INTRODUCTION TO TAXATION

BUSINESS INCOME ILLUSTRATIONS

QUESTION ONE-sole proprietorship
Mr. Kamangu prepared the following profit and loss account for the year ended 31st
December 2019.
Incomes sh.000
Sales 18,400
Discount received 600
Profit on sale of shares 100
Foreign dividend received 15
Foreign exchange gain 35.6
Insurance recovery on stolen 180
stock 19330.6

Expenditure sh.000
Purchases 12,800
Salaries 1,200
Audit fees 45
Tax consultancy fee 30
Legal expenses 325
Licences and permits 64
Depreciation 145.6
Loss on sale of equipment 78.4
Bank charges 44.2
Donations to political party 50
Subscriptions 12.8
Repairs & Maintenance 174.2
Rent & Rates 150
Purchase of loose tools 90
Commissions & Brokerage fees 23.5
15232.7
Net profit 4097.9

Additional Information
i. Legal expenses comprise;
a) Employment contracts sh.50,000.
b) Acquisition of trademark sh.80,000.
c) Successful defence of legal suit for breach of a trade contract sh. 200,000.
d) Debt collection sh.40,000.
ii. Subscriptions comprise
a) Chamber of commerce and Industry 2800
b) Childcare international 8000
c) Golf club membership 2000
12800

iii. Repairs and maintenance expenses includes sh. 74,200 used for renovation of a store.
iv. Capital allowances were agreed with the tax authorities at sh. 680,000.
Required:
Determine adjusted taxable profit/loss for Mr. Kamangu for the year ended 31st December
2019.

QUESTION TWO-sole proprietership

Mrs. S. Nkuraru is the owner of a supermarket in Nairobi East. Her accounts clerk has submitted to you
the following trading profit and loss account for the year ended 31 December 2019:

Sh. Sh.
Opening stock 8,640,000 Closing Stock 1,004,000
Purchases 96,000,000 Sales 110,000,000
Salaries and wages 1,500,000 Proceeds from sale of land allocated
Donations to Kenya Chamber of to her by the Government 500,000
Commerce 100,000 Gain on sale of shares 200,000
Redundancy payments 600,000 Gain on sale of residential plot 400,000
Contributions to registered pension General bad debts recovery 36,000
fund 100,000 Dividends (Net) 43,200
Rent, rates and taxes 110,400
Insurance 14,880
Legal and professional fees 109,200
Depreciation 363,840
Advertising 166,800
Value Added Tax 247,200
Customs duty – 2005 700,000
Income tax for 2004 312,000
Medical expenses – Mrs. S. Nkuraru 28,800
Interest on bank overdraft 49,920
Purchase of equipment 25,200
Christmas gifts to customers 20,160
General bad debts 55,200
Household expenses 100,800
Stationery and postage 33,120
Net profit 2,905,680 _________
112,183,200 112,183,200
The following additional information is provided:

1. Rent, rates and taxes include sh.20,400 being customs duty for the purchase of equipment.
2. Sales include a sum of Sh.120,000 representing the value of goods withdrawn for use by Mrs. S.
Nkuraru and her children. These goods had been purchased at a cost of Sh.96,000.
3. Opening stock as well as the closing stock are consistently overvalued by 20% above cost price.
4. The legal and professional fees are analysed below:

Sh.
Appeal to local committee against tax assessment 24,000
Renewal for 5 year lease 25,200
Defending a suit for breach of trade agreement 36,000
Court fines 20,400
Miscellaneous (allowable) 3,600
109,200

5. Wear and tear allowances were agreed at Sh.259,200.

6. Included in advertising expenses is a sign board erected at the road junction leading to the
supermarket at a cost of Sh.24,000.

Required:
(a) Mrs. S. Nkuraru’s chargeable profit for the year of income 2019. (14 marks)
(b) The tax payable on chargeable profit and state when it is payable. ( 4 marks)
(c) State the tax position if the tax payable is not paid on the due date. ( 2
marks)
(Total: 20 marks)

QUESTION THREE-partnership
Rai, Sai and Tai are former school mates who were doing business together. The business is not
registered but they registered themselves as equals in it. They keep proper books of account and have
been able to provide the following profit and loss account for the year ended 31 December 2019.

Profit and Loss Account

Sh. Sh.
Establishment expenses 800,000 Gross profit 1,908,000
Rent of business premises owned by Sundry receipts 80,000
all of them jointly 180,000 Interest Income 72,000
Interest expense 80,000 Profit on sale of shares 200,000
Stationery and printing 120,000 Gross income from farming 340,000
Light and heating 40,000 Lottery winnings 800,000
General farm expenses 294,000 Dividend (Gross) 120,000
Repair of premises 40,000
Depreciation 300,000
Interest on partner’s capital:
Rai 80,000
Tai 120,000
Salary to Sai 160,000
Commission to partners:
Rai 96,000
Sai 96,000
Tai 96,000
Bad debts 240,000
Gifts, present and charity 40,000
Donation to child welfare 200,000
Interest on loan taken to pay
Income tax 20,000
Legal charges 120,000
Net profit 398,000 _______
3,520,000 3,520,000

Additional information:

1. Capital allowances have been agreed as follows: Wear and Tear allowances sh.180,000; Farm
works deductions sh.120,000.
2. The partners had borrowed Sh.400,000 with a hope of investing it on fixed securities to earn
more income interest rates nevertheless declined. Interest expense of Sh.80,000 and interest
income of Sh.72,000 relate to the loan.
3. Legal charges include Sh.40,000 paid to finish a case in the customs department.
4. In 2019, the partners brought forward losses amounting to Sh.800,000 from this business.

Required:
(a) Compute taxable income derived from the partnership (16 marks)
(b) Show allocation among partners. (3 marks)
(c) Comment on the results of (a) above. (5 marks)
(Total: 24 marks)

QUESTION FOUR-partnership
A, K and M are in a partnership of selling imported clothes, handbags and shoes. They have provided the
following information for the year of income 2019:

Sh.
Net loss after deducting the following: (1,080,000)
Rent 180,000
Legal costs 75,000
Salaries and wages 300,000
Donations: Turkana Food Relief Fund 50,000
Electricity and water 35,000
Repairs to business premises 65,000
Stationery 12,000
Vehicle expenses 90,000
Audit and accountancy 24,000
Advertising 65,000
Depreciation: Car 10,000
Building 33,000
Salaries: K 240,000
 M 240,000
A 360,000
Interest on capital K 80,000
M 80,000
A 120,000
Bad debts 40,000
Loss on sale of shares 8,000
Political party membership: K 6,000
Withdrawals by M 5,000
Dresses taken by A for her own use 12,000
School fees paid for A’s children 55,000

Additional information:
1. Wear and tear deductions were estimated at Sh.16,000.
2. Fifty per cent of vehicle expenses was for personal use.
3. Salaries and wages include Sh.30,000 paid to A’s daughter for assisting in the business during the
school holidays.
4. Rent analysis:
Payment for Partners residence Sh. 80,000
Business Sh.100,000
5. Legal costs included a payment of Sh.15,000 paid to an arbitrator to settle a personal dispute
between K and M.
6. Bad debt analysis: Sh.
General provision 10,000
Specific provision 12,000
Written-off 8,000
A’s son (defaulter) 10,000
40,000

7. Advertising: Sh.
Advertising campaign 28,000
Cost of new sign board 5,000
Sale of clothes 9,000
A’s birthday expenses 23,000
65,000

8. Other incomes (included in trading profit) Sh.

Dividends from shares KCB Ltd. 19,000
Rental income: sub-letting business premises 22,000
Gain on sale of furniture 13,000
54,000

Required:
(a) Taxable income (loss) for the partnership business and distribution among the partners for 2019
if they share profits and losses in the ratio 2:1:1. (18 marks)
(b) Determine the taxable income of each partner. ( 3 marks)
(Total: 21 marks)

QUESTION FIVE-partnership
Gatwiri, Kiende and Kanyiri are partners, operating a supermarket in Meru town. They share profits and
losses in the ratio 2:2:1 respectively. During the year ended 31 December 2019, the partners reported a
loss of Sh.4,425,000 after deducting the following:

Sh.
Interest on capital:
Gatwiri 232,000
Kiende 232,000
Kanyiri 348,000
Salaries to partners:
Gatwiri 400,000
Kiende 420,000
Kanyiri 576,000
Motor vehicle running expenses 304,000
Repairs and maintenance 96,000
Office expenses 240,000
Goodwill 400,000
Loss on investment 600,000
Postage and telephone 170,000
Water and electricity 136,000
Subscriptions to Kenya National chamber of Commerce 128,000
Salaries and wages 712,000
Donations 300,000
Bad debts written off 346,000
Rent, rates and licences 160,000
Professional fees 960,000
Depreciation 1,760,000
Purchase of lorry 1,331,000
Dividend receive (Net) 264,000
Insurance recovery on motor vehicle 520,000

Notes:
1. Offices included cost of office cabinet of Sh.110,000.
2. Travelling expenses amount to Sh.12,000 per month related to personal use.

3. Provision for bad and doubtful debts account

Sh. Sh.
Bad debts 246,000 General b/f) 330,000
Specific (c/f) 192,000 Specific (b/f) 152,000
General (c/f) 390,000 Profit and loss account 346,000
828,000 828,000

4. Kiende had taken goods worth Sh.70,000 for her own use.
5. Wear and tear allowances agreed with the commissioner amounted to Sh.706,000.
6. Included in repairs and maintenance is Sh.80,000 paid for office partitions in 2019.

Required:
The taxable profit (loss) from the partnership business and show the distribution among the partners as at
31 December 2019 and tax payable thereon. (20
marks)

QUESTION SIX-co ltd

Mobile Options Ltd. is a distributor of mobile phones and accessories. The profit and loss account for
the year ended 31 December 2019 is as follows:

Sh. Sh.
Purchases 12,000,000 Sales 18,000,000
Salaries and wages 2,000,000 Discounts 400,000
Rent and rates 125,000 Insurance recovery 180,000
Distribution and office expenses 480,000 Profit on sale of assets 240,000
Traveling and subsistence 336,000 Provision for bad debts 80,000
Subscriptions 50,000
Licences and permits 200,000
Legal fees 436,000
Depreciation 670,000
Audit fees 130,000
Loss on sale of assets 240,000
Bank charges and interest 96,000
Bad debts 415,000
Discounts 336,000
Repairs and maintenance 705,000
Net profit 681,000 ________
18,900,000 18,900,000

Notes:
1. Distribution and office expenses include the following:
Sh.
Subscriptions to Wananchi sports Club for employees’ benefit 180,000
Directors’ personal expenses 96,000
Donations to charity 50,000

2. 15% of rent and rates relate to payments in connection with directors’ private residences.
3. Insurance recovery is in connection with mobile phones stolen while on transit to a client.
4. Bad debts provision represents a reduction in the general provision for bad debts.
5. Legal fees include the following:
Sh.
Debt collection 80,000
Employment contracts 60,000
Acquisition of trade mark 120,000
Renewal of lease – 50 years 60,000
Legal suit in relation to counterfeit
Handsets found in the company’s warehouse 116,000
436,000

6. Subscriptions are to the Mobile Phone Dealers Association.

7. Licences and permits represents sh.150,000 paid to the Communications Commission of Kenya
(CCK) and Sh.50,000 relates to the single business permit paid to the Nairobi city Council.
8. Repairs and maintenance include an extension to the warehouse at a cost of Sh.450,000.
9. Travelling expenses include sh.240,000 incurred by the sales manager when he traveled to South
Africa to attend a mobile phones and accessories trade fair.
10. Capital allowances have been agreed with the Commissioner of Income Tax at Sh.860,000.

Required:
(a) Compute Mobile Options Ltd.’s taxable profit or loss for the year ended 31 December 2019.
(12 marks)

(b) Compute the tax payable thereon. ( 2 marks)

(c) Assuming that Mobile Options Ltd.’s tax liability for the year ended 31 December 2018 was
sh.800,000, indicate the due dates for the tax you have computed in (b) above showing the
amounts payable.
( 4 marks)
(d) Compute the penalties payable by Mobile Options Ltd. if the company paid the tax of Sh.800,000
in (c) above on 30 November 2005. ( 2
marks)
(Total: 20 marks)
QUESTION SEVEN-co ltd
(a) Using two examples in each case, differentiate between allowable and non-allowable expenses
under the Income Tax Act. ( 4
marks)

(b) The directors of PQR Limited have presented you with the following profit and loss account for
the year ended 31 December 2019:

Sh. Sh.
Gross profit 29,826,000
Less: Operating expenses
Salaries and wages 8,000,000
Reserves for contingencies 1,580,000
Hire purchase interest 413,000
Laundry expenses 434,000
Legal and professional fees 400,000
Depreciation 2,450,000
Dividends paid 1,600,000
Repairs and maintenance 872,000
Insurance premiums 320,000
VAT paid 168,000
Bad and doubtful debts 228,000
Advertising 1,200,000
Bank charges 170,000
Water and electricity 1,200,000
Rent and rates 3,020,000
Subscriptions and donations 371,000
Telephone and postage 1,204,000
Sundry expenses 600,000
Motor vehicle running expenses 2,300,000 26,530,000
Net profit 3,296,000

Additional information:

1. Salaries and wages include Sh.66,000 paid to the Income Tax Department as penalties and interest
on delayed submission of PAYE deductions.

2. Hire purchase interest relates to loans obtained to purchase a delivery van sh.146,000 and the
Chairman’s personal car Sh.267,000.

3. The company directors and senior managers are given free laundry services at the company’s
laundry. The cost of cleaning their personal clothing for the year ended 31 December 2005 was
sh.133,000.

4. Legal and professional expenses include sh.146,000 incurred while defending the Managing
Director in a private suit against him.

5. Repairs and maintenance include the cost of acquiring a second hand laundry machine for
sh.167,000.

6. Bad and doubtful debts are made up of a 10% general provision against the debtors balance as at
31 December 2019 and a full provision of Sh.93,000 owed by Orient Finance Ltd. that has been
placed under receivership. The debtors balance as at 31 December 2019 was Sh.1,350,000.
7. Subscriptions and donations comprise: Sh.

Subscription to Rhino golf Club for the Managing Director 260,000

Subscription to the Chamber of Manufacturing and Commerce 63,500
Donation of books to the Watoto School for the Handicapped 35,000
Annual subscription for Finance Manager paid to the Institute of
Certified Public Accountants of Kenya 12,500

8. Sundry expenses include sh.263,000 paid to Health Africa for the Managing Director’s medical
cover. He is the only one in the company covered by the medical scheme.

9. Wear and tear allowances for the year ended 31 December 2019 have been agreed at Sh.4,320,000.

Required:
(i) PQR Ltd.’s adjusted profit (or loss) for tax purposes for the year ended 31 December 2019.
(14
marks)

(ii) Corporation tax (if any) payable by PQR Ltd. for the year ended 31 December 2019. (
2 marks)
(Total: 20
marks)

QUESTON FOUR-ltd co.

(a) Write brief notes on the following:
(i) Taxation of companies operating in export processing zones. ( 3 marks)
(ii) Taxation of members’ clubs. ( 3 marks)

(b) flora Ltd. has been in the flower business for many years. The company’s profit and loss account
for the year ended 31 December 2019 is as follows:

Sh. Sh.
Sales 29,489,600
Less: Cost of sales 20,902,400
Gross profit 8,587,200
Less expenses:
Salaries and wages 4,543,200
Shop expenses (rent, rates, lighting and telephone 1,708,800
Printing and stationery 89,600
Motor vehicle expenses 332,000
Depreciation – motor vehicle 96,000
Legal expenses 99,200
Redundancy payments to retrenchment staff 46,400
Sundry expenses (all allowable) 144,800
Bad and doubtful debts 44,800
Loss on sale of motor van 36,000 7,140,800
1,446,400
Dividend received from XYZ Ltd. 102,400
Net profit 1,548,800

Additional information:

1. Capital allowances have been agreed with the Commissioner of Income Tax at Sh.84,000.
 2. The Ledger account for bad and doubtful debts for the year is as follows:

Bad and doubtful debts

Sh. Sh.
Debts written off: Balances brought forward:
Customers 31,200 General provision 14,400
Staff 1,600 Specific provision 21,600
Balances carried forward: Bad debts recovered
General provision 24,000 (previously allowed) 4,000
Specific provision 84,800 Profit and loss account 44,800
84,800 84,800

3. Legal expenses consist of:

Sh.
Advice on staff service contracts 23,200
Tax appeals 38,400
Debt collection 37,600
99,200

Required:
Compute the adjusted taxable profit or loss for Flora Limited for the year 2019. ( 8 marks)
Calculate the tax payable thereon. (
2 marks)
If Flora Limited paid instalment tax by the due dates, when is the final tax for 2019 payable? ( 2
marks)

Assume that the management of Flora Limited neither paid the tax in (iii) above on the due date nor
submitted the self assessment return as required. What are the consequences of this action? (
2 marks)
(Total: 20
marks)