IT 3

Business income: allowable and disallowable deductions

1Scope and legal basis

Section 4 charges gains or profits from a business, defined to include a trade, profession, vocation, manufacture, adventure or concern in the nature of trade, and section 3(2)(a) brings in the profits of a business carried on partly outside Kenya by a resident. Section 15 allows, in ascertaining total income, all expenditure wholly and exclusively incurred in the production of the income, and lists specific deductions; section 16 lists what may not be deducted. Taxable profit starts from the accounting profit prepared under IFRS and is adjusted: disallowed expenses are added back, income not taxable under the Act or taxed elsewhere (final withholding tax, capital gains) is removed, capital allowances under the Second Schedule replace depreciation, and losses are treated under section 15(4). Business income of a sole trader is taxed at the individual rates with the personal relief; a company pays 30%; a partnership's profit is shared and taxed on the partners.

2Key definitions

3Charge, computation and rates

Allowable deductions (section 15)

• Cost of sales, salaries and wages, the employer's NSSF, SHIF-related payroll costs and AHL contributions, rent of business premises, rates, licences and the single business permit, insurance of business assets, advertising, repairs and maintenance, motor vehicle running costs (apportioned for private use), telephone and utilities, audit and accountancy fees, and interest on business borrowing (subject to the 30% EBITDA cap on interest to non-residents).
• Specific statutory deductions: bad debts written off; capital allowances under the Second Schedule; employer contributions to a registered pension or provident fund for employees (within KES 360,000 a year per employee); pre-trading expenses of a new business incurred in the period before commencement; the cost of structural alterations to premises to maintain rent; scientific research expenditure (100%) and contributions to approved research institutions; expenditure on registering trademarks and patents and on the training of employees; donations to a charitable organisation registered under the Act or to a county government or the Kenya Red Cross for disaster relief; entrance fees and subscriptions to trade associations that elect to be taxed; legal and professional fees on the issue of shares and debentures (limited) and on obtaining a listing; and the realised loss on the sale of an asset used in the business where no allowance was claimed.
• Club subscriptions paid by an employer for an employee are deductible to the employer as a staff cost (and taxable on the employee); entertainment of staff and customers is deductible if wholly and exclusively for the business.
• Withholding tax and VAT: the expense is deductible gross of withholding tax deducted from the payee; input VAT recoverable in the VAT return is not an expense, but VAT on exempt or blocked items (passenger cars, entertainment) is part of the cost and follows the expense's treatment.

Disallowed items (section 16) and other adjustments

• Deduct from accounting profit: income exempt under the First Schedule (interest on infrastructure bonds, dividends taxed at source), income taxed as a separate final source (qualifying dividends and interest, residential rent under the 7.5% regime, capital gains), profits on the sale of fixed assets (dealt with through the wear and tear pool or CGT), unrealised exchange gains and revaluation surpluses, and recoveries of expenses previously disallowed.
• Then deduct capital allowances (Second Schedule) and any brought-forward losses of the same business within the five-year limit; the result is the taxable profit charged at the person's rate.

4Compliance: returns, payment and penalties

A business keeps books and records, in English or Kiswahili, for five years, and issues and receives electronic tax invoices through eTIMS (every business, whether VAT registered or not, since 1 January 2024; a purchaser from an exempt small supplier issues a self-invoice). A sole trader files the individual return by 30 June with the business accounts and a tax computation; a company files within six months of its year end (four months for years starting on or after 1 January 2027), pays instalment tax on the 20th of months four, six, nine and twelve at 25% each of the lower of 110% of the previous year's tax and the estimate for the current year (75% and 25% in months nine and twelve for agricultural companies), and settles the balance within four months of the year end. Late filing costs the higher of 5% of the tax and KES 20,000 (companies) or KES 2,000 (individuals); late payment 5% plus 1% a month; understatement of tax through disallowed claims attracts the tax shortfall penalty of 20%, or 75% where deliberate. Business income below KES 25 million turnover for a resident individual or company that is not otherwise excluded is within turnover tax at 1.5% of gross unless the person elects the normal regime.

5Examinable focus