KASNEB · AdvancedAdvanced TaxationBETA — flag if wrong

Income Tax Computation

This topic focuses on the computation of income tax for individuals and corporations, including allowable deductions and exemptions.

3objectives

3revision lessons

12practice questions

What you’ll learn

Aligned to the KASNEB Advanced Taxation syllabus.

CA35.2.A Compute taxable income for individuals and corporations.
CA35.2.B Identify and apply allowable deductions and exemptions.
CA35.2.C Distinguish between different income sources for tax purposes.

Computing Taxable Income for Individuals and Corporations

BETA — flag if wrongAI 100

Taxable income computation is essential for both individuals and corporations in Kenya. It involves adjusting the reported profit or loss by adding back disallowable expenses and deducting allowable expenses. Disallowable expenses include private expenses, depreciation on non-qualifying assets, and certain legal fees. Allowable expenses typically include business-related costs such as salaries, rent, and utilities.

For corporations, the corporate tax rate is currently set at 30% as per the Income Tax Act. Individuals are taxed based on progressive rates, with the highest rate being 30% for income exceeding KES 688,000 annually. It is crucial to ensure that all adjustments are accurately reflected in the income tax computation schedule, which ultimately determines the tax payable or refundable.

When preparing the computation, ensure to follow the guidelines provided in the Income Tax Act and the Companies Act 2015. This includes recognizing capital allowances for qualifying assets, which can significantly reduce taxable income. The computation should also reflect any distributions to partners or shareholders, as these affect the taxable income of the respective parties involved.

Key points

Adjust reported profit by adding disallowable expenses.
Corporate tax rate is 30%; individuals are taxed progressively.
Recognize capital allowances to reduce taxable income.
Ensure compliance with Income Tax Act and Companies Act 2015.
Accurate computation determines tax payable or refundable.

Worked example

Computation of Taxable Income for ABC Ltd. for the Year Ended 31 Dec 2021

Reported Profit: KES 3,600,000

Add Back Disallowable Expenses:

General expenses (listing costs): KES 100,000
Debenture interest: KES 150,360
Directors' fees: KES 507,720
Legal expenses: KES 255,120

Total Additions: KES 1,013,200

Adjusted Profit:
Reported Profit + Additions
= KES 3,600,000 + KES 1,013,200
= KES 4,613,200

Less Allowable Expenses:

Salaries and wages: KES 541,500
Electricity and telephone: KES 194,700
Repair and maintenance: KES 147,200
General insurance: KES 235,500

Total Allowable Expenses: KES 1,119,900

Taxable Income:
Adjusted Profit - Allowable Expenses
= KES 4,613,200 - KES 1,119,900
= KES 3,493,300

Tax Payable:
Taxable Income × Corporate Tax Rate
= KES 3,493,300 × 30%
= KES 1,047,990

More on this topic

CA35.2.B Income Tax Computation: Allowable Deductions and ExemptionsBETA — flag if wrongAI 100

In computing taxable income for individuals and entities in Kenya, it is essential to identify allowable deductions and exemptions as per the Income Tax Act, 2015. Allowable deductions reduce the taxable income, while exemptions may exclude certain income from taxation altogether.

Common allowable deductions include:
1. Business Expenses: These are necessary expenses incurred in the production of income. Examples include salaries, rent, and utilities. However, personal expenses, such as private rent or salaries paid to partners, are disallowed.
2. Capital Allowances: Instead of depreciation, businesses can claim capital allowances on qualifying assets. For instance, furniture may attract a wear and tear allowance of 12% or 20%, depending on the asset type.
3. Interest on Loans: Interest paid on loans taken for business purposes is deductible.
4. Legal and Professional Fees: Expenses incurred for legal advice related to business operations are generally allowable.

Exemptions can include certain types of income, such as:
- Dividends from Kenyan resident companies: These are generally exempt from tax.
- Gains from the sale of capital assets: If the asset qualifies under the capital gains tax provisions, it may be exempt.

Understanding these deductions and exemptions is crucial for accurate tax computation and compliance with the Kenya Revenue Authority (KRA) requirements.

CA35.2.C Distinguishing Income Sources for Tax ComputationBETA — flag if wrongAI 100

In Kenya, income tax is governed by the Income Tax Act, 2015. Understanding different income sources is essential for accurate tax computation. Income can be categorized into several sources: employment income, business income, rental income, and investment income. Each category has specific rules regarding allowable deductions and tax treatment.

1. Employment Income: This includes salaries, wages, bonuses, and allowances. The prevailing PAYE rates apply, and deductions for contributions to retirement schemes are allowed.

2. Business Income: This encompasses profits from trade or profession. Allowable expenses such as operational costs, wear and tear, and specific deductions must be accurately computed. For instance, wear and tear on assets is calculated based on the rates provided under the Income Tax Act.

3. Rental Income: Income from property leasing is taxable. Allowable deductions include property maintenance costs, management fees, and depreciation of the property.

4. Investment Income: This includes dividends, interest, and royalties. Different tax treatments apply, such as withholding tax on dividends and interest income.

Understanding these distinctions is crucial for preparing accurate tax computations and ensuring compliance with KRA regulations.

Sample KASNEB-style questions

3 of 12 questions. Beta-flagged questions are AI-drafted and pending CPA review — flag anything that looks wrong.

Q1 · MCQ · easyBETA — flag if wrongAI 93

Which of the following is considered a taxable income for an individual under the Income Tax Act?

A.A) Capital gains from the sale of a personal residence
B.B) Dividend income from shares in a listed company✓ correct
C.C) Inheritance received from a deceased relative
D.D) Gifts received from friends

Q2 · MCQ · mediumBETA — flag if wrongAI 93

Which of the following expenses is NOT deductible when computing taxable income for a company?

A.A) Business rent
B.B) Salary to employees
C.C) Fines and penalties✓ correct
D.D) Depreciation on equipment

Q3 · SHORT ANSWER · mediumBETA — flag if wrongAI 74

State two conditions under which an expense may be considered disallowable for tax purposes.

Model answer

1. The expense is incurred for non-business purposes, such as personal expenses. 2. The expense is capital in nature, such as the purchase of fixed assets.

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Common questions

Compute taxable income for individuals and corporations.

Adjust reported profit by adding disallowable expenses.

Identify and apply allowable deductions and exemptions.

Identify allowable deductions under the Income Tax Act, 2015.

Distinguish between different income sources for tax purposes.

Identify income sources: employment, business, rental, investment.