Module 1: Tax Foundations

How Business Taxation Works

Many entrepreneurs treat tax as a once-a-year panic. In reality, tax touches almost every part of running a business: how you price, how you pay staff, how you record sales and how much cash you must keep aside. Once you understand the basic logic of business taxation, tax stops being a mystery and becomes one more predictable cost you can plan for. This lesson gives you that logic. The details vary by country, so throughout this course you will learn the principles and then confirm the current rules with your tax authority, which in Kenya is the Kenya Revenue Authority (KRA).

The main families of tax

Almost every country's tax system for businesses contains the same broad families, even if the names differ:

Two of these families involve you acting as a collector for the government rather than as the taxpayer. With VAT and employee taxes, money passes through your hands that never really belonged to you. Mixing that money up with your own cash is one of the fastest ways small businesses get into trouble.

Income, expenses and profit

Income tax is charged on taxable profit, not on sales. The basic calculation is:

Taxable profit = taxable income - allowable expenses - allowances

Allowable expenses are costs incurred wholly and exclusively to earn business income, such as stock, rent and staff costs. Allowances are special deductions set by law, for example for the cost of equipment spread over several years. You will study deductions in detail in the next module.

Many tax systems also offer simplified regimes for small businesses, where tax is charged as a small percentage of turnover instead of on profit. Kenya, for example, has had a Turnover Tax regime for qualifying small businesses. Whether such a regime exists, who qualifies, and the current rate are all things you must check with KRA or your own tax authority, because these rules have changed several times.

Worked example: Amani Bakery

Amani runs a small bakery in Nairobi as a sole proprietor. In one year (all figures hypothetical) she records:

• Sales: KES 3,600,000
• Flour, sugar and other ingredients: KES 1,500,000
• Rent and electricity: KES 600,000
• Staff wages: KES 720,000
• A new oven bought for KES 300,000

Her accounting profit before considering the oven is 3,600,000 - 1,500,000 - 600,000 - 720,000 = KES 780,000. The oven is a long-term asset, so in most systems she cannot deduct the whole KES 300,000 as a normal expense this year; instead she claims a capital allowance at whatever rate the law sets for that class of equipment. If, hypothetically, the allowance were KES 75,000 this year, her taxable profit would be KES 705,000.

Separately, if Amani is registered for VAT, the VAT she charges on taxable sales is not her income. She collects it and pays it over, after deducting the VAT she paid on her own business purchases. And the PAYE she deducts from her employees' wages must be paid to KRA by the deadline, even if the month's sales were poor.

Taxable person and tax year

Who pays income tax depends on the business structure. A sole proprietor's business profit is added to her personal income. A limited company is a separate taxable person and pays corporation tax on its own profit. You will compare structures in the next lesson. Tax is calculated for a defined tax year (often the calendar year for individuals, or the company's accounting year), and returns and payments follow a calendar of deadlines.

Common mistakes to avoid

• Thinking tax is charged on sales. Income tax is usually on profit; only turnover-based regimes use sales.
• Spending collected VAT or PAYE. That money belongs to the tax authority.
• Relying on old figures from friends, blogs or last year's notes. Always check current rates and thresholds on the official KRA website or with a qualified adviser.
• Ignoring tax until year end, when it is too late to plan or to find missing records.