cope with changes in business structures. Especially technological changes.
 To minimize corruption among the tax officers.

MAJOR STEPS TAKEN BY THE GOVERNMENT TO MODERNIZE THE KENYAN

TAX SYSTEM

The revenue reform and modernization program commenced in the year 2004 / 2005 with the
objective of transforming the tax authority into a modern, fully integrated and client focused
organization. The revenue administration reform and modernization entered its second phase
which ran until 2008 / 2009 entrenching reforms to the operational levels in order to achieve
efficiency and enhance service delivery through the implementation of the following key projects:
i) Customs reform and modernization projects.
This has been achieved through:
 Implementation of a fully function based customs structure and re-engineering of
customs procedures from physically controlled checks to risk based and post clearance
controls through strengthening of audits.
 Taking a lead in implementing an inter-agency review of border processing and
clearance time to enhance service delivery at borders.
 Taking the lead at the regional level customs in addressing deficiencies in the E. African
management Act in order to streamline the import and export process.
 Enhancement of the simba 2005 system functionality in critical areas.
 Enhancement of staff competencies in critical areas such as risk based approaches to
cargo management and the adoption of post release verification and audit.
ii) Domestic taxes department reform and modernization project.
The project sought to create a domestic taxes department structured along the key tax
administration functions; Taxpayers education and services, returns and payment processing
audit, enforcement, collection and tax operation policy. These were achieved through;
 Implementation of an integrated tax management system that integrates both income tax
and VAT operations and takes a single view of the taxpayer.

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 Enhancement of service delivery by achieving a complete taxpayer segmentation

through building capacity in the large tax office and developing programs targeting
middle and small taxpayers.
iii) Road transport department reforms and modernization project.
Considerable progress has been made in automating the road transport department processes
with the aim of automating all manual processing. Administration procedures have been
simplified through record keeping and file tracking features that support front office operations.
In addition, the reforms aim at achieving full connectivity of the transport department with all
other departments at the tax authority
iv) Investigation and enforcement reforms and modernization.
This project sought to create a modern business intelligence unit that analyses data to assess the
risks inherent in transactions and ownership relationships which constitute the basis for tax
evasion schemes.
The project also sought to strengthen the prosecution units and implement an enforcement
strategy to discourage tax malpractices by imposing maximum penalties and making public the
names of tax evaders.
v) Infrastructure development reforms and modernization project.
The project was aimed at ensuring that projects in the reform program were given adequate
support through timely acquisition and provision of needed facilities, upgrading of
infrastructure and enhancement of assets and security management systems.
It was also aimed at boosting the capacity of the revenue authority to respond to the various
needs of stakeholders through implementation of taxpayer education, integrity and
accountability programs.
vi) Business automation project
The project sought to develop and implement IT strategies for the tax authority which promotes
the integration of domestic tax administration and the exchange of information between
domestic taxes department, customs and road transport departments.
vii) Human resource revitalization program.
The project sought to upgrade and diversify the skills base at the tax authority to international
best practice standards, with emphasis on competence based management, recruitment and
retention policy.
For the reform program to be successful it had to be built on strong administration structures
that created and enhanced ownership. The tax authority also put in place an elaborate corporate
governance structure for the reform and modernization project.

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CHALLAGES FACED BY THE TAX AUTHORITY IN THE IMPLEMENTATION OF

REFORMS

The challenges include:

 Inadequate funding.
 Stakeholders resistance to reform initiatives
 The need for sustained efforts in fighting corruption and tax fraud.
 Timelines of legislative changes.
 Human resource issues such as remuneration, skills and intergrity.

Key terms
Per capita income – Is the total output or national income of a country divided by the total
population.
Productive capacity – It is measured by the resources available to a country to produce goods and
services.
Tax reform – This refers to the transformation or modernization of tax systems.
Automation – This refers to changing from manual tax systems to computer based systems

 Tax is a compulsory contribution by citizens to the government to enable it to meet its

expenses for a common cause.
 A charge is a payment which can be compulsory or voluntary but which is related to the
enjoyment of a certain benefit or privilege extended by the government.
 Tax encourages desirable economic activities by providing incentives which are allowed as
deductions against taxable income or reduced tax rates.
 An optimal tax system is one that includes as many of the principles or canons of taxation as
possible.
 Taxes maybe classified according to their effect e.g. direct and indirect taxes, tax base such as
income taxes, corporation tax, custom duties or according to the rates of tax which include
progressive rates, degressive rates, regressive rates and proportional rates.
 The impact of tax is the person on whom tax is imposed and who bears the responsibility of
accounting for the tax to the authorities.
 The incidence of tax is on the person who bears the money burden of tax.
 Tax can be shifted forward, backward or partly forward or backward.
 Tax shifting is achieved through revision of prices
 Taxable capacity is measured through the maximum amount of tax which can be paid by a
person without causing desirable effects on him.
 There are two aspects of taxable capacity i.e. absolute taxable capacity and relative taxable
capacity.

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 Budgetary policies are measures designed by the government to achieve specific objectives in
the economy,
 Fiscal policy is a combination of measures designed to achieve desirable objectives in the
economy.
 Instruments of fiscal policy include; public revenue, public expenditure and public debt

REVISION QUESTIONS

1. Write brief explanatory notes on the following miscellaneous sources of government revenue.
(a) Motor vehicle licenses
(b) Training levies
2. Define each of the following taxes and state its purpose
(a) Cess
(b) Property rates
(c) Stamp duty
(d) Roads and maintenance levy
3. Explain the following canons of a good tax system;
(a) Equality
(b) Economy
(c) Productivity
(d) Flexibility
4. (a)Distinguish between the impact and incidence of a tax.

(b)State the impact and incidence of the following taxes.

(i) Pay As You Earn (PAYE)

(ii) VAT on accountancy services
(iii) Import duty on motor vehicles not intended for resale
(iv) Excise duty on sugar

5. The following figures represent the projected Government revenue and budgeted expenditure
for the year 2011 / 2012 for Kenya:

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Projected Government Revenue Sh. ‘000, 000’

Tax Revenue
Income tax 55,079
VAT 32,907
Import duty 23,932
Excise duty 29,091

Non – Tax income 19,002

160,011
Budgeted Expenditure
Salary and wages 56,411
Debt services 58,577
Operations and maintenance 38,859
Development expenditure 17,430
Other expenditure 8,893
Total expenditure 180,175

Required:
(a) Comment on the relationship between projected revenue and budgeted expenditure as
shown by the above figures. (4 Marks)
(b) Explain briefly four additional sources of funds to the Government other than the ones
tabulated above, show clearly the constraints involved in using it as a source of funds.
(6 Marks)
(c) What are the economic consequences of increasing the Value Added Tax rate to raise
additional revenue for the Government. (5 Marks)
(d) Many of the big businesses in Kenya pay all the four types of taxes shown in the table. The
Minister for finance is moving towards creating a ‘one tax point’ system for businesses.
Specify the major advantages likely to be provided by this system. (5 Marks)
(Total: 20 Marks)

6. The Kenya Revenue Authority (KRA) is geared towards a function-based organization rather
than one structured along the types of taxes. This evidenced by the integration of VAT, Income
Tax and Excise departments into the Domestic Taxes Department.
Assess the likely benefits and drawbacks to KRA arising from integration.
(10 Marks)
7. Advancements in Information Communication Technology (ICT) among other areas have
resulted in both positive and negative effects on the administration of tax. Discuss 4 positive

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effects and 2 negative effects of technological advancement on administration of tax in your

country. (12 Marks)

SUGGESTED SOLUTION:

1. (a) Motor vehicle licenses – These are charges or levies imposed on owners of motor vehicles
by the government before granting them licenses.
(b) Training Levies – These are charges collected through hotels to support training in hotel
colleges e.g. Utalii hotel

2. (a) Cess – This is a levy that is charged by rural local authorities on commercial activities
within the local authority e.g. harvesting of sand, building materials, traders etc. the revenue
collected is used to develop roads, hospitals and provision of other services by the local
authority.
(b) Property rates – These are charged by the local authorities on owners of property such as
land or buildings within the local authority.
(c) Stamp duty – This is a tax that is levied on transfer of properties and on certain instruments.
The purpose of stamp duty is to legalise the transactions.
(d) Roads and maintenance levy – This is charged on road users in the prices of petroleum
product. The revenue collected is used to maintain roads.
3. (a) Canon of Equality – it means that every person should pay tax according to his ability and
proportion of income the rich should pay more tax than the poor and a higher proportion of
their income.
(b) Canon of Economy – The tax system should be economical to both the taxpayers and the
government. Incase of the taxpayers, they should be left with sufficient income after
payment of tax for saving and investment. The tax system should also be economical to the
government in that the cost of collections and administration of tax should not exceed the
revenue expected.
(c) Canon of Productivity – The tax system should yield substantial amounts of revenue to the
government. A few taxes, that yield high amounts of revenue are preferable to a variety of
taxes that yield low amounts of revenue.
(d) Canon of Flexibility – the tax system should not be rigid. In that the tax sections of the law
should be easy to amend or discard by the state where it is necessary.

4. (a) Impact of Tax – this is the person on whom tax is imposed and who has the responsibility of
accounting for the tax to the tax authorities
Incidence of Tax – This is the person who bears the money burden of tax.

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(b)
Impact Incidence
(i) PAYE Salary of employee Salary of employee
(ii) VAT on Accountancy Supplier of accountancy Client or customer
services services
(iii) Duty on motor vehicle not Importer of motor vehicle Importer of motor vehicle
intended for resale
(iv) Excise duty on sugar Producer of sugar Consumer
5 (a) Relationship between projected revenue and budgeted expenditure – The budgeted
expenditure is greater than the projected revenue of the government hence the budget is in deficit.
(c) Additional sources of government revenue:
 Internal borrowing – the government may borrow funds through sales of treasury bills and
bonds by the central bank on its behalf. The effect of internal borrowing is to deny the private
sector access to the same funds. This has an adverse effect on productivity and employment in
the economy.
 External borrowing - the government may borrow funds from the World Bank or IMF. This
has the effect of increasing the heavy burden of debt.
 Sale of national assets – The government may sell shares in state corporations. This is only a
one time solution to the budget deficit problem. It may not be available in future when the
government is faced with a budget deficit.
 Aid and grants – The government may receive Aid and grants from donor countries. The
amounts may not be sufficient to meet the budget deficit. In addition it is given on strict terms
and conditions which maybe humiliating to the country.
(c) Economic consequences of increasing the rate of VAT to raise additional revenue for the
government.
Additional VAT impose d on the prices of goods and services will increase the price levels in the
economy and hence the cost of living.
Workers will demand increased wages and salaries to cope with the increased cost of living. This
will in turn increase the cost of production for the manufacturer who may also increase his prices
to cover the increased cost, which will lead to inflation in the economy
(d) Advantages of a one tax point system.
(i) Information may be shared by the different departments
(ii) Tax evasion is reduced
(iii) Efficiency in monitoring tax compliance is increased
(iv) Duplication of resources is reduced leading to savings
(v) Tax payers can be assessed for all taxes at the same point.

6. Benefits as a result of integration of the departments into domestic taxes department

(DTD)

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 The integration has eliminated duplication of functions, leading to resource savings that can
be applied to other critical areas such automation.
 It has led to enhanced taxpayer compliance and risk assessment, given that taxpayers are
monitored for all taxes and there is more sharing of information.
 There is better relationship with the clients since they are no longer subjected to separate
audits from income tax and VAT officers. This is due to a better co-ordinated approach to
tax audits and taxpayer education.
 The management is able to monitor the effectiveness of tax audits and other programs in
totality as opposed to the previous situation where one program was being preformed across
different departments. Integration has reduced the likely incidence of corruption as a
taxpayer s now likely to be audited by a team and not an individual officer from a single
department.
 Information sharing is possible.

Drawbacks from integration

 Lack of clear responsibilities – previously it was possible to place responsibilities for
attaining targets on various commissioners be it for customs and excise, VAT, income tax
etc. variations were easier to spot. Currently this is not possible since all departments are
integrated into one.
 Tax payers do not know clearly whom to report to at KRA i.e. whether they fall under large
tax payers unit or otherwise since there are no clear guidelines.

7. The effects of Information Communication Technology (ICT) on tax administration

(i) Positive effects
 Efficiency in tax collection – due to employment of computerized tax points, it is
easier to correct revenue faster and more accurately since all the sales are made
through a computer system.
 Economy – due to the shift from manual to a computerized system, tax payers are
able to file their returns online thus making it more time saving and less costly.
 Convenience – the system of filing tax returns online is convenient to both the
revenue authority and the tax payers since they do not have to queue to file returns
manual. Incase of the revenue authority it is easier to use a software to do most of the
work that was previously done by a number of employees
 Flexibility – A computerized tax system is also flexible considering that if changes
are to be made, it is “just a click” away.
(ii) Negative effects
 Easy of tax evasion and avoidance - considering that it is a computerized system
there exists chances that crude people can try to override the system to avoid paying
tax

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Security threats – in this era of computers, hackers has a chance to perfect their ill motives. This
does not exclude a computerized taxsystem

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TOPIC

TAXATION OF INCOME OF PERSONS

INTRODUCTION

Income tax is charged under the income tax Act (Cap 470) which contains rules and regulations
relating to the following:
 Ascertainment of income
 Assessment of tax
 Collection of tax
 Entitlement of personal relief

S.3 (1) of the income tax act states that:

“Subject to, and in accordance with this Act, a tax to be known as income tax shall be charged for
each year of income upon all the income of a person, whether resident or non-resident, which
accrued in or was derived from Kenya.”

S.3 (2) of the income tax act states

‘Subject to this act, income upon which tax is chargeable is income in respect of
a. Gains or profits from
i) A business for whatever period of time carried on
ii) Employment or service rendered
iii) A right granted to another person for use or occupation of property
b. Dividends or Interest
c. Pension income or withdrawal from a registered provident and provident fund.
d. Any withdrawal from a registered Home Ownership Saving Plan
e. Any deemed income
f. Gains from transfer of property

The income tax Act (Cap 470) was enacted in 1973, and its date of commencement was January
1974. It replaced the East Africa Income Tax Management Act, which had served the countries of
the East Africa Community, and which became outdated following the break up of the community.
Income tax is charged for each year of income on all income of a person, whether resident or non-
resident, which accrues in or is derived from Kenya.

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Year of income and accounting year

Year of Income is a period of 12 months commencing 1 January and ending on 31 December in

each year. It is the same as calendar year.
Income tax is charged for each year of income.
The year of income should be distinguished from the accounting year. There is a date to which
accounts of a business are prepared each year, and this date would indicate the accounting year
end. The accounting year ending on 31 December would coincide with the year of income.
Other accounting year-ends would however fall in a given year of income and the profit or loss per
the accounts would be for that year of income. For example, an accounting date ended 31
May 2015 would fall to be treated as the year of Income 2015

TAXABLE AND NON TAXABLE PERSONS

A person whose income is taxed is either:

a) An individual i.e. a natural person; or
b) A legal person e.g. a company. The company here includes a Trust, Co-operative
Society, Estate, Club, Trade Association etc.

A taxable person does not include a partnership. A partnership is not taxed on its income, but the
partners are taxed on their share of profit or loss from the partnership. However, under
Turnover Tax ((TOT), a taxable person has been defined to include a partnership.

Resident and non-resident persons

There are conditions for being a resident in case of an individual and also in case of a body of
persons.

a) Resident in relation to an individual means that the individual:

i) Has a permanent home in Kenya and was present in Kenya for any period during the year of
income under consideration; or
ii) Has no permanent home on Kenya but was present in Kenya for a period or periods
amounting in total to 183 days or more during the year of income under consideration; or
iii) Has no permanent home in Kenya but was present in Kenya for any period during the year
of income under consideration and in the two preceding years of income for periods
averaging more than 122 days for the three years.

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Residence in relation to a company

A company is considered to be a resident in any year of income if:
1. It is incorporated in Kenya under the laws of Kenya.
2. Management and control of the affairs of the company was exercised in Kenya during the year
of income under consideration.
3. The company has been declared by the Minister for finance to be a resident for any year of
income through a notice in the Kenya gazette.

The significance of the concept of residence

The importance of residence is shown in the differences in the tax treatment of income derived by
residents and non-residents e.g.
Resident Non-resident
 Employment income arising in  Employment income arising only
Kenya and other sources outside From Kenya is taxable.
Kenya are taxable.
 In case of individuals personal relief  Individuals cannot claim personal
is granted as a deduction against tax relief as a deduction from tax
liability. liability.
 Pension Income - The first  The gross pension income received
Sh.600,000 received in lump sum is for services rendered in Kenya is
tax exempt. In case of Periodic subject to withholding tax of 5% As
payment, the first Sh.300, 000 p.a. is the final tax.
tax exempt.
 Rental Income - The income from  The gross rental income is subject to
property less allowable expenses is withholding tax of 30% as the final
taxed using the graduated scale for tax.
individuals or corporation tax for a
company.
 Royalty Income –
 Gross royalties are subject to  Gross royalties are subject to
withholding of 5%. withholding tax at the rate of
20% as the final tax.
 Gross royalties net of allowable
expenses are taxed using the
corporation tax for a company.

 In case of companies, profits are  In case of companies the profits are

taxed at the rate of 30%. taxed at the rate of 37.5%.

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SOURCES OF TAXABLE INCOME

Tax treatment of residents and non-residents

(i) Residents and non-residents of Kenya are taxable only on income derive from Kenya. In
general income earned outside Kenya even if remitted into Kenya is not taxable.
(ii) There is the exception in respect of residents who with regard to employment income are
taxable on all such income derived from services rendered in or outside Kenya.
(iii) Where a non-resident company has a permanent establishment in Kenya (e.g. a branch or
office) its treatment for tax purposes is the same as for a resident company. But its tax rate is
for the non- resident rate. A non-resident without a permanent establishment in Kenya, is
subjected to withholding tax on all income derived from Kenya
(iv) Where a Kenyan business is carried on partly in Kenya and partly in a foreign country all
income is chargeable to tax irrespective of whether or not it has been derived from Kenya.
(v) Where a non-resident is involved in carrying on business within Kenya of manufacturing,
growing, mining or harvesting for delivery or use in his business outside Kenya then the gains
and profits of that business are income derive from Kenya and is taxable at full open market
value of the goods in question.
(vi) A bank operated in Kenya by a non-resident owner which holds some of its deposits derive
from Kenya outside Kenya, should account for the income from such deposits to tax in Kenya
as such income is considered to be derived from Kenya.

Taxable income is classified according to specified sources.

The income tax Act lays down six categories of income or specified sources of income as follows:
 Gains from employment for services rendered.
 Profit from business such as trade, manufacture, vacation, adventure e.t.c
 Gains from the rights granted for use or occupation of property e.g. rental income or royalty
income.
 Profits from farming or commercial agricultural activities e.g. horticulture
 Investment income such as dividends and interest income.
 Any other source of income that is chargeable to tax or unspecified sources e.g. pension
income, insurance annuities e.t.c.

From 1 January 1979, losses incurred in any specified source may only be offset against income
from the same source in the following or future years. From 1 January 2010 this will be for the
subsequent four years unless an extension application is made and approved by the minister.
Note:
i) The circumstances involving a transaction are very important such as purchase, quantity and
the price offered. This determines the intention of a person.

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RUTLEDGE v COMMISSIONER OF INLAND REVENUE 14T.C 490

The appellant was a money lender who was in 1920 interested in a cinema company. He had since
that time been interested in various other businesses. Being in Berlin in 1920 on a business
connected with the cinema company, he was offered an opportunity of purchasing very cheaply a
large quantity of toilet rolls. He effected the purchase and within a short time of his return to
England, he sold the whole consignment to one person at a considerable profit. He was assessed on
that profit.

Held:
The appellant had bought a large stock of toilet rolls with a speculative intention as the quantity
was too large for private consumption. He went through the process that an ordinary trader would
do in business. The purchase and resale of the stock was an adventure in the nature of trade. Hence
the profits were taxable as gains from an adventure.

ii) Profits from illegal trade or transactions are taxable business income

MANN v NASH 16 T.C. 523

The appellant who carried on the business of providing automatic machines for public use, dealt in
and entered into arrangements for exploiting certain automatic machines , the use of which had
been declared illegal. The machines were setup in the premises to which the public resorted and
the profits arising there from were divided between the appellant and the occupier of the premises.

Held:
The profits were chargeable to tax the income tax act restricts its self to business whether the
transaction is legal or not, however penalties are disallowed.

Key terms
Permanent establishment – a branch or office operated in Kenya by a non-resident company for
a period of at least six months.
Open market value – This is defined as the value determined on the basis of the transaction
without regard to any relationship between the buyer and seller.

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NON- TAXABLE INCOME

(i) These are incomes received by a person which are neither taxable nor are they listed as exempt
under the 1st schedule of the income tax Act.
In practice such incomes are not usually subject to tax e.g. Harambee collections, donations e.t.c

N/B: with effect from January 2012 lottery winnings and bettings are subject to withholding tax at
the rate of 20%.

(ii) Interest with effect from 1 January 1996 not exceeding Sh. 300,000 known as “qualified
interest” and by earned by an individual or jointly by wife and husband on housing
development bond accounts with:
- HFCK
- Savings and Loan
- Eco Bank
i.e. institutions approved by the minister. The interest on housing development bond is subject to
withholding tax of 10% which is treated as the final tax.
(iii) With effect from 1 January 1996, income from a registered home ownership savings plan.
(iv) Interest to non-residents on the following securities:
- Kenya Government Stocks
- Nairobi City Council Stocks
(v) Dividend income of a registered venture capital company effective 1 September 1996.
(vi) Dividend income of a resident company received from a company in which the resident
company holds more than 12 ½% of the voting power.
(vii) A dividend received as income by a financial institution specified in the fourth schedule of
the income tax Act.

NB
The financial institutions specified in the fourth schedule of the income tax Act, include:
- Banking institutions
- Insurance companies
- Co-operative societies
- Building societies
(viii) The first Sh. 600,000 received in lumpsum by an individual from a registered pension
scheme or Sh. 300,000 received in periodic amounts are exempted from tax.

Key terms
Venture Capital Company – This is a company that enables a start up company with a high
potential of growth to obtain capital by investing in the shares of that company for long term.

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Government Stocks – These are securities traded on behalf of the government by the central bank
to raise funds for public expenditure. Examples include treasury bills and bonds.

TAXABLE AND NON TAXABLE PERSONS AND INSTITUTIONS

Income is exempted from tax if it is specifically included in the first schedule of the income tax
Act. Exempted income includes:

1. Salary and allowances paid to the president of the republic of Kenya out of the consolidated
fund.
Allowances paid to the vice president, ministers MP’s, speaker and deputy speaker of the
National Assembly.
N/B: under the new constitution passed on August 2010, constitutional office holders and all
other public servants are chargeable to tax on all their income.
2. Income of a registered pension fund or scheme.
3. Income of local authorities inform of rates, fees, fines, penalties e.t.c
4. Income of certain parastatals such as national irrigation board.
5. Income of amateur sporting associations subject to the following conditions:
 The main objective of the association is to foster or control an outdoor sporting activity.
 The members are amateurs and not professionals.
 Its memorandum of association or articles states that any member who becomes
professional will be discontinued from the association.
6. Income of religious bodies, charitable organizations, educational institutions and trusts. Such
organizations are exempted from tax where they are:
 Public in character and serve the whole or a section of the public.
 Set up solely for the purpose of relief of distress or poverty in Kenya.
 Set up for the advancement of religion or education in Kenya.
The income of such bodies is expended in Kenya or its expenditure will result into benefit to
Kenyan residents.

TAX EVASION
This is where the taxpayers deliberately avoid paying tax by not declaring the true income or by
claiming higher expenses to offset against income, or by making claims for allowances and / or
relief to which a person is not entitled. All these acts are illegal and when the person evading tax is
caught he will be required to pay penalties and fines and may also end up in prison.

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CAUSES OF TAX EVASION

(1) High Rates of Taxation

The prevailing high rates of taxation are one of the main causes of evasion. It cannot be denied
that the higher the rate or tax, the greater will be the temptation for evasion. However the tax rates
by themselves are not to blame for the larger extent of evasion in the country.

(2) Complexity in Tax Laws:

The complicated provisions of the Tax Acts, not all of which are easily understandable, are also
responsible, to some extent, for tax evasion. The average tax payer has inevitably to seek the
assistance of tax consultants whose advice may also assist the tax payer in tax evasion and
avoidance.

(3) Inadequacy of powers

The inadequacy of the powers vested in the personnel of the department is yet another cause for
tax evasion. The information relating to income and expenditure etc. are known only to the tax
payers and if he does not disclose all of them to the assessing officers, the task of the latter in
determining the correct tax liability becomes very difficult.

TAX AVOIDANCE

Tax avoidance is where the taxpayer arranges his affairs and finances in such a way as to reduce
his tax liability. Taxes can considerately be reduced if one is aware of loopholes existing in the tax
law which the government itself provides to tax payers. By using reliefs and allowances, one could
reduce his tax liability or avoid taxes altogether and yet remain on the right side of the law.
By exempting certain incomes from tax or by taxing it at reduced rates, the government can
channelize investments and savings according to its prevailing economic policies. For instance, the
provisions regarding deductions allowed for setting up industries in rural areas help the
government in ensuring balanced regional development. Similarly, the provisions relating to the
granting of tax benefits on savings are also intended not only to encourage savings but also to
ensure the flow of savings into desired channels.
In general, tax can be avoided or reduced by claiming:-
 Income as totally exempted from tax e.g. interest from savings account at Kenya Post Office
Saving Bank.
 Income which is subjected to withholding tax only e.g. interest from Housing Development
bonds of up to Sh. 300,000.
 Reliefs and allowances i.e. personal relief, interest on mortgage on owner occupied house,
investment allowance etc.

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N/B. One should not decide on an investment merely because of the higher rate of interest given.
The actual return will have to be worked out taking into account the rate of interest and the tax
benefits available on the income received from the investment

Key Terms

Withholding Tax – This is tax that is deducted at source i.e. at the point where income is received
Final Tax – It means that the tax suffered is all the tax there is, and no more.
Dividend income – It is income received on investments such as shares in company’s.
Qualifying dividend – It is subject to withholding tax at source of 5% which is the final tax.
Non-qualifying dividend – It is subject to withholding tax of 15% at source which is not the final
tax

ALLOWABLE AND NON – ALLOWABLE DEDUCTIONS

ALLOWABLE DEDUCTIONS
When determining the taxable income of a business certain expenses are said to be allowable or
deductible against taxable income. Sec 15(1) of Income tax act generally allows expenses that are
wholly and exclusively incurred in the production of income. These are usually normal
commercial expenses of a business such as wages, salaries, purchases, transport, rent, water etc.
When determining expenses which are wholly and exclusively incurred in production of income,
the nature of business has to be considered because allowable expenses will differ from one type
of business to another.

Example 1
Farming e.g. in case of a coffee farmer, allowable expenses will consist of wages of farm workers,
fertilizers, picking of coffee, transport of coffee to the factory, mulching etc.

Example 2
In case of a transport business, allowable expenses will include salaries to drivers and touts, cost of
fuel and oils, tyres, repairs and maintenance e.t.c.

Example 3
In case of a hotel, allowable expenses will include; purchase of foodstuffs, soft drinks, mineral
water, salaries to waiters, electricity bills etc.

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Sec 15(2) of the income tax Act specifically identifies the expenses that are wholly and exclusively
incurred in the production of income and which are allowable or deductible against taxable
income. These include:

1. The amount of trade and bad debts written off.

These bad debts must arise in the sale of trading stock or services on credit e.g. bad debts
arising from sale of an asset or loans granted to friends are not allowable expenses since these
are not trade bad debts
2. Specific provision for doubtful and bad trade debts e.g. debt owed by a particular individual or
company.
3. Any Capital expenditure for prevention of soil erosion in a farm land. This expenditure must be
incurred by the farmer or occupier of the farm land e.g. the cost of construction of gabions,
terraces, windbreaks e.t.c
4. Capital expenditure on clearing and planting permanent or semi permanent crops such as sisal,
coconuts, cashew nuts, bananas, tea, roses etc
5. Pre- trading expenses (preliminary expenses) incurred before the commencement of the
business which would otherwise be allowable if the business was in operation e.g. in case of a
farmer, the cost of cultivation, fertilizers before harvesting to obtain farming income could be
allowable expenses. Consequently in case of a new hotel the cost of recruiting and training of
staff before the commencement of the hotel business would be allowable expenses.
6. Legal costs and stamp duty.
The following legal expenses are specifically allowable:
a) For preparation of a lease agreement which does not exceed 99 years.
b) For collection of trade bad debts e.g. the legal expenses of filing a suit against a
defaulting debtor.
c) For preparation of staff contracts when recruiting new employees.
d) When incurred in the floatation of shares by a company for the first time when the
company is getting quoted in the stock exchange. Such shares must be issued to the
members of public.
7. The expenditure on the structural alteration to enable premises to be let out. e.g. The cost of
sub-division of open rooms in a house which is necessary to maintain the existing rent.

N/B: If the structural alterations lead to increase in rent income it is a disallowable expense.
8. Mortgage interest not exceeding Sh. 150,000 on borrowings in respect of owner occupied
houses.
9. Club subscription paid by the employer on behalf of an employee with effect from 1 January
2006
10. Cash donations to charitable organizations subject to the income tax regulations 2007.

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11. Expenditure on the construction of a public school, hospital, roads or any kind of social
infrastructure upon approval of the minister.
12. Diminution / decrease in value of loose tools and implements.
 The allowable amount is 1/3 of the cost per annum. i.e. the cost is written off over 3 years
on straight- line basis
13. The annual entrance and subscription fees paid by a company or an individual incase of a sole
proprietorship to a trade association such as Kenya association of manufacturers (KAM),
Kenya chamber of commerce and industry(KCCI), Federation of Kenya employers (FKE)
 For the annual subscription to be allowable the trade association must have elected under
Sec 21(2) of the Income Tax Act to be treated as a trading association and must have given
such a notice to the commissioner i.e. The annual subscription is taxed on the trade
association.
N/B
 Members clubs and trade associations will not be deemed to be trading if 75% or more of
their gross income is inform of members subscriptions.
14. The expenditure incurred for scientific research, whether capital or revenue expenditure.
15. The amount of contribution to a scientific research institution approved by the commissioner
and which undertakes research related to the class of business of the contributor e.g. Ruiru
coffee research.
16. The amount of contribution to a university or research institution approved by commissioner
for scientific research e.g. AMREF, Nairobi University, KEMRI, KARI e.t.c.
 The research must be related to the class of business of the contributor.
17. The contribution by the employer on behalf of employees to National Pension Scheme except
NSSF.
18. The expenditure on advertising to directly or indirectly promote the sale of goods or services
provided by a given business e.g. adverts on TV, radio, calendars, journals, newspapers, horse
races, rally cars, golf tournaments etc

N/B
 The advertisements inform of passenger shades at bus stops, signboards, neon light and
signs are of capital nature thus disallowable expenses.
 However these qualify for wear and tear allowances.
19. The amount of interest on money borrowed and used in production of income e.g. interest
charges on loans, debentures, overdrafts etc
20. The amount of loss brought forward from the previous year, such a loss is only allowable
against the future income of the same source that generated the loss.
21. The amount of realized foreign exchange loss of revenue or capital nature.
22. All the capital deductions or allowable capital allowances specified in the second schedule of
income tax Act. Which include:

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a) Wear and tear allowances

b) Investment allowance / deduction
c) Industrial building deduction
d) Farm work deduction
e) Mining investment deduction
f) Shipping investment deduction

23. The amount of trading loss of the business

 A trading loss occurs where a business is a going concern and all the assets in a class of
wear and tear allowance are sold/ disposed off at a value that is less than written down
value of the assets in the same class.
N/B
If a business is under liquidation and such assets are sold at a value that is less than the written
down value brought forward of assets in the same class of wear and tare allowances, it is called a
balancing deduction, which is allowable against the taxable income

NON ALLOWABLE DEDUCTIONS

These are expenses not wholly and exclusively incurred by a person in the production of income.
Usually these expenses are added back to the reported accounting profit since such expenses
cannot be traced to the profits generated by the firm.

These are not commercial expenses of the business and include:

1. The expenditure or capital loss in form of depreciation, amortization, loss on sale of assets,
writing off of assets etc

N/B
These are disallowed and capital deductions are granted instead.
2. General provisions for bad debts e.g. a provision equal 5% of all debtors.
3. Amount of personal expenditure incurred by an individual in the maintenance of himself or,
his family or for domestic purpose e.g. entertainment expenses for private purposes,
educational fees, personal traveling expenses, medical expenses for an individual paid by the
company, hotel and catering expenses except:
 When on a business trip
 During training or work related conferences or business
 Meals provided to low income employees at the employers premises
4. Pension payments, annuity premiums and contributions to pension provident schemes and
funds except for those registered.
5. Legal expenses

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 The following legal expenses are specifically disallowable

- For purchase of a house.
- For preparation of memorandum of Association or a partnership deed.
- For preparation of trade agreement or contract.
- In defense of criminal charges/ proceedings.
- In preparation of a lease agreement of more than 99 years.
- In relation to floatation of shares for private subscription.
- In relation to tax appeal, tribunal or local committee.
- When issuing additional shares on the stock exchange in case of a company already
quoted.
6. The amount of reserves and provisions other than specific provision for bad debts.
7. Any type of taxes paid by the person e.g. VAT, customs and excise etc.
8. Unrealized foreign exchange losses of revenue or capital nature.
9. The amount of expenditure or loss recoverable under insurance contract or indemnity.
10. The amount of expenditure in the production of income by a non – resident person with no
permanent establishment in Kenya. The gross incomes of such persons are subject to
withholding tax at specific rates which are final.
11. Interest payments by a non- resident controlled company to the extent that the loans made to
that company exceed the greater of three times the sum of paid up capital and revenue
reserves or the sum of all loans acquired prior to 16th June 1988 and still outstanding.

TAX DEFICITS

Tax deficits refer to business losses incurred in the cause of business for any particular year of
income.
From 1 January 2010 tax losses for a year can only be carried forward for four years. If not utilized
the losses will be lost unless an application for extension is made based on provision of evidence
of the inability to extinguish the deficit and approval received from the minister. Previously there
was no time limit on the carry forward of tax lost.
The income tax Act lays down six categories of income or specified sources of income as follows:
 Rents from immoveable property.
 Employment and self employment income
 Wife’s employment, self-employment and professional income.
 Agricultural, pastoral, horticultural, forestry and similar activities.
 Surplus funds from registered pension or provident funds.
From 1 January 1979, losses incurred in any specified source may only be offset against income
from the same source in the following or future years. From 1 January 2010 this will be for the
subsequent four years unless an extension application is made and approved by the minister.
Capital losses cannot be set off against trading income.
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No allowance is made for a terminal loss but certain expenditure incurred after the cessation of a
business may be regarded as incurred in the year in the business ceased
From 1 January 1987, interest paid on money borrowed to finance investment is restricted for tax
purposes to the amount of investment income (excluding income for most dividends) in the same
year, any excess being carried forward.

BUSINESS INCOME

Business includes any trade, manufacture, adventure and any concern in the nature of trade but not
employment.
- The business profit reported for accounting purposes is different from the taxable profit.
The difference is due to the following:
 Certain expenses allowed for accounting purposes are not allowable expenses for tax purposes
e.g. depreciation, provisions for bad debts, taxes paid e.t.c
 The profit reported for accounting purposes excludes capital expenditures. However capital
allowances are granted on capital expenditures as allowable expenses for tax purposes.
 The profit reported for accounting purposes may include non taxable income such as gain on
sale of fixed assets.
 The profit reported for accounting purposes may exclude taxable income such as income from
illegal trading activities.

COMPUTATION OF TAXABLE PROFIT OR LOSS

The profit reported for accounting purposes may be adjusted to determine the profit required for
tax purposes:
The adjustment may be carried out based on:
 The net profit per accounts.
 The gross profit per accounts

Taxations of sole proprietorship

A sole proprietor does not have a separate legal entity and for this purpose it is not treated as a
separate taxable entity. Thus gains or profits from this form of business is taken to be income of
the individual running the business and will be taxed on him using the graduated scale rate of tax.

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This is illustrated below:

Sh. Sh.
Net profit per accounts XX
Add:
Disallowable expenses XX
Deduct:
Non-taxable incomes XX
Allowable expenses not yet
Deducted e.g. wear and tear allowances XX
Non business incomes XX (XX)
Adjusted business profit (loss) XX
Add:
Other taxable income XX
Total taxable income XX

OR
Sh. Sh.
Gross profit per accounts XX
Add:
Business income e.g. discounts XX
Deduct:
Allowable expenses (XX)
Business profit (loss) XX
Add:
Other taxable income XX
Total taxable income XX

QUESTION:
(a) Highlight four benefits of progressive taxes to a country . (4 Marks)
(b) Mr. A. Kimiti prepared the following profit and loss account for his business for the year ended
31 December 2011
Sh. Sh.
Income
Sales 18,400,000
Discount received 600,000
Profit on sales of shares 100,000
Foreign dividends received 15,000
Foreign exchange gain 35,600
Insurance recovery on stolen stock 180,000
19,330,600

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Expenditure
Purchases 12,800,000
Salaries 1,200,000

Audit Fee 45,000

Tax consultancy fee 30,000
Legal expenses 325,000
Licenses & Permits 64,000
Depreciation 145,600
Loss on sale of equipment 78,400
Bank Charges 44,200
Donations to a political party 50,000
Subscriptions 12,800
Repairs & Maintenance 174,200
Rent & Rates 150,000
Purchase of loose tools 90,000
Commission & brokerage tools 23,000 (15,232,700)
4,097,900
Additional Information:
1. Legal expenses comprise: Sh.
 Employment contracts 5,000
 Acquisition of trademark 80,000
 Successful defense of a legal suit for breach of a trade contrac 200,000
 Debt collection 40,000
325,000

2. Subscriptions comprise: Sh.

 Chamber of commerce and industry 2,800
 Child care international 8,000
 Golf club membership 2,000
12,800
3. Repairs and maintenances expense includes Sh. 74,200 used for the renovation of a store.
4. Capital allowance were agreed with the tax authorities at Sh. 680,000.
Required
(i) Prepare the adjusted taxable profit or loss for Mr. A. Kimiti for the year ended 31 December
2011 (12 Marks)

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(ii) Determine the tax payable (if any), from the computations in (i) above (2 Marks)
(iii) Indicate the latest date for submission of tax returns by Mr. A. Kimiti. (2 Marks)
(Total: 20 Marks)

ANSWER:

Benefits of progressive taxes

1. Equality – The taxes enhance equity since the rates of tax increase as income increases,
hence the rich pay more tax than the poor.
2. Income redistribution – The objective of income redistribution is achieved by taxing the
rich more and using the revenue to provide public goods and services to poorer regions of
the country.
3. Productivity – More tax revenue is collected for the country since the rich are taxed more
and at higher rates of tax.
4. Economical – The cost of collection and administration to the government is minimal since
the taxes are collected through agents e.g. employers.

Mr. Kimiti
2011 computation of adjusted profit (loss)
Sh. Sh.
Net profit per accounts 4,097,900
Add:
Tax consultancy fee 30,000
Legal expenses: Trade mark 80,000
Breach of contract 200,000
Depreciation 145,600
Loss on sale of equipment 78,400
Subscriptions – Child care 8,000
-Club membership 2,000
Renovation of store 74,200
Donation to political party 50,000
Loose tools 90,000 758,200
Deduct:
Profit on sale of shares 100,000
Foreign dividends received 15,000
Capital allowances 680,000 (795,000)
Adjusted profit (loss) 4,061,100
ii) Tax computation
First Sh. (121,968 × 10%) + (114,912 @ 60%) 81,144

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Surplus (4061100 – 466704) @ 30% 1078318.8

1,159,462.8
Less p/relief (13944)
Tax payable 1,145,518.8

TAXATION OF INDIVIDUALS

INDIVIDUALS
Income from employment or services rendered S.3 (2) (a) (ii)
Income tax is imposed on the gains or profits from any employment or services rendered.
Employment is not legally defined but covers any relationship between master and servant arising
from a contract or agreement. The scope of S.3 (2) (a) (ii) extends to services rendered by one
person to another, other than in the course of employment or as part of business.

D.S TRIVEDI V CIT

The appellant, a practicing accountant was asked by a friend the managing director of a company
to effect the sale of an estate belonging to the company. The appellant took little action to find a
purchaser but succeeded in effecting a sale to another friend and was paid commission of £7,500.
The appellant have 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 profits from a business and was taxable.
2. The commission was also gains from profit from employment.

Important definitions:

Employer – For purposes of PAYE, the term employer includes:

- An agent, manager or other representative in Kenya of any employer who is outside Kenya.
- Any person having control over employment and remuneration.
- Any paying office of the government or other public authority.
- Any trust or insurance company or other body paying pension to individuals.

Employee- This refers to any holder of an appointment or office whether public or otherwise for
which remuneration is payable.
In this case employees include cabinet ministers, company CEOs, civil servants e.t.c.

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In addition, retirees receiving pension income are also charged to tax under the PAYE system
where they exceed Ksh 300,000 per annum.

Paying point- This is the place where remuneration is paid e.g.

- Where a non-resident employer calculates remuneration outside the country and remits it
directly to his employees in Kenya, such income is taxed on the employees as individuals
and the employer bears no responsibility for tax.
- When a non-resident employer remits gross salaries to a resident agent or representative in
Kenya for payment to the employees, the employees must be paid salaries net of tax i.e. the
employer has the responsibility for deducting tax on income.

Tax free remuneration- The employer may pay the employees salaries negotiated net of tax. In
such cases the employer bears the burden of tax on behalf of the employees.
The income received by employees is called tax free remuneration. However the tax paid by the
employer on behalf of the employee is a taxable benefit to the employee.

MONTHLY PAY
Monthly pay is the income from employment which includes cash and non-cash benefits.
Cash benefits comprise of:
- Receipts from employment such as salaries, leave pay, overtime e.t.c
- Cash allowances such as housing, entertainment hardship e.t.c
- Expenditure incurred by the employee which is paid for by the employer such as grocery
bills.
- Contributions paid by the employer for the employees insurance or mortgage.

Facilities - This is a benefit or advantage enjoyed by the employee in connection with employment
such as free transport, free company products e.t.c
The minimum taxable aggregate value of a facility is sh. 36,000 p.a
S.5 (2) (a) enumerates cash payments that are chargeable to tax. S.5 (2) (b) extends the scope of
chargeability to include the value of any benefit, advantage of facility whose total value is Sh.
36,000 or more in a year. The value of a benefit is usually the cost to the employer. Some benefits
may not entail a cost to the employer but are still chargeable to tax e.g. the option to subscribe for
shares at a favourable price. The important criterion is that the benefit has some monetary value.

Weight V Salmon
An employee of a company was given the privilege of obtaining unissued shares at a value that
was less than the prevailing market price.

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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 the market value which was accessible.
Non-cash benefits include:

Servants - where the employer has provided servants to the employee such as cook, watchman
e.t.c the taxable value of the benefit is the actual cost to the employer e.g. salaries paid to the
servants.

Services- These include provision of electricity and water. The taxable benefit shall be the higher
of:

(i) The prescribed amount by commission or

(ii) Actual amount paid

COMMISSIONER’S PRESCRIBED BENEFIT RATES

Monthly Annual
rates rates
Services Sh. Sh.
 Electricity (Communal or from a generator) 1,500 18,000
 Water (communal or from a borehole) 500 6,000
 Agricultural employees: Reduced rates of benefits
 Water 200 2,400
 Electricity 900 10,800

Telephone services - where the employer has provided telephone services for the benefit of the
employee. The taxable value is 30% of the telephone bill paid.
Furniture - In case the employer provides furniture for use by the employee, the taxable value is
1% per month of the cost of furniture.
Car benefit - where the employer has provided a car for the private usage of the employee, the
taxable benefit shall be the higher of:
(i) The quantified amount on the basis of cc rating of the car or
(ii) Prescribed rate of benefit of 2% per month of the initial cost of the car.

However, where the car is hired or leased from a third party, the taxable value is the cost of hiring
or leasing.
The commissioner may determine a lower rate of benefit where an employee has a restricted use of
a motor vehicle provided by the employer with effect from 1st January 2008.

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PRESCRIBED BENEFIT RATES OF MOTOR VEHICLE

PROVIDED BY EMPLOYER

Monthly Rates Annual Rates

(Sh) (Sh.)
 Saloons, Hatch Back and Estates
Up to 1200cc 3,600 43,200
1201 1500cc 4,200 50,400
1501 1750cc 5,800 69,600
1751 2000cc 7,200 86,400
2001 3000cc 8,600 103,200
Over 3000cc 14,400 172,800
 pick-ups, Panel Vans (unconverted)
Up to 1750cc 3,600 43,200
Over 1750cc 4,200 50,400

 Land Rovers/ Cruisers 7,200 86,400

QUESTION:
Mr. Ole mboga an employee of Bidii company Ltd received income in 2011 as follows:
Basic salary of Sh.550,000 p.a
A day and night watchman whose salaries were Sh.5,000 p.m. and Sh.6,500 p.m. respectively.
Furniture was also provided at cost of Sh.280,000
A car of 2000 cc whose initial cost was Sh.1,400,000 was provided for his personal use.
The company paid his telephone bills averaging Sh.4,000 p.m.
He was granted free company products valued at Sh.3,500 p.m.
Calculate his taxable income:

ANSWER:
Mr. Ole Mboga
2011 Computation of taxable income
Sh.
Basic salary 550,000
2 watchmen 138,000
Furniture 12% X 280,000 33,600
Car cc basis 86,400 336,000
24% X 1,400,000 336,000
Telephone 30% X 48,000 14,400
Free Company Products 42,000
Taxable income 114,000

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Housing Benefit – This arises where the employer has provided with accommodation or means of
payment. Employees are categorized into four types for purposes of determination of housing
benefit i.e.
 Ordinary employees and whole-time service directors;
 Agricultural employees
 Non whole-time employee service directors
 Employees provided with both accommodation and meals

Ordinary employees and whole-time service directors;

Housing benefit shall be the higher of:
(i) 15% of total gains from employment or
(ii) Market rental value of the house
Less own contribution towards rent
N/B: whole-time service director – This is a director who;
- Devotes a significant amount of his time to the service of the company as a director in a
managerial or technical capacity and
- He does not own more than 5% of the total share capital of the company

QUESTION:
Mr. Kayo received a salary of Sh. 40,000 in April 2011. He was provided with a company house to
which he contributed 3% of his basic pay as rent. The market rental value of the house was
Sh.10,000 per month. A company car of 2000 cc was provided or his personal use including a
house servant whose salary of Sh. 5,000 per month was paid by the company.
Calculate his taxable income
ANSWER:
Mr. Kayo
Computation of taxable income
Sh.
Basic Salary 40,000
Car cc basis 7,200
Servant 5,000
Housing benefit :
15% * 52,200 7,830
Market Rental value 10,000
Housing Benefit is the higher 10,000
=
Less own Contribution (1,200) 8,800
Taxable Income 61,000

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Agricultural employees – These are employees engaged in agricultural entities or farms. Housing
benefits is determined as:

10% * Total gains from employment

N/B: an agricultural employee is whose terms and conditions of employment require that he
resides within the farm.
Non whole-time service directors – These are directors whose definition falls outside that of
whole time service directors i.e. they do not devote a significant amount of their time in the
company in any capacity and hold more than 5% of the total share capital of the company.
Housing benefits is determined as the higher of:
(i) 15% of total gains from all sources i.e. employment, business etc or
(ii) Market rental value of the house

Less own contribution towards rent.

Employees provided with both accommodation and meals – such employees include those in hotel
industry where both accommodation and meals are provided.
Housing benefit is determined as 20% of the gains from employment.

Exemption of housing benefit from taxation

Housing benefit is not treated as taxable where:
i) Housing is necessary due to the nature of work of the employee e.g. caretaker of a building,
captain of a ship etc.
ii) It is for better performance of employment by the employee e.g. doctors who resides in
hospitals.
iii) Housing is provided for security reasons e.g. game wardens working in game parks.
Where housing is provided for reasons other than the above, it shall be a taxable benefit.

Nicol V Austin
Austin who was a life governing director of a company entered into an agreement which
provided inter alia that, the company should bear the cost of upkeep of his residence. The
company wished him to continue to reside at the residence for the convenience and prestige of
the business.

Held:
That the sums paid are assessable as profit of his office as the managing director.

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NOTES:
i) In case an employee had occupied only a portion of the house, housing benefit shall be
computed on the basis which the commissioner considers to be just and equitable.
ii) In case the employee had occupied the house for only part of the year, housing benefit is
apportioned accordingly.

FRINGE BENEFITS
A fringe benefit arises when employees are granted loans by the employer at an interest rate that is
lower than the prescribed/market interest rate. Fringe benefit arises on loans provided after 11th
June 1998.
Fringe benefit is determined by a formula i.e.

Fringe benefits = Amount of loan (market interest rate – Low interest rate) n/12 where n is the
number of months or period of loan

Fringe benefit tax is charged at the corporation tax rate and paid by the employer on a monthly
basis i.e.

FBT /month = FB X Corporation tax X 1/n

QUESTION:

Mr. Zoa was granted a loan of sh.2M by his employer on 1st August 2011 at an interest rate of 5%
p.a. The prescribed interest rate was 15% p.a.
Calculate fringe benefit tax.

ANSWER:
Fringe benefit = Amount of loan (market interest rate – low interest rate) n/12
= 2,000,000 (15% - 5%) 5/12
= 83,333
FBT/Month = FBT x Corporation tax X 1/n
= 83,333 x 30% x 1/5
= 5,000

NB: FBT is paid by the employer together with PAYE on or before the 9th day of the following
month after the payroll month.

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GIFTS AND REWARDS

Generally, gifts are not treated as taxable income in the hands of the recipient. This rule applies to
personal gifts e.g. a gift by a person to his friend. However if a gift is received by virtue of
employment for services rendered, it is a gain from employment and it is taxable income e.g. tips
to a waiter. This also includes gifts made to employees as “Christmas gifts” or “long service
awards”

Gifts are taxable where:

 The gifts are paid in relation to the services rendered.
 There is a contract for payment of such gifts.
 The gifts are paid by the employer in the course of the employment.
 The gifts are paid frequently or are anticipated in any kind of employment.
 The gifts are paid by a customer in the course of business or employment e.g. the gift from
a patient to a doctor.

According to the cases above, tips given to taxi drivers, waiters or tour-guides will be taxable
benefits. However rewards given to football players by well-wishers are not taxable.
A gift to the principal of a school by the PTA will not be taxable since such gifts are not from the
employer.

Weston V Hearn
On completion of 25 years of service, Weston was given £250 which he contended was a
voluntary payment.
Held
1. The sum was not a personal gift
2. This was an emolument by way of a bonus and since the employee had not left
employment, the gift was from the employer and was therefore assessable to tax.

Calvert V Wainright
Wainright was employed by a tax hire company at a definite wage. The bargain made no reference
to tips.
Atkinson J observed that; Tips received by a man as a reward for services rendered are assessable
to tax. Personal gifts, gifts to a man on personal grounds, irrespective of whether services have
been rendered or not are not assessable.

Held:
That the tips having been given in the ordinary way as remuneration for services rendered are
assessable.

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Ball V Johnson
A bank had a scheme of giving cash award to its employees who passed the institute of bankers
examination.
Held:
1. The reason for the payment was not for services rendered but for the personal success of the
employee in passing examinations and not remuneration for services rendered
2. The payments were not taxable.

Cooper V Blakiston
An appeal was made by the Bishop and supported by the church wardens stating that, it was the
privilege and duty of the laity to augment the poor stipend of the clergy by personal free will gifts
from which an offering will be collected on Easter Sunday.

Lord Chancellor: - Where a sum of money is given to an incumbent substantially in respect of his
services, it accrues to him by reason of his office. There was a continuity of annual payments from
any special occasion or purpose.

Lord Ash Bourne:- The whole machinery ecclesiastical, the Bishop, church wardens, church
collections and I am able to see room for doubt that these are made for the vicar and became part
of the profits which accrued to him by reason of his office.

Held:
That the Easter offerings were assessable.

Hochstasser V Mayer
A company operated a housing scheme for married employees transferred from one part of the
country to another. Under the scheme, any employee would be compensated for any loss on the
sale of his house in consequence of the employees transfer. Two employees entered into an
agreement under the scheme and having sold their houses at a loss on transfer, received payments
from the company.

Held:
That the payments were not profits accruing by virtue of an office or employment.

ALLOWABLE DEDUCTIONS AGAINST EMPLOYMENT INCOME

1. Subscriptions to professional associations such as ICPAK.
2. Contributions to home ownership savings plan (HOSP) subject to a maximum of Sh.48,000 p.a.
3. Contributions to a registered pension scheme subject to a maximum of Sh.240,000 p.a.

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4. Interest on a loan borrowed to purchase owner occupied house subject to a maximum of

Sh.150,000 p.a.
5. Direct expenses incurred by the employee in connection with employment e.g.
a. Travelling and entertainment expenses for salesmen.
b. Extra cost of living away from home when necessitated by employment
c. Cost of tools and equipment if the employee provides his own
d. Cost of special clothing provided if not provided by the employer

NON-TAXABLE EMPLOYMENT BENEFITS

1. Facilities – These are benefits granted to employees whose aggregate value is less than
Sh.36,000 per annum.
2. Free meals – These are non – taxable benefits if provided to low income employees by the
employer. A low income employee is one whose taxable income does not exceed the rate of
20% on graduated scale.
3. School fees – If payment by the employer is for the employee or his dependents, it is a non-
taxable benefit provided that it is taxed on the employer.
4. Medical benefits – These are non-taxable benefits if provided under a medical scheme which is
non-discriminatory.
5. Passages – where these are granted to expatriate employees who are not Kenya citizens it shall
not be taxable.
6. Contribution to pension scheme by employers on behalf of employee.
7. Fringe benefits – Loans granted to employees at an interest rate that is lower than the
prescribed interest rate are taxed on the employer who pays fringe benefit tax hence not taxable
on employee.

QUESTION:
a) Explain the meaning of the following terms as used in PAYE regulations.
i) Employer
ii) Tax free remuneration
iii) Tax deduction card
b) Mr. Paul Mbaye, a Kenyan migrated to Canada in 2003, In December 2010, he was offered a
job by a company based in Nairobi, Kenya which he accepted. The employment commenced
on 1 January 2011.
The following details relate to his salary and benefits for the year ended 31 December 2011:
1. Monthly salary Sh. 250,000 (PAYE Sh. 27,000)
2. Passage allowance of Sh. 400,000 per annum for visiting his family in Canada

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3. A fully furnished house. The house rent of Sh. 30,000 per month was paid by the employer.
The cost of furnishing the house amounted to Sh. 200,000
4. A life insurance cover whose annual premium was Sh. 30,000 was paid by the employer
5. A motor vehicle (1750 cc) for both private and official use. 25% of the vehicle’s total usage is
estimated to be private. The vehicle was leased from Rental Ltd, a car hire and leasing
company, at an annual lease charge of Sh. 130,000 payable by the employer. The book value of
the car as at 1 January 2011 was Sh. 600,000 (original purchase price Sh. 1,200,000)
6. School fees for his daughter amounting to Sh. 60,000 per annum were paid by the employer
and deducted from the employer’s income statement.
7. He was provided with mobile phone airtime worth Sh. 3,000 per month by the employer.
Approximately 30% of his mobile phone calls were for private purposes.
8. His salary was increased by Sh. 50,000 per month on 1 October 2011 and back dated to 1 July
2011.
9. He received a lumpsum pension of Sh. 360,000 during the year from his previous employer in
Canada

Required:
(i) Comment on the residential status of Mr. Paul Mbaye for tax purposes for the year ended 31
December 2011 (2 Marks)
(ii) Compute the taxable income of Mr. Paul Mbaye for the year ended 31 December 2011.
(12 Marks)
(Total: 20 Marks)
ANSWER:
a) (i) Employer – For purposes of PAYE, the term employer includes:
- An agent, manager or other representative in Kenya of any employer who is outside Kenya.
- Any person having control over employment and remuneration.
- Any paying office of the government or other public authority.
- Any trust or insurance company or either body paying pension to individuals.

(ii) Tax free remuneration- The employer may pay the employees’ salaries negotiated net of
tax. In such cases the employer bears the burden of tax on behalf of the employees.
The income received by employees is called tax free remuneration. However the tax paid by
the employer on behalf of the employee is a taxable benefit.

(iii) Tax deduction card - This is a document used for PAYE purposes. It is completed by the
employer for each of the employees. It includes details of salary and benefits of the
employee, personal relief granted and Tax paid each month. A copy of the tax deduction
card is provided to the employee as a certificate of tax paid.

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b) (i) Mr. Mbaye is considered as a resident for tax purposes since he had a permanent home in
Kenya during the year of income and was physically present.

(ii) Mr. Paul Mbaye

2011 Computation of Taxable Income
Sh.
Salary (250,000x6) + (300,000x6) 3,300,000
Passage Allowance 400,000
Furniture - 12% x 200,000 24,000
Life insurance 30,000
Car – 25% x 130,000 32,500
25%x24%x1,200,000 72,000
72,000
School fees 60,000
Mobile airtime – 30%x36,000 10,800
Housing benefits
15%x 3,889,800 584,520
584,520
Market rental value 360,000
Total taxable income 4,474,320

WIFE’S INCOME
The income of a married woman living together with her husband is deemed to be the income of
the husband for tax purposes.
A married woman is deemed to be living together with the husband, unless;
 They are separated under a court of competent jurisdiction.
 They are separated in such a manner that the separation is likely to be permanent.
 The wife is a resident person but the husband is not.
There are four types of income which must be assessed separately on a married woman. These
include:
Employment income derived at arm's length - Employment income is derived at arm’s length
unless:-
 The wife is an employee of the husband.
 The wife is employed by a partnership in which the husband is also a partner.
 The wife is an employee of a trust or settlement created by the husband.
 The wife is employed by a company which is controlled 12.5% or more by either the
husband or the wife or jointly by the couple.

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PROFESSIONAL INCOME
This is income derived from professional practice such as accountancy and audit, medical or legal
practice, engineering e.t.c
The wife's professional income is assessed separately on her.

BUSINESS OR SELF EMPLOYMENT INCOME

 The business income of a married woman is assessed separately on her.

RENTAL INCOME FROM PROPERTY

The rental income from the wife's property is assessed separately on her.

N/B:
 In case the income of the wife is assessed on the husband, only one personal relief is claimed as
a deduction by the husband.
 Where the income of the wife is assessed separately she is entitled to claim her own personal
relief as a deduction from tax liability.

COLLECTION OF TAX FROM THE WIFE

In case the income of a married woman is deemed to be the husband's for tax purposes he has the
responsibility of accounting for tax. However, a married woman may assume responsibility for tax
where the husband:
 Has been declared bankrupt or insolvent.
 Is of unsound mind.
 The wife is the main bread winner.
 The husband does not own property to be auctioned to recover tax liability.
 The husband cannot be traced.

QUESTION:
(a) Outline four main canons of an optimal tax system. (4 Marks)
(b) Highlight four objectives of fiscal policies in your country (4 Marks)
(c) The following information relates to Mr. T. Kombe and his wife for the year ended 31
December 2011:
1. He was employed by Lipa Ltd as a sales manager on the following terms:
 Basic pay per annum Sh. 900,000 (annual PAYE Sh. 250,000)
 Annual bonus of Sh. 25,000
 Monthly commission equal to 2% of monthly basic pay

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 Annual medical allowance (non-discriminatory scheme) of Sh. 180,000 paid on

reimbursement basis. During the year, he was reimbursed Sh. 120,000 for medical
cost incurred on self and family
 Free lunch valued at Sh. 35,000 per annum
2. He obtained a loan from the employer amounting to Sh. 400,000 on 1st December 20011.
The interest on the loan was specified by the employer as 5% per annum. Assume a
prescribed interest rate of 8% per annum for the month of December 2011
3. He paid life premium amounting to Sh. 72,000 during the year for policies on self and
family
4. His wife is employed by Mauzo Ltd as a financial analyst at a basic salary Sh. 60,000 per
month. Mr. T. Kombe owns 25% of the ordinary share capital of Mauzo Ltd.
5. The following additional income accrued to his wife during the year:
 She earned a profit of Sh. 400,000 from a supermarket business registered by her name
but managed by her daughter. This profit was after deducting Sh. 120,000 paid as salary
to the daughter during the year. The daughter was below eighteen years of age as at 31
December 2011.
 She owns residential houses inherited from her father. The rental income received for
the year amounted to Sh. 480,000.
Required:
(i) The taxable incomes of Mr. T. Kombe and his wife for the year ended 31 December 2011
( 10 Marks)
(ii) Briefly comment on the procedure for the filing of the wife’s income tax returns
(2 Marks)
(Total: 20 Marks)

ANSWER:
Canons of an optimal Tax system

Principle of equity
Adam smith stated that every tax payer should pay tax according to his ability and proportion of
income. Persons with high incomes should pay more tax and a bigger proportion of their income
than the persons with lower incomes.
Principle of certainty
Adam smith also stated that the tax which every person should pay must be certain and not
arbitrary.
This principle facilitates planning by both the government and the tax payers.
In case of the tax payers, they need to be certain about the dates and the amount of tax to be paid,
the methods and the rates of tax used in order to plan their cash flows.

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In case of the government, it should be certain about the amount of public revenues and the time it
is expected to flow to the exchequer.
Principle of convenience
Every tax should be levied at the time or in a manner that is most likely to be convenient to the tax
payers.
This principle encourages tax compliance by the tax payers e.g. a tax payer may pay installment
tax in 4 equal installments during the year.
Income tax on employment income is paid at the end of the month i.e. when the employees have
the means of payment after receiving their salaries.
Principle of economy
The tax system should be convenient to both the tax payer and the state. In the case of the tax
payer, he should be left with some income after paying tax both for his needs and for saving and
investments. A very heavy tax will discourage saving and investments, thus have a negative
impact on the economy
In case of the government, the cost of tax collection, administration and carrying out indepth
investigation should not exceed the tax revenue to be collected.
(b) Objectives of fiscal policies in the country
The main objectives of fiscal policy are the following:
 The achievement of a desirable price level.
 The achievement of a desirable consumption level.
 The achievement of a desirable employment level.
 The achievement of a desirable income distribution.

c) (i)Mr. and Mrs. T. Kombe

2011 Computation of taxable income and tax.
Mr. Kombe Sh.
Basic pay 900,000
Bonus 25,000
Commission 18,000
Free lunch 35,000
Wife’s salary 720,000
Taxable income 1,698,000

Mrs. Kombe
Business income 400,000
Add: Salary to daughter 120,000 520,000
Rented income 480,000
Taxable income 1,000,000
Tax computation

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Mr. Kombe
First Sh. (121,968 @10%) + (114912 @ 60%) 81,144
Surplus (1,698,000 – 466704) @ 30% 399,388.8
450,532.8
Less tax at source T.A.S PAYE (250,000)
Insurance relief 15% X 72000 (10,300)
Personal relief (13,944)
Tax payable 176,288.8

Mrs. Kombe
First Sh. (121,968 @10%) + (114,912 @ 60%) 81,144
Surplus (1,000,000 – 466704) @ 30% 159,988.8
241,132.8
Less: Personal relief (13,944)
Tax payable 227,188.8
Notes
 Medical benefits are not taxable since the scheme is non-discretionary
 Insurance relief is granted at 15% of premiums paid during the year with a maximum of
sh.60,000 p.a on life and Education policies.
 It is also granted on premium paid for an education policy with a maturity period of 10
years.

(ii) Procedure for filing wife's income tax returns

 The income of the wife derived at arm's length is assessed separately on her.
 Income deemed to be the husbands for tax purposes is taxed on the husband.
 Where income is assessed separately on the wife she submits her own returns.
 Where the wife's income is deemed to be husband's for tax purposes, a return is filed in the
name of the husband.

EMPLOYMENT INCOME RECEIVED IN LUMPSUM

Employment income is received in lump sum in case of:
- Backdated salary increment.
- Gratuity received in lump sum.
- Compensation on termination of employment contract.

BACKDATED SALARY INCREMENT

Backdated salary increment may be paid in lump sum or arrears.

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Tax liability is calculated on the lump sum using a specific procedure as follows:
- Calculate tax liability on salary before the increment.
- Calculate tax liability on the total income i.e. salary + Increment p. a
- The difference in tax liability on the total income and on the salary received is tax liability
on the arrears or lump sum.

QUESTION:
Mrs. Mjomba was granted a salary increment of 20% on 31 Dec 2011 which was back dated to 1st
January 2010. Her salary for 2010 and 2011 was sh.680,000 and sh. 760,000 respectively.
Calculate the tax liability on the salary arrears for 2010 and 2011.

ANSWERS:

Mrs. Mjomba
Computation of tax liability
Year Salary Increment (20%) Total
2010 680,000 136,000 816,000
2011 760,000 152,000 912,000

Tax computation
2010 Total income = 816,000 Sh.
First Sh. (121,968 @ 10%) + (114,912 @60%) 81,144
Surplus (816,000 – 466,704) @ 30% 104,788.8
185,932.8
Salary = 680,000
First Sh. (121,968 @ 10%) + (114,912 @ 60%) 81,144
Surplus (680,000 – 466,704) @ 30% 63,988.8 (145,132.8)
Tax on arrears 40,800
2011 Total income =912,000
First Sh. (121968 @ 10%) + (114912 @ 60%) 81,144
Surplus (912,000 – 466,704) @ 30% 133,588.8
214,732.8
Salary = 760,000
First Sh. (121,968 @ 10%) + (114,912 @ 60%) 81,144
Surplus (760,000 – 466,704) @ 30% = 87,988.8 (169,132.8)
45,600

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Total tax on arrears

2010 40,800
2011 45,600
86,400

SERVICE GRATUITY
Service gratuity is paid in lump sum although it relates to employment services rendered over the
whole period. It is deemed to have accrued evenly or equally over the period of employment.
However, in case the year of accrual is earlier that the 4 th year of backdating the income is treated
as that of 5th year of backdating.

QUESTION:
Mr. Bakari left employment in Dec 2011 after 20 years of service. He was paid service gratuity of
sh.660,000. His commencing salary was sh.400,000 p.a., which had been increasing at an average
of sh,5,000 p.a. Show how the gratuity is treated for tax purposes.

ANSWER:
Mr. Bakari
Gratuity (p.a) = Lump sum
Employment service
= 660,000
20
= 33,000

Year Salary Gratuity(p.a) Total income

2011 495,000 33,000 528,000
2010 490,000 38,000 523,000
2009 485,000 33,000 518,000
2008 480,000 33,000 513,000
2007 475,000 528,000 1,003,000

Compensation on termination of employment

Employment contracts are classified into three categories for tax purposes:
(i) A contract for a specified period which provides for compensation incase of termination
before expiry of the contract.
- The lump sum received as compensation is divided equally over the unexpired contract
period.

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QUESTION:
A contract for 5 yrs is terminated on 31 Dec 2008 after it had ran for only 3 yrs compensation is
paid amounting to sh. 1,600,000. Show the tax treatment of compensation.

ANSWER:
Compensation (p.a) = Lump sum
Unexpired contract period
= 1,600,000
2
= Sh.800,000
Compensation (p.a) is spread forward as follows:

Year Taxable income

2009 800,000
2010 800,000

(ii) A contract for unspecified period which provides for compensation on termination.
 The compensation received is divided by the employee’s salary per annum at the time of
termination.

QUESTION:
A contract for unspecified period provides for payment of sh.1.2m as compensation in case of
termination. The contract is terminated on 31 Dec 2010 when the employee’s salary is sh.55,000
per month.
Show the tax treatment of compensation

ANSWER:
Salary per annum = 55,000 x 12
= 660,000
Compensation is spread forward as follows:
Year Taxable income
2011 660,000
2012 540,000
(iii) Where the contract is for unspecified period with no provision for payment of
compensation. In this case if the employer pays compensation, it is of a voluntary nature
and not obligatory.
- Tax liability extends to any payment received by the employee whether it is voluntary or
obligatory in nature. The compensation is divided equally over a period of 3 yrs.

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QUESTION:
A contract of employment is for unspecified period with no provision for compensation on
termination. The contract was terminated of 31 Dec 2009 and a voluntary compensation of
sh.900,000 was paid. Show the tax treatment of compensation.

ANSWER:
Compensation p.a = Lump sum
3yrs
= 900,000
3
= 300,000

Compensation p.a is spread forward as follows:

Year Taxable income
2010 300,000
2011 300,000
2012 300,000

QUESTION:
Mrs. Alice Kosgei was employed by Ukweli Ltd. On a five year contract commencing 1 January
2007. The terms of the contract provided for a lump sum compensation of Sh.2,000,000 if the
contract was terminated by the company before maturity.

The contract was terminated by the company on 31 December 2009.

Required:
The taxable amount of the compensation and the year(s) in which it would be taxed.

ANSWER:
Compensation p.a = lump sum
2yrs
= 2,000,000
2
= Sh.1,000,000

Compensation p.a is spread forward as follows:

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Yrs Taxable amount

2010 1,000,000
2011 1,000,000

TAXATION OF PARTNERSHIPS

For purposes of imposing tax a partnership is not recognized as a “person” or legal entity that is
distinct and separate from the partners.
It is formed with the motive of sharing profits among the partners, hence the income of a
partnership is deemed to be that of the partners, and assessed on them.
S. 4 (b) states that “the gain or profits of a partner from a partnership shall be the sum of-
i) Remuneration payable to him by the partnership together with interest on capital so payable
less interest on drawings payable by him to the partnership;
ii) His share of the total income of the partnership calculated after deducting the total of any
remuneration and interest on capital payable to any partner and after adding interest on
drawings payable by any partner to the partnership.”
Where a partnership makes a loss as calculated in (ii) above, the gains or profits shall be the excess
of any of the amounts set out in (i) above, over his share of that loss.

Existence of a partnership
Whether a partnership exists or not is a question of fact. The basic criterion is whether two or more
persons carry on a business in common with a view to profits. This suggests that the persons
involved bear the attribute of a proprietor and have a profit motive. Other useful guidelines
include:
 Usually a partnership deed or written agreement will be drawn up.
 There is a joint tenancy or tenancy in common.
 There is sharing of gross receipts or profits.
None of the above circumstances would constitute conclusive evidence of the existence of a
partnership. Some common situation which pose difficulties in proving a partnership are whether:
1. Joint transactions may constitute a partnership;
2. The parties concerned are partners or nearly employees

A partner shall be taxed on the aggregate of the following income from the partnership:

 Remuneration paid to him by the partnership.

 Any interest on capital paid to him by the partnership less any interest paid by him to the
partnership such as interest on drawings.
 Share of the adjusted partnership income.

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PARTNERS ALLOCATION SCHEDULE

A B C TOTAL
Salaries XX XX XX XXX
Interest on capital XX XX XX XXX
Less interest on drawings XX XX XX XXX
Profit/ Loss Share XX XX XX XXX
Adjusted partnership profit XX XX XX XXX
Add: Other incomes
Rental income XX XX - XXX
Family income XX XX XX XXX
Total Taxable Income XX XX XX XXX

The income from the partnership will be added to incomes from other sources and taxed on each of
the partners as an individual using the graduated scale rates of tax.

Notes: -
(i) Interest on drawings:-This is not a business income. It is treated as an expense of the individual
partners by deducting from their share of income as individuals.
(ii) Expenses that are specifically not allowed include:
 Salaries commissions and bonuses paid to the partners
 Interest on capital
 Drawings

Key Terms
Legal entity – Recognized in law as a separate entity
Interest on drawings – Interest charged on cash drawings by partners

QUESTION:
Rotich, Mambo and Nora have been trading in partnership as Romano Enterprises sharing profits
and losses in the ratio of 2:2:1 respectively. They have presented the following profit and loss
account of the firm for the year ended 31 December 2011:

Sh.000 Sh.000
Gross profit 24,800
Investment income (gross) 450
Miscellaneous income 315
25,565

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Deduct:
Depreciation 110
Office expenses 1,568
Legal fees 360
Sundry 630
Trade expenses 380
Partners’ salaries, interest on 13,350 (16,398)
Capital and drawings
Net profit 9,167

Additional information
1. Investment income comprises: sh.000
Interest on bank deposits 210
Dividend on shares in quoted companies 130
Interest charged on partners’ drawings: Rotich 50
Mambo 40
Nora 20
450
2. Miscellaneous income comprises:
Sh.000
Gain on sale of furniture and fittings 195
Insurance recoveries for stolen stock 120
315
3. Office expenses comprise: Sh.000
Advertisements on billboards 250
Rent 800
General expenses (allowable) 518
1,568

4. Legal fees include sh.150,000 incurred on a successful defense of a partner in a private legal
suit.

5. Sundry expenses comprise:

Sh.000
Donations to watoto orphanage 420
Debt recovery charges 90
Vehicle maintenance costs 120
630

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6. Trade expenses comprise:

Sh.000
Subscriptions to a trade association 150
Value Added Tax (VAT) paid 170
Repairs to building 60
380

7. Partners’ salaries, interest on capital and drawings are analysed below:

Rotich Mambo Nora Total
Sh.000 Sh.000 Sh.000 Sh.000
Salaries 4,000 4,500 3,700 12,200
Interest on capital 200 300 330 830
Drawings 60 100 160 320
4,260 4,900 4,190 13,350
8. Capital allowances for the year ended 31 December 2011 were agreed with the tax authority at
sh.480,000.
Required:
(a) Adjusted partnership profit or loss for the year ended 31 December 2011. (12 Marks)
(b) Distribution of the adjusted profit or loss amongst the partners. (4 Marks)
(c) The tax liability for each of the partners for the year ended 31 December 2011
(4 Marks)
(Total: 20 Marks)
ANSWER:
(a) Romano Enterprises

2011 computation of adjusted profit (loss)

Sh. Sh.
Net profit per accounts 9,167
Add:
Depreciation 110
Advertisement on bill boards 250
Legal fees for partner 150
VAT 170
Partners’ salaries, Interest on capital 13,350 14,030
Deduct:
Investment income 450
Gain on sale of furniture 195
Capital allowances 480 (1,125)
Adjusted profit (loss) 22,072

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(b) Allocation of profit to partners

Rotich Mambo Nora Total
2/5 2/5 1/5
Sh.000 Sh.000 Sh.000 Sh.000
Salaries 4,000 4,500 3,700 12,200
Interest on capital 200 300 330 830
Interest on drawings (50) (40) (20) (110)
Share of profit (loss)3660.8 3660.8 1830.4 915.2
7810.8 8420.8 5840.4 22,072

Tax computation
Rotich Sh. 7,810,800
Sh.
First Sh. (121,962 @ 10%) + (114,912 @ 60%) 81,144
Surplus (7,810,800 – 466,704) @ 30% 2,203,228.8
2,284,372.8
Less p/relief (13,944)
Tax payable 2,270,428.8

Mambo Sh. 8,420,800

Sh.
First Sh. (121,962 @ 10%) + (114,912 @ 60%) 81,144
Surplus (8,420,800 – 466,704) @ 30% 2,386,228.8
2,467,372.8
Less p/relief (13,944)
Tax payable 2,453,428.8

Nora Sh. 5,840,400

Sh.
First Sh. (121,962 @ 10%) + (114,912 @ 60%) 81,144
Surplus (5,840,400 – 466,704) @ 30% 1,612,108.8
1,693,252.8
Less p/relief (13,944)
Tax payable 1,679,308.8

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CORPORATE BODIES

Corporate bodies are legal entities separate from the directors. These are taxable in their own
names at the corporation tax rate. In case of a resident company profit is taxed at the rate of 30%
whereas incase of a non- resident company the rate is 37.5%. The profit for tax purposes is
calculated in a similar manner as in the case of any business. The same proforma we discussed
earlier shall still be used for computation of taxable profit of a company. Allowable deductions
and disallowable deductions we discussed in an earlier chapter will apply in computation of
adjusted profit of a corporate body.
Interest income:
The interest income received by a corporate body is referred to as non-qualifying interest. It means
that withholding tax of 15% deducted at source is not the final tax. The interest income is subject
to further taxation; hence it is aggregated with other incomes of the company for tax purposes.
However the withholding tax of 15% suffered at source is deducted or offset against tax liability to
determine the tax payable.
Transactions between company and director or shareholder are treated as business for tax
purposes.

QUESTION:

(a) List four types of income which are subject withholding tax when received by each of the
following:
(i) Resident Persons (4 Marks)
(ii) Non-resident persons (4 Marks)

(b) Jenga Ltd presented the following income statement for the year ended 31 Decemebr 2011:

Revenue Sh. Sh.

Gross Profit 36,000,000
Bad debts recovered 1,200,000
Gain on sale of shares 200,000
Dividends from Companies 8,500,000
Interest on post office savings bank 1,300,000
account
Proceeds from sale of furniture 60,000
Total revenue 47,260,000

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Expenditure:
legal and accountancy fees 24,000,000
Salaries paid in lieu of leave 45,000
Donations 120,000
Patents written off 60,000
Repairs and renewals 1,420,000
Interests on overdue loan 14,000
Directors fees 2,450,000
Bad debt – general 160,000
Depreciation 180,000
Partitions 64,000
Purchase of furniture 128,000
Salaries and wages 3,400,000
Advertising 1,360,000
Library books 148,000
Stamp duty – transfer of land 360,000
Electricity bills 171,000
34,080,000
Net profit 13,180,000

Additional information:
1. Legal and accountancy fees include:
Sh.
Staff contact agreement 600,000
Defense of a company driver on a traffic offence 36,000
Income tax appeal 18,000
Lease agreement (100 years) 46,000
Conveyance fees – land transfer 48,500

2. Repairs and renewals include:

Replacement of a car engine 75,000
Painting of a new factory extension 24,000
Redecoration of existing premises 16,000
Carpeting of the managers’ offices 42,000
Conversion of a garage into an office 84,000
3. Advertising includes Sh. 80,000 spent on acquisition of a neon sign.

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4. Electricity bills include Sh. 20,000 incurred on additional deposits as required by the power
company.
5. Bad debts recovered include Sh. 640,000 relating to bad debts which were not previously
allowed as an expense.
6. Capital allowances for the year ended 31 December 2011 were agreed with the tax authority at
Sh. 250,000.

Required:
Adjusted taxable profit or loss for Jenga Ltd for the year ended 31 December 2011

ANSWER:
(a) Types of income which are subject to withholding tax when received by:
(i) Resident persons
 Interest
 Dividend
 Royalties
 Management fees
 Commission
(ii) Non resident persons
 Rent
 Dividend
 Pension
 Royalties
 Management fees
 Interest

(b) Jenga Ltd

2011 Computation adjusted profit or loss
Sh. Sh.
Net profit as per accounts 13,180,000
Add:
Legal fees – traffic offence 36,000
- Income tax appeal 18,000
- 100 year lease 46,000
- Conveyance fees 48,500
Donations 120,000
Patents written off 60,000
Replacement of a car engine 75,000
Painting of a new factory extension 24,000
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Carpeting of the managers’ offices 42,000

Conversion of a garage into an office 84,000
Bad debts – general 160,000
Depreciation 180,000
Partitions 64,000
Purchase of furniture 128,000
Neon sign 80,000
Stamp duty 360,000
Electricity Deposit 20,000
Library Books 148,000
1,693,500

Deduct:
Bad debts recovered 640,000
Gain on sale of shares 200,000
Dividend from companies 8,500,000
Interests on post office savings bank account 1,300,000
Proceeds from sale of furniture 60,000
Capital allowances 250,000
(10,950,000)
Adjusted profit 3,923,500

CO-OPERATIVE SOCIETIES

Co-operative societies became taxable entities with effect from 1st Jan 1985. However, this only
applies to designated Co-operative societies.
The term “designated” means a co-operative society which is registered under the co-operative
societies Act.
Designated Co-operative societies are categorized into 3 types:
- Designated primary co-operative societies.
- Designated secondary co-operative societies.
- Designated primary co-operative societies registered as Sacco’s.

Designated Primary Co-operative Societies

 These are co-operative societies whose members are individuals. In this category are included
farmers Co-operative societies dealing with crops such as tea, coffee, sugarcane or farm
products like milk.
 For tax purposes, “In the case of every Designated Primary Co-Operative society the income
on which tax will be charged shall be the total income for that year deducting there-from an
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amount equal to the aggregate of bonuses and dividends declared for that year and distributed
to the members in form of money or an order to pay money.”
 Where a Designated primary Co-operative society has distributed all income as bonuses and
dividends to its members, Corporation tax liability will not arise. However if income is
retained after the distribution of bonuses and dividends to the members, Corporation tax is
payable at the rate of 30%. In addition withholding of 15% is deducted from the bonuses and
dividends paid to the members. Such bonuses and dividends are the non-qualifying type which
means that withholding tax of 15% suffered at source is not the final tax i.e. the dividend is
subject to further taxation.
N/B: If the cooperative society makes a loss in any year of income, that loss cannot be carried
forward to be offset against the future profit of the Co-operative society.
 Bonuses and dividend are treated as allowable expenses under the following conditions:
- The bonuses and dividends must be paid out in cash or by cheque to the members.
- The payment must be approved at the Annual General meeting.
- Payment must be approved by the commissioner of co-operative societies.

QUESTION:

The following income statement was prepared by Jitegemee Co-operative Society Ltd, a district-
based farmer’s co-operative society, for the year ended 31 December 2011:

Sh. ‘000’ Sh. ‘000’

Turn over 18,000
Profit from canteen operations 4,000
Interest income:
Co-operative Bank Ltd (net) 1,200
Treasury bills (net) 750
Members’ loans (gross) 3500
Co-operative Insurance Company Ltd (net) 80 5,530
Rental Income 3,800
Total Income 31,330
Expenditure
Cost of sales 7,200
Staff costs 5,400
Depreciation 1,000
Corporation Tax (for year 2010) 2,800
Insurance premium 600
Dividend to members 4,200
Honoraria to management committee 400

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Other operating expenses 1,600

23,200
Net Profit 8,130

Additional Information
1. Staff costs include court fines amounting to Sh. 200,000 and legal fees incurred in relation to:
Sh.
 Preparation of scheme of service for staff 180,000
 Drafting of the society’s by-laws 120,000
2. Other operating expenses include Sh. 300,000 incurred to the preparation of the strategic plan
for the co-operative society
Required:
(i) Corporation tax payable by Jitegemee Co-operative Society Ltd, for the year ended 31
December 2011. (6 Marks)
(ii) State the date(s) when the tax computed in (c ) (i) above would payable (2 Marks)
(iii) Comment on your treatment of interest income received by the co-operative society for the year
ended 31 Dec 2011. (2 Marks)

ANSWER:
Jitegemee cooperative society Ltd.
2011 computation of adjusted profit (loss)
Sh.000 Sh.000
Net profit per accounts 8,130
Add:
Drafting of by-laws 120
Depreciation 1,000
Corporation tax 2,800
Strategic plan 300 4,220
Deduct:
Profit from canteen 4,000
Interest income: 5,530
Rental income 3,800 (13,330)
Adjusted business profit/loss (980)
Add:
Interest income:
Co-operative bank (gross) 1,200/85 × 100 1,411.76
Treasury bills (gross) 750/85 × 100 882.35
Co-operative insurance (gross) 80/85 × 100 94.12

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Rental income 3,800

Total taxable income 5,208.23
Corporation tax payable
30% × 5,208.23 1,562.49
Less withholding tax on interest:
Co-operative Bank (12% × 1411.76) (211.764)
T/Bills (15%×882.35) (132.353)
Co-operative insurance (15% × 94.12) (14.118)
Corporation tax payable 1,204,255

Note:
 Interest income from loans to members is tax exempt since the members are the contributors or
savers and borrowers at the same time.
(ii) 2011 Installment tax:
Corporation tax for previous year x 110/100
= 2,800,000 x 110/100
= 3,080,000

Due Dates:
- 1st Installment of 75% of tax i.e. Sh. 2,310,000 is payable by 20th September 2011.
- 2nd Installment of 25% of tax i.e. Sh. 770,000is payable by 20th December 2011.
- Tax refundable (Sh. 3,080,000 – 1,204,255) of Sh. 1,875,745 by 30th April 2012.
(iii) Tax treatment of interest income received by the co-operative society
 Interest received from loans to members is exempted from tax
 Interest income received from Banks and other institutions is non-qualifying type, which means
withholding tax of 15% deducted at source is not the final tax i.e. the gross interest income is
subject to further tax. However withholding tax of 15% suffered at source is allowed as a
deduction from the tax liability

DESIGNATED SECONDARY CO-OPERATIVE SOCIETIES (CO-OP UNIONS)

These are co-operative societies whose members are designated primary co-operative societies.
Therefore these act as umbrella bodies or unions for designated primary co-operative societies. In
this category are included KPCU, KFA, KUSCO etc.
The income tax act as states that “In the case of every designated secondary co-operative society,
the income on which tax is charged is the total income for the year deducting there from an
amount equal to the aggregate of bonuses and dividends declared for that year and distributed to

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the members inform of money or an order to pay money, but the deduction shall not exceed the
income of the society for that year.
This implies that a designated secondary co-operative society can pay bonuses and dividends only
from the current years income but not from profit retained from other years.
Where the society pays all income as bonuses and dividends to the members, no corporation tax
liability shall arise. However if profit is retained after the distribution of bonuses and dividends to
the members, corporation tax is payable at the rate of 30%.

Savings and credit co-operative societies (SACCOS)

Sacco’s are typically designated primary co-operative societies, since the members are individuals
who carry on the business of savings and credit. However the savings are from the members and
credit is granted to the same members, therefore this constitutes a mutual transaction, since the
saver is also the same as the borrower. Therefore, the interest received from loans to member is
exempted from taxation.
In the case of a Sacco, the income tax Act states that the total income for any year shall be deemed
to be the aggregate of:
(a) 50% of the gross income from interest excluding interest from loans to members.
(b) 50% of the gross income from dividends excluding dividends from quoted companies.
(c) 100% of the gross rental income from property.
(d) Gains from transfer of properties.
(e) Any other income chargeable to tax but excluding royalties.

QUESTION:

a) Write brief notes on the following terms:

(i) Pre-shipment inspection. (3 Marks)
(ii) Insurance relief. (3 Marks)
(iii) Taxation of accommodation and meals provided by the employer. (3 Marks)
(iv) Mining allowance. (3 Marks)
b) The following information relates to the income and expenditure of Sawasawa Savings and
credit co-operative Society (Sacco Ltd.) for the year ended 31 December 2011:
c)
Sh. ‘000’ Sh ‘000’
Income:
Interest: Members loans 2,800
Saving Accounts 160
Fixed deposit account 40
Other investment income 80
Rental Income 500

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Gross Income 3,580

Expenditure:
Salaries to staff 1,800
Other operating expenses 600 (2,400)
Surplus 1,180

The society paid dividends and bonuses to members amounting to Sh. 600,000 for the year ended
31 December 2011

Required:
(i) Taxable profit or loss of sawasawa Sacco Ltd for the year ended 31 December 2011
(6 Marks)
(ii) Tax liability (if any) from the profit and loss computed in b (i) above. (2
Marks)
(Total: 20 Marks)
ANSWER:
(a)
(i) Pre-shipment inspection
 This is the practice of inspecting goods before shipment into the country.
 The main objective is to check the quality of goods vis-à-vis the Kenyan standards
 To check whether the value declared is reasonable for purposes of customs duty.
 It also aims at providing information on the possibility of piracy and counterfeit goods

(ii) Insurance relief

 It is granted to resident individuals in respect of premiums paid on their life or family’s’
or spouse’s or education policy, with maturity period of at least ten years
 Insurance relief is determined at the lower of 15% of premiums paid or a maximum
amount of Sh. 60,000 per annum

(iii) Accommodation and meals provided by the employer

 Where the employer has provided accommodation and meals to the employee, the value
of benefit is 20% of the gains from employment.
 Incase meals are provided to employees other than low income, the taxable benefit on
the employee is the cost of meals to the employer
 If meals are provided to low income employees, it is a non taxable benefit

N/B. A low income employee is one whose taxable income does not exceed the rate of 20% on the
graduated scale.

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(iv) Mining Allowance

 It applies at the rate of 40% on the qualifying capital expenditure in the first year of
mining and 10% in each of the next 6 years.
 The qualifying capital expenditure for mining allowances includes:
- Cost of prospecting for minerals
- Expenditure on the acquisition of rights over the minerals
- Expenditure on buildings and machinery that would have no value after mining
operation cease.
- Cost of development and administration prior to mining
- Other tangible drilling costs
 Mining allowance only applies to specific minerals e.g. iron, limestone, gold etc

Sawa Sawa Sacco Ltd

2011 Computation of Taxable profit (Loss)
Sh.000 Sh.000
Surplus 1,180
Add
Expenditure 2,400
3,580
Deduct
Interest on members loans 2,800
Interest on Saving A/C 80
Interest on fixed deposit 20
Other investment income 80 (2,980)
Adjusted taxable income 600

(ii) Corporation tax liability

30% x 600 = 180
Less withholding tax:
Savings account (15 x 160) (24)
Fixed deposit account (15% x 40) (6)
Corporation tax payable 150

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Or
Sawa Sawa Sacco Ltd
2011 Computation of Taxable profit (Loss)
Income Amount Proportion Taxable
Sh. ‘000’ Taxable Amount
Interest on savings account 160 50% 80
Interest on fixed deposit 40 50% 20
Rental Income 500 100% 500
600
N/B: Computation of corporation tax liability is as shown above.

CLUBS AND NON PROFIT MAKING ORGANIZATIONS

MEMBERS CLUBS
A member’s club means a club or similar institution all of the assets of which are owned or held in
trust for the members thereof. Section 21 (1) of the Act states the that total income of a member’s
club including entrance fees and subscriptions are taxable. These clubs are taxed at corporation tax
rate(30%) prevailing in the year of income. However, where 75% or more of the income of a
member’s club is from member’s only, then this club is not required to pay tax on its income. But
the investment income of the club such as dividends, interest etc, will still be taxable.

TRADE ASSOCIATIONS

A trade association means anybody of persons who are engaged in different businesses of similar
type and the object of which is to safeguard or promote the business interest of these persons.
A trade association may elect to the commissioner to be treated as being in a business chargeable
to tax as per section 21 (2). In this case, the association will be liable to tax on its total income
including entrance fees and subscriptions from members. Trade associations are required to pay
tax at corporate tax rate prevailing in the respective year of income. The trade associations are
liable to tax for the year of income in which they elect to the Commissioner to be treated as trading
association and succeeding years of income.

AMATEUR SPORTING ASSOCIATIONS

These associations are required to pay tax on their investment income only. Their income other
than investment income have been exempted from tax as per paragraph 6 of 1st Schedule of the
income tax Act (Cap 470). These associations are exempted from tax on their income other than
investment income if:

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 Their sole or main objective is to foster and control any outdoor sporting activity.
 Their members consist of amateurs or affiliated associations having the membership of
amateurs.
 Their memorandum of association or by-laws have provisions defining amateurs or
professionals, providing that no person may be, or continue to be a member of such an
association if he is not an amateur.

EXPORT PROCESSING ZONES

The Eleventh schedule of the income tax Act sets out the provisions relating to the taxation of
enterprises situated in export processing zones (EPZs)
For the first ten years from the date of commencement of business by an EPZ:
 Payments to the EPZ will be subject to withholding tax at non-resident rates;
 Payments by the EPZ to non-resident persons will be exempt from tax; and
 The EPZ will be exempted from corporation tax provided that it does not carry out in
commercial activity. Commercial activities include trading in, breaking bulk, grinding,
repacking or relabeling goods and industrial raw material. Thus if any commercial
activity is carried out by the EPZ enterprise the exemption would not apply.
For a period of ten years commencing immediately after its initial ten year period, the EPZ will be
subject to corporation tax at the rate of 25%.
Notwithstanding the above, an EPZ must submit annual tax returns and accounts. Employees and
directors of EPZs if resident, are liable to tax and deduction of PAYE in the normal way

INSURANCE BUSINESS

Insurance companies are taxed like any other business. According to the Income Tax Act CAP
470, if an insurance company carries on life Assurance business together with other types of
insurance business, then the life Assurance business is treated as a separate business from other
classes. The insurance company can be mutual or proprietary. Mutual insurance business is the
case where the shareholders are the policy holders.

General Insurance Business

The gains or profits in any year of income shall be the sum of:
 Gross premium received less premium returned and premium paid on re-insurance as relates
to that business.
 The amount of other income from that business including any commission on re-insurance
and any income derive from investments held in connection with that business.

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Deducting from the sum arrived at above;

 A reserve for unexpired risks referable to that business at the end of that year of income and
adding there to the reserve for unexpired risks deducted at the end of the previous year.
 The amount of claims admitted in that year of income less any amount recovered under re-
insurance.
 Agency fees incurred in that year of income.
 Management fees.
 Interest paid on the return of premiums or maturity of policies.
 All other allowable expenses as per section 15 of the Income Tax Act.

Note:
i) Loss incurred by a general insurance business can be offset from profits realized from other
sources.
ii) Any other income realized by an insurance company should be added to the underwriting
profits realized.

QUESTION
Moto general insurance company Ltd provided the following details with respect to the financial
year ended 31 Dec 2011.
Sh
Bad debts 468,000
Investment income 960,000
Reserve for unexpired risks: 1Jan 2011 948,600
Commission on reinsurance accepted 3,484,900
Claims outstanding: 1 Jan 2011 676,200
Gross premium 24,648,600
Claims paid 4,826,000
Claims outstanding: 31 Dec 2011 1,850,000
Claims recovered on reinsurance 545,700
Legal expenses relating to claims 376,800
Commission on re-insurance ceded 728,900
Agency fees 1,296,400
Foreign exchange losses 392,700
Dividends from life insurance fund 216,400
Management fees 1,804,600
Bonus utilized in reduction of premium 371,700
Royalties from patent rights 1,460,000

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Repairs of rented premises 264,800

Travelling expenses 89,400
Purchase of motor vehicle 800,000
Re-insurance premium paid 724,800
Returned premium 1,314,600
Rental income 560,000

Additional information
1. Agency fees include sh. 16,400 relating to the life insurance fund.
2. Management fees include sh. 24,200 which relates to tax consultancy.
3. Repair of rented premises includes sh. 14,800 for purchase of furniture.

Required:
A statement of adjusted taxable profit or loss for Moto General Insurance Company Ltd for the
year ended 31 Dec 2011.

Answer:

Moto General Insurance Company Ltd

2011 computation of taxable profit (loss)
Sh. Sh.
Gross premium 24,648,600
Less returned premium (1,314,600)
Re-insurance premium (724,800) 22,609,200

Reserve for unexpired risks 1 Jan 2011 948,600

Commission on re-insurance ceded 728,900
Royalties from patent rights 1,460,000 25,746,700
Less allowable expenses
Claims paid 4,826,000
Claims outstanding: 31 Dec 2011 1,850,000
Claims outstanding: 1 Jan 2011 (676,200)
5,999,800
Claims recovered on re-insurance (545,700) (5,454,100)
Bad debts (468,000)
Commission on re-insurance accepted (3,484,900)
Legal expenses relating to claims (376,800)
Agency fees (1,280,000)
Foreign exchange losses (392,700)

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Management fees (1,780,400)

Bonus utilized in reduction of premium (371,700)
Travelling expenses (89,400)
WTA-motor vehicle expenses-25% x 800,000 (200,000)
11,848,700
Add:
Investment income 960,000
Rental income (note i) 308,150
Total taxable income 13,116,850

NOTES:
Rental income sh
Gross rent 560,000
Less repairs (264,800-14,800) (250,000)
WTA – Furniture
(12.5% x 14,800) (1,850)
308,150

LIFE ASSURANCE BUSINESSES

The profits or gains for the year of income from life insurance whether mutual or proprietary shall
be the sum of the following:
 The amount of actual surplus as determined under the Insurance Act and recommended by
the actuary to be transferred from the life fund for the benefit of shareholders and
policyholders.
 30% of management expenses and commissions that are in excess of maximum amounts
allowed by the Insurance Act.
 Any other amounts transferred from the life fund for the benefit of the shareholders.
The amount of management expenses and commissions allowed under the Insurance Act is
determined using the scale below. The scale is based on premiums recoverable for the year of
income.
Amount Rate
Sh.
1 - 5,000,000 25%
5,000,001 - 12,500,000 22.5%
12,500,001 - 20,000,000 20%
20,000,001 - 30,000,000 17.5%
Excess over 30,000,000 15%

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Question:
The following information relates to ABC Life Assurance Company Ltd. for the year ended 31st
Dec 2011.
i. The fund balance was valued by an actuary at Sh.200million as at 31st Dec 2011. 40% of
this fund balance was recommended to be transferred for the benefit of shareholders.
ii. Analysis of life assurance premiums during the year was as follows:
Sh.
Received during the year 100,000,000
st
Outstanding on 1 Jan 2011 40,000,000
st
Outstanding on 31 Dec 2011 20,000,000
iii. Management expenses and commissions paid during the year amounted to Sh.20 million
and Sh.4,000,000 respectively. The company had no other income during the year.

Required:
Taxable income of ABC Life Assurance for the year ended 31st Dec 2011.
Answer:
Premiums received during the year: Sh.
Received during the year 100,000,000
st
Add outstanding 31 Dec 2011 20,000,000
st
Less outstanding at 1 Jan 2011 (40,000,000)
80,000,000
Maximum management expenses and commissions according to the insurance Act on Premium
received: Sh. 80,000,000:
Sh.
First 5,000,000 @25% 1,250,000
Next 7,500,000 @ 22.5% 1,687,500
Next 7,500,000@20% 1,500,000
Next 10,000,000@17.5% 1,750,000
Excess (80,000,000 – 30,000,000)@15% 7,500,000
13,687,500

Management fees and commission: 24,000,000

(20,000,000+4,000,000)
Less: Amount allowed (as above) (13,687,500)
Excess 10,312,500

ABC LIFE ASSURANCE COMPANY LIMITED

2011- TAXABLE INCOME COMPUTATION
Sh.
Surplus transferred to shareholders 80,000,000
(40% × 200million)

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Management expenses & commissions 3,093,750

(30% x 10,312,500)
Taxable income 83,093,750

CAPITAL GAINS TAX

Overview

The CGT will be applicable on gains realized by companies and individuals on the transfer of
property situated in Kenya on or after 1 January 2015. This in essence brings to tax any capital
gains accumulated from the time of suspension of the CGT. The general tax rate applicable will be
5%.

The gains shall be determined by the amount by which the transfer value exceeds the adjusted cost
of the property. Adjusted cost refers to cost of acquisition of the property and other costs incurred
subsequently to enhance or preserve the property, provided that such costs had not been previously
deductible for tax purposes.

The Finance Act does not specifically provide guidelines on how the CGT relating to the transfer
of property shall be paid. It is expected that the CGT will be payable in the same manner as the
stamp duty such that, evidence of payment of CGT may be required for the transfer of property to
be registered. However, CGT due on the transfer of shares listed in the NSE (Nairobi Stock
Exchange) by an individual is payable by the stock broker who conducts the transfer.

The Finance Act does not provide for taxation of indirect transfers of property in Kenya. Such
transactions should therefore not be subject to CGT.

Determination of taxable gain

Capital gain shall be the amount by which the transfer value of the property exceeds the adjusted
cost of that property. The adjusted cost of property refers to all costs incurred with respect to the
property, whether at the date of acquisition or costs incurred after the acquisition to enhance the
property. All costs incurred by the transferor in the process of transferring the property e.g.,
professional fees, advertisement, etc., will be deductible against the income realized. No cost will
however be deductible when computing the capital gains if such costs had previously been
deducted for tax.

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Transfer value shall be the value of consideration and in cases where; there is no consideration
given, or the value of consideration cannot be determined or in cases where the parties to the
transfer are related parties, the commissioner may determine the market value of the property.

Transfer for CGT purposes

Transfer of property for purposes of CGT includes:

 Where property is sold, exchanged, conveyed or otherwise disposed of in any manner

whatever (including by way of gift), whether or not for consideration

Or

 On the occasion of the loss, destruction or extinction of property whether or not a sum by
way of compensation or otherwise, or under a policy of insurance, is received in respect of
the loss, unless that sum is utilized to reinstate the property in essentially the same form and
in the same place
 On the abandonment surrender, cancellation or forfeiture of, or the expiration of
substantially all rights to, property, including the surrender of shares or debentures on the
dissolution of a company

A Transfer shall not include:

 Transfer of property for the purpose only of securing a debt or a loan, or on a transfer by a
creditor for the purpose only of returning property used as a security for a debt or a loan
 Issuance by a company of its own shares or debentures
 Vesting of property of a deceased person to personal representative
 Transfer by a personal representative of property to a person as legatee in the course of the
administration of the estate of a deceased person
 Vesting in the liquidator, official receiver or other trustee by an order of a court of the
property of a company
 Transfer by a trustee of property, which is shown to the satisfaction of the Commissioner to
be subject to a trust, to a beneficiary on his becoming absolutely entitled thereto
 Compensation for property acquired by the government for infrastructure development

Capital gains tax for companies

Companies will be required to pay CGT on gains realized from transfer of property situated in
Kenya. The definition of property has been derived from the Interpretation and General Provisions
Act,1 and includes property acquired or held for investment purposes, excluding road vehicles.
This wide definition brings most investments held by a company into the ambit of CGT.

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However, gains realized by companies on the transfer of assets which had qualified for the wear &
tear deduction as well as on the transfer of property in exchange of other property pursuant to a
business restructuring or re-organization found by the minister to be in public interest are exempt
from capital gains tax.

Whereas the Eighth Schedule does not specifically provide for taxation of listed marketable
securities for a company as is the case for individuals, the broad definition of the term property
may be interpreted to mean that CGT will be applicable on gains from transfer of listed securities
by companies.

Capital gains tax for individuals

Individuals will be required to pay CGT on gains realized from the transfer of land or any interest
in land situated in Kenya as well as on marketable securities, whether or not they are listed in the
stock exchange.

Taxation of gains realized by an individual from the transfer of property and marketable securities
excluding listed shares shall be taxed in the same way as a company.

With regard to listed shares, the gain on shares shall be the amount by which the transfer value of
the listed shares exceeds the adjusted cost of such shares.2 The stock broker who conducts the
transfer of the listed shares shall be responsible for collecting and remitting the tax.

Previously, the CGT rate applicable on gains realized on the transfer of listed shares by an
individual was 7.5% as specified in the Eighth Schedule. Following an amendment to the Income
Tax Act (ITA) through the 2014 Finance Act, these gains will now be subject to tax at 5%. An
amendment to the ITA is however necessary to rationalize this position.

Transfer of an asset between spouses or former spouses as part of a divorce settlement or bona-fide
separation agreement shall not be treated as a transfer for purposes of CGT.

Capital gains realized by individuals from under the following instances are exempt from CGT:

 Shares in the stock or funds of the Government, the High Commission or the Authority
established under the Organization or the Community
 Shares of a local authority
 Transfer of private residence occupied continuously for a period of three years or more
prior to the transfer
 Transfer of land whose value does not exceed KES30,000
 Transfer of agricultural property of less than 100 acres situated outside an area specified to
be an urban area

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 Transfer of land adjudicated under the registered Lands Act for the first time
 Transfer of property including listed shares for purpose of administering the estate of a
deceased person

Impact

Taxpayers should review transactions involving the transfer of property where the transaction is
expected to take place on or after 1 January 2015.

Endnotes

1. Under the Interpretation and General Provisions Act, property is defined to include money,
goods, choses in action, land and every description of property, whether movable or immovable;
and also obligations, easements and every description of estate, interest and profit, present or
future, vested or contingent, arising out of or incident to property as herein defined.

2. Adjusted costs in the case of shares means: (i) the market price at which the shares could have
been purchased at arm's length for shares acquired before 13 June 1975; and (ii) the amount or
value of consideration for the shares for shares acquired on or after 13 June 1975.

INCOMPLETE RECORDS

These arise where the business has not kept a complete set of accounting records or part of the
records are lost or destroyed. It is necessary to use all the available records and information
including those from third parties such as debtors and creditors in order to prepare the income
chargeable to tax for a business.
When determining the accuracy of the information provided by a taxpayer who has maintained
incomplete records, verification is necessary to determine:
1. Inflated expenses which reduced taxable income and tax payable.
2. The authenticity and accuracy of the figures provided.
3. The omissions if any in the financial data
To establish the accuracy of the figures provided in the profit and loss account, the bank statement
is examined for cash payments. Expenses accrued and prepaid are extracted from the balance sheet
and adjustments made to determine the actual expenses for the year.
The main items affected by the lack of complete records include:
1. Credit sales and debtor – Where a business does not keep records of the sales on credit the
value can be derived from the opening and closing balances of trade debtors, payments
received from trade debtors during the period, bad debts and the discounts allowed for the
period. This is illustrated below:

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Debtors control account

Dr. Cr.
Balance b/f XX Cash received XX
Credit sales XX Sales return XX
(balancing figure)
Discount allowed XX
Bad debts XX
Balance c/f XX
XX XX
2. Credit purchases and trade creditors – A relationship exist between purchases of stock
during a particular period, opening and closing balances of trade creditors and the amounts
paid to creditors during the year. A creditor’s control account is prepared to determine the
credit purchases. This is illustrated below.

Creditors control account

Dr. Cr.
Cash paid XX Balance b/f XX
Discount received XX Credit purchases XX
(balancing figure)
Purchase returns XX
Balance c/f XX

XX XX

3. Mark-up. It is the profit expressed as a percentage of the cost of sales i.e.

Mark – up = Gross profit x 100
Cost of sales
4. Margin – It is the gross profit expressed as a percentage of sales i.e.
Margin = Gross Profit x 100
Sales
Note:
Where the mark-up as a fraction is 1/n, margin is 1/n +1
Example:
Mark-up is 25%. What is margin?
Answer:
Margin = 1
4+1
= 1
5

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N/B: 25% = 25
100
= 1
4

Question:
a) Explain the factors that determine the extent to which the incidence of a tax can be shifted
b) Fanikiwa Traders is a sole proprietorship firm that deals in household goods. The following
details were extracted from the books of the firm for the year ended 31 December 2011:
(8 Marks)

Receipts and payments account

Sh. Sh.
Balance brought forward 242,000 Payments to trade creditors 2,210,000
Payments received from 5,000,000 Electricity expense 109,000
trade debtors
Cash sales 390,000 Telephone expense 36,000
Rent expense 200,000
Advertising expense 143,000
Fixtures and fittings for office 255,000
use
Insurance expense 94,000
Motor vehicle expenses 212,000
Drawings by the proprietor 1,600,000
Balance carried down 773,000
5,632,000 5,632,000

Additional information:
1. The following balance were also obtained from the business records:
1 January 2011 31 December
2011
Sh. Sh.
 Trade creditors 159,000 244,000
 Trade debtors 260,000 400,000
 Stop fittings 420,000 500,000
 Office furniture 320,000 220,00

2. Depreciation on fixed assets for the year ended 31 December 2011 amounted tosh. 200,000.

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3. Electricity expense includes Sh. 40,000 incurred in relation to the private residence of the
proprietor.
4. During the year, the firm purchased office furniture on credit for sh. 240,000
5. Drawings by the proprietor include Sh. 300,000 representing specific provision for bad debts
6. Rent expense includes sh. 50,000 spent on replacing a wooden door in the shop with a metallic
door.
7. Closing stock as at 31 December 2011 amounted to Sh. 95,000.

Required:
Prepare a statement showing the taxable profit or loss for Fanikiwa traders for the year ended 31
December 2011.
(12 Marks)
(Total: 20 Marks)
Answer:
a) Factors that determine the extent to which the incidence of a tax can be shifted.
1. Elasticities of demand and supply
The higher the elasticity of demand, the lower the incidence of tax on the consumer. The
higher the elasticity of supply, the higher the incidence of tax on the consumer.
2. Nature of markets
In an oligopolistic market (few sellers and many buyers) tax shifting to the buyers is high
since the few sellers can team up to determine the market price. For many sellers and many
buyers, a large portion of tax will be borne by the sellers. For a monopolistic market, the
entire tax burden falls on the shoulders of the buyers.
3. Time available for adjustment
The person who can adjust faster (buyer or seller) will be able to shift tax e.g. if the buyer
can shift to substitute goods, the seller will bear the tax burden.
4. Government policy on pricing
Incase of Government price control, the supplier cannot increase price hence cannot shift
tax burden to buyers.
5. Geographical location
If taxes are imposed only on certain regions, it is hard to shift them to consumers because
consumers will move to regions of low tax.
6. Nature of tax (direct or indirect)
Direct taxes e.g. income tax cannot be shifted whatsoever, while indirect taxes can be
shifted through increase in prices.
7. Rate of tax
If too high, shifting can occur backwards or forwards.
If too low, it can be absorbed by the manufacturer.

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b) Fanikiwa Traders
2011 Computation of taxable profit (loss)
Sh.000 Sh.000
Sales: - Cash 390
-Credit 5,140
5,530
Less cost of sales
Opening stock -
Purchases 2,295
Less closing stock (95)
(2,200)

Gross profit 3,330

Less allowable expense
Electricity expense (109 – 40) 69
Telephone expenses 36
Rent expense (200 – 50) 150
Advertising expense 143
Insurance expense 94
Bad debts – specific provisions 300
Wear & tear allowances (note iii) 115
(907)

Taxable profit (loss) 2,423

Notes:
i) Credit sales
Trade debtors
Sh. 000 Sh. 000
Balance b/f 260 Receipts & Payments 5,000
Sales 5,140 A/C 400
5,400 Balance c/f 5,400

ii) Credit purchases

Trade Creditors
Sh. 000 Sh. 000
Receipts & Payments 2,210 Balance b/f 159
A/C 244 purchases 2,295

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Balance c/f 2,454 2,454

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iii) Fixtures &fittings

Sh.000 Sh.000
Balance b/f – Shop fittings 420 Depreciation 200
- Office 320 Disposals 365
furniture 255 Balance c/f – Shop 500
Fixtures & fittings 240 fittings 220
Office furniture 50 - office
Metallic door 1,285 furniture 1,285

iv) Wear and Tear allowances

Class IV
12.5%
Written down value 1.1.2011: - Shop fittings 420
- office furniture 320
Additions:
Fixtures and fittings 255
Office furniture 240
Metallic door 50
Disposals (Note iii) (365)
920
Wear and tear allowance (115)
Written down value on 31.12.2011 805

APPLICATION OF CASE LAW

LUMP SUMS

Beak v. Robson
Robson entered into an agreement with his company to continue as a director and manager for five
years at a fixed salary plus bonuses. By the last two clauses, he covenanted £ 7,000 not to compete
with the company if he left it.

Lawrence: The £7,000 comes not from having or excising an office but from the absence from
employment after the cessation of the office.

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Lord Greene: Robson is selling to the company the benefit of a covenant which only comes into
effect when the service is concluded. The £7,000 is not paid for performing the service in respect
of which he is chargeable under schedule E.

Cowan v. Seymour
Cowan acted as unpaid secretary of a company and later as a liquidator. After liquidation, the
remained a sum on hand which the shareholders voted unanimously to the secretary and chairman.
The resolution stated “the late secretary be asked to accept a moiety of such balance.”
M.R. it is more in the nature of a testimonial to him for what he had done in the past while in
office, which had then terminated.
Younger L.J. this was not a profit by reason of the office but was rarely a gift by persons in the
position of beneficiaries who had appreciated and maybe had benefitted by the personal exertions
of the holder of the office while he held it.

Held:
That the sum voted by the shareholders did not accrue to him by reason of an office or
employment or profit and was not chargeable.

Cooper V Blakiston
An appeal was made by the Bishop and supported by the church wardens stating that, it was the
privilege and duty of the laity to augment the poor stipend of the clergy by personal free will gifts
from which an offering will be collected on Easter Sunday.
Lord Chancellor: - Where a sum of money is given to an incumbent substantially in respect
of his services, it accrues to him by reason of his office. There was a continuity of annual
payments from any special occasion or purpose.

Lord Ashbourne:- The whole machinery ecclesiastical, the Bishop, church wardens, church
collections and I am able to see room for doubt that these are made for the vicar and became part
of the profits which accrued to him by reason of his office.

Held:
That the Easter offerings were assessable.

Weston V Hearn
On completion of 25 years of service, Weston was given £250 which he contended was a
voluntary payment.
Held
1. The sum was not a personal gift

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2. This was an emolument by way of a bonus and since the employee had not left
employment, the gift was from the employer and was therefore assessable to tax.

BENEFITS

Parker v. Charman
Parker was a director of a company on a salary and commission basis. His commission was
credited to his account. In 1920 a dividend was proposed together with an announcement of a new
share issue. Later, the price of the company’s trading commodity fell from £125 to £15 per ton.
The company was reluctant to pay the dividend. They also realized that the share issue would not
be taken up. To support the credit of the company, Parker utilized his dividend and commission
towards purchasing a large portion of the new issue.

Rowcatt. A company pays its debts in shares; it is applying the money which it owes it creditors
by the consent of the creditor, in buying the company.

Lord Hanworth MR. This commission was a sum which Mr. Parker did receive and subsequently
appropriated to the benefit of the company.

Held:
That the appellant was assessable on the full amount of remuneration credited to him.

Richardson v. Lyon
By agreement the company agreed to pay the annual premium on a policy on the life of the
employee.

Held:
That the payments are part of emoluments of his office.

Weight V Salmon
An employee of a company was given the privilege of obtaining unissued shares at a value that
was less than the prevailing market price.

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 the market value which was accessible.
Non-cash benefits include:

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Nicol V Austin
Austin who was a life governing director of a company entered into an agreement which provided
inter alia that, the company should bear the cost of upkeep of his residence. The company wished
him to continue to reside at the residence for the convenience and prestige of the business.

Held:
That the sums paid are assessable as profit of his office as the managing director.
Expenses

Friedson v. Glyn Tom.

Glyn Tom was a curate at Faversham. He left there to take up a curacy at Edmonton. He claimed
the expenses of removal
Samkey J. There is all the difference in the world between an expense which you have to incur in
order to go to a place to take up your duties and an expense incurred in the performance of your
duties.

Held:
That the deduction is not an allowable deduction

Ricketts v. Colquhoun
Rickets was a barrister living and practicing in London. He also held the office of Recorder of
Portsmouth. He claimed as a deduction from his emolument as Recorder, the travelling expenses
to Portsmouth and the hotel expenses while he was there.

Viscount Cave L.C. The expenses are incurred not because the appellant holds the office of
Recorder, but because of living and practicing away from Portsmouth, you must travel to that
place before he can begin to perform his duties. The expenses are incurred partly before he enters
upon the duties and partly after he has fulfilled them.

Held:
The expenses are not an allowable deduction.

Eagles V. Levy
Levy had been the chairman and managing director of a company. He started a high court action
for the recovery of the balance of remuneration which he claimed was due to him. On the second
day of the hearing, the action was settled without a court order. Counsel for the company stated in
court that “the sum is a comprehensive sum, there are no cost on either side in the matter” levy

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claimed his expenses of £6000 in making the action, as a deduction from the emoluments
recovered.

Finlay J. The £45,000 per annum did not to any extent represent costs but on the contrary, it was a
sum from which cost were excluded. This was not a sum which can be deductible.

Held:
That the costs of the action were not necessarily incurred in the performance of his duties

QUIZ

Question 1
a) With reference to the principle of equity in taxation, distinguish between ‘vertical equity’ and
‘horizontal equity’. (4 Marks)
b) Highlight four arguments in favour of direct taxes (4 Marks)
c) S. Barasa is a sales manager with Timau Millers Ltd. The following information to his income
for the year ended 31st December 2011:
1. Basic pay Sh. 960,000 per annum (PAYE Sh. 120,000 per annum)
2. He provided with house leased by the employer at Sh. 50,000 per month. He contributes 3%
of his basic pay towards the house rent.
3. On 1 July 2011, he was provided with a loan by the employer amounting to Sh. 4,200,000
at an interest rate of 4% per annum to enable him to purchase a residential house. He moved
to the new house 1 August 2011.
4. He is a member of a registered pension scheme. During the year, he contributed Sh.
180,000 to the scheme while the employer contributed an equal amount.
5. He operates a canteen which is located within the employer’s premises. The employer
deducts Sh. 2500 per month as rent for the canteen, although the market rental value is Sh.
8,000 per month. The canteen reported a taxable profit of Sh. 120,000 for the year ended 31
December 2011
6. He is provided with a motor vehicle (2000cc) for both official and private use. On average,
three quarters of the motor vehicle usage is for official purposes. The motor vehicle cost Sh.
1,600,000 in year 2008 but was valued at 1,000,000 as at 31 December 2011.
7. During the year the employer paid the following bills for him

Sh.
 School fees (expensed in the company’s books) 80,000
 Telephone Bills 30,000
 Grocery Bills 12,000
 Watchman Wages 36,000

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8. During the year, the employer contributed Sh. 20,000 for him to Mali Golf Club.
9. He is married with three children. The life insurance premium for himself and family
amounting to Sh. 22,000 per annum were paid by the employer during the year.
10. He also owns a farm which reported a loss of Sh. 80,000 for the year ended 31 December
2011. He estimates that five per cent of the farm output is consumed by his family.

Required:
(i) The taxable income of S. Barasa for the year ended 31 December 2011 (10 Marks)
(ii) Tax payable (if any) from the income computed in c (i) above (2Marks)
(Total: 20 Marks)

Question 2
(a) State four grounds on which a taxpayer can lodge an appeal with the local committee
(4 Marks)
(b) Mr. Alex makokha is a tax manager with Otieno and Kalei Associates, a firm of Certified
Public Accountants (CPAs). During the year of income ended 31 December 2011, he reported
the following:
1. Basic salary per month sh.75,000 (PAYE SH.14,000 per month).
2. He is provided with a motor vehicle of 2000 cc by the employer. The motor vehicle was
leased from Magari Leasing Ltd. For sh.22,500 per month. As at 1 January 2011, the motor
vehicle was valued at sh.400,000 after deducting accumulated depreciation of sh.150,000.
3. He was housed by the employer in a fully furnished house (cost of furniture, sh.180,000)
until 30 September 2011. During this period, he contributed 10% of his basic pay as rent.
4. On 30 September 2011, he obtained a mortgage from Nyumba Building Society Ltd. For
sh.4,000,000 at an interest rate of 18% per annum. He shifted his own residential house
with effect from 1 October 2011.
5. The employer paid his life assurance premiums amounting to sh.100,000 during the year.
6. He is a member of a registered retirement benefits scheme to which he contributed
sh.15,000 per month while the employer contributed an equal amount.
7. During his spare time, he provided free tax advice to his friends. These services were
valued at sh.100,000.
8. His wife owns residential property. During the year, she reported the following:
 Gross rental income sh.400,000 per annum.
 Repair and renovation costs before letting sh.80,000.
 Municipal council rates sh.8,000 per annum.
 Insurance for the property sh.12,000 per annum.
 Construction of a fire exit as per Municipal Council regulations sh.30,000.

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Required:
(i) Total taxable income for Mr. Alex Makokha for the year ended 31 December 2011.
(14 Marks)
(ii) Tax liability for Mr. Alex Makokha (2 Marks)
(Total: 20 Marks)

QUESTION 3:
(a) John Sululu had an outstanding loan balance of Sh. 1,000,000 from the employer as at 31
December 2011. The interest on the loan was fixed at 4% per annum.
Required:
(i) Determine the fringe benefit tax payable for the month of December 2011 assuming a
prescribed interest rate of 6 % per annum. (3 Marks)
(ii) Sate who is responsible for remitting the tax determined in (a) (i) above (1 Mark)
(b) Naivasha Dairy co-operative Society Ltd. prepared the following income statement for the year
ended 31 Dec 2011.
Sh. Sh.
Sales of milk and other products 21,600,000
Dividend from quoted companies 40,000
Revenue 21,640,000
Expenditure:
Legal fee on overdraft 125,000
Income tax paid (year 2010) 807,000
Donations 68,000
Bad debts reserve 160,000
Repairs maintenance 82,000
Loss on sale of investment 60,000
Education workshop for members 120,000
Committee sitting allowance 300,000
Interest on overdraft 200,000
Purchase of stationery 100,000
Bonuses and dividends for farmers 12,000,000 (14,022,000)
Net surplus 7,618,000)

Required:
(i) Determine the tax payable by the co-operative society for the year ended 31 Dec 2011.
(6 Marks)
(ii) State the date(s) when the tax computed in (a) above would be payable.
(2 Marks)
(c) Distinguish between the following sets of terms as used in taxation:

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(i) Trading receipts and balancing charge (4 Marks)

(ii) Objects and Appeals (4 Marks)
(Total: 20 Marks)
Question 4:
a) Mr. Claus Ochochi, a businessman, reported an accounting profit of Sh. 800,000 for the year
ended 31 December 2011. However, an assessment of the income and expenditure of his
business by the revenue authority revealed a taxable profit of Sh. 300,000 only for the year
ended 31 December 2011.

Required:
Identify possible reasons for the differences between the accounting profit and the taxable profit of
Mr. Claus Ochochi as reported above. (4 Marks)
b) Sweetfruit Ltd processes various types of fruit juice for sale.
The company reported a net profit of Sh. 7,855,500 for the year ended 31 December 2011. This
profit was after debiting and crediting the following items.

Sh.
Opening stock 1,950,000
Purchases 18,900,600
Salaries and wages 6,750,000
Lease amortization 375,000
Gross sales 42,000,000
Rental income 10,500,000
Electricity and water expense 2,400,000
Interest expense 4,500,000
Rent, rates and taxes 1,800,000
Donations to a political party 240,000
Closing stock 2,550,000
Profit on sale of shares 100,500
Impairment of assets 528,000
Depreciation 1,353,000
Cost of stolen stock 1,800,000
Legal expenses 1,200,000
Dividend income (gross) 1,800,000
Interest income (net) 3,150,000
Repairs and maintenance 2,970,750
Bad debts 2,031,000
Proposed dividend 1,800,000
Redundancy payments to employees 3,270,900

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Insurance compensation received 750,000

Business promotion cost 1,440,750
Miscellaneous income (not taxable) 315,000

Additional information:
1. Legal expenses were incurred in relation to:
Sh.
Drafting of a lease agreement (100 years) 180,000
Settling customer disputes 120,000
Conveyance fee on purchase of land 300,000
Issue of debentures 600,000
1,200,000

2. Bad debts were analyzed as follows:

Bad debts account
Sh. Sh.
Bad debts 381,000 Balance brought
written off forward:
Balance carried General provision 6,750,000
down:
General 7,200,000 Specific provision 1,500,000
provision
Specific Profit loss account
provision 2,700,000 2,031,000
10,281,000 10,281,000
3. Included in repairs and maintenance was Sh. 300,000 incurred on renovation of a factory
building.
4. Capital allowances for the year ended 31 December 2011 were agreed with tax authorities at
Sh. 2,730,000.
5. Dividend income received was analysed as follows:
Sh.
Dividend from a subsidiary company 600,000
Dividend from shares held in a commercial bank 1,200,000
1,800,000
6. Interest income comprised of:
Sh.
Interest from an account with foreign bank 1,350,000
Interest from Treasury bills 1,800,000
3,150,000

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7. Insurance compensation received was in relation to the debtors who had defaulted on
payment.

Required:
(i) Taxable profit or loss of Sweetfruit Ltd for the year ended 31 December 2011.
(10marks)
(ii) Tax liability (if any) due from the company for the year ended 31 December 2011.
(2marks)

c) The following statement was made by a senior official of the revenue authority in your country
during one of the workshops held to induct new taxpayers on tax policies.

“One of the merits of taxation is that it creates civic consciousness on government activities”.
Required:
Explain the above statement in the context of the role of taxation in a country. (4marks)
(Total: 20marks)
ANSWERS

Question 1
(a)
- Vertical equity
It means that there is reasonable differences in taxation of persons with equal abilities to pay i.e.
different people with different incomes don’t pay the same amount of tax.
- Horizontal equity
It means that there is equal taxation of persons with equal ability to pay i.e. persons with the same
income levels should pay equal amounts of tax.
(b) Arguments in favour of direct taxes:
2. Fair distribution of income and wealth
- Direct taxes are more effective in reducing the inequalities of income and wealth.
3. Ability to pay
- Direct taxes are related to the income levels of a person.
4. Revenue elasticity
- As income levels go up the revenue to the government also goes up.
5. Certainty
This is in relation to the manner, time of payment and the amount of tax to be paid.
6. Economical
- The cost of collection of direct taxes is low.
7. Simplicity
- Direct taxes are simple and easy to understand.
8. Civil responsibility
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- Direct taxes instill a spirit of Civil responsibility i.e. tax payers would want to know how their
money is used by the government.

(c)
S. Barasa
2011 computation of taxable income
Sh.
Basic salary 960,000
Canteen (8,000 – 2500)12 mths 66,000
Car.cc basis ¼ X 86,400 21,600
96,000
¼ X 24% X 1,600,000 96,000
School fees 80,000
Telephone 30% X 30,000 9,000
Grocery bills 12,000
Watchman 36,000
Golf club 20,000
Life assurance 22,000
Housing benefit
15% X 7/12*1,301,000 113,837.5
Market rental value 350,000
Housing Benefit is higher 350,000
Less own contribution (16,800)
(3%*7/12*960,000)
Less contribution to pension
Actual 180,000
Set limit 240,000 (180, 000)
30% gains from employment 490,260
Business income 120,000
Total taxable income 1,574,200
Tax computation
First Sh. (12,968 @ 10% ) + (114,912 @ 60%) 81,144
Surplus (1,574,200-466,704) @ 30% 332,248.8
413,392.8
Less T.A.S PAYE (120,000)
Life insurance 15% X 22000 (3,300)
Personal relief (13,944)
Tax payable 689,541.6

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Notes
 Mortgage interest is not granted as allowable deduction since the loan is not from a recognized
financial institution.
 Farming loss is carried forward to be set off against profits from farming in future years.
 Insurance relief is granted on life or education policies on self, spouse or child at 15% of total
premium paid during the year, with a maximum of sh.60,000 p.a.

Question 2:
(a) Grounds for lodging an appeal with the local committee:
- Where the commissioner has refused to amend an assessment
- Where the commissioner has refused to refund tax
- Where the commissioner has refused to waive penalties
- A dispute involving the valuation of assets for purposes of capital allowances
- Where the commissioner has issued a notice to the taxpayer requiring him to maintain his
books and records in a particular format

(b) (i) Mr. and Mrs. Makokha

2011 computation of taxable income
Mr. Makokha Sh.
Basic salary 900,000
Car. Cc. basis 86,400
270,000
Leasing charge 270,000
Furniture 1% X 9 X 180,000 10,800
Life assurance 100,000
Housing benefits
15 %( 9/12*1,270,000) +10,800 145,305
Less 9/12 X 10% X 900,000 (67,500) 76,995
Less contribution to pension
Actual 180,000
Set limit 240,000 (180,000)
30% earning from employment 407,338.5
(30%x 1,357,795)
Less mortgage interest
Actual 3/12 X 18% X 4,000,000 180,000 (37,500)
Set limit 3/12 X 150,000 37,500
Taxable income 1,140,295

Mrs. Makokha
Rental income (Note i) 350,000

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(ii) Tax computation

Mr. Makokha
First Sh.(121,968 @ 10%) + (114,912 @ 60%) 81,144
Surplus (1,140,295 – 466,704) @ 30% 202,077.3
283,221.3
Less T.A.S – PAYE (168,000)
Insurance relief (15% X 100,000) (15,000)
P/relief (13,944)
Tax payable 86,277.3
Mrs. Makokha
First Sh. (121,968 @ 10%) + (114,912 @ 15%) 29,433.6
Surplus (350,000 – 236,880) @ 20% 22,624
52,057.6
Less personal relief (13,944)
Tax payable 38,113.6)

NOTES
Rental Income Sh.
Gross Income 400,000
Less municipal rates (8,000)
Insurance (12,000)
Fire exit (30,000)
Taxable Income 350,000

Question 3:
(a) (i) Fringe Benefit Tax
Fringe benefit = Amount of loan (Prescribed interest rate – low interest rate) n/12
Where n is the number of months
= 1,000,000(6% - 4%) 1/12
= 1,666.667
Fringe benefit tax = Fringe benefit x corporation tax x 1/n
= 1,666.667 x 30% x 1/1
= 500
(ii) It is the responsibility of the employer to calculate and remit fringe benefit tax to the tax
authority by the 9th day of each month.

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(b) Naivasha Dairy Co-operative Society Ltd.

2011 computation of adjusted profit (loss)
Sh. Sh.
Net profit per accounts 7,618,000
Add:
Legal expenses on overdraft 125,000
Income tax 807,000
Donations 68,000
Bad debt reserve 160,000
Loss on sale of investment 60,000 1,220,000
Deduct:
Dividend from quoted companies (40,000)
Adjusted business profit (loss) 8,798
Corporation tax liability: 30% X 8,798 2,639.4
(ii) Installment tax:
807,000 X 110/100 887,700

Due dates
1st installment (75%) Sh. 665,775 is payable by 20.9.2011
2nd installment (25%) Sh. 221,925 is payable by 20.12.2011.
Balance (including penalty) Sh. 2,102,040 is payable by 30/4/2012.
(c) (i) Trading receipt - Where the assets of an entire class of wear and tear are disposed at a
value that is higher than the written down value of assets in the same class, the gain or surplus
is a trading receipt incase the business is a going concern. A trading receipt is a taxable
business gain
Balancing charge – Where the assets of an entire class of wear and tear are disposed at a value
that is higher than the written down value of assets in the same class, the gain or surplus is a
balancing charge in case the business is under liquidation. A balancing is a taxable business
gain.
(ii) Objections – A tax payer has the right to lodge an objection against an assessment
issued by the commissioner within 30 days after receiving the assessment. A valid
notice of objection must be:
- Made in writing.
- State the grounds of objection.
- Made within 30 days.
Appeals – A tax payer who is aggrieved with the decision of the commissioner my
lodge an appeal with the established bodies of appeal such as:
- Local committee

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- Tribunal
- High court
- Court of appeal
Question 4
a) Possible reasons for the difference between the accounting profit and taxable profit of
Mr. Claus Ochochi
 Inclusion of non taxable income in the reported profit for example gain on sale of fixed
assets which is not taxable.
 Failure to deduct certain allowable deductions from the accounting profit for example
capital allowances such as wear and tear allowances.
 Deducting from the accounting profit certain expenditures which are not allowable for
example salary to the owner of the business.
 Failure to include incomes which are taxable in the accounting profit.
 Failure to disclose all income and expenditure to the revenue authority but including in the
accounting profit.
 Other reasons such as arithmetical errors, poor record keeping etc

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b) (i)
Sweet fruit Ltd
2011 Computation of Taxable profit or Loss

Sh. Sh.
Reported profit 7,855,500
Add:
Lease amortization 375,000
Impairment of assets 528,000
Rent, Rates and taxes 1,800,000
Depreciation 1,353,000
Donation to Political Party 240000
Legal Expenses – 100 year lease 180,000
- conveyance fees 300,000

Repairs and Maintenance – renovation 300,000

Bad debts – increase in general provision 450,000
Proposed dividend 1,800,000 7,326,000
Deduct:
Rental income 10,500,000
Profit on sale of shares 100,500
Dividend income 1,800,000
Interest income 3,150,000
Miscellaneous income 315,000
Capital allowances 2,730,000 (18,595,500)
Adjusted business profit or loss (3,414,000)

Add:
Rental income 10,500,000
Interests from treasury bills (gross)
(1,800,000 x 100/85) 2,117,647.059
9,203,647.059

(ii) Corporation tax liability:

30% × 9,203,647.059 = 2,761,094.118
Less withholding tax on interest = (317,647.209)
(15% x 2,117,648.059 )
2,443,446.909
c) Role of taxation in creating civic awareness or consciousness
Taxes, especially direct taxes create civic consciousness among the taxpayers. Tax payers are
conscious that they are paying taxes to the government and therefore take interest in the activities

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of the state. This interest is focused on whether public expenditure is incurred from public welfare
or not. Such consciousness puts a check on the wastage of public expenditure in the country.

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TOPIC

CAPITAL DEDUCTIONS

INTRODUCTION

Key terms
Investment deduction: Is a capital deduction given on cost of buildings and machinery which
are used for manufacture, on cost of a ship, and on cost of a hotel building.
The investment deduction on buildings and machinery is intended to encourage new investments
in the manufacturing sector
The investment deduction is deducted in the income tax computation, or in arriving at the taxable
income/loss

Industrial Building allowance: This is a capital deduction or allowance given in respect of

capital expenditure on an industrial building
The amount of industrial building allowance is deducted in the income tax computation or in
arriving at the taxable income/loss for year or period

Wear and Tear allowance: The wear and tear deduction is a capital deduction on machinery used
for business. The deduction is made against income

Farm works deduction: This is a capital deduction granted only in respect of capital expenditure
on agricultural land. The farm works deduction is deducted in the income tax computation

The deductions or allowances are at standard rates for all taxpayers depending on the nature of the
capital expenditure incurred.

Section 16 of the income tax expressly provides that in calculating the gains or profits of a person
no deductions can be made for expenditure of a capital nature. The same principle is applied in
disallowing capital losses, exhaustion of capital e.g. depreciation of fixed assets.
- Capital Allowances are allowable deductions granted on the capital expenditure incurred to
acquire assets that are utilized in the business to generate taxable income.
- Capital allowances are granted for the following reasons:
 To encourage new industrial enterprises;
 To allow such deductions as may just and reasonable as representing the diminution
in value of fixed assets during a particular year.
 To encourage exportation

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- Capital allowances include the following:

(i) Investment deduction (ID)
(ii) Industrial building deduction (IBD)
(iii) Framework deductions (FWD)
(iv) Diminution in value of loose tools and implements

The capital deductions are important because:

a) Some offer incentives to business by allowing capital expenditure otherwise not claimable.
b) Some act as standard depreciation for income tax purpose. The depreciation and similar
charges are not allowable expenses against taxable income.

These are referred to as deductions (allowances) under the Second Schedule to the Income Tax
Act.

The manner of calculating and computing the various capital deductions or allowances is given
below.

The wear and tear deduction is a capital deduction on machinery used for business. 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.
As per paragraph 7 of the Second Schedule to the Income Tax Act ... ―where during a year of
income machinery owned by a person is used by the person for the purpose of his business,
there shall be made in computing the person‘s gains or profits ... a deduction ... referred to as a
‗wear and tear deduction‘.‖

It should be noted that machinery qualifies for wear and tear deduction where:
i. Owned by a person, and
ii. Used by the person for business anytime during the year of income.

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INVESTMENT DEDUCTION (ID)

This is a claim granted in the year the asset is first used on the capital expenditure incurred on
factory buildings and machinery as an incentive to encourage investments in the manufacturing
sector.
Investment deduction is granted to encourage:
 The development of industries in normal manufacture, tourism and shipping.
 Exportation to earn foreign exchange e.g. in the case of Export Processing Zones
enterprises.
 To encourage foreign investment in Kenya
The qualifying capital expenditure for purposes of investment deduction includes:
1. Construction of a factory building.
2. Installation of new or imported second hand processing machinery.
3. Construction of a hotel building certified to be an industrial building.
4. Purchase of machinery utilized for ancillary purpose such as:
 Generation, transformation and distribution of electricity.
 Machinery for clean up and disposal of effluent and other waste products.
 Machinery for the reduction of environmental damage
 Machinery for water supply and disposal
5. From 1 January 1995, specified civil works are eligible for investment deductions.
Civil works includes:
a. Roads parking areas.
b. Railway lines and related structures.
c. Water, industrial effluent and sewerage works.
d. Communication and electrical posts and pylons and other electrical supply works.
e. Security walls and fencing.
6. From 1 July 1999, workshop machinery for the maintenance of machinery used for
manufacturing.
7. From 1 January 2010, purchase of filming equipment by a local film producer.

Rates of ID are:
Year Nairobi & Mombasa Elsewhere
1988 10% 60%
1989 25% 75%
1990-94 35% 85%
1995-00 60% 60%
2001 100% 100%
2002 85% 85%
2003 70% 70%

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2004-2012 100% 100%

Notes
(i) With effect from 1st January 2010, Investment Deduction is granted at the rate of 150% on
capital expenditure incurred in an investment within satellite towns adjoining Nairobi,
Mombasa, and Kisumu provided that the value of investment is Sh. 200M or more.
(ii) An industrial building that qualifies for ID must be new i.e. it must not have been used
before for any other purpose.
(iii) When non- qualifying expenditure is included in the cost of an industrial building that
qualifies for investment deduction, such expenditure shall also qualify for ID if the
proportion to the total cost is 10% or less.
Example of non qualifying expenditure and administration offices, showrooms, retail shops
and residential areas not meant for workers.

Question:
BB Ltd constructed a factory building at a total cost of Sh.10m. The cost of construction
comprised:
Sh.000
Land 2,000
Office 600
Show room 300
Factory 7,100
10,000
Answer:
Non qualifying cost X 100
Total cost

600 + 300 X 100 = 11.25%

600 + 300 + 7100
Qualifying cost is only the factory cost of sh. 7,100,000
Cost of office and show room will not qualify for ID.

INVESTMENT DEDUCTION FOR BONDED MANUFACTURERS (IDBM)

This is an additional incentive that was granted to manufacturers to encourage manufacture for
export purposes. IDBM was introduced in Kenya in 1988. Capital expenditure that qualified for
IDBM had to fulfill the following specific conditions.
1. The expenditure must qualify for ordinary ID.

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2. The manufacturer must obtain a license from the customs department indicating that the
manufacture was for export purposes.
3. Where a person fails to manufacture for export for at least 3 years, IDBM granted was
clawed back, which means the commissioner recover the amount of IDBM that was
granted.
Currently no IDBM is given since the rate of I.D is at 100%

RATES OF IDBM
Nairobi and Mombasa
1988 1989 1990-94 95-00 2001 2002 2003 2004-2012
Normal ID 10% 25% 35% 60% 100% 85% 70% 100%
IDBM 70% 75% 65% 40% _- 15% 30% -
80% 100% 100% 100% 100% 100% 100% 100%

ELSEWHERE
Normal ID 60% 75% 85% 60% 100% 85% 70% 100%
IDBM 25% 25% 15% 40% - 15% 30% _-
85% 100% 100% 100% 100% 100% 100% 100%

WEAR AND TEAR ALLOWANCES

Class I II III IV
(37.5%) (30%) (25%) (12.5%)
W.D.V 1.1.09
Additions:
Computers 400
Fork lift 1,500
Saloon car 2000R
Office furniture 800
Aircraft 16,000
1,500 400 18,000 800
WTA (562.5) (120) (4,500) (100)
W.D.V 1.1.10 937.5 280 13,500 700
WTA (351.563) (84) (3,375) (87.5)
W.D.V 1.1.11 585.937 196 10,125 612.5
WTA (219.726) (58.8) (2,531.25) (76.563)
W.D.V 31.12.11 366.211 137.2 7,593.72 535.937

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Industrial Building deduction.

Nature of Building Qualifying Cost I.B.D2.5% Residue c/fwd
Directors house 6,000 150 5850

INDUSTRIAL BUILDING DEDUCTION (IDB)

This is granted as allowable deduction on the capital expenditure incurred on the construction of
an industrial building.
In case of an ordinary industrial building, IBD is granted on the rate 10% p.a on straight line basis,
before year 2010 the rate was 2.5% per annum. For a hotel building certified as an industrial
building IBD is granted at the rate of 10% with effect from 1st Jan, 2011 (4% p.a up to Dec 2010).
An industrial building is defined as a building used for the purpose of:
 Milling such as posho mill, sawmill etc.
 Factory building for large industries.
 Commercial undertakings for transportation purposes e.g. bridges, tunnels etc.
 Buildings used for the storage of goods such as stores, or warehouses
 Prescribed dwelling houses for the workers or staff quarters.
 Buildings used for the welfare of workers such as sports pavilion, canteens, social halls,
health clinics etc.
 Hotel building certified as an industrial building.
 Substantial renovations to the existing industrial building.
 A 50% industrial building allowance can be claimed on a hostel or educational building
from 1 Jan 2010. This allowance also applies to buildings used for training.
 From 1 Jan 2008, 5% industrial building allowance can be claimed on residential buildings
built for rental purposes to low income earners in approved, planned development area.
 From 1 Jan 2010, 25% industrial building allowance can be claimed on qualifying
commercial buildings.

Notes
i) A building would qualify as an industrial building if it is used for purposes of milling, factory
or other similar purpose.
In IRC v LEITH HARBOUR AND DOCK COMMISSIONERS it was held that grain
elevators were within the expression “mills, factories and other similar premises”.
In ELLERKER v UNION COLD STORAGE CO LTD, cold stores were held to be within
that expression on the basis that they were equipped with machinery for the purpose of
subjecting meat and other commodities to an artificial temperature, and thus were building
in which goods were treated or processed by means of machinery provided for that purpose.

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ii) A building qualifies as an industrial building if it is in use for the purpose of a business, which
consists of manufacture of goods or materials or the subjection of goods or materials to any
process.
In VIBROPLANT LTD v HOLLAND it was held that a building used by plant hire operators
for cleaning, servicing and repairing the plant on the premises was not an industrial building on
the basis that each item of plant was treated individually according to the amount of servicing it
needed.

In BUCKINGHAM v SECURITAS PROPERTIES LTD it was held that a building which was
used inter alia, for breaking down bulk cash into individual wage packets was not an industrial
building.
iii) The expression industrial building does not include a retail shop, showroom, office or dwelling
house.
In IRC v LAMBHILL IRONWORKS LTD, a company carried on business as structural
engineers. The company claimed industrial building allowance on its drawing office. The
drawing office was used for the preparation of drawings for tenders and making scale drawings
and blue prints for contracts already place with the company. The company contended that the
office was used for industrial purposes. The revenue department contended that the drawing
office was an “office”.

It was held that, the drawing office was an industrial building on the grounds that it was in
use for purposes ancillary to the industrial operations carried on in the rest of the works.

iv) Where an industrial building is utilized for only part of the year IBD is apportioned
accordingly e.g. BB Ltd constructed an industrial building for sh. 6m. The factory was brought
to use on 1st April 2011. Calculate capital allowances claimed by BB Ltd.

BB LTD

Industrial building deductions

Nature of building Qualifying cost IBD RESIDUE
Sh.000 10% C/F

Factory 6,000 400R 5600

v) Where an industrial building is purchased from a certified contractor, the qualifying cost for
capital allowances is the purchase price. However where an industrial building is purchased
from any other person, the qualifying cost for ID is the cost of construction.

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vi) Where a building changes hands more than once before it is put into use, the new owner shall
claim capital allowances based on his purchase price. However, where a building has already
been put into use the new owner can only claim IBD based on the qualifying cost of the seller
of the building.

QUESTION:
Mr. J K purchased industrial buildings from Mr. J.P in August 2011 at a cost of sh. 10 million. The
buildings were constructed by Mr. J.P at a total cost of sh. 8 million which comprised of;
Sh. 000
Factory building 4,000
Administration offices 800
Show room 400
Canteen 1,200
Store 1,600
Total Cost 8,000

The buildings were put into use by Mr. J.P in April 2003.

Required
Calculate the capital allowances claimable by Mr. J.K
ANSWER:

Mr. J.K
2011 computation of capital allowances
Industrial building deduction

Nature of building QC Residue IBD Residue

Sh000 b/f @ 2.5% C/F
Factory 1,200 950 12.5R 937.5
Canteen 1,200 950 12.5R 937.5
Store 1,600 1266.667 16.667R 1,250
41.667
NOTES
(i) The industrial buildings had already been put into use, hence the qualifying cost for IBD is the
construction cost. The purchase price of Mr. JK is irrelevant. The applicable I.B.D rate is 2.5%.
Since the building were put to use in the year 2003 when the rate was 2.5%.

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(ii) Factory building

Non-Quantifying cost / Total cost x 100

= 800+400/800+400+ 4000 x 100
= 23.1%

Therefore, Cost of Administration Offices and showroom will not qualify for ID.
(iii) IBD Quantifying cost for factory
(100% - 70%) 4,000 = 1,200
Cost (1-rn) = NBV
Where: r is IBD rate
n is No. of years of use.
Substituting in the equation:

1,200 (1-0.025 x 84/12) = 950

(iv) Canteen
Cost (I-rn) = NBV
1,200 (1-0.025 X 84/12) = 950

(v) Store
Cost (I- rn) = NBV
1,600 (1 – 0.025 × 84/12) = 1,266.667
QUESTION:

a) Many governments are gradually shifting their focus from direct taxes to indirect taxes as their
main source of tax revenue.
Explain four possible reasons for this trend (8 Marks)

b) On January 2010, Pesa Manufacturers Ltd commenced operations in Nairobi. The company
incurred capital expenditure on the following assets before starting operations:
Sh.
Industrial building 24,000,000
Forklift 960,000
Processing machinery 1,200,000
Peugeot 504 pick-up (second hand) 480,000
Water boilers 600,000
Workers quarters 1,480,000
Furniture & fittings 240,000

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Milling machine 1,800,000

Borehole 640,000
Computers 720,000
Office partitions 180,000
Tractor 780,000
Sports pavilion 440,000
Staff canteen 560,000
Conveyor belts 400,000
Saloon car (new) 2,500,00

Additional Information
1. The cost of the industrial building includes:
Sh.
Warehouse 4,000,000
Showroom 200,000
Retail shop 300,000
Dwelling house 180,000

The rest of the industrial building was used for manufacturing purposes.
2. Workers quarters were occupied with effect from 1 October 2011.
3. The saloon car was partly used for private purposes. Private use of the motor vehicle was
agreed with tax authority as 40% of the total mileage for each year. The saloon car was
disposed of in year 2011 at Sh. 800,000.
4. The cost of computers includes software purchase for Sh.120,000

Required:
Capital allowances due to Pesa Manufacturers Ltd. For the year ended 31 December 2010 and
2011

ANSWER:
(a)
Reasons for the shift from direct to indirect taxes:
 Wide coverage – indirect taxes are based on consumption to which all persons are subject
through purchase of goods or services. Hence the taxpayer bracket is wider unlike direct taxes
which are only based on income, yet a number of people may not be earning any income.
 Diversification - Due to the wide variety of goods and services, indirect taxes can be charged
on these goods and services thus increasing revenue.
 Economical – In most cases, traders collect and remit the tax hence minimal collection costs.

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 Elasticity – The taxes are easy to adjust since the rates are based on the percentage of the value
of goods or services.
 Tools of economic policy – the taxes can easily be used by the government to reduce the
consumption of harmful goods or encourage the consumption of locally manufactured goods

Pesa Manufacturers Ltd

2010 – 2011 Computation of Capital Allowances
Investment Deduction
Nature of Asset Qualifying ID @100%
cost
Sh. 000
2010 Industrial building 20,000 20,000
Processing 1,200 1,200
Machine
Water boilers 600 600
Milling Machine 1,800 1,800
Borehole 640 640
Conveyor Belts 400 400
24,640

2011 - - Nil

Industrial Building Deduction

Nature of Qualifying Residue IDB @ Residue
building cost B/F 10% C/F
Sh. 000
2010 Warehouse 4,000 - 400 3,600
Sports pavilion 440 - 44 396
Staff canteen 560 - 56 504
500
2011 Staff Canteen 560 504 56 488
Warehouse 4,000 3,600 400 3200
Sports pavilion 440 396 44 352
Workers quarters 1,480 - 37 1443
537

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WEAR AND TEAR ALLOWANCES

CLASS I II III IV
37.5% 30% 25% 12.5%
Written down value on 1 Jan 2010 - - - -
Additions:
Forklift 960
Pick-up 480
Furniture & Fittings 240
Computers 600
Office partitions 180
Tractor 780
Saloon car 2,000
780 780 2,480 1,200
Wear and Tear Allowance (292.5) (234) (620) (150)
Written down value on 1 Jan 2011 487.5 546 1,860 1,050

Disposals:
Saloon car (640)
487.5 546 1,220 1,050
Wear & Tear allowance (182.813) (163.8) (305) (131.25)
Written down value on 31 Dec 2011 304.688 382.2 915 918.75

Notes:
(i) Capital allowance on computer software is effective from 1st January 2010 at the rate of 20%
(ii) Disposal of saloon car
Sales Proceeds x restricted value
Cost

800 x 2000 = 640

2,500

WEAR AND TEAR ALLOWANCES

- These are granted as compensation for the loss in value of plant and machinery that is used
repeatedly in a business.
- There is no statutory definition of what is plant and machinery for purposes of capital
allowances.
In YARMOUTH v FRANCE, Lindley, LJ stated that:
“There is no definition of plant in the Act but in its original sense it includes whatever
apparatus is used by a businessman for carrying on his business, not his stock in trade which he

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buys or makes for sale, but all goods and chattels, fixed or moveable, live or dead, which he
keeps for permanent employment in his business.”
- Two tests have been applied by courts to determine what constitute plant for purposes of
capital allowances:
The setting test distinguishes plant as part of the apparatus with which the trade is carried on
from the assets that form part of the setting in which a trade is carried on.
In J. LYONS & CO LTD v A.G. Uthwatt J stated that he question at issue was “are the
assets properly to be regarded as part of the setting in which the business the business is carried
on or as the part of the apparatus for carrying on the business?”

The functional test – A structure will be regarded as plant if it fulfills the function of a plant in
the traders operations.
BARCLAY, CURLE & CO LTD v COMMISSIONERS OF INLAND REVENUE. The
company carried on business as ship repairers and incurred capital expenditure of £500,380 on
the concrete work used in the construction of a new dry dock and £186,928 on excavating the
land for the dry dock. The company claimed capital allowances on the whole of the
expenditure, on the grounds that it was spent on the provision of the machinery or plant for
purposes of the business. The revenue department contended that the expenditure was not on
the provision of machinery or plant but on an industrial building or structure.
It was held that the concrete work was plant on the basis of the function of the dock. Once
it was decided that the dock was plant, the cost of the excavation was expenditure on the
provision of machinery or plant.
- Machinery is categorized into 4 classes for purposes of WTA. Each class with a specific rate.
- Wear and tear is expressed as a percentage of the aggregate value of each class of
machinery.

The classes of machinery and the respective rates of wear and tear are as follows:
Class I Class II Class III Class IV
37.5% 30% 25% 12.5%
Heavy Self Office Other self Other Machinery &
propelling electronics & machinery equipment e.g.
Earth Moving machinery e.g. e.g.  Furniture &
Machinery e.g.  Computers Fittings
 Caterpillar  Printers  Tuk-tuk  Milking
 Tractors  Scanners  Motor machinery
 Lorry’s (3  Photocopiers cycles  Plough
tones)  Calculators  cars  Wheelbarrow
 Buses  Computer  Lorries  Bicycle
 Train engine peripherals  Minibuses  Telephones

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 Mobile cranes  Duplicating  Aircraft 

Fax Machines
 Fork lift machines  Delivery 
Switchboards
 Combine  Electronic vans 
Mobile phones
harvester typewriters  Pick.ups 
Ships
etc  Electronic etc 
Trailers
tax registers 
Lift
etc 
Conveyor belts

Carpet

Curtains

Partitions

Signboard

Alarm systems
Etc
Computer software’s qualify for capital allowance at 20% per annum.

COMPUTATION OF WEAR AND TEAR ALLOWANCES

When calculating wear and tear allowances, a residual value is brought forward from the previous
accounting period, called the written down value. Assets purchased during the year are pooled in
the wear and tear schedule at the qualifying cost, while assets disposed during the year are
deducted from the respective pool or class of wear and tear at the qualifying cost.

SSETS PURCHASED DURING THE YEAR

The qualifying cost for wear and tear allowances incase of asset purchased during the year include:
1. Custom duty and VAT paid on imported machinery, insurance in transit, Installation costs
e.t.c
2. In case an asset is traded in or partly exchanged for a new asset, the qualifying cost shall be
the sum of the traded in value of the old asset plus additional cash paid.
3. If an asset is acquired though hire-purchase, the qualifying cost is the cash price of the
asset.
4. In case of a non-commercial vehicles the qualifying cost is restricted as follows:
Year Restricted qualifying cost
1990-96 100,000
1997 500,000
1998-2005 1,000,000
2006-todate 2,000,000
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N/B: A commercial vehicle is one that is:

- Designed for the carriage of goods e.g. pick-up.
- Used for hire such as taxi.
- Used for public transport with a carrying capacity of 7 passengers or more excluding the
driver.

Any other vehicle which falls outside the above definition is a non-commercial vehicle whose
cost is restricted as shown above.

ASSETS DISPOSED DURING THE YEAR

The qualifying costs for assets disposed during the year include:
1. Sales proceeds of an asset.
2. In case insurance compensation is received for an asset destroyed, the amount is treated as
the disposal value of the asset.
3. Where a non-commercial vehicle whose cost was restricted for wear and tear in the year of
purchase is disposed, the disposal value is restricted as follows:
Sales proceeds X restricted value in the year of purchase
Cost
4. Where the assets of an entire class of wear and tear are disposed at a value that is higher
than the written down value of assets in the same class, the surplus or gain is a trading
receipt if the business is a going concern or a balancing charge if the business is under
liquidation. A trading receipt or balancing charge is a taxable business gain.
5. Where the assets of an entire class of wear and tear are disposed at a value that is lower than
the written down value of assets in the same class, the deficit or loss is a trading loss if the
business is a going concern or a balancing deduction if the business is under liquidation. A
trading loss or balancing deduction is a tax allowable expense.

QUESTION:
Bidii Farm enterprise is a dairy farming entity owned by Mr. Jared Mkulima
The following income statement relates to Bidii Farm enterprise for the year ended 31 December
2011:
Sh. Sh.

Sales 13,700,000
Gross Profit 2,800,000
Administrative Expense 200,000

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Salaries & wages 400,000
Traveling & Marketing 75,000
expenses
Stationery expense 39,000
Telephone expense 49,000
Accountancy charges 25,000
Rent expense 180,000
Water & electricity expenses 14,000
License fees 5,000
Depreciation 105,000
Bank charges 5,000
Interest on bank loan 15,000 1,112,000
Net profit 1,688,000
Additional Information:
1. License fees include Sh. 3,500 incurred to register a trademark owned by the farm.
2. A third of the rent expense relates to grocery store owned and managed by Mrs. Mkulima, the
wife of Jared Mkulima
3. Salaries & wages include the following:
Sh.
Wages paid to workers of the grocery 100,000
Entertainment allowance paid to Mrs. Mkulima 40,000
4. Included in the farm sales is Sh. 300,000 being sales realized by the grocery store during the
year ended 31 December 2011

5. Extract from the property, plant and equipment movement schedule were as follows
Fixed Asset
Computers Motor Furniture &
Vehicles Fittings
Sh. Sh. Sh.
Cost: January 2008 70,000 250,000 80,000
Auditions 120,000 400,000 10,000
Depreciation for the 40,000 30,000 35,000
year

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6. Before the close of the year on 31 December 2011, all motor vehicles were traded in at a value
of Sh. 750,000 in part exchange for a new tractor costing Sh. 2,400,000. The balance due for
the tractor was to be repaid over a period of 24 months commencing 1 January 2012.

7. The balances on the wear & tear schedule for capital allowance purpose were as follows

Class II Class III Class IV

Sh. Sh. Sh.
Balance as at 1 January 2011 60,000 200,000 70,000
8. A farm house costing Sh. 1,200,000 was constructed during year 2008 and utilized from 1
October 2011.
Required:
a) Capital allowances due to Bidii Farm Enterprise for the year ended 31 December 2011.
b) Taxable profit or loss of Bidii Farm Enterprises for the year ended 31 December 2011.
c) Briefly explain to Mr. Jared Mkulima the relevance of the following terminologies in the
context of the farm’s transactions:
 Hobby farming
 Trading receipt

ANSWER:

a) Bidii Farm Enterprises

2011 Computation of capital allowances
Wear and tear allowances

Class I II III IV
37.5% 30% 25% 12.5%
Written down value
1 Jan 2011 60,000 200,000 70,000
Additions
Computers 120,000
Motor vehicles 400,000
Furniture and fittings 10,000
Tractor 2,400,000
Disposals:
Motor vehicle 750,000
2,400,000 180,000 (150,000) 80,000
Trading receipt - - 150,000 -

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Wear and tear
Allowances (900,000) (54,000) - (10,000)
Written down value
31/12/2011 1,500,000 126,000 Nil 70,000
Farm work deductions (100%)
FWD – 100% x 400,000 = 400,000
N/B: qualifying cost for farm work deductions for the farm house is restricted to only 1/3 of the
construction cost.

b) Computation of taxable profit (loss)

Sh.000 Sh.000
Net profit per account 1,688
Add:
Wages (grocery store) 100
Entertainment (Mrs. Mkulima) 40
Rent expenses 1/3 X 180= 60
Depreciation 105
Trading receipt 150
Trade mark 3.5 458.5
Deduct:
Sales – grocery store 300
WTA 964
FWD 400 (1,664)
Adjusted business profit (loss) 482.5

OR

2011 Computation of taxable profit (loss)

Sh.000 Sh.000
Gross profit per accounts 2,800
Add:
Trading receipt 150
2,950
Deduct
Admin expenses 200
Salaries and wages (400- 140) 260
Traveling and marketing 75
Stationery expenses 39

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Telephone exp 49
Accounting charges 25
Rent exp 120
Water and Electricity expenses 14
License fee (5-3.5) 1.5
WTA (wear and tear allowances) 964
FWD 400
Bank charges 5
Interest on loan 15
Sales – grocery store 300 (2,467.5)
Adjusted business profit (loss) 482.5

(i) Hobby farming - where the farmer consumes 25% or more of the produce from farming
activities, it is called hobby farming and the income is not taxable.
In regard to Bidii farm enterprises, there is no information on the farm produce consumed by
Mr. Mkulima or his family hence it is treated as business income which is taxable.
(ii) Trading receipt - where the assets of an entire class of wear and tear are disposed at a value
that is higher than the written down value of assets in the same class, the gain or profit is a
trading receipt if a business is a going concern or a balance charge if the business is under
liquidation.
A trading receipt or balancing charge is taxable business gain.
In regard to bidii farm enterprises, motor vehicles are disposal or traded in at a value that is
higher than the written down value in class III, hence the trading receipt of 150,000 is a taxable
business gain.

FARMWORK DEDUCTIONS

These are allowable deductions granted on capital expenditure incurred on the construction of farm
works that are utilized in a farming business.
The rate of farm work deduction is 100% per annum effective from 1st January 2010.
2007-2009 - 50%
Up to 2006 -331/3%

Farm works include:

 A farm house that may be occupied by the farm owner or manager.
 Labour quarters for farm workers.
 Other immovable structures that are necessary for the operations of a farm e.g. Fences, cattle
dip, irrigation networks, fish ponds etc.

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N/B
(i) Where a farm house is occupied by the farm owner. The cost qualifying for farm work
deduction is restricted to only a third (1/3) of the total cost of construction.
(ii) In case a farm house is occupied by a farm manager, the total cost of construction shall
qualify farm work deduction since the farm house is occupied wholly and exclusively for
farming business.
(iii) A full year’s farm work deduction is claimed for any farm works constructed during the
year provided that the farming business is carried on for the whole year.
(iv) Farm work deductions are apportioned where the farming business is carried on for only
part of the year.

QUESTION:

a) Name the conditions that must be fulfilled in order for a building to qualify for industrial
building deductions (6 Marks)
b) Karua and Company Limited was incorporated in 2010 but did not start business until 1
January 2011 when the company commenced the business of processing tea.
The following details related to the acquisition of fixed asset in the year 2011:
Sh.
Land and Building 6,500,000
Plant & machinery 4,000,000
Motor Vehicle – 2 saloon cars 2,000,000
Tractor 5,000,000
Lorry (2 tons) 2,500,00
Furniture & Fittings 600,000
Construction of drainage 150,000
Fencing of farm 50,000
Farm House 600,000
Irrigation System 750,000
Labour Quarters 1,200,000
Computers 220,000
Milking Machinery 300,000

The following further information is provided

1. The company kept 10 cows and constructed a cattle dip worth Sh. 400,000 for the animals
during this year.

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2. Included in land and building is the cost of land valued at Sh. 2,000,000.
3. One saloon car was disposed of for Sh. 500,000 which was half the cost price.
Required:
Capital deductions for Karua and Company Limited for the year of income 2011 (14 Marks)
(Total: 20 Marks)
ANSWERS:
a) Conditions that must be fulfilled for a building to qualify for industrial building deductions are:
 The building must be used for the purpose of milling e.g. Saw mill, flour mill etc.
 Building used for manufacturing e.g. factory.
 A hotel building certified to be an industrial building.
 Prescribed dwelling houses for workers.
 Buildings used for storage e.g. warehouse.
 A building used for the welfare of workers e.g. clinic, sports pavilion etc.
 Specified civil works constructed with effect from 1 January 1995

Karua and company Ltd

2011 computation of capital allowances
Investment Deduction
Nature of assets Qualifying cost ID @ 100%
Building 4,500 4,500
Plant and machinery 4,000 4,000
8,500
Wear and tear allowances
Class I II III IV
37.5% 30% 25% 12.5%
W.D.V. 1.1.2011 - - - -
Additions
2 saloon cars 2,000
Tractor 5,000
Lorry (2T) 2,500
Furniture and fittings 600
Computers 220
Milking machinery 300
Disposals
Saloon car (500)
5,000 220 4,000 900
WTA (1,875) (66) (1,000 (112.5)
W.D.V.31.12.2011 3,125 154 3,000 787.5

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Farm work Deduction
Nature of farm work Qualifying Cost Year of claim
Sh.000 2011
Drains 150 150
Fencing 50 50
Farm house 600 600
Irrigation system 750 750
Labour quarters 1,200 1200
Cattle Dip 400 400
FWD claim 3,150

MINING ALLOWANCES

These are allowable deductions granted on the capital expenditure incurred to acquire assets
utilized in mining operations.
The cost that qualifies includes capital expenditure on:
 Searching, discovery, testing and winning access to minerals.
 Expenditure incurred in acquiring the rights over the minerals i.e. patent rights.
 Provision of specialized mining machinery.
 Construction of buildings or works which would have no value after mining operation
cease.
 Expenditure on development, general administration and management prior to the
commencement of mining operations.

N/B: Mining allowances are granted at rate of 40% in the 1st year of mining and 10% from the 2nd
to the 7th year.

Specified minerals in regard to Kenya include:

- Beryl
- Copper
- Gold
- Mica
Expenditure on acquisition of the site of mineral deposits or the site on which buildings are
constructed do not qualify for mining allowances.
Minerals do not include common clay, Murram, sand, limestone, sulphur, dolomite, bauxite, and
sodium or potassium compounds.

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QUESTION:
Tullow mining company Ltd started prospecting for minerals in Turkana in 2008. Expenditure
relating to research testing and wining access to minerals amounted to sh.120m. The company paid
sh.6m to the government to acquire the rights over the minerals and sh.80m for the purchase of
land.
Labour quarters were constructed at a cost of sh.5m; a senior manager’s house was constructed on
the site at a cost of sh.3m and the director’s house at a nearby trading centre at a cost of sh.6m.
Specialized processing machinery for mining was acquired at sh.300m, computers at sh.400,000, a
fork lift for sh.1.5m, a saloon car for the general manager at sh.2.4m, furniture for the office at
sh.800,000.
An aircraft was acquired for sh.16m and a store was constructed at a cost of sh.600,000.
Mining operations commenced in January 2009.
Calculate the capital allowances due to the company from 2009 to 2011.

ANSWERS:

Tullow mining company Ltd.

2009-2011 computation of capital allowances

Mining allowances Qualifying Cost 2009 2010 2011

Nature of Expenditure Sh.000 40% 10% 10%
Research, testing e.t.c 120,000 48,000 12,000 12,000
Patent rights 6,000 2,400 600 600
Labour quarters 5,000 2,000 500 500
Senior manager’s house 3,000 1,200 300 300
Specialized machine 300,000 120,000 30,000 30,000
Store 600 240 60 60
173,840 43,460 43,460

SHIPPING INVESTMENT DEDUCTION

Shipping ID is granted as allowable deduction on the capital expenditure incurred to acquire a ship
which is utilized in a shipping business to generate taxable income.
Shipping ID is granted on capital expenditure which includes:
 Purchase of a new, unused power driven ship of more than 495 tonnes.
 Purchase and subsequent refitting of a used power driven ship of more than 495 tonnes.

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Shipping ID is granted at the rate of 40% on the qualifying capital expenditure
Wear and tear allowances are granted on the cost of the ship net of the shipping ID at the rate of
12.5% p.a.
In case a ship is disposed before five years have elapsed, the shipping ID that was granted would
be clawed back by the commissioner, i.e. the amount of shipping ID which had been claimed will
be recovered. However wear and tear allowances will be deducted from the clawed back amount.

Question:
Mwambao shipping company limited acquired a ship, MV. Poa of 600 tons at a cost of
Sh.25,000,000 in the year 2008. The ship was disposed in the year 2011 for Sh.20,000,000.
Calculate the capital allowances claimable for the years 2008 to 2011.

Answer:
Mwambao Shipping company Ltd
2008 – 2011 computation of capital allowances
Shipping investment deduction

Name of ship Qualifying SID @ Residue for

Cost
40% WTA
Sh. 000
2008 MV. Poa 25,000 10,000 15,000

Wear and tear allowances

Class IV
12.5%
Written down value on 1.1.2008 -
MV. Poa 15,000
Wear and tear allowance (1,875)
WDV 1.1.2009 13,125
WTA (1,640.625)
WDV 1.1.2010 11,484.375
WTA (1,435.547)
WDV 1.1.2011 10,048.828
Disposal (20,000)
(9,951.172)
Trading receipt 9,951.172
Nil

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Notes
i) MV. Poa is disposed before five years have elapsed hence the shipping investment deduction
claimed in year 2008 is clawed back or recovered by the commissioner.
ii) Wear and tear allowances for the three year period when the ship was used is granted as
compensation on the clawed back amount.
iii) The clawed back amount is calculated as follows:
Cost (1-r)n = net book value (NBV)
10,000,000 (1-0.125)3 = Sh.6,699,218.75

OTHER DEDUCTIONS

Diminution in value of loose tools and implements

This is allowable deduction against taxable income. In a workshop, loose tolls may consist of
spanners, screwdrivers, bolts and nuts etc.
In a farm loose tools and implements consist of slashers, rakes, pangas etc.
A hotel may acquire loose tools such as utensils, cutlery etc.
The nature of loose tools and Implements is such that, these are susceptible to breakages.
Diminution or loss in value is claimed at the rate of 33 1/3% per annum on a straight line basis.

APPLICATION OF CASE LAW

1) A building would qualify as an industrial building if it is used for purposes of milling, factory
or other similar purpose.
In IRC v LEITH HARBOUR AND DOCK COMMISSIONERS it was held that grain
elevators were within the expression “mills, factories and other similar premises”.
In ELLERKER v UNION COLD STORAGE CO LTD, cold stores were held to be within
that expression on the basis that they were equipped with machinery for the purpose of
subjecting meat and other commodities to an artificial temperature, and thus were building
in which goods were treated or processed by means of machinery provided for that purpose.
2) A building qualifies as an industrial building if it is in use for the purpose of a business, which
consists of manufacture of goods or materials or the subjection of goods or materials to any
process.
In VIBROPLANT LTD v HOLLAND it was held that a building used by plant hire operators
for cleaning, servicing and repairing the plant on the premises was not an industrial building on
the basis that each item of plant was treated individually according to the amount of servicing it
needed.

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In BUCKINGHAM v SECURITAS PROPERTIES LTD it was held that a building which was
used inter alia, for breaking down bulk cash into individual wage packets was not an industrial
building.
3) The expression industrial building does not include a retail shop, showroom, office or dwelling
house.
In IRC v LAMBHILL IRONWORKS LTD, a company carried on business as structural
engineers. The company claimed industrial building allowance on its drawing office. The
drawing office was used for the preparation of drawings for tenders and making scale drawings
and blue prints for contracts already place with the company. The company contended that the
office was used for industrial purposes. The revenue department contended that the drawing
office was an “office”.

It was held that, the drawing office was an industrial building on the grounds that it was in use
for purposes ancillary to the industrial operations carried on in the rest of the works.

WEAR AND TEAR ALLOWANCES

1. There is no statutory definition of what is plant and machinery for purposes of capital
allowances.
In YARMOUTH v FRANCE, Lindley, LJ stated that:
“There is no definition of plant in the Act but in its original sense it includes whatever
apparatus is used by a businessman for carrying on his business, not his stock in trade which he
buys or makes for sale, but all goods and chattels, fixed or moveable, live or dead, which he
keeps for permanent employment in his business.”
2. Two tests have been applied by courts to determine what constitute plant for purposes of
capital allowances:
The setting test distinguishes plant as part of the apparatus with which the trade is carried on
from the assets that form part of the setting in which a trade is carried on.
In J. LYONS & CO LTD v A.G. Uthwatt J stated that he question at issue was “are the assets
properly to be regarded as part of the setting in which the business the business is carried on or
as the part of the apparatus for carrying on the business?”
The functional test – A structure will be regarded as plant if it fulfills the function of a plant in
the traders operations.
BARCLAY, CURLE & CO LTD v COMMISSIONERS OF INLAND REVENUE. The
company carried on business as ship repairers and incurred capital expenditure of £500,380 on
the concrete work used in the construction of a new dry dock and £186,928 on excavating the
land for the dry dock. The company claimed capital allowances on the whole of the
expenditure, on the grounds that it was spent on the provision of the machinery or plant for

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purposes of the business. The revenue department contended that the expenditure was not on
the provision of machinery or plant but on an industrial building or structure.
It was held that the concrete work was plant on the basis of the function of the dock. Once it
was decided that the dock was plant, the cost of the excavation was expenditure on the
provision of machinery or plant.

Key terms
Qualifying capital expenditure – This is the cost that is used in granting capital allowances.
Industrial buildings – These are defined as buildings used for certain specific purposes such as
milling, manufacture, hotel etc.
Pooling method – It is the method used in classifying machinery for purposes of obtaining
aggregates for each class of wear and tear.
Reducing balance – It is used to claim wear and tear allowances. The claim for each year reduces
since it is based on the balance of the previous year.
Straight line method – The same amount is claimed as a deduction each year e.g. for industrial
building deduction.

SUMMARY

 Capital allowances are incentives granted as deductions to manufacturers to encourage

investment.
 Investment deduction (ID) is granted on capital expenditure incurred to acquire industrial
buildings, plant and machinery.
 Investment deduction for bonded manufacturers (IDBM) is granted as additional incentive to
encourage manufacture for export under specific conditions.
 Shipping investment deduction is granted on capital expenditure incurred to acquire a ship
under specified conditions.
 Mining allowances are granted on capital expenditure incurred to acquire assets used in mining
operations.
 Industrial building deduction (IBD) is granted on capital expenditure incurred to acquire
industrial buildings utilized in a business, including hotel buildings.
 Wear and tear allowances are granted on machinery utilized to generate taxable income in a
business.
 Machinery is categorized into four classes or pools for purposes of wear and tear allowances.
 Farm work deductions are granted on capital expenditure incurred to acquire farm works which
are utilized in a farming business to generate taxable income.

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 Diminution in value is granted as a deduction on the cost of loose tools and implements that are
utilized in a business.

QUIZ

Question 1:
a) A group of women in your neighbourhood have pooled some capital which they intend to
invest in securities that would generate income inform of interest and dividend. The leader of
the women group has approached you for information on taxation of interest and dividend
income accruing from various investments.

Required:
Briefly advise the women group on the taxation of income accruing from:
(i) Treasury bills. (2 Marks)
(ii) Preference shares. (2 Marks)
(iii) Fixed deposit accounts (2 Marks)
(iv) Ordinary shares. (2 Marks)

b) Biashara Ltd commenced the business of manufacturing on 1 January 2010 after incurring
expenditure on the following assets
Sh.
Processing Machinery 1,800,000
Factory building (including showroom Sh. 4,800,000
480,000)
Godown 1,500,000
Parking Bay 800,000
Trailer ( for a tractor) 400,000
Saloon ,motor vehicle 2,000,000
Computers 900,000
Tractor 1,500,000
Furniture 460,000
Staff canteen 1,2000,000

During the year ended 31 December 2011, the following transactions took place related to the
assets:
1. The saloon motor vehicle purchase in year 2010 was traded in for a pick up costing 2,500,000.
The trade in value of the saloon vehicle was Sh. 1,800,000.
2. All assets in class II were disposed of for Sh. 900,000

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3. Electronic typewriters were purchased at Sh. 300,000 and carpets at Sh. 120,000
4. A factory extension was constructed and put into use from 1 October 2011. The cost of the
extension was Sh. 1,500,000 which included material storage room whose cost was Sh.
200,000
5. Staff quarters were constructed at a cost of Sh. 800,000 and occupied from 1 September 2011.

Required
Capital allowances due to Biashara Ltd, for the years ended 31 December 2010 & 2011
(12 Marks)
(Total: 20 Marks)
Question 2:
(a) (i) List four types of buildings that qualify for industrial building deduction (IBD) under the
second schedule of the income tax Act (Cap 470) (4 Marks)
(ii) X Ltd a manufacturing company constructed an industrial building at a cost of Sh.
5,000,000 on 1 May 2011. The company sold the building before use to another
manufacturing company, Y Ltd, for sh. 8,000,000. Y Ltd was unable to used the building
and sold it to Z Ltd which used the building from 1 October 2011 for manufacturing
purposes

Required:
Explain the basis of computing the capital allowances for the building above for the year ended 31
December 2011 (4 Marks)

Madini mining company Ltd has been prospecting for gold in Kakamega District since 1995. In
year 2009, the company discovered huge deposits of the mineral and commenced mining
operations on 1 July 2009.
The following expenditure was incurred on 1 July 2009:
Sh.
Patent rights paid to the government 4,800,000
Payment of local council license fees 840,000
Construction of labor quarters at site 1,200,000
Construction of go down in Kakamega town 2,680,000
Construction of go down at site 780,000
Purchase of specialized machinery for mining 1,960,000
Transport of specialized machinery to site 450,000
Purchase of 10 tone lorry 1,920,000
Purchase of tools and implements for mining 90,000
Purchase of computers 900,000

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Purchase of furniture and fittings 360,000
Purchase of a Toyota Hilux pick-up 1,400,000

Additional information:
1. The company had incurred exploration expenses amounting to sh. 1,500,000 as on 1 July 2009.
2. The administration expenses incurred prior to 1 July 2009 amounted to sh. 3,000,000.

Required:
Compute the capital allowances due to Madini Mining Company Ltd for the years ended 31
December 2009, 2010 and 2011.
(12 Marks)
(Total: 20 Marks)
Question 3:
a) Define the following terms:
(i) Impact of a tax (2 Marks)
(ii) Incidence of a tax (2 Marks)
(iii) Tax point for VAT purposes (2
Marks)

b) Mr. J Mavindu. Owns a twenty acre farm in Ruiru on which he grows coffee and rears
livestock. The following is a summary of the farm transactions for the year ended 31 st
December 2011.

Sh.
Sale of tractor 500,000
Sale of livestock (cost Sh. 320,000) 840,000
Sale of coffee 5,580,000
Purchase of feeding troughs for livestock 150,000
Purchase of a tractor 820,000
Purchase of fertilizer 164,500
Purchase of coffee plants 120,000
Clearing land for planting coffee 80,000
Construction of gabions 190,000
Construction of a pig sty 300,000
Construction of a cattle dip 600,000
Planting of wind-breaks 18,600
Presumptive tax paid 90,000
Mortgage interest on farm house 124,200
Subscription to farmers association 60,000

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Labour wages 172,000
Electricity expense 86,400
Water expense 44,600
Provision for loss on crop failure 128,000
Livestock stolen (market value) 85,000

Additional information:
1. The wear and tear allowance was agreed with the tax authority at Sh.200,000 for the year
ended 31st December 2011.

Required:
(i) The taxable income of Mr. J Mavindu. for the year ended 31st Dec 2011.
(12 Marks)
(ii) The tax liability accruing from the income computed in (i) above.
(2 Marks)
(Total: 20 Marks)
Question 4
a) Many flower growers and exporters are unaware of the benefits accruing from registering for
VAT and claiming capital allowances available to them under the income tax Act. Write brief
notes on the benefits arising in the two areas
(5 Marks)
b) You have been approached by the directors of Flower Export Ltd to help them do their income
tax returns for 2011.The following information is available.
Written down values at 1 January 2011 per self assessment return submitted are as follows:

Sh..
Motor vehicle - Lorries 250,000
- Tractors 375,000
- Pick-up and saloons 1,250,000
Farm House (constructed in 2011) 300,000
Computers 750,000
Plant 475,000
Equipment 275,000
Furniture 725,000

During the year the company purchased and sold the following:
1. Mercedes Benz for use by the director costing Sh. 2,500,000
2. Security systems were fixed into company’s Lorries to comply with the insurance
requirements. The cost to the company was Sh 250,000.

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3. The company traded – in four Nissan Sunny cars which were purchased in 2009. The trade-
in value of each of the cars was Sh..1, 800,000(Net book value of Sh. 1,600,000).
4. Four new cars were bought at Sh..2, 500,000 each. The vehicles are used by the senior
officers of the company and their rating is 1300cc.
5. Equipment worth Sh. 1,650,000 was acquired while carpet worth Sh. 450,000 was disposed
off and furniture with net book value of Sh. 460,000 was disposed of.
6. Computers worth Sh. 1,250,000 were acquired for purposes of speeding up computerization
of the company’s operations.
7. The company’s adjusted profit before wear and tear allowances is Sh 1,599,000.

Required:
i) Compute the capital allowances for Flower Export Ltd as at 31 December 2011.
(13 Marks)
ii) Calculate the tax liability for the year.
(2 Marks)
(Total 20 Marks)
Question 5
Bahari shipping company Ltd commenced business in year 2005. In January 2011, the written
down values of assets were: Class I Sh. 1.8m, Class II Sh. 1.5m, Class III Sh. 1.4m, Class IV Sh.
2m. During the year, the company purchased a new ship MV. Tewa(498T) at a cost of Sh.6m, MV.
Yao (900T) acquired in 2008 for Sh.8m was disposed at Sh.5m. The company also acquired MV.
Poa (600T) at Sh.9m and disposed MV.Sawiya acquired in year 2005 at a disposal value of Sh.4m.
Other machinery acquired during the year include:
- Two forklifts at Sh. 1.5M each
- 4 Computer installed in the ship Sh.250,000
- 4 saloon cars purchased at Sh.2.4m each.
The assets disposed during the year include:
Furniture which was destroyed by fire and insurance compensation received amounted to
Sh.350,000 (cost was 500,000).
2 saloon cars purchased in 2005 were disposed at sh.800,000 each. The cars had cost sh.1.5m each.
A tractor purchased in 2008 was stolen and insurance compensation was received amounting to
sh.450,000 ( cost was sh.900,000)
The company reported a profit of sh.7m before deducting capital allowances.

Required:
Calculate the capital allowances for the year.
Calculate the adjusted profit or loss for tax purposes.

Question 6:

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a) Outline the benefits which may accrue to a country from being a signatory to the “most
favoured nation status” agreement.
(4 Marks)
b) Style Ltd obtained a license from the Customs and Excise department on 15 December
2009 to manufacture leather Jackets for export. The company commenced its operations on
2 January 2010.
The following information relates to the company’s operations for the financial years ended 31
December 2010 and 2011:
1. The company incurred the following costs prior to the commencement of its operations:
Sh.
Purchase of land 8,000,000
Demolition of an old building on the land 500,000
Factory construction 12,000,000
Stone perimeter wall 1,400,000
Staff canteen 800,000

2. Part of the factory construction costs related to the following:

Sh.
Store 700,000
Office 1,740,000

3. Other assets acquired prior to 2 January 2011 comprised:

Sh.
Water pump 200,000
Sewage treatment plant 700,000
Factory machinery 400,000
Lorry (10 tones) 3,600,000
Heating plant 500,000
Furniture and fittings 120,000
Photocopier 150,000
Delivery van 1,800,000
Computer and printers 380,000
Folk lift 1,500,000

4. A borehole was drilled at a cost of sh 800,000 and utilized with effect from 1 July 2010.
5. An extension to the factory and a loading bay were constructed and utilized with effect from 1
January 2011. The extension cost sh. 4,800,000 while the loading bay cost sh. 600,000.
6. The following additional assets were acquired on 1 January 2011:

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Sh.
Imported machinery (including import duty of sh.600, 000) 2,400,000
Fax machine 120,000
Pick up 2,000,000
Conveyor belts 640,000

7. On 1 July 2011 Style Ltd ceased to manufacture for export and instead started selling the
leather jackets in the local market. The export manufacturing license was subsequently
withdrawn by the customs and Excise department with effect from 1 July 2011.
8. The company disposed of the following assets on 1 July 2011:
Sh.
Lorry (10 tones) 2,200,000
Heating plant 480,000
Photocopier 100,000

The company reported a net profit (before deducting capital allowances) of sh. 7,200,000 for the
year ended 31 December 2011.

Required:
i) Determine the capital allowances due to Style for the years ended 31 December 2010 and
2011. (14 Marks)
ii) Determine the tax payable (if any) by Style Limited for the year ended 31 December 2011.
(2 Marks)
(Total: 20 Marks)

ANSWER

Question 1
(a)
(i) Interest from treasury bills - withholding tax of 15% deducted at source is the final tax i.e.
there is no further taxation.
(ii) Dividend from preference shares – withholding tax of 5% deducted at source is the final tax.
(iii) Interest from fixed deposit accounts – withholding tax of 15% deducted at source is the
final tax, if income is received by individuals
(iv) Dividend from ordinary shares – withholding tax of 5% deducted at source is the final
tax.

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(b)
Biashara Ltd
2010 - 2011 Computation of Capital Allowances
Investment Deduction
Nature of assets Qualifying Cost ID @ 100%
Sh.000
2010 Factory building 4,800 4,800
Processing machinery 1,800 1,800
Parking bay 800 800
7,400
2011 Factory extension 1,300 1,300

Industrial Building Deduction

Nature of Qualifying Residue IDB @ Residue
building Cost b/f 10% C/F
Sh. 000
2010 Godown 1,500 - 150 1,350
Staff canteen 1,200 - 120 1080
270

2011 Godown 1,500 1,350 150 1200

Staff canteen 1,200 1,080 120 960
Storage room 200 - 5 195
Add staff quarters 800 - 26.667R 773.333
301.667

Wear and Tear Allowances

Class I II III IV
37.5% 30% 25% 12.5%
Written down value on 1 Jan 2010 - - - -
Additions:
Trailer 400
R
Saloon motor vehicle 2,000
Computers 900
Tractor 1,500
Furniture 460

1,500 900 2,000 860

Wear & Tear allowance (562.5) (270) (500) (107.5)
Written down value on 1 Jan 2011 937.5 630 1,500 752.5
Additions:
Pick-up 2,500
Electronic typewriters 300

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Carpets 120
Disposals
Saloon motor vehicle (1,500)

937.5 930 2,500 872.5

Wear and Tear allowance (351.563) (279) (625) (109.063)
Written down value on 31 Dec 2011 585.938 651 1,875 763.438

Question 2:
(a) (i) Buildings that qualify for industrial building deduction (IBD)
Industrial buildings used for the purpose of:
 Milling e.g. saw mill
 Factory used for manufacture
 Prescribed dwelling houses for workers
 Hotel buildings
 Storage e.g. warehouse
(ii) Z Ltd shall claim capital allowances based on the purchase price form Y Ltd. the rate of
investment deduction was 100% in year 2011, hence the total purchase price of the industrial
building by Z Ltd is clamed as investment deductions.

Madini Mining Company Ltd

2009-2011 Computation of capital allowances

Mining allowances QC 2009 2010 2011
Nature of expenditure sh000 40% 10% 10%
Patent rights 4,800 1,920 480 480
Administration expenses 3,000 1,200 300 300
Exploration expenses 1,500 600 150 150
License fees 840 336 84 84
Labor quarters 1,200.4 480.16 120.04 120.04
Godown on site 780 312 78 78
Specialized machinery 450 180 45 45
5028.16 1257.04 1257.04
Industrial Building Deduction
Nature of building QC Residue IBD Residue
Sh 000 b/f 2.5% c/f
2009 Godown at Kakamega 2,680 - 33.5R 2,646.5
2004 Godown at Kakamega 2,680 2,646.5 67 2,579.5
2005 Godown at Kakamega 2,680 2,579.5 67 2,512.5

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NB: In the year 2009, the rate for IBD was 2.5%. it will be applied onward until the residue is
zero.

Wear and Tear allowances

Class I II III IV
37.50% 30% 25% 12.50%
W.D.V.31.12.09 - - - -
Additions
Lorry (10T) 1,920
Computers 900
Furniture and fittings 360
Pick-up 1,400
1,920 900 1,400 360
WTA (360R) (135R) (175R) (22.5R)
W.D.V.1.1.10 1,560 765 1,225 337.5
WTA (585) (229.5) (306.25) (42.1875)
W.D.V.1.1.11 975 535.5 918.75 295.3125
WTA (365.625) (160.7) (229.6875) (36.9141)
W.D.V.31.12.11
609.375 374.85 689.0625 258.3984

Diminution in value
Qualifying
Cost Year of claim
Item sh 000 2009 2010 2011
Tools and implements 90 15R 30 30

Question 3:
(a)
i. Impact of a tax – This the person on whom tax is imposed and who bears the responsibility
of accounting for the tax to the tax authority.
ii. Incidence of a tax – This is the person who bears the money burden of a tax i.e. it is where
tax payment is made.
iii. Tax point for VAT purposes – The tax point is where VAT becomes payable, defined as
the earliest of when:
- A supply of goods or services is made;
- An invoice is issued in respect of a supply;
- Payment is received for all or part of the supply;

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- A certificate is issued by an architect, surveyor or any person acting in a supervisory
capacity in respect of the service.
(b) (i)
MR. J. Mavindu
2011 COMPUTATION OF ADJUSTED PROFIT OR LOSS
Income Sh. Sh.
Sale of livestock 840,000
Sale of coffee 5,580,000
Total income 6,420,000
Less Expenses:
Purchase of fertilizers 164,500
Purchase of coffee plants 120,000
Clearing land for planting coffee 80,000
Construction of gabions 19,000
Planting wind breaks 18,600
Mortgage interest 124,200
Subscription to farmers association 60,000
Labour wages 172,000
Electricity expense 86,400
Water expense 44,600
Wear and tear 200,000
Farm work deductions (Note i) 1,050,000
320,000 (2,459,300)
Cost of livestock sold
Taxable profit 3,960,700

(ii) Tax Computation

Sh.
First Sh. (121,968 @ 10%) + (114,912 @ 60%) 81,144
Surplus (3,960,700 – 466,704) @ 30% 1,048,198.8
1,129,342.8
Less Personal relief (13,944)
1,115,398.8
Notes
i. FARMWORK DEDUCTION
Qualifying cost Residue Year of claim
Nature of farm work Sh. B/F 2005
Feeding troughs 150,000 - 150,000
Pig sty 300,000 - 300,000
Cattle dip 600,000 - 600,000

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Farm work deduction claim 1,050,000

ii. Cost of clearing land for planting coffee is allowable since it is part of permanent or semi
permanent crops.
iii. Provision for loss on crop failure is not allowable
iv. Cost of livestock stolen is not allowable as an expense.
v. Purchase of a tractor is a capital expenditure which is not allowable expense
vi. Sale of a tractor is capital in nature hence not a taxable income.
vii. Presumptive is not allowable as an expense
viii. Capital expenditure on the prevention of soil erosion by a farmer is allowable as an expense
e.g. construction of gabions

Question 4
Answer
(a)
i) Registration for VAT – incase the flower growers and exporters register for VAT, they can
claim the input tax paid on their purchases as a refund since under the VAT Act cap 476,
exports are zero rated for VAT purposes.
ii) Capital Allowance available under the income tax act – the flower growers and exporters
can claim capital allowances as allowable expenses e.g.
- Wear and tear allowances on the cost of machinery such as tractors, lorries, pickups etc
- Farm work deductions on the cost incurred on farm structures such as fences, farm
house etc.
- Diminution in value on the cost incurred on loose tools and implements such as spades,
slashers etc

Flower Export Ltd

2011 Computation of capital allowances
Wear and tear allowances
Class I II III IV
37.5% 30% 25% 12.5%
W.D.V.1.1.11
Lorries 1,250
Tractor 375
Pick-up and saloons 1,250
Computers 750
Plant 475
Equipment 275

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Furniture 725
Additions
Mercedes Benz 2,000R
Security system 250
R
4 new cars 8,000
Equipment 1,650
Computers 1,250
Disposals
4 Nissan sunny cars (6,890.625)
Carpet (450)
Furniture (460)
625 2,000 4,359.375 2,465
WTA (234.375) (600) (1,089.844) (308.125)
W.D.V.31.12.11 390.625 (1,400) (3269.531) (2,156.875)

NOTES
i) Nissan sunny cars
Cost (I-r) n =
NBV
Cost = NBV/ (I-r) n
= 1,600/0.8752
=2,089.796
ii) Disposal of Nissan sunny
Sales proceeds/Cost × restricted value
1,800/2,089.796 x 2,000 = 1,722.656
Hence 4 cars = 6,890.625
iii) Farm work deductions = 100% x 300
= 300

b)Flower export Ltd

2011 Computation of adjusted profit (loss)

Sh 000 Sh 000
Reported profit before wear and tear 1,599
Less wear and tear allowances
Class I 234.375
II 600
III 1,089.844
IV 308.125
Farm work Deductions (note iii) 300
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(2,532.344)

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Adjusted profit (loss) (933.344)

Corporation tax liability nil

Question 5:
Bahari shipping company Ltd
2011 computation of capital allowances
Shipping investment deduction
Name of ship Qualifying cost SID Residue for
Sh.000 40% WTA
Mr. Tewa (498 T) 6,000 2,400 3,600
Mr. Poa (600T) 9,000 3,600 5,400
6,000

Wear and tear allowances

Class I II III IV
37.5% 30% 25% 13.5%
W.D.V 01.01.11 1,800 1,500 1,400 2,000
Additions:
Mr. Tawa 3,600
Mr. Poa 5,400
2 Folk lifts 3,000
4 Computers 250
Saloon cars 4,000R
Disposals:
Mr. Yao (5,000)
Mr. Sawiya (4,000)
Furniture (350)
2 saloon cars (1,066.667)
Tractor (450)
4350 1750 4333.333 1650
WTA (1,631.25) (525) (1,080.333) (206.25)
W.D.V 31.12.11 2,718.75 1,225 3,250 1,443.75

Computation of adjusted profit loss

Sh.000 Sh.000
Reported profit 7,000
Add:

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Clawed back amount 2,143.75
9,143.75
Deduct:
Shipping ID 6,000
WTA 3,445.833 (9,445.833)
Adjusted profit (loss) (302.083)
Corporation tax liability Nil

NOTES
Clawed back amount – MV. Yao
Shipping ID = 40% x 8,000
= 3,200
Deduct wear & tear allowances for 3 years:
Cost (1-r) n = NBV
3
3,200(0.875) = 2,143.75

Question 6:
a) Benefits of being a signatory to the most favoured nation status agreement
 A country that grants MFNS on imports will have its imports provided by the most efficient
supplier. This may not be the case if the tariffs differ according to the country of exports.
 MFNS allows smaller countries in particular to participate in the advantages that larger
countries often grant to each other, whereas on their own small countries would often not
powerful enough to negotiate such advantages by themselves.
 Granting MFNS has domestic benefits i.e. having one set of tariffs for all countries simplifies
the rules and makes them more transparent. It also lessens the frustration problem of having to
establish rules of origin to determine which country a product must be attributed to for
purposes of customs.
 MFNS restrains domestic special interests from obtaining protectionist measures e.g. lobbying
for high tariffs to prevent cheap imports from a developing country.

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b)
Style Ltd
2010 - 2011 Computation of capital allowances

Investment Deduction
Nature of assts Qualifying Cost ID @ 100%
Sh. 000 Sh. 000
2010 Factory 10,060 10,060
Perimeter wall 1,400 1,400
Water pump 200 200
Sewerage plant 700 700
Factory machinery 400 400
Heating plant 500 500
Borehole 800 800
14,060

ID @100%

2011 Factory extension 4,800 4,800

Loading bay 600 600
Imported machinery 2,400 2,400
Conveyor belt 640 640
8,440

Industrial building deduction

Nature of building Qualifying Cost Residue b/f IBD @ 10% Residue c/f
Sh. 000 Sh. 000 Sh. 000 Sh. 000

2010 Staff canteen 800 - 80 720

Store 700 - 70 630
150

2011 Staff canteen 800 720 80 640

Store 700 630 70 560
150

Wear and Tear Allowances

Class I II III IV
37.50% 30% 25% 12.50%
Written down value1.1.2010 - - - -

Additions
Lorry (10 T) 3,600

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Furniture and fittings 120
Photocopier 150
Delivery van 1,800
Q Computers and printers 380
Forklift 1,500
5,100 530 1,800 120
WTA (1,912.5) (159) (450) (15)
Written down value 1.1.2011 3,187.5 371 1,350 105
Additions
Fax machine 120
Pick-up 2,000
Water pump 52.5
Sewerage plant 183.75
Factory Machinery 105
Heating plant 131.25
Disposals
Lorry (2,200)
Heating plant (480)
Photocopier (100)
987.5 271 3,350 217.5
WTA (370.313) (81.3) (837.5) (27.1875)
W.D.V. 31.12.2011 617.1875 189.7 2,512.5 190.3125
(ii)
Computation of taxable profit (Loss)
Sh. 000 Sh. 000
Reported Profit 7,200
Deduct
ID 8,440
IBD 150
WTA 1,316.30 (9,906.3)
Taxable profit (Loss) (2,706.3)
No corporation tax is payable

Notes
i) Factory construction
Sh. 000
Construction cost 12,000
Less store (700)
Total cost 11,300
Non Qualifying cost x 100
Total cost

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= 1,740 x 100
11,300
= 15.4%

Therefore cost of office will not qualify for ID

ii) ID Qualifying cost
Sh 000
Total cost 11,300
Less office (1,740)
9,560
Add: Demolition of old Building 500
10,060

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TOPIC

ADMINISTRATION OF INCOME TAX

OVERVIEW OF INCOME TAX ACT

Income tax in Kenya is charged under the income tax Cap 470. The Act contains provisions
relating to:
 Ascertainment of income.
 Assessment of tax.
 Collection of tax
 Entitlement to personal relief

The income tax Act Cap 470 was enacted on 20 December 1973 to replace the former East Africa
income tax management Act. It contains:
 14 parts
 133 sections
 13 schedules
 8 subsidiary legislation

IDENTIFICATION OF NEW TAX PAYERS

The finance Act 1992 introduced the thirteenth Schedule to the income tax Act which took effect
from 1st January 1993. A personal identification number (PIN) shall be required for tax
purposes for any of the following transactions:

Institution Purpose of transaction

 Commissioner of lands  Registration of title and stamping of instruments
 Local Authorities  Approval of plans and payment of water deposits
 Registrar of motor vehicles  Registration of motor vehicles and transfer of motor
vehicles, licensing under traffic act
 Registrar of Business Names  New registrations
 Registrar of Companies  New registrations
 Insurance companies  Underwriting of policies
 Ministry of Commerce  Importing licenses or trade licensing
 Commissioner of VAT  Applying for registration
 Kenya Power  Payment of deposit for power connection

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TAX ASSESSMENT: SELF-ASSESSMENT, ADDITIONAL ASSESSMENTS AND

ESTIMATED ASSESSMENTS

ASSESSMENT
 Assessment means computation of tax liability on any income derived in a particular year.
 In case a person has submitted a self assessment return to the tax authority, the commissioner
may:
- Accept the assessment return and consider the amount declared in the return as the correct
self assessment, in which case no further notification will be given.
- If the commissioner has reasonable cause to believe that the self assessment return is not
true or correct, he may determine according to the best of his judgment the amount of
income of that person and prepare an assessment on that basis.
 In case a person has not submitted a self assessment return for any year and the commissioner
considers that he has income chargeable to tax, he may determine the amount of income of that
person to the best of his judgment and prepare an assessment on that basis.

The time limits for making assessments.

- An assessment may be made at any time by the commissioner for any year of income before
the expiry of 7 years. However, incase fraud or willful negligence has been committed, an
assessment may be made at any time.
- In case of an assessment upon the executors or administrators of the estate of a deceased
person, an assessment must be made before the expiry of 3 years after the year in which the
person died.

REMITTANCE OF TAX: INSTALLMENT TAX, FINAL TAX

 Payment of installment tax serves as an assessment to installment tax. The tax is payable not
later than the 20th day of the month of the current accounting year. The commissioner may
issue an installment tax assessment in the event of failure to pay tax in time; tax assessed is
payable within 30 days of service of the assessment.
 The amount of the installment tax payable is the lesser of:
- The tax payable by the person on his total income for the year:
- The tax assessed, or in the absence of an assessment, estimated as assessable for the
proceeding year of income, multiplied by 110%.

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 Installment tax is not payable in the case of an individual to the extent the total liability to tax
for a year of income does not exceed Sh. 40,000.
 Installment tax is payable in four equal installments after the commencement of the accounting
period on the 20th day of the fourth, sixth, ninth and twelfth month.
 For agricultural enterprises installment tax is payable on the 20th day of the nineth month while
the second installment is due on the 20th day of the twelfth month.
 Adjustment to installment tax payable is required where there are changes in the length of a
company’s accounting period, where companies have merged or have been acquired or where
substantial transfer of assets between companies have taken place.

TURNOVER TAX

Turnover tax with effect from 1 January 2007 for businesses with a turnover of less then Sh. 5
Million p.a. the applicable rate is 3% of the gross receipt of the business.
Turnover shall not apply to:
 Employment income.
 Exempt incomes.
 Incomes subject to final withholding tax.
 Business incomes below Sh.500,000.
Turnover tax is charged at the rate of 3% on gross sales per annum. No expenditure or capital
allowance shall be granted against turnover tax.

For income tax purpose, turnover tax is a final tax.

For turnover tax purposes, the tax period means every 3 calendar months commencing 1st of
January of every year that is, turnover tax payers shall submit a quarterly return. Payment shall be
made on or before the 20th day of the month immediately following the end of the quarter.
For turnover tax purposes, registered tax payer shall maintain the following records;
 Cashbook
 Sales receipts and invoices (daily sales summary)
 Purchase invoices
 Bank statements

Benefits of Turnover tax

 It simplifies tax procedures.
 It simplifies tax computation.
 Makes filing of returns easier.
 Simplifies record keeping
 Reduces cost of compliance

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OPERATION OF PAYE SYSTEM

 Employers are required to deduct tax from payment made to employees in respect of
employment income. The PAYE rules set out the manner in which this is to be done, and the
tax tables are issued on which the appropriate deductions should be based.
 Employers no longer have to refer lumpsum payments to their domestic taxes department for
notification of tax deductable, but may now calculate the appropriate tax themselves.
 Under the PAYE rules, all deductions made by an employer must be paid to the domestic taxes
department before the nineth day of the month following the month in respect of which the
deductions are made.
 PAYE deductions are included in an individual self assessment return and are deducted from
the tax calculated on his total income in that return.
 PAYE must be deducted on the value of all benefits in kind, including loans at favourable rates
of interest paid to an employee, in addition to that calculated on the value of salary and housing
benefits.
 For loans granted to employees after 11 June 1998, the employer is required to account for
fringe benefit tax at the resident corporate tax rate, on the difference between the interest
actually paid by employees and the market interest rate. The market interest rate is the average
rate of interest for the 91 – day treasury bills issued in the month prior to the in which the tax is
charged. The fringe benefit tax is payable by the employer on a monthly basis on or by the 9th
day of the month following the month in respect of which it is due.

TAX COMPLIANCE AND TAX AUDIT

RETURNS
 Every person liable to tax must submit a self assessment return of income for each year.
 In case of an individual, the return of income must be submitted by 30th of June every year.
However with effect from Jan 2011 those individuals whose only income is from employment
need not submit self assessment returns.
 In case of a company self assessment returns must be submitted by the end of the 6th month
after the end of the accounting period.
 The commissioner may, where he considers it appropriate, send to any person return forms to
enable that person to furnish the required return of income.
 Currently returns of income may be submitted online to the tax authority.
 Audit procedure (PAYE Audit). This is the examination of records and documents prepared for
purposes of PAYE.
 The audit is carried out by officers from the revenue authority.
 The tax officers will check details such as:

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- If the correct PAYE amounts were deducted.
- If all amounts paid to employees were included in the pay roll.
- The correct transfer of PAYE details to the tax deduction cards.
- Ascertaining that the tax deducted was paid to the bank for transfer to the tax authority.
 In addition to the ordinary PAYE audit an audit may be triggered by:
- Material fluctuation of PAYE payments from one month to another.
- Where PAYE is not usually paid on time.
- In case of non-compliance detected in a normal tax examination of VAT or corporation tax.
- Information emerging from related companies that have been audited and non-compliance
is detected.
- Information from third parties or information from newspaper reports.
- Where salaries and wages figures as per the audited accounts are higher or lower than the
amounts reflected in the PAYE returns.

PAYE RETURNS

It is a system of deducting tax from an employee’s employment income at the end of every month.
It is computed on graduated scale rate and personal relief is granted. The tax so deducted is
payable to pay master general by 9th of the following month but where 9th falls on a
weekend/holiday it should be paid on the last working day before 9th.

The normal offences committed in respect of paye are:

1. Non-operation of PAYE systems, non deducted of all the paye, not accounting for the
PAYE deducted, non-submission of PAYE return by 28th Feb of the following year. Penalty
is 25% of outstanding tax or sh. 10,000 whichever is higher.
2. Late payment (remittance) of PAYE deducted. Penalty is 20% of outstanding paye and
an interest at the rate of 20% p.m. compound.

Employers’ responsibilities in respect of PAYE

i. At the beginning of the year, the employer is required to collect all the documents of paye
for each employee from DTD e.g. Tax tables, Tax deduction cards (p9s)

ii. In course of the year

 The employer should compute paye for each employee on a monthly basis
 Fill in the details in the tax deduction card
 Pay the PAYE deducted by 9th of the following month to the tax department.

iii. At the end of the year

 Reconcile the PAYE deducted and PAYE paid

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 Complete the tax deduction cards fully
 File PAYE returns by 28th Feb of the following year.

PAYE return comprises of:

1. Tax deduction card i.e. form P9s. This shows an employee’s employment income and
paye due including reliefs for every month.
There are 3 types of tax deduction cards.

a) Form P9A

It is used for all employees earning over Shs. 11,135p.a. including non-cash benefits
over sh. 3,000 p.p. and all company directors whether receiving benefits or not (nil
certificate at the back)

b) Form P9A (HOSP)

Used for all employees eligible to a defined home ownership savings plan contribution

c) Form P9B

Used in circumstances where the employer bears the burden of tax on behalf of the
employee i.e. tax free remuneration

2. Employee supporting list i.e. Form P10A. It shows the total tax paid for each
employee for the whole year.
3. End of the year certificate employers i.e. Form P10. It shows the total tax paid month by
month for all employees. If all the tax deducted has been paid to the tax department, the
total of P10A should be equal to the total of P10.
4. Form 10A. Used for fringe benefits tax returns. It shows the total loan amount advanced to
all the employees and tax paid on such benefits.
5. Form P10C. It is the employers’ certificate for the government ministries and National
assembly.
6. Form P11. This is the pay in slip. It is a receipt for acknowledgement of payment of tax.

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OBJECTIONS, APPEALS AND RELIEF OF MISTAKE

NOTICE OF ASSESSMENT
The commissioner may serve or issue a notice of assessment to the tax payer which contains
information that:

1. The tax payer has not been assessed or he has failed to submit his own self assessment returns.
2. The amount of income assessed.
3. The tax reliefs to which the tax payer is entitled.
4. The taxes already paid at source.
5. Information in regard to penalties or interest on the unpaid tax.
6. The due dates for payment of tax.
7. Information regarding the right of the taxpayer to raise an objection to the assessment from the
commissioner.

TYPES OF ASSESSMENTS

1. Self assessment
It was introduced with effect from the year of income ending 1992. It modified the final
returns.
It is required to be made by both individuals and companies. A tax payer is required to
compute own taxable income, tax payable and make payments in accordance with his
assessments. This tax is due by last day of the 4th month after the accounting year end. For
businesses whose year end is on 31 December, the self assessment returns should be submitted
by 30th June.
In case of failure to submit a self assessment return, the commissioner of income tax may issue
an estimated assessment and charge a penalty of 20% of tax due and an interest of 2% per
month on tax dues plus penalty as long as the tax remains unpaid.
The self assessment return should be submitted by:
 All liable body corporate
 Individuals with other income apart from employment
 All partnerships, i.e. only the income detail of partners is required.

Final return
A final return is submitted by partnerships only. It is due by the end of the 4th month following
the partnership account year end.
Since a partnership is not a separate taxable entity each partner will be required to submit his
own return of income as an individual.

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The final return will contain:
 The total income or loss of the partnership and how this was shared between the partners.
Supporting documents must be submitted alongside the return.
 A signed declaration that the return of income contains a full and true statement of a
partnership income or loss.
Other returns include:
 Pay as you earn (PAYE) returns – required by 28th of the following month
 Withholding tax return – dividends, royalties, interests, commissions

Notice of assessment
The commissioner shall assess every person who has income chargeable to tax as expeditiously
as possible after the expiry of the time allowed to that person under the Act for the delivery of
the return of income.
Where a person has delivered a return of income the commissioner may:
i. Accept the return and deem the amount that person has declared as his self assessment in
which case no further notification is required, or
ii. If he has reasonable cause to believe that the return is not true and correct, he may
determine according to the best of his judgement the amount of true income of that person
and assess him accordingly
iii. Where a person has not delivered a return of income for a year of income, whether or not he
has been required by the commissioner to do so but the commissioner considers that the
person has income chargeable to tax for that year, he may according to the best of his
judgement determine the amount of income for that person and assess him accordingly.

Service of notice of assessment

A notice of assessment is the tax bill which is issued by the commissioner of domestic taxes to
all tax payers for each year of income.
After the introduction of the self assessment return, assessments only originate from tax payers
rather than the commissioner. This means that a person who is chargeable to tax is required to
submit a return with self assessment.

All assessments must be submitted with:

i. Audited accounts where applicable
ii. Income tax computation
iii. A cheque or balance of tax deducting installment tax paid and withholding tax
iv. Dividend tax account where applicable
v. A cheque for compensating tax where applicable

Collection and recovery of taxes

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Where taxes assessed are not collected by due dates the collector of income tax has the power
to collect the tax due as a debt owed to the government. Such a debt can be collected as
follows:
i. The tax payer can be sued for the recovery in a court of law
ii. The taxes collected through an authorized agent
iii. Restraining order against tax payer. In case the commissioner can seize the property of
the defaulting taxpayer, which would be auctioned so as to satisfy the tax debt.

Content of an assessment
i. A notice to the taxpayer that he has been assessed under the Income Tax Act Cap 470 of
the laws of Kenya.
ii. Information to the person assessed that he has a right to object where he does not agree
to the assessment
iii. The tax assessed and loss carried forward
iv. The amount of relief available, i.e. for individuals
v. Amount of any tax paid at source
vi. Any penalties and interests where applicable as per the Income Tax Act
vii. Any amount of tax payable and due dates where taxes have been overpaid, a tax credit
should be reflected.

2. Installment assessment
The commissioner may make an installment assessment for tax in respect of any person after
the expiry of the time allowed to that person under the Act for the payment of installment tax.
When a person has paid installment tax he shall be deemed to have been assessed for the
purposes of installment tax on the basis of installment tax paid.

3. Estimated assessment
This is issued by the commissioner of income tax on any income that he estimates to the best of
his knowledge where:
 The tax payer has failed to submit installment returns
 The tax payer has failed to submit self assessment returns
 The C.I.T. does not agree with the tax payers self assessment return
 Returns have been made but the documents accompanying them do not satisfy the
commissioner.
Penalties are normally charged of 5% per annum based on the outstanding tax. The minimum
penalty being Sh.5,000 in case of a body corporate and Sh.1,000 in case of an individual.

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4. Additional assessment
It is issued by the income tax department after the tax payer has submitted his self assessment
return. Additional assessment is issued when income tax department discovers that there are
some incomes which have not been declared by the tax payer or discovers some expenses
claimed by the tax payer which do not relate to business.
Where under declaration or non-declaration of income is through fraud or willful negligence,
heavy penalties are normally imposed.
In case of a tax payer, 200% of the tax evaded and in case of the agent or the accountant, a fine
of up to Sh. 200,000 is imposed or imprisonment of up to 2 years or both.

5. Amended assessment
This is issued by the commissioner where a tax payer has lodged a notice of objection to the
commissioner against an assessment or has applied for relief of error or mistake or has made an
appeal to the local committee tribunal or court against an assessment.
Amended assessment is not considered to be a different assessment as such as it is issued to
correct an error in the previous assessment. Amended assessment can either be amended
upwards or downwards.

NOTICE OF OBJECTION TO AN ASSESSMENT

A person may object to the assessment from the commissioner.

An objection is raised formally and becomes valid if it is submitted and accepted by the
commissioner.
A notice of objection is considered to be valid if:
 It is made in writing.
 It states the grounds of objection or the reasons for raising the objection.
 It must be made within 30 days from the date of receiving the notice of assessment from the
commissioner.

LATE NOTICE OF OBJECTION

In certain cases, a person may not be able to raise an objection within 30 days as stipulated.
However he may lodge a late notice of objection on the following grounds:
 Sickness.
 Absence from Kenya.
 Any other reasonable cause e.g. failure to receive the notice of assessment on time.
 If there was no reasonable delay on the part of the taxpayer e.g. where he had sent the objection
on time but it was delayed in the post office.

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POWERS OF THE COMMISSIONER ON RECEIPT OF A NOTICE OF OBJECTION

Where the commissioner receives a valid notice of objection from a tax payer he may:
1. Amend the assessment in accordance with the objection in which case he will issue an
amended assessment to the tax payer.
2. Propose to amend the assessment in the light of the objection, in which case if the tax payer
agrees with the proposed amendments, he will issue agreed amended assessment. However, if
the tax payer does not agree with the proposed amendments the commissioner issues a non-
agreed amended assessment.
3. Refuse to amend the assessment, in which case the commissioner issues a notice confirming
the estimated assessment he had issued.
4. Take no action. The commissioner may take no action where the notice of objection from the
tax payer is not valid.

RELIEF OF ERROR OR MISTAKES S.90 (2) OF INCOME TAX ACT

Where a person after having made a return of income and assessed on his return discovers that he
had made a mistake of fact in the return as a result of which he had been assessed excessively, he
may within 7 years after the year of income to which the return relates makes an application to the
commissioner for relief. In case the relief is granted by the commissioner the amount is repaid.

APPELLANT BODIES

APPEALS
Where the commissioner issues a non-agreed amended assessment or a notice confirming the
estimated assessment, the tax payer may lodge an appeal to the relevant bodies which include:
 Local committee
 Tribunal
 The high court
 Court of appeal

LOCAL COMMITTEE
This is an appeal body established by the minister for finance through a notice in the Kenya
gazette.
The duties of a local committee are to hear and determine tax appeals on tax disputes lodged by
the taxpayer against the commissioner.
The local committee consists of a chairman and not more than 8 other members
The members usually hold office for a period of 2 years.

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The local committee hears appeals on the following matters.
1. Refusal by the commissioner to amend an assessment
2. Where the commissioner has issued a non-agreed amended assessment.
3. Where the commissioner has refused to refund tax.
4. Where the commissioner issues a notice to the tax payer requiring him to maintain
books and records in a particular format.
5. Where the commissioner refuses to waive penalties.
6. In case of a dispute involving the valuation of assets for purposes of capital allowances.

TRIBUNAL
It consists of a chairman and 4 other members.
There is only one tribunal that sits in Nairobi.
A tribunal deals with appeals against assessments by the commissioner involving:
1. Transactions designed or intended to avoid tax liability i.e. where the commissioner is of
the opinion that the purpose for which a transaction was effected was the avoidance of tax
liability.
2. Avoidance of tax liability through non-distribution of dividends. A company must
distribute at least 40% of its distributable earnings as dividends to ordinary shareholders;
failure by a company in this regard is called shortfall distribution. It means that revenue in form
withholding tax on dividends of 5% will be avoided. The commissioner may issue an
additional assessment based on the shortfall distribution of dividends.

Procedure for computing shortfall distribution of dividends

1. Ascertain the profits before tax from operating activities

2. Compute corporation tax at 30% and arrive at profit after tax
3. Deduct the permissible retention of 60% of profit after tax in order to arrive at the
distributable amounts, that is, 40% of profit after tax from business operations.
4. Add other incomes to arrive at total distributable amounts
5. Ascertain the amount distributed to members as dividends, the difference between
distributable amounts and distributed amounts is known as short fall distribution.

NB:
If a tax payer is unable to pay out the distributable amount as dividends, he has a right to make a
representation to the Commissioner of Domestic Taxes requesting him not to enforce the
distribution.
In his representation he has to include the following:
a. A statement of liquidity position of the company, that is, current assets Vs Current liabilities

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b. A confirmation that the directors do not owe the company any amount
c. The planned capital requirements
d. The development plan of the company for the future

HIGH COURT
A party to an appeal to the local committee or tribunal who is dissatisfied with the decision may
appeal to the high court.
An appeal to the high court may be made on a question of law or law and fact.

COURT OF APPEAL
A party to an appeal who is dissatisfied with the decision of the high court may appeal to the court
of appeal on the following grounds:
 The decision of the high court was contrary to the law.
 The decision failed to determine material issues of law.
 A substantial error or mistake in the procedure provided by the Act produced an error or
mistake in the decision of the case.

COLLECTION AND RECOVERY OF TAXES

COLLECTION OF OVER DUE TAX

 The income tax Act empowers the commissioner to effect the recovery of unpaid tax, which is
delegated to the collector of the income tax.
 The methods used for recovery of unpaid tax include:
- By an Agent
- By suit of court action
- By distrait
- By notice to the commissioner of lands to hold title of property owned by the tax payer as
security for the tax due and unpaid.

REFUND OF TAXES AND WAIVERS

 Where the commissioner is satisfied that a tax payer has over paid tax in respect of any year of
income, the overpaid tax must be refunded.
 Where the person claiming the refund has any tax due, the amount refundable will be offset
against the tax due.
 The time limit to claim the refund of overpaid tax is seven years after the expiry of the
respective year of income

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OFFENCES, FINES, PENALTIES AND INTERESTS

Under the income tax Act the offence committed by tax payers can be categorized as:
 Failure to comply with a notice
 Submission of incorrect returns
 Submissions of fraudulent return
 Obstruction of officers
Where taxpayer has committed an offence under the Act, the commissioner can impose penalties
which are listed below:

OFFENCE PENALTY
 Failure to keep adequate books of Sh. 20,000
accounts
 Failure to submit a final return with self – 5% of the normal tax
assessment
 Failure to submit a compensating return 5% of compensating tax for each month
 Omission, claim or statement due to fraud Additional tax not exceeding twice the
or gross negligence tax concealed
 Underestimation of installment tax 20% of the difference between
installment tax payable and that paid.
 Penalty and interest on unpaid tax Prior to 11 June 2010, 20% of tax unpaid
plus interest of 2% per month.
With effect from 13 June 2008, the 2%
interest shall not exceed 100% of the
principle tax
 General penalty – offence under the act Maximum fine of Sh. 100,000 and / or
for which no other penalty is specified. imprisonment not exceeding six months.

CHAPTER SUMMARY

 The income tax Act Cap 470 has provisions relating to assessment and collection and recovery
of tax.
 The tax authority can obtain relevant information about a taxpayer through PIN which is
required in various transactions.
 Assessments refer to tax computation on income derived in any year.
 Every taxpayer is required to submit a return on income together with his self assessment for
any year of income.

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 Where a tax payer has failed to submit his own self assessment a commissioner may issue
assessments based on his judgment.
 Installment tax is payable in advance during the year of income based on estimated tax liability.
 Where a taxpayer has been issued with an estimated assessment by the commissioner he has a
right to raise an objection against the assessment.
 In case a taxpayer is aggrieved with the decision of the commissioner he may appeal to the
established appellant bodies.
 The income tax Act empowers the commissioner to collect and recover overdue taxes from the
taxpayers.
 Where a taxpayer commits an offence under the act the commissioner has powers to impose
fines, penalties and interests

QUIZ

Question ONE:
(a) Now that there is self assessment under the Income Tax Act, does the commissioner of Income
Tax have to issue any assessment? Explain (3 Marks)
(b) Does an individual person have to raise an objection for tax assessed under the Income Tax Act
now that there is self assessment? Explain (3 Marks)
(c) Mr. Banu Shah provided the following information for the year ended 31 December 1996:
- He was employed as a full time director of Letex Limited at a salary of Sh. 80,000 per
month (P.A.Y.E Sh. 31,200 per month was deducted)
- Free goods worth Sh. 30,000 were received from the company in the year for personal use.
- He enjoyed free medical treatment under a medical scheme operated by the company which
was assessed at Sh. 50,000 in the year.
- Mr. B. Shah and his wife operate a company fully owned by them whose taxable income
has been agreed at Sh. 200,000 after charging wife’s salary of Sh. 120,000 (P.A.Y.E. Sh.
22,000).
- Latex Limited provided him with free housing from 1 August 1996 prior to which he lived
in his own house.
- His wife also works as a nurse in a private hospital and earned Sh. 20,000 per month
(P.A.Y.E Sh. 11,500 before letting. The house had a mortgage of Sh. 2,000,000 and Sh.
600,000 was paid on it of which Sh. 330,000 was capital.
Required:
i) Total taxable income of Mr. Banu Shah for 1996. (9 Marks)
ii) Tax payable / repayable on the income computed above. (3 marks)
iii) Comment on the importance e of P9 A in Income Tax Returns. (2 Marks)

(Total: 20 Marks)

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ANSWER

Answer:
(a) Yes-The commissioner may issue assessments which include:

1. Estimated assessment
It is issued by the commissioner where the tax payer has failed to file his own self assessment.

2. Amended assessment
It is issued by the commissioner where the tax payer has raised an objection against the estimated
assessment. It may be agreed or non-agreed mended assessment.
3. Additional assessment
It is issued by the commissioner where a tax payer had filed his own self assessment but the
commissioner is of the opinion that some income was not disclosed or other income is discovered
which was not included in the self assessment

(b) No. Where a person has discovered that due to errors and mistakes in his self assessment
returns tax was overpaid, he may appeal to the commissioner for the relief of errors, or
mistakes in which case the overpaid tax may be refunded.

Mr. Banu Shah

2011 computation of taxable income
Sh.
Basic salary 960,000
Housing benefit 15% X 5/12 X 960,000 60,000
Less mortgage interest
Actual 7/12 X 270,000 157,500 (87,500)
7
Set limit /12 X 150,000 87,500
Business income 200,000
Add: Wife’s salary 120,000 320,000
Rental income note (iii) 37,500
Total taxable income 1,290,000

Tax computation
First Sh. (121,963 @10%) + (114,912 @ 60%) 81,144
Surplus (1,290,000 – 466,704) @ 30% 246,988.8
328,132.8
Less T.A.S PAYE –Self (374,400)
-Wife (22,000)
Tax refundable (68,267.2)

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Importance of form P9A

This is a tax deduction card prepared by the employer for each of his employees
It serves as a certificate of tax and pay to the employee.
Notes
1. Free goods are non taxable benefits since the aggregate value is less than sh.36,000 p.a
2. Medical benefits enjoyed the employee under a medical scheme which is non-discriminatory
are not-taxable benefits.

3. Rental income Sh.

Gross 150,000
Less interest 5/12 X 270,000 (112,500)
Taxable income 37,500
4. Repairs and paintings before letting of property is capital expenditure hence not allowable.
5. Wife’s employment income will be taxed separately on her.

APPLICATION OF ICT IN TAXATION:

iTax
iTax is a web-based system developed to simplify revenue collection in Kenya by allowing
taxpayers to simply update their tax registration details, file tax returns using Microsoft Excel or
Open Office, register all tax payments and make status enquiries with real-time monitoring of their
ledger/account.

iTax is a web-enabled tax collection system by KRA to end the inefficient manual processes. It’s
an answer to simplify the tax processes, shorten time taken to file returns and increase revenue
collection. The system is automatic, updates the empoyee and employer ledgers in realtime after
filing and sends them notifications whether the returns have been filed successully or rejected.

The iTax system is used to collect taxes on three types of income-employment income, business
income and rental income. iTax allows users to apply for their KRA TAX PIN, check certificate,
generate e-slip, file their returns electronically, view your ledger, check status and as well apply
for a tax compliance certificate or file VAT, Income Tax, PAYE and Standards levy for KBS.

The system was launched countrywide to help simplify taxpayers registration and as well enable
them to file returns from wherever they are. iTax aimed to end the reliance on the old KRA web-
based system which was tedious to use and still had manual processes for taxpayers to follow up
unlike this automatic iTax system.

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Taxpayers can use iTax to file returns for Pay As You Earn (PAYE), Value Added Tax (VAT),
Individual annual Income Tax Return (IT1), and agency revenue that includes Sugar Development
Levy and Kenya Bureau of Standards.

To register for iTax, one needs to provide their e-mail address and a unique password. Those that
already have a KRA PIN only need to provide their PIN to log in

The system has a security stamp everytime a user logs in and as well has a mental sum to
determine if the data is being entered into the system by a machine or a human being.

Agencies that have access to KRA data include banks, Safaricom’s M-Pesa, Kenya Bureau of
Standards, the Foreign Affairs dept, taxpayers, KRA staff, the company registrar, treasury,
ICPAK, and the ministry of lands.

To those looking for refunds, KRA only has deposit accounts which means it can never withdraw
the cash for its own use and has to requisition for money from the treasury for its own operations
as well as for tapayers refunds.

For those who have no Internet, the iTax System can also be accessible at various cyber cafes and
within Huduma Centres countrywide with support officers on standby to help taxpayers. Go to
http://itax.go.ke , enter your PIN or User ID or sign up for a PIN if you’re registering and start
filing before the June 30th deadline as the new iTax system automatically penalises taxpayers that
haven’t paid when the deadline hits.

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TOPIC

ADMINISTRATION OF VALUE ADDED TAX

INTRODUCTION AND DEVELOPMENT OF VAT

VAT is a tax on expenditure that is collected by suppliers of goods and services and passed on to
the government.
VAT is charged on the supply of goods and services in Kenya by a taxable person in the cause of
or in furtherance of any business carried on by that person and on the importation of goods and
services into Kenya.
VAT was introduced in Kenya 1990 to replace sales tax. The decision to replace sales tax with
VAT was as a result of the perceived deficiencies in the sales tax system which includes:
 The sales tax system was a single stage system- sales tax was levied only once at the
manufacture level. However, in a country where tax evasion is widespread, a single stage tax
system will result in a higher loss of revenue than would normally be the case if the system was
multi stage.
 Where the inputs for manufacturing were subject to sales tax, the imposition of sales tax on the
finished product will result in the imposition of tax on another tax i.e. cascading effect.
 The sales tax system had a limited scope - sales tax was levied only on certain specific
manufactured Goods. Services were not within the scope of tax. Therefore sales tax had a
narrow tax base as compared to VAT, with the result that the revenue yield was comparatively
low.
 VAT is an indirect tax, It is essentially a tax on the domestic expenditure or consumption.
Under VAT, it the end user or consumer that ultimately bears the tax burden.
 VAT is charged on each transaction in the production and distribution chain.

QUESTION:
A manufacturer purchased raw materials at sh. 1 m on which VAT was charged at 16%. At each
stage of the production and distribution chain conversion cost of 25% was incurred and a markup
of 30% included to determine the selling price. Calculate the total VAT collected for the
government.

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ANSWER:
Value VAT
Sh.000 Sh.000
Supplier
Cost of materials 1,000
VAT @ 16% 160 160
1,160
Manufacturer
Purchase of materials 1,000
Conversion cost @ 25% 250
1,250
Mark-up @ 30% 375
Selling price 1,625
VAT @ 16% 260 260
1,885
Less input VAT (160)
100
Wholesaler
Purchase of product 1,625
Additional cost @25% 406.25
2,031.25
Mark-up @ 30% 609.375
Wholesale price 2,640.625
VAT @ 16% 422.5 422.5
3,063.125
Less input VAT (260)
162.5
Retailer
Purchase of product 2,640.625
Additional cost @ 25% 660.156
3,300.181
Mark-up @ 30% 990.234
Retail price 4,291.015
VAT @ 16% 686.562 686.562
4,977.577
Less input VAT (422.5)
264.0

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Total VAT collected for Cost
Sh.000
Supplier 160
Manufacturer 100
Wholesaler 162.562
Retailer 264
686.562

NB

 The illustration above demonstrates that it is the end user or consumer to bears the burden of
tax. The participants in the production and distribution chain are simply the collection agents of
the government.
 It also shows that incase there is tax evasion, the loss of revenue by the government is
minimized.

REGISTRATION AND DE-REGISTRATION OF TAXABLE PERSONS

REGISTRATION FOR VAT

 Registration, de-registration and changes affecting registration are dealt with in the sixth
schedule of the VAT Act.
 Compulsory registration applies to any person who in the course of his business has supplied
taxable goods or taxable services or expects to supply taxable goods or taxable services, or
both, the value of which is Sh. 5,000,000 or more in a period of twelve months.
 Any person who meets the above conditions is a taxable person and should, within thirty days
of becoming a taxable person, apply for registration.
 Voluntary registration is permissible under the law, but is granted at the discretion of the
commissioner.
 Where a person qualifies for registration, a registration certificate shall be issued within ten
working days after receipt of the application by the commissioner.
 Where an application for registration is made within 30 days of becoming a taxable person, the
effective date for registration is deemed to be the 30th day from the date the person became a
taxable person. However, the commissioner has the discretion to vary the effective date, and in
practice, the date of receipt of the certificate applies.
 Every registered person is required to display the registration certificate in a clearly visible
place in his business premises. Where a person has more than one place of business, certified
copies (by the commissioner) must be displayed in each of those places.

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 A group of companies that is owned or substantially controlled by another person may apply to
be registered and treated as one person, subject to the discretion of the commissioner.
 The commissioner may de-register a group of companies upon giving a notice of thirty day to
each company in the group if he is satisfied the group registration has caused or is causing
undue risk to revenue, or one of the companies ceases to make taxable supplies, or the person
in whose name the group is registered ceases to have a substantial control of the group.
 Upon registration, a person who has in stock goods on which tax has been paid, or has
constructed a building or civil works or purchased assets within one year before registration, he
may, within thirty days or such longer period as allowed by the commissioner, claim the input
tax charged thereof. Such a person must have submitted the application for registration within
the prescribed time limit.

DEREGISTRATION

 If the value of taxable turnover does not exceed five million shillings in any period of twelve
months, a registered person may apply for de-registration and will be subject to turnover tax
under the Income Tax Act, upon notifying the Commissioner.
 A person applying for de-registration should notify the Commissioner of the value of his
supplies in the relevant periods and the description and value of taxable materials and other
goods in stock.
 If the commissioner is satisfied that the trader should be de-registered, he will do so from the
date when that person pays the tax due in respect of goods and materials on which tax has not
been paid or input tax has been claimed.
 Where a person ceases to make taxable supplies, he must notify the commissioner immediately,
of the date of cessation and submit a return showing details of taxable assets, materials and
other goods in stock and their value and pay any tax due on such assets and goods within thirty
days from the date he ceased to make taxable supplies.

CLASSIFICATION OF TAXABLE GOODS AND SERVICES

Supplies may be classified into three types for VAT purposes:

- Standard rated supplies.
- Zero rated supplies.
- Exempt supplies.

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STANDARD RATED SUPPLIES
These are supplies that are subject to VAT at the standard rate of 16% or incase of electricity 12%.
The input tax on standard rated supplies is deductible against the output tax.
Suppliers making standard rated supplies must register for VAT and the value of such supplies is
taken into account in considering whether a person is to register for VAT or not.

ZERO RATED SUPPLIES

It means that tax is charged at zero (0) % on the supply but the supply is treated as a taxable supply
in every other respect.
The value of zero rated supplies is taken into account in determining whether a supplier is a
taxable person who is required to register for VAT
A registered person making zero rated supplies will not charge VAT on his supplies but can obtain
a refund of the input tax paid on his purchases.

EXEMPT SUPPLIES

VAT is not chargeable on exempt supplies the value of exempt supplies is disregarded in
determining the minimum turnover required for registration.
A person who makes only exempt supplies cannot obtain any refund of the input tax suffered on
their purchases.

Exempt services
1. Financial services excluding:
 Financial and management advisory services
 Safe custody services
 Trustee services
2. Insurance and re-insurance services
3. Education and training services offered to students
4. Medical, dental, veterinary and nursing services
5. Sanitary and pest control services rendered to domestic households
6. Agriculture, animal husbandry and horticultural services
7. Social welfare services provided by charitable organisation
8. Burial and cremation services (up to time of disposal)
9. Transportation of passengers by any means of conveyance except where the means of
conveyancing is hired/leased.
10. Postal services

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CHANGES AFFECTING REGISTRATION

A registered person is required to notify details to the commissioner within fourteen days of the
following changes:
 Change of address of the place of business; or
 Additional premises which are, or will be used for the purpose of the business; or
 Premises used for the business cease to be so used; or
 Business or trading name is changed; or
 An interest of more than thirty per cent of the share capital of a limited company has been
acquired by a person or group of persons; or
 The person authorized to sign returns is changed; or
 The partners in a partnership are changed; or
 A change occurs in the trade classification of the goods or services supplied.

SUPPLY OF SERVICES
The following shall be designated services and shall be taxed at whatever threshold;
a. Accounting services including any type of audit, book keeping or similar services
b. The provision of reports, advice, information or similar technical service in the following
areas:
 Management, financial and related consultancy
 Recruitment, staffing and training
 Market research
 Public relations
 Advertising
 Actuarial services
 Material testing services, excluding medical, dental or agricultural testing services.
c. Computer services of any description including the provision of bureau facilities, system
analysis and design, software development and training but excludes training offered to
students in the furtherance of education and which is not part of user training or other
business training.
d. Legal and arbitration services including any services supplied in connection therewith
e. Services supplied by architects, drawings and interior designers
f. Services supplied by land and building surveyors, quantity surveyors, insurance assessors,
fire and marine surveyors, loss adjusters or similar services.
g. Services supplied by consulting engineers
h. Services supplied by auctioneers, estate agents and valuers
i. Services supplied by agents excluding insurance agents

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j. Services supplied by contractors
k. Services supplied by clearing and forwarding agent
l. Services supplied by brokers, excluding services supplied by insurance brokers, stock
exchange brokers and tea and coffee brokers dealing exclusively in tea and coffee for export
m. Services supplied by security and investigation organisations including rental of security
equipment and installation.

Imported services

Where a person in Kenya imports a taxable service from overseas, the importer will be required to
account for the VAT to the VAT department. This is referred to as reverse charge. In order to
assist the collection of tax, the Central Bank is required to ensure that any person applying for
foreign exchange has remitted the fees overseas and has accounted for VAT to the department.
Such a person will be required to produce a tax clearance certificate from the commissioner of
VAT certifying that the VAT has been paid.

ACCOUNTING FOR VAT, TAXABLE VALUE, TIME OF SUPPLY

ACCOUNTING FOR VAT

VAT is charged where:

 The supply of goods or services and on the importation of goods or services into Kenya;
 The supply is a taxable supply;
 The supply is made by a taxable person;
 The supply is made or provided in Kenya; and
 The supply is made or provided in the course of the furtherance of a business carried on by
the taxable person.
The expression “supply” includes:
 The sale, supply or delivery of taxable goods to another person;
 The sale or provision of taxable services to another person;
 The appropriation of taxable goods or services by a registered person for his own use
outside the business;
 The making of a gift of any taxable goods or taxable services;
 The letting of taxable goods on hire, leasing or other transfers;
 The provision of taxable services by a contractor to himself in constructing a building and
related civil engineering works for his own use, sale or renting to other persons;

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 The appropriation of taxable goods by a registered person for use in the business where, if
supplied by another person, the tax charged on the supply would have been excluded from
the deduction of input tax; and
 Any other disposal of taxable goods or provision of taxable service.

TAXABLE VALUE

The charge for VAT is determined by the value attributable to the supplier of goods and services.
The general rule for determining the value of a supply is as follows:
 Where a supplier and a buyer are independent of each other and dealing at arm’s length, the
value for tax is the price for which the supply is provided;
 Where the supplier and the buyer are not independent of each other, the taxable value of the
supply is the price at which the supply would have been provided in the ordinary course of
business by a supplier who is independent of the buyer; and
 If in the above case the price cannot be determined, the commissioner is empowered to fix
the price at the open market selling price.

In determining the price of goods for purposes of ascertaining the value for tax, the charges for the
following items must be included;
 Wrapper, package, box, bottle or other container in which he goods are contained;
 Any other goods contained in or attached to such wrapper, package, box, bottle or other
container; and
 Any liability the purchaser has to pay to the vendor by reason of the supply in addition to
the selling to the selling price, including excise duty, and any amount charged for
advertising, financing, servicing, warranty, commission, transportation etc.
Where taxable goods are sold in returnable containers which were purchased or imported tax paid
then no tax will be chargeable in respect of the containers.
Where tax has been charged in respect of returnable containers, which are then returned to the
supplier, the supplier will be entitled to take credit for the tax in his next succeeding return.
For taxable goods imported into Kenya, the taxable value is the value for duty (whether duty is
payable or not) plus the duty actually paid.
The taxable value in respect of imported services is the price charged for the supply.
Where goods are purchased under hire purchase terms the consideration for the supply will
represent the cash price and the additional interest or finance charge will be disregarded in
determining the value of the goods.
Where interest is charged for late payment on the price of a taxable supply, it shall be disregarded
in determining the value of goods.

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TIME OF SUPPLY/TAX POINT

Tax becomes due and payable at the time when;

 Goods are supplied or services have been rendered; or
 An invoice is issued in respect of the supply; or
 Payment is received for all or part of the supply; or
 A certificate is issued by an architect, surveyor or any person acting in a supervisory
capacity in respect of the service, whichever time shall be the earliest.
The time of supply in respect of imported services is the earlier of:
 The time when the services are rendered; or
 When payment for the service is made; or
 When an invoice is received in respect of the service.

CHARGE TO TAX, DEDUCTIONS OF INPUT TAX, APPORTIONMENT METHOD OF

INPUT TAX

The input tax which may be deductible by a registered person is maybe:

- The whole of the input tax incase all supplies are taxable.
- Such part of the tax as can be attributed to taxable supplies where only a proportion of the
supplies are taxable.
- Where a person makes both exempt and taxable supplies, he may only claim the input tax
attributable to taxable supplies. However he can claim the whole of the input tax if input tax
related to exempt supplies is always less than 5% of the total input tax.

QUESTION:
The management of Masaa Ltd a registered supplier of vatable goods presented the following
information relating to the companies transactions for the month of October 2011.

Sh.
Sales at standard rate 36,000,000
Sales at zero-rate 14,000,000
Export sales 4,000,000
Exempt sales 6,000,000
Purchase at standard rate 30,000,000
Purchase at zero rate 12,000,000
Salaries and wages 6,000,000
Purchase of ETR 120,000

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Required:
Determine the VAT payable or refundable by the company for the month of October 2011

ANSWER

Output tax
Nature of supplies Supplies Value VAT
Sh. ‘000’
Standard- rate 36,000 5,760
Zero- rate 18,000 0
Exempt 6,000 -
5,760

Input tax
Std- rate purchases 30,000 4,800
Zero -rate purchases 12,000 0
ETR 120 19.2
4,819.2

Deductible input tax:

= Value of taxable supplies x Input Tax
Value of total supplies

= 54,000
X 4,819.2
60,000

= 4,337.28

VAT payable = Output tax – Deductible input tax

= 5,760 – 4,337.28
= 1,422.72

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VAT RECORDS

RECORD KEEPING

Paragraph 7 of the VAT Regulations and the seventh schedule to the Act prescribes the records to
be kept which include:
1. Copies of all invoices issued in serial number order;
2. A VAT account showing totals of the output tax and input tax in each period and the tax
payable or refundable;
3. Copies of all credit and debit notes issued, in chronological order;
4. Purchase invoices, copies of customs entries. Receipts for the payment of customs duty or
tax, credit and debit notes received, all to be filed chronologically;
5. Details of the amounts of tax charged on each supply made or received;
6. Totals of the output and the input tax in each period and a net of the tax payable or the
excess input tax at the end of each period;
7. Details of goods manufactured and delivered from the factory;
8. Details of each supply of goods and services from the business premises; and
9. Copies of stock records kept in a chronological order.

 All records must be kept in the Kiswahili or English language and for a period of five years
from the date when the last entry was posted.
 The commissioner is empowered to issue a notice requiring a taxable person to keep such
records or take such action as the commissioner may specify.
 The commissioner is empowered to allow a taxpayer to file returns and receive other
information electronically.
 The commissioner is empowered to require any person to use an electronic tax register for
purposes of accessing information that may affect the tax liability of that person.

TAX INVOICES
 Every registered person who makes a taxable supply on credit must issue a tax invoice at
the time of making payments to the supplier. In the case of a cash sale, a tax invoice must
be issued immediately upon payment for the supply. A simplified tax invoice may be issued
in respect of cash sales from retail outlets.
 No tax invoice should be issued on any supply which is not a taxable supply or if the
supplier is not registered. If an invoice is issued in contravention of this requirement, the tax
collected shall be payable to the commissioner within seven days of the date of the invoice.
 A tax invoice must be generated from a register or attached to a register receipt. The details
required on a tax invoice are:

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- The name, address, PIN, and VAT registration number of the supplier;
- The serial number of the invoice
- The date of the invoice
- The date of supply, if different from the date of the invoice
- The name, address, PIN, and VAT registration number of the person to whom the supply
was made
- The description, quantity and price of the goods or services being supplied
- The taxable value of the supply, if different from the price charged
- The rate and amount of tax charged on each of the supply
- Details of whether the supply is a cash or credit sale, and details of cash or other discount, if
any;
- The total value of the supply and the total amount of VAT charged
- A logo unique to his business; and
- The unique identification number of the electronic tax register, printer or special secure
fiscal device for record signing.

CREDIT NOTES

 A credit note may be issued where goods are returned or for good and valid business reasons, a
supplier decides to reduce the value of a supply after a tax invoice has been issued. The amount
to be shown on the credit note is the amount of the reduction.
 A credit note must be issued within twelve months after the issue of the relevant tax invoice.
 A credit note must show the following details:
a. The serial number;
b. The name, address and PIN of the person to whom it is issued; and
c. Sufficient details to identify the tax invoice on which the supply was made and the tax that
was originally charged.
 Where a credit note has been issued, the relevant adjustments are made in the month in which
the credit note was issued.
 The recipient of a credit note shall reduce the input tax for the month in which the credit note is
received.

DEBIT NOTES

 Where a tax invoice has been issued and subsequently, the supplier wishes to make a further
charge in respect of that supply, he may either issue a debit note or a further tax invoice.
 A debit note is required to show all the details required of a tax invoice as listed above. In
addition, it should show details of the tax invoice issued at the time of the original supply.

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 The recipient of a debit note may claim credit for the further tax charged, if eligible, in the
month in which the further charge was made, or in the next month.

VAT RETURN

Every registered person is required to submit a monthly Vat return to the commissioner giving the
following details:
 Showing separately for each rate tax, the total value of supplies, the rate of tax and the
amount of tax payable for the supplies made during the month;
 Showing separately for each rate of tax the total values of supplies, the rate of tax and the
amount of tax paid in respect of which input tax is claimed;
 Where necessary, to state that no supplies were made or received during the tax period.
The VAT return is completed for every month on form VAT 3 and is accompanied by a VAT 3A,
showing input tax claimed and VAT 3B, showing zero – rated supplies. The return must be
submitted to the commissioner by the 20th day of the following month. Where the 20th day falls on
a weekend or public holiday, the return shall be submitted on the last working day prior to the
weekend or public holiday.

VAT DUE FOR PAYMENT OR CREDIT

VAT ACCOUNT
The VAT account is posted with monthly totals. The total input tax is debited to the account and
the total output tax is credited.
If the debit side is greater than credit side (debit balance) the balance is VAT refund which is
carried forward to be offset against the output tax of the following month. However where the
credit side is greater than the debit side the balance is the VAT payable to the commissioner by the
20th day of the following month.

The VAT account is completed as follows:

Profoma of VAT a/c

Sh. Sh.
Sundry creditors’ xx Sundry debtors xx
(VAT on credit purchases) (VAT on credits sales)
CB (VAT on cash purchases) xx CB (VAT on cash sales) xx
Sundry debtor’s xx sundry creditors xx
(VAT on sales returns) (VAT on purchase returns)

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VAT payable (bal) xx VAT refund (c/f) (bal) xx
xx xx
VAT refund b/f xx

REMISSION, REBATE AND REFUND OF VAT

REMISSION OF VAT
Remission of tax applies to all taxable persons. The remission granted shall only apply in respect
of:
 Capital goods excluding motor vehicles, imported or purchased for investment, subject to
the regulations;
 Taxable goods for emergency relief purposes subject to specified conditions;
 Goods and taxable services imported or purchased by a company that has been granted an
oil exploration or prospecting license, subject to specified conditions;
 Capital goods and equipment for use in a customs bonded factory for export only;
 Official aid funded projects;
 Goods for use by the Kenya Armed Forces;
 Goods including motor vehicles imported or purchased by any company granted geothermal
resource license;
 Goods and services for use in the construction or expansion of private universities,
excluding student hostels and staff housing, subject to the approval of the minister for
finance;
 Goods and service for the construction of more than 20 housing units for low income
earners, subject to the regulations.

REBATE AND REFUND OF VAT

The commissioner will refund tax in the following circumstances:

 Where the amount of input tax exceeds the amount of output tax as a result of either the
trader making zero – rated supplies or having incurred physical capital investment the input
ax of which exceeds Sh. 1,000,000;
 Where VAT charged has been withheld by the buyer of the taxable supplies;
 Where taxable goods has been manufactured in or imported into Kenya and tax has been
paid in respect of those goods and before being used those goods are subsequently exported
under customs control;
 Where tax has been paid in error.

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Where a person has supplied goods or services and has accounted for or paid tax on that supply,
but has not received any payment from the buyer, he may apply for a refund or remission of the
tax on the following conditions;
 A period of 3 years has elapsed from the date of supply;
 The buyer has become insolvent.

Refund in respect of bad debts

An application for refund of tax in respect of bad debts must be made within 5 years from the date
of supply and must be accompanied by the following:

i. A document issued by the person with whom he proves the insolvency of the debtor,
specifying the total amount proved.
ii. A copy of the tax invoice in respect of each supply upon which the claim is based
iii. Evidence that every effort has been made to recover the amount owed
iv. A declaration that the seller and the buyer are independent of each other. No refund will be
made if the applicant is not up to date in submitting all VAT returns
v. When input exceeds output tax and this is a common feature of business e.g. zero rated
persons.

PRIVILEGES AND RIGHTS OF A VAT REGISTERED PERSON

RIGHTS OF A REGISTERED PERSON

Under the VAT Act, a registered trader has the following rights:-

 To deduct allowable input tax.

 To get a refund where input tax exceeds output tax as a result of either dealing with zero
rated supplies or making heavy capital investment.
 To get relief for stock in trade as at the time of registration.
 To get relief or refund on capital goods (Including buildings) acquired or put up within
twelve (12) months prior to the date of registration.
 To get a refund of bad debts.
 To defer payments of tax to a date not later than the 20th day of the month succeeding that
in which tax is charged.
 To request for reconsideration of an assessment.
 To appeal to the tribunal.
 To demand that every authorized officer identifies himself or herself.
 Have free access to the commissioner or any other authorized officer.

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 To expect that information obtained in the course of duty by the VAT officers shall be
treated in confidence.

OBLIGATIONS OF A TAXPAYER
On the other hand, a registered trader has obligations under the VAT Act which includes:-

 To apply for registration.

 To charge VAT at the right rate on all taxable supplies.
 To pay tax to his registered suppliers.
 To issue a tax invoice for every supply made by him.
 To submit monthly returns to the VAT Department on or before 20th day of the month
succeeding that in which tax is charged.
 To pay to the commissioner any amount he may have charged on an invoice by error.
 To keep full, and true records written and retain them for five years.
 Install and maintain a functional electronic tax register machine
 To avail records to authorized officers of the department at reasonable time for inspection.
 To produce for examination by the commissioner or an authorized officer any records,
books of accounts balance sheets or other documents as may be required.
 To allow an authorized officer to enter premises upon which he carries on business
 To notify details to the changes affecting his business.
 To pay VAT due (Output tax - input tax) to the commissioner on or before 20th day of the
following month.
 To display the VAT certificate of registration in a clear visible place within the business
premises

WITHHOLDING VAT AGENTS

 These are institutions which have been appointed by the revenue authority for purposes of
withholding VAT tax from the supplier of goods or services.
 Input tax is withheld from the seller of goods or services and a copy of withholding certificate
is issued.
 VAT withholding agents include:
- Government ministries
- State corporations or parastatals
- Banks and insurance companies

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OFFENCES, FINE, PENALTIES AND INTEREST

OFFENCES AND PENALTIES

OFFENCE PENALTY
 Late payment of tax  Interest at 2% per month compounded
 Failure to comply with the  Fine not exceeding Sh. 15,000 and/ or up
commissioner’s notice to pay money to six months imprisonment and liability
owed to a taxable person from whom tax to pay the amount discharged
is due, or furnish a return showing
monies held or due to a person from
whom tax is due
 Failure to produce books, records or  Fine not exceeding Sh. 15,000 and/or up
provide information as required by an to six months imprisonment
authorized officer
 Failure to produce books, records,  Fine not exceeding Sh. 15,000 and/or up
statements or other documents or to to two years imprisonment
attend summons or to answer questions
put by the VAT tribunal
 Making false statements, producing false  Fine up to Sh. 400,000 or double the tax
documents, providing false information, evaded, whichever is the greater. In
involvement in fraudulent evasion of tax, addition, any taxable goods connected
a non-registered person who holds with the commission of the offence may
himself out as a registered person be forfeited.
 Failure to display registration certificate  Default penalty of up to Sh. 20,000 and a
in a visible place in the business premises fine of up to Sh. 200,000 and/ or
imprisonment for up to two years
 Late submission of application for  Penalty of Sh. 20,000
registration
 Failure to apply for registration  Penalty of Sh. 100,000
 Failure to issue a tax invoice as required  Penalty of between Sh. 10,000 and Sh.
200,000. Any goods connected with the
offence are liable to forfeiture
 Failure to keep proper books or records  Penalty of between Sh. 10,000 and Sh.
200,000
 Failure to submit a return  Penalty of Sh. 10,000 or 5% of the tax
due, whichever is the higher
 General penalty for offences under the  A maximum fine of Sh. 200,000 and/ or

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Act for which no specific penalty is up to three years imprisonment
prescribed
 Failure to withhold VAT, remit withheld  Penalty of Sh. 10,000 0r 10% of tax
VAT, submit withholding VAT return or due, whichever is higher
issue a withholding VAT certificate at the
time of payment
 Withholding VAT without being  Penalty of Sh. 10,000 or 10% of tax due,
appointed as a withholding VAT agent whichever is higher
 Making a fraudulent claim for VAT  Penalty of double the amount claimed or
refund to imprisonment for a period not
exceeding three years or both.

REQUIREMENTS OF OBJECTIONS AND APPEALS

VAT TRIBUNAL
 The tribunal is established by the minister and consists of the chairman and two or more
members also appointed by the minister. The minister may make rules prescribing the manner
in which the appeal may be made to the tribunal, prescribing the procedure to be adopted in
hearing an appeal, the manner in which it shall be convened and a scale of costs.
 Any person aggrieved by any decision of the commissioner may appeal to the tribunal within
30 days of being notified of the decision. However the tax payer must have:
- Submitted all his monthly returns;
- Paid tax as computed by him in his returns.
 Further, the tax payer must pay 50% of the tax accessed by the commissioner before his appeal
can be registered. If the tribunal decides in favour of the tax payer, the tax so deposited is
credited to be offset against his future tax liability under the Act.
 Within 14 days of giving the notice to the commissioner, the appellant is required to submit 5
copies of the memorandum of the appeal to the secretary of the tribunal. Within two days after
submitting the memorandum to the secretary the appellant shall serve the commissioner with
the copy of the memorandum including the statement of facts and the relevant documents.
 If the commissioner is not satisfied with the facts of the appellant he shall file a statement of
facts within 21 days together with 5 copies to the secretary of the tribunal.
 If the commissioner has no objection to the statement of facts he shall give a written notice to
the secretary and to the appellant. The appellant shall appear before the tribunal either in person
or through an advocate. The tribunal may confirm, reduce, increase or annul the assessment or
make such other order at its discretion

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TAX COMPLIANCE AND TAX AUDIT

 Tax compliance refers to registration for VAT, payment of tax, submission of documents and
general compliance with any other requirements of the VAT Act.
 Assessments of tax will usually be made where:-
- A taxable person fails to submit the monthly return (VAT 3);
- An inspection by the VAT department of the taxpayer’s books and records reveals
discrepancies which give rise to additional tax.
 There are basically two types of assessments, factual assessment or the best evidence
assessment. The factual assessment is based on the records of a taxpayer and is normally used
to correct mistakes in the returns. The best evidence assessment is used where the tax authority
has no facts available in which case the commissioner uses whatever evidence that is available
from the taxpayer or other sources.
 Where a factual assessment has been made after an inspection of the taxpayers records, the
taxpayer may request a reconsideration of the assessment incase he has new evidence that
could change the assessment.
 An aggrieved taxpayer may within 30 days of a decision by the commissioner appeal to the
appeals tribunal established by the minister to hear and settle VAT disputes.
 The decisions of the tribunal are subject to appeal to the high court however the aggrieved
party must first pay the tax in dispute.

TAX AUDITS

AUDIT OF VAT REFUND CLAIMS

IT is a requirement that all VAT refund claims should be audited by an accountant. The audit
certificate is required to authenticate the amount claimed. The audit should follow the same
stringent rules of a normal audit. The auditor must ensure the VAT refund audits are properly
planned and is conducted to ensure that an opinion on the truth and fairness of the amount claimed
can be given. The commissioner of DTD has undertaken to refund the amount claimed within 2
weeks of receiving a claim accompanied by a clean audit opinion but they also reserve the rights
after making such repayments to visit the registered persons or review the audit working papers to
verify the claims themselves.

Vat refund claim audit was introduced to:

i. Avoid delay in remittance and processing of the claim
ii. Reduce the workload at the VAT department

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iii. Avoid the tying up of the funds that could be used by the registered person and the
commissioner
iv. The need for the assurance that the amount refundable has been accurately computed.

Audit procedures on VAT refund claim

i. Review and document the adequacy of the system of recording and accounting for VAT
ii. Ensure that a VAT control account is maintained and reconciled
iii. Establish why the trader is in a refund position
iv. Check that due output tax on supplies has been charged
v. Input claims should be supported by the proper invoices and suppliers documents and VAT
numbers.
vi. Ensure that correct VAT rates have been applied
vii. If there are categories of sales, that is, exempt sales, zero rated sales and taxable standard
sales, then the input tax should be apportioned accordingly.
viii. VAT orders have been considered to ensure that input tax which is not claimable has not
been claimed as of furniture and fittings, entertainment, food, fuel, petrol etc
ix. VAT should be claimed within 6 months of VAT invoice. In case it is not it will be
withdrawn
x. Ensure that all VAT returns were submitted in time, if not compute the penalties and
interest to be deducted from the claim if the trader has not done so.
xi. Prepare a statement analyzing the correct claim.

Auditors certificate under VAT regulations

(Registered persons)
Period (ended 2011)

We have examined the attached claim for refund of VAT amounting to Ksh.xxxx made by
(registered person) from dd.mm.yy to ensure compliance with the VAT Act and regulations, and
have obtained all information and explanations necessary for the purpose of our examination. Our
examination was designed to enable us to obtain reasonable assurance that the claim is free from
material misstatements and included verification, on a test basis, of evidence supporting the
amount. It also included an assessment of the adequacy (registered persons) system of recording
and accounting for VAT.

In our opinion the attached VAT claim gives a true and fair view of the amount claimed and is
properly refundable under the VAT Act and regulations.

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Certified Public Accountant
Date
Key Terms
Tax invoice – This is a document issued by a supplier of goods or services who is registered for
VAT.
Taxable supplies – These are supplies that are subject to VAT at the standard rate of 16% or 12%
incase of electricity. Taxable supplies also include zero – rated supplies.
Zero-rated supplies – These are supplies that are subject to VAT at the rate of 0% but are treated
as taxable supplies in all other respects.
Exempt supplies – These are supplies that are exempted from VAT
Remission of tax – This refers to waiver of tax. The power to remit tax is vested in the minister
for finance
Refund of Tax – This refers to the repayment of tax to the taxpayer by the commissioner.

CHAPTER SUMMARY

 VAT was introduced in 1990 to replace sales tax.

 VAT is charged on the supply of taxable goods or services made in Kenya by a taxable person
in the cause of furtherance of any business and on the importation of goods and service in
Kenya.
 Compulsory registration for VAT applies to any person who in the cause of his business has
supplied taxable goods or services the value of which Sh. 5,000,000 or more in a period of 12
months.
 If the value of taxable turnover does not exceed Sh. 5,000,000 in any period of 12 months, a
registered person may apply for de-registration and will be subject to turnover tax under the
income tax Act.
 A registered person must submit a VAT return by the 20th day of he month following the month
of transactions.
 Withholding VAT agents are persons or institutions appointed by the commissioner to
withhold VAT from the suppliers of taxable goods or services.
 VAT remission is made under the conditions specified in section 23 of the VAT act.
 The commissioner has power to impose penalties fines and interests on offence committed by
tax payers on the VAT Act.
 Where taxpayer has failed to submit VAT returns the commissioner will issue assessments
based on factual evidence or the best available evidence.
 An aggrieved taxpayer may within 30 days of a decision by the commissioner appeal to the
appeals tribunal.

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QUIZ

QUESTION 1:
(a) Citing examples briefly explain the term “withholding VAT agents” (4 Marks)
(b) Mr. Thomson Mawele is a registered accountant operating under the name Mawele and
Associates. During the month ended 31 December 2011, the firm undertook the following
transactions:
December:
1: Audited the accounts of Marura County Council and raised an invoice of Sh. 60,000
excluding VAT.
2: Undertook financial consultancy assignment for Jakumu Traders and raised an invoice of
Sh. 96,000 inclusive of VAT.
6: Reviewed the internal control systems of Waalimu Sacco at an agreed fee of Sh. 70,000
exclusive of VAT.
8: Audited the accounts of the Nairobi branch of Starcoach Traders, a business entity with its
headquarters in Kampala, Uganda. The fees were agreed at Sh. 100,000 exclusive of VAT.
15: Billed Maendeleo Traders Sh. 69,000 inclusive of VAT for debt collection services
rendered.
20: Provided management consultancy to Watoto Children’s Home on a voluntary basis. The
value of the services was Sh. 23,200 exclusive of VAT.
24: Undertook tax consultancy work for Mapesa Bank Ltd. and raised an invoice of Sh.
150,000 exclusive of VAT.
30: Prepared the final accounts for Kisii Supermarket Ltd and raised an invoice of Sh. 116,000
inclusive of VAT.
31: Received goods worth Sh. 60,000 from Maendeleo Traders in full settlement of the amount
billed for services rendered on 15 December.

Additional Information:
1. Kisii Supermarket Ltd, was wound up on 31 December 2011 before settling the amount due
to Mawele and Associates.
2. The following expenses were paid by the firm during the month:

Sh.
Salaries and wages 800,000
Electricity 5,600
Telephone 8,400
Water 5,200
Fuel 16,000
Garbage collection 720
Computer repairs and 2,800

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maintenance
Rent 12,000
The above expenses are stated as VAT exclusive where applicable.

Required:
(i) VAT account in the books of Mawele and Associates for the month of December 2011
(12 Marks)
(ii) Assume Mawele and Associates did not submit a VAT return together with any payment until
20th April 2012.
Compute the penalties payable (inclusive of interest) by the firm. (4 Marks)
(Total: 20 Marks)

QUESTION 2:
(a) List four circumstances under which the customs department may revoke a license granted to a
manufacturer of excisable goods. (4 Marks)
(b) Explain the following terms as used in customs control:
i) Clean report of findings (CRF) (4 Marks)
ii) Bond security (4 Marks)
(c) The following information was extracted from the books of Sasumua Traders, a registered
business for Value Added Tax (VAT) purposes, for the month of August 2011:
Sh.
Export sales 150,000
Imported goods for resale (dutiable value) 900,000
Telephone expenses 72,000
Audit fees 180,000
Purchases at zero rate 240,000
Exempted sales 184,000
Sales at standard rate 3,500,000
Purchase at standard rate 1,480,000

Transactions are stated as exclusive of VAT where appropriate. The rate of VAT is 16%

Additional Information for the month of August 2011:

1. Sasumua Traders received debit notes and credit notes of Sh. 400,000 and Sh. 200,000
respectively for standard rated supplies
2. The imported goods for resale were subject to customs duty at the rate of 30%. These goods
were subsequently transported to the business premises at a cost of Sh. 40,000 and repackaged

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at a cost of Sh. 10,000. The goods were then sold at a mark-up of 20% (the sales proceeds on
these goods were not included in the reported sales at standard rate).
3. A debtor for goods sold at standard rate for Sh. 120,000 was declared bankrupt.

Required:
The amount of VAT payable (if any) by Sasumua Traders for the month of August 2011
(8 Marks)
(Total: 20 Marks)
ANSWER

Question 1:
(a) Withholding VAT agents
 These are institutions which have been appointed by the revenue authority for purposes of
withholding VAT tax from the supplier of goods or services.
 Input tax is withheld from the seller of goods or services and a copy of withholding
certificate is issued.
 VAT withholding agents include:
- Government ministries
- State corporations or parastatals
- Banks and insurance companies

(b) Mawele and Associates

VAT A/C
Dec Sh. Dec Sh.
Maendeleo Traders 9,600 Marura Council 9,600
(16% X 60,000) (16% X 60,000)
Kisii Supermarket 16,000 Jakumu Traders 13,241
(Bad debt relief) (16/116 X 96,000)
Electricity 672 Waalimu Sacco 11,200
(12% X 5,600) (16% X 70,000)
Telephone 1,344 Star Coach Traders 16,000
(16% X 8,400) (16% X 100,000)
Garbage collection 115 Maendeleo Traders 9,600
(16% X 720) 16/116 X 69,600
Computer repairs 448 Watoto Home 372
(16% X 2,800) (16% X 23,200)
Rent 1,920 Mapesa Bank 24,000
(16% X 1,200) (16% X 160,000)

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VAT Payable 73,254 Kisii Supermarket 16,000
(16% X 116,000)
103,353 103,353
N/B:
- VAT is not levied on water
- VAT on fuel is prohibited from being claimed hence not deductable.

(i) Penalties
Non-filing of VAT return = Sh.10,000
Interest of 2% p.m compounded i.e. V(1+r)n – V
73254 (1.02)3 – 73254 = 4,483.73 + 10,000
Total penalty = 14,483.73

Question 2:
(a) The commissioner may revoke, suspend or refuse to renew a license where he is satisfied that:
 The licensee has been convicted of an offence involving dishonesty or fraud.
 The licensee has become bankrupt.
 The factory or the plant therein is of such nature or so maintained that goods manufactured
are likely to be adversely affected.
 The factory is so designed, equipped or sited as to render its supervision difficult.

(b) (i) Clean report of findings (CPF)

 It is a document issued to the importer after the goods are subjected to pre-shipment
inspection.
 The pre-shipment inspection is carried out in the country of origin before shipment of
goods.
 It shows dutiable value of goods and the customs coding.
 It is issued by the global testing, inspection and certification of the organization after the
satisfactory inspection of the subject goods and the receipt of the final documents.
 It authorizes the goods to be imported.

(ii) Bond security

 This is where the tax payer delivers a document as proof of legal ownership of an asset and
enters into a binding agreement to fulfill the obligations with regard to compliance and
payment of customs duty.
 If the taxpayer fails to fulfill the conditions he looses the asset.

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Sasumua Traders
Output tax
Nature of supplies Supplies Value VAT
Sh. ‘000’ Sh. ‘000’
Standard rate 3,500 560
Imported goods (SP) 1,464 234.24
Bad debt relief (120) (19.2)
Zero rate (exports) 150 0
Exempt 184 -
Total output tax 775.04

Input tax Supplies value VAT

Sh. ‘000’ Sh. ‘000’
Standard rate purchases 1,480 236.8
Debit note 400 64
Credit note (200) (32)
Imported goods 1,170 187.2
Audit fees 180 28.8
Telephone expenses 72 11.52
496.32
Deductable input tax
Value of taxable supplies x input tax
Value of total supplies
1,494/5,178 X 496.32
= 478.683
VAT Payable = output tax – deductable input tax
= 775.04 – 478.683
= 296.357
Note
(ii) Imported goods
Value
Sh.000
Value of imports 900
Customs duty at 30% 270
Value for VAT 1,170
Transport 40
Packaging 10
1,220
Mark-up @ 20% 244

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Selling price 1464

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TOPIC

CUSTOMS TAXES AND EXCISE TAXES

CUSTOMS PROCEDURE

INTRODUCTION

Customs and Excise duties are charged under the custom and excise Act cap 472. The custom
department is charged with the responsibility of controlling imports and exports, enforcing
prohibitions and restrictions and collecting revenue on both imports and excisable goods.

 On arrival cargo from an aircraft, vehicle or vessel which unloaded must be declared to
customs in a prescribed form within 21 days. The goods should be entered either for home
consumption, transit, transshipment, warehousing or to an export processing zone.
 Where there is insufficient information, the declaration maybe made on provisional status
subject to approval by the proper officer. Where provisional entry has been allowed, the proper
officer will require the owner to deposit an amount estimated as the duty payable.
 Where goods have not been entered for clearance within 21 days, they will be deemed as
deposited in a customs warehouse where rent will be charged at the prescribed rates. Where
goods are not removed from the customs warehouse within the notice period granted by
customs, they may be sold by public auction to recover customs duty and warehouse rent
payable on them.

TAX POWERS AND RIGHT TO REVENUE

POWERS OF THE COMMISSIONER OF CUSTOMS AND EXCISE

1. S. 9 of customs and excise Act states that the commissioner can appoint and fix the limits in the
Kenya gazette of:
 Ports
 Customs airport
 Customs areas
 Entrances and exits
 Routes in Kenya over which goods in transit can be conveyed
 Bonding stations i.e. area appointed by the commissioner for air crafts and vessels
arriving or departing from a port may be kept.
 Places of loading and unloading of goods within a port.
 Places of examination of goods.

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 Places for landing and embarkation of persons.

2. Provision of suitable accommodation for offices

3. Power to permit roads, area, place, boarding station, route entrance and exit etc to be used on a
temporary basis if so appointed
4. Power to disclose information to a person in the service of the government in the revenue
department for official duties.
5. Power to compound an offence by agreement
6. Power to revoke a license issued to manufacture excisable goods
7. Power to furnish to a competent authority any information, certificate or official import
document etc of goods in or from a foreign country
8. Power to require information from importers concerning dumping of goods

POWERS OF THE OFFICERS

To prevent smuggling and evasion of duty the Act gives the following powers to officers:
1. Power to require vessels to board failure to which the master of the ship or vessel is liable to a
fine of sh. 100,000 and seizure of the vessel.
2. Power to require a vessel to depart from the Kenyan port within 12 hours, failure to which a
maximum fine of Sh.100,000 is imposed and the vessel is liable to forfeiture.
3. Power to patrol freely and move the vessels i.e. He can take the aircraft of vessel to a place
convenient for investigation of smuggling or evasion without any legal liability to the office.
4. Power to board a vessel and make a search. If the master of the ship refuses he is liable to;
a) A fine not exceeding Sh. 500,000 or
b) 3 years imprisonment
c) Forfeiture of goods
5. Power to require persons entering or leaving Kenya to answer questions concerning their
luggage.
6. Power to search persons where he has reasonable grounds to believe that the person has
excisable goods or uncustomed goods. However, a female office can only search a female
person
7. Power to seal and search premises. They can sea, lock or secure:
a) Buildings, rooms or receptacle of a plant
b) Excisable goods or material in a factory
c) Aircraft, vessels, vehicles or container
8. Power to have a search warrant issued by the magistrates to enable the officer to enter day and
night premises to seize and carry away uncustomed goods, plant or documents

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IMPORTS AND EXPORT DUTIES

DUTY
 Duty is defined to include:-
Customs duty, excise duty, levy, cess, imposition of tax, surtax
Imposed on goods by the commissioner
CUSTOMS DUTY
 This is the duty or tax paid on goods imported through any port of Kenya or goods imported
and which are specified in the first schedule of the Customs and Excise Act
 Goods subject to customs duty include:
- Machinery
- Textiles
- Electronics
- Vehicles
- Food commodities

 The purposes of customs duty are:

- To raise revenue for the government.
- To protect local industries e.g. impose high customs duty to discourage consumption
of imports.
- To prevent dumping of goods into the Kenyan Market e.g. impose high anti –
dumping duty
- To discourage production of harmful goods e.g. excise duty imposed on manufacture
of beer and cigarettes.

EXPORT DUTY
 This is tax that is imposed on goods which are exported to foreign countries. The main
purposes of excise duties are:
- To raise revenue for the government.
- To discourage the exportation of certain goods e.g. scrap metal, hides and skins.
- To encourage the use of materials locally e.g. scrap metal.

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GOODS SUBJECT TO CUSTOMS CONTROL

S.12 of the Custom and Excise act specifies goods which are subject to customs control:
1. Imported goods through the post office from the time of importation to delivery of goods for
home or importation whichever happens first.
2. Dutiable goods and excisable goods on which duty has not been paid.
3. Goods which have been seized and all goods under notice of seizure.
4. Goods on board and aircraft or used within a port or place in Kenya
5. Goods under drawback from time of claim of drawback
6. Goods subject to export duty from the time of bringing to the port for export to the time of
exportation.
7. Goods subject to restriction on exportation
8. Goods pending exportation and are stored in a customs area with the permission of a proper
office.

VALUATION OF IMPORTS AND EXPORTS

Customs valuation is based upon the world trade organization (WTO) agreement on customs
valuation which establishes a custom valuation system that primarily bases the customs value on
the transaction value of imported goods. The customs value of imported goods constitutes the
taxable bases for customs duties.

VALUATION OF EXPORTS

The value of export goods whether exempt from duty, liable to specific duty or liable to

Ad-volorem duty shall include:

 The cost of goods to the buyer outside Kenya
 Packaging charges
 Any Levy, cess, duty, tax or surtax
 Transport and all other charges up to the exit from Kenya

Sec 127(b) states that where goods for exportation or re-exportation are below the normal price,
the commissioner or any authorized officer will cause the goods to be revalued or appraised in
accordance with the rate and price at which goods of similar kind and quality have been exported
or imported. Re-exportation occurs when goods are imported from outside Kenya and then
exported outside Kenya without being used in Kenya. The value of goods for exportation purposes
consist of:
 Landed cost at the time of importation

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 Transport and all other charges up to the time of delivery of goods on board the exporting
vessels or aircraft at a place of exit from Kenya.
Once goods are re-valued or appraised a certificate of appraisal shall be granted by the officer
indicting the appraised value.

Exchange rate for exports

To determine the value of export goods in Kenya shillings, the exchange rate used shall be the
higher of:
 The prevailing current bank rate of sight drafts as last notified by CBK
 The rate applied by banks or financial institutions
 The commissioner may use weighted average of prevailing bank exchange rates in force
during the previous week subject to any revaluation or ordinary valuation as notified by
CBK.

Valuation of imported goods sec 127(C)

For the purpose of levying duty of imported goods shall be the sum of:
 The value ascertained for the purpose of import duty
 The amount of import duty and dumping duty if any.

When determining the value, the following assumptions are made:

 Imported goods are delivered to the Kenyan buyer at the port of importation.
 The seller bears the freight, insurance, commission and other charges, expenses and costs
relating to sale of goods.
 The buyer/ importer shall bear any duty/ tax chargeable in Kenya.
 The proceeds from resale of imported goods in Kenya shall not accrue directly or indirectly
to the seller or a person related to him.
 The price of imports is not influenced by commercial, financial or other relationship
between the seller and the buyer (importer)

For locally manufactured goods excise duty is imposed. For the purpose of levying Ad Valorem
excise duty the value of locally manufactured goods shall be the Ex-factory or selling price. Ex-
factory selling price is the price at which goods can be sold from the factory exclusive of VAT and
excise duty. It consists of:-
 Cost of wrapper, package, box, bottle or other container in which excisable goods are packed.
 Cost of any other goods contained or attached to the wrapper, package, box, bottle etc
 Incidental cost of goods e.g. transportation costs, advertising costs, financial costs,
commission given to seller, or any cost incurred in delivery of goods to the purchaser.

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WTO Customs Valuation Methods

Kenya adopted the WTO’s Agreement on Customs Valuation, which came into effect from 1
January 2000. The methods adopted are contained in the Finance Act 1999. The significant feature
of the new methods is that the revenue authority can no longer arbitrarily fix the value for duty.
Under this system, Customs Authorities’ role is to be trade facilitators and not barriers to the free
flow of goods.
Tanzania and Uganda, which are classified as Least Developed Countries, (LDCs) are required to
implement the agreement from 1 January 2006.

The thrust of the new method is to value goods at the transaction value. The general principle is
that goods should be valued based on their actual price, which is generally shown on the invoice.
There are six methods that can be used. In most cases the first method will suffice, but where there
is no transaction value or transaction value is rejected by Customs department, the other five
methods apply in their hierarchical order.

Method 1 – Transaction Value

The customs value is the transaction value (the price paid or actually payable, including all
payments made as a condition of sale:
The following conditions apply:
1. There are no restrictions imposed as to the disposal of the goods by the buyer other than
restrictions which:
 Are imposed by law (e.g. a firearms dealer is restricted under the law)
 Limit the geographical area in which the goods can be resold (say under a
distributorship contract)
 Do not substantially affect the value of the goods.
2. The price should not be subject to some conditions for which a value cannot be assigned to
the goods.
3. No part of the proceeds of the disposal of the goods will accrue directly or indirectly to the
seller.
4. The buyer and seller should not be related. If they are related, the relationship should not
influence the price. The following will be added to the transaction value if incurred by the
buyer and not the transaction value:
 Commissions and brokerage (Except buying commissions)
 Packaging and container costs and charges
 Royalties and license fees
 The cost of transport, insurance and related charges up to the port of discharge (CIF basis)

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 Assists (i.e. material, components, tools, dyes and moulds) supplied by the importer free
of charge or at a reduced cost in connection with the production of the goods.

This method relies heavily on the documentation provided by the importer. However, Customs
must be satisfied as to the truth or accuracy of the documents. If Customs is in doubt, the burden of
proof of the value of the goods shifts to the importer. The new valuation method pre-supposes that
customs authorities including the local prices of such goods. If the value presented by the importer
is rejected, then Customs department is obliged to give a written explanation or if the importer so
requests, within thirty days of request. Should a consignment fail to meet the conditions of method
1, then method 2 will be used.

Method 2- Transaction value of identical goods

Where the value of duty cannot be ascertained using method 1, then the transaction value of
identical goods sold by other sellers in Kenya will be applied.
Goods are identical if they are:
 The same in all respects, including physical characteristics, quality and reputation
 Produced in the same country as the goods to be valued
 Produced by the producer of the goods being valued.

The following conditions must be fulfilled before the transaction value of identical goods is used:
 The identical goods must be sold in the same commercial level
 The identical goods must be sold in substantially the same quantities as the goods are being
valued.
 The identical goods must have been imported into Kenya at or about the same time as the
goods being valued.

Where the application of this method produces more than one transaction value, the lowest value
shall apply.

If this method does not give an acceptable Customs Value, then method 3 applies.

Method 3- Transaction value of similar goods

This is similar to method 2 but deals with similar rather than identical goods. In this context, goods
are similar if:
 They have similar characteristics
 They have similar components
 They have similar quality and reputation, which make them commercially interchangeable
in their performance or functions.

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The transactions value will be subject to certain adjustments to take account of quality, and /or
commercial level factors.

Method 4
This is strictly not a valuation method but guidance for the use of methods 5 and 6. Under the
guidelines, where methods 1, 2 and 3 fail to produce an acceptable value then method 5 or method
6 (where 5 does not work) will apply. The guideline merely provides that where an importer so
requests, method 6 can be considered before method 5.
Method 5 deductive value
The value for duty is the unit price of identical or similar imported goods sold in Kenya in the
same condition as they were imported in the greatest aggregate quantity at or about the same time
of importation of the goods being valued.
The unit price will be subject to the following deductions.
 Commissions payable
 Profits
 General expenses
 Cost of materials and components supplied by the importer free of charge or at reduced
prices
 duties

Method 6- Fall back method

This is applied as a last resort when the other methods have failed to give acceptable Customs
value. It provides that the value for duty will be determined using any of the previous methods in a
flexible manner subject to specified conditions.
Obviously, many importers will avoid getting this far and try to reach a compromise with customs.
However, if the first three methods do not work, it is advisable to proceed to method 6 before
evaluating method 5. As specified under method 4, the importer has to request this.

It is not possible for one to state at this point which method will be suitable for a particular
importer without a thorough and careful evaluation of the surrounding circumstances. Whichever
method is applied, one can reap maximum benefit only through careful planning.

NB: It is possible that disputes will arise in the valuation of the imports between Customs and
importers. The new rules make provision for this and allow importers to collect the goods after
depositing or securing the duty demanded. Under the Kenyan legislation, the importer is entitled to
appeal to higher authorities within the Customs Department. Such disputes must be resolved by
Customs within six months. If the importer is not satisfied with the manner in which the dispute is
resolved by Customs, then he can refer the matter to the high court.

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PROHIBITION AND RESTRICTION MEASURES

DUMPING
Imported goods are deemed to have been dumped in Kenya if:
1. Goods are sold in Kenya at a price lower than the cost of importing i.e. cost of insurance,
freight, duties or taxes, cost of goods etc. in the country exporting the goods.
2. The export price in the country, which is exporting the goods, is less than the fair market
value or price of goods in that country.
3. If the country exporting goods to Kenya had imported the goods and;
(a) The export price of goods in the original country is less than fair market price in
that country.
(b) The export price of goods in the country, which is exporting, is less than fair
market price in that country.

Anti- dumping measures imposed by the government include:

a) Imposing high dumping duty.
b) Imposing a quota (limiting the amount of imports) on particular persons or any organization
dumping goods in Kenya.
c) Having a pre-shipment inspection at the ports.
The inspection of imported goods is to ensure that;
 There is no evasion of duty / tax
 The imported goods, which are being shipped inland, have been acquired legally.
 The right goods have been shipped as per the orders.
d) Getting a clean report of finding
This is a report issued by international transporters e.g. Bureau de veritas to certify that;
(a) The importer legally owns the goods
(b) Those good have been legally acquired.
(c) Goods are of the correct value.
 The imported goods are as per the specifications as indicated at the time of
importation.
e) Filling in of import declaration forms (IDF)
These are forms supplied by customs department to the importer to ensure that:
 He declares the goods he is importing.
 Indicates the correct value of such imported goods.
 To enable the government to determine the value and amount of foreign currency
flowing out of the country.
f) The transporting Lorries or vessels may be escorted upcountry to borders to ensure that the
goods transported to another country e.g. Burundi through the Kenya port are not dumped
in Kenya.

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g) Having the importers code number to restrict the imports by the importers.

PROHIBITED IMPORTS

1. False or counterfeit money.

2. Indecent or obscene prints, books, painting.
3. Articles marked with ceremonial ensigns or court of arms of Kenya.
4. Adverts to promote sale of medicine to cure cancer, T.B and Aids etc.
5. Distilled beverages with injurious chemicals which can affect the health of individuals e.g.
Methanol, hyssop etc.

RESTRICTED IMPORTS

1. Tear gas.
2. Traps for killing or capturing game animals.
3. Silencers or firearms and sound moderators.
4. Articles bearing boy scouts or girl guides, emblems or tokens.
5. Postal franking machines unless permitted by the manager of postal Kenya.

TRANSIT GOODS AND BOND SECURITIES

Customs bonds are used to suspend payment of import duty. Some transactions that require bonds
include transit, warehousing, temporary importation and inward processing. All bonds must be
witnessed by a customs officer and guaranteed by an insurance company or a bank. Where the
conditions of the bond have not been complied with, the commissioner may require the person
who has given the security to pay the amount secured. For the purposes of enforcing security, the
guarantor of the bond is treated as having the same status as the principal.
All importers and guarantors must ensure that bonds are duly cancelled and document showing
proof of cancellation maintained.

BONDED SECURITY

A bond is commitment to honour certain terms and conditions and to fulfill obligations relating to
an agreement. The failure to honour the commitment leads to consequences, which include
forfeiting of an asset that may have been given out as a security.

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Forms of security:

1. Cash deposits: A taxpayer can deposit cash with the customs department to ensure
compliance with payment of tax.
2. Bond security: A tax payer may be required to deliver a document indicating the legal
ownership of an asset. He will therefore enter into a binding commitment to fulfill his
obligation with regard to compliance and payment of tax failure to which he will loose the
asset.
3. Use of guarantors or sureties: This is where a 3rd party gives his guarantee that a taxpayer
will comply with the terms and conditions of the Act.
4. Partly by bond and partly by cash deposits.

DISCHARGE OF A BOND / SURETY

A bond may be withdrawn if:

1. The conditions of the bond are fulfilled or performed.
2. On expiry of 3 years the Commissioner may discharge the bond and ask for fresh securities.

EXCISABLE GOODS

Excise duty is the tax imposed on goods manufactured locally and specified on the 5th schedule of
the Customs and Excise Act – excisable goods include:
- Beer - Soda
- T.V. - Cigarettes
- Shoes - Textiles
- Furniture

RULES OF ORIGIN AND THEIR ECONOMIC CONSEQUENCES

These are a set of criteria used to determine the origin of goods for purposes of customs duty.
Under COMESA the rules of origin or the criteria goods should meet to attract preferential tax
treatment are:
 The goods should be wholly produced in the member states.

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 The goods should be produced in the member states and the cost insurance and freight
(CIF) value of any imported materials in the goods should not exceed 60% of the total cost
of materials used in the production of the goods.
 The goods should be produced in the member states and should be classified under a tariff
heading other than that of the imported materials used in the production of the goods.
 The goods should be designated by the council of ministers as “goods of particular
importance to the economic development of the member state” and should contain not less
the 25% value added.

Key terms:
Importation – This refers to bringing in to the country from a foreign country.
Prohibited goods – This are goods which may not be imported into the country
Restricted goods – This are goods which may only be brought in to the country subject to
compliance with certain requirements set by customs and excise department.
Certificate of origin – This is a document showing that goods originate from a partner state of
East African Community
Rules of origin – This is the criteria that is used to determine goods that qualify for preferential
tax treatment under the EAC or COMESA treat.
Ad valorem duty – This is customs duty rate that is applied on the value of the imported goods
Specific duty – This customs duty rate applied on the quantity, weight, volume or other specified
unit of measure to determine the amount of duty payable.

EAST AFRICAN COMMUNITY CUSTOMs MANAGEMENT ACT

The East African Customs Management Act establishes the department of customs which is
responsible for the management of the customs law in the East African Community.
The decisions, rulings, opinions, guide lines and interpretations given by the directorate, the world
trade organization or the customs corporation council shall be taken into consideration when
determining the value of imported goods.
The East African Community Customs Management Act came into force on 1 January 2005 whilst
the regulations which facilitate the operationalisation of the EACCMA came into force with effect
from 1 January 2007

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CHAPTER SUMMARY

 Imported goods are subject to custom duty

 Customs duty maybe ad valorem or specific duty
 Exports are subject to export duty whose main purpose is to discourage the exportation of
certain commodities.
 Prohibited imports are goods that cannot be imported under any circumstances.
 Restricted imports are goods that maybe imported under strict conditions which must be
complied with.
 Customs bonds are used to suspend payment of import duty.
 Excisable goods are goods that are subject to excise duty on which duty has not been paid.
 Rules of origin are a set of criteria that determine whether goods qualify for preferential tax
treatment under East African Community and COMESA

QUIZ

1. Write short notes on the following:-

(a) Custom Duties

(b) Excise Duties
(c) Export Duties
2. In what circumstances may customs duty paid be refunded?
3. Write short notes on the following:-

(a) Import Declaration Form (I.D.F)

(b) Pre – Shipment Inspection (PSI)
(c) Restricted Imports.
(d) Prohibited Imports.

ANSWER

1. (a)
Customs duty
This is the duty or tax paid on goods imported through any port of Kenya or goods imported
and which are specified in the first schedule of the Customs and Excise Act
Goods subject to customs duty include:
 Machinery
 Textiles
 Electronics

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 Vehicles
 Food commodities

(b) Excise
Excise duty is the tax imposed on goods manufactured locally and specified on the 5th
schedule of the Customs and Excise Act – excisable goods include:
- Beer - Soda
- T.V. - Cigarettes
- Shoes - Textiles
- Furniture

(c) Export duty

This is tax that is imposed on goods which are exported to foreign countries. The main
purposes of excise duties are:
 To raise revenue for the government.
 To discourage the exportation of certain goods e.g. scrap metal, hides and skins.
 To encourage the use of materials locally e.g. scrap metal.

2. circumstances under which customs duty paid maybe refunded

The customs duty paid on imported goods may be refunded under the following circumstances;
 Where goods are returned to seller.
 Where goods are lost or destroyed by accident.
 Where goods are damaged, destroyed or pillaged during a voyage or while under
customs control.
 Where duty has been paid in error or overpaid or there is a cancellation of a bond given
as a security.
 Where goods have been abandoned to the customs department by the importer who had
paid the duty.
 Where imports are used in production of exports or specified duty exempt goods.
 Duty paid by privileged persons and institutions e.g. UN, Armed forces, ILO, UNDP,
WHO, FAO, ETC.

3.
(a) Import Declaration Form (I.D.F)

These are forms supplied by customs department to the importer to ensure that:
 He declares the goods he is importing.

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 Indicates the correct value of such imported goods.
 To enable the government to determine the value and amount of foreign currency
flowing out of the country.

(b) Pre – Shipment Inspection (PSI)

This is inspection of imported goods is to ensure that;

 There is no evasion of duty / tax
 The imported goods, which are being shipped inland, have been acquired legally.
 The right goods have been shipped as per the orders

(c) Restricted Imports. These are goods whose importation is controlled and subject to certain
conditions being fulfilled for example the importation of fire arms
(d) Prohibited Imports. These are goods whose importation is strictly not allowed under any
circumstances and the importation is illegal for example hard drugs

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