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What Is Investment Deduction?
This is an allowance or a deduction allowed against profits, on the expenditure of a capital nature expended on buildings and machinery used for purposes of manufacture and certain hotels. The deduction is given only once during the year of first use of qualifying assets - i.e. the first year of income in which the machinery or/and the building is used for purposes of manufacture or certified hotel.

The word "manufacture" means the making (including packaging) of goods or materials from raw or partly manufactured materials or other goods, but does not extend to any activities which are ancillary to manufacture such as design, storage, transport or administration. Likewise, "an hotel" means a hotel building which is certified by the Commissioner of Income Tax as an industrial building.

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Who is entitled to Investment Deduction?
Any person who incurs expenditure on the construction of a building or purchase and installation of machinery is entitled to the claim provided that both the building and the machinery are used for purposes of manufacture or hotel as the case may be. Prior to the year 1992, the machinery had to be new and installed in a building not previously used for purposes of manufacture or in replacement of machinery previously used for this purpose. As from 1st January 1992, it does not matter whether the machinery is new or old as long as it is installed in a building and used first time in that building for purposes of manufacture.

Where a taxpayer constructs an industrial building and leases it to another taxpayer who installs qualifying machinery in that building, investment deduction is allowed to the owner of the building in respect of the building and the lessor is -given, investment deduction in respect of the machinery. But where a taxpayer erects an industrial building and installs qualifying machinery in the building and then leases both the building and the machinery to another person, investment deduction is allowable to the lessor (owner) on both the building and machinery leased out for purposes of manufacture. If the lessee installs machinery in the leased building and uses the machinery for purposes of manufacture, the investment is allowable to the lessee on machinery owned by him.

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When is the Deduction claimable & what documents should be submitted in support?
Ordinarily, the claim is lodged at the time of submitting the returns and accounts and is shown as a deduction against taxable profits of the claimant during the year the claim is due. The claim must be supported by documents for the capital expenditure incurred. Physical inspection of the machinery and building may be carried out by the tax authority officers.

Specific documents needed include:-
(i)Buildings (Including Hotels):-

(a) Building plans and architect’s certificates
(b) Local authority occupation certificates
(c) Factory layout sketches showing the location of machinery
(d) Other supporting documents to support the expenditure incurred e.g. suppliers’ invoices, contract documents etc.
(ii)Plant and Machinery:
(a) Suppliers invoices and vouchers
(b) Customs documents where machinery is imported
(c) Clearing and forwarding documents
(d) Documents to support foreign currency transactions
(e) Documents to support cost of installation of machinery
Advance Ruling:
Where a taxpayer intends to incur expenditure on qualifying assets he can submit the claim for advance decision or ruling. In this case, a proposed building plan and Proforma-invoices for machinery and a sketch plan for Installation of the machinery should be submitted.
NOTE:
To make it easier for the department to examine the documents, a breakdown of the costs and the relevant supporting documents should be done by the taxpayer or his agent. This will expedite the approval of the claim.

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What expenditure qualifies for the claim?
Generally, there are three major categories of expenditure incurred which qualify for investment deduction claim:-

(i) Expenditure incurred on the construction of a building used for purposes of manufacture.
(ii) Expenditure incurred on the purchase and installation of machinery used for purposes of manufacture.
(iii) Expenditure incurred on the construction of a hotel building certified by the Commissioner.
Note:

(a) An independent extension to a building is considered to be a new building and hence qualifies for investment deduction as a separate entity. Also capital expenditure incurred on the construction of a building does not include the cost of land on which the building stands.
(b) For machinery to qualify it must be involved directly in the process of manufacture. However, with effect from the year 1995, machinery used for the following ancillary purposes qualifies:-

(i) Generation transformation and distribution of electricity.
(ii) Clean up and disposal of effluent and other waste products.
(iii) Reduction in environmental damage.
(iv) Water supply or disposal.

(c) Effective from the year 1995, the following items of civil works also qualify together with the cost of the industrial building:-

(i) Roads and packing areas.
(ii) Railway lines and related structures.
(iii) Water, industrial effluent and sewage works.
(iv) Communications and electrical posts and phylons and other electrcity supply works.
(v) Security walls and fencing.

(d) Prior to the year 1993, the definition of a hotel did not include surrounding structures necessary for the operation of a hotel. However, with effect from 1st January, 1993, the definition extended to all buildings and structures within the hotel complex which are a necessary part of a hotel e.g.

(i) Staff quarters
(ii) Kitchens & cold rooms
(iii) Sporting and entertainment facilities.
(iv) Roads, parkings and fencings
(e) An investment deduction can only be obtained once on construction of a building and hence (iii)Ship-owners:

A special investment deduction is available to ship-owners who purchase a new power driven ship weighing more than 495 tonnes gross, or on the purchase and subsequent refitting of a used power driven ship. This is at the rate of 40% of the qualifying expenditure. However, the ship must operate for a period of five years before it is sold otherwise the deduction will be withdrawn and the amount added back to the taxable income for the year of sale.

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Rates for Investment Deduction

For the period 1990-1994, the rate for Nairobi and Mombasa was 15%. All other areas were given investment deduction at the rate of 85%. MUB investments deduction was given at the rate of 15% in Nairobi and Mombasa and 65% in all other areas.
From 1995 onwards. the investment deduction is uniform in all areas at the rate of 60%. MUB and EPZ enterprises are given at the rate of 100%.

Note:

Investment deduction claim is made according to the laws prevailing in the year the claim is due.

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Relationship between Investment Deduction and Industrial Building / Wear & Tear Allowances.
Subsequent Wear and Tear allowances or Industrial building deduction have to be calculated on the residue of the expenditure on which investment deduction has been claimed. For example, if a taxpayer incurs expenditure of Shs.10,000,000/= on construction of a new factory in which he installs machinery costing Shs.5,000.000/= (inclusive of installation cost), his investment deduction as well -as industrial building allowance and Wear and Tear deduction will be computed as follows:-
(i) Investment deduction:
Qualifying expenditure - KShs. 15,000.000
Investment Deduction (1995
et seq.) @ 60% thereof KShs. 9,000,000
Residue - KShs. 6,000.000

(ii) Industrial Building:
Residue after I.D. - KShs. 4,000,000
Industrial Building
@ 2½% - KShs. 100,000
Residue - KShs. 3,900,000

(iii) Wear & Tear deduction:
Balance after I.D. - KShs. 2,000.000
Wear & Tear @12½ - KShs. 250,000
Balance for next year - KShs. 1,750,000

NB:
For hotels, industrial buildings deduction is given at the rate of 4% p.a. until the expenditure is exhausted.