How to differentiate between Allowable & Disallowable expenses when filing for V.A.T.

If you have interacted with the Kenyan Taxing system, either as an employee looking to pay your taxes, self-employed individual planning on filing your taxes, or even a business owner of a business that remits its taxes to the Kenya Revenue Authorities, you have come across words like allowable and disallowable expenses.

To best understand what the two terms mean in the taxation context, it is wise to determine what expenses are in the world of business.

Expenses put in a layman’s language are the costs incurred by a company. These costs are encountered daily, and hence a company/Business must have a good tracking system of all expenses.

Another critical thing to note is the relationship between taxes and expenses in an organisation. This will also help in understanding how some expenses are okayed as allowable and the rest disallowable.

Tax is for the most part based on profits less allowable expenses. And as we all know; profits are a result of revenue less expenses. Inasmuch as expenses are cut down in both situations, it is wise to remember that not all expenses fall in either allowable or disallowable expenses. Expenses in an organisation, particularly if they fall under the allowable expenses, help reduce an organisation’s tax liability. In that case, filing for such deductions helps reduce the amount one pays as tax.

The Kenya Revenue Authority (KRA), is the responsible organ for determining what should be treated as an allowable or disallowable expense. That being the case, KRA has come up with certain strict terms and conditions that must be met before an expense is considered as an allowable expense or a disallowable expense. These conditions are;

• An expense is warranted as an allowable expense only if it is wholly and exclusively incurred for revenue production.
•  One must provide substantiating documents that the expense at hand indeed was incurred solely for income generation.
• The expense is allowable if the figure quoted is reasonable. This is because deductions come in limitations of amounts you can claim.

We can now mention a few common allowable expenses and disallowable expenses widely accepted in Kenya with the above in mind.

Allowable expenses include but are not limited to;

• Bad debts considered bad and doubtful.
• Specific capital allowances as provided by the Income Tax Act (I.T.A.)
• Just and reasonable expenses as may be justified by the Commissioner of Taxes.
• Donations made to a charitable organisation that is tax exempted.

• Legal fees incurred to get a lease for the premises used for the business.
• Entrance fee/annual subscription incurred during the year of income
• Interest paid to generate investment income etc.
• Capital expenditure on farmlands.

Disallowable expenses include but are not limited to;

• All expenses that are not incurred wholly and exclusively for revenue generation.
• Expenditure or loss that is recoverable under an insurance cover.
• Legal and professional fees of a capital nature.
• General and other provisions for bad debt.
• Pensions paid by the employer exceeding the prescribed limits.
• Capital repairs and maintenance etc.

Granted that allowable expenses and disallowable expenses are told apart merely by if they are wholly and exclusively incurred for revenue collection, it is important to remember that some expenses can be intended for revenue generation and still serve a different purpose unrelated to the business.

In such a situation, it then becomes a challenge determining the extent to which such an expense serves the business and when it ceases. A good example is when an employee is provided with a motor vehicle by the business for business purposes. In such a situation, the employee may decide to use the motor vehicle for personal use, say running personal errands when performing the company’s duties.

Therefore, it becomes difficult to tell to what extent one should claim for a deduction when filing for the organisation’s taxes keeping in mind that there were also personal expenses.

Usually, the task is best placed in the hands of a qualified accountant with the capability to discern and solve such predicaments. The other advantage of engaging a team of experts to handle your tax subject is, the allowable and disallowable expenses mentioned above are not the only items in that list. This means that an expert team will be able to derive a longer list of allowable expenses that will, in turn, help reduce your tax burden.