IT 4

Investment deductions and capital allowances

1Scope and legal basis

Depreciation charged in the accounts is not deductible; instead the Second Schedule to the Income Tax Act grants an investment allowance on capital expenditure incurred on qualifying buildings and machinery used in a business. The Finance Act 2020 rewrote the Schedule from 1 January 2021: the old regime of industrial building deductions, wear and tear on reducing-balance pools, investment deductions at 100% or 150% and farm works deductions was replaced by a single 'investment allowance' at straight-line rates by asset class, with a first-year rate and an annual rate on the residue. The Finance Act 2025 and 2026 adjusted the rates for hotel, manufacturing and hospital buildings and machinery (50% in the first year and the balance at 25% a year) and added a 100% allowance for petroleum and gas storage facilities above KES 10 billion. Allowances are claimed in the year the asset is first used and are computed per asset (no pooling), on cost including installation, and pro-rated where a period is shorter than a year.

2Key definitions

Investment allowance

The deduction the Second Schedule grants on capital expenditure on a building or machinery used for the purposes of a business, at the rate for its class, in place of depreciation.

Building classes

Hotel building (licensed), building used for manufacture (industrial building, including a building used in agriculture, an electricity generating plant and a mining building), hospital building, petroleum or gas storage facility, educational building including student hostels, commercial building (offices, shops, showrooms, godowns, and residential buildings let for gain), and any other building.

Machinery classes

Machinery used for manufacture, hospital equipment, ships and aircraft, motor vehicles and heavy earth-moving equipment, computer and peripheral hardware, software, calculators, copiers and duplicating machines, furniture and fittings, telecommunications equipment, filming equipment, farm works, and other machinery.

Qualifying cost

The cost of the asset including delivery and installation, and the cost of structures ancillary to a building; for a passenger vehicle that is not a commercial vehicle, the cost is capped at KES 3,000,000 for allowance purposes.

Residue of expenditure and balancing adjustments

Cost less allowances given to date. On disposal, if the proceeds exceed the residue, the excess up to cost is a balancing charge (taxable, or deducted from allowances on the asset class); if they are less, the shortfall is a balancing deduction. Proceeds above cost are a capital gain within the Eighth Schedule (buildings and land) or, for machinery, outside the charge.

3Charge, computation and rates

The rate table

Asset	First year of use	Subsequent years	Basis
Hotel buildings; buildings used for manufacture; hospital buildings; petroleum or gas storage facilities	50%	25% per year on the balance (equal instalments) until fully written off	Straight line
Educational buildings and student hostels	10%	10% per year	Straight line
Commercial buildings (offices, shops, godowns, residential buildings let for gain)	10%	10% per year in equal instalments (clarified by the Finance Act 2026)	Straight line
Machinery used for manufacture; hospital equipment; ships; aircraft	50%	25% per year on the balance	Straight line
Motor vehicles and heavy earth-moving equipment	25%	25% per year	Straight line; passenger vehicle cost capped at KES 3,000,000
Computer and peripheral computer hardware, software, calculators, copiers and duplicating machines	25%	25% per year	Straight line
Furniture and fittings; telecommunications equipment; other machinery	10%	10% per year	Straight line
Filming equipment (licensed local film producer)	25%	25% per year	Straight line
Farm works (farm buildings, fences, dips, dams, boreholes, roads, water and electricity works on a farm)	50%	25% per year on the balance	Straight line
Purchase or acquisition of an indefeasible right to use a fibre optic cable; spectrum licences	10%	10% per year	Straight line
Petroleum or gas storage facility where the investment exceeds KES 10 billion	100%	Nil	Finance Act 2026

Accelerated allowances and other rules

A 100% investment allowance in the first year of use applies to buildings and machinery used for manufacture where the cumulative investment in the preceding four years from 1 January 2021 (or the investment in that year) is at least KES 2 billion, and to a manufacturing investment of at least KES 1 billion outside Nairobi City County and Mombasa County (reduced from KES 2 billion by the Tax Laws (Amendment) Act 2024); a 150% allowance applied to investments outside Nairobi and Mombasa under the pre-2021 rules and continues for projects that qualified then. Special economic zone enterprises get 100% on buildings and machinery.
Where an asset is used partly for the business and partly for another purpose, the allowance is restricted to the business proportion; where a building is partly qualifying (a factory with offices attached), the non-qualifying part is ignored if it is 10% or less of the cost, otherwise apportioned.
An asset acquired second-hand qualifies on its cost to the buyer; an asset transferred between related parties or on a reorganisation passes at its residue where the parties so elect, so no balancing adjustment arises.
Leased assets: the lessor claims the allowance and taxes the rentals; the lessee deducts the rentals. Hire purchase: the buyer claims the allowance on the cash price and deducts the interest element.
The allowance is computed on a per-asset basis from the year the asset is first put into use, not the year of purchase; assets bought but unused at the year end earn nothing until used. There is no time apportionment within the first year except where the business itself starts mid-year.

Disposals: balancing charges and deductions

A manufacturing company's plant and a delivery van

Plant bought and installed in March 2024 for KES 8,000,000 (machinery used for manufacture). Allowances: 2024, 50% = 4,000,000; 2025, 25% of 8,000,000 = 2,000,000; 2026, 2,000,000, leaving a residue of nil at the end of 2026. Sold in January 2027 for 1,500,000: balancing charge of 1,500,000 (proceeds above a nil residue, within cost), taxable in 2027.

Delivery van (commercial vehicle) bought July 2025 for KES 3,600,000: 25% a year, 900,000 in 2025 and 900,000 in 2026, residue 1,800,000 at 31 December 2026. Sold in 2026 for 1,200,000: balancing deduction 600,000, deductible in 2026 in addition to that year's allowance being disallowed (the allowance is not given in the year of disposal; the deduction replaces it).

Saloon car for the sales manager bought 2026 for KES 4,500,000: cost restricted to 3,000,000; allowance 25% = 750,000 a year; on disposal the proceeds are scaled by 3,000,000/4,500,000 for the balancing adjustment.

4Compliance: returns, payment and penalties

Investment allowances are claimed in the annual income tax return through the capital allowances schedule, supported by a fixed asset register showing the date of first use, cost, class, allowances to date and residue, with invoices, import documents and installation certificates retained for five years and eTIMS invoices for local purchases from 2024. A claim depends on the asset being used in the business in the year; the Commissioner disallows allowances on assets not yet in use, on passenger vehicles above the cap, and on buildings without evidence of the qualifying use (a hotel needs its licence; a factory building needs to house manufacturing). Balancing charges are declared as income in the year of disposal and balancing deductions claimed in the same return. Excess allowances create or add to a business loss carried forward within the five-year limit. Understating income by over-claiming allowances attracts the tax shortfall penalty (20%, or 75% if deliberate) plus interest at 1% a month.

5Examinable focus

What KASNEB tests

A capital allowances schedule is set nearly every sitting, usually feeding into an adjusted-profit computation: classify each asset (the classification is where marks are won or lost), apply the first-year and subsequent rates, restrict passenger vehicles to KES 3,000,000, compute balancing charges and deductions on disposals, and carry the total to the tax computation. Show the residue for each asset at each year end. Theory parts ask for the conditions for the 100% investment allowance (the KES 2 billion and KES 1 billion thresholds and the location rule), the treatment of assets bought but not yet used, leased and hire purchase assets, and how the 2021 rewrite differs from the old wear-and-tear pools (straight line, per asset, no pooling).