c) For preparation of staff contracts when recruiting new employees.
DAYSTAR UNIVERSITY d) When incurred in the floatation of shares by a company for the first time when the
ACC 315 TAXATION I
S. 15 allowable expenses
When determining the taxable income of a business certain expenses are said to be allowable or
deductible against taxable income. The allowable expenses are wholly and exclusively incurred in
the generation of the taxable income by an individual. 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 profits 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 coffee farmer allowable expenses might consist of wages for farm labourers,
fertilizers, picking of coffee, transport of coffee to the factory, mulching etc.
Example 2
In case of 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
Incase of a hotel allowable expenses will include; purchase of foodstuffs, soft drinks, water, salaries
to waiters, electricity bills etc.
S.15 specifically identifies the expenses that are wholly and exclusively incurred in the generation of
taxable 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 loan granted to friends are not allowable expenses since they are
not trade bad debts
2. Specific provision for doubtful and bad trade debts e.g. a debt owed by an individual or a legal
person.
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. incase 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 bad debts e.g. the legal expenses of filing a suit against a defaulting
debtor.
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.
NB: If the structural alterations lead to increase in rent income it is a disallowable expense.
8. Mortgage interest not exceeding Kshs 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.
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 or subscription fees paid by a company or an individual incase of a sole
proprietorship to a trade association such as Kenya association of manufacturers, Kenya
chamber of commerce and industry, federation of Kenya employers FKE
 For the annual subscription to be allowable the trade association must have
elected under S 21(2) of the Income Tax Act to be treated as a trading
association and must have given such a notice to the CDT i.e. The annual
subscription is taxed on the trade association.
NB
 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 association approved by the CDT 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 CDT 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. advert on TV radio, calendars, journals, newspapers, horse
races, rally cars, golf tournaments etc
NB
 The advertisements inform of passenger shades at bus stops, signboards, neon
light and signs are of capital nature thus disallowable expenses.
 However they qualify for wear and tear allowances.
19. The amount of interest on money borrowed and used in production of income e.g. interest
charge 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
cap 470. these include:
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 less than
written down value of the assets in the same class.
NB
If a business is under liquidation and such assets are sold at a value less than the written down value
brought forward. It is called a balancing deduction, which is allowable against the taxable income
S. 16 Disallowable expenses
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 they 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
NB
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:
a. When on a business trip
b. During training or work related conferences or business
c. Meals provided to low income employees in the employers premises
4. Pension payments, annuity premiums and contributions to pension provident schemes and
funds except for those registered.
5. Legal expenses
 The following legal expenses are specifically disallowable
a. For purchase of a house
b. For preparation of memorandum of Association or a partnership deed
c. For preparation of trade agreement or contract
d. In defense of criminal charge/ proceedings
e. In preparation of a lease agreement of more than 99 years.
f. In relation to floatation of shares for private subscription
g. In relation to tax appeal, tribunal or local committee
h. When issuing additional shares on the stock exchange in case of a company already
quoted.
6. The amount of reserves and provisions e.g. general 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.
TAXATION OF BUSINESS INCOME.
Business includes any trade,profession or vocation, manufacturer, adventure and
any concern in nature of trade but not employment. The income upon which tax
is charged includes:-
 Gains or profits from business for whatever it is carried out.
Where business is carried on partly in Kenya and partly outside Kenya by a
resident person the gains or profit from such a business are derived to have
accrued in Kenya and there fore wholly subject to tax in Kenya.
Computation of taxable
The business profit reported by an accountant in the published financial stocks is
different from taxable profit. This is due to the following:
(i) Some expenses deducted for a/c purposes are not allowable deductions
for tax purposes e.g. depreciation, tax paid, donations, general provision
for bad debt.
(ii) Capital expenditures cannot be deducted from profit for a/c purposes
but this are granted capital allowances for tax purposes e.g. investment
deduction granted on cost or buildings &machinery, used on furniture
&fittings and motor vehicle.
(iii) The reported profit from a/c point of view may include non-taxable
income e.g sale of subsidiary, sale of shares etc.
(iv) Some incomes excluded from reported profits may be taxable income
e.g income from illegal trading.
The accounting profit may be adjusted to reflect the taxable profit using
the following
(i) The reported profit.
Reported profit xx
Add: disallowable expenses xx
xx
Deducted: non-taxable income (xx)
Investment income farming xx
 Allowable expenses e.g __ Depreciation 1,540,000
Electricity and water expenses 1,600,000
WTA, other capital Allowance (xx) Interest expense 3,000,000
Adjusted income (xx) Rent, rates and taxes paid 1,200,000
Add: other taxable income xx Donations to a political party 160,000
Total taxable xx Loss of stock through theft 1,200,000
Legal expenses 800,000
Repairs and maintenance cost 1,980,500
OR Bad debts expenses 1,354,000
(ii) The gross profit Proposed dividend 1,200,000
Redundancy payments 2,180,000
Gross profit per a/c xx Business promotion costs 960,500
Add: other business xx Net profit 5,238,000 _________
xx 40,777,000 40,777,000
Deducted: allowable expenses (xx)
Profit (income) from business xx Additional information:
Add: other taxable income xx 1. Legal expenses comprised:
Total taxable income xx Shs
Drafting of lease agreement (50 years) 120,000
Setting customers disputes 80,000
Conveyance fee on purchase for land 200,000
Issue of debentures 400,000
800,000
2. Bad debts were analyzed as follows:
Bad debts account
Shs Shs
Bad debts written off 254,000 Balance brought
forward
Balance carried down - General 4,500,000
- General 4,800,000 - Specific 1,000,000
- Specific 1,800,000 Income statement 1,354,000
PRACTISE QUESTIONS ON BUSINESS INCOME 6,854,000 6,854,000

ILLUSTRATION I 3. Repairs and maintenance cost include Shs 200,000 incurred on renovation of a warehouse.
4. Dividend income was received from the following investments:
The following income statement was prepared by the management of Viwandani Ltd for th e year Shs
ended 31 December 2007. Shares in Amani Ltd., a subsidiary company 1,000,000
Income statement Shares in Mapesa Commercial Bank Ltd 200,000
Year ended 31 December 2007 1,200,000
Shs Shs 5. Interest income arose from deposits held with various financial institutions.
Sales (gross) 28,000,000 6. Insurance compensation received related to stock lost through theft.
Rental income 7,000,000 7. Capital allowances were agreed with the tax authorities at Shs 1,820,000 for the year
Profit on sale of shares 67,000 ended 31 December 2007.
Dividend income (net) 1,200,000
Interest income (net) 2,100,000 Required:
Insurance compensation received 500,000 i) Adjusted taxable profit or loss of Viwandani Ltd for the year ended 31 December 2007.
Miscellaneous income (taxable) 210,000 (10marks)
Closing stock 1,700,000 ii) Tax payable (if any) by Viwandani Ltd or the year ended 31 December 2007. (1mark)
Opening stock 1,300,000
Purchases 12,600,000
Salaries and wages 4,500,000
ILLUSTRATION II 10,281,000 10,281,000
a) Sweetfruit Ltd processes various types of fruit juices for sale. 3. Included in repairs and maintenance was Shs 300,000 incurred on renovation of a
The company reported a net profit of Shs 7,855,500 for the year end ed
31 factory building.
December 2008., this profit was after debiting and crediting the 4. Capital allowances for the year ended 31 December 2008 were agreed with tax
following items: authorities at Shs 2,730,000.
Shs 5. dividend income received was analysed as follows:
Opening stock 1,950,000 Shs
Purchases 18,900,000 Dividend from a subsidiary company 600,000
Salaries and wages 6,750,000 Dividend from shares held in commercial bank 1,200,000
Lease amortisation 375,000 1,800,000
Gross sales 42,000,000 6. Interest income comprised of:
Rental income 10,500,000 Shs
Electricity and water expenses 2,400,000 Interest from an account with a foreign bank 1,350,000
Interest expenses 4,500,000 Interest from Treasury bills 1,800,000
Rent, rates and taxes 1,800,000 3,150,000
Donations to a political party 240,000
Closing stock 2,550,000 7. Insurance compensation received was in relation to debtors who had defaulted on
Profit on sale of shares 100,500 payment.
Impairment of assets 528,000
Depreciation 1,353,000 Required:
Cost of stolen stock 1,800,000 i) Taxable profit or loss of Sweetfruit Ltd for the year ended 31 December 2008.
Legal expenses 1,200,000 (10marks)
Dividend income (gross) 1,800,000 ii) Tax liability (if any) due from the company for the year ended 31 December 2008.
Interest income (net) 3,150,000 (2marks)
Repairs and maintenance 2,970,750
Bad debts 2,031,000
Proposed dividend 1,800,000 ILLUSTRATION III
Redundancy payments to employees 3,270,900 i) Mr. A. Kimiti prepared the following profit and loss account for his business for the
Insurance compensation received 750,000 year ended 31 December 2004.
Business promotion cost 1,440,750 Shs Shs
Miscellaneous income(not taxable) 315,000 Income
Sales 18,400,000
Additional information: Discount received 600,000
1. Legal expenses were incurred in relation to: Profit on sale of shares 100,000
Shs Foreign dividends received 15,000
Drafting of a lease agreement (100 years) 180,000 Foreign exchange gain 35,600
Settling customer disputes 120,000 Insurance recovery on stolen stock 180,000
Conveyance fee on purchase of land 300,000 19,330,600
Issue of debentures 600,000 Expenditure
1,200,00 Purchases 12,800,000
2. Bad debts were analysed as follows: Salaries 1,200,000
Bad debts account Audit fees 45,000
Shs Shs Tax consultancy fees 30,000
Bad debts written off 381,000 Balance brought forward Legal expenses 325,000
Balance carried down: General provision 6,750,000 Licences and permits 64,000
General provision 7,200,000 Specific provision 1,500,000 Depreciation 145,600
Specific provision 2,700,000 Profit and loss account 2,031,000 Loss on sale of equipment 78,400
 Bank charges 44,200
Donations to a political party 50,000
Subscriptions 12,800
Repairs and maintenance 174,200
Rent and rates 150,000
Purchase of loose tools 90,000
Commission and brokerage fees 23,500 (15,232,700)
Net profit 4,097,900

Additional information
1. Legal expenses comprise: Shs
 Employment contacts 5,000
 Acquisition of a trade mark 80,000
 Successful defence of a legal suit for breach
of a trade contract 200,000
 Debt collection 40,000
325,000

2. Subscription comprise: Shs

 Chamber of Commerce and Industry 2,800
 Childcare international 8,000
 Golf club membership 2,000
12,800
3. Repairs ad maintenance expense includes Shs 74,200 used for the renovation of a
store.
4. capital allowances were agreed with the tax authorities at Shs 680,000

Required:
i) Prepare the adjusted taxable profit or loss for Mr. A. Kimiti for the year ended 31
December 2004. (12marks)
ii) Determine the tax payable, (if any), from the computations in (i) above. (2marks)