Tax Revision Kit

TAXATION II
SUBJECT NO. 15
RevisionKit
STRATHMORE
UNIVERSITY
DISTANCE LEARNING
CENTRE
P.O. Box 59857,
00200, Nairobi,
KENYA.
Tel:
Fax:
+254 (02) 606155

+254 (02) 607498
Email: dlc@strathmore.edu
Copyright
ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval system or transmitted in
any form or by any means, electronic, mechanical, photocopying, recording or otherwise without the prior written
permission of the copyright owner. This publication may not be lent, resold, hired or otherwise disposed of by any way
of trade without the prior written consent of the copyright owner.
THE REGISTERED TRUSTEES STRATHMORE EDUCATION TRUST 1992
ii
Acknowledgment
Acknowledgment
We gratefully acknowledge permission to quote from the past examination papers of the following bodies:
Kenya Accountants and Secretaries National Examination Board (KASNEB); Chartered Institute of
Management Accountants (CIMA); Association of Chartered Certified Accountants (ACCA).
We also wish to express our sincere gratitude and deep appreciation to Mr. Geoffrey M. Ngene for giving his
time, expertise and valuable contribution, which were an integral part in the initial development of this
Revision Kit. He holds the following academic honours, MBA, BCOM (Finance) (at the University of
Nairobi), CPA (K), CFA (E.A.). He is a senior lecturer at Strathmore University, School of Accountancy.
STRATHMORE UNIVERSITY REVISION KIT
Contents
Acknowledgment............................................................................................................................................................ii
Part I: Introduction....................................................................................................................................................iv
Approach to Examinations.....................................................................................v
Syllabus.................................................................................................................vi
Topical Guide to Past Paper Questions...............................................................viii
Part II: Revision Questions and Answers..................................................................................................................1
Questions past papers - taxation II......................................................................1

ANSWERS- PAST PAPERS.............................................................................47
Part III Comprehensive Mock Examination............................................................................................................47
Questions -mocks..............................................................................................47
Answers - Mocks...............................................................................................47
TAXATION II
iv
Introduction
Part I: Introduction
This revision kit addresses needs of students preparing to sit CPA Part 3 examination for Paper No. 15
Taxation 2.
The kit is divided into THREE main parts:
Part I: INTRODUCTION
Approach to Examinations
Syllabus
Topical guide to CPA past paper questions
Part II: REVISION QUESTIONS AND ANSWERS

Past paper questions with model answers
Part III: Comprehensive MOCK examinations papers with sample answers
To make effective use of this kit, candidates are advised to:
Read widely so as to have adequate background information relating to the issues raised in the
revision questions.
Do the MOCK papers in Part III under exam conditions and then check the solutions provided to
assess their success in tackling the questions.
This kit should be useful in enabling any student preparing for examinations in Taxation 2 to pass with
good grades in the exams.
TAXATION II
vi
Introduction
This review kit is intended to assist students preparing for the CPA III Taxation II paper by emphasizing
on exam technique and practice. The kit is to supplement texts and study packs available to the student.
The kit consists of a number of examination style questions arranged in the order of sittings for the Kenya
Accountants and Secretaries National Examinations, from 1998 to year 2003. Full-suggested solutions
are provided along with the Questions. The ability to attempt all questions in the kit prepares one to meet
challenges in the examination question itself.
Topical Guide to Past Paper Questions
vii
Syllabus
CPA PART III SECTION 5

PAPER NO.15 TAXATION II
OBJECTIVE
To ensure that the candidate can prepare tax returns, evaluate the tax implications of business decisions,
and analyse the impact of government fiscal measures on industry and the economy.
15.0
SPECIFIC OBJECTIVES
A candidate who passes this subject should be able to:
Discuss the theory underlying taxation process

Utilize the legal framework governing taxation in Kenya
Prepare returns for all form of taxes
Design tax procedures and systems for organizations
Undertake tax management of orgnaisations
Understand current developments affecting taxation in Kenya.
CONTENT
15.1
Theory of Taxation
-
15.2
Taxable Income and persons

-
15.3
Fiscal policy reforms and their impact on Government revenue, expenditure and
economic activities
The Government budget and economic activities: production, investment, savings,
financial markets
Equity in taxation.
Sources of taxable income

Exempt income
Income of individuals, corporate bodies and partnerships
Tax computations
Incomplete records
Application of case law
Tax planning opportunities
Capital Deductions
-
Allowable capital deductions under Income Tax Act

Controversies in definition of qualifying capital expenditure
Capital expenditure and the VAT and Customs and Excise Acts
Use of capital deduction in tax planning
Lessons from case law
15.4Tax Administration under the Various Acts (Income Tax Act, VAT Act, Customs and Excise Tax Act)
TAXATION II
viii
Topical Guide to past Paper Questions

-
15.5
VAT Computation
-
15.6
Effects of Customs and Excise Duties

Tax powers and rights to revenue
Goods subject to customs control
Valuation of imports and exports
Anti-dumping measures
Bond security
Tax Investigation
-
15.8
Taxation of goods and services: classification of goods and services; exempt goods;
remission; designated goods and services.
Registration and de-registration of taxable persons
Accounting for VAT by registered payers: VAT on sales; deduction of VAT on purchases;
examination methods; VAT due for payment; VAT records
Rights and privileges of a VAT registered person.
Customs and Excise Tax

-
15.7
PIN
Returns and Notices
Objections, appeals and relief of mistakes
Collection, recovery and refund of Tax
Offences, penalties and interest
PAYE System
Lessons from case law
Tax evasion and tax avoidance

Investigations under the Income Tax Act:: Back-duty, in-depth examination
VAT refunds, false claims and Accountants Certificate
Customs and Excise Investigations
Applications of case law
Evaluation and Critical Analysis of the Theory and Practice of Taxation in Kenya and
Other Countries:
-
Double-taxation agreements: Theory, design and application

International perspective, with particular reference to Common Market for Eastern and
Southern Africa (COMESA) and East African Corporation (EAC) area taxation laws and
practice
Most favoured nations status
Modernization of tax systems
ix

Analysis of Past Papers
The student must note that a thorough preparation is required where a working knowledge of each
syllabus topic is required for a taxation paper. It is therefore not sensible to try to rely entirely on
prediction of contents of future papers using a few past papers. However, an analysis of some past papers
set give an appreciation of the nature, style and depth of questions and major topics tested often. Set out
below is an analysis of paper content from 1998 to year 2004.
Year 2005
DECEMBER
Tax Incentives, Dump
of Goods, Tax free
employment benefits
and set off duty
Business income and
Tax Liability Individual
taxable income
Business income/capital
allowances And Tax
Liability
PIN Number,Vatable
Supplies, VAT
Computations
Tax Planning and
Partnership income
Year 2002
MAY
Tax elasticity and tax
policy units
Capital allowances and
business income
Year 2005
JUNE
Year 2004
DECEMBER
Partnership income with
incomplete records.
Year 2004
JUNE
Employment income
options to an individual
Income of a bank and

tax liability.
Income of insurance
business.
Capital allowances,
business income and
dates of tax payment.
Section 25 provisions,
capital allowancies and
business income
Recovery of VAT, VAT

payable and use of
allocative method of
restricting input VAT.
VAT refund audit, VAT

account
Computation for VAT,

Remission Export
processing zone for VAT Notes refund or duty
and VAT, tax incentives,
thin capitalisation,
goods subject to
customs control.
Partnership income
Year 2002
DECEMBER
Exemptions to sec 44,
provisions of sec 45, tax
set-off, PAYE audit
Year 2003
JUNE
Tax shifting and factors
and customs duty.
Year 2003
DECEMBER
Back duty and income
estimation.
Partnership income and

tax liability.
Capital allowances
Individual taxable
income and tax liability
Business income/capital
allowances.
Shortfall distribution,
double taxation relief
Business income and
Tax Liability
Most favoured nation

statue, income of
TAXATION II
Notes on tax set-off,
VAT refunds and

refund audit certificate
Income of individual
and tax liability.
Business income, tax
liability and taxation of
royalties
individual.
Penalties on VAT goods

liability to forfeiture,
VAT input tax.
short fall distribution

and double taxation
treaty.
Insurance business
Business income and

tax liability.
Compensating tax,
farming income.
VAT account and

penalties
Capital allowances and

business income
Sole proprietorship and

tax liability.
Business income and

conversion
Year 2000
JULY
Business income/capital allowances.
Individuals taxable income, double taxation relief.
Advice on VAT matters
Back duty investigations
Taxation of foreign income, deductable expenditure travel expenses within Kenya and outside Kenya.
Customs and excise.
Year 2000
DECEMBER
Back duty investigation.
Year 2001
JUNE
Capital deductions
Employment income of individuals.
Tax liability in the case of

deceased person
Business income and non-resident

company.
Double taxation agreement and
relief.
VAT account.
Back duty and taxable income

estimation
Year 2001
DECEMBER
COMESA treaty objectives,
E.P.Z enterprise tax
incentives, anti-avoidance
provisions
VAT computation
Categories of L.T.U capital

deductions and taxable
income of Company
Limited.
Notes on exceptions to Section

44, Fraudulent return and penalty,
incidence of taxes
VAT computations, input tax

deductions and bad debt
relief.
Business income and business

cessation.
WTO customs valuation

methods, anti-dumping
measures, tax exemptions
under VAT and Customs and
Excise Acts.
Individual incomes and tax
liability
USE CURRENT RATES APPLICABLE TO YEAR OF SITTING

RATES OF TAX (Including wifes employment, self employment and professional income rates of tax).
YEAR OF INCOME 2005 (for year 2006 Exam)
xi
Taxable Employment Benefits - Year 2005

Monthly taxable pay
(shillings)
1
10,164
10,165
19,740
19,741
29,316
29,317
38,892
Annual taxable pay

(shillings)
1
121,968
121,969
236,880
236,881
351,792
351,793
466,704
Rates of tax % in each

shilling
10%
15%
20%
25%
Personal relief Shs. 1,162 per month (Shs. 13,944 per annum)
Prescribed benefit rates of motor vehicles provided by employer
Monthly
rates
(Sh.)
Capital allowances:
(i)
Wear and tear allowances

Class I
37.5%
Class II
30%
Class III
25%
Class IV
12.5%
Industrial building allowance:
Industrial buildings
2.5%
Hotels
4.0%
Farm works
33.3%
allowance
Investment deduction allowance:
2003
70%
2004
(ii)
Saloon, Hatch Backs

and Estates
Upto
- 1200 cc
1201
- 1500 cc
1501
- 1750 cc
1751
- 2000 cc
2001
- 3000 cc
Over
- 3000 cc
Pick-ups, Panel Van
(Unconverted)
3,600
4,200
5,800
7,200
8,600
14,400
43,200
50,400
69,600
86,400
103,200
172,800
1750 cc
3,600
43,200
Over
1750 cc
Land Rovers/Cruisers
4,200
7,200
50,400
86,400
Upto
(iii
)
100%
Annual
rates
(Sh.)
OR 2% of the initial capital cost of the vehicle for each

month, whichever is higher.
2005
100%
Shipping investment deduction
40%
Mining allowance:
Year 1
40%
Year 2 - 7
10%
Commissioners prescribed benefit rates

Services
(i)
(ii)
(iii)
Electricity (Communal or from a generator)

Water (Communal or from a borehole)
Provision of furniture (1% of cost to employer)
TAXATION II
Monthly rates
Sh.
1,500
500
Annual rates
Sh.
18,000
6,000
xii
(iv)

If hired, the cost of hire should be brought to charge
Telephone (Landline and mobile phones)
Agricultural employees: Reduced rates of benefits

(i)
Water
(ii)
Electricity
30% of bills
200
900
2,400
10,800
Low interest rate employment benefit:

The benefit is the difference between the interest charged by the employer and the prescribed rate of
interest.
Other benefits:
Other benefits, for example servants, security, staff meals etc are taxable at the higher of fair market value
and actual cost to employer.
The current VAT rate is 16%
Note: ALL THE SOLUTIONS provided are based on year 2005 Tax rates to be used for year 2006 Exam
Questions Past Papers
Part II: Revision Questions and Answers
QUESTIONS PAST PAPERS - TAXATION II
JULY 2000
QUESTION ONE
J.T Ltd. are manufacturers of belts, hats and shoes. The company has given the following information to
be used in the self assessment return for the year of income 1999.
Stock (opening balance)
Purchases
Salaries and wages
Electricity and water
Insurance
Rent, rates and taxes
Vehicle running expenses
Traveling expenses
NSSF
Bank charges and interest
Donations
Sales returns
Postage and telephone
Bad debts
Depreciation
General expenses
Repairs and renewals
Legal expenses
Net loss brought down
Directors fees
Proposed dividends
Sh.
1,500,000
12,000,000
6,500,000
654,000
346,000
1,230,000
3,670,000
429,500
190,500
139,000
41,000
4,000,000
126,000
354,000
916,000
1,300,000
980,000
99,500
34,475,500
2,128,500
6,000,000
3,500,000
11,628,500
Gross sales
Stock (closing)
Profit on exchange
Profit on sale of shares
Dividends
Interest
Net loss for the year
2,128,500
_______
34,475,500
Profit brought forward
Net loss carried forward
The following information is further obtained from the company:

1.
Sh.
30,000,000
1,900,000
120,000
77,000
100,000
150,000
Legal expenses were analysed as follows:

Sh.
Renewal of factory lease for 10 years 12,500
Notices to defaulting debtors
37,000
Letters of authentication for overdraft 25,000
Purchase of directors private house
25,000
99,500
TAXATION II
9,000,000
2,628,500
_______
11,628,500
Revision Questions and Answers
2.
Bad debts analysis:

BAD DEBTS ACCOUNT
Bad debts
Balances carried forward:
Specific provisions
General provisions
3.
4.
5.
6.
7.
154,000
4,500,000
700,000
5,354,000
Balances brought forward:

Specific provisions
General provisions
Profit and loss account
4,000,000
1,000,000
354,000
5,354,000
The profit on exchange was from an amount payable on 1 February 2007 to a foreign creditor of
10,000 US dollars.
Rent, rates and taxes include Sh.421,000 paid to Kenya Revenue Authority as instalment tax for
the year 1999.
The interest of Sh.150,000 was earned from deposits held in a Swiss account.
Donations analysis:
Sh.
Annual fees paid to association of leather goods manufacturers 12,000
National Chamber of Commerce and Industry
9,000
Barnardos Home and Salvation Army
20,000
41,000
Included in general expenses was the cost of renovations to the old factory costing Sh.1,000,000
done on 1 July 1999. The companys directors were of the opinion that the building had a
lifespan of 20 years and had made an application to the Commissioner of Income Tax on 1
January 1996 when the building was completed. The building had been constructed for
Sh.4,000,000 and was used from 2 January 1996.
The companys writen down values of assets as at 31 December 1998 were as shown below:
Class I
Class II
Class III
Class IV
Sh.
4,500,000
500,000
160,000
220,000
Required:
(a)
Taxable income of J.T. Ltd for the year ended 31 December 1999.
marks)
(b)
Indicate when the isntalment tax is payable
(15
(2 marks)
(Total: 17 marks)
QUESTION TWO
Mr. Sacrodina Katumbi has been employed as an accountant by Mwangaza Manufacturers Limited since
1998. In 1999 his emoluments comprised:
-
Salary 42000 p.a.

Company car of 2000cc valued at 50,000 from January 1999 was also provided. He used 50%
in course of employment and 50% privately. The company had paid all the vehicle running and
maintenance costs .
A companys house leased at Sh.30,000 per month was provided. He contributed 5% of his basic
salary towards rent. He also contributed 10% of his salary towards a home ownership saving
plan recognized by the Commissioner of Income Tax.
On 31 May 1999 he resigned from the company and was employed by Kusadikika Bank Limited as a
Finance Manager from 1 June 1999. His emoluments comprised:
Salary 60,000 p.a.
Medical cover for self and family 70,000 (Company had a registered scheme for all its employees).
A loan of Sh.3.6 million was granted with effect from 1 June 1999, which he used to construct his
residential house at Karen. Interest was charged at 5% p.a. He entered the house on completion from 1
August 1999.
The company also paid his bills as follows:
Grocery bill
Telephone
Electricity
School fees
Sh.
30,000
24,000
36,000
100,000
Total PAYE deducted was Sh.328,000 during the year from both employments.
At the end of the year he was accorded for free 2% of the companys shares valued at 16,000. Mr.
Sacrodina Katumbi has two wives. His first wife Rose Carey, was employed by Jamii Nursing Home as a
medical doctor. Mr. Sacrodina holds 30% of the shares in Jamii Nursing Home.
Her income for the year comprised:
Salary 32,000 p.a (PAYE sh.128,000)
From a farm inherited from her late grandfather, she made a profit of 7,000
Share of profit from Westland Drapers in which she is a partner 20,000.
From her clinic in town made a loss of 18,000
Dividends from Shauri Yako company Limited 9,500 (net)
Pension from her previous employer 10,000 p.a.
During the year she contributed 8,500 towards her companys Provident Fund which is recognized by
the Commissioner of Income Tax.
His second wife Magdarina Kahemba is employed by Kalavani Company Limited, located in Botswana
where she earns a salary of an equivalent of Kenya shilling 60,000 per month; PAYE Sh.15,000
equivalent of Kenya shillings is deducted in Botswana. Kenya and Botswana have a double taxation
treaty. Kalavani Limited paid her life insurance premium in 1999 amounting to Sh.65,000. She received
a bonus from the company amounting to Sh.35,000, being distribution of end year profits.
The company houses her with her three children and sh.8,000 (Kenyan equivalent) per month is deducted
from her salary.
She is a member of a co-operative union based in Kenya and received Sh.35,000 (net) as dividends during
1999. The co-operative union deals with computer sales and installations. In 1999 she earned Sh.20,000
from subletting part of her residence and paid Sh.5,600 as legal expenses in relation to the tenant who had
failed to pay rent. In addition sh.4,000 was spent on decoration.
Required:
Mr. Sacrodina Katumbis and wives taxable income and tax liabilities for the year 1999. (18 marks)
QUESTION THREE
(a)
You have recently received a request from the management of a newly-created business for your
help with matters concerning Value Added Tax. The following is an extract from their letter.
TAXATION II
1.
2.
3.
4.
5.
We understand that some businesses are registered for VAT whilst others are not registered. We
have only recently commenced trading and consider that it will take us about five years to reach
full potential sales which we envisage will rise from Sh.1 million to Sh.4 million in that period.
Could you please advise us on the position regarding VAT registration?
How should the VAT content of our income and expenditure be reflected in our budgets and final
accounts at the year end?
When and how is the amount of VAT to be accounted for to the Commissioner of VAT?
What is the position if we should pay out more VAT that we charge?
What records must be kept by us in order to satisfy the regulations?
Required:
Prepare a tabulated report in response to the above request.
Note:
Marks will be awarded for the style and presentation of your report.
(b)
(10 marks)
Briefly comment and advise on the VAT position of each of the following cases:
Basil commenced a part-time self-employed consultancy in building trade while in part-time
employment. He expects his fees chargeable to clients to be Sh.300,000 excluding VAT for his
first year of operation. However, if he does not register for VAT purposes he would have to add
approximately 15% to his fees chargeable to cover VAT which is chargeable to him. All his
clients are large businesses supplying goods liable to VAT.
John runs a business supplying exempt goods. Jane, his sister, runs a business supplying Zerorated goods, Neither charges any VAT to customers though both have a turnover of Sh.4,000,000
p.a. How, if at all, do their VAT positions differ?
Martin runs a laundry from Monday to Thursday each week. His turnover for the last 12 months
amounted to Sh.2,500,000. Molly also runs the same laundry on Fridays, Saturdays and Sundays
and her turnover for the last 12 months amounted to Sh.1,500,000. Neither Martin nor Molly is
registered for VAT.
Gladiator Limited is incorporated in Kenya but trades wholly in Uganda as an agent of
manufactured goods. The company will purchase sh.600,000 of services in Kenya during year
2000.
Otieno, who has carried on business as a cobbler for many years, is registered for VAT purposes
though he finds the administrative work required very time-consuming. His VAT exclusive
turnover for the past two years has been Sh.1,200,000 p.a. and due to the declining number of
people requiring shoe repairs he does not expect it to increase for the next few years.
(10
marks)
(Total: 20 marks)
QUESTION FOUR
(a)
You have recently been appointed by an individual running his own business to act on his behalf
in a back duty investigation. Following preparation of a capital statement for a number of years
you have agreed with the District Assessor handling the case, the additional amounts to be
assessed and calculations showing the amount of tax interest on overdue tax and penalties arising
on the additional amounts assessable.
Your client is puzzled as to how the back duty investigation began. He has also asked whether
the Income Tax Department will accept a settlement of lease than the full amount.
Required:
Write a letter to your client advising him:
(i)
(ii)
(b)
Of the information the assessor might have received which resulted in an investigation into his
affairs.
(3 marks)
Of the circumstances of the case which the Income Tax Department might take into consideration
in deciding whether to accept a payment of less than the full amount due.
(2
marks)
Your client, Sophia Town, has owned a general retail store since 1 April 1995. The Tax Assessor
has recently begun an investigation into her affairs as he is not satisfied that she has been making
full declaration of income in recent, years. On your advice, Sophia decided to co-operate fully
with the Income Tax Department and after discussing the matter with her and investigating her
records you have managed to paper the following statements:
Year ended:
31 March
1996
Sh.
Sales (recorded)
Cost of sales
Gross profit
Bank deposit interest
(undeclared)
Expenditure:
Items for which receipts
are available
Other items
Net profits
(assessed to tax)
31 March
1997
Sh.
31 March
1998
Sh.
31 March
1999
Sh.
40,000
34,000
6,000
50,000
42,500
7,500
60,000
45,000
15,000
65,000
58,000
7,000
300
6,300
700
8,200
800
15,800
1,200
8,200
3,510
1,490
3,820
1,680
4,840
1,760
5,120
2,080
5,000
5,500
6,600
7,200
1,300
2,700
9,200
1,000
You ascertain that the bank deposit account was opened in May 1995. Your calculations reveal her gross
profit percentage should be 33% on cost. Sophia informs you that she banked 1/11 of her takings in a
National Savings Bank ordinary account which earned interest at 5% per annum throughout the period
under review. The National savings Bank account which had not been declared on her tax return form
was opened on 31 December 1995 and undeclared takings were banked annually on 31 December each
year. Sophias turnover fluctuates very little from month to month. Of the expenditure for which no
receipts are available you have satisfied yourself that 60% is genuine business expenditure, while the
other 40% is of a doubtful nature. Sophia also has casual dealings in antiques which have not been
declared to the Income Tax Department. Her antique dealings also commenced in April 1995.
TAXATION II
Preparation of capital statements reveals the following:
Assets at cost:
Shop premises fittings and
stock
Debtors and cash
Bank deposit account
National Savings Bank Account
Investments (legacy from
deceased Aunt)
Liabilities
Loan from friend to purchase
shop
Creditors
1 April
1995
Sh.
31 March
1996
Sh.
31 March
1997
Sh.
31 March
1998
Sh.
31 March
1999
Sh.
25,000
500
-
30,000
2,500
2,800
32,000
4,500
7,620
36,500
6,000
9,040
40,000
7,000
13,150
3,000
7,900
14,045
21,122
__ _25,500
__ _38,300
7,000
59,020
7,000
72,585
7,000
88,272
(20,000)
_____(20,000)
5,500
(20,000)
(2,000)
(22,000)
16,300
(20,000)
(6,000)
(26,000)
33,020
(20,000)
(8,000)
28,000
33,020
(20,000)
(11,000)
(31,000)
57,272
Close questioning of Sophia reveals that no stock of antiques is held on the above dates and she has no
other assets of significance for investigation.
Sophias outgoings in the year concerned may be deducted from the following information:
Year ended
Personal drawings
Tax and national insurance
Cash gifts to enable her
mother to buy a house
31 March 1996
Sh.
3,140
105
-
31 March 1997
Sh.
5,200
120
31 March 1998
Sh.
6,240
525
31 March 1999
Sh.
9,800
2,420
2,000
12,000
Sophia inherited Sh.10,000 of 10% debentures in Akamba Limited on the death of her aunt on 1 July
1996. The debentures were valued at 70% for probate purposes and interest is paid half-yearly on 30 June
and 31 December. Sophia is a widow and living with her mother.
Required:
(i)
Prepare schedules which will form the basis of your negotiations with the Income Tax
Department on the question of undeclared income
(13 marks)
(ii)
Suggest what factors the Assessor will take into account in negotiating penalties and interest on
the lost tax.
(7
marks)
QUESTION FIVE
(a)
Wanda has recently returned from California University after studying for a PhD. For three years.
While in the USA she operated a large business and saved a substantial sum of money. She is
undecided whether to accepted an offer of full-time employment from the University of Nairobi
as an Associate Professor or to set up a business consultancy firm near her home where she would
use her home as the base for her business.
You have advised her that the rules governing the deductibility of expenses for employees differ
from the rules for self-employed persons. Wanda has now asked for a report summarizing the
position. She is also concerned about the tax position of the income she earned in USA now that
she has come with it to Kenya.
Required:
Prepare the report for Wanda including decided cases and practical situations to illustrate the relevant
rules and conditions.
Your report should firstly cover the basic rules governing the taxation of foreign income, the deductibility
of expenditure, and then apply these rules to traveling expenses both within Kenya and outside Kenya
subscriptions food and clothing.
Note:
Candidates will not be penalized if they cannot remember the names of decided cases.
(10 marks)
(b)
In Kenya, the custom and excise duties are imposed in accordance with the provisions of
Customs and Excise Act (Cap 472). With reference to this Act, explain the following:
(i)
Customs clean report of finding and its importance.
(ii)
Specific measures under the Customs and Excise Act designed to prevent dumping in Kenya.
(2 marks)
(iii)
The circumstances under which the Commissioner of Customs and Excise may remit excise duty
on certain goods.
(5
marks)
(Total: 20 marks)
TAXATION II
(3 marks)
DECEMBER 2000
QUESTION ONE
Mrs. Hongera hasnot been keeping proper books of account since she started her business. She has been
able to provide you with the following information relating to the five years 1995 to 1999.
Assets:
Land
Inherited house (leasehold)
Investments (Treasury bills)
Motor cars
Furniture and fittings
Computers
Stocks
Business bank account
Personal savings account
Debtors
Cash
Liabilities
Mortgaged house
Trade creditors
Bank overdraft
Loan from brother
95
Sh.
96
Sh.
97
Sh.
98
Sh.
99
Sh.
2,000,000
?
?
490,000
150,000
340,000
50,000
_____?
3,030,000
2,000,000
?
?
450,000
150,000
250,000
300,000
100,000
_____?
3,250,000
2,000,000
?
400,000
?
500,000
150,000
?
290,000
150,000
_____?
3,490,000
2,000,000
?
200,000
?
500,000
300,000
300,000
250,000
190,000
90,000
_____?
3,830,000
2,000,000
?
?
500,000
300,000
400,000
200,000
220,000
110,000
_____?
3,730,000
150,000
500,000
650,000
105,000
450,000
555,000
3,500,000
135,000
380,000
4,015,000
4,000,000
140,000
150,000
280,000
4,570,000
5,000,000
90,000
210,000
_______5,300,000
Additional information:
1.
2.
3.
4.
5.
6.
7.
8.
Mrs. Hongera did not employ the services of a valuer to estimate for her the value of the house,
thus no records were maintained in relation to the house.
Two saloon cars were donated to her by her friend who left Kenya to go back to her country. The
cars were bought in 1990 at a cost of Sh.500,000 each.
In 1995, she made drawings amounting to Sh.20,000 per month. The drawings increased by 20%
per year in subsequent years.
The amounts indicated in the statement relating to the bank accounts are the balances with the
banks at year end. The banks consistently paid interest at a rate of 7% from 1996 to 1999.
Part of investments were sold in 1998 and a loss of sh.60,000 was incurred in June 1999. The
balance was sold at a gain of Sh.70,000.
Furniture and fittings and computers have been consistently carried at cost in the books.
Inventory was destroyed by fire in 1997 and no records could be traced to give an indication of
the value.
All cash was deposited with business bank at year end thus no balance was recorded in each of
the years. In 1996, the cashier defrauded the business of Sh.80,000 and in 1998, he again
defrauded the business of sh.60,000. None of these sums were recorded. Insurance compensated
the cash loss for 1998 by paying sh.70,000 to the business which Mrs. Hongera deposited in her
personal bank account. No compensation was paid in relation to the loss incurred in 1996.
Required:
(a)
(b)
Use the above information to estimate the taxable income for each of the five years 1995 to 1999
inclusive.
(14 marks)
State and justify any other information that may be required.
(6 marks)
(Total: 20 marks)
QUESTION TWO
Mr. Joab is a director of Fofo Limited. During the year 1997, the company allowed him to purchase
40,000 shares based on his enormous contribution to the company. The companys share capital is
300,000 shares.
During the year of income 1999, Mr. Joab had the following income:
1.
Employment income
Salary per annum Sh.805,000 (PAYE sh.185,000)
Bonus from current employment Sh.265,000 (PAYE Sh.45,000)
Pension contribution paid by employer to a registered scheme Sh.48,000
Unapproved scheme Sh.55,000
Life insurance premium paid by the employer Sh.68,000.
He was provided with a cook during the year. The salary of the cook per month was sh.2,000.
the employer had provided him with a car which was bought for Sh.2,500,000. Its capacity was
1750cc. At the beginning of January 1999, the employer rented for him a house at a monthly rent
of Sh.20,000. He is charged 5% of his monthly salary as part of rent contribution.
2.
Dividend income
-
3.
Kenya Commercial Bank

Sh.485,000 (net)
Home based Co-operative society involved in weaving Sh. 45,000 (net)
Interest
-
Post office savings bank

A housing finance company
A commercial bank
Sh. 850,000
Sh.1,300,000
Sh. 24,000
4.
Pension receipt from previous employer
Sh. 360,000
5.
Lottery and sweepstake
Sh.
6.
Mr. Joabs wife was paid sh.360,000 as salary (PAYE Sh.85,000) and sh.48,000 as sick leave pay
in the year 1999. Mrs Joab owns 28% of the shares in Alex Ltd. where she is in employment.
Due to her being sick, her colleagues contributed Sh.800,000 at the end of 1999 which she used
to cover medical expenses. The employer contributed sh.250,000 as part of medical expenses.
Only directors have a medical scheme in Alex Ltd. Before Mrs. Joab got married on 1 January
1999, she used to operate a retail shop where she had an accumulated loss of Sh.48,000. In 1999,
the retail shop made an additional loss amounting to Sh.22,000.
15,000
Required:
(a)
Determine Mr. Joabs taxable income and tax liability for 1999.
(b)
Comment on any information not used in answering part (a) above.
marks)
TAXATION II
(15 marks)
(5
10

(Total: 20 marks)
11
QUESTION THREE
KK Ltd. was incorporated in Kenya in 1992. It subsequently transferred the head office to Tanzania but
retained its subsidiary known as VL Ltd. in Kenya.
For the year 2001, the following results of the parent company and the subsidiary have been presented to
you in Kenya currency.
KK Ltd
VL Ltd
Shs.
Shs.
Gross profit
40,000,000
15,030,000
Gain on shares disposal
50,000
10,000
Recovery from insurance bad debts
150,000
45,000
Goods transferred to subsidiary
2,000,000
Goods transferred to parent company
500,000
Gain on sale of land
300,000
Interest income:
Commercial bank
110,000
Treasury bills
200,000
Gain on sale of a building
350,000
Loan interest income
130,000
Bonus shares
250,000
_________
42,930,000
16,195,000
Directors fees
1,200,000
190,000
240,000
98,000
Preliminary expenses
150,000
80,000
Retrenchment cost
4,000,000
1,000,000
Rent, rates and insurance
460,000
210,000
Goodwill written off
20,000
Legal and accountancy fees
830,000
170,000
Depreciation
230,000
120,000
Interest on overdue VAT
23,000
Subscriptions
25,000
9,000
Donations
180,000
70,000
General administration expenses
360,000
140,000
Purchase of equipment
3,500,000
Loss of stock
2,200,000
1,500,000
Mortgage interest
650,000
Salaries and wages
4,500,000
2,130,000
Pension contribution
1,700,000
300,000
Net profit
22,685,000
10,155,000
42,930,000
16,195,000
Additional information
1.
2.
3.
4.
5.
6.
7.
8.
9.
Goods transferred from the subsidiary or from the head office was marked-up at 10% above cost.
The land sold was a subject of legal challenge regarding ownership
The building sold was donated by an NGO, the value of which was Sh.3,000,000 at the time of
donation. Revaluation value was estimated at Sh.3,500,000.
Loan interest income was in respect of a loan obtained from the subsidiary company.
Bonus shares were from a company in which KK Ltd. has 70% control.
Rent, rates and insurance: The building in which VL Ltd. operates is owned by KK Ltd. VL Ltd.
pays Sh.100,000 per year as rent.
Donations were to an orphans home.
Part of the equipment purchased was from the subsidiary: valued at Sh.1,400,000. The rest of the
equipment was imported from abroad and duty was paid amounting to Sh.130,000. This was
omitted from the cost of the equipment.
Retrenchment cost analysis:
TAXATION II
12
Golden handshake
Pension payments
10.
11.
12.
KK Ltd
Shs.
2,500,000
1,500,000
4,000,000
VL Ltd
Shs.
800,000
200,000
1,000,000
Loss of stock: Fire razed down a warehouse where goods are stored before they are transported to
the parent company as well as the subsidiary. VAT at 15% was not included in the stock, which
was destroyed by fire.
Mortgage interest was in relation to two residential houses and one office block.
Ten executive employees rendered their services to both the parent company and the subsidiary
and they received salary and pension, which was contributed by both companies.
Required:
Taxable income and tax payable thereon for KK Ltd. and its subsidiary VL Ltd.
(20 marks)
QUESTION FOUR
(a)
Mr. Maji Mengi knows very little about double taxation agreements. He is a consultant, who
works in many countries and in many cases, he has ended up paying taxes on the same income
more than once.
Required:
Explain to Mr. Maji Mengi the concept of double taxation treaty.
(b)
(6 marks)
For the year of income 1999, Maji Mengi earned an equivalent of Ksh.5,000,000 from
employment in Canada where he paid tax equivalent to Ksh.400,000. In Kenya, he earned
consultancy fee of sh.2,000,000 and employment income of sh.900,000 (PAYE sh.220,000). His
Kenyan employer has provided his family with accommodation where rent paid is sh.85,000 per
month. He is married to two wives and has 10 children. The wives do not earn any income.
Required:
The tax liability for Maji Mengi for the year of income 1999.
(c)
(12 marks)
What is the tax position on double taxation agreements in relation to non-residents?

(2 marks)
(Total: 20 marks)
13
QUESTION FIVE
(a)
Ratif Sheng Shah carries out a business in Nairobi. He deals with motor-vehicle spare parts. He
sells spare parts obtained legally from Dubai and other authorized sources. To beat competition
in the second-hand market he also accepts spare parts from freelance agents, many of whom do
not pay tax. He is therefore able to sell such parts at a relatively lower price, since he also obtains
them cheaply due to tax evasion by the freelance agents.
He experiences problems in maintaining accurate records regarding the freelance spare parts. He
does not charge VAT on these spare parts.
Required:
Explain in brief what VAT Law states in relation to vatable goods obtained from illegal sources.
marks)
(b)
2000:
( 4
Ratif Sheng Shah carried out the following transactions during the period January to August
January 4
April 3
May 6
June 15
July 19
August 3
August 17
Purchased spare parts from Dubai for Sh.5,000,000

Purchased spare parts from Kamau Mwangi, a freelance supplier, for sh.500,000
Sold spare parts to Mrs. Moshay for Sh.150,000
Sold second hand spare parts to Kariuki for Sh.300,000 on credit. Kariuki had a
car accident and passed away the following day.
Purchased spare parts from England for Sh.10,000,000
Sold new spare parts to Michael Birech for Sh.600,000
Unknowingly bought a stolen saloon car from Miss X for Sh.150,000 and sold it
the same day to Mr. Y for sh.200,000.
All the above prices are exclusive of customs duty and VAT.
Required:
i)
Calculate the VAT payable by Ratif Sheng Shah in the 8 months of year 2000.
marks)
ii) Comment on VAT treatment of the credit sale to the late Kariuki.
iii) Comment on the tax position of the gain on sale of the stolen car.
TAXATION II
(12
( 2marks)
( 2 marks)
(Total: 20 marks)
14
JUNE 2001
QUESTION ONE
(a)
State the tax position on losses clearly indicating the four categories of losses. (4 marks)
(b)
The Thagana Processing Company Ltd. was established in 1999. During the year of income
1999, the following expenditure was incurred on the purchases of assets for use in the processing
business.
Sh.
Land
Cost of construction of building:
Processing plant
Administrative offices
Show room
Stores (for finished goods)
Labour quarters
Godown
Recreation facility
Sports pavilion
Bridge across a stream
Retail shop
10,000,000
8,000,000
1,500,000
800,000
500,000
900,000
1,200,000
600,000
400,000
700,000
300,000
Machinery installed in the building included

Processing machine
Installation costs
2,500,000
200,000
Other assets
Forklift
Secondhand imported lorry (20 tonnes and 10 years old)
Tools and implements for repairing and maintaining company assets
3 saloon cars (Sh.1.5 million each)
Computers
Scanner
Mobile telephones
4,500,000
3,000,000
950,000
4,500,000
120,000
300,000
100,000
130,000
The company obtained a bank loan during the year and purchased two cottages in Mombasa at a cost of
Sh.10,000,000. In addition Sh.2,000,000 and sh.3,500,000 was incurred for constructing parking lot and
for storage facilities respectively.
Required:
The capital deductions for the years of income 1999 and 2000
QUESTION TWO
(a)
What is the position regarding penalties for failure to submit a self-assessment return for a
deceased person? Who is responsible for the submission of returns on behalf of a deceased
person?
(4 marks)
(b)
State and explain the duties of a tax agent.
marks)
(6
(c)
15
Mr M. Mwaki was a marketing manager of Ozone Ltd. His salary was sh.150,000 per month
(PAYE sh.30,000 per month in year 2002). He also earned a commission of 20% on all sales
above sh.2,500,000 per month. The sales for January, February, March, April and May 2002 were
Sh.2,000,000, Sh.3,500,000, Sh.3,000,000, Sh.2,500,000 and Sh.1,000,000 respectively. For the
rest of the year the sales of the company averaged sh.500,000 per month. On 30 September 2002,
Mr Mwaki passed away. Funeral expenses amounted to sh.80,000.
His other income was as follows:
1.
2.
Rent:
Gross income
Insurance recovery
Loss (fire)
Maintenance expenses
200,000
150,000
90,000
180,000
He did some farming on a small piece of land where surplus income for the year amounted to
Sh.160,000. Presumptive tax of sh.8,000 had been deducted. His family members consumed
30% of the farm products.
His wife Solace operated a hair salon and the net income for the year was Sh.350,000. She also
worked as a part-time consultant and earned Sh.400,000 during the year.
Mr Mwakis self-assessment return for the year of income 2002 was not submitted. This was
noticed when the Income Tax Department was carrying out tax audits.
Required:
The taxable income and tax liability thereon, clearly indicating when it is payable and by who. (10
marks)
(Total: 20 marks)
QUESTION THREE
(a)
Identify and explain instances when a capital statement may be required.
(b)
Mr. Juma Jundo has not bee keeping proper books of account since the inception of the business
in 1995. The following balances relate to Jundos business for the period 1995 to 2000.
Leasehold Land
Lorries (cost)
Saloon cars (cost)
Swimming pool
Stocks
Computers
Bank account
Business deposit account
Treasury bills Investment
debtors
House mortgage
Creditors
Bank overdraft
Interest on bank deposit
Loss on sale of
investments
Gain on foreign exchange
(4 marks)
1995
Sh.
1996
Sh.
1997
Sh.
1998
Sh.
1999
Sh.
2000
Sh.
15,000,00
0
5,000,000
2,000,000
800,000
1,200,000
500,000
400,000
15,000,00
0
7,000,000
2,000,000
800,000
2,300,000
500,000
300,000
15,000,00
0
4,000,000
2,000,000
800,000
2,000,000
500,000
20,000
15,000,00
0
3,000,000
2,000,000
800,000
1,800,000
400,000
20,000
15,000,00
0
6,000,000
2,000,000
800,000
1,800,000
400,000
20,000
15,000,00
0
6,000,000
2,000,000
800,000
1,400,000
400,000
20,000
2,200,000
3,000,000
2,200,000
3,000,000
2,200,000
3,000,000
2,200,000
4,500,000
2,200,000
4,000,000
2,200,000
3,000,000
200,000
340,000
20,000
150,000
60,000
250,000
80,000
300,000
7,000,000
400,000
120,000
280,000
7,000,000
160,000
520,000
7,000,000
200,000
10,000
5,000
8,000
7,000
6,000
3,000
TAXATION II
16
150,000
120,000
200,000
160,000
50,000
60,000
40,000
30,000
20,000
10,000
Required:
(i)
(ii)
Estimate the taxable income for each of the three years 1998, 1999 and 2000.
(6 marks)
Itemise and briefly explain other information which may be required in assessing
the tax liability of a taxpayer.
(10 marks)
(Total: 20 marks)
QUESTION FOUR
Mr. M. Muriungi is a wholesaler. He sometimes deals with imported goods. Given below are details of
his business transactions for the months of November and December 2000 and January to March 2001:
01.11.2000
08.11.2000
10.11.2000
16.11.2000
30.11.2000
05.12.2000
11.12.2000
20.12.2000
02.01.2001
05.01.2001
15.01.2001
31.01.2001
10.02.2001
20.02.2001
28.02.2001
01.03.2001
05.03.2001
15.3.2001
30.3.2001
Imported 10 radios and 2 tape recorders worth Sh.150,000 and Sh.100,000 respectively.
Imported 10 TVs for Sh.500,000
Sold 5 radios for Sh.150,000
Sold 2 tape recorder for Sh.200,000
Fire destroyed the whole of his remaining stock
Imported motor-car spare parts worth Sh.1,500,000
Sold spare parts worth Sh.800,000
Thieves broke into his shop and stole the remaining stock
Imported 20 cars at a total cost of Sh.30,000,000.
Sold 2 cars for Sh.4,000,000
Imported 4 motorbikes at a total cost of Sh.1,000,000
Sold 3 motorbikes for Sh.900,000
1 car was stolen at gunpoint
Imported clothes for himself and his family worth 500,000
Sold the remaining motorbike for Sh.350,000
Sold 10 cars to a local motorcar dealer for Sh.20,000,000
Insurance claim received amounting to Sh.1,000,000 in relation to radios and TVs
destroyed by fire since they were insured.
Received Sh.600,000 from insurance company being compensation for the stolen spare
parts for the motor vehicles.
Sold 5 cars to a local institution for a total of Sh.10,000,000.
Note:
1.
2.
All purchases and sales are inclusive of VAT at 18%

Mr. Muriungi had not paid any VAT pertaining to the above transactions although he was
registered for VAT.
Required:
a)
b)
c)
d)
The VAT payable or refundable for each month, clearly indicating when due.
The penalties (where applicable) relating to the above transactions.
State and explain the VAT position on recoveries from insurance.
State the customs duty position of the above transactions.
(12 marks)
(4 marks)
(1 mark)
(3 marks)
(Total: 20 marks)
QUESTION FIVE
(a)
Write short notes on:

(i)
(ii)
(iii)
Liability of a person in whose name income of another person is assessed.

(3 marks)
Additional tax in event of fraud in relation to a return.
(5 marks)
Incidence of taxes on imports and exports.
(6 marks)
(b)
17
Amsa owns and runs a supermarket in Nairobi. For the year of income 2000, he withdrew from his trading
stock goods worth Sh.200,000 for use by his family. The selling price of these goods was Sh.250,000. He
also paid school fees for his children amounting to Sh.150,000 during the year from business income.
On 31 December 2000, he sold his entire business for Sh.20,000,000 which was Sh.5,000,000 above the fair value
of the assets of the business.
Required:
State and explain the tax treatment of the above transactions.
(6 marks)
(Total: 20 marks)
DECEMBER 2001
QUESTION ONE
Having read in the press about the benefits accruing to Kenya businessmen as a result of regional
initiatives such as the East African Community and COMESA, Mr. Jitendra Kumar, a prominent foreign
businessman has contacted you seeking your advice on how he could reduce his liability to tax arising
from expansion of his business operations into Kenya.
Required:
A report addressing in clear and concise details, the following matters raised by Mr. Jitendra Kumar.
(a)
(b)
(a)
(d)
(e)
The tax objectives under the COMESA treaty.

(4 marks)
Rules of origin provisions under the COMESA treaty.
(4 marks)
The main tax incentives available to investors setting up companies in the
Export Processing Zones (EPZs) in Kenya.
(4 marks)
Anti-avoidance provisions under the Income Tax Act.
(4 marks)
Tax treatment of expatriate staff.
(4 marks)
(Total: 20 marks)
QUESTION TWO
(a)
The Kenya Revenue Authority has recently set up a unit to deal with tax issues of large taxpayers,
who are currently producing about 60% of the total tax revenue.
Required:
List any four categories of taxpayers falling under the Large Taxpayer Unit (LTU).
(b)
( 2marks)
The management of Doshi (K) Ltd. has furnished you with the following statement in respect of
its profits for the year ended 31 December 2000.
Summary of profits for the year 2000
Profit from manufacturing

Interest from a south African Bank
Dividends from Associated Company
Royalty received from Zambia
Interest from Barclays Bank Ltd (net)
Sh.
36,000,000
1,000,000
12,000,000
8,000,000
425,000
57,425,000
TAXATION II
18
1.
Profit from manufacturing has been arrived at after charging:

(i)
Legal expenses amounting to Sh.1,000,000 which comprised the following:

Transfer of shares from a subsidiary Sh.200,000
Prosecution of one of the companys managers involved in bank fraud Sh.350,000.
Collecting bad debts sh.150,000
Obtaining a bank overdraft Sh.180,000
Preparation of a business agreement with a distributor sh.120,000.
(ii)
Expenditure on scientific research of sh.400,000 paid to a public university to perfect a product

design.
(iii)
Depreciation of Sh.7,200,000 on the following assets:

Asset
Factory building
Factory machinery
Factory extension
Computers
4 tonne transport trucks
Year
2004
2005
2006
2005
2005
New machinery
Furniture
2006
2005
Cost in Sh.
9,000,000 (including store Sh.4,000,000)
3,000,000
4,000,000
800,000
3,600,000 (one sold for Sh.1,000,000 in
the year 2006)
2,000,000
1,400,000 (Excess sold for Sh.400,000
in
the year 2006)
The factory extension and new machinery were brought into use with effect from 1 January 2006.
Doshi (K) Ltd. owns 22% of shares of the company that paid the dividends
The royalties were paid by Doshi (K) Ltd.s subsidiary in Zambia
in 1999 Doshi (K) Ltd.s tax liability was Sh.9,500,000.
Required:
(i)
(ii)
(iii)
(iv)
The capital allowances due to Doshi (K) Ltd in the year 2000.
(6 marks)
The profit (loss) chargeable to tax for the year 2000.
(4 marks)
Tax payable by Doshi (K) Ltd. for the year 2000 indicating when it is payable.
(3 marks)
Assuming that the management of Doshi (K) Ltd. did not pay the tax computed
in (iii) above by the due dates, calculate the late filing return penalty, late payment
penalty and late payment interest payable by 30 November 2001.
(5 marks)
QUESTION THREE
(a)
Persons registered for VAT are entitled to input tax deductions for VAT paid on inputs which
relate directly to their taxable supplies except where the law prohibits these as non-deductible.
List eight items that are prohibited for input tax deduction.
(4
marks)
(b)
State the circumstances under which a registered person can qualify for bad debt relief as per the
VAT regulations.
(2 marks)
(c)
19
Bloggs Boots (K) Ltd. is a leading manufacturer of a wide range of goods which are either
consumed locally or exported. During the month of September 2000, the following transactions
took place:
September
2:
Paid sh.960,000 to Dr. Greg William, an American, who had come to design the companys
website.
4:
Received architects certificates amounting to sh.3,200,000 for the construction of an

extension to the factory building which had been completed. Out of this amount,
sh.1,000,000 represents retention money.
5:
Purchased goods on credit from KLM Ltd. worth Sh.1,360,000.
6:
Purchased stationery for use in the business on credit from Text Book Centre worth
Sh.500,540.
6:
Sold goods worth Sh.2,650,000 on credit to Options (K) Ltd.
7:
Sold goods to Zim Bank (K) Ltd. for Sh1,790,200
9:
Paid Maersk shipping Line sh.350,000 for transporting goods purchased by Zim Bank (K)
Ltd.
11:
Options (K) Ltd returned goods worth Sh.300,000 due to some major defects.
11:
Sold goods worth Sh.865,000 on credit to Homa Bay Wholesalers.
12:
Returned defective office stationery, which had cost Sh.50,800 to Text Book Centre.
14:
Sold goods for Sh.1,220,000 to Rwanda Miners Ltd. a company based in Rwanda.
16:
Goods worth Sh.200,000 were stolen while in transit to Rwanda.
18:
Granted Sh.20,000 allowance to Rwanda Miner Ltd. for some minor defects on some items.
18:
Agreed to cancel the account received from Zim Bank (K) Ltd. in exchange for services
rendered by them to the company in the Coast Province.
Sold goods for cash amounting to Sh.2,734,000.
20:
23:
Homa Bay Wholesalers was declared insolvent by the High court and a winding up order
issued.
30:
Telephone and electricity bills for the month were received. The VAT on the telephone and
electricity bills was Sh.30,000 and Sh.17,500 respectively.
Required:
(i)
(ii)
(iii)
(iv)
The VAT account for Bloggs Boots (K) Ltd. for the month of September
2000 (where applicable prices and payments made are VAT inclusive.
(9 marks)
Amount of VAT payable and when it is due.
(2 marks)
Briefly describe the procedure for payment of VAT on an imported service.
(2 marks)
Comment on any information not used in (i) above.
(1 mark)
(Total: 20 marks)
QUESTION FOUR
TAXATION II
20
(a)
Your country has adopted the World Trade Organisation (WTO) valuation methods for imports
and exports.
Write short notes on two of the following WTO customs valuation methods:
(i)
(ii)
Method 1
Method 2
Transaction value
Transaction value of identical goods
(b)
Owing to the high incidences of dumping goods in the country, the tax authority in your country
has sought your professional advice on how to end this vice. Outline some of the measures that
the authority can utilize in preventing dumping of goods.
(4 marks)
(c)
is
(i)
State the conditions which should be fulfilled before an exemption from payment of tax
granted under the VAT and Customs and Excise Acts.

(ii)
(4 marks)
(4 marks)
(4 marks)
Explain the procedure for applying for such an exemption under the VAT and Customs and
Excise Acts.
(4
marks)
(Total: 20 marks)
QUESTION FIVE
Prof. Mohamed Omar, a registered architect, is the proprietor of Omar Architects. Since he is a full time
employee of TRD Ltd., Omar Architects is managed by his wife, Mrs. Zahra Omar who draws a monthly
salary of Sh.87,500 (PAYE deducted per month Sh.20,000).
TRD Ltd. provided the following emoluments to Prof. Omar for the year ended 31 December 2000:
1.
Basic salary of sh.450,000 per month (PAYE deducted was Sh.85,000 per month).
2.
Free housing was provided with water, electricity and telephone with effect from September
2000. Prior to this, he was living in his own house. He paid a nominal rent of Sh.10,000 per
month towards rent. Water consumed was for Sh.14,400, telephone was Sh.15,000 and
electricity was sh.18,000 during the year. The market rental value for the house is estimated at
Sh.150,000 per month.
3.
In December 2000, the Board of TRD Ltd. issued him 2,000 ordinary shares for his good
performance during the year. The last valuation of the shares was at Sh.50 each. TRD Ltd.s
issued share capital is now 25,000 shares. The company paid a dividend of Sh.10 per shares on
30 December 2000.
4.
Company car of 2000cc which cost Sh.950,000 in 1999
5.
Leave pay equal to one months basic salary.
6.
Life insurance premium per each household member of Sh.10,000 per annum. This covers
himself, wife and son.
7.
Pension contribution at 5% of basic salary per month to the companys registered pension
scheme. He contributes a similar amount.
21
8.
During the year, the company paid school fees for his son amounting to Sh.95,000. The amount
was disallowed for tax purposes on TRD Ltd.
9.
TRD Ltd. operates a medical cover for all staff with AAR. In the year 2000, the amount paid for
Prof. Omars cover amounted to Sh.45,000.
Prof. Omars other incomes were as follows:
Omar Architects made a loss of Sh.700,000 for the year 2000.

During the year, he received pension amounting to Sh.280,000 from his previous employer. He has
been receiving this annually since 1997.
Amounts received for rented personal property was Sh.100,000 per month from September 2006.
Repairs and painting cost sh.25,600 before letting. The house was later furnished at a cost of
Sh.600,000 in October 2006. The house had a mortgage of Sh.2,000,000 and Sh.600,000 was paid
during the year, out of which Sh.330,000 was capital.
Mrs. Zahra Omar had previously been working for World Vision, an International NGO, on contract
since January 1998. However, on 31 December 1999, her five year contract was terminated and a
compensation of Sh.1,200,000 was paid. Before termination her remuneration was Sh.360,000 per
annum. She used the proceeds to purchase a plot in Nairobi, which she sold in November 2000 and
made a profit of sh.600,000. The balance of the amount was used to set up a small business whose
accounts reflected the following:
Sh.
Gross profit
Less: expenses
Staff salaries
Salary to self
Partitions
Computers
Insurance, rent and rates
General expenses
Interest on loan
480,000
600,000
200,000
1,200,000
180,000
220,000
365,000
Sh.
3,000,000
3,245,000
(245,000)
Required:
(a)
(b)
(c)
(d)
Taxable income of Prof. Omar for the year of income 2000.

Tax payable by Prof. Omar for year of income 2000.
Show how the compensation paid to Mrs. Zalma Omar will be assessed.
Comment on any information not used above.
TAXATION II
(12 marks)
(3 marks)
(3 marks)
(2 marks)
(Total: 20 marks)
22
MAY 2002
QUESTION ONE
Revenue production of a tax system is measured through as buoyancy and elasticity.
(a)
Distinguish buoyancy from elasticity of a tax.
(b)
State and explain two methods that can be used to estimate tax elasticities.
marks)
(c)
Explain the elasticity of taxes with reference to:
(i)
(ii)
(iii)
Value Added Tax (VAT)

Income tax
Customs and excise duty.
(4 marks)
(6
(2 marks)
(2 marks)
(2
marks)
(d)
As part of institutional reforms of tax systems, governments usually establish advisory units
within tax departments such as Tax Policy Units (TPUs). What role would such TPUs play in
your country?
(4 marks)
(Total: 20 marks)
QUESTION TWO
Membley Ltd. prepares its accounts to 31 December each year. The trading and profit and loss account
for the year ended 31 December 2001 is as follows:
Sh.
Gross profit
Less:
Directors fees
Depreciation
General office expenses
Salaries and wages
Donations
Dividends paid
Repairs and maintenance
Interest expenses
Net profit transferred to reserves
Sh.
21,400,000
3,637,500
5,250,000
1,950,000
2,365,500
412,500
2,250,000
2,162,500
3,050,000
(21,050,000)
322,000
On 1 January 2001, Membley Ltd. purchased its current factory from Kokoto Ltd., a registered contractor,
for Sh.240 million. Kokoto Ltd. availed the following details concerning the cost of construction of the
factory:
Sh.
Acquisition of land
Demolition an clearing of old factory from the site
Labour quarters built on site
Factory building
Stone wall around the factory
Bank interest during period of construction
12,880,000
8,640,000
28,800,000
89,280,000
14,400,000
11,520,000
165,520,000
The factory building houses administrative offices worth sh.23,040,000 and a raw materials and finished
goods store worth Sh.8,640,000. Membley Limited installed machinery worth sh.120,000,000 on 3
January 2001 and started manufacturing drugs for human and animal use
23
The following assets were acquired in the course of the year in addition to those mentioned above:
Date
Asset
Cost
Sh.
10 January 2001
11 January 2001
11 January 2001
11 January 2001
11 January 2001
15 January 2001
17 January 2001
New computers
Furniture
Photocopier
Scanner
Television set (colour)
3 saloon cars (Sh.1.2 million each)
2 lorries (4 tonnes at Sh.2 million each)
1,120,000
360,000
240,000
80,000
20,000
3,600,000
4,000,000
The following assets were disposed of during the year:

Date
Asset
5 February 2001
6 March 2001
7 March 2001
Machinery (original cost sh.960,000)

Saloon car (original cost Sh.920,000)
Furniture (original cost Sh.820,000)
Proceeds
Sh.
640,000
400,000
360,000
The balances brought forward for capital allowances purposes as at 1 January 2001 were as follows:
Class I
Sh.
5,780,000
Class II
Sh.
1,340,000
Class III
Sh.
2,650,000
Class IV
Sh.
3,650,000
Required:
(a)
(b)
(b)
(c)
Capital allowances available to Membley Ltd. in 2001. Show all your workings. (12 marks)
The companys taxable profit (or loss) and tax payable (if any)
(4 marks)
Instead of outright purchase, Membley Ltd. had the option of leasing the
factory and machinery from Kokoto Ltd. for sh.960,000 per month. Advise
Membley Ltd. on the tax effect of this option.
(2 marks)
Assume that the government wishes to convert the area where Membley Ltd.s
factory is located into an Export Processing Zone (EPZ). What benefits would
accrue to Membley Ltd. as a result of this?
marks)
(2
QUESTION THREE
(a)
(b)
(c)
(d)
It may be advantageous for a trader whose turnover is below the legislated

turnover limits under the sixth schedule to the VAT Act to register for VAT
voluntarily. Under what circumstances could this be beneficial?
(3 marks)
Under what circumstances is a VAT refund properly due?
(6 marks)
What is the procedure for obtaining the refund in (b) above?
(3 marks)
The management of Kasuku Rolling Mills Ltd. appointed your firm their auditor with effect from
1 January 2001. The Senior Partner of your firm assigned you the responsibility of dealing with
the companys tax affairs. You have just completed performing the audit of the companys VAT
refund claim. You have also confirmed that the VAT refund is properly due under the VAT
regulations.
Prepare a draft VAT audit refund certificate for your Senior Partners review.
TAXATION II
(6 marks)
24
(e)
After your firm issued the VAT refund certificate in (d) above, the VAT department made their
own independent investigations and established that the companys refund claim was grossly
misstated.
What are the consequences of this error to the management of Kasuku Rolling Mills Ltd. and to
your audit firm?
(2 marks)
(Total: 20 marks)
QUESTION FOUR
(a)
(b)
State and explain any four deductions that may be available against gains or profits from
employment.
( 2 marks)
You have been approached by Mr. Kujua to help him determine his taxable income for the year
ended 31 December 2001. He provided you with the following information:
1.
Employment income:
He is employed by Nyorosha Ltd. where he earns a salary of Sh.75,000 per month. Other
benefits from employment include the following:
Company car of 1850cc which was bought in the year 2000 for Sh.850,000
Housed in Furaha Estate. The house has a market rental value of Sh.35,000 per month
Annual performance bonus of one months salary if he is rated more than 80% in the companys
annual performance review. In the year 2001, he was rated 85%.
A watchman and a house girl who are paid by the company Sh.5,000 each per month.
2.
Business income:
He runs an internet caf in Furaha shoping Centre. It generated sh.725,000 in the year 2001.
However, in the year 2000, it had made a loss of sh.300,000.
3.
Wifes income:
His wife is employed by Sukari Ranch Ltd. where she draws a salary of sh.45,000 per month. In
addition, she is given five litres of milk per day to take home. The market price of the milk is
sh.30 per litre. PAYE of sh.98,400 was deducted and paid to the Income Tax Department for the
year 2001.
4.
In the course of the year, Mr. Kujua sold his personal saloon car for Sh.620,000. This
represented a gain of sh.200,000 which he used to travel to Dubai for a holiday.
5.
Through the advice of his Personal Financial advisor, he had obtained the following
investment income in the year:
Dividends
Castle Breweries Ltd.
South Africa Creameries Ltd. (A South African Company)
Sh.
240,000
360,000
Interest
HFCK Ltd. Housing development bonds
Treasury bills
Akiba Bank fixed deposit
Loan to a friend
120,000
420,000
96,000
200,000
25
Required:
(i)
(ii)
(iii)
Total income chargeable to tax for Mr. Kujua for the year 2001.
Tax payable and its due date.
Comment on any information not used.
(10 marks)
(5 marks)
(3 marks)
(Total: 20 marks)
QUESTION FIVE
Maxmin Ltd. is a company incorporated in Kenya and owns 80% of the ordinary share capital ofRed Ltd.
which is also incorporated in Kenya. Both companies prepare their accounts to 30 September each year.
In its latest twelve-month accounting period ending 30 September 2001, Maxmin Ltd. reported the
following results:
Sh.
Gross profit per accounts
Less:
Loan interest
Travel expenses
Legal expenses
Patent royalties (paid to a south African Company)
Telephone expenses
Salaries and wages
Electricity
Depreciation
Net profit
Add:
Patent royalties received
Loan interest received
Dividend received
Total income
Sh.
40,851,200
664,000
136,000
320,000
800,000
160,000
12,000,000
280,000
2,240,000
1,280,000
160,000
4,320,000
16,600,000
24,251,200
5,760,000
30,011,200
Notes
1.
The legal expenses include an amount of Sh.200,000 for the disposal of a factory (note 5), an
amount of Sh.40,000 for debt collection and Sh.80,000 for successfully defending a court action
against a companys product.
2.
The loan interest paid is made up of the following:

-
Interest amounting to Sh.320,000 on a loan used to purchase plant and machinery for use in
production.
Interest amounting to Sh.344,000 on another loan used to purchase the shares in Red Ltd.
3.
The loan interest received was the full amount due from a major shareholder on an amount
borrowed to purchase his main residence.
4.
Royalties paid of Sh.160,000 were outstanding as at 30 September 2005. This fact had been
overlooked by the accountant.
5.
The company disposed of a factory for Sh.11,694,400 in March 2001. This had cost
Sh.3,200,000 in the year 1990.
TAXATION II
26
6.
Capital allowances have been agreed with the Commissioner of Income Tax at sh.1,230,000
after making adjustments for the factory disposed of.
7.
Net rent of Sh.1,440,000 was received from one lease, a net loss of Sh.344,000 was made on
another and a loss of sh.160,000 had been carried forward from 30 September 2000. This has
not been shown in the accounts.
8.
Travel expenses include sh.350,000 paid for Mr. John smith, a new employee who was hired
from Australia.
9.
Salaries and wages include directors fees amounting to Sh.4,250,000.
10.
Patent royalties received were from Red Ltd. while those paid were to a South African Company
that has allowed Maxmin Ltd. to manufacture their products locally.
Required:
(a)
(b)
(c)
Taxable income and tax chargeable thereon for Maxmin Ltd. for its accounting period ending 30
September 2001.
(12
marks)
Assuming that Maxmin Ltd.s tax liability for the year ending 30 September 2000 was
sh.6,400,000, show the dates and amounts of tax instalments to be paid for the tax liability you
have computed in (a) above.
(6 marks)
Briefly comment on the taxation of royalties for both residents and non-residents in your country.
(2 marks)
(Total: 20 marks)
27
DECEMBER 2002
QUESTION ONE
(a)
List thee circumstances under which:

(i)
(ii)
(b)
The income of a taxable person is assessed on another person.

(3 marks)
A married woman living with her husband may be called upon to bear the burden of tax.
(3 marks)
Briefly describe the treatment of the following classes of taxpayers with regard to Pay As You
Earn (PAYE):
(i)
(ii)
Casual workers.
Taxpayers with multiple sources of income
(2 marks)
(2 marks)
(c)
What circumstances may trigger a Pay As You Earn (PAYE) audit?
(5
marks)
(d)
What tax set-offs are available to an individual taxpayer which may reduce the gross tax liability?
(5 marks)
(Total: 20 marks)
QUESTION TWO
(a)
Explain the tax implications of the most favoured nation status.
(4
marks)
(b)
You have been approached by Mr. Kenneth Kamau, seeking your assistance in the computation of
his tax liability for the year ended 31 December 2001. he has provided you with the following
information:
Mr. Kamau works for Chip.com Ltd. as the technical director. During the year ended 31 December 2001,
he received the following emoluments:
1.
A salary of Sh.600,000 per month
2.
Dividends amounting to Sh.360,000 (gross). He holds 30% of the shares in the company.
3.
He is housed by the company in a house whose market rental value is Sh.180,000 per month. The employer
has rented the house from an estate agent.
4.
He receives directors fees amounting to Sh.90,000 per month.
5.
He has free use of a company vehicle since at times he works late. The vehicle, with an engine capacity of
2200cc had cost Sh.3,600,000 in the year 2000.
6.
On 1 January 2001, Mr. Kamau obtained a loan of Sh.10,000,000 from the company at an interest rate of
5% per annum repayable in 10 years.
7.
Mr. Kamau has a small scale horticultural farm in Nanyuki. The profits/losses from the farm for the last
three years were as follows:
Year ended 31 December 1999
Loss sh.960,000
Profit sh.120,000
Profit Sh.450,00o
In each of the three years, the family

consume vegetables from the farm valued
at kshs. 75,000 and converted into their
TAXATION II
28
own use flowers valued at Kshs. 130,000
8.
Mrs. Kamau is a nurse and is employed by Chip.com Ltd. at a salary of Sh.85,000 per month (PAYE
deducted per month is Sh.20,000).
Mrs. Kamau also owns rental premises in Nakuru. The following were the details of income and expenses
for the year of income 2001:
Gross rent
Less:
Caretakers salary
Painting
Repairs
Interest on Mortgage
Renovations after which rent was increased
Net income
9.
Sh.
1,120,000
(300,000)
(20,000)
(60,000)
(240,000)
(400,000)
100,000
Mrs. Kamau is a member of a registered Individual Retirement Benefits Scheme managed by the Insurance
Company of Africa. She contributes sh.20,000 every month towards the scheme.
Required:
i) Compute the taxable income for Mr. Kamau for the year ended 31 December 2001. ( 8 marks)
ii) Determine tax payable and specify when it is to be paid.
( 2 marks)
iii) Is Mr. Kamau to blame for the PAYE not deducted from his emoluments? Briefly explain. ( 1
mark)
iv) Assuming that the market rate of interest for January 2001 was 10% per annum. Compute the fringe
benefit tax (FBT) payable on Mr. Kamaus loan. When would the FBT be paid to the Commissioner
of Income Tax?
( 3 marks)
v)
Comment on the tax implications of Mrs. Kamaus contributions to an Individual Retirement Benefit
Scheme.
( 2 marks)
(Total: 20 marks)
QUESTION THREE
Salim Mambo and Shem Bakari have been running Mabaka Enterprises as a partnership for the last five
years.
They have provided you with the following information relating to their business in the year ended 31
December 2001.
29
Sh.
Sh.
Opening stock
Purchases
Gross profit c/d
500,000
2,650,000
3,458,000
6,608,000
Sales
Closing stock
5,648,000
960,000
6,608,000
Salaries and wages

Rent and rates
Single business permit
Office expenses
Website hosting costs
Computer maintenance
Telephone and postage
General insurance
Depreciation
VAT paid
Marketing and advertisement
Legal expenses
Medical expenses
Consultancy fees
Bank charges
Loss from farming
1,235,000
304,000
50,000
432,000
144,000
68,000
288,000
120,000
350,000
100,000
120,000
360,000
120,000
420,000
96,000
200,000
4,407,000
Gross profit b/d

Rental income
Interest income (net)
Net loss
3,458,000
143,500
100,000
705,500
_______
4,407,000
1.
The business was converted from a partnership into a limited liability company known as Salma Ltd
with effect from 1 July 2001 with Mambo and Bakari as directors.
2.
Mambo and Bakari had been sharing profits and losses equally. However, after incorporation of Salma
Ltd. Mambo owned 60% of the ordinary shares while Bakari owned 40%.
3.
Closing stock in the trading and profit and loss account above has been stated at the selling price which
is 20% above cost.
4.
All revenues and expenses are assumed to have been earned and incurred evenly throughout the year.
5.
The business is housed in a building owned by Mambo. Included in rent and rates is a monthly rental
charge of sh.25,000 paid to Mambo.
6.
Marketing and advertisement represents a billboard constructed and maintained by Eagle Outdoor
Advertising Company. Given the competition in the industry, the agreement with the advertising firm
provides that the billboard be redesigned every year.
7.
Legal expenses include Sh.120,000 for defending Bakari in a case in which he had been sued by a
supplier for breach of contract.
8.
Consulting fees include Sh.210,000 paid to Maarifa and company for computerizing the companys
operations, Maarifa and Company is owned by Mrs. Mambo.
9.
Capital allowances for the year ended 31 December 2006 have been agreed with the Income Tax
Department at Sh.280,000.
10.
Salaries and wages include:

Sh.20,000 that each partner was paid for reach of the six months to 30 June 2001.
Sh.40,000 that each director was paid as fees for each of the six months to 31 December 2001.
Required:
(a)
Taxable incomes of:
TAXATION II
30
(i)
Mabaka enterprises for the year ended 31 December 2001.
(ii)
Salma Limited for the year ended 31 December 2001.
(7
marks)
(7 marks)
(b)
Tax payable under (a)(i) and (a)(ii) above.
marks)
(c)
(4
Are there any tax advantages arising from the conversion of a business from a partnership into a
limited company?
(2 marks)
(Total: 20 marks)
QUESTION FOUR
Afro Insurance Ltd. underwrites three classes of insurance. The management has provided you with the
details shown below on their operations for the year ended 31 December 2001:
Class of insurance
Gross premium written
Reinsurance ceded
Unearned premium brought forward
Unearned premium carried forward
Claims paid
Claims outstanding brought forward
Claims outstanding carried forward
Legal expenses on claims
Depreciation
Gain on sale of motor vehicles previously written off
Specific bad debts
Management expenses
Commissions (net)
Fire
Sh.000
Motor vehicle
Sh.000
Theft
Sh.000
23,088
14,747
4,205
2,035
2,216
2,781
2,755
645
60
24,664
15,007
6,293
9,259
5,538
10,325
9,416
420
125
9,780
4,822
1,466
668
1,215
4,532
8,756
125
65
80
1,606
255
50
35
2,350
1,546
62
876
890
1.
Wear and tear deductions have been agreed with the Income Tax Department at sh.454,000.
2.
The company invested surplus funds and earned investment income as follows:
Interest from Treasury bills (net)
Interest from fixed deposits in local bank (net)
Gross dividends from Zim-Re of Zimbabwe (a foreign company)
Dividends from KELP Ltd.
3.
Sh.
2,040,000
762,450
450,000
912,000
The company paid Sh.745,000 to ABC Investment Management Services, their fund managers
for professional services for the year ended 31 December 2001.
4.
The company owns Afro House which houses its offices. Part of the office space is rented out to
other tenants. In the year to 31 December 2001, the company received sh.2,200,000 net rental
income from their estate agents. Property management fees amounting to sh.2,400,000 for the
year to 31 December 2001 had been deducted.
5.
Afro Insurance Ltd. owns 80% of the ordinary share sin KELP Ltd. a locally incorporated
company.
Required:
31
(a)
Compute the taxable profit or loss for Afro Insurance Ltd. for the year ended 31 December 2001.
(16 marks)
(b)
(c)
Compute the tax payable in (a) above.

Comment on any information you have not used in your computations.
(2 marks)
(2 marks)
(Total: 20 marks)
QUESTION FIVE
Mrs. Carol Wasike is a practicing accountant working under the style and name of Wasike and Associates.
Her firm is registered for Value Added Tax (VAT). During the month of September 2001, she undertook
and completed the following assignments:
2 September
Tax consultancy work for ABC Ltd. her fees were sh.240,000 inclusive of VAT.
4 September
Audit for Rwandacell, a company based in Rwanda. Her fees amounted to

Sh.840,000 exclusive of VAT.
10 September
Management consultancy services for Kikwetu Ltd. she billed them for
sh.360,000 inclusive of VAT.
15 September
Her firm was appointed by XYZ Ltd. to undertake a review of the internal control
systems of the company. Her fees were Sh.1,200,000 exclusive of VAT.
17 September
The firm conducted the audit of Kikwetu Ltd. for the year ended 31 December
2000. Charges were Sh.480,000 inclusive of VAT.
18 September
The firm was appointed by Stima Ltd to conduct a survey on power consumption
at a fee of Sh.2,400,000 (exclusive of VAT).
19 September
Her firm audited the accounts of Miracle Ministries, a church where she serves as
a volunteer auditor. She estimated that her fees would have been Sh.720,000
exclusive of VAT.
21 September
The firm bill Kikwetu Limited Sh.136,000 (inclusive of VAT) for debt collection
services.
22 September
The firm undertook a financial consultancy assignment for Worldnet South

Africa, a company based in South Africa. The fees were Sh.420,000 exclusive of
VAT.
24 September
Conducted audit of Lengo Ltd. at a fee of Sh.180,000 inclusive of VAT.
26 September
Provided accountancy services to Rehema Childrens Home on a volunteer basis.

The estimated value of the services was Sh.90,000 inclusive of VAT.
30 September
Performed audit services for Ujamaa County Council. The fees earned were
Sh.860,000 exclusive of VAT.
During the month of September 2001, the firm paid for the following services:
Electricity
Sh.42,500
Water
Sh.2,400
Rent
Sh.120,000
Garbage collection
Sh.36,000
Stationery
Sh.960,000
Computer repairs and maintenance Sh.240,000
Telephone
Sh.330,000
(where applicable, the above payments were VAT inclusive)
TAXATION II
32
Required:
(a)
(b)
(c)
Prepare a VAT Account for Wasike and Associates for the month of September 2001. (14 marks)
The VAT you have computed in (a) above, was paid on 22 October 2001 since 20 October was on a Saturday. The
VAT return was also submitted on the same day. How much additional tax would be payable, if any?( 2 marks)
Kikwetu Limited was the subject of a creditors voluntary winding up and the appropriate resolution was
passed on 1 April 2002. By that time the company paid Wasike and Associates only Sh.240,000 for
services rendered. Assuming that all the conditions for the refund of bad debt relief are met, calculate the
amount of VAT bad debt relief.
(4 marks)
(Total: 20 marks)
JUNE 2003
QUESTION ONE
(a)
(b)
Giving appropriate examples, distinguish between forward and backward tax shifting. (6 marks)
Briefly explain five factors that determine tax shifting.
(10 marks)
Outline the main types of duties to be levied on goods according to the provisions
of the Customs and Excise Act (Cap.472).
(4
marks)
(Total: 20 marks)
QUESTION TWO
Njagi and Otiento are partners running a glass making plant and sharing profits and losses in the ratio 3:2
respectively. They have provided the following profit and loss account, notes and explanations for the
year ended 31 December 2007:
Sh.
Income:
Sales
Sale of old plant (Sh.30,750) and Lorry (Sh.150,000)
Refund of VAT
Post office savings bank interest
Dividend (net)
Expenses:
Purchases
Wages
National Hospital Insurance Fund (NHIF)
Rent
Lorry maintenance expenses
Salaries to partners
Otienos household expenses
Repairs and maintenance (plant)
Advertising
Insurance premiums
Interest on loan
Subscription glass Makers Association
Donation to Bursary Fund
Legal expenses
Bad debts
Water and electricity
Depreciation: Furniture and fittings
4,882,000
180,750
21,250
5,750
42,500
5,132,250
1,491,500
408,750
35,500
620,500
1,165,750
1,200,000
86,250
233,750
75,000
156,750
125,000
25,000
8,000
89,000
298,000
86,250
111,500
33
Plant
Total expenses
61,750
8,000
11,500
(1,165,500)
1. Glass worth sh.65,000 was used by Njagi and Otieno for their private purposes. This amount should
be apportioned to the partners in their profit sharing ratio.
2. Lorry maintenance expenses include cost of a new lorry sh.750,000 and depreciation charge for the
year of Sh.162,500.
3. Annual rent for Njagis house was sh.300,000. This was paid for by the business.
4.
5.
6.
7.
During the year ended 31 December 2002, new plant was acquired for Sh.200,000. This has been
included in the repairs and maintenance costs of plant.
Njagis personal car insurance was paid for by the business. It amounted to Sh.90,000.
Interest on loan and the legal expenses relate to Otienos mortgage loan.
Bad debts were made up of:
Specific provision
General provision
8.
Written down values as at 31 December 2001 were as follows:

Motor vehicles
Plant
9.
Sh.50,000
Sh.61,500
Sh. 49,500
Sh.107,000
Sh. 9,000
Otieno and Njagi received salaries of Sh.800,000 and sh.400,000 respectively.
Required:
(a)
The adjusted profit or loss for tax purposes for the year ended 31 December 2002.
(10
marks)
(b)
Division of profit (or loss) between the partners.
(6 marks)
(c)
Tax payable by each partner for the year ended 31 December 2002.
(4
marks)
(Total: 20 marks)
QUESTION THREE
(a)
In the context of the provisions of the VAT Act, write explanatory notes on the following:
(i)
(ii)
(b)
Penalty for the non-payment of tax on the export of a taxable supply.

Provisions relating to goods liable to forfeiture.
(5 marks)
(5 marks)
Southlands Service Station is a retail outlet for petroleum products and a variety of other
consumer goods. The consumer goods are sold through a shop situated next to the petrol station.
The service station commenced business on 1 January 2003 and was also registered for VAT on
the same date. The accounting records are maintained by a clerk who has provided you with the
following details relating to the month of January 2003:
Gross sales
Purchases for the month
Petrol station
Sh.
14,911,542
10,260,000
TAXATION II
Shop
Sh.
4,035,600
2,407,950
34
Closing stock
2,400,000
825,000
Additional Information:
1.
Other payments during the month of January 2003 were as follows:

Salaries and Wages
Security Ltd. for cash in transit services
Security Ltd. provision for security
guards
Electricity
Insurance premiums
Water
Telephone
Interest on bank overdraft
2.
3.
Sh.
220,000
56,800
45,152
88,500
10,000
6,000
17,700
10,000
The accounts clerk has informed you that on average, 4% of the consumer goods purchased and
sold in the shop are exempt from VAT while 10% are zero rated.
The accounts clerk has not been recording VAT separately under the VAT Act and regulations.
All records were applicable, therefore, have been inclusive of the amount of VAT.
Required:
(a) The input tax deductible for the month of January 2003.
(b) The amount of VAT payable
(c ) What are the consequences of not submitting the VAT return and paying VAT
by the due date?
(6 marks)
(2 marks)
(2 marks)
(Total: 20 marks)
QUESTION FOUR
Haraka Ltd was incorporated in the year 2000. It is involved in cleaning, maintenance and general
management of properties. In addition, the company also collects rent on behalf of its clients. The
managing director has kept all the transaction vouchers in a filing cabinet and has maintained proper
client records on rent received, rent paid and commissions receivable.
The following information was extracted from the records of the company for the year ended 31
December 2002:
Rent received from clients tenants
Salaries and wages
Maintenance costs of clients properties
Subscription journal of property maintenance and management
Fees received (cleaning)
Dividends received (net)
Interest on fixed deposits (net)
Donations to disaster fund
Depreciation
Legal fees
Rent and rates
Instalment tax paid
Directors remuneration
Sh.
45,000,000
2,250,000
6,750,000
150,000
4,500,000
85,500
204,000
105,000
900,000
132,000
150,000
720,000
75,000
1,080,000
35
Auditors fees
Insurance premiums
Office expenses
Rent outstanding from tenants as at 31 December 2002
Rent outstanding from tenants as at 1 January 2002
700,000
225,000
675,000
15,460,000
8,680,000
1.
Haraka Ltd. signs a standard management contract with all clients. The contract provides for a
management fee of 8.5% on gross rent payable by the tenants. Clients are therefore paid rent net
of management fees.
2.
The company charges tenants interest at the rate of 10% per month for any overdue rent. On
average, 20% of the gross rent receivable every year is paid late every month. However, no rent
remains unpaid for more than one month.
3.
The cost of maintaining clients properties is met by the owners of the properties. Haraka Ltd.
pays the cost of maintenance and recovers this from the rent collected.
4.
Auditors fees include Sh.150,000 incurred in representing the company in a tax dispute in the
High Court.
5.
Included in insurance premiums is sh.60,000 being insurance premium for a clients property for
the year to 31 December 2003. This was to be recovered from the rent receivable from the
client in January 2003.
6.
Legal fees relate to debt collection. However, Sh.20,000 was incurred in defending one of the
directors in a private suit.
7.
The written down values of the companys assets as at 1 January 2002 were as follows:
Class II
Class III
Class IV
8.
9.
Sh.
1,350,000
2,850,000
1,200,000
During the year ended 31 December 2002, the company bought one saloon car for the property
manager for Sh.1,600,000 and computers worth Sh.270,000. It disposed of some furniture for
Sh.80,000. The furniture had been bought in the year 2000 at Sh.160,000.
Included in the directors remuneration is a payment for medical cover for a non-executive
director of Sh.50,000.
The company paid subscriptions for its top management to Starehe Golf Club, amounting to
Sh.240,000. This has been included in office expenses.
Required:
(a)
Compute the taxable profit or loss of Haraka Ltd. for the year ended 31 December 2002.(14
marks)
(b)
(c)
Compute the tax payable by the company, if any.

Comment on any information not used in your computations.
QUESTION FIVE
TAXATION II
(3 marks)
(3 marks)
(Total: 20 marks)
36
Londakin Ltd., a manufacturing company, is a branch of Londakin International of England. For the year
ended 31 December 2002, you have extracted the following information on Londakin Ltds trading results
and tax position:
1.
The accounting profit before tax but after charging depreciation of Sh.2,204,025 and crediting a
gain on disposal of fixed assets of Sh.10,125,000 was Sh.36,243,375.
2.
As at 1 January 2002, the balances brought forward for capital allowances purposes were as
follows:
Plant and machinery
Computers and office equipment
Motor vehicles
Tractors and other self propelling machines
Sh.32,250,000
Sh.1,640,000
Sh.5,062,500
Sh.2,750,000
Sh.12,440,000
3.
The balance brought forward for industrial building deduction purposes, as at 1 January 2002
was Sh.5,625,000
4.
During the year ended 31 December 2002, the company incurred the following capital
expenditure:
Computers sh.2,647,500 (including Sh.375,000 incurred on electrical rewriting of the

offices).
Plant and machinery was acquired from an overseas supplier in February 2002 upon
payment of a deposit of Sh.1,250,000. Londakin Ltd. was able to negotiate credit terms so
that the balance due of Sh.3,750,000 would not be paid until July 2003.
A Mercedes Benz car for the new finance director worth Sh.2,800,000
Office furniture worth sh.420,000.
5.
In March 2002, the company completed the construction of an additional manufacturing and
office facility at a total cost of Sh.24,500,000 which was opened for use in April 2002. The
facility occupies 20,000 square feet of which 4,000 square feet is office space, the cost of which
is estimated at Sh.3,630,000. The new facility enabled the company to lease the premises it had
previously occupied to Quality Suppliers Ltd. from May 2002 at an annual lease charge of
Sh.1,200,000, payable in advance (This had not been reflected in the companys financial
statements).
6.
During the year ended 31 December 2002, Londakin Ltd. wrote off a loan of Sh.2,325,000 made
to Exotica Ltd. a company owned by the family of one of Londakin Ltds local directors. The
loan was advanced to Exotica Ltd. in 1996. Exotica Ltd. went into liquidation on 2 June 2002.
7.
Londakin Ltd. had a VAT inspection in August 2002. Errors in calculating input tax were
identified. The company paid Sh.1,911,975 additional VAT and interest amounting to
Sh.342,150. These were charged to the profit and loss account for the year.
8.
In August 2002, the company was contracted by an overseas company to provide technical
support in the overseas companys engineering department. The total value of the contract was
Sh.1,000,000 but since a 10% withholding tax was imposed, only sh.900,000 was received and
only that amount was credited as part of turnover in the financial statements for the year. The
withholding tax is a final tax representing the profit deemed by the overseas authorities to have
arisen in their country. The company estimates its total costs on carrying out the contract at
sh.320,000.
37
9.
The company incurred a bad debt from a customer and had to write it off (Sh.1,360,000). Of
this amount, Sh.1,200,000 was provided for in the financial statements for the year ended 31
December 2001 as a specific bad debt. The companys management have made a provision of
sh.5,600,000 at 31 December 2002 being 3% of the total trade debtors at the end of the year.
10.
During the year ended 31 December 2002, the company incurred expenditure of Sh.2,100,000
on entertainment, out of which Sh.1,340,000 related to staff functions and the balance to
overseas customers.
11.
The company made the following disposals of assets during the year ended 31 December 2002:
Disposal proceeds
Sh.13,750,000
Sh.1,250,000
Sh.860,000
Sh.420,000
Plant and machinery

Computers
Pick-up
12.
Professional fees incurred during the year included the following:

Sh.60,000 in relation to negotiation of new loan facilities with the companys bankers.
Sh.340,000 in relation to advice on the possible establishment of a sales office in the Middle
East.
Required:
(a)
2002.
Compute the capital allowances claimable by Londakin Ltd. for the year ended 31 December
(8 marks)
(b)
Compute the corporation tax payable (if any) for the year ended 31 December 2002.
(6
marks)
(c)
Briefly comment on any information you have not used in your computations in (a) and (b)
above.
Any assumptions made must be clearly stated.
(6 marks)
(Total: 20
marks)
TAXATION II
38
DECEMBER 2003
QUESTION ONE
Mr. Joseph Omuora commenced a soft drinks distribution business on 1 January 1998. He has not been
maintaining proper books of account and the Commissioner of Income Tax has raised doubts about the
accuracy of the annual tax returns submitted by him.
You have been appointed to estimate the correct amounts of taxable incomes for the years ended 31
December 1998, 1999, 2000, 2001 for comparison with those disclosed in the annual returns. These
returns had disclosed the following profits or losses:
Year ended 31 December
Profit (Loss)
Sh.
1,800,000
2,150,000
(10, 000)
1,600,000
3,000,000
2002
2003
2004
2005
2006
A schedule of Mr. Omuoras assets and liabilities, both private and business, is presented below:
Warehouse: Cost
Residential house: Cost
Lorries (Business): Cost
Vans (Business): Cost
Household furniture:
Cost
Business furniture: Cost
Office Carpets
Saloon Vehicles:
Business
Land: Business
Loans: Business
Debtors: Business
Cash: Business
Inventory
Computers & Printers:
Business
Liabilities: Personal
Appliances: Household
Vehicle spares: Business
1 January
19 98
Sh.
1,800,000
4,000,000
700,000
80,000
12,000
1,280,000
8,000,000
2,500,000
140,000
-
31 December
1998
Sh.
1,800,000
4,000,000
860,000
100,000
70,000
12,000
1,280,000
8,000,000
2,000,000
720,000
600,000
31 December
1999
Sh.
2,300,000
4,000,000
1,200,000
400,000
140,000
85,000
18,000
1,900,000
8,000,000
2,000,000
600,000
800,000
680,000
31 December
2000
Sh.
2,900,000
4,000,000
1,200,000
600,000
140,000
98,000
22,000
2,000,000
8,000,000
2,900,000
860,000
320,000
450,000
31 December
2001
Sh.
3,400,000
4,000,000
2,700,000
750,000
140,000
107,000
22,000
2,000,000
8,000,000
4,000,000
750,000
720,000
20,000
7,000
6,000
-
20,000
2,000
6,000
80,000
28,000
9,000
30,000
32,000
4,000
70,000
36,000
4,000
10,000
100,000
31December
2002
Sh.
3,400,000
4,000,000
3,600,000
900,000
320,000
110,000
30,000
2,500,000
8,000,000
2,000,000
1,050,000
80,000
960,000
1.
All fixed assets have been stated at cost and there were no disposals. Ignore depreciation on fixed
assets.
2.
Mr. Omuoras living expenses for each of the five years ended 31 December were as follows:
2002
2003
2004
2005
2006
3.
Sh.
750,000
820,000
690,000
900,000
640,000
In the Year ended 31 December 2004, Mr. Omuora received an inheritance gift of Sh. 300,000.
36,000
3,000
8,000
8,000
4.
5.
39
In the year ended 31 December 2006, Mr. Omuora made a contribution to a political party of
Sh.180,000.
Mr. Omuoras utility bills for each of the five rears ended 31 December (not included in the living
expenses in (2) above), are given below:
2002
2003
2004
2005
2006
Private
Sh.
600,000
450,000
740,000
1,200,000
950,000
Business
Sh
1,700,000
1,300,000
1,500,000
1,900,000
1,400,000
Required:
(a)
(b)
Compute the capital allowances due to Mr. Omuora for each of the five years ended 31 December
1998, 1999, 2000,2001 and 2002.
(8
marks)
Compute the correct taxable profit for each of the five years ended 31 December 1998, 1999,
2000, 2001 and 2002.
(15
marks)
Comment on the treatment of any undeclared income discovered in your analysis. (2 marks)
(Total: 25 marks)
QUESTION TWO
The following is the balance sheet of Maliza Limited, a registered company, as at 31 December 2001:
Fixed assets:
Land and buildings
Equipment:
Cost
Accumulated depreciation
Furniture and fittings:
Cost
Accumulated depreciation
Sh.
6,000,000
(1,200,000)
4,800,000
(900,000)
Investments:
100,000 ordinary shares in Hisa
Limited
(Sh.10par value)
Net current assets
Financed by:
750,000 ordinary shares of Sh. Par value
Retained earnings
10% Debentures
Sh.
10,000,000
4,800,000
3,900,000
18,700,000
800,000
4,500,000
24,000,000
15,000,000
7,000,000
2,000,000
24,000,000
The company operated up to 31 May 2002 on which date it transferred the business to Mwanzo Limited,
a newly registered company. The directors of Maliza Limited provided the following information:
1.
2.
Land and buildings include the cost of land Sh. 2,000,000. The construction of the buildings had
been completed on 1 January 2001 and these were immediately used as a factory for processing
insecticides.
The equipment was acquired on 1 January 2001 and was installed in the factory.
TAXATION II
40
3.
4.
Furniture and fittings were purchased on 31 March 2001.

For the five months ended 31 May 2002, the following income statement had been prepared:
Sales
Cost of sales
Gross profit
Dividends on investments
Gain on sale of land and buildings
Gain on sale of equipment
Tax refund for the year 2001
Expenses:
Winding up costs
Loss on sale of furniture and fittings
Administration costs
Depreciation:
Equipment
Bad debts
Advertising costs sale of business
Valuation fees
Directors fees
Interest on debentures
Reported profit
8,000,000
(3,500,000)
4,500,000
300,000 (net)
2,000,000
150,000
180,000
7,130,000
420,000
235,000
670,000
500,000
500,000
80,000
200,000
10,000
22,000
83,333
(2,720,333)
4,409,667
The bad debts expense related to ten customers who were unable to pay their debts to the company by the
expiry of a ninety days notice. The land and buildings were sold to Mwanzo Limited for Sh.12,000,000,
equipment for sh.4,450,000 and furniture and fittings for Sh.3,165,000.
The takeover by Mwanzo Limited was on a going concern basis and included the investments and the
10% debentures. Mwanzo Limited had no other assets or liabilities before the takeover. In a major
strategy, as at 1 July 2002, Mwanzo Limited had incurred the following additional expenditure:
Completed the construction of a factory extension at a cost of Sh.2,500,000, installed a stand-by generator
at a cost of Sh.80,000 and processing machinery at a cost of Sh.500,000.
Undertook the electrical wiring of the factory extension at a cost of Sh.50,000.
Installed an underground 10,000 litre plastic water tank at a cost of Sh.10,000.
Spent Sh.300,000 on a research project to improve the quality of insecticides.
Purchased a Toyota Prado motor vehicle for the managing director at Sh.3,000,000.
Computerized the administration department at a cost of Sh.800,000
For the seven months ended 31 December 2002, Mwanzo Limited made a profit before interest and tax
and before deducting any capital allowances of Sh.12,000,000.
Required:
(a)
2002.
Capital allowances and taxable profits (or losses) of Maliza Limited for the period to 31 May
(b)
(c)
41
(10 marks)
Capital allowances and taxable profits (or losses) for Mwanzo Limited for the period to 31
December 2002.
(8 marks)
Tax payable by or refundable to the two companies for the year ended 31 December 2002.
(2 marks)
(Clearly state all your assumptions)
(Total: 20 marks)
QUESTION THREE
(a)
With reference to Section 39 of the Income Tax Act (Cap.470) and Section 117 of the Customs
and Excise Act (Cap.472), list the conditions under which import duty can be set off against
income tax.
(6 marks)
(b)
Define the term shortfall distribution tax. Under what circumstances can a company be
exempted from shortfall distribution tax?
(5 marks)
(c)
Kenya has entered into double taxation agreements with a number of countries. Explain the
meaning and implications of a double taxation relief.
(4 marks)
(d)
Charitable trusts are non-profit-making orgnaisations formed with the objective of promoting the
social well being of the general public. With reference to Sections 25 and 26 of the Income Tax
Act (cap.470), explain the tax treatment of charitable trusts.
(5
marks)
(Total: 20 marks)
QUESTON FOUR
(a)
(b)
(c)
Briefly explain what is meant by compensating tax.

(3 marks)
Using an example, explain the procedure of taxing lumpsum payments like gratuities. (3 marks)
Kiserian Ltd. practices mixed farming, rearing livestock and growing vegetables and flowers for
the local and export markets.
For the year ended 31 December 2002, the following profit and loss account has been prepared:
Income
Sale of horticultural products
Sale of livestock
Gain on sale of old tractor
Sh.
4,000,000
3,250,000
21,500
Sh.
7,271,500
Expenditure:
Packaging materials
Insecticides
Fertilizers
Dairy meal
Purchase of hay
Veterinary services
Professional fees
Depreciation:
Machinery
Vehicle
Subscriptions paid
276,000
250,000
576,250
225,750
300,000
325,750
237,500
62,500
222,500
26,250
582,500
TAXATION II
42
Motor vehicle running costs

Interest on loan
Salaries and wages
General expenses
Net profit
700,000
202,500
2,070,000
135,250
6,192,750
1,078,750
43
1.
Repairs and maintenance comprise:

Repairs to machinery
Provision for fencing expenditure
Repairs to building
Repairs to irrigation system
Sh.
145,000
100,000
237,500
100,000
582,500
2.
General expenses comprise:

Staff medical expenses
Staff Christmas party
Decrease is specific bad debts provision
Increase in general bad debts provision
Sh.
24,000
81,250
(20,000)
50,000
135,250
3.
Subscriptions comprise:
Donations to childrens home
Membership fees of Horticultural Association
Donations to district schools fund raising
Membership fees of Agricultural Society
4.
Professional fees comprise:

Architects fees on proposed farm works
Farm valuation fees
Audit fees
5.
Disposals and additions of assets in the year ended 31 December 2002 were as follows:
The old tractor was sold for Sh.249,000
A farm vehicle costing sh.400,000 was bought.
6.
Farm works
Year of expenditure
Labour quarters
Livestock pen
Produce store
2000
2000
2000
Sh.
5,000
3,750
7,500
10,000
26,250
Sh.
137,500
25,000
75,000
237,500
Cost
Sh.
375,000
120,000
450,000
Residue
Sh.
125,000
40,000
150,000
7.
A new house for the supervisor was constructed at a cost of Sh.600,000 in the year ended
31 December 2002.
8.
Written down values (WDVs) as at 31 December 2001 were as follows:

Tractor
Vehicle
Plant and machinery
Sh.
216,500
109,600
122,000
Required:
(i)
(ii)
Adjusted profit (or loss) for the year ended 31 December 2002.
Tax payable (if any) by Kiserian Ltd.
TAXATION II
(12 marks)
(2 marks)
44
(Total: 20 marks)
QUESTION FIVE
Mr. Abdi, a businessman, has provided the following information to the year ended 31 December 2002:
PROFIT AND LOSS ACCOUNT
Sh.
Rent for premises
owned by Mr. Abdi
Establishment expenses
Printing and stationery
Interest expense
Electricity
Farm expenses
Repairs to premises
Depreciation
Salary to Mr. Abdi
Drawings by Mr. Abdi
Legal expenses
Interest on loan obtained to pay
income tax
Bad debts
Staff wages
Net profit
180,000
600,000
135,000
46,000
40,000
210,000
30,000
196,000
380,000
200,000
166,000
125,000
Gross profit
Interest income
Dividends (Gross)
Farming income (Gross)
Lottery winnings
Other income
29,000
180,000
144,000
285,200
2,946,200
Sh.
1,272,000
48,000
80,000
226,600
533,000
733,300
53,300
_______
2,946,200
1.
Capital allowances have been agreed as follows:

Farm works deduction
Sh.
120,000
80,000
2.
Legal expenses include Sh.50,000 paid with regard to pursuing a dispute with the VAT
department.
3.
Establishment expenses include Sh.400,000 incurred in acquiring furniture and equipment for the
business before commencement of operations.
Required:
(a)
Mr. Abdis taxable income for the year ended 31 December 2002.
marks)
(b)
Tax payable on the taxable income in (a) above.
(12
(3 marks)
(Total: 15 marks)
45
JUNE 2004
QUESTION ONE
(a)
Briefly explain the basis of the taxation of the income of co-operatives.
(b)
Mr. Moses Kahama is a citizen of Tanzania. He received two job offers in Kenya for which he
has sought your advice. Both offers require him to commence work on 1 January 2005.
Offer A
Mr. Moses Kahama would be employed as a public relations officer with East African Airways, a
regional airline with its headquarter in Nairobi, Kenya. The offer provides for the following:
1.
2.
3.
4.
5.
6.
7.
8.
A basic salary of Sh. 130,000 per month to be increased by 10% semi-annually.

A monthly bonus of 5% of the basic pay to be received on the ninth day of the month
following that to which the pay relates.
A fuel allowance of Sh.10 per kilometre. He estimates to cover 10,000 kilometres per
annum, three quarters of which will be on official duties.
Access to loan facilities from the employer to a maximum of five million shillings per
annum. He plants to obtain a loan of two million at 5% interest rate per annum on 1
August 2005. Assume a prescribed interest rate of 12% per annum.
The company will provide him with free return air tickets worth Sh. 8,000 on 30 June and
31 December each year to enable him visit his family in Tanzania.
Entrance fees of Sh. 3,000 to join the Public Relations Society of Kenya would be paid
for him by the company. He would however, personally pay the subscription to the
society amounting to Sh. 1,200 per month commencing 1 February 2005.
He will be provided with free mobile phone airtime worth Sh.5,000 per month
commencing 1 February 2005. This will be utilised on official calls.
The company will provide him with a house whose market rental value is Sh. 18,000 per
month. The company will deduct Sh. 3,000 from his pay in respect of the house each
month. The company will furnish the house fully at a cost of Sh. 800,000. In addition,
the company will provide a night watchman and a house servant, each of whom will be
earning Sh. 2,000 per month.
Offer B
Mr. Moses Kahama would be employed as Director of Human Resource with Chaguo Lako
Limited, a private limited company. The offer provides for:
1. A basic salary of Sh. 150,000 per month and an allowance of Sh. 2,000 per month for
attending board meetings.
2. An annual allowance of Sh. 220,000 for the purchase of office attire in line with his
new status.
3. A provision for sending directors to their Uganda office on a month job rotation. Mr.
Moses Kahama will be sent to Uganda in November 2005 and he will receive his
monthly pay there, though he will still attend the board meeting in Nairobi for that
month.
4. A Mercedes Benz saloon car costing Sh. 1,800,000 (3,000 c.c)
5. A night watchman (at a monthly salary of Sh. 2,000). The company will settle Mr.
Moses Kahamas water and electricity bills.
Required:
Evaluate the tax impact of each job offer and advice Mr. Moses Kahama on which one he should accept.
(Assume the rates of tax and the Commissioners prescribed benefit rates remain as they were for the year
of income ended 31 December 2003).
(14 marks)
(Total: 20 marks)
TAXATION II
46
QUESTION TWO
(a)
(b)
Write brief notes on the determination of the taxable income of resident insurance companies.
(6 marks).
Bima Insurance Company Limited is registered in Kenya to carry out life and general insurance
business. From its general ledger and other records for the year ended 31 December 2003, you
have been able to extract the following information:
Insurance premiums received

Interest on fixed deposits (net)
Interest on loans to policy holders
Interest paid on maturity of policies
Premiums returned
Interest on premiums returned
Premiums paid to reinsurance company
Commission received from reinsurance
company
Agency expenses
Management expenses
Depreciation of fixed assets
Travelling expenses
Postage and telephone expenses
Advertising expenses
Bad debts (specific)
Rent income Bima Apartments
Rent expenses (office)
Life business General business Total

Sh.
Sh.
Sh.
360,000,000
740,000,000 1,100,000,00
119,000,000
63,000,000
0
26,000,000
8,000,000
182,000,000
3,000,000
34,000,000
27,000,000
3,000,000
8,000,000
17,000,000
27,000,000
700,000
25,000,000
36,000,000
74,000,000
700,000
3,600,000
7,400,000
110,000,000
36,000,000
88,800,000
11,000,000
15,160,000
74,000,000
124,800,000
22,000,000
33,000,000
89,160,000
6,000,000
11,000,000
55,000,000
3,500,000
6,200,000
17,000,000
2,200,000
3,400,000
9,700,000
1,300,000
800,000
5,600,000
9,000,000
2,100,000
10,000,000
14,000,000
9,000,000
24,000,000
1.
Reserves for unexpired risks as determined by Mr. Wafula Mengo, a registered actuary, were as
follows:
Life business
Sh.
29,000,000
17,000,000
1 January 2003
31 December 2003
2.
Claims
Claims outstanding 1 January 2003
Claims paid during the year
Claims outstanding 31 December 2003
3.
General business
Sh.
89,000,000
91,000,000
Total
Sh.
118,000,000
108,000,000
Life business General business Total

Sh.
Sh.
Sh.
23,000,000
16,000,000
39,000,000
39,000,000
113,000,000
152,000,000
32,000,000
9,000,000
41,000,000
Wear and tear allowances for the year ended 31 December 2003, have been agreed with the
Commissioner for Income Tax at Sh. 26 million for life business and Sh. 29 million for the
general business respectively.
Required:
i)
47
Taxable income of Bima Insurance Company Ltd, for the year ended 31 December 2003. (12
marks)
Tax payable (if any), on the taxable income computed in (i) above.
(2
marks)
(Total: 20 marks)
ii)
QUESTION THREE
(a)
Explain briefly the key provision of Section 125 of the Income Tax Act (Cap. 470) relating to the
official secrecy binding all employees of the Income Tax Department.
(5 marks)
Maendeleo Ltd., a manufacturer of soft drinks, commenced operations on 1 April 2003. The
following information relates to the assets it purchased or constructed, upon commencement of its
operations:
(b)
Processing machinery: New

Imported (second-hand)
Factory building (including godown Sh. 300,000)
Tarmacked driveway constructed
Drainage system constructed
Waste recycling machine
Stand-by generator
Delivery vans
Office block (including staff canteen Sh. 400,000)
Sh.
1,200,000
600,000
3,200,000
400,000
250,000
650,000
300,000
700,000
900,000
1. On 1 July 2003, the company obtained a loan of Sh. 1,700,000 from Wananchi Bank Ltd. at 25%
interest per annum. Sh. 1 million of this amount was used to construct an extension to the factory
which was completed on 1 September 2003. The balance was used to construct an additional
office block which was completed on 1 November 2003.
2. On 15 September 2003, one of the vans with an original cost of Sh. 400,000 and a market value
of Sh. 250,000, was traded in for a new van worth Sh. 600,000. The balance was paid in cash.
3. Due to an acute shortage of water, the company incurred a cost of Sh. 500,000 on the construction
of a borehole which was completed on 1 October 2003. On the same date, a diesel water pump
was purchased at Sh. 30,000.
4. On 1 November 2003, a part of the godown was destroyed by fire. The loss was estimated at Sh.
180,000 including stock worth Sh. 25,000. A total of Sh. 120,000 was received from the
insurance company as compensation (including Sh. 15,000 for stock). This amount was utilised
in reconstructing the godown.
5. On 15 December 2003, two saloon cars were purchased for senior managers at Sh. 1,400,000
each. On the same date, the company also leased a new lorry at a rental of Sh. 20,000 per month.
6. On 30 November 2003, the company undertook a computerisation project costing Sh. 240,000.
The project had not been completed by 31 December 2003.
7. The companys profit before capital allowances for the year ended 31 December 2003, amounted
to Sh. 12,500,000.
Required:
(a)
(b)
2003.
Capital allowances due to Maendeleo Ltd. for the year ended 31 December 2003. (12 marks)
Taxable profit (or loss) and the tax liability for the company, for the year ended 31 December
(3 marks)
TAXATION II
48
(Total: 20 marks)
QUESTION FOUR
(a)
Wanga Ltd. is seeking a tax refund from the Commissioner of VAT. In this connection, the
company has engaged Koech and Otieno Associates (CPAs), so that they may issue an auditors
certificate in conformity with regulation 13A of the VAT Act (Cap. 476) Regulations.
Required:
As the audit senior of Koech and Otieno Associates (CPAs), prepare a programme of work that
you and your team will follow to enable you determine whether Wanga Ltd. should obtain the
refund it seeks from the Commissioner of VAT.
(8
marks)
(b)
ABC Ltd. has VAT due amounting to Sh. 3,600,000. It was late in making the returns and
payment of the amount due by five months.
Required:
The penalties that ABC Ltd. will be required to pay by the VAT Department.
(c)
(4 marks)
The following is a summary of the sales and purchases of Panda Limited for the six months
ended 31 December 2003:
Month
Sales
Sh.
1,200,000
1,400,000
1,650,000
2,200,000
Nil
2,800,000
July
August
September
October
November
December
Purchases
Sh.
450,000
300,000
Nil
700,000
650,000
900,000
1.
2.
3.
4.
5.
6.
The composition of each months sales is as follows:

At the standard rate 85%
Exempt sales 4%
Export sales 11%
One tenth of all purchases are made from suppliers not registered for VAT purposes. The
rest of the purchases are made from suppliers registered for VAT purposes, at the standard
rate.
As at 1 July 2003, the following balances were to be brought forward:
For the six month period ended 31 December 2003, the company issued credit notes
amounting to Sh. 40,000, exclusive of VAT, for sales made at the standard rate.
In addition, the company received debit notes amounting to Sh. 22,000 (exclusive of
VAT) from suppliers registered for VAT purposes.
A customer who had purchased supplies worth Sh. 200,000 at the standard rate in
October 2003, was declared bankrupt in December 2003.
As at 31 December 2003, the company had not yet received payment for the sales made
in August 2003.
49
Required:
VAT account for the six-month period ended 31 December 2003.
(Where applicable, the transactions are exclusive of VAT at the standard rate).
TAXATION II
(8 marks)
(Total: 20 marks)
50
QUESTION FIVE
Jackson and Martin, who are both resident in Kenya, are in partnerhip trading as Jama Investments. The
following details relate to their business for the year ended 31 December 2003. Profits and losses are
shared by Jackson and Martin in the ratio of 2:3 respectively.
Jama Investments
Trading and profit and loss account for the year ended 31 December 2003:
Sh.
Opening stock
500,000 Sales
Purchases
20,000,00 Interest income
Repairs
0 Dividends received
Maintenance costs
50,000 Miscellaneous income
Advertisement costs
120,000 Interest on drawings:
Donations to St. Peters Childrens Home
250,000
Jackson
Bad debts general provision
320,000
Martin
Rent expense
80,000 Recoveries from insurance
Value added tax (VAT) paid
800,000 company
Office expenses
160,000 Closing stock
Legal fees
518,000 Net loss for the year
Depreciation of fixed assets
360,000
Sundry expenses
90,000
Subscriptions to Chamber of Commerce and
130,000
industry
70,000
Sh.
Drawings:
Jackson
Martin
Interest on capital:
Jackson
Martin
Salaries:
Jackson
Martin
Sh.
140,000
180,000
250,000
320,000
8,700,000
4,500,000
37,538,000
________
37,538,000
Sh.
35,000,00
0
250,000
120,000
210,000
70,000
40,000
95,000
300,000
1,453,000
Revision Question and Answers
51
1.
Jackson operates a farming business where he received net farming income of Sh. 50,000 for the
year ended 31 December 2003, after deducting the following:
Farmworks deductions
Salary of self
Drawings for family use
Donations to local church
1.
2.
3.
4.
Sh.
150,000
300,000
450,000
60,000
Legal costs paid by the business in defending a private legal suit against Jackson amounted to Sh.
140,000.
Specific provisions for bad debts amounted to Sh. 170,000. These had not been taken into account in
preparing the above trading and profit and loss account.
Interest income and dividends are stated at their gross amounts.
Capital deductions for the year ended 31 December 2003 were agreed at Sh. 480,000.
Required:
(a)
(b)
(c)
(d)
Adjusted taxable income for the partnership business for the year ended 31 December 2003.
(8 marks)
Distribution of the income computed in (a) above between the partners and the total taxable
income of each partner for the year ended 31 December 2003.
(6
marks)
Comment on any information not used in the computation of the adjusted taxable income. (3
marks)
Explain whether Jacksons tax treatment would have been different if he was a non-resident.
(3 marks)
(Total: 20 marks)
TAXATION II
Questions-Past Papers
52
DECEMBER 2004
QUESTION ONE
Shada and Pete have been operating a jewellery retail business in Nairobi and sharing profit and losses
equally. They have not maintained proper records of their transactions.
They have engaged you at an agreed fee of Sh. 50,000 to prepare their books and make their annual tax
returns. You establish that the partners earn salaries annually and also charge 10% interest per annum on
their drawings.
The following presented to you is relevant::
1.
Assets and liabilities as at 31 December:
Stock in trade
Creditors
Prepaid rent
Accrued electricity bills
Balance at Bank
Accrued salaries
2002
Sh.
860,000
740,000
30,000
21,000
230,000
520,000
2003
Sh.
1,680,00
0
890,000
42,000
16,000
165,000
480,000
2.
The partners banked all cash collections after deducting the monthly expenses shown below:
Cash drawings: Shada
15,000
Pete
10,000
Casual labour
12,000
Purchase of goods for resale
18,000
Sundry expenses
10,000
Petrol for motor vehicle
8,000
3.
Payments made through the Bank during the year ended 31 December 2003, have been summarized as
follows:
Sh.
General expenses
Motor vehicle running expenses
Purchase of goods for resale
Rent
Electricity
Salaries
Purchase of motor vehicle
Delivery to customers
Casual labour
Cost of meals to employees
4.
5.
6.
7.
8.
30,000
16,000
1,515,000
504,000
139,000
4,800,000
3,000,000
140,000
514,000
123,000
On average the partners sold all goods at a gross profit margin of 33. During the year, Shada and
Pete had taken jewellery (at cost price) worth Sh. 250,000 and Sh. 100,000 respectively.
The partners estimate the use of motor vehicle to be 40% for private purposes.
On 1 October 2003, the partners admitted Kidole as a new partner. He paid Sh. 4,000,000 as his
capital contribution. The new profit sharing ration was agreed at 2:2:1.
A half of the salaries expense relate to the partners. Out of these, Kidole received Sh. 268,000 being
his salary dues to 31 December 2003.
Assume that income and expenses accrue evenly throughout the year.
Required:
(a)
Compute taxable income for the year ended 31 December 2003 in respect of each partner.
(b)
(c)
53
(12 marks)
Using the information computed in (a), compute the tax payable by each partner. (6 marks)
Name the tax returns to be made in respect of the tax computed in (b) above.
(2 marks)
(Total: 20 marks)
QUESTION TWO
The management of Shamrock Bank Ltd. has sought your professional guidance in determining the
Banks tax liability for the year ended 31 December 2003.
The income statement of Shamrock Bank Ltd. for the year ended 31 December 2003 is given below:
Income
Interest on loans and advances to customers
Interest on government securities
Interest on placements with other banks and institutions
Fees and commissions income
Rental income
Income from foreign exchange dealings
Gain on disposal of property and equipment
Other operating income
Total income
Sh. 000
Expenses:
Salaries and employee benefits
Occupancy expenses
Deposit protection fund contributions
Depreciation expense
Interest on customers deposits
Interest on deposits from other Banks and institutions
Directors emoluments:
Fees
Other
Auditors remuneration:
Current year
Under provision for the previous year (2002)
Operating lease rental
Loss on disposal of equipment
Other administrative expenses
Provision for bad and doubtful debts
Provision for interest suspense
Total expenses
Loss for the year
360,400
20,350
12,360
43,700
202,450
80,200
11,200
3,600
2,100
300
1.
Salaries and employee benefits comprise:
Leave benefits
Pension contributions
Termination costs
Provision for staff leave accruals
Sh. 000
540,800
120,600
40,650
39,360
2,190
31,980
12,300
42,950
830,830
Sh. 000
720
1,460
2,860
4,920
9,960
TAXATION II
14,800
2,400
16,300
7,250
20,620
80,500
20,950
882,280
(51,450)
54
2.
Included in the Directors other emoluments are:

School fees for the Chairmans children
Entertainment allowance (used on clients)
Travelling costs for a newly recruited expatriate
director
Sh. 000
1,200
1,800
600
3.
The movement in provisions for bad and doubtful debts during the year was as follows:
Specific provisions General
Total
Sh. 000
provisions
Sh. 000
Sh. 000
Sh. 000
Sh. 000
Sh. 000
At 1 January 2003
630,500
630
631,130
Charge for the year
83,800
15,300
99,100
Released during the year
(18,600)
(18,600)
At 31 December 2003
695,700
15,930
711,630
4.
Provision for interest suspense represents non-performing loans and advances on which interest
has been suspended. The management has confirmed that the loans and advances are fully
secured.
Capital allowances for the year ended 31 December 2003 amounted to Sh. 18,900,000.
Lease rental charges relate to office equipment leased from AB office solutions for use in the
entire bank network.
5.
6.
Required:
(a)
(i)
Taxable income of Shamrock Bank Ltd. for the year ended 31 December 2003. (11
marks)
(ii)
Tax payable (if any), on the taxable income computed in (i) above. (2 marks)
(b)
Given the Shamrock Bank Ltds taxable income for the year ended 31 December 2002, was
assessed at Sh. 2,400,000, show how the tax computed in (a) (ii) above is to be paid, inclusive of
the due dates.
(5 marks)
Explain the implication of Income Tax Act section 15(7) (e) (specified sources of income) on
Shamrock Bank Ltds income.
(2 marks)
(Total: 20 marks)
(c)
QUESTION THREE
Omega Tea Ltd. operates a Tea processing factory built on sixty acres of land in Kericho. The
information relating to its assets and other staff off costs incurred since commencing operations on 20
January 2002 given below:
Year 2004:
1.
Planting tea:
Ploughing land and preparing gabions

Purchase of tea seedlings
Felling trees
Cutting and clearing logs
Purchase of water sprinklers
Planting and weeding
Sh. 000
5,000
1,000
2,000
500
600
2,500
55
The logs were processed into timber and sold for Shs. 4 million.
2.
3.
4.
Constructed the processing plant building at a cost of Sh. 50 million and installed machinery
worth Sh. 40 million.
Furniture for use in the plant was bought at Sh. 2 million while the office equipment cost Sh. 8
million.
Motor vehicle purchases:
Three lorries for transporting tea at a cost of Sh. 7 million each.
One saloon car at a cost of Sh. 1,400,000
One saloon car at Sh. 1,900,000
One saloon car worth Sh. 1,200,000 was donated to Omega tea Ltd. by Bazaar Motors for
procuring all vehicles from them.
YEAR 2005:
5.
6.
7.
8.
9.
Purchase of additional assets:

One forklift for Sh. 6 million
Two computers for Sh. 500,000
One printer for Sh. 50,000
Five office calculators for Sh. 40,000
The pick-up was involved in an accident on 2 February 2003. The insurers, Relief Assurance,
paid Omega Tea Ltd. Sh. 1,400,000 compensation on 3 December 2003.
On 1 May 2003, a tree fell on one of the lorries damaging it in the process. The lorry was
repaired at a cost of Sh. 350,000 and disposed off for Sh. 5 million on 1 July 2003.
Omega Tea Ltd. sold 5 acres of land to Kiptum for Sh. 500,000 on 10 November 2003 after
clearing temporary structures on the land at a cost of Sh. 20,000.
The reported income for the two years ended 31 December 2002 and 2003 are shown below, after
deducting depreciation and tax paid, but before adjusting for the items above:
2002
2003
Sh.
Sh.
Reported income
21,200,000 63,000,000
Depreciation charged
9,000,000
8,500,000
Tax paid
1,000,000
2,000,000
Required:
(a)
(b)
Capital allowances due to Omega Tea Ltd. for the year ended 31 December 2002 and 2003.
(12 marks)
(i)
Taxable income for the year ended 31 December 2002 and 2003.
(4 marks)
(ii)
Tax payable (if any) on the taxable income computed in (b) (i) above.
(2 marks)
(iii)
State the due dates for filing annual tax returns for the tax computed above and the
consequences of non-compliance.
(2 marks)
(Total: 20 marks)
QUESTION FOUR
(a)
Explain how section 19 (1) of the VAT Act, on recovery of tax due and payable from a person
who owes money to the tax payer may be enforced by the commissioner.
(6
marks)
(b)
Meka Ltd. imports goods vatable at standard rate and transports them to its factory in Mazeras,
where they are converted into finished goods for sale in the local market.
The cost of conversion is 25% of the total costs incurred in bringing the goods to Mazeras. The
company then charges a profit margin of 40%. During the month of May 2004, the firm imported
TAXATION II
56
goods worth Sh. 2,000,000 and paid import duty at 20%. It then incurred a further 10% as
transport cost to Mazeras. The goods were all converted and sold in May 2004. The above costs
are inclusive of VAT.
Required:
Compute the VAT payable by Meka Ltd. and show the due date.
(c)
(6 marks)
Mediner Ltd. deals in a variety of goods in the month of September 2004, the Company
accountant recorded the following transactions (exclusive of VAT):
Wages and salaries
Audit fee paid
Provision for doubtful debts
Telephone and electricity bills
Export of goods
Sales at standard rate
Exempt sales
Purchases at standard rate
Purchases at zero rate
Sale of motor vehicle
Sh. 000
4,200
700
400
500
10,000
45,000
20,000
25,000
10,000
1,200
The accountant believes that the allocative method is the best in restricting the input VAT deductible
against output VAT. The accountant is also of the opinion that on average, twenty percent of the standard
rate purchases were sold as standard rate sales.
Required:
Compute the input VAT deductible against output VAT using the allocative method.
(8 marks)
(Total: 20 marks)
QUESTION FIVE
(a)
List four circumstances under which duty paid on imports is refundable.
(4 marks)
(b)
Explain the term thin capitalization.
(4 marks)
(c)
Name four incentives given by the government to encourage the growth of capital market in
Kenya.
(4 marks)
(d)
Explain briefly the meaning of goods subject to customs control under the Customs and Excise
Act (Cap. 472)
(4 marks)
(e)
Explain the requirements of an application for refund of VAT paid in respect of Bad debts.
(4 marks)
(Total: 20 marks)
57
JUNE 2005
QUESTION ONE
a) With reference to Sections 46 and 47 of the Income Tax Act (Cap 470), explain how the incomes of the
following persons are assessed for tax.
i.
ii.
Incapacitated persons
Non resident persons
b) Mr. Dan Mbazo, a citizen of Zambia is employed by Southnet International Ltd, a company based in
Lusaka Zambia. Southnet International Ltd opened a branch in Nairobi Kenya on 1 January 2004 and
posted Mr. Mbazo as the branch operation manager on the same date.
The following information relates to Mr. Mbazos employment for the year ended 31 December 2004
(All amounts are stated in Kenya Shillings (Kshs))
1. His basic pay commencing 1 January 2004 was Sh.200,000 per month
2. He was booked by the employer in a hotel for the month of January pending the availability of a
suitable residential house. The employer paid Sh.50,000 to the hotel for this accommodation and
meals.
3. On 1 February, he rented a house in a Nairobi suburb for a monthly rent of Sh.35,000. It is the
employers policy to reimburse half of the rent paid by an employee.
4. In March, he relocated his family from Lusaka to Nairobi. The employer paid Ksh25,000 for the
air tickets used by the family.
5. Commencing 1 July, he received a monthly entertainment allowance of Ksh.12,000 from the
employer which he spent on visiting local tourist sites.
6. In August, passages of Ksh110,000 were paid by the employer for Mr. Mbazo to attend a two
week seminar in Cape Town, South Africa. While in South, he purchased a motor vehicle costing
Sh.2,000,000 for his use in Kenya. The total fuel and maintenance costs of the motor vehicle to
31 December 2004 amounted to Ksh.120,000. Three quarters of the vehicle usage related to
official duties.
7. On 1 October the employer effected the following changes on Mr. Mbazos basic pay and benefits
with effect from 1 October 2004:
His basic pay was increased by twenty five per cent

A comprehensive insurance cover for his motor vehicles for an annual premium of
Ksh.80,000 payable on 1 October each year
A medical cover for self and family to a maximum of Ksh.2,000,000. Monthly contributions
by the employer to the scheme amounted to Ksh8,000
8. On 30 December he received a cheque of Ksh.150,000 from the employer for being the best
foreign based employee for the year ended 31 December 2004
9. The PAYE remitted from his pay for the year ended 31 December 2004 amounted to
Ksh.200,000.
Required:
i.
Comment on the residence of Mr. Mbazo (for tax purposes) for the year ended 31 December 2004
(2
marks)
ii.
Calculate the taxable income of Mr. Mbazo for the year ended 31 December 2004
(12
marks)
TAXATION II
58
iii.
Compute the tax payable (if any) from the income calculated in (ii) above
marks)
(2
(Total: 20 marks)
QUESTION TWO
a) Outline the benefits which may accrue to a country from being a signatory to the most favoured
nations status agreement
(4 marks)
b) Style Limited obtained a licence from the Customs and Excise department on 15 December 2002 to
manufacture leather jackets for export. The company commenced its operations on 2 January 2003.
The following information relates to the companys operations for the financial years ended 31
December 2003 and 2004:
1. The company incurred the following costs prior to the commencement of its operations:
Purchase of land
Demolition of an old building on the land
Factory construction
Stone perimeter wall
Staff canteen
Ksh.
8,000,000
500,000
12,000,000
1,400,000
800,000
2. Part of the factory construction costs related to the following:

Store
Office
Ksh.
200,000
1,740,000
3. Other assets acquired prior to 2 January 2004 comprised:

Ksh.
Water pump
200,000
Sewerage treatment plant
700,000
Factory machinery
400,000
Lorry (10 tonnes)
3,600,000
Heating plant
500,000
120,000
Photocopier
150,000
Delivery van
1,800,000
Computers and printers
380,000
Forklift
1,500,000
4. A borehole was drilled at a cost of Ksh.800,000 and utilised with effect from 1 July 2003.
5. An extension to the factory and a loading bay were constructed and utilised with effect from 1
January 2004. The extension cost Ksh.4,800,000 while the loading bay cost Ksh.600,000.
6. The following additional assets were acquired on 1 January 2004:
59
Imported machinery (including import duty of Ksh.600,000)

Fax machines
Pick up
Conveyor belts
Ksh.
2,400,000
120,000
2,000,000
640,000
7. On 1 July 2004, Style Limited ceased to manufacture for export and instead started selling the
leather jackets in the local market. The export manufacturing licence was subsequently
withdrawn by the Customs and Excise department with effect from 1 July 2004:
8. The company disposed of the following assets on 1 July 2004:
Lorry (10 tonnes)

Heating plant
Photocopier
9
Ksh.
2,200,000
480,000
100,000
The company reported a net profit (before deducting capital allowances) of Ksh.7,200,000 for
the year ended 31 December 2004
Required:
i)
ii)
Determine the capital allowances due to Style Limited for the years ended 31 December 2003 and
2004.
(14
marks)
Determine the tax payable (if any) by Stlye Limited for the year ended 31 December 2004
(2
marks)
(Total: 20 marks)
Question Three
a) Section 24 (1) of the Income Tax Act (Cap 470) requires companies to adequately distribute their
profits as divided within twelve months after the end of the accounting period.
Outline the circumstances under which a company may apply for exemption from the shortfall
distribution requirements.
(4
marks)
b) The following information relates to Vuma Limited for the year ended 31 December 2004:
1. The companys operating profit before tax amounted to Ksh.2,000,000 excluding Ksh.400,000
from investment activities
2. The company intends to distribute Ksh.200,000 as dividend for the year ended 31 December
2004.
3. The corporate tax rate is 30%
Required:
Compute the short fall tax payable by Vuma Limited for the year ended 31 December 2004.
c) Write short notes on the following:
TAXATION II
(4 marks)
60
i) Exemption of individuals from paying instalment tax

ii) Double taxation relief
iii) Refund of overpaid tax
(4 marks)
(4 marks)
(4marks)
(Total: 20 marks)
Question Four
a) With reference to the Income Tax Act (Cap.470) explain how a Kenyan branch of a foreign company is
taxed
(6
marks)
b) The management of Mazuri Limitd has presented the following trading and profit and loss account
for the year ended 31 December 2004:
Ksh. 000
Sales
Less cost of sales:
Opening Stock
Purchases
Cost of goods available for sale
Closing stock
Gross profit
Other incomes:
Interest on savings account
Refund of import duty
Gain on foreign exchange
transactions
4,200
5,600
9,800
(2,400)
Ksh. 000
18,500
(7,400)
11,100
120
40
80
100
11,440
Expenditure:
Goodwill amortisation
Legal expenses
Salaries
Bad debts
NSSF contribution
General expenses
Advertising
Staff meals
Travelling expenses
Donations to a trade association
Property rates
Depreciation
Interest on long term
Interest on bank overdraft
Insurance
Cost of stolen stock
Branch closure costs
Net profit
25
420
2,000
500
60
600
300
190
180
40
45
150
300
80
124
20
100
(5,134)
6,306
61
1. The closing stock on 31 December 2004 was valued at a cost plus a mark up of twenty per cent.
2.
Legal expenses related to:

Ksh.
150,000
Preparation of the Memorandum of

Association
Conveyance fees on purchase of land
Acquisition of leasehold property
Settling customer disputes
Acquisition of a bank loan
60,000
90,000
100,000
20,000
420,000
3. The directors had withdrawn goods costing Ksh.600,000 (selling price Ksh.720,000) for their personal
use. These goods have been included in both purchases and sales for the year ended 31 December
2004.
4. Sales (expense) includes:
Directors allowances
Christmas gifts to staff
Golden handshake to a retiring director
Ksh.
720,000
600,000
400,000
5. Bad debts include:

Ksh.
200,000
120,000
Loan to director
Estimated defaults by trade debtors
5.
6.
7.
Advertising expense includes Ksh.100,000 for a neon sign

Twenty per cent of the travelling expenses relate to the private usage of company motor vehicles.
Capital allowances were agreed with the revenue authority at Ksh.200,000.
Required:
i) Adjusted taxable profit or loss for Mazuri Limited for the year ended 31 December 2004.
(12
marks)
ii) The tax payable by Mazuri Limited (if nay) for the year ended 31 December 2004
(2
marks)
(Total: 20 marks)
Question Five
a) Local supplies of goods and services to an Export Processing Zone (EPZ) are zero rated under the
VAT Act (Cap 476)
Explain the two alternative methods of zero rating such supplies.
marks)
(6
b) Under Section 23(1) of the VAT Act, the Minister for Finance may, by order in the Kenya Gazette,
remit wholly or partly the VAT payable in respect of any taxable supply or class of taxable supplies.
TAXATION II
62
Outline the circumstances under which such remission may be made.

marks)
(4
c) You have been approached by the proprietors of Kabuku Wholesalers to assist in the preparation of
the firms VAT returns for the months of January and February 2005. The following are the extracts
of the sales and purchases accounts of the firm for the two months.
Sales Account
January
17
February
18
January
10
12
17
February
2
11
16
A. Ali-Debtor
Ksh. January
14,000 3
10
12
18
30
S. Kazi
Debtor
Cash account
Cash account
A. Ali Debtor
P. Juma Debtor
Cash account
Ksh.
40,000
18,000
60,000
75,000
16,000
February
8,000 7
S. Kazi Debtor
54,000
16
21
Cash account
A.. Ali Debtor
6,000
46,000
Purchases account
Ksh. January
P.Mwanzia Creditor
36,000 12
Cash account
18,000
M. Mpole Creditor
22,600
Cash account
J. Kali Creditor
B. Bilali Creditor
February
8,000 1
32,000 18
46,000
P. Mwanzia Creditor
Ksh.
4,000
P. Mwanzia Creditor
B. Bilali creditor
6,000
2,200
Required:
Determine the VAT payable (or refundable) by Kabuku Wholesalers for the months of January and
February 2005.
(10 marks)
(Total: 20
marks)
63
DECEMBER 2005
QUESTION ONE
a) Explain the main tax incentives provided to newly listed companies in your country.
marks)
(4
b) Under what circumstances are imported goods considered to have been dumped in your country?
(6
marks)
c) Write brief notes on the following:
i) Tax-free employment benefits
marks)
ii) Set off of import duty
marks)
(6
(4
(Total: 20
marks)
QUESTION TWO
a) Alpha Insurance Company Ltd, provides motor vehicle and fire insurance covers to its policy holders.
The following information was extracted from the financial records of the company for the year ended
31 December 2004:
Gross premiums:
Unearned premiums
Claims paid
Claims outstanding:
Depreciation
Reinsurance ceded
Gain on sale of
equipment
Agency expenses
Commission received
Telephone & postage
Management expenses
Advertising
1 January 2004
31 December 2004
1 January 2004
31 December
Motor Vehicle
Insurance
Ksh. 000
56,000
8,240
4,630
2,860
3,950
3,680
700
22,400
64
Fire
Insurance
Ksh. 000
12,640
2,360
1,070
1,250
4,820
10,340
860
5,200
-
480
300
1,460
3,475
600
846
170
1,690
1,580
1,875
230
802
Additional Information:
1. The agency expenses for motor vehicle insurance include:
TAXATION II
64
Commission paid on sale of investments

Commission paid on purchase of equipment
Ksh.
120,000
80,000
2. Capital allowances have been agreed with the tax authorities at Ksh.6,000,000 for the year ended 31
December 2004
Required:
Compute the taxable income or loss for Alpha Insurance Company Ltd. for the year ended 31 December
2004.
(10
marks)
b) Mr. C. Kamau is employed by Makazi Ltd. as the finance director. He holds 12% of the companys
issued ordinary share capital. During the year ended 31 December 2004, he reported the following
incomes:
1. Employment income:
Basic Salary per annum

Bonus for the year
Annual pension contribution by employer:
- To registered scheme
- To unregistered scheme
Annual life insurance premium paid by employer
Ksh
1,200,000 (PAYE
Ksh.200,000)
300,000 (PAYE Ksh.50,000)
120,000
155,000
70,000
On January 2004, the employer rented a house for him at a monthly rent of Kshs.20,000. He is charged
5% of his monthly basic salary a part of rent contribution.
2. Dividend income:
Biashara Commercial Bank Ltd
Kahawa Farmers Co-operative Society
Ksh
180,000 (net)
100,000 (gross)
3. Interest income:
Post Office savings Bank
Nyumba Housing Finance Company
Bank deposits
Ksh
22,000 (gross)
150,000 (gross)
65,000 (net)
4. Lumpsum pension received from previous employer Ksh.500,000.

5. His wife is employed by Amua Ltd. where he owns 30% of the ordinary share capital. During th year
ended 31 December 2004 she received the following salary and benefits:
i) Basic pay Ksh.400,000 per annum (PAYE Ksh.50,000)
ii) Sick leave allowance Ksh.60,000
iii) Harambee contributions for her medical costs:
65
From fellow employees Ksh.400,000

From employer Ksh.150,000
She owns a retail shop which is registered in her name. The shop reported a net loss of Ksh.200,000 for
the year ended 31 December 2004.
Required:
Compute the taxable income of Mr. C. Kamau for the year ended 31 December 2004
marks)
(10
(Total: 20
marks)
QUESTION THREE
a) Outline two types of capital allowances granted to companies manufacturing bond.
Marks)
(4
b) Mapato Ltd. has been in the manufacturing business since 1995. The following relates to the
companys assets as at 31 December 2002:
Asset
Factory building
Processing machinery
Other machinery (non processing)
Tractors
Computers
Saloon car
Partitions
Photocopiers
Factory extension
Conveyor belts
Sports pavilion
Staff canteen
Cost Sh.
5,600,000
3,400,000
1,600,000
3,000,000
600,000
1,800,000
400,000
300,000
2,400,000
960,000
360,000
1,200,000
Year of first use

1 January 1995
1 January 1995
1 July 1995
1 July 2000
1 September 2000
1 September 2000
1 September 2001
1 September 2001
1 September 2002
1 September 2002
1 September 2002
1 September 2002
1. On 1 January 2003, a sewerage system was constructed at a cost of Ksh.720,000. A generator was also
purchased on the same date for Ksh.450,000.
2. The following additional assets were purchased or disposed of in the year 2003:
Date
1 March 2003
4 May 2003
24 July 2003
10 September 2003
15 October 2003
Date
2 July 2003
Asset purchased
Computers
2 Saloon cars
Trailer
Lorry (5 tonnes)
Curtains
Cost (Sh.)
300,000
1,800,000 (each)
400,000
1,200,000
10,000
Asset disposed of
TAXATION II
Original cost
Sale proceeds
600,000
540,000
66
20 September 2003
30 November 2003
Saloon car (purchased 1 September 2000)

Tractor
1,800,000
1,200,000
650,000
800,000
3. On 1 January 2004, the company imported the following machines:

Ksh.
1,200,000
640,000
420,000
Weighing machines
Water pump
The cost of the imported processing machinery excludes an import duty waiver of Ksh.300,000
granted by the tax authorities.
4. The company reported a profit of Ksh.5,000,000 for the year ended 31 December 2004. This was
after deducting the following expenses, among others:
Insurance
Repairs and Maintenance
Import licence fees
Ksh.
180,000
420,000
140,000
5. The investment deduction (ID) rates applicable prior to the year 2003 were:
Year
1995 to 2001
2002
ID rate
70%
85%
Required:
i) Compute the capital allowances due to the company for the two years ended 31 December 2003 and
2004
(14
marks)
ii) Determine the tax payable by the company for the year ended 31 December 2004
(2
marks)
(Total: 20
marks)
Question Four
a) With reference to section 132(7) of the Income Tax Act (Cap.470), list six types of transactions for
which personal identification number (PIN) is required.
(6 marks)
b) With reference to the sixth schedule of the Value Added Tax Act (Cap. 476) outline four vatable
supplies which are not subject to the VAT threshold turnover requirements.
(4 marks)
67
c) The management of Hekima Ltd. has presented the following information relating to the companys
sales and purchases for the half year ended 30 June 2005:
Month
January
February
March
April
May
June
Purchases
KSh.
1,800,000
840,000
Nil
680,000
1,000,000
1,500,000
Sales
KSh.
1,600,000
1,860,000
470,000
Nil
1,200,000
2,400,000
1. The composition of each months sales were as follows:
Standard rate sales
Exempt sales
Export sales
2.
92%
4%
4%
5% of all purchases were made from suppliers who were not registered for VAT.
3. Under declared VAT as at 1 January 2005 amounted to Ksh.25,000.

4. The company issued debit notes amounting to Ksh.50,000 in the month of February 2005, and
received credit notes amounting to Ksh.76,000 in the month of May 2005. These debit and credit
notes related to vatable supplies at the standard rate.
5. One of the customers who purchased supplies worth Ksh.120,000 in May 2005 at the standard rate was
declared bankrupt on 15 June 2005
6. The above transactions are exclusive of VAT.
Required:
Prepare a VAT account for the six months period ended 30 June 2005 showing the net VAT payable or
refundable. (Use a standard VAT rate of 16%).
(10
marks)
(Total: 20
marks)
QUESTION FIVE
a) i) Define the term tax planning
marks)
ii) Briefly explain two instances in which a business may apply the concept of tax planning
marks)
(2
(4
b) Ali and Musa are in partnership trading as Alimusa Enterprises. They share profits and losses in the
ratio of 2:3 for Ali and Musa respectively. The partners presented the following profit and loss
account of the partnership for the year ended 31 December 2004:
Sales
Ksh.
7,000,000
TAXATION II
68
Closing stock
Rental income
Dividend received (net)
Foreign exchange gain
Interest income (net)
Discount received
Opening stock
Purchases
Sales and wages
Insurance
Travelling expenses
Salaries to partners: Ali
Musa
Rent and rates
Interest expenses
Medical expenses for partners
Legal expenses
Bank charges
Stamp duty
Loss on sale of equipment
VAT paid
Purchase of furniture
Depreciation
Net loss
980.000
435,400
45,200
45,800
100,000
70,000
8,676,400
800,000
3,400,000
1,200,000
240,000
156,000
400,000
600,000
465,000
1,560,000
100,000
200,400
120,200
76,400
150,000
16,000
32,600
48,000
40,000
9,604,600
(928,200)
1. On 1 April 2004, Kaka was admitted as a partner. He contributed Ksh.800,000 as his share of capital
and goodwill. The profit and loss sharing ratio was revised to 2:2:1 for Ali, Musa and Kaka
respectively with effect from 1 April 2004. Kaka was not entitled to a salary for the year ended 31
December 2004.
2. Interest expenses comprised:
Interest on capital: Ali

Musa
Kaka
Interest on loan
Fringe benefit tax
Sh.
400,000
360,000
40,000
560,000
200,000
1,560,000
3. All transactions relating to equipment and furniture occurred after 1 April 2004. All other revenues
and expenses accrued evenly throughout the year.
Required:
i) Determine the adjusted profit or loss of the partnership for the year ended 31 December 2004.
69
(12
marks)
ii) Allocate the profit and loss computed in (i) above amongst the partners.
marks)
(2
(Total: 20 marks)
JUNE 2006
Time allowed: 3 hours
Answer ALL questions. Marks allocated to each question are shown at the end of the questions.
Show all your workings. Any assumptions made must be clearly and concisely stated.
RATES OF TAX (including wifes employment, self employment and professional income rates of tax).
Year of income 2005
Monthly taxable pay
(shillings)
1
10164
10165 19740
19741 29316
29317 38892
Excess over 38892
Annual taxable pay

(shillings)
1
121968
121969 236880
236881 351792
351793 466704
Excess over 466 704
Personal relief Sh.162 per month) Sh.13, 944 per annum)

Prescribed benefit of motor vehicles provided by employer
Monthly
Annual
Rates
Rates
(Sh.)
(Sh.)
TAXATION II
Rates of tax
% in each shilling
10%
15%
20%
25%
30%
70
Capital allowances:
Wear and tear allowances:
Class I
37.5%
Class Ii
30%
Class III
25%
Class IV
12.5%
Industrial building allowances:
Industrial building
2.5%
Hotels
4.0%
Farm works allowances
33%
2003 70%
2004 100%
2005 100%
Shipping investment allowances
Mining allowance:
Year 1
40%
Year 2-7
10%
(i)
Saloons Hatch Backs and Estates

Upto
1201 - 1500cc
1501 - 1750cc
1751 - 2000cc
2001 - 3000cc
1200cc
4,200
5,800
7,200
14,400
3,600 43,200
50,400
69,600
86,400
172,800
(ii)
Pick-ups, panel vans (Unconverted)
(iii)
Upto 1750cc 3,600 43,200

Over 1750cc 4,200 50,400
Land Rovers/Cruisers 7,200 86,400
OR 2% of the initial capital cost of the
vehicle for each month.

Monthly rates
Sh.
Services
(i) Electricity (Communal or from a generator)
1,500
(ii) Water (communal or from a borehole)
500
(iii) Provision of furniture (1% of cost to employer)
(iv) Telephone (Land line and mobile)
30% of bills
Agriculture employees: reduced rates of benefits

(i)
Water
(ii)
Electricity
200
900
Annual rates
Sh.
18,000
6,000
2,400
10,800
Other benefits
Other benefits for example, servants, security, staff meals etc are taxable at the higher of fair market value
QUESTION ONE
Starlit company Ltd. has been operating in Kenya Since 1 January 2003. The company is a subsidiary of
Mega Holdings Ltd. which is used on the United Kingdom.
The financial statements of Starlit Company Ltd. for the year ended 31 December 2005 are presented
below.
Sales
Less cost
Profit and loss account for the year ended 31 December 2005
Sh 000
Sh 000
97,440
44,940
Gross profit
Less expense
Wages
Depreciation
Interest
General expenses
Net profit
Proposed dividend
Retained profit for the year
71
52,500
30,000
7,500
1,500
9,000
48,000
4,500
600
3,900
Balance sheet as at 31 December 2005

Sh 000
Sh 000
Fixed assets (net)
Current assets
Stock
Trade creditors
Bank balance
Total assets
Capital and liabilities
Ordinary share capital
Debentures
Retained profits
Current liabilities
Trade creditors
Accrued wages
Proposed dividend
Total capital and liabilities
Balance brought forward

Receipts from customers
6,000
2,250
15,000
23,250
116,250
87,000
13,500
10,000
4,125
375
600
5,100
116,250
Bank account for the year ended 31 December 2005:

Sh 000
Sh 000
1,500
Wages
30,375
98,250
General expenses
9,000
Payments to suppliers 43,125
Interest
1,500
Dividend
750
Balance carried down 15,000
99,750
99,750
1.
Included in sales was Sh.2,100,000 representing goods sold to the parent company. All sales
to the parent company are made at 10% below the normal selling price.
2.
General expenses include:
Sh. 000
Flotation cost on issue of debentures
1,400
Stamp duty on issue of debentures
800
Conveyance fees on purchase of land 2,000
Foreign exchange losses relating to the
parent companys transactions.
560
3.
The written down values of fixed assets extracted as at 1 January 2005 were as follows:
Industrial building
Computers
Processing machinery (imported from United Kingdom)
Office partitions
TAXATION II
Sh.
17,100,000
900,000
19,906,250
400,000
72
Lorries (each 3 tonnes)

Delivery vans
Pick-ups
Office equipment
4,500,000
3,600,000
2,500,000
600,000
800,000
The company did not claim investment (ID) allowance on h industrial building and
processing machinery in year 2003. However, the company claimed industrial reduction (IBD)
and tear allowances on the industrial building and processing machinery respectively
from
years
2003 and 2004.
1.
Included in the cost of processing machinery was import duty so Sh.1,200,000 and freight
charges of sh.400,000.
Required:
(a) (i)
Compute the investment deduction allowance that was due to the company in year
2003.
(4 marks)
(ii)
Calculate the total over or under-claimed wear and tear allowance in relation to the
processing machinery as at 31 December 2004.
(4
marks)
(iii)
(b)
Compute the industrial building deduction allowance due to the company in years
2003, 2004 and 2005.
(2 marks)
Determine the companys adjusted taxable profit or loss for the year ended
31 December 2005.
(10 marks)
(Hint: Start your computation with the reported profit)
(Total: 20 Marks)
QUESTION TWO
Mr. A. Wakaba started a retail business on 1 January 2000. He has not been filling income tax returns for
the six years to 31 December 2005.
An investigation of his affairs revealed the following:
1.
The balance sheet of the retail business as at 31 December 200 was as shown below:
Sh. 000
Sh. 000
Fixed assets:
Premises
2,000
Motor vehicle
1,000
500
35,000
Current assets:
Stock
Debtors
Bank balance
Cash in hand
250
160
81
9
Total assets
Capital: 1 January 200
Net profit for the year
Drawings
Mortgages loan
Creditors
Total capital an liabilities
500
4,000
3,000
300
1,300
(500)
2,800
1,000
200
73
4,000
2.
3.
He constructed an extension to the premises in year 2004 at a cost of Sh.625,000.

The following account balances were outstanding in the respective year shown below:
2001
2002
2003
2004
2005
Sh.
Sh.
Sh.
Sh.
Sh
Trade debtors
173,000
190,000
208,000
232,500
253,000
Bank balance
109,000
194,000
281,000
409,500
(32,000)
Trade creditors
230,000
241,000
253,000
272,000
291,500
Cash in hand
10,000
10,000
10,000
10,000
10,000
Stock
255,000
302,500
332,500
366,000
402,500
4.
He withdrew goods worth Sh.5,000 per annum from the business for his personal use.
5.
The principal repayments on each mortgage loan amounted to Sh. 250,000 per annum from
31 December 2001. The mortgage interest paid in each of the four years ended 31 December
2001, 2002, 2003 and 2004 amounted to Sh.100,000, Sh.75,000, Sh.50,000 and 25,000
respectively.
6.
His wife opened a savings account in a commercial bank in year 2001. The balances in this
account after crediting the interest carried were as follows:
2001
2002
2003
2004
2005
Sh.
Sh.
Sh.
Sh.
Sh
Savings account
300,000
900,000
100,000
725,000
750,000
Interest earned
25,000
75,000
90, 000
70,000
60,000
7.
His living expenses and wear and tear allowances were agreed with the authorities as follows:
2001
2002
2003
2004
2005
Sh.
Sh.
Sh.
Sh.
Sh
Living expenses
300,000
400,000
450,000
500,000
600,000
Wear and tear
155,500
130,500
109,000
73,000
157,000
Required:
Compute the annual taxable income of Mr. A. Wakaba from year 2001 to year.
(20 marks)
QUESTION THREE
Write brief notes on the following
(a) Withholding VAT agents
(4 marks)
(b) Clean report of findings
(4 marks)
(c) Bond security
(4 marks)
(d) Fringe benefit tax
(4 marks)
(e) Exempt interest income
(4 marks)
(Total: 20 marks)
QUESTION FOUR
(a)
Outline the main provisions of the COMESA tax treaty
(b)
Highlight the benefits of an effective tax policy to a developing country.
(c)
The following details were extracted from the books of Abib Traders, VAT No. A11146789P for
the month of December 2005:
Date
December
2
Sales Journal
Invoice
number
Mr. J. J. Kamau
812
Customer
TAXATION II
Number of
units sold
80
Total invoice
price (Sh.)
800,000
74
8
10
14
17
24
27
29
Date
December
1
5
15
Ministry of Finance
Mr. A. Otieno
NSSF
Daily Ltd
Wasa Ltd
Government Printer
Mrs. M. Mwenda
813
814
815
816
817
818
819
145
90
82
50
15
80
25
1,450,000
720,000
1,640,000
416,200
300,000
1,200,000
360,000
6,886,200
Purchases Journal
Invoice
Number of
number
units purchased
Babo Ltd
80
300
Kilo manufactures 46
180
Wakili Ltd
52
200
Supplier
Total invoice
amount (Sh.)
960,000
3,600,000
1,860,000
6,420,000
Additional information relating to December 2005:

1. On 7 December, 38 units purchased from Kilo Manufacturers for Sh.760,000 were stolen in transit.
2. On 16 December, Abib Traders returned 8 units costing Sh.74,400 to Wakili Ltd.
3. On 30 December, Mr. A. Otieno was declared bankrupt.
4. The computer stock sheets did not tally with the physical stock count at th4 month end. Further
investigations revealed that 20 units costing Sh.240,000 had been stolen from the store.
5. The units sold to the Ministry of Finance were VAT exempt.
6. The transactions were exclusive of VAT at the rate of 16% where applicable.
Required:
A VAT account for the month of December 2005.
(12 marks)
(Total: 20 marks)
QUESTION FIVE
(a) Related companies may understate their taxable profits by engaging in transfer pricing. With
reference to Section 18 (3) of the Income Tax Act (Cap. 470), briefly explain three transactions
that may constitute transfer pricing.
(b) Kiplimo, Kosgey and Kurgat are partners trading as Kiko Enterprises. Kiplomo and Kosgey are
active partners while Kurgat is a sleeping partner. The partnership agreement is silent on the
profit and loss sharing ratio.
The partners have presented the following profit and loss account for the year ended 31
December 2005:
Income
Gross profit
Foreign exchange gain
Farming income
Interest on bank deposits (net)
Insurance compensation for stolen vehicle
Expenditure
General expenses
Sh,
Sh.
6,000,000
312,000
560,000
120,000
400,000
7,392,600
3,500,000
Salaries and wages

75
Kipimo
Kosgey
Legal expenses
Loss on sale of assets
Stamp duty on lease agreement
Licenses and permits
Subscriptions to trade association
Conveyance fees
Rent and rates
Farmworks (cost)
Furniture purchased (cost)
Bank charges
Reported loss
2,400,000
180,000
150,000
487,500
15,200
8,160
14,400
56,000
150,000
240,000
60,000
84,000
80,000
7,845,260
(452,660)
1.
Embezzlement by a cashier
Directors Christmas party
Compensation paid to an employee
for wrongful; termination of employment
Replacement of car engine (second hand)
Partition of an office
2.
3.
4.
5.
6.
Sh.
1,200,000
800,000
760,000
140,000
600,000
3,500,000
Salaries and wages include Sh. 700,000 and Sh. 800,000 paid to Kiplome and Kosgey
respectively, during the year.
Interest on capital was provided at 10% of the capital contribution.
Legal expenses include:
Sh.
Parking fines paid top city council
15,200
Legal fees for breach of contract
200,000
Drafting of tender documents
18,000
Drafting of lease documents 100 years
9,000
Defending a partner at income tax tribunal
Rent and rates relate to a period of 15 months commencing 1 January 2005.
Mortgage interest relates to a partners residential house.
Required:
(i)
The adjusted partnership profit or loss for the year ended 31 December 2005.
(10 Marks)
(ii)
An allocation of the profit or loss calculated in (i) above to the partners. (4 marks)
(Total: 20 marks)
DECEMBER 2006
Time allowed: 3 hours
Answer ALL questions. Marks allocated to each question are shown at the end of the
questions. Show all your workings. Any assumptions made must be clearly and concisely
stated.
TAXATION II
76
RATES OF TAX (including wifes employment, self employment and professional income rates
of tax). Year of income 2005
Monthly taxable pay
(shillings)
1
10164
10165 19740
19741 29316
29317 38892
Excess over 38892
Annual taxable pay

(shillings)
1
121968
121969 236880
236881 351792
351793 466704
Excess over 466 704
Rates of tax
% in each shilling
10%
15%
20%
25%
30%
Personal relief Sh.162 per month) Sh.13, 944 per annum)

Prescribed benefit of motor vehicles provided by employer
Monthly
Annual
Rates
Rates
(Sh.)
(Sh.)
Capital allowances:
Wear and tear allowances:
Class I
37.5%
Class Ii
30%
(i)
Saloons Hatch Backs and Estates
Class III
25%
Class IV
12.5%
Industrial building allowances:
Upto 1200cc 3,600 43,200
Industrial building
2.5%
1201 - 1500cc 4,200 50,400
Hotels
4.0%
1501 - 1750cc 5,800 69,600
Farm works allowances
33%
1751 - 2000cc 7,200 86,400
2001 - 3000cc 14,400 172,800
2003 70%
2004 100%
2005 100%
(ii)
Pick-ups, panel vans (Unconverted)
Shipping investment allowances
Mining allowance:
Upto 1750cc 3,600 43,200
Year 1
40%
Over 1750cc 4,200 50,400
Year 2-7
10%
(iii)
Land Rovers/Cruisers 7,200 86,400
OR 2% of the initial capital cost of the
vehicle for each month.
Monthly rates
Annual rates
Sh.
Sh.
Services
(i) Electricity (Communal or from a generator)
1,500
18,000
(ii) Water (communal or from a borehole)
500
(iii) Provision of furniture (1% of cost to employer)
(iv) Telephone (Land line and mobile)
30% of bills
Agriculture employees: reduced rates of benefits
(i)
Water
(ii)
Electricity
200
900
2,400
10,800
Other benefits
6,000
77
Other benefits for example, servants, security, staff meals etc are taxable at the higher of fair market value
QUESTION ONE
(a)
The Diffusion Theory and the Demand Supply Theory are two of the many theories
advanced to explain the nature of tax incidence.
Analyse the key provisions and assumptions of each of these two theories. (8 marks)
(b)
Malipo General Insurance Company Limited has provided the following details with respect
to its financial year ended 31 December 2005.
Sh.
Gross premium
19,000,000
Claims paid
5,400,000
Claims outstanding:
1 January 2005
740,000
31 December 2005
1,640,000
Claims recovered on reinsurance`
400,000
Legal expenses relating to claims
Commission of reinsurance accepted
Commission on reinsurance ceded
Reserve for unexpired risks:
1 January 2005
Agency expenses
Bad debts
Investment income
Life insurance fund
Depreciation
Foreign exchange gains
Dividends from life assurance e fund
Management salaries
Bonus utilized in r4eduction of premium
Rental income on premises
Repair or rented premises
Advertisement expense
Purchase of furniture
Returned premium
Reinsurance premium paid
540,000
2,800,000
860,000
980,000
1,560,000
450,000
890,000
1,540,000
630,000
420,000
180,000
1,670,000
425,000
1,260,000
280,000
124,000
120,000
1,230,000
670,000
2.
The company acquired a saloon car for the General Manager for Sh. 2,000,000 on 1 July
2005.
3.
Bad debts relate to compensation due from a reinsurance company under receivership.
4.
Management salaries include wages amounting to Sh 670,000 for part-time employees
working in the life assurance department,
Required:
(i)
Taxable profit or loss for Malipo General Company Limited for the year ended 31 December
2005.
(10 marks)
(ii)
Tax payable (if any) from the profit or loss computed in (i) above. (2 marks)
(Total 20 marks)
QUESTION TWO
TAXATION II
78
Jared Kimutai and Peter Wakoli have been trading in partnership as Kimwa Enterprises for the
past ten years. The business was converted into a private limited liability company, Mwanzo Ltd,
on 1 October 2005 with the partners becoming the directors of the new company.
The following details were availed to you to assist in the filing of tax returns for the financial year
ended 31 December 2005.
Income
Sales
Rental income
Dividend income
Miscellaneous receipts (taxable)
Gains on forward contracts
Interest on deposits with a foreign bank
Profit on sale of motor vehicle
Total income
Less expense:
Cost of goods sold
Registration of patents
Design of business website
Acquisition of computer hardware
Directors fees
Partners salaries:
J. Kimutai
P. Wakoli
Audit fees (statutory)
Insurance
Purchase on machinery
J. Kimutai
P. Wakoli
Stamp duty paid to the Registrar of Companies
Good will written off
Bank charges
Corporation tax (installment): year 2005
Repair to machinery
Purchase of telephone equipment
Legal fees
Sh.
Sh.
3,600,000
720,000
560,000
150,000
64,000
45,000
36,000
5,175,000
700,000
40,000
72,000
106,000
640,000
150,000
180,000
30,000
300,000
500,000
100,000
150,000
24,000
16,000
25,000
185,000
18,200
54,000
170,000
Gifts to employees
62,000
Compensation paid to an injured employee while on duty
40,000
Drawings of goods
195,000
Donations to charitable trusts
30,000
Loans to employees written off
38,200
Costs of relocating to new premises
76,800
Redundancy payments to employees
182,000
Investment seminar for retired employees
26,500
Depreciation
85,000
4,229,000
Net profit
946,000
1.
2.
3.
No entries were made to close the books of the partnership on 1 October 2005.
The directors retained the controlling interest they had as partners.
Insurance comprises:
4.
5.
6.
7.
8.
9.
79
Sh.
Insurance cover for imported machinery against loss at sea
100,000
Insurance cover for business premises
200,000
Legal fees include Sh.20,000 incurred on drafting a loan agreement between Mwanzo Ltd. and a
bank.
Drawings of goods comprise:
Sh.
Goods consumed by partners
45,000
Goods consumed by directors 150,000
Cost of goods sold includes carriage costs of a machinery to he business premises amounting to
Sh.32,000.
Closing stock was undervalued by Sh.18,000 on 31 December 2005. This comprised stock
purchased before and after conversion of the partnership into a company.
Dividend income was received by Mwanzo Ltd, from its investment in shares.
All income and expenses, including redundancy payments to employees are assumed to have
accrued evenly throughout the year where otherwise specified.
Required:
(a)
Prepare a statement of adjusted taxable profit of loss for the partnership and for the company for
the year ended 31 December 2005.
(14 marks)
(Hint: start with the sales figure)
(b)
Allocate the partnership profit or loss between the partners.
(4 marks)
(c)
Determine the payable (if any) by Mr. J. Kimutai and Mr. P. Wakoli for the year ended 31
December 2005.
(2 Marks)
(Total 20 marks)
QUESTION THREE
(a)
The Kenya Revenue Authority (KRA) is geared towards a function-based organization rather than
one structured along the types of taxes. This is evidenced by the integration of VAT, Income Tax
and Excise departments into the Domestic Department.
(b)
Asses the likely benefits and drawbacks to KRA arising from this integration.
(4 marks).
Zawadi Ltd is a Nakuru based company dealing in a variety of VAT designated goods. The
following transactions were recorded for the month of September 2006:
September
1:
5:
8:
9:
12:
15:
16:
16:
18:
20:
22:
27:
Opening stock 8,000 units valued at Sh.576,000.

Imported 10,000 units at Sh.80 per unit being cost, insurance and freight (CIF).
Purchased 5,000 units from the local market at Sh.60 per unit.
sold 6,000 units at sh.90 per unit
Purchased a motor vehicle for Sh.400,000 for use in the business
Paid Sh.10,000 for photocopy and printing of office documents.
Purchased oil filters and lubricants for use in the factory for Sh60,000.
Paid an invoice for Sh.70,000 in respect of fuel for company vehicles. The fuel
had been used in August 2006.
Supplied 3,000 units to a department in the Ministry of Finance at a price of
Sh.90 per unit.
Sold 2,000 units at Sh.85 per unit to a company in Uganda.
Purchased on credit 2,500 units locally at Sh.80 per unit, before deducting a case
discount of 5%.
Paid electricity expense of Sh.15,000 and telephone expense of Sh.9,000.
TAXATION II
80
The amounts stated above are inclusive of VAT at the rate if 16% where applicable, unless otherwise
specified. Assume the rate of import duty is 20%.
Required:
The VAT account for the year month of September 2006.
(10 marks)
( Total: 20 marks)
QUESTION FOUR
i.
ii.
The income Tax Act (Cap.470) grants the Commissioner General the power to effect the
recovery of unpaid taxes.
Outline three ways through which the commissioner General my exercise this power.
marks)
10.
(6
Kamare Ltd. commenced manufacturing operations on 1 January 2003. The management of the
company has prepared the following financial statements for the year ended 31 December
2005:
Balance sheet as at 31 December 2005:
Sh.
Sh.
Non-current assets:
Factory building
8,600,000
Motor vehicles
2,500,000
Machinery
5,400,000
Computers
900,000
360,000
17,760,000
Current assets:
Stock
840,000
Trade debtors
360,000
Cash at bank
780,000
1,980,000
19,740,000
Financed by:
Ordinary share capital of Sh.20 each
10,000,000
Profit and loss account
1,500,000
Loan
10% debenture stock (issued
1 January 2003)
Current liabilities
Trade creditors
Bank overdraft
2,500,000
3,000,000
2,000,00
740,000
0
2,740,000
19,740,000
Profit and loss account for the year ended 31 December 2005:
Sh.
Gross sales
Less expense
Administration expenses
Depreciation
Subscriptions to the chamber of Commerce
Sh.
12,000,000
364,000
321,000
425,000
100,000
81
Hire purchase interest

Annual lease payment for a 99 year lease
Reported profit
36,000
87,000
1,333,000
10,667,000
1. Non-current assets are stated net of depreciation including for year 2005. \It is the policy of he
company to charge depreciation at 20% per annum on a straight line method
2. The company had not claimed allowances since it commenced operations.
3. The companys has not claimed capital allowances since it commenced operations.
4. The companys reported taxable profits for the year ended 31 December 2003 and 2004 were
Sh.8,00,000 and Sh.6,400,000 respectively.
5. Factory building includes an extension to the factory constructed art a cost of sh.1,600,000 which
was put into use on 1 January 2005.
6. Machinery include a generator and conveyor belts bought for Sh.1,400,000 and Sh.800,000
respectively. These were put in use on 1 January 2005.
7. Motor vehicles include a forklift purchased in year 2003 at Sh1,160,000.
8. A saloon car purchased in years 2004 at Sh.1,200,000 was disposed of during he year 2005 for
Sh.600,000 n\o adjustments have been made to record this disposal.
9. The loan was received on 1 January 2005 and is subject to interest at eh rate of 8% per annum.
Required:
(i)
Capital allowances due to Kamere Ltd. for each of he three years ended 31 December 2003, 2004
and 2005.
(10 marks)
(ii)
Adjusted taxable profit or loss for the company in each of the three years above. (4 marks)
(Total: 20 marks)
QUESTION FIVE
(a)
Explain the circumstances under which a tax authority may conduct a PAYE audit on a business.
(8 marks)
(b)
With reference to decided cases on tax, comment on the tax treatment of payments received or
cancellation of a business contract.
(4 Marks)
(c)
(i)
State the key provisions of section 19 of he Income Tax Act (Cap.470) relating to
the taxation of savings and credit cooperative societies (SACCOS). (4 marks)
(ii)
Makazi Savings and Credit Cooperative Society (Sacco) Ltd. reported the following
incomes and expenditure for he year ended 31 December 2005:
Income:
Interest on loans to members
Interest on savings accounts
Interest on fixed deposit accounts
Other investment income
Rental income
Total income
Sh.
1,500,000
30,000
400,000
12,000
600,000
2,242,000
Expenditure
Surplus
300,000
1,942,000
Required:
The taxable profit of Makazi Sacco Ltd. for the year ended 31 December 2005.
TAXATION II
(4 Mark)
82
(Total: 20 marks)
83
ANSWERS- PAST PAPERS
JULY 2000
QUESTION ONE
(a)
J.T Ltd
Taxable Income for year ended 31 December 1999
Sh.000
Net loss reported
Add: disallowable expenses
Donations Barnados Home
Depreciation
Legal expenses letters of authentication
Purchase of directors private house
Rent, rates and taxes instalment tax
General expenses renovations to old factory
Deduct non-taxable income and other expenses
allowable
Profit on exchange not realized
Profit on sale of shares capital profit
Dividends assume withholding tax final
Interest foreign income
Directors fees omitted
Bad debts specific and actual bad
debts reduced (154 + 146)
By fall in general provision
Capital allowances see workings (1)
Net loss for year (c/f)
(b)
20
916
25
25
421
1,000
Sh.000
2,128.5
2,407
4,535.5
120
77
100
150
6,000
300
1,990
8,737
(4,201.5)
Instalment tax is payable during the year under consideration as follows:

1st instalment by 20th of 4th month (i.e 20th April 1999);
2nd instalment by 20th of 6th month (i.e 20th June 1999);
3rd instalment by 20th of 9th month (i.e 20th September 1999);
4th instalment by 20th of 12th month (i.e 20th December 1999).
5th or final instalment by end of 4 month after accounting year i.e. 30 th April 2000.
Workings:
1.
Industrial Building Deduction

Nature of
building
Old factory
Renovation
Q.Cost
Sh. 000
1,200*
1,000
Res. B/fwd
Sh.000
1,020*
Nil
4,000,000 (70% x 4,000,000) = 1,200,000
TAXATION II
IBD @ 5%
Sh.000
60
25
85
Res. C/fwd
Sh.000
1,140
975
84
1,200,000
1,200,000
20 yrs x3
= 180
85
Wear and Tear Allowance

Class
WDV 1 Jan
1999
WTA 1999
WDV
31/12/1999
I @ 37
Sh.000
4,500
(1,687.5)
2,812.5
II @ 30%
Sh.000
500
150
350
III @ 25%
Sh.000
160
(40)
120
IV @ 12%
Sh.000
220
(27.5)
192.5
Summary of Capital Allowances:

IBD
WTA
Sh.000
85
1,905
1,990
Notes and assumptions

It is assumed that the Commissioner Income Tax accepted the application for a 20 year life for the
industrial building (5% p.a. IBD).
Half year IBD on renovation is provided since the building was used from 1 st July 1999
6
(1,000 x 5% x
)
12
Profit on exchange is not yet realized hence not taxable.
Profit on sale of shares is capital profit not taxable
Dividend income is assumed qualifying type hence withholding tax is final tax.
Interest income is foreign income not taxable.
With effect from 1st January 2003, the 1st installment is payable by 20th day of 4th month while
amount of contribution to a registered scheme by an employee is the actual amount.
Renovations qualify for IBD only.
QUESTION TWO
Mr. Sacrodina and Wives
First 5 months Mwangaza Ltd
Ksh000
Salary 42,000 x 20 x 5/12
Company car: Higher of
86,400 x 5/12 = 36,000
2% x 1,000,000 x 5 months = 100,000
350.00
100.00
Housing benefit: 30,000 x 5

Less rent paid = 5% x 350
Less H.O.S.P: less of
Set limit = 48,000 x 5/12 = 20,000
Actual amount = 10% x 350,000 = 35,000
150.0
(17.5)
132.50
(20.00)
_____
562.50
Total employment income

Last 7 months Kusadikika Ltd
Salary 1,200,000 x 7/12
Bills paid by employer
700.00
TAXATION II
86
Grocery bill
Telephone
Electricity
School fees
Less owner occupied interests (w1)
Free shares 16,000 x 20
Wifes salary from nursing home
Farming income Rose
Gross non-qualifying dividends Magdarina
30.00
24.00
36.00
100.00
(41.67)
320.00
640.00
140.00
35,000
0.85
41.18
1,989.51
Total income for the year = 562.5 + 1,989.51
2,552.01
Wives income assessed separately

Rose Carey
Income from West Drapers
Periodic pension (200,000 150,000)
Less provident fund contributions: lower of
(i) Actual amount 170,000
(ii) set limit
210,000
(iii) 30% x 400,000 = 120,000
Total taxable income
Magdarina Kahemba
Salary
Life insurance
Year end bonus
Pensionable pay
Add Housing benefit 15% x 820,000 = 123,000
Less rent paid 8,000 x 12
= 96,000
400,000.00
50,000.00
(120,000.00
)
330,000.00
720,000.00
65,000.00
35,000.00
820,000.00
_27,000.00
847,000.00
Tax liability
Mr. Sacrodina KSh.2,552,010
First Ksh. 121,968 @ 10%
Next Ksh. 114,912 @ (15 + 20% + 25%)
Surplus (Ksh.2,552,010 466,704) @ 30%
Gross tax liability
Less Personal relief
PAYE: Self
Wife (Rose)
W/T on non-qualifying dividends
15% x Sh. 41,180
Net tax liability
12,196.8
68,947.2
625,591.8
706,735.8
13,944
328,000
128,000
6,177
Rose Carey on Ksh. 330,000

First Ksh.121,968 @ 10%
Next Ksh.114,912 @ 15%
(476,121.0)
230,614.8
12,196.8
17,236.8
87
Surplus (Ksh.330,000 236,880) @ 20%

Gross
Less personal relief
Next tax liability
18,624.0
48,057.6
(13,944.0)
34,113.6
Magdarena on Ksh.847,000
First Ksh. 121,968 @ 10%
Next Ksh. 114,912 @ (15% + 20% + 25%)
Surplus (Ksh.847,000 466,704) @ 30% =
12,196.8
68,947.2
114,088.8
195,232.8
(13,944.0)
(180,000.0)
1,288.8

Double taxation relief 15,000 x 12
Net tax liability
Notes & Assumptions:
1.
2.
3.
4.
5.
6.
7.
Medical cover is for all employees hence benefit not chargeable on Katumbi.
Low interest benefit on loan attracts Fringe Benefit Tax payable by employer.
Dividends for Rose Carey (1st wife) is subject to withholding tax as final tax.
The first 7,500 of pension to Rose Carey is exempt from taxation.
It has been assumed that Magdarina Kahemba (2nd wife) did set foot in Kenya in the year under
consideration hence was resident. Consequently double tax relief is taken to be the lower of tax
paid in Botswana on her employment income and increase in Kenya tax liability resulting from
inclusion of Botswana income in computation of Kenyan tax.
Dividends to Magdarina Kahemba is the non-qualifying type hence grossed up for further
taxation. Relief is granted by way of set off of withholding tax on the dividends.
Magdarina rent income is from outside Kenya hence not taxable in Kenya.
Workings
Mortgage Interest
Lower of
(a) Actual interest paid
5
x3,600,000 x5% 75,000
12
(b) Maximum Allowable Limit

5
x100,000 41,677
12
Note: However, with effect from 01/01/06, the allowable mortgate interest rate has been increased to
Kshs. 150,000. Had this been used, the allowable mortgate interest rae would have been the lower of:
(a) 75,000 (see above)
(b)
5
x150,000 62,500
12
TAXATION II
88
QUESTION THREE
(a)
Response to Value Added Tax Matters Raised
1.
Registration for VAT

Who qualifies for Registration?
For a person to qualify for registration he must have attained or expect to attain a taxable turnover of
KSh. 3,000,000 p.a.
Such a person must apply for registration voluntarily, but if he fails to do so, the Commissioner will
register him compulsorily retrogressively from the date he became registrable in which case he loses his
right to claim input tax relief besides being subjected to a hefty penalty of Ksh.100,000.
There are other cases of registration without turnover limits. These include:
-
2.
Designated persons who deal in designated jewelry, pre-recorded music and timber.
Saw millers
Persons who sell four or more motor vehicles in any one year
Persons who deal in motor vehicle parts and accessories.
Persons who deal in household or domestic electric or electronic appliances and apparatus
Designated services contained in part II of the Fourth Schedule of the VAT Act which include:
Accounting services including any type of auditing, bookkeeping and similar services.
Legal and arbitration services including any services supplied in connection therewith
Services supplied by auctioneers, estate agents and valuers.
Clearing and forwarding services.
VAT in Budgets and Final Accounts
The VAT content of your income and expenditure must be reported separately by maintaining the
VAT account and separate accounts for sales and purchases. The budgets in turn will reflect.
VAT on income is reflected as output tax while on expenditure as input tax. The sales and
purchases accounts are shown net of VAT.
3.
When and How VAT is accounted to Commissioner VAT

Once a person, is registered he is required to charge, collect and account for VAT on all his
taxable operations and remit the tax to the Commissioner. All registered persons are legally
bound to submit monthly returns (VAT 3s) containing details of tax on goods charged to his
customers (output tax) and tax suffered on goods and services charged by his suppliers (input
tax).
Whenever you make a taxable supply the supply is your output and the tax you charged is
your output tax. If you purchase taxable supplies for furtherance of your business the supply
is your input and the tax you pay is your input tax.
At monthly intervals on your VAT returns (VAT 3s) you subtract your input tax attributable
to taxable supplies from your output tax and pay the difference to the Commissioner of VAT.
If your tax is greater than your output tax you carry the difference as a credit to your next
VAT return.
Pay VAT using a bankers cheque addressed to the Commissioner VAT.
When a registered person provides both taxable and exempt supplies the input tax that is not
directly attributable to the former is apportioned.
VAT payable is due by the 20th day of the following month i.e the month following one in
which the VAT is charged. Should the 20 th day of the following month fall on a Saturday,
89
Sunday or public holiday then the VAT due is to be remitted to the CVAT by the last working
day before each such holiday.
4.
5.
-
Excess Input Tax

Should your business pay out more VAT than charged then the excess input tax can be carried
and credited to your next VAT return. In certain circumstances you may be refunded the excess of
your input tax over output tax if the commissioner is satisfied that such excess arises from:
making zero rated supplies; or
physical capital investments where input tax deducted exceeds one million shillings. Provided that
the investments are used in making taxable supplies.
Where input tax is in excess of output tax and this is a common feature to the business then a refund
is due from the Commissioner VAT.
Records to be kept to satisfy VAT regulations
Copies of all invoices in serial number order.
VAT account showing tax payable
Credit and debit notices issued and received in chronological order
Purchase invoices, copies of customs entries, receipts for payment of duty, or tax.
Details of tax charged on each supply made or received
Details of goods manufactured and delivered from the factory
Details of each supply of goods and services from business premises
Relevant correspondences
All ledgers and cash books.
Note:
Records must be kept for 5 years.
6.
Comment and advise on the VAT position of cases raised

Compulsory registration applies to a person who attains or expects to attain a taxable turnover
of Ksh. 3,000,000 p.a.
Basil is a consultant and as such his registration for VAT is not subject to turnover limits.
Thus he should register for VAT. It is also illegal for him to be charging output VAT on his
customers having not registered.
To enable him to claim input tax
To enjoy soft loan (VAT collected not yet remitted) where VAT was charged to customers on
cash basis.
To attract customers who equally make supplies of taxable goods or services.
John supplies exempt supplies and consequently:
He need not register for VAT;
Input tax in relation to exempt supplies is not claimable;
Exempt supplies are not taxable supplies.
On the other hand, Jane supplying zero-rated goods:
Needs to register for VAT;
Can therefore claim input tax related to zero-rated supplies when she charges VAT at zero
rate.
Zero-rate supplies are regarded taxable supplies.
Where a person is related to another and owns or controls more than one business entity, the
value of taxable supplies for purposes of registration is the aggregate value of the taxable supplies
of all the business entities, i.e.
TAXATION II
90
Martins turnover (1 year)

Add: Mollys turnover
Sh.000
2,500
1,500
4,000
Therefore turnover of 4 million for a twelve month period will necessitate that the two register for VAT.
Supply of taxable goods by a taxable person in Kenya will attract value added tax. Purchase in Kenya of
services in Kenya is taxable at the standard rate while manufacturing goods exported to Uganda would be
zero-rated. Since the services purchased in Kenya relate to exported manufactured goods, input suffered
thereof is claimable.
A person may apply to be deregistered for VAT purposes where taxable turnover of goods or services
handled in a period of 12 months does not exceed three million shillings and turnover is not expected to
increase in the next 12 months period. If the Commissioner VAT is satisfied that the trader should be
deregistered he will do so from the date when that person pays tax due in respect of goods and materials
on which tax has not been paid or input tax has been claimed.
The above can be properly put as:
If they were to register; this would enable them to
(a) Claim input tax on their supplies.
(b) Avoid penalties for non-registration.
(c) Avoid penalties for late registration.
QUESTION FOUR
(a)
Saambaya & Associates

Certified Public Accountants
P.O. Box X2222
Nairobi
December 5th, 1999
Client
P O Box X3333
Nairobi
Dear Sir,
Re: Back Duty Investigation
The following write up in response to queries raised by you with respect to the above subject
matter.
(i)
The obligation to declare all incomes for tax purposes rests with the person liable to pay tax (tax
payer) whether or not he has been specifically told to do so by the Income Tax Department.
Yours is a case of under declaration of income for a number of years and the following
information may have been received by the assessor regarding your affairs:
Reference was made to your PIN (personal Identification Number) records and this may have
revealed discontinued disclosure of incomes from certain sources;
91
You may have consistently done business promotions through the public media regarding a
business line but have consistently not declared any income from such source;
You did register a business at the Registrar Generals office but have not made return of such
income.
You may have been in receipt of farming income from a farming organization and such
information has landed in the assessors hands through informers.
(ii)
The income tax department may take into consideration the following circumstances of your case
in accepting a payment of less than the full amount due:
The assistance (co-operation) you give to the revenue officials in arriving at the income underdeclared;
The degree of deliberation carrying out of the fraud or omission/motive for false declarations.
Whether or not payment of additional tax arrived at in the back duty investigation will cripple
your business financial position.
Defaulters circumstances during period of omissions such as age and health and whether or not a
voluntary declaration had been made by the tax payer.
Yours faithfully,
Michael Odutu
Partner
(b)
Sophia (client)
(i)
Capital Statements
Year of income
Net assets:
Beginning
End year
Add: Personal drawings
Tax & National Insurance
Cash gifts
Deduct: Legacy
(ii)
1996
Sh.000
5.5
16.3
10.8
3.14
0.105
7.555
1997
Sh.000
16.3
33.02
16.72
5.2
0.12
2.00
(7)
17.04
1998
Sh.000
33.02
44.585
11.565
6.24
0.525
12
(7)
23.33
1999
Sh.000
44.585
57.272
12.687
9.8
2.42
(7)
17.907
Factors the assessor will take into account in negotiating penalties and interest charges
Gross or willful negligence on the part of the tax payer or his accountant;
Fraud on part of taxpayer
Number of years involved (year of non/under declaration)
Level of co-operation from the taxpayer under investigation
Whether or not a quasi voluntary declaration was made by the taxpayer.
Motive of non-declaration of income
Whether such payment of additional tax plus penalties and interest charges will affect adversely the
taxpayers financial position.
TAXATION II
92
QUESTION FIVE
(a)
Wanda
Report on Taxation of Foreign Income, Deductibility of Expenditure

(i)
Taxation of Foreign Income
Income tax is tax on income and is 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.
That a Kenyan resident is chargeable to tax on the whole of his business income even if this is earned
partly inside and partly outside Kenya, Sec.4 (a).
That a Kenyan resident is chargeable to tax on the whole of his income from employment for services
rendered whether earned inside or outside Kenya, Sec.5 (i) (a).
(ii)
93
Deductibility of Expenditure
Employee
Allowable Deductions (Sec.15)
Cost of running and maintaining a car
which enables him to perform duties.
Travelling expenses if necessary in the
performance of duties;
The direct extra cost of living away from
home necessitated by the employment.
Self-Employed Persons
Generally expenses are allowed only if
incurred wholly and exclusively in the
production of income Sec.15 (i).
Expenses specifically allowed by the Act
include:
Bad debts written off and in practice those
specifically provided for.
Capital allowances
Cost of tools and implements, special

clothing where employee provides his
own.
Note that the above-mentioned expenses
are deductible against employment
income where they deductible against
employment income where they are not
reimbursed by the employer.
Disallowable Expenditure
Travelling costs from home to workplace.
Legal expenses and stamp duties in

connection with the acquisition of a lease
not exceeding 99 years.
Expenses incurred prior to
commencement of business where these
would have been deductible if incurred
after the date of commencement.
Cost of books are allowable where it
represents replacement of existing or
obsolete books. Cost of initial purchases
will not be deductible.
Cost of normal clothing

Special clothing necessitated by
professional work.
Cost of meals while on duty

Fees to an employment agent to find
employment
Education fees paid by an individual to
improve his employment capability
Professional subscriptions.
A proportion of car expenses and wear

and tear allowance relating to use of own
car for professional work. Cost of travel
to or from work to dwelling house is not
deductible.
Proportion of rent relating to professional
work is deductible.
Professional subscriptions is deductible
against professional income.
Note that personal expenditure for food or
normal clothing is not deductible
Cases Involved:
Profession:
Whether barristers books are Plant: Daphane V Shaw II TC 256, over ruled. Held that the books were
plant.
House to office travel: Ricketts V Colgloum. Held not allowable expense.
Employment
TAXATION II
94
Membership of certain Professional Societies of which is not a condition of his employment: Simpson V
Tate Held: Subscriptions not a deduction from earnings.
fee paid to an employment agency. Short V Mcllegorm: held the fee was not expense incurred
inperforming duties.
(b)
(i)
Customs Clean Report of Finding
This is a report made following a pre-shipment inspection of goods destined for importing country. It
clears goods imported as correct for the purposes of importation, ensures no prohibited goods are
imported and that no dumping of sub-standard goods takes place.
(ii)
Specific measures under Customs & Excise Act Designated to prevent dumping in Kenya.
(iii)
Establishment of the Advisory Committee to recommend to the Minister the imposition of

anti-dumping or countervailing measures on investigated products imported into Kenya.
Prohibitions and restrictions on certain imports as per the law in force from time to time.
Preshipment inspect done by qualified and reputable inspection firms and institution of
regular off-shore inspections.
Collusion between customs officers and importers are policed strictly and heavily penalized.
Levying of a definite anti-dumping or countervailing duty on investigated products.
Circumstances under which the Commissioner of Customs and Excise may remit Excise Duty
The minister may, by order in the Gazette, remit in whole or in part duty payable by any person on
goods, aircraft, vessels or vehicles imported by that person if he is satisfied that it is in the public
interest to do so. Remission shall apply in respect of:
Such other goods, including passenger motor vehicles and computers (excluding passenger motor
vehicles of a seating capacity of up to twenty six persons, building materials audio and audio visual
electronic equipment, spare parts, edible vegetable fats and oils, office equipment, stationery, office
furniture, textiles, new and used clothing, footwear, maize, wheat, sugar, milk and rice) donated or
purchased for donation by any person to non-profit making organizations or institutions approved by
the Government, for their official use or for free distribution to poor and needy persons, or for use in
medical treatment, educational, religious or rehabilitation work or for other Government approved
projects.
Raw materials for use in the manufacture of insecticides, fungicides and similar products, including
component parts used in the manufacture of agricultural and horticultural equipment.
Capital equipment and machinery imported solely for use in the manufacture of goods in a licenced
customs bonded factory for export only.
Goods, including motor vehicles and aircraft imported o purchased by any company which has been
granted an oil exploration or oil prospecting licence in accordance with a production sharing contract
with the Government of Kenya and in accordance with the provisions of the Petroleum (Exploration
and Production) Act.
Official aid funded projects, subject to a security being given to the commissioner in accordance with
the laws where the project is being executed by a contractor other than the official aid funded agency.
Provided that an exemption under this paragraph shall not apply to spare parts, equipment machinery,
materials or motor vehicles in respect of any agreement between the Government and an aid agency
entered into after the 1st January 2003.
95
DECEMBER 2000
QUESTION ONE
(a)
Hongera
Total assets
Total liabilities
Increase/(decrease)
Add: Cash drawings
Less: Bank interest
Interest personal savings
Insurance recovery
Add cash defrauded
Less: Mortgage interest
Wear & Tear
Adjusted income
1995
3,030,00
0
650,00
0
2,380,00
0
-
1996
3,250,000
555,000
2,695,000
315,000
288,000
(21,000)
(7,000)
80,000
(100,000)
(124,589)
430,441
1997
3,490,000
4,015,000
(525,000)
(3,220,000)
345,600
(20,300)
(10,500)
(100,000)
(104,641)
(3,109,841)
1998
3,830,000
4,570,000
(740,000))
(215,000)
414,720
(17,500)
(13,300)
(70,000)
60,000
(100,000)
(128,451)
(69,531)
1999
3,730,000
5,300,000
(1,570,000
)
(830,000)
497,664
(14,000)
(15,400)
(150,000)
(98,635)
(610,371)
Note:
The owner is entitled to occupied mortgage interest of Sh.100,000 p.a. (Sh. 150,000 w.e.f 1/1/2006)
(b)
Hongera should invite registered and qualified valuer to value the inherited house
which shall be taken as an additional asset to increase taxable income.
2.
A valuation and open market value of the vehicles should be done as at 1 Jan 1995, a
suitable basis of depreciation should be established so that wear and tear on the vehicle
can be calculated otherwise should be included.
3.
The issue relating to investment shall require the following details:

-
The market value of investment as at date of disposal

The rate of interest.
4.
Additions and disposal of fixtures and fittings and computers should begin for purposes
of capital allowances.
5.
If the stock was insured, valuation of the stock would be necessary so as to assess the
damage for compensation. Any such loss is allowable for tax purposes.
6.
Any interest on bank overdraft should be disclosed.
7.
Interest payable on his brothers loan and rate should be deducted from income estimated
TAXATION II
96
WDV b/f 1.1.95

Additional furniture
Computer
Less Wear & Tear
WDV c/d 31.12.95
WDV b/f 1.1.96
Additional Int.
Less: Disposal
Less Wear & Tear
WDV c/d 31.12.96
WDV b/d 31.12.97
Additional furniture
Less wear & tear
W.D.V c/d
W.D.V b/f 1.1.98
Additional computer
Less wear & tear
W.D.V c/d 31.12.98
WDV b/d 1.1.98
Less Wear & Tear
W.D.V c/d 31.12.98
Class II
30%
Nil
150,000
150,000
(45,000)
105,000
105,000
105,000
105,000
31,500
73,500
73,500
75,000
(22,500)
52,500
52,500
60,750
202,500
60,750
141,750
141,750
42,525
99,225
Class III
25%
237,305
237,305
(59,326)
177,979
177,979
177,979
177,979
44,495
133,484
133,484
133,484
33,371
100,113
100,113
100,113
25,028
75,085
75,085
18,771
56,314
Class IV
12%
Nil
490,000
490,000
(65,576)
428,750
428,750
428,750
40,000
388,700
48,594
340,156
340,156
50,000
390,156
48,770
341,386
341,386
341,386
42,673
298,712
298,712
37,339
261,373
97
QUESTION TWO
(a)
Joab Income Tax Computation

Employment
Salary
Bonus
Employer Contribution to pension approved
Employer contribution to pension unapproved
Life insurance premium
House servant higher of
(i) Fixed benefit of Sh.18,000
(ii) Actual salary 2000 p.m x 12 = 24,000
Motor car: Higher of:
(i) Fixed benefit on 1750 cc = 69,600
(ii) 2% p.m x 2,500,000 x 12 = 600,000
Other incomes
Dividend from society (W1)
Interest on HFCK bonds
H. Benefit = higher of
(i) 15% x 2,814,940 = 422,241
(ii) Rent 20,000 p.m x 12 = 240,000
Wifes income
Salary
Sick leave
Employer contribution to medical
Less: rent paid 5% x 805,000
Total income
Tax liability
Ksh. P.a.
805,000
265,000
68,000
24,000
600,000
52,940
1,000,000
2,814,940
422,241
360,000
48,000
250,000
First Ksh. 121,968 @ 10%

Next Ksh. 114,912 @ (15% + 20% + 25%)
Surplus Ksh.(3,854,931 466,704) @ 30%
Less: tax set-offs
PAYE salary
Bonus
Wifes salary
W/T on dividends = 52,940 45,000
P/relief
Net tax liability
658,000
(40,250)
3,854,931
12,196.8
68,947.2
1,016,486.1
1,097,612.1
185,000
45,000
85,000
7,940
13,944
(336,884.0)
760,728.1
Notes:
1.
Dividend from home-based co-op society is non-qualifying dividends hence W/T is 15%. The
gross income =
2.
45,000
0.85
52,940
Mr. Joab is not a whole time service director. His housing benefit is based on total income from
all sources. He owns 13.3%
40,000
which is greater than 12.5% of shares of the firm. The
300,000
wife holds 28% of shares of Atex hence her income is assessed on husbands income.
TAXATION II
98
3.
Interest from HFCK the 1st Sh.300,000 suffers 10% W/T which is final and any surplus is taxed
on graduated scale.
(b)
(i)
The loss from retail shop of 22,000 + 48,000 = 70,000 will be carried forward to be offset
against income from same source.
(ii)
Interest from POSB - exempt
(iii)
Interest from bank W/T is final
(iv)
Lottery and sweepstake non-taxable income
(v)
Pension contribution to approved and unapproved schemes non-taxable benefit.
(vi)
Dividend from KCB 5% W/T final
(vii)
Pension from previous employer the 1st lumpsum income of Ksh.360,000 exempt with
effect from 1st Jan. 2004 Ksh.480,000 lumpsum pension income is exempt.
QUESTION THREE
Net profit
Add back:
Goodwill W/o
Depreciation
Interest on overdue tax
Donation
Purchase of Equipment
Preliminary expenses
Gross income (a)
Less:
Transfer of goods
(i)
Sale of land
(ii)
Buildings gain and a/c (ii)
Shares disposal
Bonus shares
VAT on lost stocks
(iii)
Interest from commercial bank
Interest on treasury bills
Total expenses
Tax payable
KK Ltd
22,685,000
VK
10,155,000
20,000
230,000
180,000
3,500,000
150,000
26,765,000
120,000
23,000
70,000
80,000
10,448,000
181,818
350,000
50,000
250,000
330,000
1,161,818
37.5% x 1161818 =
435,682
45,455
300,000
10,000
225,000
110,000
200,000
890,455
30% x 890,455 = 267,137
Workings:
(i)
Transfer from KK Ltd @ 10% above cost i.e 110%

2,000,000
x100 181,819
Mark-up = 2,000,000
110 %
500,000
x100 45,455
Transfer to parent mark-up = 500,000
110 %
(ii)
(iii)
Gain on sale of land on non-business income (capital gains). This also applies to gain on sale of
building.
VAT = 15% x 2,200,000 = 330,000 and 15% x 1,500,000 = 225,000
(iv)
KK is a non-resident company hence taxed at 37.5% rate.
99
QUESTION FOUR
(a)
Refer to December 1999 Question One (a) Solution
(b)
Tax liability on Kenyan Income

Kshs.
Consultancy fees
Employment income
Total Kenyan income
2,000,000
900,000
1,020,000
1,020,000
3,920,000
Kenyan income
Canadian Income
3,920,000
5,000,000
Total Kenyan and foreign income
8,920,000
Housing benefits 85,000 x 12
Tax on Kenyan and foreign income of Sh.8,920,000

1st Ksh. 121,968 @ 10%
next 114,912 @ (15% + 20% + 25%)
(8,920,000 466,704) @ 30%
12,196.8
68,947.2
2,535,988.8
2,617,132.8
Less tax on Kenyan income only of Sh.3,920,000

1st Ksh.121,968 @ 10%
next 114,912 @ (15% + 20% + 25%)
(3,920,000 466,704) @ 30%
12,196.8
68,947.2
1,035,988.8
1,117,132.8
Kenyan tax on foreign income

Foreign tax on foreign income
Double taxation relief (lower of the two)
Total tax liability
Less:
Double taxation relief
PAYE
Personal relief
Net tax liability
(c)
1,500,000.0
400,000.0
400,000.0
2,617,132.8
(400,000.0)
(220,000.0)
(13,944.0
)
1,983,188.8
Double taxation for non-resident only pay taxes on specified incomes earned to Kenya at special
rates.
Dont pay taxes on foreign income. Thus double tax relief does not apply.
TAXATION II
100
QUESTION FIVE
(a)
(b)
VAT on illegal good

Since he is registered for VAT, he should change VAT on all his sales irrespective of the source
whether he has paid input tax on his purchases (for legal supplies) or not (for illegal purchases).
There will be no distinction between the source of his purchases for as long as his business deals
in the taxable supplies (spare parts)
Input Tax
Purchases
Date
4/1/2000
3/4/2000
29/7/2000
15/5/2000
Output Tax
Date
6/5
15/5
3/8
Purchase
Input Tax
5,000,000 x 16%
500,000 x Nil
10,000,000 x 16%
Credit on Kamau 3,000 x
16%
800,000
Nil
1,600,000
48,000
Sales
150,000 x 16%
300,000 x 16%
600,000 x 16%
Refund
Output Tax
24,000
48,000
96,000
2,448,000
168,000
2,280,000
Note:
(i)
Although 16% VAT rate has been consistently used the examiner had the following in mind:
on imported spare parts import duty should have been imposed before VAT. However, no rate of
duty was given.
The year 2000 budget was read on 14/7/2000. Before this date VAT rate of 15% should be used
and after this date, the VAT, which takes effects immediately was increased to 18%.
(ii)
The gain on sale is a capital gain hence not taxable. It doest not mater that the car sold was
stolen.
101
JUNE 2001
QUESTION ONE
(a)
Four types of losses:
Investment losses disallowable

Foreign exchange losses allowable if realized
Business losses allowable
Farming losses - allowable
(b)
(2)
(1)
Investment deduction (1999 only)

Nature of asset
Q.Cost
I.D @ 100%
Processing plant
Processing machine
8,000,000
2,700,000
8,000,000
2,700,000
10,700,000
Residual for WTA

and IBD
-
Diminution in value of loose tools and implements @ 33% p.a.

Items
Tools & Implements
i.e 1999 316,667
2000 316,667
(3)
Q.Cost
950,000
Diminution @ 33% p.a.

316,667
Industrial building deduction

Building
Stores
Labour quarters
Godown
Recreation facility
Sports pavilion
Bridge
Cottages
Parking Lot
Food storage
IBD
1999 = Sh.727,500
2000 = Sh.727,500
Q.Cost
500,000
900,000
1,200,000
600,000
400,000
700,000
10,000,000 @ 4%
2,000,000 @ 4%
3,500,000 @ 4%
IBD @ 2.5%
12,500
22,500
30,000
15,000
10,000
17,500
400,000
80,000
140,000
727,500
Notes:
The total cost of administration office, showroom and retail shop (Sh.3,000,000) is more than 10% of the
cost of construction of building (Sh.14,900,000)
The cottages are hotel building and IBD is at 4% p.a. The parking lot and food storage facilities also
qualify for IBD.
TAXATION II
102
(4)
Wear and Tear allowance

Class
WDV 1:1:99
Fork lift
20 tones lorry
3 saloon cars
Furniture & fittings
Computers
Scanner
Mobile phones
W.T.A 1999
WDV 1:1:2000
W.T.A
WDV 31/12/2000
I@
37.5%
4,500,000
3,000,000
7,500,000
(2,812,500)
4,687,500
(1,757,812.5)
2,929,687.5
II @
30%
300,000
100,000
130,000
530,000
(159,000)
371,000
(111,300)
259,700
III @
25%
3,000,000
3,000,000
(750,000)
2,250,000
(562,500)
1,687,500
IV @
12.5%
120,000
120,000
(15,000)
105,000
(13,125)
91,875
Summary
Year
I.D
Diminution
IBD
W.T.a
1999
10,700,000
316,667
727,500
3,736,500
2000
316,667
727,500
2,444,737.5
QUESTION TWO
(a)
Failure to submit a SAR of a deceased
5% of tax due with a minimum of Sh.1000 for individuals (Sh.5000 for companies)
Failure to pay tax due
20% of tax due
2% p.m interest penalty on tax due
Penalties imposed on executors and administrators
Income of a deceased assessed on admin/executors as if it was their income.
(b)
Duties of a tax agent:
Agent is a person in control of remuneration who pays tax on behalf of his subjects e.g employer
Duties include:
-
proper records of tax payable

issue certificate (PAYE) to employees
determine tax payable on graduated scale or where appropriate, W/T
pay withheld tax within 20 days (9th day of following month incase of PAYE) and pay all taxes within
30 days from date of appointment as agent.
Inform CIT of his inability to comply with tax notice and give reasons as to why
(c)
103
Salary 9 months x 150

Commission
- Feb 20% x (3.5m 2.5m)
- March 20% x (3m 2.5m)
Rent income:
Gross
200,000
Insurance recovery
150,000
Less: - Loss due to fire
(90,000)
- Maintenance expenses
(180,000)
Wifes income Part time consultancy
1,350,000
200,000
100,000
80
1,730,000
350,000
400,000
750,000
Tax on Mr. Mwakia

Less PAYE 30,000 p.m x 9
Personal relief 1050 p.m x 9
Net tax liability
462,936
(270,000)
(9,504)
183,432
Tax payable within 30 days of appointment by Administrator/executor of the estate.

Notes:
Farming income presumptive, income tax (PIT) final
Hobby/subsistence farming since more than 25% is consumed by family
Loss due to fire allowable hence recovery taxable.
QUESTION THREE
(a)
A capital statement may be required where:
(b)
(c)
no accounting records are kept by the tax payer

tax payer maintains incomplete records
when a self assessment has been filed but indepth assessment has to be carried out.
Year
Total assets
Less liabilities
Net worth
Increase in net worth
Add back: forex gain
Loss on sale of investments
Less interest income
Adjusted income
Forex gain assume realized hence taxable.
1997
29,770
(80)
29,690
-
1998
30,020
(7,520)
22,500
(4,190)
30
(7)
4,167
1999
32,500
(7,160)
25,340
2,840
20
200
(6)
3,054
Other information
-
Interest on bank overdraft if business, it is allowable

Extent of usage of asset for business use to claim capital allowances for the business
Stocks what is the stock valuation method
What is the interest income on investment in treasury bills.
What was the purpose of house mortgage. If business interest charges are allowable.
Bank account what was the source of the deposits.
TAXATION II
2000
31,340
(7,200)
24,140
(1,200)
10
160
(3)
1,033
104
Debtors do we need specific or general provision for bad debt

Leasehold land and swimming pool should be valued by an expert.
QUESTION FOUR
(a)
Using 16% VAT Rate, input/output VAT =
16
116
x price inclusive of VAT.
Nov. 2000 VAT A/c

1/11 Radios
Recorders
6/11 T.Vs
Input tax
20,690
12,793
68,966
103,449
10/11 Radios
16/11 Recorders
VAT refund
Output Tax
20,590
27,586
55,173
103,449
Dec. 2000 VAT A/c

5/11 Spare parts
Input tax
206,897
______
206,897
11/12 Spare parts

VAT refund
Output Tax
110,345
96,552
206,897
Jan 2001 VAT A/c

2/1 Cars
15/1 Motor bikes
Input tax
4,137,793
137,931
______
4,275,724
5/1 Cars
31/1 Motor bikes
VAT refund
Output Tax
511,724
124,138
3,639,862
4,275,724
Feb 2001 VAT A/c

VAT payable
Input tax
20,690
_____
20,690
28/1 Motor bikes
Output Tax
20,690
_____
20,690
March 2001 VAT A/c

VAT payable
Input tax
1,600,000
______
1,600,000
5/3 Insurance claim

15/3 insurance claim
30/3 Cars
Output Tax
137,931
82,759
1,379,310
1,600,000
Note:
VAT for imported personal clothes cannot be offset against business output VAT.
(b)
The penalties are:

Failure to file VAT return = Sh.10,000 or 5% of tax due whichever is higher.
Failure to pay VAT on due date = 2% p.m compounded interest on unpaid VAT
(c)
Recoveries from insurance are treated as taxable supplies hence output tax shall be charged
accordingly.
(d)
105
If customs duty was imposed, then VAT should be charged after duty has been included in lauding
price of goods e.g
Assume landing price of imports (CIF)
+ 20% customs duty
Value for VAT
Add 16% input tax
Import price inclusive of VAT
500,000
100,000
600,000
96,000
,696,000
QUESTION FIVE
(a)
(i)
The income of one person may be assessed on another person e.g in case of a deceased
person, any income at time of death and thereafter not assessed shall be assessed on the
executors/administrators of the estate of the deceased.
They would be liable to tax jointly and severally including any penalties arising there
from.
(ii)
The additional tax penalty in event of fraud is a penalty of Ksh.200,000 or double the
amount of tax evaded (whichever is higher) and/or a 3 year imprisonment. This is in
addition to the normal penalties of 20% of tax due to late payment of tax and 2% p.m
interest penalty.
(iii)
-The impact and incidence of tax on imports fall on the importer especially for
imported goods for personal use.
-If for sale the tax can be shifted through the vehicle of price either wholly or partially.
For exports, incidence is on the foreign importer (buyer). Depending on whether
t
he demand of export is elastic or inelastic, the exporter can increase selling price
to shift the tax burden to the buyer.
(b)
The goods withdrawn will be deducted from purchases at Sh.200,000 cost price.
The school fees is a disallowable expense hence added back to reported profits to
increase tax liability
The Sh.5M constitute the component of goodwill. This would not be taxable since it
does not arise from trading and it is of capital nature.
TAXATION II
106
DECEMBER 2001
QUESTION ONE
(a)
Objectives of COMESA treaty:- Free movement of capital to encourage investment

- Have a customs union with a single tariff for non-COMESA goods by year 2004
- Have a monetary union and a common currency by year 2005.
- Common visa arrangements and right of establishment and free movement of persons to
encourage labour mobility.
- Have a free trade without tariff and non-tariff barriers.
(b)
Rules of origin provisions:

o The rules of origin stipulate that to be granted COMESA rates for goods, such goods must be
consigned from a member state directly to a consignee in another member state and:
be wholly produced in a member state
be wholly or partially produced in a member state (firm materials
imported from outside the member state) by a process which effects
substantial transformation of those materials such as:
o The C.I.F value of those materials do not exceed 60% of the total cost of materials used in the
production of the goods.
o The value added resulting from the production process account for at least 35% of the exfactory cost of the goods.
o Be produced in the member state and are designated by the council of COMESA to be of
particular importance to economic development of the member state and contain not less than
25% of value added.
(c)
Tax incentives under EPZs.

- 10 year tax holiday and a corporate tax rate of 25% from year 11 20
- 100% investment deduction
- Zero rated exports hence claim a refund for input tax.
- No withholding taxes on dividends and other payments to non-resident for the first 10 years.
- Exemption from import duty on machinery raw material and other intermediate inputs.
(d)
Anti-avoidance provisions under Cap.470

Sec 23 transactions designed to avoid tax liability
Sec 24 Shortfall distribution of dividends
Sec 18 A branch cannot deduct/allow interest, royalties, management and professional fees paid
to the head office. There is also limitations on artificial inter company pricing practices.
Sec 16(2)(i) interest expense of a company controlled by a non-resident person alone or
together with four or few persons and the companys debt. Equity ratio exceeds 3:1 (thinly
capitalized) shall be restricted as an allowable expense.
Sec 4(A) Foreign exchange losses of a thinly capitalized firm (where loan is borrowed) from
outside Kenya) shall be deferred as a deductible expenses if the foreign currency assets and
liabilities of the business were despaired on the last day of the year of income.
(e)
Tax treatment of expatriate staff:

-
Cost of passage to a firm abroad not a taxable benefit

Any income accrued from Kenya is taxed in full at resident graduated tax rates.

1
107
of employment income is not taxable if employee works for a non-resident
company/employer and is absent from Kenya for at least 120 days in a year.
An expatriate is a resident in Kenya for tax purposes if he is present in Kenya for at least 183
days in a year of income.
QUESTION TWO
(a)
LTU handles the following:

- Income tax all business enterprises with an annual turnover of Kshs. 500 million and above;
all banks and financial institutions; insurance companies, Government corporations and nonresident enterprises.
- VAT entities with 12 million per annum in terms of VAT remittance
- Excise duty top 30 excise duty payers.
- Companies turning over losses in excess of Ksh.250 million per year.
- Any special assignments directed by the Commissioner general and commissioners.
(b)
(i)
Year 2000 capital allowances (Using year 2004 ID rates)
1.
Investment deduction
Item
Building extension (yr.2000)
Machinery (yr. 2000)
2.
Q.Cost
I.D @ 100%
4,000,000
2,000,000
4,000,000
2,000,000
6,000,000
Industrial Building Deduction (Yr 2000)

Item
Store
Old building
Q.Cost
4,000,000
1,500,000
Bal. b/f
3,800,000
1,425,000
4,000,000
4,000,000
x 2 yrs
40 yrs
=
3,800,000
5,000,000 (70% x 5,000,000)
1,500,000
1,500,000
1,500,000
40 yrs x 2 yrs
=
1,425,000
3.
Residual for
IBD & WTA
-

Class
I @ 37.5%
WDV 1.1.99
Additions:
4 tracks
Computers
Furniture
W.T.A for 1999
WDV 1.1.2000
Additions:
Disposals:
Trucks
Furniture
IBD @ 2.5%
100,000
37,500
137,500
II @ 30%
IV @ 12.5%
3,600,000
_______
3,600,000
(1,350,000)
2,250,000
-
800,000
_______
800,000
(240,000)
560,000
-
1,400,000
1,400,000
(175,000)
1,225,000
-
(1,000,000)
___-_____
______-
400,000
TAXATION II
Bal c/f
3,700,000
1,387,500
108
2,150,000
(806,250)
1,343,750
WTA for yr 2000

WDV 1.1.2001
560,000
(168,000)
392,000
825,000
(103,125)
721,875)
It is assumed that the old machinery was granted 100% ID.

(b)
(ii)
Adjusted income
Profit form manufacturing
36,000,000
425,000
Gross interest from BBK
0.85
(b)
(iii)
500,000
36,500,000
Add: back disallowable expenses

Depreciation
Legal expenses:
Share transfer
Prosecution
Business agreement
7,200,000
200,000
350,000
120,000
Less capital allowances

IBD
WTA
Adjusted profits
600,000
137,500
1,077,375
Tax liability = 30% x 37,155,125

Less W/T on interest = 15% x 500,000 =
Net tax liability
7,870,000
44,370,000
7,214,875
37,155,125
11,146,538
(75,000)
11,071,538
Tax paid in 1999 = 9,500,000

Instalment tax of year 2000 = 110% x 9,500,000 =
Instalment
1st
2nd
3rd
4th
5th (final)
(b)
Due date
20/4/2000
20/6/2000
20/9/2000
20/12/2000
30/4/2000
10,450,000
Amount
25% x 10,450,000
Balance
= 2,612,500
= 2,612,500
= 2,612,500
= 621,538
11,550,506
(iv)
Instalment
1st
2,612,500
Late filing
penalty @
5%
-
Late payment
penalty @
20%
522,500
2nd
2,612,500
522,500
3rd
2,612,500
522,500
4th
2,612,500
522,500
No. of Late interest penalty @ 2%

months
delayed
19 2% (2,612,500 +
522,500)19 = 1,191,300
17 2% (2,612,500 +
522,500)17 = 1,065,900
14 2% (2,612,500 +
522,600)14 = 877,800
11 2% (2,612,500 +
522,600)11 = 689,700
(final)
621,538
553,577
11,071,538
553,577
109
124,308
7 2%(621,538 + 553,577 +
124,308)7 = 181,919
QUESTION THREE
(a)
Non-deductible input VAT on the following items:

-
(b)
Entertainment services
Restaurant services
Staff welfare costs
Household or domestic electrical appliances
All motor vehicles (other than passenger cars and minibus) bodies, pars and service for repair
and maintenance of such vehicles.
All fuels and oils for use in motor vehicles and such other bodies.
Furniture, fittings and ornaments or decorative items in buildings other than items
permanently attached to the buildings.
Passenger cars and mini-buses, parts and service for the repair and maintenance of such
vehicles and the leasing and hiring of such vehicles.
Bad debt relief.

Where the buyer (debtor) has become legally insolvent.
When the debt of a registered person (for which tax has been paid) remains unpaid for a 3 year
period from date of supply.
VAT Account (Using 16% VAT rate)
2/9
Reverse charge (website)
4/9
Factory building
5/9
KLM Ltd
6/9
Textbook Centre
9/9
Transport
11/9 Return inwards
18/9 Services from Zim bank
23/9 Bad debt Homa Bay
30/9 Telephone VAT
Electricity
132,414
441,379
187,586
69,040
48,276
41,379
246,897
119,310
30,000
17,500
1,333,781
6/9
7/9
11/9
12/9
20/9
Options (K) Ltd

Zim Bank
Homa Bay W/S
Return outwards
Cash sales
VAT refund
365,517
246,897
119,310
7,007
377,103
217,947
_______
1,333,781
Note:
(i)
Any input tax incurred in construction of a factory building is deductible against the
output
(ii)
(iii)
tax as the factory is not sold before the lapse of five years from the date it was first put
into use.
The VAT refund is due on 20th October 2000. However, this being a public holiday, its
due
on or before the last working day before 20th October.
VAT on imported services
TAXATION II
110
This VAT is called reverse charge and is due and payable at the time the service is
received or when payment is made for all or part of the service by importer.
The VAT is declared through form VAT 7 and payment is made to the designate banks using form VAT 28.
The VAT is allowable as a deduction against the output tax.
-
(iv)
Information not used
Sales to Rwanda Miners Ltd zero rated.
Sh.20,000 allowance to Rwanda Miners Ltd. Zero rated hence no effect on VAT computation.
Stolen goods on transit no VAT is charged since its on zero rate export.
QUESTION FOUR
(a)
WTO customs Valuation Method
Method 1 Transaction Value

The customs value is the transaction value i.e. the price paid or actually payable, including all payments
made as a condition of sale.
Some of the conditions that apply include:
There is no restrictions imposed as to disposal of the goods by the buyer other than those imposed by law,
those which limit the geographical area in which goods can be resold or those that do not substantially
affect the value of the goods.
The price should not be subject to some conditions for which a value cannot be assigned to the goods.
No part of the proceeds of the disposal of the goods will accrue directly or indirectly to the seller.
The buyer and seller should not be related, and if they are the relationship should not influence the price.
The following will be added to the transaction value included if incurred by the buyer and not included in
the transaction value:
-
Commissions and brokerage (except buying commissions).

Packaging and container costs and charges.
Royalties and licence fees.
The cost of transport, insurance and related charges up to the port of discharge (CIF basis).
Assists (i.e. materials, components, etc.) supplied by the importer free of charge or at a reduced
cost in connection with the production of goods.
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.
Conditions which must be fulfilled before the transaction value of identical goods is used include:
The identical goods must be sold in the same commercial level.
111
The identical goods must be sold in substantially the same quantities as goods 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.
(b)
Anti-dumping measures
o Imposing quotas on particular persons or any organisation dumping goods into Kenya.
o Imposing high dumping duties.
o Ensuring that transit goods are escorted out of the country.
o Use of different colours for petroleum products meant for export as a way of
differentiating it from that meant for local consumption.
o Ensuring that where possible petroleum meant for export to landlocked countries like
Uganda and Rwanda is transported via pipeline.
o Ensuring proper import documentation, i.e import declaration Forms (IDFs) are properly
filled and verified for accuracy.
o Use of pre-shipment inspection at the port. This should be enforced to the letter and
CRFs (Clean Report of Findings) adhered to.
o Identifying of customs audits.
o Ensuring that KRA staff are adequately remunerated to avoid incidences of corrupt
practices.
(c)
(i)
Conditions for exemption
Goods (excluding office equipment, stationery and office furniture in the care of customs and
excise) being bonafide gifts donated to an institution which has been exempted from registration
by the Registrar of Societies, which the commissioner is satisfied are imported or purchased by or
consigned to charitable organizations and have been approved by the commissioner of social
services for:
-
Free distribution to the needy and poor.

Use in medical treatment
Rehabilitation work in charitable institutions.
Goods that are free donations to registered charitable organizations

Goods including equipment, motor vehicles, vessels and aircraft donated to or purchased by an
organization that are for alleviation of hardship or disaster.
Goods consigned to or purchased by St. Johns ambulance for first aid training
Goods for the Kenya Red Cross for free distribution in relief work.
Altar bread, sacramental wine imported to any religious organizations for use in conduct of
religious service.
Foodstuffs, vehicles, equipment and other commodities for the National Freedom from Hunger
Committee (Customs & Excise Duty).
(iii)
Procedure for application

Where duty payable is less than sh.40,000 exemption should be sought from the commissioner
concerned. However, if more than Sh.40,000 it should be sought from Treasury.
TAXATION II
112
The application should be in writing and should include:

-
A copy of the institutions rules, objectives and registration certificate.

A copy of the institutions just set of audited accounts.
An analysis of any donations made indicating recipients, amounts and purpose.
A list of trustees or officials of the institution and if any, remunerations paid to them and
amount.
In the case of customs and excise, a gift certificate, registration certificate and a letter of exemption if
duty exceeds Ksh.40,000 (from Treasury).
113
QUESTION FIVE
(a)
Prof. Mohammed Omar

Computation of taxable income for 2000
Employment income
Ksh.
Salary 450,000 x 12
5,400,000
Benefits:
Housing (150,000 10,000) x 4
Electricity
Water
Telephone
Ordinary shares
Company car
Leave pay
Life insurance
560,000
6,000
4,800
1,200
100,000
228,000
450,000
30,000
6,780,000
Other incomes
Pension (280,000 180,000)
Rent income
Gross 100,000 x 4
Less repairs and painting
WTA on furniture
12.5% x 600,000 x 4/12
interest 270,000 x 4/12
100,000
400,000
(25,600)
(25,000)
(90,000)
259,400
Wifes income from Omar Architects

Loss reported
Add back wifes salary
(700,000)
1,050,000
350,000
Less owner occupied mortgage interest (8 months)

Amount = 8/12 x 150,000
Pension contribution 5% x 5,400,000 or Shs. 240,000 limit
Net taxable income
(100,000)
(240,000)
7,089,400
Mrs. Zachras income at arms length

Compensation for Yr 2000
Business income Gross
Less:
Salaries
Insurance, rent & rates
General expenses
Interest on loans
WTA Partition 12.5 x 200,000
Computers 30% x 1,200,000
360,000
3,000,000
480,000
180,000
220,000
365,000
25,000
360,000
TAXATION II
1,630,000
1,370,000
1,730,000
114
(b)
Mr. Omar Tax Liability

[Shs. 121,968 @ 10% + Sh.114,912 @ (15% + 20% + 25%)]
(Shs. 7,122,733 466,704) @ 30%
Less PAYE
Omar 85,000 x 12
Zahra 20,000 x 12
Personal relief
Net tax liability
(c)
81,144.0
1,996,808.7
2,077,952.7
(1,020,000)
(240,000)
(13,944)
804,008.7
Taxation of compensation to Zahra
This will be taxed for the unexpired period of contract at Zahras last rate of remuneration before
termination. It will be spread events forward.
Year 2000
Sh.
400,000
Year 2001
Sh. 400,000
Year 2002
Sh. 400,000
The rates to be used are the last known rates by the date of payment.
(d)

- Company dividend payment withholding tax is final tax.
- Medical cover not taxable because it is not discriminatory
- School fees not taxable on Prof. Omar.
- Gain from plot not taxable, capital gains tax suspended.
115
MAY 2002
QUESTION ONE
(a)
(i)
Buoyancy
Buoyancy of a tax is the responsiveness of tax revenue to changes in national income and
to discretionary changes.
(ii)
a
Elasticity of a tax is the responsiveness of the tax revenue to changes in national income
djusted for discretionary changes.
Where discretionary changes are the changes in tax rates and rules governing the tax
system.
(b)
to
(i)
Historical time series tax data (HTSTD) attempts to eliminate discretionary tax changes
estimate elasticity by using a single equatica model.
(ii)
Log (Ti)
Log a + Log bi + log (i) + ei
Where: T
e
bi
=
=
=
=
adjusted HTSTD to discretionary tax changes

tax base (or GDP aggregate level)
disturbance term
tax elasticity
Adjusted HTSTD with time trends or dummy variables as proxies for discretionary tax measures.
Adjustments could done using.
The proportional adjustment method
The constant rate structure method
The dummy variable approach
(c)
(i)
Value Added Tax (VAT)
This is tax elastic because a slight change in VAT rate leads to a significant fall in revenue. This
applies for taxable goods.
However, for zero-rated and exempt goods, VAT is tax inelastic.
(ii)
Income Tax
Income tax is tax inelastic since the amount of tax tend to be proportional to tax rate in case of
proportional corporate taxes.
For individual taxes reduction or increase in tax rates does not significantly change tax collectible
but works to encourage or discourage tax evasion or tax avoidance.
(iii)
Customs and Excise Duty
Excise taxes tend to be tax inelastic as consumers tend to reorganize their spending in the case of
excise tax.
TAXATION II
116
Customs tax however is tax elastic and increase in import tax discourages imports leading to low
customs tax collected.
(d)
TPUs role is to make policies relating to Kenyan taxes specifically issues relating to:
Harmonisation and rationalization of Kenyas tax rates.

Widening or narrowing tax brackets
Narrowing or widening the tax net as all the above have implications on tax revenue
Long term tax objectives.
QUESTION TWO
(a) Qualifying costs for ID and IBD interest charges are absorbed/allocated to each asset as follows:
Asset
Land
Demolition
Labour quarters
Factory
Stone wall
Interest slim
14.00
12.88
x11 .52 0.90 12.88
165.52
8.64
x11.52 0.60 8.64
165.52
28.8
x11.52 2.00 28.8
165.52
89.28
x11.52 6.20 89.28
165.52
14.4
x11.52 1.00 14.4
165.52
9.24
30.80
95.50
15.50
Approximate cost
165.00
The qualifying cost will be based on Sh 240million to be allocated as follows:

Land
Demolition
Labour quarters
Factory
Stone wall
14
x240m
165
9.24
x240m
165
30.80
x240m
165
95.50
x240m
165
15.40
x240m
165
Approximate cost
20.36
13.44
44.80
139.00
22.40
240.00
Land does not qualify for any capital allowance. The qualifying cost for factory will consist of
1.
2.
Factory cost
Demolition cost
Total
139.00
13.44
152.44
This cost consists of:

Administration offices
Store
Factory (Balance)
23.04
8.64
120.74
117
152.44
Percentage of administration offices =
23.04
x100 16% 10%
23.04 120.76
It does not qualify for ID. The store quality for IBD automatically:
Capital allowances in Shm
(2) Investment deduction
Asset
Q Cost
ID@100%
Factory
New machine
120.76
120.00
120.76
120.00
240.76
(2) IBD
Building
Stonewall
Stores
Labour quarters
Q Cost
22.40
8.64
44.80
IBD@2.5%
0.560
0.216
1.120
1.896
Residual for
IBD & WTA
-
Wear and Tear Schedule

Class I
37.5%
5,780,000
WDV
Addition:
Computer
Furniture
Photocopier
Scanners
TV
Saloon cars (3)
Lorries (2)
Class II
30%
1,340,000
Class IV
12.5%
3,650,000
1,120,000
360,000
240,000
80,000
20,000
4,000,000
9,780,000
Disposals:
Machinery
Saloon car
Furniture
__ ___2,780,000
3,000,000
______5,650,000
_______2,780,000
834,000
1,946,000
333,333
______5,316,667
1,329,167
3,987,500
______4,030,000
640,000
_______
9,780,000
(3,667,500)
6,112,500
W&T
WDV
Summary
Investment Deduction
IBD
WTA -
Class III
25%
2,650,000
I
II
III
IV
240,760,000
1,896,000
3,667,500
840,000
1,312,500
376,250
248,852,250
TAXATION II
360,000
3,030,000
378,750
2,651,250
118
(b)
Computation of taxable profit/loss

Sh.
Net profit
Depreciation
Donations
Dividends paid
322,000
5,250,000
412,500
2,250,000
Less capital allowance

Loss
(c)
(d)
Sh.
7,912,500
8,234,500
(248,852,250)
240,617,750
If they lease factory and machinery then they would not qualify for capital deductions. Though
the lease charges will be allowable, they are better off purchasing given the attractive investment
deductions.
If Membley were to be in an EPZ they would get the following benefits:
100% investment deduction for building and machinery to manufacture exports.

Take a tax holiday for the first ten years
Pay a lower rate of corporation tax of 25% for the next 10 years
Be zero rated for VAT purposes.
Imports of raw materials to manufacture exports.
QUESTION THREE
(a)
-When sales are predominantly to businesses registered for VAT. This will enable the trader
claim VAT paid on purchases.
When sales are zero-rated items and the trader wishes to reclaim input VAT (exports)
When the trader wishes to conceal the small size of business from customers.
(b)
Refund
VAT refund is properly due under the following circumstances:
Where input tax exceeds output tax continually and it is a regular feature of the business
Where goods are imported and then re-exported without being used in Kenya VAT on import is
refundable.
Where newly registered persons have goods in stock which are intended for us in the manufacture
of taxable supplies.
Refund for credit sales which became bad debt as long as 3 years have lapsed and supplier have
taken all necessary legal actions in an attempt to recover the bad debt.
Where tax has been paid in error.
Where the registered person has incurred major capital costs in construction of building to
manufacture taxable supplies.
Where taxable goods have been imported into Kenya and tax has been paid in respect of those
goods and before being used, the goods are exported under customs control
Where in the opinion of the Minister, a refund is due in the public interest.
(c)
Procedure
Fill in VAT 4 (Refund Claim Form)
If claim is for an amount of Ksh. 1M and above attach audit certificate
Lodge the claim with the VAT department
Trader must have filled a VAT 3 (return form) which must correspond to VAT 4.
(d)
VAT Audit Refund Certificate

Kasuku Rolling Mills Ltd (KRM)
119
VAT Refund Audit Certificate for January 2001.

We have examined the attached claim for refund of VAT amounting to Ksh made by KRM Ltd. for the
period from 1st January 2001 to 31st January 2001 to ensure compliance with the VAT Act and regulations,
and have obtained all the information and explanations necessary for the purposes of our examination.
Our examination was designed to enable us to obtain reasonable assurance that the claim is free from
material misstatement, and included verification, on a test basis, of evidence supporting the amount
claimed. It also included an assessment of the adequacy of KRMs 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.
QUESTION FOUR
(a)
NSSF contribution
Owner occupied mortgage interest upto Sh.100,000 p.a. (Sh. 150,000 w.e.f 1/1/2006).
Contributions to Home ownership savings plans upto Sh.48,000 p.a.
Contributions by an employee to a registered pension and provident fund
(b)
(i)
1/3 cost of tools and implements provided by architects, mechanics, engineers etc. in performance
of employment services.
Travelling expenses incurred in performance of duty.
Employment income
Salary (75,000 p.m x 12)
Company car: Higher of fixed benefit on 1850cc
or 2% p.m x 85,000 x 12
Performance bonus (monthly salary)
Watchman: Higher of actual amount paid 5,000 x 12
Fixed benefit by C.I.T
(b)
(ii)
75,000
60,000
60,000
14,400
House girl: Higher of actual amount paid 5,000 x 12

Fixed benefit by C.I.T
Add housing benefit: higher of actual rent paid
35,000 x 12 = 15% x 1,299,000
Business income year 2001 profits
Less loss b/f
900,000
204,000
86,400
204,000
60,000
14,400
60,000
_______
1,299,000
420,000
194,850
725,000
(300,000)
420.000
1,719,000
425,000
Interest income loan to a friend
200,000
2,344,000
Wifes income
Salary 45,000 x 12
Milk benefit 5 litres x 30/= x 365
540,000
54,750
594,750
Tax liability (using year 2006/2007 rates) on Kshs. 2,344,000

(121,968 x 10%) + 114,912 (15 + 20 +
25%)
(2,344,000 466,704) @ 30%
Net tax
Wife on Kshs. 594,750
(5,808 x 2) + 5,472(2 + 3 + 4)
(29,737.5 22,224) @ 6/=
81,144.0
563,188.8
(13,944.0)
630,388.8
77,280
45,081
122,361
(12,672)
(98,400)
Less: Personal relief

PAYE deducted
TAXATION II
120
11,289
634,464
11,289
645,753
Total tax payable husband

Wife
Tax payable
Mr. and Mrs. Kujua shall file a self assessment return since they have more than one source of income.
The tax is due and payable by the last day of the 4 th after the accounting year i.e 30 th April 2002. The self
assessment return should be filed by end of the 6th month after the accounting year i.e 30th June 2002.
(iii)
Information not used:

Interest from HFCK, Treasury Bills and Akiba bank is subject to W/T which if final.
Dividends from Castle Breweries Ltd W/T is final
Dividends from a South African Co. tax exempt.
QUESTION FIVE
(a)
Maximum Ltd
Sh.
Net profits as per accounts
Add back
Depreciation
Legal expenses
Loan interest
Patent royalties
2,240,000
200,000
344,000
860,000
Less: Royalties outstanding

Capital allowances
160,000
1,230,000
Add other taxable income

Patent royalties
Net rent income
Gross loan interest
1,280,000
936,000
188,235
Corporate tax @ 30% =

Less W/T on interest 15% x 188,235
Net tax liability
(b)
Sh.
24,251,200
3,684,000
27,935,000
1,390,000
26,545,200
2,404,235
28,949,435
8,684,831
28,235
8,656,596
Instalment tax payable shall be based on previous years tax i.e 110% x 6,400,000 = 7,040,000
1st instalment (25%)
2nd instalment (25%)
3rd instalment (25%)
4th instalment (25%)
5th instalment
Final tax
20th January 2001

20th March 2001
20th June 2001
20th September 2001
31st January 2001
1,760,000
1,760,000
1,760,000
1,760,000
1,616,596
8,656,596
(8,656,596
7,040,000)
(c)
Royalties income
Non-residents the gross income is subject to a 20% W/T which is final
Residents the gross income is first subject to a 5% W/T. The net income is then grossed up with other
incomes and taxed on graduated scale.
The taxpayer enjoy a tax credit on the 5% W/T.
121
DECEMBER 2002
QUESTION ONE
(a)
(i)
The income of a taxable person is assessed on another person in case of a:

-
(ii)
Deceased person income assessed on executors or administrators

Incapacitated persons and minors income assessed on guardian or trustee.
Married women income not earned at arms length assessed on the husband
Non-resident ship owners income assed on the captain of the ship
Payment of tax by a married woman living with the husband.

-
(b)
one
(i)
Where the husband has been declared bankrupt

Where the husband is of unsound mind
Where the husband does not have distrainable goods
Where the husband does not have any taxable income (wife is the sole bread winner)
The husband is untraceable or has gone underground.
Casual workers casual workers who are engaged by the employer for periods less than
month are not taxable. However, if the casual worker is employed regularly he will be
taxed.
(ii)
(c)
Circumstances that trigger off PAYE Audit

-
(d)
Multiple sources of income

These are taxed on all incomes but granted personal relief only by the main employer
Salaries and wages figure per the audited accounts is higher or lower than the amounts
reflected in the PAYE returns.
PAYE is usually not paid on time
Material fluctuations over the months on PAYE payments
Third party information or complaints
Non-compliance noted/detected during a normal tax examination be it VAT or Corporate tax
examination.
Off-late KRA is offering rewards to anybody who divulges information that leads to a tax
recovery by authorized persons only.
Newspaper reports
Court cases
Construction sites sign boards This affects mainly contractors and professionals in the
construction industry.
Information emanating from related companies audited
Cessation of business on a large part of a business
Higher salaries awarded to middle level managers compared to those awarded to their
seniors.
Tax set-offs available to an individual tax payer to reduce gross tax liabilities are:
-
PAYE deducted at source

Double taxation relief
Personal relief
TAXATION II
122
Any installment tax paid

Withholding tax on non-qualifying dividends and royalties income
Tax refunds of previous years of income.
Insurance relief.
123
QUESTION TWO
(a)
Most favoured nation status

This is preferential tax treatment of a given country by another
Usually, tax rules and regulations are charged/relaxed when dealing with the favoured nation
e.g reduction in import duties between the two countries.
The concept/status is meant to encourage:
(b)
Trading between the two countries.

Exchange of technical expertise
Labour mobility
Investments, especially tax rules may be relaxed for investment purposes etc.
(i)
Mr Kamau taxable income

Employment income
Salary 600,000 x 12
Directors fees 90,000 x 12
Company car benefit: Higher of
Quantified benefit
2% p.m x 3,600,000 x 12
7,200,000
1,080,000
103,200
864,000
Housing benefit: Higher of

15% x 9,144,000
Market rent = 180,000 x 12
Total employment income
1,371,600
2,160,000
Rent Income
Net income
Add back disallowable expense (renovations)
Farming income
Profit for 2005 and 2006 = 120,000 + 450,000
Add consumption 75,000 x 3
Add personal flower usage 130,000 x 3
Loss b/f
Wifes income
Salary 85,000 p.m x 12
Less contributions to scheme: Lower of
Actual: 20,000 x 12 = 240,000
Set limit =
240,000
30% x 1,020,000 =
306,000
(ii)
864,000
9,144,000
2,160,000
11,304,000
100,000
400,000
500,000
570,000
225,000
390,000
(960,000)
225,000
1,020,000
(240,000)
780,000
12,809,000
Tax liability on Ksh.12,839,000

1st 121,968 @ 10%
Next 114,912 (15% + 20% + 25%)
(12,809,000 466,704) @ 30%
12,196.8
68,947.2
3,681,688.8
3,762,832.8
(240,000.0)
(13,944.0)
3,508,888.8
Less wifes PAYE = 20,000 x 12

Personal relief
Net tax liability
Tax was payable through self-assessment by 30th April 2006
(iii)
Mr. Kamaus employer is to blame for not deducting PAYE. The employer is liable to heavy
penalties in form of 25% of tax due or Sh.10,000 whichever is higher.
TAXATION II
124
(iv)
FBT
Employers loan amount
Interest charged
Market interest rate
Fringe benefit
= 10% - 5% = 5% x Sh.10m
= Sh.500,000 per annum or Sh.41,667 per
annum
FBT payable by employer
30% of Ksh.41,667 = Ksh.12,500
Sh.10,000,000
5% per annum
10 % per annum
FBT is due and payable together with PAYE on or before 10th February 2001.
(v)
Mrs. Kamau qualifies for a deduction amounting to Sh.240,000 p.a on her taxable income for
contributing to individual retirement benefit scheme with effect from 1 st January 2003 the actual
amount contributed is allowable against employment income.
QUESTION THREE
(a)
Computation of taxable profit for 2001 for:

(i) Mbaka Enterprises
Sh.
Net loss
Add back
Legal Expenses
Depreciation
VAT paid
Rent paid to Mambo
Loss from farming
Partners salaries
(ii) Salma Kenya Ltd

Sh.
(352,750)
60,000
175,000
50,000
150,000
100,000
240,000
Deduct:
Capital allowances
Interest income
Closing stock overstated
Adjusted income
(b)
Sh.
(140,000)
(50,000)
(80,000)
775,000
422,250
(270,000)
152,250
60,000
175,000
50,000
100,000
(140,000)
(50,000)
(80,000)
Tax payable
Salma Kenya Ltd. reported a loss and therefore no tax is payable
For Mabaka the partners will be taxed as follows
Share of Profit
Salaries
Share of profit (loss)
Add other income
Rent = 25,000 x 12
Mambo
120,000
(43,875)
76,125
Bakari
120,000
(43,875)
76,125
300,000
376,125
76,125
Mr. Mambo on Ksh.376,125

1st 121,968 @ 10%
Next 114,912 @ (15% + 20%)
12,196.8
40,219.2
Sh.
(352,750)
Total
240,000
(87,750)
152,250
385.000
32,250
(270,000)
(237,750)
(c)
125
(376,125 351,792) @ 25%

Gross tax liability
Less personal relief (6 months) 1162p.m x 6
Net tax liability
6,083.3
58,499.3
(6,972.0)
51,527.3
Mr. Bakari on Ksh.76,125

Tax = 76,125 x 10%
Net tax liability
7,612.5
(6,972.0)
640.5
From a tax point of view the advantages include:

-
Separate legal entity The company pays its tax at the corporate rate while in a partnership
individual parties pay.
Some expenses such as salaries to partners are disallowed in a partnership while directors
fees in a company are allowed.
QUESTION FOUR
(a)
Afro Insurance Ltd.

Computation of taxable profit for year ended 31 December 2001
Fire
Theft
Total
Sh.000
23,088
14,747
Motor
Vehicle
Sh.000
24,664
15,007
Sh.000
9,780
(4,822)
Sh.000
57,532
(34,576)
Unearned premium b/f

Unearned premium c/f
Gross income earned
Less allowable expenses
Claims paid
Claims outstanding b/f
Claims outstanding c/f
Claims incurred
4,205
(2,035)
40,005
6,293
(9,259)
36,705
1,466
(668)
15,400
11,964
(11,962)
2,216
(2,781)
2,755
2,190
5,538
(10,325)
9,416
4,629
1,215
(4,532)
(8,756
5,439
8,969
(17,638)
20,927
12,258
Commissions (net) paid

Management expenses
255
1,606
1,546
2,350
890
876
2,691
1,832
Legal expenses
Specific bad debts
Total Expenses
645
80
4,776
420
35
8,980
125
62
7,392
1,190
177
21,148
Underwriting profit/loss
35,229
27,725
8,008
70,962,000
Total underwriting profit
70,962,000
Gross premium written

Reinsurance ceded
Less wear and tear
(454,000)
70,508,000
Investment income
Interest from Treasury bills
Interest from Fixed deposits
Less: investment mgt. Fees
2,400,000
897,000
(745,000)
2,552,000
Rental income
Less mgt. Fees
2,200,000
(2,400,000)
(200,000)
72,860,000
Total taxable profit
TAXATION II
126
127
QUESTION FIVE
(a)
Wasike and Associates

VAT Account for September 2001
Using 16% VAT rate
VAT A/C
Item
Input
Sh.
5,862
4,996
132,427
33,107
45,517
811,889
Electricity
Garbage collection
Stationery
Computer repair
Telephone
VAT payable
_______
1,033,768
Date
Output
2/9
10/9
15/9
17/9
18/9
19/9
21/9
24/9
26/9
30/9
ABC Ltd
Kikwetu Ltd.
XYZ Ltd.
Kikwetu Ltd
Stima Ltd.
Miracle ministries
Kikwetu Ltd.
Lengo Ltd.
Rehema
Ujamaa C. Council
Output
Sh.
33,104
49,655
192,000
66,208
384,000
115,200
18,759
24,828
12,414
137,600
1,033,768
Note:
- If prices are exclusive of VAT, VAT = 16% x price excl. of VAT.
-
If prices are inclusive of VAT, VAT = 16
116
x price incl. of VAT
VAT on commercial rent was introduced with effect from 1 September 2001 but withdrawn on December
2001.
Candidates should be able to distinguish when a service is zero rated.
(b)
Additional tax payable;

-
(c)
Failure to submit return 2% of 811,882 (interest)-
Sh.10,000
Sh.17,238
Sh.27,248
Bad debt relief

September 10
September 17
September 21
Sh.
360,000
480,000
136,000
976,000
VAT
49,655
66,208
18,759
134,622
976,000
(240,000)
736,000
134,622
VAT relating to debt still owing:

sh.736,000
134,622
976,000
= Sh.101,518 (Bad debt relief)
TAXATION II
128
JUNE 2003
QUESTION ONE
(a)
Forward tax shifting This refers to shifting the tax burden to the consumer through increase in
selling prices. For instance when the government increases the amount of tax levied on products
such as beer or cigarettes companies increase prices of these goods.
Backward shifting This occurs when a producer of a taxed commodity transfers the money
burden of tax to the supplier of factors of production, who in turn is paid a lower price for the
factors of production. E.g. farmers are at times paid lower prices for their produce when a tax is
imposed on the processor of the produce.
(b)
Factors determining tax shifting:

(i)
Elasticity of demand and supply The more the elasticity, the lower the incidence on the
sales. The higher the incidence on supply.
(ii)
Nature of markets
In an oligopolistic market (i.e sellers and many buyers) tax shifting to buyers is high
since few sellers can team up to determine the market price.
In a situation where there are many buyers and sellers, a large portion of tax will be borne
by sellers.
For a monopolistic market, the entire tax burden falls on the shoulders of the buyer.
(iii)
Government policy on pricing
In the case of government price control, the supplier cannot increase prices hence cannot
shift tax burden to buyers and vice versa.
(iv)
Geographical location
If taxes are imposed on certain regions, it is hard to shift them to consumers because
consumers wil move to regions with low taxes.
(v)
Nature of tax (direct or indirect tax)
Direct tax e.g PAYE cannot be shifted whatsoever while indirect taxes can be shiften
through increase in prices.
vi)
Rate of tax
If too high, shifting can occur backwards or forwards, if too low, it may be absorbed by
the manufacturer.
(vii)
Time available for adjustment
The person who can adjust faster (buyer or seller) will be able to shift tax e.g if the buyer
cash shift to substitute goods, the seller will bear the tax burden.
(viii) The tax point
(c)
Duties according to Cap. 472

- Import duties on goods imported at rates specified in first schedule
- Suspended duties on imported goods at specific rates given in second schedule
- Export duties on goods exported at rates given in fourth schedule
- Excise duty on goods produced at rates specified in the fourth schedule
- Dumping duty; duty charged in addition to any other duty charged under Cap 472.
129
QUESTION TWO
(a)
(i)
(ii)
Njagi and Otieno Partnership

Capital allowances
Item
Q.Cost
I.D @ 100%
Plant
200,000
200,000
200,000
Residual for
WTA
-
Wear and Tear Allowances
Class
WDV 1/1/2002 Motor vehicles
Plant and furniture and fittings
Additions:
Lorry
Disposal:
Lorry
Old plant
III @ 25%
107.000
-
IV @ 12.5%
58,500
750,000
(150,000)
____ _
707,000
(176,750)
530,250
(30,750)
27,750
(3,469)
24,281
Less W.T.A
W.D.V 31/12/2002
Total capital allowances = 200,000 + 176,750 + 3,469 = 380,219

Adjusted profit/loss
Sh.
Net loss per the accounts
Add back:
Otienos household expenses
Donations bursary fund
Income tax paid
Depreciation furniture and fittings
- plant
personal use of glass
cost of new lorry
depreciation motor vehicles
rent for Njagis house
Njagis car insurance
Otienos car insurance
Otienos mortgage legal charges
bad debts general provisions
acquisition of plant
Less:
Capital allowance
Sale of plant and lorry
Refund of VAT
Post office savings bank interest
Dividend
Adjusted profit
(1,165,500)
86,250
1,200,000
8,000
298,000
8,000
11,500
65,000
750,000
162,500
300,000
90,000
125,000
89,000
61,500
200,000
2,289,500
(380,219)
(180,750)
(21,250)
(5,750)
(42,500)
1,659,031
TAXATION II
130
(b)
Division of Profits
Ratio
Partner
Salary
(c)
3
Njagi
400,000
275,419
675,419
2
Otieno
800,000
183,612
983,612
5
Total
1,200,000
459,031
1,659,031
Tax liability
Sh.
Njagi on Ksh. 675,419
1st 121,968 @ 10%
Next 114,912 (15% + 20% + 25%)
Surplus (675,419 466,704) @ 30%
Net tax liability
12,196.8
68,947.2
62,614.5
143,758.5
(13,944.0)
129,814.5
Otieno on Ksh.983,612
1st 121,968 @ 10%
Next 114,912 (15% + 20% + 25%)
Surplus (983,612 466,704) @ 30%
Net tax liability
12,196.8
68,947.2
155,072.4
236,216.4
(13,944.0)
222,272.4
QUESTION THREE
(a)
(i)
Penalty for non-payment on export of taxable supply
Where a registered person exports a taxable supply as zero rated and payment for the
export is not deposited in foreign currency, then double the tax that would otherwise have
been payable on the supply or has been refunded in respect of the supply, shall become
payable immediately and in addition;
Interest at the rate of 25% per month (compounded) or part thereof shall be payable upon
these amounts from the date of exportation.
(ii)
Provisions relating to goods liable to forfeiture:
Commissioner may require any person in possession of any taxable goods sold by a
registered person to produce proof that tax has been paid on such goods.
Where any person who is required to produce proof that tax has been paid on any goods
fails to do so within 7 days, those goods shall be liable to forfeiture.
Commissioner may seize any taxable goods, air-craft, vehicle, vessel, animal or other
thing liable to forfeiture or which he has reasonable grounds to believe is liable to
forfeiture and the taxable goods, air craft, vehicle, vessel, animal or other thing may be
seized whether or not a prosecution for an offence which rendered it liable for forfeiture
has been or will be taken.
Any taxable goods, aircraft, vehicle, vessel, animal or other thing seized and detained
shall be kept or taken to such place of security as the commissioner may decide.
Commissioner may, at any time prior to the commencement of proceedings relating to an
aircraft, animal, vehicle, vessel, taxable goods or other thing which has been seized,
131
release it to the person from whom it was seized, if he is satisfied that it was not liable to
seizure.
(b)
No officer shall be liable to legal proceedings for any action taken in good faith in
accordance with Section 49(6).
(i)
The breakdown of consumer goods is as follows:

4% x 2,407,950 = 96,318 (Exempt)
Total Sh. 2,407,950
10% x 2,407,795 = 240,795 (Zero rated)

86% x 2,407,950 = 2,070,837 (Standard rated)
Item
Amt inclusive
of VAT
2,070,837
Standard purchases
Exempt
285,633
-
Zero rated
240,795 0% x 240,795 =
Security (56,800 +
45,152)
101,952
16 x 101,952 =
116
14,062
Telephone
17,700
16 x 17,700 =
116
2,441
Electricity
88,500
16 x 88,500 =
116
12,607
314,743
Vatable supplies x Total input tax

Total supplies
4,035,600 4% x 4,035,600 x 314,743 = 302,153

4,035,600
Computation of output tax

Item
Standard supplies
Zero rate supplies
Exempt supplies
VAT payable
=
=
16 x 2,070,837
116
96,318 -
Deductible input tax
(ii)
Input tax
Amount incl. of VAT

86% x 4,035,600 =
3,470,616
10% x 4,035,600 = 403,560
4% x 4,035,600 = 161,424
Total output tax
Output tax - Input VAT
478,706 302,156
176,553
TAXATION II
Output tax
16/116 x 3,470,616
0 x 403,560
-
478,706
0
_____478,706
132
QUESTION FOUR
(a)
Haraka Ltd.
Income
Sh.
Sh.
Management fees (8.5% of 51,780,000)

Rent Received
45,000,000
Add Outstanding c/f 15,460,000
Less Outstanding b/f 8,680,000
51,780,000
Interest on late accounts (0.1 x 0.2 x 51,780,000)
Cleaning fees
Dividends received
Interest income (204/0.85)
Gross income
4,401,300
1,035,600
4,500,000
240,000
10,176,900
Less: allowable expenses only

Salaries and wages
Journal subscriptions
Legal fees (132,000 20,000)
Rent and rates
Auditors fees (700,000 150,000)
Insurance
Office expenses (675,000 240,000)
Directors remuneration (1,080,000 50,000)
Capital allowances
Taxable profit
2,250,000
150,000
112,000
150,000
720,000
550,000
165,000
435,000
1,030,000
1,588,500
7,150,500
3,026,400
Wear and Tear Schedule
W.D.V 1/1/02
Additions
Disposals
Less WTA
WDV 31/12/02
(b)
Sh.
30%
Class II
1,350,000
270,000
1,620,000
1,620,000
486,000
1,134,000
Tax payable
Gross tax liability (30% of 3,026,400)

Less WHT paid dividends
- interest
Net tax liability
(c)
Sh.
25%
Class III
2,850,000
1,000,000
3,850,000
3,850,000
962,500
2,887,500
Sh.
30%
Class II
907,920
(4,500)
(36,000)
849,420

Depreciation wear and tear used
Instalment tax paid is an after tax expenditure
Donations not allowable
Maintenance not an expenditure to Haraka Ltd.
Sh.
12.5%
Class IV
1,200,000
1,200,000
80,000
1,120,000
140,000
980,000
133
QUESTION FIVE
(a)
Investment deductions
Factory Case (24,500,000 3,630,000)=20,870,000
% of office space
=
3.63M x 100
24.50M
14.8% > 10%
Hence does not qualify for I.D

Asset
Q.cost
Factory
Plant &
machinery
20,870,000
5,000,000
25,870,000
I.D 100%
20,870,000,
5,000,000
25,870,000
Residue for
WTA & IBD
-
Wear & Tear Allowance

WDV b/f
Plant & machinery
Computers and equipment
Motor vehicle
Tractors
Additions:
Computer
Mercedes Benz
Office furniture
Disposal a/c
Plant & machinery
Computer
Furniture & Fittings
Pick-up
W.T.A
Class I
Class II
Class III
Class IV
12,440,000
5,062,500
-
2,750,000
-
32,250,000
1,640,000
-
2,272,500
-
1,000,000
-
420,000
_____12,440,000
(4,665,000)
7,775,000
1,250,000
______6,085,000
(1,825,500)
4,259,500
420,000
3,330,000
(832,500)
2,497,500
13,750,000
860,000
_
19,700,000
(2,462,500)
17,237,500
Total capital allowances

ID
25,870,000
WTA
9,785,500
35,655,500
TAXATION II
134
(b)
Londakin Ltd.
Sh.
Account profit
Add back:
Depreciation
VAT penalty and interest
Professional fees
Lease payments received
General provisions (bad debts)
Loan written off
Bad debt written off (provided in previous year)
Less:
Capital allowances
Gain on disposal of assets
Taxable profit
Sh.
36,243,375
2,204,025
2,254,125
600,000
800,000
5,600,000
2,325,000
1,200,000
35,655,500
10,125,000
14,983,150
51,226,525
45,780,500
5,446,025
Tax payable 37.5% x 5,446,025 = 2,042,259
(c)
(i)
Treatment of various matters

No.6 The loan is not allowable given that one of the companys directors owns
the company that is indebted.
(ii)
No.8
(iii)
No.9 The bad debt will be allowed as a deduction in full. However, the amount
provided for it in 2001 would be taxable. The general provision for bad debts is not allowable.
(iv)
No.10 Entertainment expenditure is for customers outside Kenya. The staff

function would be allowable expenses.
The fees earned from overseas are not taxable in Kenya.
135
DECEMBER 2003
QUESTION ONE
(a)
Capital allowances due to Mr. Omuora

INDUSTRIAL BUILDING DEDUCTIONS
Sh.
2001 Warehouse: 2.5% x 1,800,000
45,000
2002 Warehouse: 2.5% x 2,300,000
57,500
2003 Warehouse: 2.5% x 2,900,000
72,500
2004 Warehouse: 2.5% x 3,400,000
85,000
2005 Warehouse: 2.5% x 3,400,000
85,000
WEAR AND TEAR ALLOWANCE

2002
Lorries
Furniture
Office carpets
Saloon vehicles
Printers
WTA:
To 1999:
WDV b/f
Lorries
Vans
Furniture
Carpets
Saloon vehicles
Printers
WTA:
2004
WDV b/f
Vans
Furniture
Carpets
Saloon vehicles
Printers
WTA:
2005
WDV b/f
Lorries
Vans
Furniture
Computers, printers
WTA
2006
WDV b/f
Lorries
Vans
Class I
37.5%
Class II
30%
Class III
25%
Class IV
12.5%
860,000
70,000
12,000
_____
860,000
(322,500)
537,500
537,500
340,000
20,000
20,000
(6,000)
14,000
14,000
1,280,000
_______
1,280,000
(320,000)
960,000
960,000
_____
82,000
(10,250)
71,750
71,750
400,000
15,000
6,000
______
877,500
(329,063)
548,437
8,000
22,000
(6,600)
15,400
548,437
15,400
620,000
______
1,980,000
(495,000)
1,485,000
1,485,000
200,000
______
92,750
(11,594)
81,156
81,156
13,000
4,000
______
548,437
(205,664)
342,773
4,000
19,400
(5,820)
13,580
100,000
_______
1,785,000
(446,250)
1,338,750
______
98,156
(12,270)
85,886
342,773
1,500,000
13,580
1,338,750
85,886
150,000
_______
1,842,773
( 691,040)
1,151,733
4,000
17,580
(5,274)
12,306
_______
1,488,750
372,188)
1,116,562
9,000
_______
94,886
(11,861)
83,025
1,151,733
900,000
12,306
1,116,562
83,025
150,000
3,000
TAXATION II
136
Furniture
Office carpets
Saloon vehicles
WTA:
WDV
YEAR
2002
2003
2004
2005
2006
(b)
______
2,051,733
(769,400)
1,282,333
______
12,306
(3,692)
8,614
500,000
1,766,562
(441,641)
1,324,921
IBD
45,000
57,500
72,500
85,000
85,000
WTA
65,875
842,257
670,004
1,080,363
1,226,486
8,000
______
94,025
(11,753)
82,272
TOTAL
703,750
899,757
742,504
1,165,363
1,311,486
Correct taxable profit or loss
ASSETS:
Warehouse
House
Lorries
Vans
Furniture:
House
Business
Office carpets
Saloon vehicles
Land
Debtors
Cash
Inventory
Printers
Household appliances
Spares
TOTAL ASSETS
LIABILITIES
Business loans
Personal liabilities
Total liabilities
CAPITAL(net worth)
Increase in capital/net worth
Add:
Living expenses
Political party payments
Utility (private)
Less: Capital allowances
Taxable profit/loss
1 Jan
1998
Sh.
31 Dec
1998
Sh.
31 Dec
1999
Sh.
31 Dec
2000
Sh.
31 Dec
2001
Sh.
31 Dec
2002
Sh.
1,800,000
4,000,000
700,000
-
1,800,000
4,000,000
860,000
-
2,300,000
4,000,000
1,200,000
400,000
2,900,000
4,000,000
1,200,000
600,000
3,400,000
4,000,000
2,700,000
750,000
3,400,000
4,000,000
3,600,000
900,000
80,000
12,000
1,280,000
8,000,000
140,000
20,000
6,000
________16,038,000
100,000
70,000
12,000
1,280,000
8,000,000
720,000
600,000
20,000
6,000
80,000
17,548,000
140,000
85,000
18,000
1,900,000
8,000,000
600,000
800,000
680,000
28,000
9,000
30,000
20,190,000
140,000
98,000
22,000
2,000,000
8,000,000
860,000
320,000
450,000
32,000
4,000
70,000
20,696,000
140,000
107,000
22,000
2,000,000
8,000,000
750,000
720,000
36,000
10,000
100,000
22,735,000
320,000
110,000
30,000
2,500,000
8,000,000
1,050,000
80,000
960,000
36,000
8,000
8,000
25,002,000
2,500,000
7,000
2,507,000
13,531,000
2,000,000
2,000
2,002,000
15,546,000
2,015,000
2,000,000
_______2,000,000
18,190,000
2,644,000
2,900,000
________2,900,000
17,796,000
(394,000)
4,000,000
4,000
4,004,000
18,731,000
935,000
2,000,000
3,000
2,003,000
22,999,000
4,268,000
750,000
820,000
690,000
900,000
600,000
(703,750)
2,661,250
450,000
(899,757)
3,014,243
740,000
(742,504)
293,496
1,200,000
(1,165,363)
1,869,363
640,000
180,000
950,000
(1,311,486)
4,726,514
Declared income
Under-declared income is spread over the years and taxed
An additional assessment will be issued for each year of under-declaration.
137
QUESTION TWO
(a)
Capital allowances and taxable profits or losses of Maliza Limited:

Capital Allowances
(i)
Industrial building deductions:

No allowance as the building had enjoyed 100% investment deduction on 1 January
(ii)
Wear and Tear allowances
2001.
Class IV
WDV Brought forward
Sales proceeds
Balancing deduction
4,200,000
3,165,000
1,035,000
(87.5% x 4,800,000)
MALIZA LIMITED
ADJUSTED TAXABLE PROFITS
PERIOD TO 31 MAY 2002
Sh.
Reported income
Add:
Winding up costs
Loss on sale of furniture
Depreciation
Equipment
Furniture
Advertising costs sale of business
Valuation fees
Less:
Gain on sale of land and buildings
Tax refund
Balancing deduction
Add:
Dividends (Gross)
Taxable profits
Sh.
4,409,667
420,000
235,000
500,000
500,000
200,000
10,000
1,865,000
6,274,667
(300,000
(2,000,000)
(180,000)
(150,000)
(1,035,000)
2,609,667
315,789
2,925,456
CAPITAL ALLOWANCES: MWANZO LIMITED

(i)
Asset
Factory extension
Generator
Electrical wing
Processing machine
Qualifying cost
2,500,000
80,000
50,000
500,000
3,130,000
TAXATION II
ID: 100%
2,500,000
80,000
50,000
500,000
3,130,000
Residual
-
138
(iii)

Class II
30%
Purchases:
Equipment
Furniture & fittings
Water tank
Toyota prado
Computers
Class III
25%
Class IV
12.5%
4,450,000
3,165,000
10,000
1,000,000
800,000
800,000
WTA
240,000 x
_
1,000,000
7
7
250,000 x
12
12
140,000
660,000
WDV
______7,625,000
953,125 x
145,833
854,167
7
12
555,990
7,069,010
MWANZO LIMITED
ADJUSTED TAXABLE PROFITS
PERIOD TO 31 DECEMBER 2002
Reported profits
Interest::
10% x 2,000,000 x
7
12
Capital allowances: ID
WTA
Taxable profits
(iv)
Sh.
Sh.
12,000,000
12,000,000
(116,667)
(116,667)
(3,130,000)
(841,823)
7,911,510
856,197
(3,638,136)
8,361,864
Tax liabilities:
Maliza Limited
Mwanzo Limited
2,925,456 x 30%
7,911,510 x 30%
=
=
877,637
2,373,453
QUESTION THREE
(a)
Conditions under which import duty can be set off against income tax
- Duty is paid on capital goods qualifying for wear and tear allowance excluding passenger
cars.
- Capital goods imported with the prior approval of the Minister of Finance.
- The capital goods are to be used in a project the cost of which is not less than US dollars
70,000.
- The capital goods should be used within a period of 2 years
- The Minister is satisfied that the investment is capable of generating income benefits to
Kenyans
- The project is private but not aid funded or funded by the government.
(b)
Shortfall distribution tax

- A tax imposed on companies which have not met the commissioners requirements as to
distribution of dividends.
- Companies are required to distribute at least 40% of their operating profit after tax and 100%
of other incomes.
- A short fall distribution arises if the actual distribution is below the minimum distribution.
Shortfall tax = 30% (Minimum distribution Actual distribution)
139
Exemptions from shortfall distribution tax

(c)
Where the company is facing liquidity problems.

Where the company has commitments to purchase fixed assets
Where the company has commitments to repay loans
Where shareholders do not owe the company any amounts.
Double taxation relief:
(d)
A relief allowed for income tax in two different counties, one of which must be Kenya.
The foreign tax will be compared with the increase in the Kenyan tax liability and the lower of
the two taxes is allowed as the double taxation relief.
Time limit for claims is six years.
The double taxation agreement must be Gazetted in the Kenya Gazette.
Encourage cross boarder investments.
Taxation of charitable trusts
Charitable trusts have their incomes exempted from tax.
The conditions for exemption are:
- It must be public in character for a small section of the public or for the general public.
- It is for relief of distress of poverty to the public or if the beneficiary is not liable to tax.
- It is for the advancement of religion or education.
- Its income must be wholly or mainly expended in Kenya for charitable purposes.
QUESTION FOUR
(a)
Compensating Tax
Introduced in 1993
Additional tax affecting companies
Arises when the dividends paid and tax refunds exceed dividends received and tax paid in the year.
i.e. Compensating tax
Dividend paid x
paid
t
+ Tax refunds
1 t
Minus Dividend received x
t
1 t
minus taxes
Where t = Corporate tax rate

The computation of the compensating tax should be reflected in the self assessment return.
(b)
Lump sum and withdrawals
Lump sum received in computation of a pension or withdrawal from a registered pension or provident
fund will exempted from taxation as follows:
1/1/2004, the tax-free lump sum withdrawals has been increased to 480,000 from both registered pension
and provident funds. If the individual has worked for 10 or more years or Shs. 48,000 p.a. if worked for
less than 10 years. In case of gratuity, the back dating is done for the last 5 years. The gratuity for year 6
and prior years is aggregated and taxed together with 5 th backdating year income.
TAXATION II
140
(c) Kiserian Ltd.

Adjusted Income 2002
Sh.
Net profit per the accounts
Add: Back
Machinery depreciation
Vehicle depreciation
Provision for fencing
General bad debts provisions
District schools fundraising
Architects fees (capital item)
1,078,750
62,500
222,500
100,000
50,000
5,000
7,500
137,500
1,663,750
(21,500)
1,642,250
(515,000)
(142,650)
984,600
32,500
20,000
1,037,100
Less gain on sale of tractor

Less: Farm works deduction (ii)
Wear and Tear allowance (i)
Add: Trading receipt
Decline in specific bad debt provisions
Adjusted taxable income
Farm works
Farm Works Deductions (ii)

1
Q. Cost
FWD @ 33 %
Labour quarters
Livestock pen
Produce stove
Farm house
375,000
120,000
450,000
600,000
(i)
125,000 p.a. for yrs 2000, 2001 and 2002

40,000 p.a. for yrs 2000, 2001 and 2002
150,000 p.a. for yrs 2000, 2001 and 2002
200,000 p.a. for yrs 2002, 2003 and 2004
515,000
Wear and Tear allowances
01.01.2002 WDV
Additions
Disposals
Trading receipts taxable
Balance b/f
Wear and tear allowance
WDV 31/12/2002
Class I
37.5%
Class III
25%
Class IV
12.5%
216,500
_ 216,500
(249,500)
32,500
-
109,600
400,000
509,600
_____509,600
(127,400)
382,200
122,000
_____122,000
_____122,000
(15,250)
106,750

Class III 127,400
Class IV - 15,250
142,650
141
QUESTION FIVE
(a)
Mr. Abdi
Taxable income 2002
Sh.
Net profit per the accounts
Add back:
Rent for premises paid to self
Depreciation
Salary to Mr. Abdi
Drawings by Mr. Abdi
Interest on loan to pay tax
Legal expenses VAT case
Established expenses
285,200
180,000
196,000
380,000
200,000
166,000
29,000
50,000
600,000
2,086,200
Less:
Dividends
Lottery earnings
Other income
Wear and Tear allowance
FWD
Interest
(b)
(80,000)
(533,000)
(733,300)
(53,300)
(120,000)
(80,000)
486,600
Tax payable by Mr. Abdi for year 2002

Sh.
Total Taxable income Sh.486,600
1st 351,792 = (121,968 x 10%)
114,912 x 60%
Surplus = (486,600 466,704) x 30%
Gross tax
Less P/relief
Net tax
12,196.80
68,947.20
5,968.80
87,112.80
(13,944)
73,268.80
TAXATION II
142
JUNE 2004
QUESTION ONE
(a)
Taxation of co-operative societies

Corporative societies become taxable entities with effect from 1 st Jan 1985. This was with the
introduction of sect 19(a) of cap 470. This section states that, designated co-operative societies
shall be required to pay tax on their incomes.
Designated co-operative societies can be broadly classified into 3.
(i)
Designated Primary Co-op Societies:

These are co-op societies whose members are individuals. Many of the farmers co-op
societies fall under this category. Such societies usually deal with tea, coffee, milk,
sugarcane etc.
Section 19(a)(iii) states in the case of every designated primary society the income on
which tax should be charged shall be its total income for the year of income, deducting
there from on amount equal to the aggregate of bonuses and dividends declared for that
year and distributed by it to its members in money or an order to pay money.
Total income
Less: Allowable expenses
Adjusted income
Less: Bonus and dividends
Taxable income
xx
(xx)
xx
(xx)
xx
If a primary co-op society pays all the adjusted incomes as bonuses and dividends, then it
shall not pay any tax liability. However, if this is not the case, any income that remains
after distribution of business and dividends shall be taxed at 30% corporate tax rate.
(ii)
Designated Secondary Co-op Societies (Co-op Unions)

These are co-op societies whose members are not individuals but the designated primary co-op
societies. Therefore they act as umbrella bodies of unions for primary co-op societies. Examples
are KPCU, KFA, Meru Farmers Union (MFU). For tax purposes, sect 19(a)(ii) states, in the case
of every designated secondary co-op society, the income on which tax shall be charged shall be the
total income for the year of income deducting therefrom an amount equal to the aggregate of
bonuses and dividends declared for that year and distributed by it to its members in money or an
order to pay money but the deduction shall in no case exceed the total income of the society for
that year of income.
This implies that a designated secondary co-op society can only pay bonuses and dividends from
the current year of income profits but not from any profits retained in the past years.
Total income
Less: allowable expenses
Adjusted income
Less: bonuses and dividends
Adjusted taxable business income
(iii)
xx
(xx)
xx
(xx)
xx
Should the co-op society pay all adjusted income as bonuses and dividends, then no tax
liability shall arise otherwise the adjusted taxable income shall be subjected to 30%
corporate tax rate.
Savings and Credit Co-op Unions/Societies (SACCOs)
143
SACCOs are typically primary co-op societies since members are individuals but they carry on the business
of savings and credit where the savings are for members or the credit is granted to the same members.
Therefore this constitutes a mutual transaction where the saver is the same as the borrower.
Section 19(a)(iv) states, in the case of a designated primary society which is registered and carries on
business as a credit and savings co-op society its total income for any year of income shall be deemed to be
the aggregate of;
(a) 50% of its gross income from interest other than interest from its members.
(b) Its gross income from any right granted for the use or occupation of any property (rent income and not
royalties income.
(c) The gains chargeable to tax under sec 3(2)(f) i.e. deemed income.
(d) Any other income excluding royalties chargeable to tax under this Act not falling within a, b and c above
ascertained in accordance with the provisions of this Act.
NB: If a SACCO or any other type of co-op society makes a loss in any year of income
that loss cannot be carried forward to be offset against the future profits of the society.
- The total income of a SACCO shall be subject to 30% corporate tax rate when
determining the tax liability.
- No allowable expense shall be deducted in determining the gross rent income.
However, a society shall be granted wear and tear allowance just like any other
ordinary business.
- In case of designated primary co-op societies, dividends and bonuses shall be treated
as deductible expenses (deducted from adjusted income) under the following
conditions:
(i)
(ii)
(iii)
They must be paid in cash or by cheque to the members.

The payment must be approved at the AGM by the members of the primary co-op
society.
The payment must be approved by the commissioner of co-op societies.
Primary co-op societies are considered as home-based societies and the dividend income
received by the members is called non-qualifying dividends.
(b)
Offer A 1 year only

Salary (130,000 x 6) + (130,000 x 6 x 1.10)
Bonus (5% x 130,000 x 6) + (130,000 x 6 x 1.10 x 5%) = 5% x 1,638,000
Fuel allowance private Sh.10 x 10,000 x 25%
Entrance fees
Watchman
Actual salary 2000 p.m x 12
House servant 2000 p.m x 12 = 24000 or 27,000
Furniture 12% x 800,000
Telephone 30% x 5000 x 12
Housing benefit: Higher of:
(i) 15% x 1,912,900 = 286,935
(ii) Rent paid 18,000 x 12 = 216,000
Less rent paid by employer 3000 p.m x 12
Subscriptions to professional body 1200 x 11
1,638,000
81,900
25,000
3,000
24,000
27,000
96,000
18,000
1,912,900
286,935
(36,000)
(13,200)
2,150,635
Offer B
Salary 150,000 p.m x 12
Allowance 2,000 p.m x 12
Clothing allowance
Car benefit: Higher of:
(i) % of cost = 2% x 1,800,000 x 12
(ii) Fixed benefit on 3000 cc
Night watchman 2,000 p.m x 12
Water bills Fixed benefit
Electricity bills Fixed benefit
1,800,000
24,000
220,000
432,000
24,000
6,000
18,000
TAXATION II
144
2,524,000
Tax Liability
Offer
1st Ksh.121,968 @ 10%
next Ksh.114,912 @ 15% + 20% +
25%
Surplus (2,150,635 466,704) @ 30%
Net tax liability
A
12,196.
8
68,947. (2,524,000 466,704)
2 @30%
505,179
586,323
(13,944)
505,179
B
12,196.8
68,947.2
617,189.
0
698,333.
0
(13,944.0
)
684,389.
0
Notes:
1.
Under offer A, he will receive low interest benefit where the employer will pay fringe
benefit tax of
2.
12% 5% 2,000,000x30% 112 3,500 p.m
Option A seems more attractive because of low interest rate benefit, housing benefit and
salary increamental so that in the long run, income will be higher than that of Option B.
QUESTION TWO
(a)
Resident Insurance Companies

The companies are exempted from specified sources of income such that a loss from one
source could be offset against gains/profits from another source.
Profits from life business should be ascertained separately from other general insurance
business.
The taxable profits from insurance business shall be the gross written premium net of the
following expenses.
(b)
(i)
Claims paid
Agency and brokerage expenses
Provisions for unexpired risk
Nature of business
Premiums received
Commission received
Premium returns + interest
Net premiums received
Interest paid on policies
Premium paid to re-insurance
Agency expenses
Management expenses
Traveling expenses
Postage and telephone
Advertising
Specific bad debts
Reserves 31/12/03
Less 1/1/03
Claims paid
8 + 0.7
Life
General
360.0
3.6
(8.7)
354.9
740.0
7.4
(17.0)
730.4
27.0
36.0
36.0
15.16
6.0
3.5
2.2
1.3
17
(29)
39
17+0
74.0
88.8
74.0
11.0
6.2
3.4
0.8
91
(89)
(113)
145
Less outstanding claims 1/1/03

Outstanding claims 31/12/03
W.T.A
Profits from insurance business
(23)
32
26
Rent income
Less rent expenses
9
(10)
Gross interest - deposit
119
0.85
Interest on bonus to policy holders

(ii)
(189.16)
165.74
(1.00)
140.0
16
( 9)
29
(398.2)
332.2
(14)
63
0.85
3.0
307.74
(14.0)
74.12
392.32
Tax Liability
Total income (307.74 + 392.32)
Tax 700,060,000 x 30%
=
Less W/T on interest on deposit
15% x 140, (life)
15% x 74.12 (General)
Net tax liability
= 700.06 = 700,060,000
210,018,000
(21,000,000)
(11,118,000)
177,900,000
QUESTION THREE
(a)
Provisions of Section 125 of cap 470 on official secrecy.

-
Any officer, any other person employed shall deal confidentially with all documents and
information relating to income of a person as if it was a secret.
An officer on appointment shall make and subscribe to an oath before a magistrate or
commissioner for oaths.
The officer shall provide such information or document in his possession or to his
knowledge in court in the course of prosecution for an offence committed in relation to
tax.
The officer can disclose such documents or information to/for:
(i)
(ii)
(iii)
(iv)
(v)
another officer or person authorized by Minister or

a court of law
to another person for revenue or statistical purpose in the service or the
government or
Controller and Auditor General or a member of this department
Double taxation relief purposes.
Where in all the above cares, the document or information is for official duties.
-
(b)
An officer shall disclose any allowance of relief from the arrangements and facts of
granting such a relief or for purpose of prevention of fraud or for administration of
statutory provisions against legal avoidance of tax.
Since the business was carried on for only 9 months, the capital deductions will be apportioned.
Except ID. The ID rate for year 2003 was 70%.
Asset
Machine New
- Second hand
(i) Investment deduction

Kshs. 000
Q.Cost
I.D @ 70%
1,200
840
600
420
TAXATION II
Bal c/f
Residual
360
180
146
Factory 3,200,000 300,000

Tarmack
Recycling machine
Generator
Factory extension
Drive way
Drainage system
2,900
400
650
300
1,000
400
250
2,030
280
455
210
700
280
175
5,390
970
120
195
90
300
120
75
147
(ii) IBD
Kshs. 000
Building
Q. Cost
Residual b/f
300
400
75
500
870
120
300
120
Godown
Staff canteen
Drainage system*
Borehole
Factory*
Tarmac*
F. Extension*
Driveway*
IBD @ 2.5% x
Residual c/f
12
5.625
7.50
1.406
9.375
16.3125
2.25
5.625
2.25
50.3435
294.375
392.5
73.594
490.625
853.6875
117.75
294.375
117.75
* Cost net of I.D.

(iii) WTA
Class
III @ 25%
Others net of I.D*

Delivery van
Traded in van
2 Saloon cars @ 1,400,000 each
Disposals Van @ market value
Water pump
WTA
700,000
600,000
2,000,000R
(250,000)
-___
3,050,000
(762,500)
2,287,500
IV @
12.5%
825,000
30,000
855,000
(106,875)
748,125
Total
______
766,250
Notes:
Residuals of 360 + 180 + 195 + 90 = 825,000
Office blocks do not qualify for any capital deduction.
Computers cannot qualify for WTA since they are not used in the year to generate taxable
income
The nine month capital allowance is granted (except in case of IBD) irrespective of the
time the asset was brought into use during this period.
(ii)
Profit before capital allowances

ID
IBD
WTA
Adjusted taxable profits
NB:
12,500,000
5,390,000
50,343.5
869,375
(6,309,718.5)
6,190,281.5
Assumed that the lease charges, interest on loan and loss of stock (all allowable
expenses) have been adjusted in the profits of Sh.12,500,000.
Tax liability = 30% x 6,190,281.5 = 1,857,085
TAXATION II
148
QUESTION FOUR
(a)
The following is a suggested program of work to be carried out by an auditor certifying a VAT
refund. It is not exhaustive and may require tailoring to circumstances.
1.
2.
Review and document the adequacy of the system of recording and accounting for VAT.
Ensure that the VAT 4 corresponds with the supporting VAT return and that the entries in
the return agree to the books of account.
Establish why the trader is in refund position (e.g trader in an exporter, inputs taxed at
higher rate than outputs, significant capital expenditure, seasonal trading/purchases, etc).
The reason for the refund must be soundly based.
Check if the trader is subject to partial exemption rules, and if so, whether the rules have
been applied correctly as required by regulation 17, especially the annual adjustment.
Select a sample of invoices from VAT 4 and perform the following tests where
applicable:
3.
4.
5.
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(b)
Penalties
(i)
Failure to file VAT return = higher of:
(ii)
(c)
July
Aug
Sep
Oct
Nov
Dec
Input tax has been claimed within 6 months after the issue of the invoice.
The invoices meet the requirement of Regulation 4.
Simplified tax invoices have not been used to claim relief
The invoices are not photocopies or fax copies
Ensure that input tax in respect imported goods is properly supported by a
Customs Entry from and contained within an original KRA receipt for payment
of duty and VAT.
Ensure that tax has been properly accounted for in respect of imported services
(reverse charge).
Ensure the input tax does not relate to items scheduled on the blocking order
VAT Order, 1994.
Ensure the input tax has not been claimed in advance.
Trace the invoices to the relevant ledger accounts
Confirm that the expenditure is business related and not private..
Fixed penalty of Sh.10,000

5% x 3,600,000 = 180,000
Interest penalties @ 2% p.m compounded

3,600,000 (1.02)5 3,600,000
Total penalty
180,000
374,691
554,691
VAT A/c
Input VAT
90% x 450,000 x 16%
64,800
90% x 300,000 x 16%
43,200
90% x 700,000 x 16%
100,800
90% x 650,000 x 16%
93,600
90% x 900,000 x 16%
129,600
Returns inwards 40,000 x 16%
6,400
Bad debt relief 200,000 x 16%
32,000
Over declared VAT
18,000
VAT payable
780,620
Jul 85% x 1,200,000 x 16%

11% x 1,200,000 x 0%
Aug 85% x 1,400,000 x 16%
11% x 1,400,000 x 0%
Sep 85% x 1,650,000 x 16%
11% x 1,650,000 x 0%
Oct 85% x 2,200,000 x 16%
11% x 2,200,000 x 0%
Nov
Dec 85% x 2,800,000 x 16%
11% x 2,800,000 x 0%
Output VAT
163,20
0
0
190,400
0
224,400
0
299,200
0
380,800
149
Return out 16% x
22,000
Undeclared VAT
_______
1,269,02
0
NB:
0
3,520
7,500
1,269,020
For purchases acquired from unregistered persons, no input VAT was charged. No output
VAT is charged on exempt sales.
QUESTION FIVE
(a)
Sh.000
Add back:
Legal costs
Donations St. Peters Church
Bad debts General pension
VAT paid
Depreciation
Partners drawings (140 + 180)
Interest on capital (250 + 320)
Partners salaries (8,700 + 4,500)
Less:
Specific bad debts
Capital allowances
Dividends and interest incomes (250 + 120)
Interest on drawings (70 + 40)
Recoveries from insurance
Adjusted partnership income
(1,453)
140
320
80
160
90
320
570
13,200
170
480
370
110
95
Jacksons Farming Income

Net profit
Add back salary to self
Drawings
Donations
Adjusted Farming income
(b)
(c)
14,880
13,427
(1,225)
12,202
50
300
450
60
860
Partner
Salaries
Interest on capital
Interest on drawings
Share of profit (loss)(2:3)
Partnership income
Add: Other incomes Farming
Jackson
8,700
250
(70)
(583.2)
8,296.8
860.0
9,156.8
Martin
4,500
320
(40)
(874.8)
3,905.2
3,905.2
Total
13,200
570
(110)
1,458
12,202
Comments on any information not used:

-
Farmworks deductions are allowable hence not added back in determining Jacksons
farming income.
Subscriptions assumed the chamber of commerce and industry has elected to be treated
as a taxable concern under Sec 21(2) of Cap 470.
Miscellaneous income assumed business income.
Advertising and maintenance costs assumed directly related to business.
TAXATION II
150
(d)
If Jackson was a non-resident, then:

(i)
(ii)
he could have been taxed on gross income without deducting allowable expenses
tax could have been computed using a given withholding tax rate and not graduated scale.
151
DECEMBER 2004
QUESTION ONE
Determine the cost of sales
Purchases Bank
Cash purchases 18 000 x 12
Drawings 250 000 + 100 000
Total purchases
Add credit purchases (year end)
Less credit purchases (year start)
Add Opening stock
Less Closing stock
Cost of goods sold
1,515,000
216,000
350,000
2,081,000
890,000
(740,000)
860,000
(1,680,000)
1,411,000
Determine the amount of sales

If margin is 331/3% i.e 1/3, then mark-up is 50% i.e 1/3-1 = = 50%
Sales = (1,411,000 x 1.5) = 2,116,500
Alternatively sales = 661/3% = 1,411,000
Sales = 1005 = ??
Sales = 1411,000 x 1000
= 2,116,500
662/3%
Sales
Less cost of sales
Gross profits
Less allowable expenses only
Casual labour 514 +12
General expenses 30 +10
M.V expenses 60% (16 + 8)
Rent paid
Less prepaid (31/13/03)
Add prepaid (31/12/02)
Electricity paid
Add accrued (31/12/03)
Less accrued (31/12/02)
Salaries 505 X (4,800,000 + 480,000 520,000)
= 4,760,000 x
WTA on MV 25% x 3,000,00
Delivery to customers (carriage outwards)
Cost of meals to employees
Net loss
9 months = 9/12 x 3,893,900
3 months = 3/12 x 3,893,900
2,116,500
1,411,000
705,500
526,000
40,000
14,400
504,000
42,000
(30,000
139,000
16,000
(21,000)
492,000
134,000
2,380,000
750,000
140,000
123,000
(4,599,400)
(3,893,900)
(2,920,425)
(973,475)
Allocation: 9 months
Salary for 9 months = 9/12 x 2,380,000
Salary for 3 months
1,785,000
595,000
Partner
Salary 1:1
Interest on drawings 10% x 9/12 x 15,000,10,000
Share of loss
Loss from partnership
Shada
892,500
(1,125)
(2,351,775)
(1,460,400)
3 months
TAXATION II
Pete
892,500
(750)
(2,351,775)
(1,460,025)
Total
1,785,000
(1,875)
(4,703,550)
(2,920,425)
152
Total salary
Less kidoles salary
Shared between shada and pete
Partner
Salary
Ondrawings 10% x 3/12 x 15,00,
10,000
Share of loss (2:2:1)
(b)
(c)
595,000
268,000
327,000
Shada
163,500
Pete
1,63,500
Kidole
268,000
Total
595,000
(375)
(627,140)
(464,015)
(250)
(627,140)
(463,890)
(313,570)
(45,570)
(625)
(1,567,850)
(973,475)
No tax is payable by any of the partners since they all had losses
The following returns should be filed
(1)
Final return for the partnership business filed by 30th April the following year.
(2)
Self assessment returns by each of the partners
QUESTION TWO
(a)
(i)
Sh 000
(51,250)
Reported net loss

Add back disallowable expenses
Salaries provision for staff leave accruals
School fees for chairman children
Traveling cost for expatriate
General bad debt provisions
Provision for interest expense
Depreciation
Auditors fees under provision
Loss on disposal of equipment
Rental income
Gain on disposal of property
NB
(b)
4,920
1,200
600
15,930
20,950
43,700
300
7,250
18,600
2,190
12,300
Assumed that income from forex dealing is realized hence taxable
Assumed the pension fund is registered hence contributions allowable
(ii)
Tax payable
Year 2002 tax liability =

Year 2003 instalment tax
Year 2003 actual tax
=
10,510,000 x 30% =
94,850
43,600
(33,090)
10,510
3,153,000
2,400,000 x 30%
=
720,000
=
110% x 720,000
=
792,000
10,510,000 x 30%=
3,153,000
20/4/2002 = 1st instalment = 25% x 792,000

20/6/2003 = 2nd instalment = 25% x 792,000
20/9/2003 = 3rd instalment = 25% x 792,000
20/12/203 = 4th instalment = 25% x 792,000
Total paid
198,000
198,000
198,000
198,000
792,000
153
30/4/2004 = final 15th instalment = 3,153,000 792,000 = 2,361,000

(c)
A bank is exempted from provisions of sec 15(7) (e) so that a loss from one some of income can
be offset against a gain from another source of income.
QUESTION THREE
(a)
Capital Allowances
Year 2002
(i)
Asset
Building
Machinery
(ii)
Q. Cost
50
40
Residual for IB and WTA

-
Wear and tear allowance WTA
Class
WDV 1/1/2002
+ Furniture + office equipment
Transport lorries 3 x 7m
2 saloon cars
Donated saloon
WTA 2002
WDV 31/12/2002
(iii)
Shs. million
I.D@ 100%
50
40
90
I@
37.5%
NIL
21,000
-__
21,000
(7,875)
13,125
II@
30%
NIL
-__
-__
-___
III@
25%
NIL
2,000R
1,000R
3,00
(750)
2,250
IV@
12.5%
NIL
10,000
-__
10,000
(1,250)
8,750
Diminution (sprinklers) = 331/3 x 600,000 = 200,000
Year 2005
(i)
W.T.A
Class
WDV 1/1/2003
Add forklift
2 computers + printer
Calculators
Less pick up
Lorry
WTA 2003
WDV 31/12/2003
(b)
I@
37.5%
13,125
6,000
(5,000)
14,125
(5,297)
8,828
(i)
Year
II @
30%
550
40
-__
990
(297)
693
2002
TAXATION II
III @
25%
2,250
(1,400)
-__
850
(212.5)
637.5
IV @
12.5%
8,750
10,000
-__
8,750
(1,094)
7,656
2003
154
Net profits
Add back depreciation
Tax paid
Investment deductions
Diminution
W.T.A (Total)
(ii)
21,200,000
9,000,000
1,000,000
31,200,000
63,000,000
8,500,000
2,000,000
73,500,000
(90,000,000)
(200,000)
(9,875,000)
(68,875,000)
(200,000)
(6,900,500)
66,399,500
Tax liability
Year 2002
Year 2003
30% x 66,399,500
NIL
19,919,850
A body corporate should file returns by end of 6th month after the accounting year. The
returns are filed whether or not there is tax payable. Given year ends as 31 st Dec, then
(iii)
(a)
(b)
Year 2002 returns due date is 30th June 2003

Year 2003 returns due date is 30th June 2004
QUESTION FOUR
(a)
The commissioner may recover tax due and payable from a person who owes money to the tax
payer. Accordingly the commissioner may by notice in writing, require any person
From whom any money is due or accruing or may become due to a taxable
person; or
Who holds or may subsequently hold money on account of a taxable person;

or
Who holds or may hold money on accounts of some other person for
payments to the taxable person; or
Any person having authority from some other person to pay money to the
taxable person; to pay t the commissioner that money or so much thereof as may be
sufficient to pay the tax so due and payable.
(b)
Cost insurance and fright (CIF) value
Add 20% duty
Buying price exclusive of V.A.T
Input VAT = 16% x 2400 000 = input VAT
Buying price inclusive of V.A.T
2,000,000
400,000
2,400,000
384,000
2,784,000
Buying price exclusive of VAT

Add transport cost 10%
2,400,000
240,000
2,640,000
660,000
3,300,000
2,200,000
5,500,000
880,000
6,380,000
Add 25% conversion cost

Cost of sales
Add mark-up = 40% = 2/5-2 = 2/3
Selling price exclusive of VAT
Add VAT @ 16% - output VAT
Selling price inclusive of VAT
VAT payable
= 880,000 384,000 = 496,000
Due date
= 20th June 2004
(c)
Items of wages and salaries, provision for doubtful debts and sale of motor vehicle are irrelevant
155
Compute the output VAT
Item (exclusive of VAT)

Standard rate sales
Exports
Exempt sales
Amt
45,000
10,000
20,000
75,500
VAT rate
16%
0
-
Output VAt
7,200
0
-__
7,200
Compute input VAT

25,000
10,000
500
700
Purchases at standard rate

Zero rate purchases
Telephone and Electricity
Audit fees paid
16%
0
16%
16%
4,000
0
80
112
4,192
Eliminate the 25% effects

- Total input VAT
- Less 25% input VAT on purchases
- Sold at std rate = 25% x 4000
Net
- Tax supply (Std and zero rated)
Less 25% of Std sales purchases at standard rate = 25% x 25 000
Net
Total supply
Less
Net
Restricted input VAT = 48,750 x 3,192 =
68,750
4,192
1,000
3,192
55,000
(6,250)
48,750
75,000
(6,250)
68,750
2,263
QUESTION FIVE
(a)
Import duty is refundable if

-
Imported goods are returned to the seller

Duty was paid in error (overpaid)
Where goods are destroyed/ damaged while under customs control ware
Where goods are destroyed or lost through accident
Where imports are used in production of exports or other specified duty exempt goods
Duty was paid by privileged persons as institutions such as WB, UN, Armed forces etc
(b)
Thin capitalization
This refers to the extent of mix of debt and equity capitalized. Debt is defined to include
-
(c)
Tax incentives given by the government to encourage growth of capital markets

-
(d)
Long term loans

Debentures and bonds
Short term loans
Bank overdraft
Creditors
Overdrawn current accounts
Other amounts used t o 3rd parties
Withholding tax on dividends is only 5%

Capital gains are tax exempt
Floatation costs are tax allowable
Stock brokerage services are VAT exempt
Venture capital firms enjoy a 10 year tax holiday
Income from collective investment schemes is tax exempt
Goods are subject to customs control if measures are taken by commissioner of customs and Excise to ensure
compliance with provisions of cap 472. Examples of such goods are
TAXATION II
156
(e)
Goods on which duty (import or excise duty) has not been paid
Goods subject to seizure
Restricted exports
Goods lending exportation stored in a customs area under permission of proper officer
Goods on board an aircraft to be used or used within Kenya
Refund of VAT for Bad debts

-
The refund is made if

No payment for supplies has been received and 3 yeas have elapsed
The claim must be made within 5 years of making application
The following documents must accompany the refund claim application

Copy of tax invoice issued upon supply
Declaration that the seller and buyers are independent parties
Evidence that every effort has been made to recover the amount owed
Document evidence by liquidator that the
JUNE 2005
QUESTION ONE
a) Taxation of
i)
Incapacitated person
ii)
According to Section 46 of Cap 470 (Income Tax Act) the income of incapacitated person shall
be assessed on and tax thereon charged on that person in the name of his trustee, guardian,
curator, committee or receiver appointed by the court.
It shall be assessed on such a name in the same manner and to the same amount as that
incapacitated person would have been assessed and charged if he were not an incapacitated
person.
Non-resident persons (Section 47 of Cap 470)

The income shall be assessed on and tax thereon charged on that person either in is name or the
name of his trustee, guardian, curator or committee or of attorney, factor, agent, receiver or
manager.
For tax purposes a normal agent maybe deemed to be the master of a ship or the captain of an
aircraft owned by a non-resident person chargeable to tax shall does not exclude any other agent.
Non-resident persons are taxed at a specified withholding tax rates.
Individuals dont enjoy personal relief.
b) i) Mr. Mbazo was an individual resident in Kenya for tax purposes because he was present in Kenya
for a period exceeding 183 days during year of income under consideration although he does not
have a permanent home in Kenya
Mr. Mbazo taxable income for year ending 31/12/2004
Basic pay Jan Sep (200,000 p.m x 9)
Oct Dec (200 x 1.25 x 3 months)
1,800,000
750,000
2,550,000
Add other benefits

Rent reimbursed (35,000 p.m. x
x 11)
Air tickets (not an expatriate)

Entertainment allowance (12,000p.m x 6)
192,500
25,000
72,000
Motor vehicle insurance (80,000 x
157
3
12
20,000
Medical cover/allowance (8,000 p.m x 3)

Performance bonus
24,000
150,000
3,033,500
Less motor vehicle maintenance costs

75% x 120,000
Net taxable income
ii)
(90,000)
2,943,500
Tax liability (using year 2005 rates)

1st Ksh.121,968
Next 114,912
Next 114,912
Next 114,912
466,704
Surplus (2,943,500 466,704) @ 30%
@10%
@15%
@20%
@25%
12,196.8
= 114,912 x 60% =
68,947.2
81,144.0
743,038.8
824,182.8
(13,944.0)
(200,000.0)
610,238.8
Less personal relief 1162p.m x 12

P.A.Y.E. deducted
Net tax liability
QUESTION TWO
a) Most favoured nation Status
This is a reciprocated economic and tax favour granted to a member country if a trading or
economic block first as the receiving member has granted other members of block. It generally
involves agreement on tax/tariff concessions on particular goods. The benefits are
It enhances international trade among member countries due to lower tariffs on imports and
exports.
Facilitates comparative advantage as countries specialise in production of what they produce at
lowest cost
Promotes free trade as member countries remove any restrictions on trade barriers on
imports/exports of member countries.
It accords equal commercial opportunities on import duties and freedom of investment
Enable member countries to enjoy trading benefits accorded to third states by member countries
b) The 1.0 rate for year 2003 was 70%. The remaining 30% of cost quality for IDBM. This is
because IDBM is granted over and above 1.0 on ordinary manufacture.
1) Year 2003 ID and IDBM
Ksh.000
Asset
Factory Building
Stone wall
Water pump
Sewer treatment
Factory machine
Heating plant
Q.Cost
10,060
1,400
200
700
400
500
13,260
ID @ 70%
7,042
980
140
490
280
350
9,282
The Qualifying Cost for factory building is ascertained as follows:Clearing/demolition of old building
Construction cost (includes office and store)
500
12,000
12,500
TAXATION II
IDBB @30%
3,018
420
60
210
120
150
3,978
158
Less store
Office
Net cost
(700)
(1,740)
10,060
% cost of office = ___1740___ x 100 = 14.75% > 10% hence office does not qualify for I.D store quality
for
10,060 + 1740
IBD automatically.
2.
Year 2003 IBD

Building
Store
Canteen
Borehole
* 800 x 2.5% x 6
Q.Cost
700
800
800
Residual b/f
-
IBD @ 2.5%
17.5
20.0
10.0*
47.5
Residual c/f
682.5
780.0
790.0
12 = 10.0
3. I.D for year 2004 (Ksh000)
Asset
Q.Cost
I.D @ 100%
4,800
640
2,400
600
8,440
4,800
640
2,400
600
8,440
Factory extension
Conveyor Belt
Imported machine
Loading bay
4. IBD for year 2004

The company stopped manufacturing for export after only two years. The IDBM granted shall be
withdrawn and treated as taxable income in the year of withdrawal (year 2004). The firm shall however
be granted capital allowances on withdrawn IDBM for each of the two year.
IBD for year 2004
Building
Q.Cost
Residual
b/f
IBD @2.5%
Residual c/f
700
800
800
682.5
780.0
790.0
17.5
20.0
20.0
665
760
770
420
420
3018
3018
9176
409.5
2942.55
10.5
10.5
75.45
75.45
229.40
409.5
399.0
2942.55
2867.10
Store
Canteen
Borehole
IBD on IDBM withdrawn
Stone wall: year 2003
year 2004
F. Building: year 2003
year 2004
5. Wear and Tear allowance (2003 and 2004)

The machinery that qualified for IDBM in year 2003 shall be granted year 2003 WTA on IDBM withdrawn as
follows.
Asset
Class IV
@12.5%
Water pump IDBM

Sewerage plant IDBM
Factory machinery IDBM
Heating plant IDBM
WTA for year 2003
WDV 1/1/2004
60
210
120
150
540
(67.5)
472.50
159
W.T.A Ksh. 000
Class
Year 2003:
I@
37.5%
Lorry & Fork Lifts

Photocopy, computer & printers (150 + 380)
Delivery van
W.T.A (2003)
WDV 31/12/03
Less IDBM WTA
WDV 1/1/2004
+ WDV IDBM
Fax machines
Pick-ups
Less disposals lorry
Heating plant
Photocopier
WTA year 2004
Totals year 2003 = 2,604

Year 2004 = 1,337.3
TAXATION II
II @
30%
III @
25%
IV @
12.5%
5,100
-___
5,100
(1,912.5)
3,187.5
_____3,187.5
(2,200)
-
530
___530
(159)
371
____371
120
(100)
1,800
___1,800
(450)
1,350
____1,350
2000
-
120
120
(15)
105
472.5
105
472.5
(480)
-
987.5
(370.3)
617.2
391
(117.3)
273.7
3,350
837.5)
2,512.5
97.5
(42.2)
85.3
160
ii) Style Ltd

Adjusted taxable income (loss) for year ended 31/12/04
Ksh. 000
7,200
3,978
11,178
Accounted net profits

Add IDBM withdrawn (for year 2003)
I.D for year 2004
IBD for year 2004
WTA for year 2004
IBD on IDBM withdrawn Factory Building
Stone wall
WTA on IDBM
8,440
229.4
1,337.3
75.45
10.50
67.50
(10,160.15)
1,017.85
NB: Just like IDBM of year 2003 becomes taxable income in year 2004 (year of withdrawal), the capital
allowances on the year 2003 IDBM (IBD and WTA on IDBM) becomes taxable in year , the year of
withdrawal (2004)
Tax liability 30% x 1,026,250 = Ksh.307,875
QUESTION THREE
a) a) Shortfall distribution tax
A tax imposed on companies which have not met the commissioners requirements as to distribution of dividends.
Companies are required to distribute at least 40% of their operating profit after tax and 100% of other incomes.
A short fall distribution arises if the actual distribution is below the minimum distribution.
Shortfall tax = 30% (Minimum distribution Actual distribution)
Exemptions from shortfall distribution tax
Where the company is facing liquidity problems.
Where the company has commitments to purchase fixed assets
Where the company has commitments to repay loans
Where shareholders do not owe the company any amounts.
b) Vuma Ltd
Shortfall distribution tax
The investment income is not taxable since it is only available for distribution to shareholders. Its only
operating income which is taxable. The mandatory distribution is 40% (60% retention)
Operating income
Less tax @ 30%
Distributable profits
Less 60% statutory retention
Statutory distribution (40%)
Add investment income
Total available for distribution
Less amount distributed
Short fall distribution
Short fall distribution tax = 30% x 760,000 =
2,000,000
600,000
1,400,000
(840,000)
560,000
400,000
960,000
(200,000)
760,000
228,000
c) Exemption from paying instalment tax

Non-employment income is less than 1/3 of total income (employment + non-employment)
Tax liability for year of income does not exceed Ksh.40,000.
The source of income is only employment income which is taxed under PAYE
Where total tax liability for the year is expected to be nil or negative (refund)
ii)
Double Taxation relief
This avoids double taxation of employment income earned by Kenyan citizens from outside
Kenya
161
If a Kenyan citizen earns employment income from Kenya and from foreign country the foreign
employment income would be taxed in foreign country and in Kenya. To avoid this double
taxation Section 41, 42 and 43 of Cap 470 grants double taxation relief where:-
TAXATION II
Comprehensive Mock Examination
162
The tax payer must prove that the tax was deducted in the foreign country on foreign
employment income.
The tax payer must claim the double taxation relief within 6 years of paying such tax
liability in foreign country.
The double taxation relief shall be the lower of
a) Tax paid on foreign employment income in the foreign country
b) Tax paid on foreign employment income in Kenya.
W.e.f. 1/1/2002 a resident person with foreign employment income shall be granted
double taxation relief whether or not Kenya has a DTA with the foreign country.
Currently, Kenya has a DTA with Zambia, UK, Germany, South Africa, Canada etc.
iii) Refund of over-paid tax
- According to Section 105 of Cap 470, refund of overpaid tax shall occur as follows
Where the CIT is satisfied that a person paid, in respect of a year of income tax in
excess of amount payable, the CIT shall refund the amount of excess together with any
interest
When tax is due and payable by a tax payer who is expecting a refund, any amount
refundable shall be applied towards the satisfaction of the tax due and payable
A claim for repayments/refund shall be made within seven years after expiry of the
year of income to which the claim relates.
QUESTION FOUR
a) Taxation of a Kenyan branch of a foreign company (Section 18 of Cap 470)
The branch is considered as a non-resident and taxed at 37.5% corporate tax rate
Expenses of interest, royalties and management or professional fees paid to head office are not
allowable expenses.
Sales abroad (exports) by the branch of items manufactured locally are deemed to have arisen in
Kenya hence taxable in Kenya
Expenditure incurred by the branch outside Kenya is only allowable/deductible to the extent the
C.I.T may consider.
For the purpose of ascertaining taxable income, gains or profits arising from transactions of the
branch with related parties shall be determined as if the transactions were at arms length
Answers -Mocks
163
b)
Mazuri Ltd
Adjusted taxable income for year ended 31/12/04
Kshs.
Reported accounting Net Profits
preparing M.O.A
- Fees for land purchase
- Bank loans
Bad debts Loan to director
- General bad debts
Advertising Neon sign
Travelling expenses private = 20% x
180
Goodwill amortisation
Christmas gifts to staff (salaries)
Donations to trade association
Cost of goods withdrawn
Depreciation
Less allowable/deductible items
Capital allowances
Sales to directors
Overstated closing stock = 2400 -
Kshs
Kshs
6,306
150
60
20
200
120
100
36
25
600
40
600
150
2,101
200
720
400
2400
1.20
Gain on sale of equipments
Refund of import duty
120
40
80
(1560)
6487
Assumed foreign exchange gain realised hence taxable

Golden handshake is for services rendered in the past, present or could have rendered in future hence
allowable
ii) Tax payable 6,847,000 x 30% = 2,054,100
QUESTION FIVE
a) Methods of zero rating supplies to EPZ
1) Supplies of taxable goods and services to EPZ businesses could be made without charging VAT
provided that the suppliers maintain records of
Proof of payment made for on acquisition of such goods and services.

A certificate signed by the buyer (EPZ business) that the goods were received.
A copy of the invoice showing the supply of goods or services to the EPZ business.
2) Treating EPZ as a territory outside Kenya.
Local suppliers to EPZ businesses are treated as exporters and exports are zero rated.
They charge V.A.T at zero rate ( zero output VAT) on such supplies but they have to complete the
usual export entry forms and maintain copies thereof duly certified by a proper office of customes
at their business premises.
The copies would be examined by VAT officers during routine audit examination.
TAXATION II
164
b) Remission of VAT
This is a pro-active approach where a taxpayer applies for waiver of payment of V.A.T on imported
goods as long as such goods are:i.
ii.
iii.
iv.
v.
vi.
vii.
For official aid funded project

Imported for manufacture under bond (manufacture for exports only for at least 3 years)
For use by the Kenya armed forces
Capital equipment and machinery acquired solely for use in manufacture of goods in a licensed
customs bonded factory for exports only.
Donated or purchased for donation by any person to NGO (excludes motor vehicles and
computers)
Goods including motor vehicles and aircraft acquired by a person who has been granted an oil
exploration or prospecting licence by Government of Kenya
Capital goods (excluding motor vehicles) purchased for a total value of net less than
US$70,000 for new investments aimed at generating net foreign exchange savings or earnings.
c) Sales and purchases accounts (for trading purposes only) are always shown net of VAT since VAT
has to be accounted for separately in the VAT account
Therefore, input/output VAT = 16% x purchases/sales exclusive of VAT
VAT Account
Date
10/1
12/1
17/1
17/1
P. Mwanzia
Cash account
M. Mpole
Return in A.
Ali
36,000 x 16%
18,000 x 16%
22,600 x 16%
14,000 x 16%
January 2005
Input Date
VAT
5,760 3/1
2,880 10/1
3,616 12/1
2,240 18/1
30/1
12/1
VAT payable
Cash account
Cash account
A.Ali
P. Juma
40,000 x 16%
18,00 x 16%
60,000 x16%
75,000 x 16%
Output
VAT
6,400
2,880
9,600
12,000
Cash account
Return out P.
Mwanzia
16,000 x 116%
4,000 x 16%
2,560
640
19,584
34,080
_____
34,080
VAT Account
February 2005
Date
2/2
Cash account
8,000 x 16%
Input
VAT
1,280
11/2
16/2
18/2
J. Kali
B. Bilali
Return in by
S. Kazi
32,000 x 16%
46,000 x 16%
8,000 x 16%
5,120
7,360
1,280
Date
7/2
16/2
18/2
1/2
21/2
VAT payable
Return out to P.
Mwanzia
S. Kazi
Cash account
Returns out to B.
Bilali
A. Ali
3,232
______
18,272
6,000 x 16%
Output
VAT
960
5,400 x 16%
6,000 x 16%
2,200 x 16%
8,640
960
352
46,000 x 16%
7,360
______
18,272
Answers -Mocks
165
NB: - A debit to sales account means return inwards and a credit to purchases account means returns
outwards.
TAXATION II
166

DECEMBER 2005
QUESTION ONE
a) Tax incentives to newly listed companies:
Floatation costs e.g. Legal expenses are allowable
Reduced corporate tax rate of 20% p.a. for the first 5 years if listed any time after 1/1/2006. Any
issues at least 40% of shares to the public with effect from 1/1/2003. The rate applies for first
five years of listing.
A tax amnesty for past tax evasion activities.
A reduced corporate tax rate of 27% p.a. for the first 3 years for any company that get listed after
1/1/2002.
b) Imported goods are deemed to have been dumped in Kenya if: Goods are sold in Kenya at a price lower than the cost of importing (cost of insurance, freight,
duties and cost of goods to the exporter)
The export price by the foreign exporter to Kenya is less than the fair market price in the
exporting country.
If the country exporting goods to Kenya had imported such goods and either
a) The export price of the original country less than fair market price in that country
b) Export price of the country re-exporting the goods is less than fair market price in that reexporting country.
c) i) Tax free (exempt) employment benefits
Fringe benefits
Benefits in kind not exceeding Ksh.36,000 p.a (3,000p.m)
Education fees paid by employer for employee and his dependents if such fees are taxed on the
employer.
Medical benefits if scheme is non-discriminative.
Passages/translocation costs for non-citizen expatriates.
Contribution by employer for employees to registered and unregistered pension and provident
funds.
QUESTION TWO
Gross premium received

Add reinsurance ceded
Add commission received
Add unearned premium b/f
Less unearned premium c/f
Total business income
Agency expenses 480 120-80
Claims - paid
Add outstanding claims c/f
Less outstanding claims b/f
Telephone and postage
Management expenses
Specific bad debts
Advertising
MV
Insurance
Ksh.
Fire
Insurance
Ksh.
Kshs
56,000
22,400
300
8,240
(4,630)
82,310
12,640
5,200
1,690
2,360
(1,070)
20,820
68,640
27,600
1,990
10,600
(5,700)
103,130
(170)
(370)
(6,770)
(1,580)
(1,875)
(230)
(802)
9,393
(9,360)
(3,040)
(280)
2,860
3,680
(3,950)
(2,590)
(1,460)
(3,475)
(600)
(846)
73,059
1,250
10,340
(4,820)
Total
(830)
1,648)
82,452
Answers -Mocks
167

(6,000)
76,452
b) Mr. Kamau is a part-time director since he holds more than 5% of shares of the firm. The housing
benefit shall be based on total income from all sources including the wifes income not at arms length.
The wife holds more than 12.5%(30%) of shares of Amua hence her income is not at arms length
and shall be assessed on the husband.
Mr. Kamaus taxable income for year 2004
Kshs.
Employment Income
Basic Salary
Bonus for the year
Insurance premium paid by employer
Gross dividend income (non-qualifying)
Wifes income
Basic Salary
Sick leave allowance
Medical benefit (assumed discrimination)
Taxable income
Housing Benefit: Higher of 15% x (1670 + 610) =
342,000
- Rent paid (20,000 x 12) =
240,000
- Less rent paid 15% x 1,200,000
Kshs.
1,200,000
300,000
70,000
100,000
400,000
60,000
150,000
610,000
2,280,000
342,000
(60,000)
Notes
1) Pension contribution by employer
To registered scheme Exempt employment benefit

To unregistered scheme Taxed on employer as disallowable expense hence not taxable on
employee
2) Dividend income Biashara commercial bank qualifying hence 5% w/t final

3) Interest income from
POSB exempt
Bank deposits qualifying hence 15% w/t final
Nyumba Housing Finance Company The first Ksh.300,000 subject to 10% final W/T
4) Lumpsum pension
First Ksh.480,000 is exempt. The first surplus of Ksh.400,000 is subject to 10% tax
5) Harambee contribution for medical costs by fellow employees gift hence non-taxable
6) Loss from retail shop will be carried forward to be offset from profits from retail shop in subsequent
years according to specified sources of income.
Tax Liability of Mr. Kamau on
Ksh.2,562,000
TAXATION II
168
1st Ksh.121,968
Next 114,912 x 60% (Q1(b) June 2005)
Surplus (2,562,000 466,704)@ 30%
Gross tax liability
Less tax credits
Personal relief
PAYE husbands salary
- wifes salary
- Bonus
- Non-qualifying dividends 15% x 100,000)
Net tax liability
12,196.8
68,947.2
81,144.0
768,600.0
849,744.0
(13,944.0)
(200,000.0)
(50,000.0)
(50,000.0)
(15,000.0)
520,750.0
QUESTION THREE
a) i) Investment deduction for ordinary manufacture
ii) Investment deduction for manufacture under Bond = (100% - I..D on ordinary manufacture)
iii) IBD on stores and warehouses, staff quarters, bore holes, substantial renovations etc.
iv) Wear and tear allowance on other machines.
v) Diminution in value of loose tools and implements.
b) Capital allowances
i) Investment deduction
1995
Kshs 000
Asset
Factory Building
Processing machine
Q.Cost
5,600
3,400
I.D @70%
3,920
2,380
Residual for IBD and WTA

1,680
1,020
2003
Asset
Sewerage system
Generator
Q.Cost
720
450
Kshs 000
I.D @100%
720
450
1,170

-
2004
Asset
Processing machine
Water pump
Q.Cost
1,200
420
Kshs 000
I.D @70%
1,200*
420
1,620

-
The government subsidy does not qualify for capital allowances

2002
Asset
Factory extension
Conveyor Belt
Q.Cost
2,400
960
Kshs 000
I.D @70%
2,040
816

360
144
ii) Industrial Building deduction (IBD)

Year 2003
Building
1995 F.Building
2002 F. Extension
2002 Sports
Pavillon
2002 Staff
Q.C
1,680
360
Residual b/f
1,344 (W1)
357 (W2)
IBD @ 2.5%
42
9
Residual c/f
1,302
348
360
357 (W3)
348
Answers -Mocks
Canteen
169
1,200
1,190 (W4)
30
90
1,160
W1 = 1,680 [ (1,680 x 2.5%)p.a x 8 years] = 1,344

W2 and W3 = 360 (360 x 2.5%p.a) x 4
W4 = 1,200 (12W x 2.5% p.a.) x 4
12
12
= 357
= 1,190
IBD = 2003 IBD = 90

iii) Wear and Tear Allowance (WTA)
Class
1995 Processing machine (net)
1995 Non-processing machine
Total Qualifying cost
WDV as at 1/1/2000 after 5 years
(1995 1999) = Q.Cost (1 r)n
= 2,620 (1 0.125) )5 =
1,343.8
Class
WDV
Add
WDV
Add
WTA
WDV
Add
WTA
WDV
Add
Less
1/1/2000
Saloon car
Tractors
Computers
WTA year 2000
1/1/2001
Partitions
Photocopiers
Year 2001
1/1/2002
Conveyor Belts net of I.D
Year 2002
1/1/2003
Computers
2 Saloon cars @ 1,800,000
each
Trailer
Lorry (Stones)
Curtains
Processing machine
Saloon car
Tractor
WTA
WDV
Add
Year 2003
1/1/2004
Weighing machines
WTA
WDV
Year 2004
1/1/2005
IV @ 12.5%
1,020
1,600
2,620
I @ 37.5%
3,000
3,000
(1,125)
1,875
___1,875
(703)
1,172
____(439.5)
732.5
-
II @ 30%
___600
600
180
420
300
720
(216)
504
____(151.2)
352.8
300.0
-
III @ 25%
1000R
___1,000
250
750
___750
(187.5)
562.5
____(140.6)
421.9
2,000.0R
IV @ 12.5%
1,343.8
___1,343.8
(168.0)
1,175.8
400.0
___1,578.8
(197.0)
1,378.8
144.0
(190.4)
1,332.4
-
-1,200
(800)
1,132.5
(424.7)
707.8
___707.8
(265.4)
442.4
- (W1)
652.8
(195.8)
457.0
___457.0
(137.1)
319.9
400.0
10.0
(540.0)
1,202.4
(150.3)
1,052.1
640.0
1,692.1
(211.5)
1,480.6
TAXATION II
361.1 R
2,060.8
(512.2)
1,5445.6
____1,545.6
(386.4)
1,159
170
W1 = 650,000 sale proceeds x 1,000,000 restricted Q.C = 361,111

1,800,000 cost
Total WTA year 2003 = 1,286
Year 2004 = 1000.4
b) ii)
Ksh
000
5,000
140
5,140
Reported profits
Add back import licence fees
ID
IBD
WTA
1,620
90
1000.4
(2,710.4)
2,429.6
QUESTION FOUR
a) Transaction of for which PIN is required.
The 13th Schedule of Income Tax Act indicates the following transactions with various institutions
Registration of titles and stamping of transactions by commissioner of lands

Registration of motor vehicles transfer by registrar of motor vehicles.
Underwriting of policies by insurance companies
Trade licensing by Ministry of Commerce
Application for VAT registration
New registration of business and companies
Importation and exportation of goods, customs clearance and forwarding under customs and
excise
Payment of deposit for power connection by KPLC
Approval of plans by and payment of water deposits to local authorities
b) Vatable supplies not subject ot VAT threshold turnover requirements under the 6 th schedule of VAT
act Cap 476 are
Four or more motor vehicles p.a

Jewellery
Pre-recorded music cassettes
Timber
Motor vehicle parts and accessories
Household electric or electronic apparatus and appliances
Accountancy services
Computer services
Legal and arbitration services
Answers -Mocks
171
Provision of reports, advice information or similar technical services such as advertising,

research, public relations, acturial, recruitment, staffing and training etc.
c)
Hekima Ltd
VAT Account for January June 2005
Input Vat
Purchases
January
16% x 1,800,000 x 95%
273,600
February
April
16% x 840,000 x 95%

15% x 680,000 x 95%
127,680
103,360
May
June
16% x 1,000,000 x 95%

16% x 1,500,000 x 95%
152,000
228,000
June Bad debts
120,000 x 16%
Return inwards
VAT payable
16% x 76,000
19,200
Output Vat
Sales
Balance b/f
January
February
Return
Outward
March
May
June
16% x 1,600,000 x
92%
16% x 1,860,000 x 92
16% x 50,000
16% x 470,000 x 92%
16% x 1,200,000 x
92%
16% x 2,400,000 x
92%
12,160
233,736
1,145,576
250,000
235,520
273,792
8,000
69,184
176,640
353,280
________
1,145,576
No input VAT was paid on purchases from suppliers who were not registered.
QUESTION FIVE
a) i) Tax planning
The arrangement of affairs of tax payer in such a way as to minimize tax liability at the lowest
cost without contradicting any tax laws and regulations. It involves determining in advance the
tax effect of any proposed business action and decision.
It requires a deep understanding of tax legislations and decided case law of taxation. The aims of
tax planning are to
i.
ii.
iii.
Achieve the most advantageous financial position from business transactions measured in
terms of direct tax savings and improved cash inflows.
Ease tax administration (internally) in terms of methods of accounting for tax, records to be
maintained and tax reports to be prepared.
Achieve the highest level of compliance with the tax laws.
ii) The planning areas in business decision may include

Lease a buy decisions do we lease assets and pay lease charges (allowable) or buy assets and
enjoy capital allowances
Financing decisions: - do we use debt capital (interest charges are allowable) or equity capital
(dividends not allowable)
TAXATION II
172
Firm of business ownership do we operate as a partnership, sole proprietorship or a limited

company.
Trading decisions do we produce and sell locally or export (exports are zero rated for VAT
purposes)
b) I)
Alimusa enterprises
Adjusted patnership
Kshs 000
Sales
Less cost of sales
Opening stock
+ Purchases
- Closing stock
Gross profits
Apportioned G. profits
Other incomes discount
received
Foreign exchange gains (realised)
Salaries and wages
Interest on loans
Insurance
Travelling expenses
Rent and rates
Legal expenses (assumed
allowable)
Bank charges
WTA on furniture 12.5% x 48,000
Kshs. 000
Kshs. 000
Jan- March
April Dec
800
3,400
(980)
Kshs
000.
Total
7,000
3,220
3,780
945.0
17.5
2,835.0
52.5
70.0
11.45
973.95
34.35
2,921.85
45.8
3,895.8
(300)
(140)
(60)
(39)
(116.25)
(30.05)
(900)
(420)
(180)
(117)
(348.75)
(90.15)
(1,200.0)
(560.0)
(240.0)
(156.0)
(465.0)
(120.2)
(10.10)
____269.55
(57.3)
(6.0)
802.65
(76.4)
(6.0)
1072.2
ii) Allocation to partners
Period
Jan March
Item
Salaries
Interest on capital
Share of profits (Balance)
2:3
Kshs.
000
Ali
100
100
(68.18)
Kshs.
000
Musa
150
90
(107.27)
Kshs.
000
Kaka
-
Kshs. 000
Total
250
190
(170.45)
Answers -Mocks
173
Partnership income
+ Rent income (2:3)
Period
April Dec
131.82
43.54
175.36
Item
Salaries
Interest on capital
Loss/profit share 2:2:1 (Balance)
Partnership income
Rental income
(W1) = 435,400 x 3
Kshs.
000
Ali
300
300
(222.94)
377.06
130.62
507.68
137.73
65.31
203.04
Kshs.
000
Musa
450
270
(222.94)
497.06
130.62
627.68
269.55
108.85* (W1)
378.40
Kshs.
000
Kaka
40
(111.47)
(71.47)
65.31
(6.16)
Kshs. 000
Total
750
610
(557.35)
802.65
326.55 (W2)
12 = 108,850
(W2) = 435,400 x 9
12 = 326,550
JUNE 2006
QUESTION ONE
(a)
Starlit Company Ltd.
2003 Computation of Investment deduction
Nature of assets
Industrial Building
Processing Machinery
QC
ID @ 70%
18,000,000
26,000,000
12,600,000
18,200,000
30,800,000
NOTES:
(1) Industrial Building - Qualifying cost
Cost (1-rn) =NBV
Therefore, Cost = NBV
1-rn
=17,000,000
( 1-0.025)2
= 18,000,000
(2) Processing machinery
Cost (1-rn)
= NBV
TAXATION II
Residue for WTA or

IBD
5,400,000
7,800,000
174
Therefore, Cost= NBV

(1-r)n
= 19906250
(0.875)2
=26,000,000
(ii) Over-or under-claimed wear and tear allowances
Actual
IV 12.5%
26,000,000
(3,250,000)
22,750,000
(2,843, 750)
19,906,250
Class
WDV 1.1.2003
Processing machine
WTA
WDV 1.1.2004
WTA
WDV 31.12.2004
Revised
IV 12.5%
7,800,000
(975,000)
6,825,000
(853,125)
5,971,875
Over-under claimed
2,275,000
1,990,625
4,265,625
(iii) Industrial Building Deduction

Nature of Building
2003 Industrial Building
QC
5,400,000
5,400,000
5,400,000
Residue
5,265,000
5,130,000
IBD @ 2.5%
135,000
135,000
135,000
Residue c/f
5,265,000
5,130,000
4,995,000
(b) 2005 Computation of adjusted profit (loss)

Sh.000
Reported profit
Add:
Understated sales (100/90x2100)-21000
Floatation costs-debentures
Stamp duty
Conveyance fees
Forex losses- parent company
Depreciation
Deduct
Accrued wages
IBD
WTA
Sh.000
4,5000
233.33
1400
800
2,000
560
7,500
12,493.333
375
135
4593.984
(5,103.984)
11,889.349
NB: (3) Wear and tear allowances

Class
WDV 1.1.2005
Process .Mach.
7,800(0.875)2
Computers
I
37.5%
-
II
30%
III
25%
IV
12.5%
5,971.875
900
Answers -Mocks
175
Office partitions
Lorries
Delivery vans
Pick-ups
Furniture $ Fittings
Office Equipment
400
4,500
3,600
2,500
600
800
1700
(510)
1,190
4500
(1,687.5)
2,812.5
WTA
WDV 31.12.2005
6100
(1525)
4,575
6,971.875
(871.484)
6,100.391
QUESTION TWO
Mr. Wakaba
2000-2005 Capital Statements
Total Assets
Less total liabilities
Net assets
Increase/(Decrease) in
Net Assets
Add:
Drawings
Prepayment-Mortgage
Mortgage-interest
Living Expenses
Deduct;
Interest on deposits
WTA
Estimated profit (loss)
2000
Sh.000
4000
(1200)
2,800
2001
Sh.000
4347
(980)
3,367
2002
Sh.000
5096.5
(741)
4,355.5
2003
Sh.000
4431.5
(503)
3,928.5
2004
Sh000
5868
(272)
5,596
2005
Sh.000
5540
(323.5)
5,217.5
567
988.5
(427)
1,667.5
(379)
5
250
100
300
5
250
75
400
5
250
50
450
5
250
25
500
5
600
(25)
(155.5)
1,041.5
(75)
(130.5)
1,515
(90)
(109.5)
128.5
(70)
(73)
2304.5
(60)
(157.5)
8.5
QUESTION THREE
(a) Withholding VAT agents
VAT is tax paid by end users or consumers.
TAXATION II
176
The participants in the production and distribution chain are only to collect VAT on behalf of the
tax authorities.
VAT is a multi-stage tax where withholding tax agents collect VAT at each stage.
The withholding tax agents who account for VAT at each stage include; suppliers, manufactures,
wholesalers and retailers
VAT payable= output tax input tax withheld at each stage.
(b) 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 goods have been legally acquired
c. Goods are of the correct value
d. The imported goods are as per the specifications as indicated at the time of
importation.
Bond security
The commissioner may require a person to give security to:
Ensure due compliance by the person with the provisions of CAP. 472
Protection of customs and excise revenue on imported goods
Cover any transaction entered into by the person within a specified period.
(d) Fringe Benefit Tax
It is tax paid by the employer on fringe benefits granted to the employee.

Fringe benefits are loans granted by the employer to the employees at an interest rate that is lower
than the prescribed interest rate.
For loans granted after 11th June 1998 employers are required to pay fringe benefit tax at the
resident corporate tax rate, on the difference between market interest rate and the rate paid by the
employees.
Prescribed low interest rate for January to June 20006 is 8%.
Prescribed market interest rate for April to June 2006 is 8%.
(e) Exempt interest income
Interest received from outside Kenya.

Interest income of a registered retirement scheme or fund.
Interest income arising from contribution to home ownership savings plan (Hosp) after ten years
of saving.
Interest arising from government stocks/bonds and Nairobi city council stocks held by nonresidents.
Interest from savings in post office savings bank.
QUESTION FOUR
(a) Main provisions of COMESA tax treaty
To enable free movement of capital for encouraging investment within the COMESA region.
To have a customs union with a single tariff for COMESA goods.
Answers -Mocks
177
To have a free trade area without tariffs and the elimination of non-tariff barriers.
To have a common visa arrangementincluding a right of establishment and free movement of
persons.
To have a monetary union and a common currency.
(b) Benefits of effective tax policy to a developing country.
Increased rate of savings and capital accumulation.

Mobilising of economic surpluses i.e. excess of current output over essential consumption for
accelerating economic growth.
Indirect taxes are utilised to:
-Promote development by checking conspicuous consumption.
- Mobilise resources for the public sector
- Increase the savings ratio
A suitable tax policy directs resources from:
- Private to public sector
- Consumption goods industries to investment goods industries.
- Import goods to export goods.
b)
VAT A/C
Dec
Sundry Creditors (16%x6420)
Bad debt relief (16%x720)
Sundry Bebtors (16%x1,450)
Jun VAT refund b/f
Sh.000
1,027.2
Dec
115.2
232
1,374.4
Sh.000
Sundry Debtors (16%x6,886.2) 1,101.792
Sundry Creditors (16%x74.4)
VAT refund c/f
11.904
260.704
1,374.4
260.704
QUESTION FIVE
(a) Transactions that constitute transfer pricing include:
Sale of goods to a subsidiary or branch by the head office at a price that is not at arms length
i.e. prices that are not granted on sale of goods to third parties.
Purchase of goods to another company in which one or more of the directors are also
directors in the selling company and the goods are not sold at the open market.
(b) i)
Kiko Enterprises
TAXATION II
178
2005 Computation of adjusted profit (loss)

Shs.
Reported loss
Add:
Embezzlement by cashier
Directors party
Compensation for wrongful term
Replacement of car engine
Partitions
Parking fines
Breach of contract
Lease-100 yr
Defending partner
Rent & rates 3/15x240,000
Mortgage interest
Interest on capital
Loss on sale of assets
Stamp duty
Conveyance fees
Farmworks at cost
Furniture at cost
Deduct:
Farming income
Interest on deposits
Insurance compensation-vehicle
WTA (Note i)
Adjusted partnership profit
Shs.
(452,660)
12,0000,000
800,000
760,000
140,000
600,000
1,500,000
15,200
200,000
9,000
12,000
48,000
240,000
330,000
15,200
8,160
150,000
180,000
84,000 6,291,560
560,000
120,600
400,000
85,500 (1,166,100)
4,672,800
(ii)
Distribution Schedule
Kiplimo
Salaries
(1/3)
Interest on capital
700,00
Share of profit
180,000
947,600
1,827,600
Farming income
166,667
Total taxable
1,994,267
income
Kosgey
(1/3)
800,000
150,000
947,600
1,897,600
166,667
2,064,267
NOTES
(i) Wear and tear allowances

Class
Partitions
Furniture
WTA
WDV 31.12.2005
IV
12.5%
600,000
84,000
684,000
(85,500)
598,500
Kurgat
(1/3)
947,600
947,600
166,667
1,114,267
Total
Sh.
1,500,000
330,000
2,842,800
4,672,800
Answers -Mocks
179
(ii) Farming Income

Gross Income
Less FWD(331/3%x180,000)
Taxable income
Sh
560,000
(60,000).
500,000
DECEMBER 2006
QUESTION ONE
(a) Theories of tax shifting
1. The Diffusion Theory
This theory states that eventually, it becomes impossible to trace the final incidence of any tax
and that in reality, all taxes get diffused in the economic system.
It is based on the assumption that the market is sufficiently competitive and that the factors of
production can move from one employment to the other quickly, easily and without significant
costs.
Because of the constant interactions by sales/purchases transactions, a tax imposed at one place
could shift to all sectors of the economy thus becoming untraceable.
(4marks)
2. Demand and supply Theory
A tax may be shifted through sale/purchase transactions depending on the elasticity of

demand and supply.
Shifting is through a revision of prices.
If the demand is inelastic , tax can easily be shifted by the seller to the buyer.
TAXATION II
180
Where demand is elastic, the burden of tax will mainly be borne by the seller.
(4marks)
(b)
Malipo General Insurance Company
Computation of taxable profitsor losses
For the year of income 2005
Sh.
Gross premium
Less: Returned premium
Re-insurance premium
Net premium
Add:
Investment income
Commission on reinsurance ceded
Reserve for unexpired risk
Recovered claims on reinsurance
Foreign Exchange gains
Bonus utilisation in reduction of premium
Deduct
Claims(5400+1640-7440)
Commission on reinsurance accepted
Agency expenses
Bad debts
Management Salaries (1670-670)
Legal expenses relating to claims
Advertising
WTA-Class III-(25%x1,000,000)
IV(121/2% x120,000)
Other income
Less repairs
Adjusted profit
1,230, 000
670,000
890,000
860,000
980,000
400,000
420,000
425,000
6,300,000
2,800,000
1,560,000
450,000
1,000,000
540,000
124,000
250,000
15,000
1,260,000
(280,000)
Sh.
19,000,000
1,900,000
17,100,000
3,975,000
21,075,000
13,039,000
8,036,000
980,000
9,016,000
(10 marks)
Total : (20 marks)
QUESTION TWO
(a)
Sales
Rental income
Dividend income
Miscellaneous receipts
Forward contract profit
Drawings(W1)
Closing stock
Mwanzo partnership Ltd.

Statement of adjusted taxable profits or losses
For the year on income 2005
Sh
Sh Sh
2,700,000
540,000
112,500
48,000
37,500
13,500
3,451,500
Less
Cost of goods sold(700-32 carriage)3/4
Legal fees
501,000
112,500
Sh
900,00
180,000
560,000
37,500
16,000
150,000
4,500
1,848,600
167,000
37,500\
Answers -Mocks
181
Insurance (300,000-100,000)capitalized
Design website(1/3x72,000)=Dimunition
value
Registration of patents
Director fees
Audit fees(statutory)
Stamp duty
Bank charges
Repair of new machinery
Gifts to employees-taxed on employee
Relocation costs
Redundancy costs-Employees
Seminar
Wear &tear (W2)- class IV
-Class III
150,000
18,000
50,000
6,000
10,000
640,000
30,000
24,000
6,250
4,550
15,600
19,200
45,600
6,625
30,000
18,750
13,650
46,800
57,600
136,800
19,875
89,813
31,800
121,613
91,209
2,255,318
22,453
7,950
30,403
755,272
(14 marks)
(b) Allocation of profit
Interest on capital
Share of profits
Taxable profit
Allocation to partners-9 months

Kimutai
Wakoli
Sh.
Sh
150,000
180,000
100,000
150,000
837,659
837,659
1,087,659
1,167,659
Total
Sh.
330,000
250,000
1,682,816
2,262,816
Wear and tear Allowance

Computer
Machinery
Telephone
Neon-sign
Class II
30%
106,000
106,000
Class III
25%
-
Tax payable
121,968(0.1)+114,912(0.15+0.2
+0.25)
Excess over:466,704
-Kimutai
620,955x0.3
- Wakoli
Kimutai
1,087,659
81,142
Wakoli
1,167,659
81,142
186,287
210,287
TAXATION II
Class IV
12.5%
632,000
54,000
32,500
718,500
182
700,955x0.3
Personal relief
Tax payable
268,553
(13,944)
254,609
291,429
(13,944)
278,609
(2 marks)
(Total: 20 marks)
QUESTION THREE
(a) Benefits as a result of integration of the Departments into Domestic Taxes Departments
The integration has eliminated duplicated of functions, leading to resource savings that can be
applied to other critical areas such as 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 as they are no longer subjected to separate audits from
income Tax and Vat officers. This is due to better co-ordinated approach to tax audits and
taxpayers education.
The management is able to monitor the effectiveness of tax audit and other programmes in
totality as opposed to the previous situation where one programme was being performed across
different departments.
Integration has reduced the likely incidence of corruption as a taxpayer is now likely to be
audited by a team, not an individual officer from a department.
Information sharing is possible.
(10 marks)
Drawbacks from integration.
Lack of clear responsibilities

i.
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. Not possible now since all these are integrated into one.
ii.
Tax payers do not clearly know who to report to at KRA i.e. whether they fall under
Large Taxpayer Unit or otherwise. No clear guidelines.
(10 marks)
(b)
Value Added Tax Accopunt
September 2006
September
1 Balance b/f
5 Imports
8 Purchases
12 Motor vehicle
15 Photocopying, printing
16 Oil filters
22 Purchases
27 Electricity
27 Telephone
Sh.
79,448
153,600
41,379
1,379
8,276
26,207
2,069
1,241
September
9 Sales
18 Ministry of finance
20 Exports-Uganda
31 VAT refundable
Sh
74,483
37,241
0
201,875
Answers -Mocks
183
(10 marks)
(Total : 20 marks)
QUESTION FOUR
(a) Ways the commissioner is empowered to use in collecting overdue tax under Income Tax Act are:
He can sue for the recovery of the tax through a court of law.
He can collect overdue tax under section 102 by distrait i.e. can seize the property of the tax
payer.
He can collect the overdue tax through authorised agents section 96e.g. through an employer,
debtor etc.
He can under section 103, notify that person of his intention to apply to the registrar of lands for
the land or buildings to be the subject of security for tax of an amount specified in the notice i.e.
(attach property of a taxpayer as security for unpaid tax)
(6 marks)
(b) (i) Capital allowances

(W1)
Qualifying cost of Factory Building as at 1.1.2003
Book 31.12.2005
Less Factory Extension
(1600-20% x 1600)
8,600,000
1,280,000
7,320,000
Cost of Factory Building as at 1.1.2003

40% =7,320,000
100 = ?
= 7,320,0000x100
40
= Sh. 18,300,000
(W2) Machinery
= Sh 5,400,000- 1,760,000
=3,640,000
= 3,640,000x100
40
= 9,100,000
2003
Nature of asset
Qualifying
Cost
ID
@ 70
Residue
WTA & IBD
Factory Building (W1)

Machinery (W2)
2004
18,300,000
9,100,000
-
12,810,000
6,370,000
19,180,000
5,490,000
2,730,000
-
1,600,000
1,400,000
800,000
100%
1,600,000
1,400,000
800,000
2005
Factory Extension
Generator
Conveyor belt
TAXATION II
184

3,800,000
Industrial Building Deduction

Asset
Year 2003:
Factory Building
Year 2004:
Factory Building
Year 2005:
Factory Building
Wear and Tear Allowance Schedule

Class 1
Sh
2003:
Machinery
Computers
Forklift
1,160,000
Motor vehicles
Furniture& fittings
WTA 2003
Additions
WTA 2004
Disposal
WTA 2005
WDV 31.12.2005
1,160,000
435,000
725,000
725,000
271,875
453,125
453,125
169,122
283,203
Qualifying cost
5,490,000
5,490,000
5,490,000
Class II
Sh
Class III
Sh
IBD 21/2 %
137,250
137,250
137,250
411,750
(10 marks)
Class IV
Sh
2,730,000
2,250,000
3,890,000
2,250,000
675,000
1,575,000
1,575,00
472,500
1,102,500
1,102,500
330,750
771,750
3,290,000
822,500
2,467,500
1,000,000R
3,467,000
865,875
2,600,625
500,000R
2,100,625
525,156.25
1,575,,468..75
900,000
3,630,000
453,750
3,176,250
3,176,250
397,031
2,779,219
2,779,219
347,402
2,431,817
(10 marks)
(ii) Adjusted taxable profits

Reported profits
Add back depreciation
Deduct: Investment deduction
IBD
Wear & Tear
Debenture interest
2003
Sh.
8,000,000
2004
Sh.
6,400,000
8,000,000
(17,570,000)
(137,250)
(2,386,250)
(300,000)
6,400,000
(137,250
(2,008,281)
(300,000)
2005
Sh.
10,667,000
425,000
11,092,000
(3,800,000)
(137,250)
(1,372,530)
(300,000)
Answers -Mocks
185
Loan interest
Taxable profit or loss
Carried
Loss brought forward
(12,393,500)
(12,393,500)
(12,393,500)
NIL
Loss carried forward

Loss carried forward
(3,954,469)
(3,954,469)
(12,393,500)
(8,439,031)
8,439,031
NIL
(200,000)
(5,282,220)
5,282,220
(8,439,031)
3,156,811
(4 marks)
(Total: 20 marks)
QUESTION FIVE
(a) PAYE audit
i.
ii.
iii.
iv.
v.
vi.
Non-remittance of PAYE which has been deducted.

Fluctuating and late payment of PAYE by the employer.
Irregularities detected through examination of PAYE end year returns.
Employers whose final accounts submitted to the department are suspect i.e. they arose
suspicion.
When directors fees and bonuses are claimed in the accounts with no corresponding
PAYE remittances.
When proper books of accounts are not kept by the organisation.
(8 marks)
(b) Payments received for cancellation of a business contract

(Bush Beach & Gent Ltd, Vs Road 1938)
The receipts represent profit gain that could have been received had the contract been carried.
They are taxable provided:
1) The contact was made in the ordinary course of business.
2) Payment was made in respect of the profits to have been earned under the contract.
3) The cancellation of the contract would not effect the structure of the companys business.
(4marks)
(i) Section 19:
The income of the savings and credit cooperative societies that is liable to tax is determined as follows;
1) 855% of its gross income from dividends, interest and royalties.
2) 70% of its gross income from rents and other rights granted for the house or occupation of any
property other than royalties.
(4 marks)
(ii) Approach A
Makazi Sacco
Taxable Profits
Sh.
Gross income
Less: Interest on loan on members
Rent income
85% x 142,000
12,700
TAXATION II
Sh.
2,242,000
(1,500,000)
(600,000)
142,000
186
70%x 600,000(rent)
Taxable income
420,000
540,700
Approach B.
Makazi Sacco
Taxable Profits
Sh.
Sh.
30,000
100,000
12,000
142,000

Interest on fixed deposit account
Other investment income
Taxable income 85% x 142,000
70% x 6000,000
120,700
420,000
540,700
(4 marks)
(Total: 20 marks)
Part III Comprehensive Mock Examination
Answers -Mocks
187
QUESTIONS -MOCKS
RATES OF TAX (Including wifes employment, self employment and professional income rates of tax).
YEAR OF INCOME 2005 (for year 2006) Exam)
Taxable Employment Benefits - Year 2005
Monthly taxable pay
(shillings)
1
10,164
10,165
19,740
19,741
29,316
29,317
38,892
Excess over
38,892
Annual taxable pay

(shillings)
1
121,968
121,969
236,880
236,881
351,792
351,793
466,704
Excess over
466,704
Rates of tax % in each

shilling
10%
15%
20%
25%
30%
Personal relief Shs. 1,162 per month (Shs. 13,944 per annum)
Prescribed benefit rates of motor vehicles provided by employer
Monthly
rates
(Sh.)
Capital allowances:
(i)

Class I
37.5%
Class II
30%
Class III
25%
Class IV
12.5%
Industrial building allowance:
Industrial buildings
2.5%
Hotels
4.0%
Farm works
33.3%
allowance
2003
70%
2004
100%
(ii)
Saloon, Hatch Backs

and Estates
Upto
- 1200 cc
1201
- 1500 cc
1501
- 1750 cc
1751
- 2000 cc
2001
- 3000 cc
Over
- 3000 cc
Pick-ups, Panel Van
(Unconverted)
3,600
4,200
5,800
7,200
8,600
14,400
43,200
50,400
69,600
86,400
103,200
172,800
1750 cc
3,600
43,200
Over
1750 cc
Land Rovers/Cruisers
4,200
7,200
50,400
86,400
Upto
(iii
)
Annual
rates
(Sh.)
OR 2% of the initial capital cost of the vehicle for each

month, whichever is higher.
2005
100%
Shipping investment deduction
40%
Mining allowance:
Year 1
40%
Year 2 - 7
10%
TAXATION II
188

Services
(i)
(ii)
(iii)
(iv)
Electricity (Communal or from a generator)

Water (Communal or from a borehole)
Provision of furniture (1% of cost to employer)
Telephone (Landline and mobile phones)
Agricultural employees: Reduced rates of benefits

(i)
Water
(ii)
Electricity
Monthly rates
Sh.
1,500
500
Annual rates
Sh.
18,000
6,000
30% of bills
200
900
2,400
10,800
Low interest rate employment benefit:

The benefit is the difference between the interest charged by the employer and the prescribed rate of
interest.
Other benefits:
Other benefits, for example servants, security, staff meals etc are taxable at the higher of fair market value
The current VAT rate is 16%
Answers -Mocks
189
MOCK 1
QUESTION ONE
In my judgement, not every payment made to an employee is necessarily made to him as a profit arising
from his employment. Indeed, in my judgement, the authorities show that to be a profit arising from
employment the payment must be in reference to the services the employee renders by virtue of his office,
and it must be something in the nature of a reward for services past, present or future. Justice Upjohn in
Hochstrasser v Mayes (1960) 38 TC 673.
Required:
In the light of the above judgement and the relevant provisions of Income Tax Act (Cap 470) of the laws
of Kenya, explain the tax benefits arising out of the use of the following in the design of an Executive
Remuneration Package.
Expense reimbursement.
Benefits in kind
Pension entitlement
Bonus Schemes
Share Purchase arrangements for employees.
(4 marks)
(4 marks)
(4 marks)
(4 marks)
(4 marks)
(Total: 20 marks)
QUESTION TWO
(a) What conditions must be satisfied before the income of a trust may be exempted
from Income Tax?
(2 marks)
(b) A trade association may elect under Sec. 21 of the Income Tax Act (Cap.470) to
be deemed to carry on a business. What are the consequences of such an election? (2 marks)
(c) Kioko and Wanza trade in partnership sharing profits and losses in the ratio 3:2 respectively. The
following is the Partnership Profit and Loss Account for the year ended 31 December 2005:
Profit and Loss Account
Sh.
Interest on Capital
Kioko
Wanza
Bad debts (1)
Professional expenses (2)
Motor vehicle expenses
Depreciation
Special expenses (3)
Withholding tax on dividends
Partnership salaries
Wanza
Loss on sale of investment (4)
Repairs and Renewals (5)
Salaries and Wages
Utilities (light, water etc.)
Net profit
Sh.
20,000
10,000
4,000
20,000
20,000
30,000
60,000
8,000
3,000
Gross profit from trading

Net dividends received
Sub-letting rent income
60,000
10,000
6,000
100,000
20,000
32,000
403,000
380,000
17,000
6,000
______
403,000
Notes:
1.
Bad Debts Account:

Write-offs
Carried down:
General
Specific
10,000
Brought down:
General
Specific
Recovered
Profit and Loss
80,000
22,000
_____
112,000
TAXATION II
60,000
30,000
2,000
20,000
112,000
190
2.
Professional Expenses:
Audit fee
Partners Insurance
Legal fees for debt collector
Partnership deed
Sh.
10,000
2,000
500
7,500
20,000
3.
Special Expenses:
Penalty for breach of VAT regulations
Redundancy pay to an employee (ex-grafts)
Christmas gift to the partners spouses
4.
Loss on sale of investment:
Sh.
4,000
3,000
1,000
8,000
The shares in a quoted company were sold during the year. They had cost Sh.60,000 and
they fetched Sh.50,000. There were no incidental expenses.
5.
6.
Repairs and Renewals:

Office partitions
Office carpet
Replacement of adding machine
General repairs
2,000
1,000
1,000
1,500
6,000
Wear and Tear allowances schedule:

Written down value
7.
Sh.
Class II
Sh.
90,000
Class III
Sh.
56,000
One-third of motor-vehicle expenses is used on private motoring by partners.
Required:
Calculate the adjusted profit for tax purposes for each partner and the tax payable by each, assuming that
they have no other sources of income.
(16 marks)
(Total: 20 marks)
QUESTION THREE
Mr. S. Kibesa, a single man has recently received a Preliminary Enquiry Form from the Income Tax
Department. He is required to show income chargeable to tax for the years of income 1985 to 1992
inclusive.
Your discussion with him yields the following information:
(i)
(ii)
(iii)
Using savings from employment and a winning from Kenya Charity Sweepstake he built a shop
in 1998 at a cost of sh.800,000.
Furniture and stock-in-trade were purchased the following year when he started as a general
merchant.
He has not kept proper books of account for his business and has not paid any income tax since
he became a general merchant.
From his explanations and the scanty records available, you have been able to reconstruct the
following:
Answers -Mocks
Assets
191
1998
Sh.
000
1999
Sh.
000
2000
Sh.
000
2001
Sh.
000
2002
Sh.
000
2003
Sh.
000
2004
Sh.
000
2005
Sh.
000
800
150
950
800
100
100
50
1050
800
100
100
20
1020
800
150
120
8
1150
800
150
120
8
1078
800
200
300
250
150
50
20
1770
800
200
300
250
200
60
10
1820
800
200
300
250
200
80
10
1840
25
25
100
10
10
125
5
5
150
5
5
150
80
200
280
200
85
200
285
200
90
80
170
200
Building
Furniture
Freehold land
Commercial motor vehicle
Stock-in-trade
Debtors
Cash in bank
Total Assets
Liabilities
Trade creditors
Loan from a friend
Total liabilities
Living expenses (estimates)
(iv)
(v)
(vi)
No interest has been charged on the loan from the friend.

There has been no sales of fixed assets.
There has been no other investment.
Required:
(a)
Calculate the income chargeable to income tax for each year of income.
(Ignore private use of the motor vehicle).
(15
marks)
(b)
State briefly what further information the Income Tax Department may require to satisfy itself
that the chargeable income you have calculated reflects the true and correct income of the tax
payer for each year of income.
(5
marks)
(Total: 20 marks)
QUESTION FOUR
Dr. H. Kutibu, Dr.(Mrs.) W. Kutibu and Dr. F. Nafuu operate Watu Clinic in Nairobi in line with their
desired mission of providing health services to the people. Dr. H. Kutibu and Dr. F. Nafuu spend all their
time at the clinic. Dr.(Mrs) Kutibu, who is an eye specialist, only spends two days at the clinic since she
works at the nearby Government hospital and also attends to their two children. Profit and losses are
shared in the ratio of 40% to Dr. H. Kutibu, 20% to Dr.(Mrs.) W. Kutibu and 40% to Dr. F Nafuu after
charging partners salaries and interest.
In comparison with other clinics, Watu Clinic charges minimal fee. The clinic relies very much on donors
goodwill. The profit and loss account of the clinic for income 2005 is provided below:
Income
Professional fees
Donations and grants
Dividends (Gross)
Interest from bank deposits
Receipts from Jumbo sale
Goodwill from incoming partner
Expenditure
Purchase of pharmaceutical products
Salaries and wages
Rents, rates and service charge
Shs.
6,400,000
3,600,000
50,000
12,000
38,000
140,000
3,120,000
2,560,000
82,000
TAXATION II
192

Interest paid (Note 5)
Insurance
Motor car expenses
Depreciation of assets
Jumbo sale costs
Medicine to the people programme
1.
Donations and grants were received as follows:
Overseas
Local
2.
3.
35,000
250,000
55,000
168,000
200,000
8,900
20,100
3,175,000
425,000
3,600,000
Receipts from Jumbo sale represents amount received from the local community in support of the
clinic.
On 1 October 2005, Dr. M. Mganga was admitted into partnership to deal with the ever increasing
eye problems. He was given 10% share of the profit, reducing that of Dr.(Mrs.) W. Kutibu to
10%. The amount of Sh.140,000 goodwill represents his purchase of future profits.
4.
Salaries and wages include that of:

Dr. H. Kutibu
Dr. F. Nafuu
Dr. M. Mganga
Shs.
240,000
240,000
30,000
5.
Interest paid includes:

Bank overdraft
Dr. H. Kutibu
Dr. F. Nafuu
Dr.(Mrs.) W. Kutibu
Dr. M. Mganga
Mortgage account for:
Dr.(Mrs.) W. Kutibu
Loan to the clinic
Shs.
40,000
20,000
20,000
7,000
3,000
Insurance includes:
Professional indemnity
Life cover for partners
Clinics property
Shs.
36,000
15,000
6.
80,000
80,000
50,000
4,000
55,000
7.
40% of the motorcar expenses are personal to partners.
8.
Capital allowances have been agreed at Sh.96,000.
Required:
a)
The partners are of the view that due to their very useful community service, they should be
exempt from income tax. Explain under what conditions this is possible.
(4
marks)
b)
Compute the adjusted clinic income for the year of income 2005.
(9 marks)
Answers -Mocks
193
c)
Show allocation of taxable income among the four partners. Assume income accrued evenly
throughout the year.
(3 marks)
d)
Explain how the income allocated under part (c) above will be taxed.
e)
If Dr.(Mrs.) W. Kutibus income from her other job was Sh.240,000 per annum; P.A.Y.E.
Sh.97,200 and the family has no other income, show tax payable by Dr.(Mrs.) W. Kutibu. (3
marks)
(Total: 20 marks)
(2 marks)
QUESTION FIVE
(a) What is fraudulent financial reporting and how is it related to taxation?
marks)
(b) Specify how such reporting is penalized under:
(i) The Income Tax Act, Cap 470;
(ii) The Customs and Excise Act, Cap 472;
(iii) The Value Added Tax Act, Cap 476.
(6
(2 marks)
(2 marks)
(2 marks)
(c) To what extent can tax authorities rely on auditors to prevent fraudulent
financial reporting?
marks)
(d) Explain in detail how the Income Tax Act attempts to prevent creative
accounting of multinational enterprises.
TAXATION II
(4
(4 marks)
(Total: 20 marks)
194
MOCK 2
QUESTION ONE
Mr. Kuweka received a revised assessment from the Commissioner of Income Tax under Section 77 of
the Income Tax Act. The assessment revised his tax payable from sh.250,000 to sh.620,000 for the year
of income 2005. The income shown in his self-assessment for 2005 was sh.851,566. The grounds of
revision were:
1.
He had sold shares in the following companies and made profits as shown:
Kenya Commercial Bank
National Bank of Kenya
Credit Finance Bank of Kenya
2.
3.
4.
5.
Profit (Sh.)
160,000
40,000
20,000
Interest of sh.70,000 due to him and shown in the accounts of Thika Limited had not been
included in the returns. He had loaned sh.1,000,000 at 7% to the company. The interest has not
been received by him.
He earned Sh.50,000 in South Africa. He was paid a honoraria in Johannesburg when he gave
advisory services t a women group. He was there on a private visit.
He was a partner in a coffee farm with two other people. Presumptive tax was deducted as
required. His share of profit omitted from the returns was sh.80,000.
His wife, an employee of Kuweka Limited a family company, had employment income of
Sh.300,000. This was taxed separately in accordance with P.A.Y.E rules and excluded from the
returns.
Mr. Kuweka objected to the assessment in light of the requirements of Section 84 of Income Tax Act. The
Commissioner of Income Tax has responded and given the ruling as provided by Section 85(1)(c).
Required:
(a)
Specify the rulings provided for under section 85 of the Income Tax Act.
( 6 marks)
(b)
Write a memorandum of appeal on behalf of Mr. Kuweka as provided for under the Income Tax
(Local Committees ) Rules.
(14 marks)
(Total: 20 marks)
QUESTION TWO
(a)
The issue relating to taxation of housing benefit has attracted considerable attention. In Langley
and Others v- Appleby (1976) STC 368, the taxpayer successfully claimed that he was obliged
to occupy the accommodation under his terms of service and he could better perform his duties in
doing so.
Required:
Present a case for exempting the housing benefit from income tax in Kenya today.
( 6
marks)
(b)
Taxation of gifts and prizes is an interesting area. For example in Moore v. Griffiths (1972) 48
TC 338 the World Cup Bonus to Bobby Moore was deemed not assessable while in Calvert vWainwright (1947) 27 TC 475, taxi drivers tips were assessable as a reward for services
rendered.
Answers -Mocks
195
Required:
Explain which factors may be examined by the tax department in deciding whether a gift or prize is
assessable on an employee.
TAXATION II
196
(c)
to:
Is there any use that tax authorities could apply financial ratios? Explain with specific reference
(i)
(ii)
(iii)
(d)
Income Tax;
Value Added Tax;
Excise Tax.
(3 marks)
(3 marks)
(3 marks)
What is the tax amnesty?

(Total: 20 marks)
QUESTION THREE
Sometimes critics allege that many accounts prepared in Kenya are open to suspicion of having been based on
records which to a degree are incomplete.
You have been approached by the owner of a legal firm to test the reliability of the accounts prepared by the firms
accountant, bearing in mind that the accounts can be selected by the Commissioner for indepth examination. His
first year of trading is 2005, bearing in mind that the accounts can be selected by the Commissioner for indepth
examination. His first year of trading is 2005.
The draft accounts are as follows:

Fixed Assets
- Buildings
- Motor vehicles
- Computers
- Furniture and fittings
Current Assets
Cash at bank
Debtors, deposits and prepayments
Balance Sheet as at 31 December 2005

Sh.
Sh.
1,000,000
545,312
300,000
225,000
72,836
798,000
870,836
Current Liabilities
Taxation
Hire purchase creditor
Trade creditors, sundry creditors and accruals
100,000
150,000
1,075,000
1,325,000
Net Current Liabilities

Total Assets
Presented by:
Loan
Capital account
Total Assets
Capital Account
Profit for the year
Drawings
Capital Self and wife
2,070,312
Sh.
430,500
1,185,648
Sh.
365,000
(240,000)
1,060,648
1,185,648
(454,164)
1,616,148
Sh.
1,616,148
1,616,148
Answers -Mocks
197
Profit and Loss Account
Sh.
4,249,000
Professional fees
Expenses
Salary - Self and wife
- Others
Taxation
Motor vehicle running expenses
Professional fees legal
Travel and subsistence
Insurance for vehicles
Subscriptions Law society
Depreciation
Bank and hire purchase charges
Repair and maintenance
Office rent
House keeping expenses
Telephone
500,000
750,000
50,000
725,000
55,000
104,000
170,000
10,000
120,000
128,000
600,000
360,000
175,000
137,000
3,884,000
365,000
Net Profit
Required:
State ten areas you may require to make further enquiries, indicating the additional information and any evidence
you may require from management. What are recommended action in each case to comply with the tax law?
(Total: 20 marks)
QUESTION FOUR
Mukunga Properties Ltd. makes its accounts to 31 December each year and has prepared the following
profit and loss account for the year ended 31 December 2005:
Notes
Sh.
General Administrative Expenses
Directors Fees and Expenses
Repairs and Renewals
Subscriptions and Donations
Bad debts
Preliminary Expenses
Retirement Benefits
Rent, Rates and Insurance
Patents written off
Legal and Accountancy
Interest in lieu of Dividends
Depreciation
Net Profit before Taxation
Gross Profit
Bad debts previously written off
Gain on sale of property
Gross dividends
Post office Savings Bank Interest
Gain on sale of plant and machinery
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
TAXATION II
800,000
100,000
240,000
40,000
160,000
60,000
1,000,000
600,000
50,000
830,000
50,000
100,000
200,000
620,000
4,850,000
4,000,000
20,000
600,000
100,000
30,000
100,000
4,850,000
198
Notes
Sh.
1.
2.
Repairs and Renewals:

Redecoration of an existing business
Renovation of new buildings
Partitioning and carpeting of new building to create an
extra office for the Personnel Manager
Subscription and Donations:
National Chamber of Commerce and Industry
Kenya Red Cross Society
Contribution to school raffles
3.
Bad Debts:
A loan given to a supplier who has subsequently been
adjudged bankrupt.
4.
Preliminary expenses:
Balance of Stamp Duty on issue of share capital
Secretarial Services not written off
5.
6.
Retirement Benefits:
NSSF Contributions
Pension to Management
Contribution to an Approved Provident Fund
Legal and Accountancy:
Drawing up Staff Service Agreement
Contract for purchase of new business
Audit fees
Income Tax Appeal to Local Committee
Lease preparation (5 year lease)
60,000
100,000
80,000
240,000
12,000
10,000
18,000
40,000
40,000
20,000
60,000
100,000
800,000
100,000
1,000,000
40,00
110,000
600,000
40,000
40,000
830,000
7.
Interest in lieu of Dividends

The company did not pay dividends in 2005 but instead paid interest at 10% on
shares issued and fully paid.
8.
Gain on Sale of Property

The company is in the business of buying and selling real estate. Owing to the
difficult economic conditions in 2005 the volume of business was low and only one
property was bought and sold. The gain has been arrived at after deducting all
charges and expenses.
9.
Dividends:
They were from a subsidiary company in which Mukunga Properties Ltd. holds
75% of the issued share capital.
10.
Gain on Sale of Plant and Machinery:

One line of business was discontinued in 2005 and all its plant and machinery was
sold. The following details may be relevant:
Sh.
Cost
1,600,000
Aggregate Depreciation to 31.12.2005
655,200
944,800
Sale proceeds
1,044,800
Gain on disposal
100,000
The written down value on this plant and equipment had been agreed with the Assistant Commissioner at
Sh.937,900 for the year ended 1.1.2005.
Required:
(a)
Compute Income Tax liability of Mukunga Properties Ltd. for 2005.

(Ignore Wear and Tear Deductions).
(15 marks)
Answers -Mocks
199
(b)
Explain how the company could reap maximum benefits by use of the funds marked for tax
liabilities.
(5 Marks
( Total 20 Marks)
)
QUESTION FIVE
Mr. Pesa provide the following accounts with his returns for 2005:
Mr Pesa
Trading and profit and loss account for the year ended 31 December 2005
Sh.
Sales
Less: Cost of goods sold
Gross profit
Less: Salaries expense
Office rent
Advertising
General expenses
Motor upkeep
Travelling expenses
Provision for bad debts
Depreciation expense
Interest on capital
Net discounts
Net loss
Sh.
12,040,000
11,530,000
510,000
1,200,000
220,000
97,500
60,000
137,500
94,500
100,000
175,000
30,000
265000
10,000
2,389,500
1,879,500
Mr. Pesa
Balance sheet as at 31 December 2005
Assets:
Sh.
Cash at bank
Cash in hand
Sundry debtors (less provisions)
Stocks
Fixtures and fittings (depreciation Sh.10,000)
Office car (depreciation Sh.20,000)
Equity and liabilities

Capital
Add: Addition
Interest on capital
Less: Loss for the year
Less: Drawings
Outstanding liabilities
Salaries outstanding
Rent payable
Sundry creditors (less discount sh.46,200)
1,910,000
85,000
1,298,800
2,500,000
190,000
80,000
6,063,800
Sh.
6,200,000
200,000
265,000
(1,879,500)
4,785,500
660,000
Sh.
4,125,500
14,500
100,000
20,000
1,803,800
6,063,800
An indepth investigation has been commenced and you, as the assessor in charge, has been provided with
the following information in support of the above accounts.
1.
Balances as at 31 December:
Cash at bank
Cash in hand
Stock-in-trade
Sundry debtors
Sundry creditors
Fixtures and fittings
2004
Sh.
300,000
40,000
2,200,000
2,340,000
200,000
TAXATION II
2005
Sh.
1,910,000
85,000
2,500,000
3,500,000
1,850,000
-
200
Office car
2.
3.
4.
5.
6.
7.
100,000
From past financial statements, the line of business of Mr. Pesa maintains a steady gross profit
rate of 25% on sales.
The bills outstanding as at 31 December 2005 were:
Sh.
Petrol
2,500
Advertising
7,500
Printing
4,500
The motor car and fixtures are depreciated by 20% and 5% respectively. Capital allowances have
been agreed at Sh.32,000.
5% interest is allowed on capital.
Provision was made at 5% for doubtful debts and 2% on creditors for discounts.
The cash book analysis show the following figures among others:
Sh.
Receipts from customers
Discounts allowed on them
Further capital introduced
Salaries to 30 November 2005
Office rent to 30 November 2005
Advertising
General expenses
8.
13,500,000
140,000
200,000
1,100,000
220,000
90,000
60,000
Sh.
Motor upkeep
Drawings
Payments to creditors
Discounts allowed by them
Travelling expenses
135,000
80,000
660,000
11,200,000
120,000
100,000
Specific bad debts were Sh.215,000.
Required:
(a)
Using the information provided, validate the accuracy or otherwise of the figures in the accounts and prepare a
computation of adjusted taxable income.
Provide all supporting details.
(16 marks)
(b)
Specify the tax consequences of incorrect returns of income.
(4 marks)
(Total: 20 marks)
MOCK 3
QUESTION ONE
Dr. Pesa ran his enterprise solely until 30 April, 2005. On 1 May, 2005 the business was incorporated as
Pesa International Limited. The following information relates to the profit and loss account for the year
ended 31 December 2005.
Sh.
Selling expenses
Interest due to Pesa
Salaries
Printing and Stationery
Travelling expenses
Advertisement
Miscellaneous trade expenses
Rent
Electricity expenses
Bad debts
Commission to selling agents
2,520,000
420,000
4,800,000
480,000
1,680,000
1,600,000
3,780,000
2,640,000
420,000
320,000
1,600,000
Sh.
Gross profit b/d
32,000,000
Answers -Mocks
Debenture interest
Directors fees
Capital allowances
Audit fees
Net profit c/d
201
300,000
1,120,000
960,000
600,000
8,760,000
32,000,000
________
32,000,000
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
Dr. and Mrs. Pesa are the only two directors of the company. Mrs. Pesas share of the directors
fees was Sh.120,000.
Salaries include sh.30,000 paid to Dr. Pesa per month.
Dr. Pesas monthly traveling expenses amounted to sh.10,000 for business and Sh.5,000 for
private purposes.
Rent includes an amount of Sh.18,000 per month paid for housing Dr. and Mrs. Pesa.
Bad debts were specifically bad
Capital allowances were calculated in line with the requirements of the second schedule of the
Income Tax Act.
Dr. Pesa was to be paid sh.10,000,000 for his business by Pesa International Limited. The
interest due to him was for the unpaid balance.
Total sales for the year, which amounted to Sh.192,000,000 arose evenly to 30 June 2005.
Thereafter they recorded an increase of two thirds during the rest of the year.
Dividends of Sh.2,000,000 are proposed but not yet paid. Dr. Pesa owns 95% of the shares and
his wife the balance.
The Pesas have life insurance covers for both husband and wife with Kenya National. Premiums
paid amounted to Sh.18,000 in 2005.
All expenses accrued evenly throughout the year.
Required:
(a)
(b)
(c)
Taxable income of Dr. Pesa for the year of income 2005.

(10 marks)
Tax payable by Dr. Pesa in 2005. No PAYE was paid on salary.
(3 marks)
Does incorporating the business provide any advantage? In this particular case does it involve
payment of more or less tax? Explain.
(7 marks)
(Total: 20 marks)
QUESTION TWO
(a)
(b)
Write brief notes on specified sources of income. To what extent do the rules on specified
sources apply to insurance companies?
(5
marks)
Wananchi General Insurance Limited provided the following details with respect to the activities
for the year ended 31 December 2005:
Sh.
Claims paid
Claims outstanding on 1 January 2005
Claims intimated and accepted, but not paid on 31 December 2005
Premiums received
Re-insurance premium paid
Commission paid
Commission on re-insurance ceded
Commission on re-insurance accepted
Repair of rented premises
Fees paid to investment managers
Expenses of management
Provision for unexpired risk on 1 January 2005
Bonus utilized in reduction of premium
Re-insurance recoveries of claims
TAXATION II
4,800,000
400,000
700,000
12,000,000
1,200,000
2,000,000
80,000
40,000
150,000
600,000
3,020,000
4,000,000
120,000
80,000
202
Medical expenses regarding claims

Loss on sale of motor car
Bad debts specific
Tax credit for double taxation
Interest received (Gross)
Dividend received (Gross)
Provision for unexpired risk 31 December 2005
Legal expenses regarding claims
Profit on sale of investments
Rent income on property
Depreciation
50,000
35,000
25,000
45,000
2,600,000
4,500,000
4,677,200
400,000
2,350,000
750,000
1,200,000
Wear and tear allowances have been agreed at Sh.800,000.

Required:
(i)
(ii)
With specific reference to the provisions of the Income Tax Act, compute the taxable income of
Wananchi General Insurance Limited for 2005.
(12 marks)
Comment on any losses, gains or specified sources of income which you have ascertained in (i)
bove.
(3 marks)
(Total: 20 marks)
QUESTION THREE
Limo and Mango were partners in the manufacturing partnership of L & M Processors, sharing profits
and losses in the ratio of 3:2. They decided that with effect from 1 January 2005 they would share profits
and losses equally but the decision was taken after the 2005 profits were divided in the previous ratio. On
the question of the television being taken up, it was discovered that:
1.
Profits for 2002, 2003, 2004 and 2005 had not been properly arrived at as outstanding expenses
and accrued income had not been taken into account. The figures in this respect were as follows:
Profit for the year (as per P & L)

Outstanding expenses 31 December
Accrued income
- 31 december
2.
2002
Sh.
2003
Sh.
2004
Sh.
2005
Sh.
4,000,000
600,000
200,000
4,200,000
300,000
200,000
5,000,000
400,000
300,000
6,000,000
500,000
200,000
The partners were ignorant of the need to charge depreciation expense or claim capital
allowances. The details of assets were as follows:
On 2 January 2002 they purchased for the partnership a farm, Embuzi. The consideration paid
was Sh.6,000,000. Embuzis value of assets was as follows:
Year of purchase/
Construction
1996
1998
2001
1995
2000
Type of Asset
Farm house
Animal sheds
Workers quarters
Land
Grain dryer (fixed)
Dryer building
Motor vehicles
Cost
Sh.
300,000
560,000
600,000
1,000,000
800,000
400,000
1,200,000
The farm house was immediately converted into an office. The grain dryer and its building had
not been used at all at the time of purchase by the partners. The partners immediately brought in and
fixed by fabrication to the dryer some milling plant worth Sh.4,000,000 and started milling and packaging
Answers -Mocks
203
maize meal. The animal sheds were converted into stores, where finished products were kept. The
quarters housed employees from the mill.
By 2003, their production had expanded sufficiently such that they acquired two distribution
trucks (Sh.1,800,000 each). They also invested in computers automation and the office, the cost of which
was Sh.2,000,000.
In 2006, new stores were built at a cost of sh.2,800,000 and were brought to use on 1 January.
The partnership also contracted all transport needs and sold all motor vehicles for Sh.3,800,000 as one lot.
3.
4.
On 1 January 2006, Namu was admitted into the partnership and was given 1/5 share in profits or
losses.
The profits (before capital allowances) were Sh.3,600,000 for 2006.
Required:
(a)
(b)
(c)
(d)
marks)
Compute capital allowances for 2002 to 2006.

(8 marks)
Compute the revised taxable income (loss) of each partner for the years 2002 to 2006.
(8 marks)
Show its allocation to partners.
(5 marks)
Comment on the tax implications arising thereon.
(2
(Total: 23 marks)
QUESTION FOUR
The following trial balance was extracted from the books of Leta Limited at 31 December 2005.
Sh.
Share capital
Share premium
12% Debentures
Fixed assets at cost:
Factory buildings
Machinery and equipment (fixed)
Motor lorries
Provisions for depreciation to 31 December 2005:
Factory buildings
Machinery and equipment
Motor lorries
Goodwill (net)
Sales
Discounts allowed
Discounts received
Bank account
Purchases
Debtors and creditors
Provision for doubtful debts 31 December 2005
Bad debts
Depreciation expenses
Wages and salaries
Goodwill amortisation expense
Administrative expense
Research and development expenditure
Debenture interest paid
Instalment tax paid
Retained profit
Stocks at 1 January 2005
Sh.
2,000,000
1,000,000
2,250,000
4,350,000
600,000
2,250,000
360,000
300,000
1,070,000
240,000
7,916,000
142,000
98,000
356,000
4,582,000
525,000
314,000
530,000
45,000
570,000
684,000
6,000
328,000
96,000
135,000
400,000
330,000
1,134,000
TAXATION II
935,000
________
204
16,773,000
16,773,000
Notes:
1.
2.
Accrued expenses not included for wages and administrative expenses are sh.15,000 and
Sh.9,000 respectively.
Stock held at 31 December 2005 was as follows:
Ziga
Zepa
Zela
3.
4.
5.
Cost
Sh.
Net Realisable value

Sh.
563,000
362,000
478,000
468,000
267,000
586,000
The factory was brought to use on 1 January 2004. The directors were not aware of the need to
claim capital allowances and none has been made to date. A tax of Sh.420,000 was paid for the
year of income 2004 upon final assessment.
Half years debenture interest is still outstanding.
Research and development expenditure is to be written off.
Required:
(a)
Explain what happens if an error from previous tax returns is observed by a tax payer.
(4 marks)
(b)
Compute the taxable profit (loss) of Leta Limited for the year of income 2005
(16 marks)
(c)
Show the tax account for Leta Limited as at 31 December 2005.
(2
marks)
(Total: 22 marks)
QUESTION FIVE
The Assistant commissioner in charge of the Tax District called in the records of Rahamingi Traders, a firm owned
by Raha and Mingi in partnership. He wished to carry out an investigation in depth in line with the rules of self
assessment. The partners sent the following statement to him in line with the inquiry as their position as at 31
December 2005.
Sh.
Capital account balances at 1 January 2005
Raha
Mingi
Current account balances at 1 January 2005
Raha
Mingi
Sales
Stocks at 1 January 2005
Wages
Rent
Expenses
Heat and light
Debtors and creditors
Delivery costs
Drawings:
Raha
Mingi
Cash
Fixed assets
Purchases
Sh.
900,000
200,000
90,000
150,000
4,500,000
900,000
435,000
150,000
90,000
36,000
420,000
159,000
210,000
270,000
135,000
180,000
3,300,000
34,500
Answers -Mocks
205
The Assistant Commissioner requested them to provide more information in support of the statement together with
the supporting taxable profit or loss allocation to each partner. They approached you for advise and you ascertained
from their records that:1.
Fixed assets comprise two saloon cars which cost Sh.400,000 and Sh.300,000 respectively. Both vehicles
were purchased on 1 January 2003. The cars are used as follows:60% for private use
40% for official business
2.
3.
Stock at 31 December 2005 was valued at Sh.1,200,000.

Raha took goods that had cost the business sh.10,000 for his own use during the year. No entry had been
made in the books to record this drawing.
On 1 November 2005, the business ordered and paid for goods costing Sh.21,000. These were recorded as
purchases but were never received as they were lost by the carrier responsible for their delivery. The
carrier accepted liability for the loss during December 2005 and paid full compensation of Sh.21,000 in
January 2006. No entries had been made in the books in respect of the loss or claim.
At 31 December 2005 wages accrued amounted to Sh.15,000 and rent of Sh.30,000 was prepaid.
The partnership agreement provided that profits and losses should be shared equally between partners after:
4.
5.
6.
Allowing annual salaries of Sh.60,000 to Raha and Sh.120,000 to Mingi

Allowing interest of 5 per cent per annum on the balance of each partners capital account;
Charging Raha Sh.6,000 and Mingi Sh.9,000 interest on drawings.
Required:
(a)
(b)
Explain the meaning of examinations in depth when applied to income taxation. (8 marks)
Show the allocation of the partnership profit or loss for tax purposes. Provide all the relevant supporting
schedules.
(12 marks)
(Total: 20 marks)
MOCK 4
QUESTION ONE
(a)
(b)
1.
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)
You have been approached by the director of Flower Export Ltd. to help them do their tax returns
for 2005. The following information is available.
Written down values at 31 December 2004 per self-assessment return submitted are as follows:
Sh.
Motor vehicles:
Lories
Tractors
Pick-up and saloons
Farm house (constructed in 2003)
Computers
Plant
Equipment
Furniture
250,000
375,000
1,250,000
300,000
750,000
475,000
275,000
725,000
2.
During the year the company purchased and sold the following:
Mercedes Benz for use by the director costing Sh.2,500,000.

Security systems were fixed into companys lorries to comply with the insurance requirements. The
cost to the company was sh.250,000.
TAXATION II
206
The company traded-in four Nissan Sunny cars which were purchased in 2003. The trade-in value of
each of the cars was Sh 1,500,000 (Net book value of Sh 1,000,000)
Four new cars were bought at Sh.500,000 each.
The vehicles are used by the senior officers of the company and their rating is 1300cc.
Equipment worth Sh.1,650,000 was acquired while carpet worth Sh.450,000 was disposed of,
furniture with net book value of Sh.460,000 was disposed of.
Computers worth Sh.1,250,000 were acquired for purposes of speeding up computerization of the
companys operations.
The companys adjusted profit before wear and tear allowances is Sh.1,599,000.
Required:
i)
ii)
Compute the capital allowances for Flower Export Ltd. as at 31 December

2005 and calculate the tax liability.
Comment on the motor vehicle benefit available to senior officers who are
provided with motor vehicles.
(13 marks)
(2 marks)
(Total: 20 marks)
QUESTION TWO
The accountant of Mahindi, Ngano and Wimbi Traders has prepared the following trading, profit loss
account for the year ended 31 August 2005.
Sh.
Opening stock
Cost of sales
Factory expenses
Staff salaries
Interest on capital
Bonus and commissions
Partners Drawings
Audit fees and expenses
Compensation to Swaga Limited
Donations for wheat research
Contributions to:
NSSF
Pension Fund
Provident Fund
General expenses
Depreciation
Bad debts provision
Taxation paid
Redundancy payments
Partners salaries
Net Profit
50,000
10,000,000
2,000,000
4,000,000
140,000
40,000
50,000
56,000
55,000
1,000,000
20,000
70,000
Sh.
Sales
Closing stock
Bad debts allowed as a
donation in earlier years
Interest (Net)
5,000
30,000
10,000
414,750
90,000
115,250
750,000
300,000
2,000,000
2,000,000
23,196,000
23,050,000
118,000
10,000
18,000
________
23,196,000
The Partners, J Mahindi, K. Ngano and Wimbi share profits and losses and receive interest on capital and
salaries in the ratio 2:2:1 respectively.
Required:
Answers -Mocks
(a)
(b)
(c)
(d)
207
Examine the accounts and specify which items you may require additional information and
explain why such information is relevant in direct reference to the Income Tax Act.
(6 marks)
Assuming you are an assessor of Income Tax prepare a statement showing the amount of taxable
profit or loss of each partner.
(8 marks)
What right under the Act has the tax-payer got on receipt of notice of the assessment arising from
(b) above?
(3 marks)
What will be the direct tax consequences if the partnership is converted into a limited liability
company and interest on capital, partners drawings and partners salaries become dividends,
directors expenses and directors salaries respectively?
(3 marks)
(Total: 20 marks)
TAXATION II
208
QUESTION THREE
(a)
(b)
State the major tax considerations you would take into account while advising your client
regarding doing business either as a partnership or a private company.
(5
marks)
Ujenzi Ltd., prepares its accounts to 31 August each year. For the year ended 31 August 2005 it
submitted the installment tax return on 31 May 2005 and paid an installment tax of sh.20,000 on
the due date. It failed to submit the self assessment and was issued with a notice of estimated
assessment on estimated income of Sh.1,000,000 on 28 February 2006. It expects its income to
be higher than the estimate. The self assessment and accounts were submitted on 30 May 2006.
The tax payable for the year 2004 was sh.80,000.
(i)
What action would you advise the company to take on receipt of estimated assessment?
(2 marks)
(ii)
What action will the Commissioner take if the self assessment return and accounts reflect an
income of Sh.1,200,000?
(1 mark)
(iii)
Calculate the tax payable and state the date tax was payable.
(iv)
Assume the tax is not paid by 30 June 2006. Calculate late filing return penalty, late payment
penalty and late payment interest payable by 30 June 2006.
(5 marks)
(v)
Why does the Commissioner impose stiff penalties and interest?
(5 marks)
(2 marks)
(Total: 20 marks)
QUESTION FOUR
Pesa Limited was formed on 1 January, 2004 to trade in antiques. A bank account was opened for the
company with Sh.5,000,000. The company immediately bought two saloon cars for Sh.400,000 each, and
furniture and fittings for Sh.250,000. The directors did not maintain proper books of account. One of
their employees, Miss Kuuza, obtained her PIN certificate in line with the requirements of the Income Tax
Department. As a result, the directors have been requested to attend an interview at the Department. You
have been approached to act as consultant to help them in preparing for their meeting and determining her
tax position. They have provided the following information:
1.
2.
The only records kept were of cash sales which amounted to Sh.7,500,000 in 2004 and
Sh.9,000,000 in 2005. There were no credit sales.
All expenses of the business were paid by cheque. An analysis of the Bank statements showed
the following payments in the two years:
-
3.
4.
5.
Purchases (2004 Sh.7,400,000)

Rent and rates
Salaries
Advertising
Other expenses
Sh.
12,750,000
1,020,000
2,200,000
280,000
576,000
The value of stocks on 31 December, 2005 was sh.3,000,000. No stock was taken on 31
December 2004, but a uniform rate of gross profit of 331/3% may be assumed.
Private income of Sh.450,000 was paid into the companys bank account.
The directors took for private consumption goods estimated to cost Sh.100,000 in 2004 and
Sh.150,000 in 2005.
Answers -Mocks
209
TAXATION II
210
6.
Liabilities outstanding at 31 December, 2005 were as follows:

Purchases
Advertising
Other expenses
Sh.
1,500,000
100,000
34,000
7.
Amounts paid in advance at 31 December 2005 were:

Sh.
Rent and rates
20,000
Other expenses
10,000
8.
All business expenses can be assumed to have arisen equally in the two years.
Required:
(a)
b)
(c)
d)
Compute the profit chargeable to tax for 2004 and 2005.

Is it necessary to compute for each year as in (a) above? Support your
Answer using provisions of Section 27(2) of the Income Tax Act.
Should the company have filed instalment returns? Explain.
What are the consequences, if any, on the failure to file instalment
returns? (Quantify them for Pesa Ltd.)
(11 marks)
(4 marks)
(3 marks)
(2 marks)
(Total: 20 marks)
QUESTION FIVE
Dr. Pesa is a prominent Kenyan businessman. He is the Executive Chairman of Pesa Holdings Limited, a
company doing business under two divisions, Trading and Hotels. The following details have been
provided for the year of income 2005:
Trading, Profit and Loss Account for the year ended 31 December 2005:
Sh.
Opening stock
Purchases
Bank charges
Wages and salaries
Insurances
NSSF contributions
Legal charges
Bad debts
Commissions
Repairs and replacements
General expenses
Car expenses
Depreciation
Donations
Rent and rates
Travelling expenses
Pension to retired staff
Entertainment
Loose tools
Telephone
Net profit
240,000
1,670,000
66,000
401,200
24,000
12,600
11,860
25,300
17,860
45,960
26,900
75,000
96,700
4,320
48,000
13,460
259,680
24,240
13,560
1,800
12,960
2,151,960
5,243,400
Sh.
Sales
Closing Stock
Repair Revenue
Insurance/Recovery/
Capital gains
4,800,000
211,720
105,880
125,800
________
5,243,400
Answers -Mocks
211
1.
Legal expenses are made up of:
Drawing up of 80 year lease
Recovery of bad debts
Staff housing loans
2.
3.
4.
5.
Sh.
6,600
1,200
4,060
11,860

Cleaning materials
Periodicals for hotels
Tip of licensing officer
Sh.
10,240
6,660
10,000
26,900
Included in repairs and replacement are:

- Sewing machine for Watu Beach Hotel
- Sh.16,000
- Kettle for making tea in office
- Sh.1,500
Travelling expenses of Sh.168,720 were incurred by Dr. Pesa on a tour for hotel owners organized by
Ministry of Tourism and Wildlife to Germany and America to market Kenya Hotels.
The company opened on 1.1.2005 a small food processing factory to can and pack foods for the hotels.
The following costs were incurred:
Sh.
300,000
800,000
1,200,000
Land purchased at Miritini

Building housing the plant
Canning and processing plant fixed
Free floating machinery
6.
7.
400,000
Watu Beach Hotel tax account indicated the following:

Hotel building cost Sh.5,000,000 (investment deduction sh.3,000,000).
Class IV Machinery WDV 1.1.2005 Sh.400,000.
In January 2005, the building, furniture and fittings and plant and machinery with the exception of vehicles
of Watamu Cottages, one of his hotels were destroyed by fire. The cottages had been certified as an
industrial building in pursuant to paragraph 5(1)(c) of the second schedule. The following details are
available.
Cottages
Original cost
Residual of qualifying
Expenditure 1.1.2005
Insurance Recoveries
A
Sh.
800,000
480,000
B
Sh.
1,200,000
720,000
C
Sh.
1,600,000
960,000
115,200
700,000
409,600
1,000,000
614,400
1,400,000
Machinery, Motor-vehicles and Equipment (MME)

Class I
Class II
Cost
660,000
250,000
WDV 1.1.2005
475,000
210,000
Insurance Recovery
300,000
Class III
1,400,000
810,000
-
Class IV
2,000,000
1,220,000
750,000
Reconstruction costs were incurred as follows:

Cottages
Paid to contractor
Government Subsidy
A
Sh.
2,400,000
700,000
B
Sh.
3,600,000
1,000,000
TAXATION II
C
Sh.
4,800,000
1,400,000
212
MME
Class II
Class IV
Sh.
Sh.
800,000
3.000.000
All these activities took place in January and the Cottages were brought to use in the same month.
8.
The capital gains resulted from sale of publicly quoted shares.
Required:
Adjusted profit or loss for tax purposes of Pesa Holdings Limited showing clearly all your supporting schedules.
(Total: 20 marks)
MOCK 5
QUESTION ONE
Kaka and Wao have each received an assessment notice from the Commissioner of Income Tax
demanding a tax of Sh.120,000 for the year of income 2005 together with interest chargeable under the
Act. Kaka and Wao have approached you for advice. They have provided the following information:
They started trading as fruit sellers in partnership on 1 January, 2005 but did not keep a set of double
entry books. The firms bank account for 2005, prepared from the record of cheques issued and cash paid
into the bank was:
Sh.
Capital introduced:
Kaka
Wao
Sales receipts bank
120,000
20,000
200,000
Sh.
Purchases
Wages
Rent and rates
Light and head
Delivery Van
Drawings: Kaka
Wao
Balance c/d
_____
340,000
150,000
17,000
3,500
1,260
119,000
18,000
16,000
15,240
340,000
Notes:
The following payments were made directly from cash sales receipts:
Petrol for van
Maintenance
Advertising
Purchases
Sh.
2,000
1,000
900
2,500
6,400
The van, purchased on 1 January, 2005 was expected to have a life of five years at the end of
which its scrap value will be Sh.3,000.
The partners agree that separate capital and current accounts are to be kept and all profits and
loses are to be shared equally.
At 31 December 2005:
Debtors
Trade creditors
Prepaid rent
Light and heat accrued
Sh.
5,460
3,800
100
140
Answers -Mocks
213
Stock
-
9,200
During 2005 both Kaka and Wao took groceries for personal use at cost price as follows:
Kaka
Wao
Sh.
1,000
1,260
2,260
Required:
(a)
The income chargeable to tax and its allocation between Kaka and Wao.
(b)
The interest charged on the assessment notices received by Kaka and Wao as at 31 May 2006.
(3 marks)
Explain the action which Kaka and Wao should take with regard to the assessment notice received
from the Commissioner, and in light of their desire to reduce their overall tax liability.
(5 marks)
(Total: 20 marks)
(c)
(12 marks)
QUESTION TWO
Mr. Chuma is a company secretary with Metal Limited, a local company and was resident in Kenya for
the whole of 2005. The following extracts relate to information about his income and related benefits for
2005:
(i)
(ii)
Basic salary from Metal Limited was at the rate of Sh.50,000 per month up to 30 June 2005. It
was raised to Sh.56,000 with effect from 1 July 2005.
The company made the following payments to him per month:
-
(iii)
Home to office car allowance Sh.3,000;

House allowance of Sh.10,000 (up to 30 June)
Sh.2,000 for making sales check trips.
On 1 July he moved to a company house and paid a nominal rent of 5% of basic pay. The
company, as from that date, provided him with a gardener, a watchman and a maid. In addition
his house was linked to Securex Kenya Ltd.s 24 hour security alarm system.
The company incurred the following expenditure in respect of these benefits in 2005.
Actual Amount
Sh.
Salaries per annum:
Gardener
42,000
Watchman
43,200
Maid
24,000
Securex Kenya Ltd.
48,000
(iv)
(v)
He rented his house to a tenant from 1 July for Sh.20,000 per month. The house was fully
furnished when he rented it to the tenant. Furniture worth Sh.200,000 was acquired for this
purpose. Other expenditure on the house included repairs of Sh.10,000 and mortgage interest.
He had a mortgage of Sh.1,000,000 with H.F.C.K. Mortgage repayments were Sh.20,000 per
month and interest rate was 20% p.a. Due to some cash flow problem he had only paid 9
instalments in the year.
Dividend income (net) was Sh.9,000 from Metal Limited. He holds 4% of the share capital.
TAXATION II
214
(vi)
Mr. Chuma is a lawyer by profession and during their spare time they practice law with his wife,
Mrs. Jane Chuma, also a lawyer. Due to unforeseen circumstances, they made a taxable loss of
Sh.300,000 in 2005.
Mrs. Jane Chuman works for Metal Limited as personnel manager. Her basic salary was
Sh.30,000 per month. In the year, she also received Sh.20,000 as a productivity bonus from the
company. She obtained a loan of Sh.400,000 from the company repayable over 5 years at 10%.
She immediately, on 21 January when she received the money invested it as follows:
Sh.100,000 in 15% Kenya Government Stock
Sh.100,000 in 12% Post Office Savings Account
Sh.200,000 in 20% Golden Premium Account with KCB.
She also received Sh.4,500 net dividend from Dress Making Limited.
Mr. Chuma was in the companys life insurance scheme into which the company paid Sh.5,000 p.a. Mrs.
Chumas life cover was of her own and she paid Sh.6,000 p.a.
On 1 December, after some serious disagreement, Mr and Mrs. Chuma were permanently separated by the
court. Mrs. Jane Chuma received custody of their child, Juma and an alimony of Sh.20,000 per month.
The legal practice was to continue on an equal sharing basis. PAYE paid at source was, Mr. Chuma
sh.72,000 and Mrs. Chuma Sh.60,000, respectively.
Required:
Mr and Mrs. Chumas tax liability for 2005, commenting on the effects of their separation.
marks)
(20
QUESTION THREE
(a)
The Managing director of Athi Production Limited has passed to you a copy of the companys
capital budgets for the year ended 31 December 2005:
You have extracted the following items of capital expenditure from these budgets:
New plant and machinery for fixed in factory extension Kshs. 2,400,000
Extension to existing factory building Kshs. 13,600,000
New sports pavilion for staff welfare and recreation Kshs. 14,400,000
A patent from another company for special tools for Kshs. 3,600,000
A new factory which will cost Kshs. 64,000,000 made up from:
Land
Site clearance
Construction materials
Architects fees
Labour costs
-
Kshs.
14,000,000
7,000,000
23,000,000
6,000,000
14,000,000
A new extruding machine for Kshs. 10,000,000 of which Kshs. 2,000,000 will be paid as deposit and
balance over the next five years with interest at 10% p.a., fixed in new factory.
A fleet of seven identical new cars for sales representatives Kshs. 14,700,000.
A new Volvo for the managing director Kshs. 10,500,000
To spend Kshs. 7,000,000 on pure scientific research.
To purchase old factory building for Kshs. 12,700,000 which originally cost the first owner Kshs.
2,600,000 when constructed in January 1962.
Computerize the system of the company Kshs. 9,000,000
Answers -Mocks
215
Required:
(a)
(b)
(i)
(ii)
A statement showing the capital allowances available in respect of the accounting period ended
31 December 2005, assuming all items are purchased according to the budget.
(12
marks)
The company made a profit of Kshs. 100m before allowances and other allowable expenditure in
(a) above. The directors do not intend to distribute a dividend.
Determine the taxable profit for the year.
(4 marks)
Provide a rationale to the Commissioner of Income Tax why the company should not be
penalized for non-distribution of dividend, indicating clearly under what conditions such penalty
arises.
(4
marks)
(Total: 20 marks)
TAXATION II
216
QUESTION FOUR
(a)
Using the Income Tax Act and with direct reference to decided tax cases, explain how each of the
following situations are to be handled in taxation:
-
(b)
Legal fees incurred in obtaining overdraft facilities from a bank.

Compensation payment for an action which reduces a companys annual expenditure
Tax reliefs in a polygamous marriage
Money held on behalf of customers.
(16 marks)
Explain the importance of tax amnesty like that declared by the Minister of Finance and specify
its legal consequences.
(4 marks)
(Total: 20 marks)
QUESTION FIVE
Andrew Ndwiga practices mixed farming and closes his books on 31 December every year. He has
provided the following income and expenses summary for the year ended 31 December 2005:
Income:
Sale of milk to Maziwa Dairies
Sale of vegetables
Sale of broilers to Chicken World Ltd.
Sale of sheep and heifers
Sale of firewood
Total income
Sh.
547,500
365,000
2,575,000
380,000
165,000
4,032,500
Expenses:
Fertilizers
Pesticides
Seeds
Planting of tea seedlings
Motor vehicle expenses (Pick-up)
Insurance for farm works
Agricultural shows for employees
Salaries and wages for employees
Vaccines for livestock
Purchase of chicks
Animal feeds
Wood shavings and saw dust (for poultry)
Construction of water storage tank
Construction of chicken sheds
Loan repayment Wakulima Farmers SACCO Ltd.
Interest on loan Wakulima Farmers SACCO Ltd.
Repairs on dairy sheds and fences
Subscriptions to Starehe sports Club
Value of goats killed by a leopard
Wages for Ndwigas housegirl
Ndwigas personal accident insurance cover
Bad debt written off Shambani Stores Ltd. (in receivership)
School fees for Mr. Ndwigas children
Depreciation motor vehicles
Total expenses
90,000
55,000
36,000
111,000
180,000
69,000
133,000
420,000
88,000
66,000
585,000
675,000
24,000
235,000
900,000
312,000
106,800
156,000
60,000
110,000
33,600
23,000
77,500
300,000
85,500
4,931,400
Answers -Mocks
217
Net loss
(898,900)
1.
2.
3.
4.
5.
6.
Insurance for farm works includes cover for Ndwigas household items amounting to sh.19,000.
Mr. Ndwiga received sh.25,000 dividend, net of withholding tax from Majani Ltd.
Farm produce consumed by Mr. Ndwigas family was valued at Sh.265,000.
Mr. Ndwiga received Sh.135,000 from the local farmers co-operative society as consultancy fees.
The farmers co-operative society uses his farm as a demonstration farm for training other
farmers.
Salaries and wages include sh.100,000 paid to Ndwigas wife.
Capital allowances for the year ended 31 December 2005 have been agreed with the
Commissioner of Income Tax at Sh.196,400.
Required:
(a)
(b)
Mr. Ndwigas taxable income for the year ended 31 December 2005.
Tax payable on taxable income computed in (a) above.
TAXATION II
(16 marks)
(4 marks)
(Total: 20 marks)
218
ANSWERS - MOCKS
SUGGESTED SOLUTIONS
MOCK 1
QUESTION ONE
(i)
Expense Reimbursement
Reimbursement of personal expenses constitutes a taxable benefit. The assessed benefit will be
equivalent to the cost of the employer. Consequently, this scheme does not have any benefits if
the reimbursement is for personal expenses. The reimbursement of expenses incurred in the
course of carrying out the business of the employer does not constitute a taxable benefit. Here, it
is assumed the reimbursement is for the actual cost incurred by the employee. If the amount
reimbursed exceeds the cost to the employee, the difference will be subject to tax.
The personal expenses reimbursed will be tax deductible by the employer if the employee has
been taxed. Reimbursement of business expenses is tax deductible if the employee has been
taxed. Reimbursement of business expenses is tax deductible if the expenditure is incurred
wholly and exclusively for the purpose of the business.
(ii)
Benefits in Kind
Benefits in kind are taxable, unless the aggregate value does not exceed Ksh.36,000 p.a (Kshs.
3,000 pm). This amount is not significant enough to be included in an Executive Remuneration
Package. Other benefits not subject to tax include:
Medical services to full time employees;
Employers contribution to a pension or provident fund (whether registered or not);
Education fees of an employees dependents, where treated as a non-deductible expense by the
employer;
Passages between Kenya and any place outside Kenya for expatriates.
(iii)
Pension Entitlement
- Contributions by an employer to a pension or provident fund, whether registered or not are
not taxable on the employees. However, the employer is not allowed to deduct contributions
to non-registered schemes. The employees can benefit from these schemes but may not be
tax efficient because the employer will be taxed on the contributions.
- The employer is tax exempt (e.g. NGO), contributions to unregistered schemes are fully
taxable on the employees.
(iv)
Bonus Schemes
Bonuses constitute cash payments to employees. All cash payments received as a gain or profit
from employment are taxable in full. This item will not be tax effective to be included in a
remuneration package.
(v)
(a)
Share Purchase Arrangements

The granting of bonus share for better performance by the firm is a benefit in kind received for
employment services rendered thus a taxable benefit.
where the shares are given free, the taxable benefit is based on the prevailing market price per
share (MPS). Where the shares are issued at price lower than the market price per share, the
taxable benefit shall be (MPS issue price) number of shares issued.
Answers -Mocks
219
Where the difference between MPS and issue price is 5% or less of the MPS, the benefit is not taxable
example.
Assume
MPS
Issue price to employee
Different/discount
% of MPS
1
Sh.100
Sh. 96
Sh. 4
4 x 100 = 4%
100
2
Sh.100
Sh. 91
Sh. 91
9 x 100 = 9%
100
Where the shares are redeemable, the taxable benefit shall be the higher of the difference between:
issue price and nominal value; or
issue price and redemption value.
QUESTION TWO
(a)
Must be public in character and serve the total public as a section of the public
Set up for relief of distress or poverty in Kenya
For advancement of education or religion in Kenya
Income expended in Kenya for benefit of Kenyans
(b)
Kioko and Wanza

Income tax computation
Net profit as per accounts
Increase in general provision for bad debts
Partners insurance
Partners deed
VAT penalty
Christmas gift to partners spouses
Loss on sale of investment
Office partitions
Office carpet
Replacement of adding machine
Interest on capital
W/Tax on dividends
Depreciation
Partners salaries
Motor vehicle expenses
32,000
20,000
2,000
7,500
4,000
1,000
10,000
2,000
1,500
1,000
4,000
30,000
3,000
60,000
60,000
10,000
Less net dividends

W/Tear (WI)
Adjusted profits
17,000
22,562
216,000
248,000
(39,562)
208,438
Allocation to partners
Kioko
3
20,000
71,063
91,063
Ratio
Interest on capital
Salary
Profit share
Wanza
2
10,000
60,000
47,375
117,375
Notes:
Bad debts written off
-
Assumed this was specific trade debt written off hence allowable
Bad debt recovered assumed it was trade bad debts hence taxable when recovered.
TAXATION II
Total
5
30,000
60,000
118,438
208,438
220
W1:
Wear & Tear allowances

Class
III @ 25%
IV @ 12.5%
90,000
-___
90,000
(22,500)
67,500
56,000
2,000
1,500
1,000
60,500
(7,562)
52,938
WDV
Add: Partitions
Carpets
Adding machines
Less W.T.A
Summary
Class III
WTA
Class IV
WTA
TOTAL
22,500 ( x 22,500) =
=
15,000
7,562
22,562
QUESTION THREE
(a)
Mr. S Kibesa
1998 2005 INCOME COMPUTATION
Year of
Income
1998
1999
2000
2001
2002
2003
2004
2005
Net Assets
950,000
1,025,000
1,010,000
1,145,000
1,073,000
1,490,000
1,535,000
1,670,000
Growth in
Assets
75,000
(15,000)
135,000
(72,000)
417,000
45,000
135,000
Living
Expenses
100,000
125,000
150,000
150,000
200,000
200,000
200,000
Chargeable
Income
175,000
110,000
285,000
78,000
617,000
245,000
335,000
WTA
(12,500)
(10,938)
(15,820)
(13,843)
(80,862)
(62,942)
(49,215)
WTA Computation
Class
WDV 1/1/1999
Additions:
Furniture
1999 WTA
WDV 1/1/2000
2000 WTA
WDV 1/1/2001
Additions:
2001 WTA
WDV 1/1/2002
2002 WTA
WDV 1/1/2003
Additions
Comm. Vehicle
Furniture
2003 WTA
WDV 1/1/2004
2004 WTA
WDV 1/1/2005
2005 WTA
III @ 25%
NIL
IV @ 12.5%
100,000
(12,500)
87,500
(10,938)
76,562
50,000
126,562
(15,820)
110,742
(13,843)
96,899
250,000
_____250,000
(62,500)
187,500
(46,875)
140,625
(35,156)
50,000
146,899
(18,362)
128,537
(16,067)
112,470
(14,059)
(80,862)
(62,942)
(49,215)
Taxable
Amount
162,500
99,062
269,180
64,157
536,138
182,058
285,785
Answers -Mocks
221
WDV 1/1/2006
(b)
105,469
98,411
More about the building wholly occupied or partly

More about the freehold land what purpose wholly business
Motor vehicle private usage
Stock in trade method of valuation
Debtors Are they trade or non-trade debtors?
Loan from a friend investigate authentically.
QUESTION FOUR
(a)
Charitable Trust are exempted from taxation if:

-
One public in for a small section or the public in general (not discriminative)
for enhancement of education or religion
for purpose of eradication of poverty and disease
no profit sharing
income generated is expended in Kenya for benefit of Kenyan citizens
registered as a charitable trust
Watu clinic does not qualify as a charitable trust hence not exempted from tax.
(b)
Income statement
Net profit (income expenditure)
Salaries partners
Interest partners
Life cover for partners
40% M.V expenses
Depreciation
Less: non- income & all. Expenses
Donation and grants
Goodwill
Capital allowances
Dividends
Int. on deposits
Adjusted partnership profits
Profits for 9 months =
3,741
5.0
12.0
15
67.2
200
922.2
4,663.2
3,600
140
96
50
12
3,898
765.2
9/12 x 765.2 = 573.9
(c)
9 months to 30/9/2005
Interest x 9/12
Salaries x 9/12
Profits x 9/12
3 months from
Int. 3/12
Salaries x 3/12
Profits x 3/12
Add for 9 months
above
(d)
H. Kutibu
40%
15
180
71.46
266.46
Mrs. W Kutibu
20%
5.25
35.73
40.98
F. Nafuu
40%
15
180
71.46
266.46
Mganga
Total
35.25
360
173.65
573.9
1 :10 :2005
31/12/2005
40%
5
60
10.62
75.62
266.46
342.08
10%
40%
10%
Total
1.75
2.655
4.405
40.90_
45.385
5
60
10.62
75.62
266.46
342.08
3.0
30
2.655
35.655
- ___
35.655
14.75
150
26.550
191.3
565.2
765.2
Combine Kutibus p/ship income and tax on husband
TAXATION II
222
(e)
For Nafuu and Mganga, aggregate with other incomes and taxed on graduated scale.
Dr. (Mrs) Kutibu would be assessed separately on her Sh.240,000 salary as follows:
121,968 @ 10%
114,912 @ 15%
236,880
= 12,196.8
= 17,236.8
=
(240,000 236,880) @ 20%

Gross liability
PAYE
Tax refund
624.0
30,057.6
(13,944.0)
(97,200.0)
(81,086.4)
The refund would be used to offset the husbands tax liability as follows:
Partnership income
Add: Wifes partnership income
Tax liability on Kshs. 387,465
Sh. 121,968 @ 10%
Sh. 114,912 @ (15% + 20%)
(Sh.387,465 351,792) @ 25%
Wifes refund
Tax refund
342,080
45,385
387,465
= 12,196.8
= 40,219.2
8,918.3
61,334.3
(13,944.0)
(81,086.4)
(33,696.1)
QUESTION FIVE
(a)
(b)
Fraudulent financial reporting is defined as intentional or reckless reporting that results in

materially misleading financial statement.
Fraudulent financial reporting can usually be traced to the existence of conditions in
either the internal environment of the firm.
Excessive pressure on management; such as unrealistic profit or other performance goals
can lead to fraudulent financial reporting
In taxation fraudulent financial reporting happens when the intention is to evade tax.
That is to reduce tax liability that has arisen in genuine transaction.
The income tax act under section 110 and 111 deals with issues of incorrect returns and
fraudulent returns. These actions give rise to offences under the act.
-
In the case of income returns, the penalties will be in the form of late payment interests
charged on the additional taxes, as due date of payment does not after.
In the case of fraudulent returns, the penalty will be a fine not exceeding Sh.10,000
double the amount of tax arising from the undisclosed income whichever is greater or
imprisonment for a term not exceed two years or both.
Customs and Excise Act
Section 187 deals with false declaration resulting into losses of revenue.
-
Penalty is charged based on the amount involved. Penalties could be in form of:
Answers -Mocks
223
goods being forfeited or seized or

imprisonment of offender
VAT Act
(c)
to
Any person, who makes a false statement or produces a false document or makes a false return is
guilty of an offence under Sec.40 of the VAT Act.
Such a person is liable to a fine not exceeding Sh.400,000 or double the tax evaded, whichever it
is greater or imprisonment for a term not exceeding 3 yrs or both.
Goods relating to the offence may also be forfeited.
-
(d)
The accounting profession is of the opinion that it is not the responsibility of the auditor
detect fraud beyond what can be detected with the diligent application of generally
accepted auditing standards.
The auditor is not an insurer and the report does not constitute a guarantee that material
misstatements do not exist on the financial statements.
The tax authorities are entitled to assume the exercise of diligence as long as he has not
participated in the fraudulent accounting where liability arises where an auditor is
involved, that he will face the liability relating to fraud as defined by the Tax Act.
Under Section 18 of the Income Tax Act

-
Where a non-resident company produces goods in Kenya and is sold elsewhere, the gains
or profit arising therein is deemed to be derived from Kenya.
In a related party transactions the arms length rule shall apply.
No deductions of administrative expense is allowed other than under special
circumstances.
No deduction in respect of interest, royalties or management fees are allowed on as
payments to head office by a branch/subsidiary.
TAXATION II
224
SUGGESTED SOLUTIONS
MOCK 2
QUESTION ONE
(a)
(b)
i)
See Section 85 of the Income Tax Act.

Mr. Kuweka
Memorandum of Appeal
Profit from disposal shares
The assessment goes to bring to charge gains made on the disposal of shares. As the taxpayer
does not trade in shares, the gains made from the shares do not constitute trading income.
Consequently, they fall to be treated as capital gains which are not subject to income tax.
ii)
Honoraria
The assessment seeks to bring to charge a honoraria of Sh.50,000. This amounts was not earned
in the course of any business or employment. Consequently, it was not derived from any
designated source that qualifies for tax. It should be treated as wind fall gain that is not subject to
tax.
iii)
Farming Income
The arming income has erroneously been assessed. Where farming income is subject to 2%
presumptive income tax (PIT), no further tax applies in respect of individual taxpayers. PIT
becomes final tax.
iv)
Wifes Employment Income

The wifes income was not earned at arms length and should be aggregated with the husbands
income assessed on him. The revised tax liability is thus as follows:Taxable income as per self-assessment
Add wifes income
Sh.
851,566
300,000
1,151,566
Tax liability thereon

(121,968 @ 10%) + (114,912 x 60%)
(1,151,566 466,704) @ 30%
Less PAYE on Sh.300,000
121,968 @ 10%
114,912 @ 15%
236,880
(300,000 236,880) @ 20% = 12,164.0
Less tax paid
Additional Tax payable (refund)
81,144.0
205,458.6
286,602.6
= 12,196.8
= 17,236.8
= 12,164.0
(42,057.6)
(250,000.0)
(5,455.6)
Answers -Mocks
225
QUESTION TWO
(a)
Housing benefit could be exempted for taxation where:

-
(b)
It is necessary for the performance of employees duties to reside in the accommodation.

The accommodation is provided for the better performance of the duties of the
employment and in type of employment it is customary for employers to provide living
accommodation.
There is a special threat to the employees security and he lives in the accommodation as
part of special security arrangements.
Gifts/prizes become taxable when:

There is frequency with which such payments are made
Whether there is any contractual entitlement to the voluntary payment for employees as that
particular office or employment to receive such voluntary payments of gifts.
Related to line of business of receiver e.g. doctors gift from patient
Related to service rendered in the past.
(c)
Financial ratios
(i)
Income tax Determination of reasonableness of financial statements particularly using
inter-period comparisons
Use of expected standard industry financial ratios to determine any significant variation
in fixed account.
(ii)
VAT (Value Added Tax)

Relationship between sales and purchases/Manufacturing; cost-volume-sale in business
and therefore VAT payable.
VAT claims based on check of stable working capital ratios.
(iii)
Excise Tax
Relationship between production figure with sales
Evaluation between inputs V. outputs to check understatement.
(d)
Tax amnesty is basically forgiveness given to past tax offenders, all those who have not been
remitting tax, those who have been evading tax etc.
It is important in the following ways:
It means that taxpayers can declare their income truthfully without any fear of their taxes being
backdated.
It reduces the work to be done by I.T department in terms of investigations and prosecutions.
TAXATION II
226
QUESTION THREE
Item
Additional
Information
Type of vehicle
Value or cost
Commercial or noncommercial
Source of
Evidence
Log book
Purchase invoice
Register of motor
vehicles
Payment for purchase

Is it for business
Why is there rent
expenses
Date a/c was opened
Type of a/c (savings or
current)
Sources of banking (loan,
savings, etc)
Short term or long term
Purpose of the loan
Mortgage loan agreement

Purchase agreement or
written will in case of
inheritance
Bank statement
1.
Motor vehicles
2.
Buildings
3.
Cash at Bank
4.
Loan
5.
Capital by
wife and self
Source of capital
introduced
Savings, loan, past salary

or inheritance.
6.
Debtors,
deposits and
prepayments
List of debtors and

amount owed by each
debtor
Sales invoices
Correspondence with
debtors and
circularization
7.
Hire purchase
creditors
8.
Salary to self
and wife
What items was bought on

H.P (business or private)
H.P period
Are statutory deductions
computed and paid?
Correspondence with
seller.
H.P. agreement
Payroll records and
cheque counterfoils.
9.
Motor vehicle
running
expenses
Why are the expenses

higher than the NBV of
the motor vehicle?
The extent of private
usage of motor vehicle
Payment receipts
10.
Repairs and
maintenance
expenses
Professional
fees
What are they for

building, furniture,
computers, etc?
Main sources of income
Payments, bills and

receipts
11.
Loan agreement to
establish the purpose
Fee notes to check

whether VAT is paid
Action to comply with

Tax Act
If the vehicle is noncommercial, the
qualifying cost will be
restricted to
Sh.1,000,000 for WTA
purposes.
If mortgage loan and
building is used for
business, interest
charges are allowable.
Called the source of
bankings be undisclosed
source of income.
If loan is for business,
interest charges are
allowable.
Confirm that no capital
was introduced from
untaxed sources.
Non-trade debtors
consist loans to
outsiders and the
business should charge
interest.
If a business item, the
HP interest charges are
allowable.
Salary to self and wife
are disallowable
expenses.
If a capital item is
included in the
expenses, it should be
disallowed like expenses
relating to private usage
of motor vehicles.
If for private items, they
are disallowable.
Advice on VAT
implications for noncompliance.
Answers -Mocks
227
QUESTION FOUR
(a)
Mukungu Properties:
Income tax computation
Sh.
Net profit as per accounts
Add back:
Renovations for new building
Partitioning and carpeting
Kenya Red Cross Society
School raffles
Bad debt on debt loan
Increase of stamp duty
Pension to the management
Contract on purchase of business
Interest in lieu of dividends
Trading receipt (1044800 9,379,000)
Depreciation
Patent written off
Income tax appeal
100,000
80,000
10,000
18,000
160,000
40,000
800,000
50,000
110,000
100,000
106,900
200,000
50,000
40,000
Less:
Dividends from subsidiary
Gain on sale of P & Machinery
P.O.S.B interest
Adjusted income
Tax thereon 30% x 2,244,900 =
(b)
Sh.
620,000
1,854,900
2,474,900
100,000
100,000
30,000
(230,000)
2,244,900
673,470
Delay payment upto the last day.
Invest tax fund in an investment whose yield exceeds tax penalty.
QUESTION FIVE
(a)
Alternative 1
Sh.
Net Loss as per accounts
Add: understated sales
Overstated cost of sales
Overstated printing and stationery
Net discount as per accounts
Sh.
(1,879,500)
2,000,000
1,000,000
10,000
10,000
1,140,500
20,000
1,120,500
26,200
1,146,700
Less: office rent understated

Add: correct discount net
Adjusted accounting profit
Add back: depreciation
Provision for bad debts
Interest on capital
30,000
175,000
265,000
Less: tax allowances

Specific Bad debts provision
32,000
215,000
From the workings:

- Sales are understated by Sh.2,000,000
- Cost of goods sold are overstated by Sh.1,000,000
- Office rent is understated by Sh.20,000
- Printing and stationery is overstated by Sh.10,000
- Net discounts should be credit of Sh.26,200 (income)
TAXATION II
470,000
1,616,700
(247,000)
1,369,700
228
Opening capital is overstated by Sh.1,000,000

Alternative 2
Sh.
Gross profit (see workings)
Less: Allowable expenses
Salaries
Office rent
Advertising
General expenses
Motor upkeep
Printing & Stationery
Travelling expenses
Wear and Tear
Allowance
Sh.
3,510,000
1,200,000
240,000
97,000
60,000
137,500
84,500
100,000
215,000
32,000
2,166,500
1,343,500
26,200
1,369,700
Add: Discount net

Taxable income
Workings:
DEBTORS ACCOUNT
Balance b/d (**)
Credit Sales
4,700,000 Cash
12,440,000 Discount
________ Balance c/d
17,140,000
13,500,000
140,000
3,500,000
17,140,000
CREDITORS ACCOUNT
Cash
Discount
Balance c/d
11,200,000 Balance b/d

120,000 Purchases (**)
1,850,000
13,170,000
Sales:
Sh.
2,200,000
10,830,000
13,030,000
2,500,000
10,530,000
3,510,000
14,040,000
Opening stock
Purchases
Closing stock
Cost of goods sold
Add: 33
1
3
% mark-up
Total sales
(**) Balancing figures
Tax consequences on incorrect returns of income:
(b)
In the case of the tax payers:

Penalties of 200% or imprisonment for 2 years or both
20% of tax payable
2% per month on unpaid tax.
2,340,000
10,830,000
________
13,170,000
Answers -Mocks
229
TAXATION II
230
SUGGESTED SOLUTIONS
MOCK 3
QUESTION ONE
Dr. Pesa & Pesa Intl. Ltd.
2005 Income Computation
Gross profit
Less: allowable expenses
Directors fees
Salaries:
Others
Pesas
Travelling:
Others
Pesas Business
Put
Rent: Others
Pesa
Bad debts
Capital allowances
Interest due to Pesa
Selling expenses
Printing & stationery
Advertisement
Misc. Trade expenses
Electricity expenses
Commission to agents
Debenture interest
Audit fees
(b)
Total
Shs.
P.T Ltd
Shs.
Dr. Pesa
Shs.
32,000,000
24,000,000
8,000,000
1,120,000
1,120,000
4,440,000
360,000
2,960,000
240,000
1,480,000
-
1,500,000
120,000
60,000
2,424,000
216,000
320,000
960,000
420,000
2,520,000
480,000
1,600,000
3,780,000
420,000
1,600,000
300,000
600,000
1,000,000
80,000
40,000
1,616,000
144,000
213,333
640,000
420,000
168,000
320,000
1,066,667
2,520,000
280,000
1,066,667
300,000
400,000
500,000
400,000
808,000
106,667
320,000
840,000
60,000
533,333
1,260,000
140,000
533,333
200,000
1,078,667
Summary of Dr. Pesas income

Business income (4 months
Directors fees
Salary
Travelling
Interest
1,078,667
1,120,000
240,000
40,000
420,000
Add 15% HB
434,800
3,333,467
Let x = sales upto June

X + x = July December sales
X + x = 193m
1x = 192m
x = 72m = sales to June
x = x x 72m = 48m x 3
= 144 (May December)
Answers -Mocks
231
Dr. Pesa & Pesa Intl. Ltd

Let X = sales upto 30th June
Sales from July to December = X + x
Total sales = XT x +x = 192m = x = 72m
Sales up to April 4/6 x 72
Sales May December
=
=
48m 1
144
3
192m
QUESTION TWO
(a)
Income is currently classified into the following sources:
Employment and professional income

Business income
Farming income
Gains or rights arising from use or occupation of property
Investment income
Unspecific sources
Pension and provident funds
Exceptions from unspecified sources computation
Banks
Insurance companies
Financial institutions other than banks
Housing financial institutions
Companies quoted in the NSE
Oil companies
Large multi-national companies (manufacturing)
NB:
The above exceptions do not cover farming income.
TAXATION II
232
(b)
WANANCHI GENERAL INCOME LTD

2005 INCOME COMPUTATION
INCOME
SHS.
SHS.
Premium received
Communication on reinsurance
Bonus utilized to reduce premium
Re-insurance recoveries of claims
SHS.
12,000,000
80,000
120,000
80,000
12,280,000

Claims: Brought forward
For the year
Carried forward
Re-insurance premium paid
Commission on re-insurance accepted
Management expenses
Provision unexpired risk
Closing
Opening
Medical expenses
Bad debts specific
Legal expenses regarding claims
(400,000)
4,800,000
700,000
5,100,000
1,200,000
2,000,000
40,000
3,020,000
4,667,200
(4,000,000)
677,200
50,000
25,000
400,000
800,000
(13,312,200)
(1,032,200)
Adjusted business income/(loss)

Rental Income: gross
Less expenses
Interest income
Investment income
Less inv. Managers fees
750,000
(150,000)
2,350,000
(600,000)
Total Taxable Income
(ii)
600,000
2,600,000
1,750,000
3,917,800
The loses from one source can be offset against the income from other sources.
QUESTION THREE
(a)
Capital allowances
(1)
Investment deductions (using year 2003 rates)
Asset
Grain dryer
Dryer building
Milting plant
(2)
Q. Cost
I.D @ 70%
Residual for
IBD & WTA
800
400
4,000
560
280
4,000
5,200
240
120
1,200
Industrial Building deduction (IBD)

Build up
1991 Dryer building
Workers quarters
1992
1993
1994
1995
Add store 1995
Q.Cost
Residual b/f
120
400
520
520
520
520
520
2,800
507
494
481
468
-
IBD @
2.5%
3
10
13
13
13
13
13
38
Residual c/f
117
390
507
494
481
468
455
2,730
Answers -Mocks
(3)
233
WTA Sh.000
Class
I @ 37.5
II @ 30%
III @ 25%
IV @
12.5%
1,200
1,200
(450)
750
3,600
4,350
(1,631)
2,719
(1,020)
1,699
(637)
1,062
(3,800)
2,738
-__
Nil
-_
2,000
2,000
(600)
1,400
(420)
980
(294)
686
(206)
480
-_
-_
-
240
1,200
_-__
1,440
(180)
1,260
-__
1,260
(158)
1,102
(138)
964
(121)
843
(106)
737
WDV 1:1:91
Additions
Grain dryer
Milting plant
Motor vehicle
WTA 1991
WDV 1/1/92
Add 2 trucks & computers
WTA 1992
WDV 1/1/93
WTA 1993
WDV 1/1/94
WTA 1994
WDV 1/1/95
Less disposal
Trading receipt = 1995
WTA 1995
WDV 1/1/96
Summary
Year
WTA Sh,000
1991
1992
1993
1994
1995
(b)
630
2,389
1,578
1,052
312
Income computation Sh.000
Year
Profit before tax
Add accrued expenses
Add accrued income (W1)
Trading receipt
Less accrued income
Less accrued expenses (W2)
IBD
WTA
I.D
Adjusted income
(c)
1991
1992
1993
1994
1995
4,000
(600)
4,200
600
200
(200)
(300)
5,000
300
300
(200)
(400)
6,000
400
200
(300)
(500)
3,600
2,748
-
(13)
(630)
(3,640)
(683)
(13)
(2,389)
_____
(2,098)
(13)
(1,578)
_____
3,409
(13)
(1,052)
_____
4,735
(83)
(312)
_____
5,943
200
-
Allocation to partners Sh.000

Year
Limo
1991
(410)
1992
1,259
1993
2,045
1994
2,367.5
1995
2,377.0
Mango
(273)
839
1,364
2,367.5
2,377.0
Note
From 1994, profits and losses are shared equally between Limo and Mango.
TAXATION II
Namo
1,189
Total
(683)
2,098
3,409
4,735
5,943
234
W1
W2
(d)
accrued income is taxable income in the year of accrual

the accrued expenses have already been adjusted (added) to profits before tax and
has to be deducted.
The difference between profits computed above for each partner and declared profits for each
year would be computed and back duty tax computed and paid with corresponding penalties.
QUESTION FOUR
(a)
(b)
Refer to Sec. 90 of Income Tax Act.

Adjusted taxable income for Leta Ltd.
Sh.
Sales
Less Cost of Sales
Opening stock
Add purchases
Less closing stock (W1)
Gross profit
Add discounts received
1,134,000
4,582,000
(1,213,000)

Wages and salaries
Add accruals
Add accruals
Debenture interest
Add accruals
Research and development
Discount allowed
Bad debts
Capital allowances
WTA (W3) + ID (W2) (4350 + 600 +
527,344)
W1
684,000
15,000
328,000
9,000
135,000
135,000
(4,503,000)
3,413,000
98,000
3,511,000
699,000
337,000
270,000
96,000
142,000
45,000
400,000
5,477,344
(7,466,344)
3,955,344
The stocks are valued at the lower of cost a net realizable value i.e.
Ziga
Zepa
Zela
W2
Sh.
7,916,000
468,000
267,000
478,000
1,213,000
ID on factory Building
=
ID on machinery and equipment =
100% x 4,350,000
100% x 600,000
600,000
There is no residual for IBD and WTA
4,350,000
=
Answers -Mocks
W3
235
W.T.A
Class
Motor lorries
Machine & equipment
W.T.A. 2004
W.T.A. 2005
WDV 31/12/2005
I @ 37.5%
2,250,000
-_____
2,250,000
(843,750)
1,406,250
(527,344)
878,906
The I.D and W.T.A for 2004 would be claimed in 2004 since they were incurred in generation of 2004
income. The 2004 final assessment has an error and require adjustment with respect to the 2004
unclaimed capital deductions.
(d) Tax payable in 2005 = 30% x 994,656 = 298,397
Tax Account
Instalment Tax paid
Sh.
330,000 Tax payable
______ Tax refund
330,000
Sh.
298,397
31,603
330,000
QUESTION FIVE
(a)
In depth Examination
Also called in depth investigation or assessment and involves carrying out of detailed scrutiny of
the tax returns to ensure their arithmetic accuracy, completeness and truthfulness. The tax
officers will do the following:
Visit the tax payers business premises to ascertain issues such as nature of business, tax records,
accounting system etc.
Collate evidence from 3rd parties on items in tax returns e.g. circulate debtors, creditors, bankers etc.
Invite the tax payer and his agents for an interview at income tax department premises
Take all the necessary records or books of accounts such as sales and purchases ledgers, cash book,
cheque counterfoils, bank statement, balance sheet etc.
(b)
RAHA MINGI TRADERS:

Sh.
Income: Sales
Less Cost of Sales
Opening stock
Purchases
Closing stock
Goods lost in transit
Drawings
Less Allowable expenses:
Goods lost in transit
Wear & tear allowance (W1)
Wages (435 + 15)
Rent (150 30)
Expenses
Heat & Light
Delivery cost
Sh.
4,500,000
900,000
3,300,000
(1,200,000)
(21,000)
(10,000)
21,000
11,250
450,000
120,000
90,000
36,000
159,000
TAXATION II
2,968,800
2,968,800
1,531,200
236
Adjusted business profit for the year
(643,950)
ALLOCATION TO PARTNERS
Interest received
Interest paid
Salaries
Profit
W.1
RAHA
(KSH.
45,000
(6,000)
60,000
209,475
MINGI
(KSH.)
15,000
(9,000)
120,000
209,475
335,475
TOTAL
(KSH.)
60,000
(15,000)
180,000
418,950
643,050
Wear & Tear allowance (in Ksh.)

Class III
25%
Cost in 2003
2 cars (restriction 100,000)
W.T.A
W.D.V 1.1.2004
W.T.A
W.D.V 1.1.2005
W.T.A
W.D.V 1.1.2006
200,000
(50,000)
150,000
37,500
112,500
(28,125)
84,375
Class IV
12.5%
NIL
WTA for business

40% x 28,125 = 11,250
Answers -Mocks
237
SUGGESTED SOLUTIONS
MOCK 4
QUESTION ONE
(a)
The flower growers and exporters could benefit as follows:

-
Exports are zero rated for VAT purposes and thus can claim a refund for input tax
Exemptions from import duty on machinery, materials and other intermediate inputs
They can claim the following capital allowances:-
Farmworks deductions
Diminution in value of farm tools and implements
Wear and Tear allowances on furniture, computers, tractors etc
I.B.D on storage facilities/buildings
(b)
(i)
Capital allowances
(I)
Farmworks deduction @ 33
Farmwork
Farm house
FWD
Residual
1
3
% of cost p.a.
Q-Cost
900,000
900,000
NIL
2003
300,000
(300,000)
NIL
2004
900,000
(300,000)
NIL
2005
900,000
(300,000)
NIL
The FWD is equal to the residual/WDV as at 31st December 2004.

(2)

Class
WDV Lorries & Tractors
Pick-ups & saloons
Computers
Plant, equipment & Furniture
Additions: M. Benz
Security systems
4 new cars @ 500,000
Equipment
Computers
Disposals: carpets
Furniture
4 traded in cars (W1)
W.T.A
WDV 31/12/2005
Total WTA = 1,361,250
W1
II @ 30%
III @ 25%
IV @ 12.5%
625,000
-__
625,000
(234,375)
390,625
750,000
1,250,000
-___
2,000,000
(600,000)
1,400,000
1,250,000
1,000,000R
2,000,000
(3,375,000)
875,000
(218,750)
656,250
1,475,000
250,000
1,650,000
(450,000)
(460,000)
-____
2,465,000
(308,125)
2,156,875
Assuming reducing balance method of depreciation, net book value (NBV)

= cost (1V)n
Where: V
n
Therefore:
I @ 37.5%
Cost =
=
=
depreciation rate = WTA rate for class III = 25%

number of years = 2 years (2003 & 2004)
NBV
1,000,000
1,777,778each
(1 r)n
(1 0.25)2
The cost was higher than the Shs. 1,000,000 restricted qualifying cost in year 2003.
TAXATION II
238
Qualifying cost in 2003. The disposal value would be restricted as follows:Trade-in value x Sh.1,000,000 restricted =
Cost
Q.C. in 2003
[1,500,000 x 1,000,000] x 4 = 3,375,000

1,777,778
Taxable profits
Reported profits
Less:
Farmwork deduction
W.T.A
Adjusted loss
(b)
1,599,000
(300,000)
(1,361,250)
(1,661,250)
(62,250)
The motor vehicle benefit would be taxable on the directors at the higher or
2% p.m x 500,000 x 12 = Sh.120,000 or
fixed benefit on 1300cc = Sh.50,600
QUESTION TWO
(a)
Item:
(1)
Opening and closing stock:

What is the method of valuation
Could the method lead to over or under statement of profits.
(2)
Compensation to swage
- was it for business purposes. If so, it would be allowable.
(3)
Bad debt provision

- is it specific or general provision? If specific, it is allowable and if general, it is disallowable.
(4)
Depreciation
What was the nature of assets? Do they qualify for capital deductions?
If so, capital allowances are allowable.
(5)
Was it of revenue or capital nature? If capital e.g neon sign, it is disallowable expense.
(6)
Contribution to pension and provided fund

Are they registered? If so, the contributions are allowable.
Answers -Mocks
(b)
239
MAHINDI, NGANO AND WIMBI TRADERS

Sh.
Net profit
Add: interest on capital
Partners drawing
Compensation to Swaga
Depreciation
Bad debts provision (assumed general)
Taxation paid
Partners salaries
Opening stock
Sh.
2,000,000
140,000
50,000
1,000,000
90,000
115,250
750,000
2,000,000
50,000
Deduct:
Interest (net)
Donations allowed
Closing stock
4,195,250
6,195,250
18,000
10,000
118,000
(146,000)
6,049,250
Adjusted profit for the year
ALLOCATION TO PARTNERS
Interest
Salaries
Profit share
(c)
MAHINDI
(SHS)
56,000
800,000
1,563,700
2,419,700
NGANO
(SHS)
56,000
800,000
1,563,000
2,419,700
WIMBI
(SHS)
28,000
400,000
781,850
1,209,850
TOTAL
(SHS)
140,000
2,000,000
3,909,250
6,049,250
To raise an objection and justify the inclusion or exclusion of the amounts the form of objection:
should be in writing
should state the grounds of objection
should be made within 60 days
should be supported with relevant accounts
(d)
Partnership
- Interest on capital not allowable
- Partners drawings not allowable
- Partners salaries not allowable
Limited company
- Dividends not allowable
- Directors expenses allowable
- Directors salaries allowable on the company
but
taxed on directors.
QUESTION THREE
(a)
The major tax considerations to take into account before doing business as a partnership or a
private company are:
- Salaries and allowances to the partners are disallowable expenses but the same paid to
directors of a private company are allowable.
- Partners are taxed on profits of partnership on graduated scale and enjoy personal relief. A
company pays tax at a fixed corporate tax rate.
- Going concern a partnership ceases to be a going concern if a partner dies. This is not the
case with private firms which are separate legal entities from the owners.
(b)
(i)
On receipt of estimated assessment, Mr. Ujenzi should:
TAXATION II
240
prepare his accounts and tax returns

file the returns with income tax department
pay all the tax as per self-assessment
(ii)
If the self-assessment reflects Sh.1,200,000 the CIT will issue additional assessment
(iii)
The tax payable for 2005 is equal to 110% of 2004 tax liability i.e. 2005 tax liability (estimated)
= 110% x 80,000 = 88,000
Assuming Mr. Ujenzi operate his firm which is a body corporate, then actual tax for 1996
= 30% x 1,200,000 = 360,000
His 2005 accounting year started on 1st September 2004. The instalment tax was thus payable as follows:
1st instalment 20th Dec 2004
2nd instalment 20th Feb 2005
3rd instalment 20th May 2005
4th instalment 20th Aug 2005
5th instalment (final)
(iv)
=
=
=
=
=
25% x 88,000 =
25% x 88,000 =
25% x 88,000 =
25% x 88,000 =
360,000 88,000=
22,000
22,000
22,000
22,000
272,000 by 31/12/2005
360,000
Late filling penalty

Interest penalty = 2% p.m of unpaid tax + penalty
Tax is paid on 30th June 2006
1st
Instalment
due date
Late payment penalty

@ 20%
Late filling
penalty @
5%
Interest penalty @ 2%
20/12/2004
20/2/2005
20/5/2005
20/8/2005
31/8/2005
22,000 x 20% =
22,000 x 20% =
22,000 x 20% =
22,000 x 20% =
272,000 x 20% =
360,000
360,000 x 5%
= 18,000
2%(22,000+4,400)x18 months =
2%(22,000+4,400)x16 months =
2%(22,000+4,400)x13 months =
2%(22,000+4,400)x10 months =
2%(272,000+54,400)x6 months =
4,400
4,400
4,400
4,400
54,400
72,000
9,504
8,448
6,864
5,280
41,328
71,424
Note:
With effect from 1/1/2003, instalment tax is payable by 20th day of the 4th, 6th, 9th and 12th month. The
last/final instalment is payable by last day of the fourth month after the accounting period/year.
(v)
The CIT will impose stiff penalties and interest to encourage compliance with tax legislation and
deter the defaulters.
Answers -Mocks
241
QUESTION FOUR
(a)
INCOME COMPUTATION
Total
Sh.
2004
Sh.
2005
Sh.
16,500,000
9,000,000
7,500,000
11,000,000
5,500,000
125,000
5,625,000
2,300,000
6,850,000
(3,000,000)
(150,000)
6,000,000
3,000,000
75,000
3,075,000
7,400,000
(2,300,000)
(100,000)
5,000,000
2,500,000
50,000
2,550,000
Less Allowable expenses

Rent & rates (1,020 20)
Salaries
Advertising (280 + 100)
Other expenses (576 + 34.10)
Wear & Tear All. (W1)
1,000,000
2,200,000
380,000
600,000
408,594
500,000
1,100,000
190,000
300,000
177,344
500,000
1,100,000
190,000
300,000
231,250
Taxable profit
1,036,406
807,656
223,750
30% x 807,656 =
242,297
30% x 223,750 =
67,125
Sales
Less: cost of sales
Opening stock
Purchases
14,250,000
Closing stock (3,000,000)
Drawings
(250,000) @ SP
Gross profit
Profit on drawings
Tax there on
(b)
The rates of taxation may be different for the 2 years.

Penalties to be charged will not be the same for the 2 years due to period of lateness
No authority sought from CIT to combine incomes
Accounts should not exceed 12 months
(c)
Yes, the firm should file instalment returns.
(d)
Failure to file tax returns = 5% x 242,297 = 12,115
W1
Wear & Tear Allowances
Cost 1997
WTA (1997)
WDV 31/12/97
WTA (1998)
WDV 31/12/98
Class III
@ 25%
800,000
(200,000)
600,000
(150,000)
450,000
Class IV
@12%
250,000
(31,250)
218,750
(27,344)
191,406
Total
1,050,000
(231,250)
818,750
(177,344)
641,406
QUESTION FIVE
Capital allowances
(1)
This shall be granted on building housing plant, canning and processing plant, free floating machine and
the new cottages (net of government subsidy)
TAXATION II
242
Item
Building housing plant
Canning & processing plant
Free floating machine
Cottage net of subsidy
A
B
C
(2)
Q. Cost
I.D @ 100%
800,000
1,200,000
400,000
800,000
1,200,000
400,000
1,700,000
2,600,000
3,400,000
1,700,000
2,600,000
3,400,000
10,100,000
Residual for IBD

& WTA
-
Industrial Building Deduction (IBD)

The old hotel building and cottages qualify for IBD @ 4% since they are industrial hotel building
Building
Old Hotel Building
Q.Cost
Residual b/f
2,000,00
0
IBD @
2.5%
-
IBD @ 4%
Residual c/f
80,000
1,920,000
Total IBD = 80,000

(3)
Diminution in value of loose tools

Loose tools
Add: Kettle for making tea
Diminution @ 33
(4)
1
3
1,800
1,500
3,300
% = 3,300 x 1/3 = 1,100

Class
WDV 1/1/2005
Machinery WDV
Add: Additional Sewing machine
MME
Disposals: MME
Insurance recovery
WTA
WDV 31/12/2005
I @ 37.5%
II @
30%
III @ 25%
IV @ 12.5%
475,000
______475,000
(178,125)
296,875
210,000
(300,000)
710,000
(213,500)
497,000
810,000
______810,000
(202,500)
607,500
1,220,000
400,000
16,000
3,000,000
(750,000)
3,886,000
(485,750)
3,400,250
Total WTA = 1,139,375

Adjusted profits
Net profits as per the accounts
Add back
Staff housing loans
Tip to licensing officer
Sewing machine
Kettle
Depreciation
Donations
Pension to retired staff
Loose tools
Less: Insurance recoveries (capital gains)
I.D
IBD
2,151,960
4,060
10,000
16,000
1,500
96,700
4,320
24,240
1,800
125,800
10,100,000
80,000
158,620
Answers -Mocks
243
Diminution
WTA
Adjusted business losses
1,100
1,079,875
(11,260,975)
(9,109,015)
SUGGESTED SOLUTIONS
MOCK 5
QUESTION ONE
(a)
Kaka & Yao

Sales
Cash
Credit
Banked
Cost of sales
Cash purchases
Credit purchases
Banked Purchases
Less closing stock
Drawings
Gross profit
Wages
Rent & rates 100
Light & Heat + 1280
Petrol
Maintenance
Advert
W.T.A. 25% x 119,000
(b).
Date of payment 30.4.2005

20%
Outstanding amount 31.4.2005 2%
Penalty 120,000 x 20% = 24,000
Interest 2% x (120,000 + 24,00)
(c).
They should do the following

(i).
Prepare all the accounts and tax returns
(ii).
File the returns and pay all tax due
(ii).
Lodge an objective with the C.I.T which should be:
-
6,400
5,460
200,000
211,860
2,500
3,800
150,000
(9,200)
(2,260)
154,840
57,020
170,000
3,400
1,400
2,000
1,000
900
29,730
penalty
interest
In writing
State the grounds of objectives
Supported by all relevant accounts
Made within 60 days of receiving the notice of assessment.
TAXATION II
55,450
1,570
Share of profits = 1,570 x
= 785 each
244
QUESTION TWO
Mr. Chuma
Upto 30th June
Salary
Car allowance
House allowance
Gardener 42,000 x 6/12
Watchman 43,200 x 6/12
Maid 24,000 x 6/12
Insurance
Insurance
Upto 31st Dec
Total
336,000
36,000
21,000
21,600
12,000
24,000
636,000
72,000
60,000
21,000
21,600
12,000
5,000
2,500
300,000
36,000
60,000
2,500
453,100
House benefit
=15% x 453,100 = 67,965
Less rent paid
= 10% x 336,000 =(33,600)
Less owner occupied

Mortgage interest W1
Rent income
Gross income 20,000 x 6
Less interest 20% x 1,000,000 x 6/12
WTA 12.5% x 200,000 x 6/12
Repairs
Net loss
Mrs. Chuma
Salary
Bonus
Less practice (W2)
398,500
34,365
487,465
28,965
(50,000)
348,500
487,465
120,000
(50,000)
835,965
100,000
12,500
10,000
(122,500)
(2,500)
360,000
20,000
(12,500)
367,500
W1:
The house was occupied for only 6 months. Therefore, the owner occupied mortgage interest
was 6/12 x 100,000 = 50,000
W2:
Loss for the whole year sh. 300,000

Loss for 12th month 1/12 x 300,000 = 25,000
This loss would be share equally i.e. x 25,000 = 12,500 for Mrs. Chuma. Professional losses of
a woman are allowable against her other incomes at arms length.
Tax liability
Mr. Chuma on sh. 835,965
Sh. 121,968 x 10%
Sh. 114,912 (15% + 20% + 25%)
(835,965 466,704) 30%
Gross liability
Less PAYE
Personal relief
Net tax liability
Mrs. Chuma on Sh. 367,500
Sh. 121,968 @ 10%
Sh. 114,912 (15% + 20%)
[367,500 351,792] 25%
PAYE
Tax payable (refund)
12,196.8
68,947.2
110,778.3
191,922.3
(72,000.0)
(13,944.0)
105,978.3
12,196.8
40,219.2
3,927.0
56,343.0
(13,944.0)
(60,000.0)
(17,601.0)
Answers -Mocks
245
QUESTION THREE
(a).
ATHI PRODUCTION LIMITED

2005 INCOME & CAPITAL ALLOWANCES COMPUTATIONS INVESTMENT DEDUCTION
Kshs. 000
Nature of Assets
Quality cost
Kshs.
2,400
13,600
50,000
10,000
Cash price
Plant and mach

Factory ext
New factory building
Extruding machine
ID at 100%
Kshs.
2,400
13,600
50,000
10,000
76,000
Residue for
WTA & IBD
-
INDUSTRIAL BUILDING DEDUCTION
Kshs. 000
Nature of Building
Sport portion
1962 Building
Qualifying cost
14,400
2,600
WEAR & TEAR ALLOWANCES (Kshs. 000)

Class
WDV 1/193
Additions
7 cars
MDs Volvos
Computers
WTA
WDV 31/12/98
Total WTA
(b).
(i)
Residue b/foreword
Nil
IBD @ 25%
360
____360
II @ 30%
III @ 25%
9000
9000
(2700)
6300
7000R
1000R
______8000
(2000)
6000
12,300
INCOME COMPUTATIONS
Kshs.
Profit as per A/Cs

Less:
Interest (for extruding machine)
Pure scientific research
I.B.D.
W.T.A.
Adjusted profit
(ii)
Residue c/foreword
140,040
-
Kshs. 000
100,000
800
7000
76,000
360
12,300
(96,460)
3,540
TAX DIVIDENDS COMPUTATIONS
Kshs. 000
Profit before tax

Tax for the year @ 30%
Profit after tax
Permissible Relation (60%)
Distributable Amount (40%)
W/Tax payable 5% x 991,200 = 49,560
Penalties @ 10% x 49,560 = 4956 or, a maximum of Ksh
1,000,000 w.e.f 1/7/2004
Kshs. 000
3,540
(1,062)
2,478.0
(1,486.8
991.2
If a company is unable to payout the distributable amount as dividend, it has to make a representation to
the Company which should state:
(i).
The company is insolvent i.e Total Assets total liabilities
TAXATION II
246
(ii).
(iii).
(iv).
Confirm that the directors & shareholders do not owe the company any amount.
Commitment to repayment of loan.
Development envisaged in the future e.g. acquisition of capital assets.
If the C.I.T. is dissatisfied with the representation he can enforce the recovery of the tax.
QUESTION FOUR
(a) (i) Legal fees incurred in obtaining overdraft facilities:
S15 of the Act states for an expenditure to be deductible, it must be wholly and exclusively incurred in the
production of income. In CIT v Buhemba Mines Ltd (1955), it was held that production of income means
production of profits (See Lesson 3 page 2).
In the light of the above authorities, legal fees to obtain overdraft is allowable because, the overdraft will
be used in the production of profits.
(ii) Compensation payment which reduces a companys annual expenditure.
This is a situation reverse of that portrayed in Marshal Richards Machine Co. Ltd v Jervitt (ChD). The
annual expenditure would have reduced the companies taxable profits. As it is, the profits have been
enhanced. The compensation is thus taxable.
(iii)
Tax reliefs in a polygamous marriage:
As per S30 of the Act, the husband will be entitled to personal relief however only the same personal
relief as a husband with only one wife.
Each of the wives who earn wifes employment income or wifes professional income shall be entitled to
a personal relief of S31 of the Act.
The husband will also claim insurance relief in relation to insurance premium paid on his life and on his
wives lives up to maximum relied of Sh.36,000 per year or 15% of premium paid which is lower.
(iv)
Money held on behalf of customers
This does not form part of the holders income and is thus not taxable. It is a debt owed to the customer
and not a profit from business.
QUESTION FIVE
(a)
Mr. Ndwigas taxable income for the year ended 31 December 2002
Note
Net loss before tax per the accounts
Add back:
Water storage tank construction
Chicken sheds construction
Loan repayment Wakulima Farmers SACCO
Subscription to Starehe Sports Club
Wages for house girl
Personal accident insurance
School fees for children
Depreciation motor vehicles
Insurance for household items
Drawings by wife
Sh.
(898,900)
1
1
2
3
3
3
4
5
3
3
Less: Wear and tear allowances
235,000
900,000
312,000
60,000
33,600
23,000
300,000
85,500
19,000
100,000
1,169,200
(196,400)
972,800
Add:
Answers -Mocks
247
Produce consumed by family

Consultancy fees
Taxable income
265,000
135,000
1,372,800
Notes:
1.
2.
3.
4.
5.
6.
(b)
These are items of capital nature that will be subjected to capital allowances.
This is a capital item not chargeable to income.
These items do not contribute to the generation of the farming income for Mr. Ndwiga
This can either be on the farming income or on Mr. Ndwiga. It is being taxed on the farming
income.
Depreciation is not an allowable expense instead wear and tear allowance is allowed.
Dividends received net of tax are not subjected to further taxation the 15% withholding tax
deducted at source is a final.
Tax payable on taxable income computed in (a) above of Kshs. 1,372,800.
1st Kshs. 466,704 = (121,968 @ 10%) + (114,912 x 60%) =

Surplus (1,372,800 466,704) @ 30% =
Gross tax
Less p/relief
Net tax
TAXATION II
81,144
271,828.8
352,972.8
(13,944.0)
339,028.8
248

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Questions past papers - taxation II......................................................................1

Part II: REVISION QUESTIONS AND ANSWERS

STRATHMORE UNIVERSITY REVISION KIT

STRATHMORE UNIVERSITY REVISION KIT

Topical Guide to Past Paper Questions

CPA PART III SECTION 5

Discuss the theory underlying taxation process

Taxable Income and persons

Sources of taxable income

Allowable capital deductions under Income Tax Act

Topical Guide to past Paper Questions

Effects of Customs and Excise Duties

Customs and Excise Tax

Tax evasion and tax avoidance

Double-taxation agreements: Theory, design and application

STRATHMORE UNIVERSITY REVISION KIT

Topical Guide to Past Paper Questions

Topical Guide to Past Paper Questions

Income of a bank and

Recovery of VAT, VAT

VAT refund audit, VAT

Computation for VAT,

Partnership income and

Most favoured nation

Notes on tax set-off,

Topical Guide to past Paper Questions

VAT refunds and

Penalties on VAT goods

short fall distribution

Business income and

VAT account and

Capital allowances and

Sole proprietorship and

Business income and

Employment income of individuals.

Tax liability in the case of

Business income and non-resident

Back duty and taxable income

Categories of L.T.U capital

Notes on exceptions to Section

VAT computations, input tax

Business income and business

WTO customs valuation

USE CURRENT RATES APPLICABLE TO YEAR OF SITTING

Topical Guide to Past Paper Questions

Taxable Employment Benefits - Year 2005

Annual taxable pay

Rates of tax % in each

Wear and tear allowances

Saloon, Hatch Backs

OR 2% of the initial capital cost of the vehicle for each

Commissioners prescribed benefit rates

Electricity (Communal or from a generator)

Topical Guide to past Paper Questions

Agricultural employees: Reduced rates of benefits

Low interest rate employment benefit:

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QUESTIONS PAST PAPERS - TAXATION II

The following information is further obtained from the company: