Capital Allowances
Income Tax
Capital Allowances
Syllabus tag: KASNEB CPA | Intermediate Level | CA26 Public Finance and Taxation | Topic 5 Capital Allowances
Rates check. The rates below reflect the Second Schedule as reformed by the Finance Act 2020 and subsequent Acts. Capital allowance rates are amended frequently, so confirm the current Second Schedule before relying on them.
Lesson objectives
By the end of this topic, you will be able to:
- Explain why capital allowances replace depreciation
- Identify qualifying and non-qualifying expenditure
- Compute investment allowance in the year of acquisition
- Compute written-down allowances on the reducing balance
- Compute a balancing allowance or balancing charge on disposal
Why this matters
The tax computation adds back depreciation and deducts capital allowances instead. This topic supplies that second figure — and a candidate who cannot compute it cannot complete a corporation tax question.
Why depreciation is replaced
Depreciation depends on management's estimate of useful life and residual value. Two identical companies could report different profits purely by choosing different estimates.
The Income Tax Act removes the discretion. It sets its own rates, applies them uniformly, and so makes taxable profit comparable between taxpayers. That is the whole reason for the substitution.
Qualifying expenditure
Qualifies: machinery and plant, industrial buildings, computers and software, motor vehicles used in the business, and the cost of installation.
Does not qualify: land, which does not wear out; office buildings not used in manufacturing; goodwill; and the private-use portion of any asset.
Where an asset is used partly privately, the allowance is restricted to the business proportion.
Investment allowance
The reformed Second Schedule gives an investment allowance in the year the asset is first used:
| Circumstance | Year 1 allowance |
|---|---|
| Qualifying investment meeting the statutory conditions | 100% of cost |
| Other machinery and plant | 50% of cost in year 1 |
The balance is then written down at 25% on the reducing balance.
The 100% rate exists to encourage investment in particular sectors and locations. Where it applies, the whole cost is deducted immediately and there is no written-down value to carry forward.
A worked example
Chui Ltd buys machinery for KES 24,000,000, qualifying for the standard 50% investment allowance.
| Year | Working | Allowance | Written-down value |
|---|---|---|---|
| 1 | 50% × 24,000,000 | 12,000,000 | 12,000,000 |
| 2 | 25% × 12,000,000 | 3,000,000 | 9,000,000 |
| 3 | 25% × 9,000,000 | 2,250,000 | 6,750,000 |
Note that reducing balance never reaches nil. The remaining value is cleared only on disposal, through a balancing adjustment.
:::checkpoint The company's accounts depreciate the same machine straight-line over 8 years, charging 3,000,000 a year. Compare the first three years of accounting depreciation with the capital allowances above, and say what this does to the timing of the company's tax payments. :::
Balancing allowance and balancing charge
On disposal, compare the proceeds with the written-down value.
Proceeds below WDV — balancing allowance. Too little relief was given, so the shortfall is allowed.
Sold for 5,000,000 against a WDV of 6,750,000: Balancing allowance = KES 1,750,000, deducted in the tax computation.
Proceeds above WDV — balancing charge. Too much relief was given, so the excess is clawed back.
Sold for 8,000,000 against a WDV of 6,750,000: Balancing charge = KES 1,250,000, added to taxable profit.
The charge is capped. A balancing charge can never exceed the allowances actually given. If the machine sold for 26,000,000 — above its original cost — the charge is restricted to 24,000,000 − 6,750,000 = 17,250,000. The further 2,000,000 of gain above original cost is a capital gain, not a balancing charge, and falls under the capital gains rules instead.
That cap is the point candidates most often miss. Tax cannot claw back more relief than it gave.
Presenting the computation
An examiner expects a schedule, not a narrative:
- One column per class of asset
- Opening written-down value
- Additions, with the investment allowance shown separately
- Disposals, with the balancing adjustment
- Allowance for the year
- Closing written-down value
The total allowance for the year is then the figure deducted in the corporation tax computation.
:::checkpoint A company sells a vehicle for more than it originally paid. Explain which part of the excess is a balancing charge and which part is not, and say why the distinction matters to the rate of tax applied. :::