Tax deductions are misunderstood. Perhaps, the best way to understand them is to first recognise how income tax works. The income tax law imposes tax on all income irrespective of its source.
Conversely, whether and to what extent deductions are allowed depends upon legislative grace and only as there is clear provision, therefore, can a deduction be allowed. It is also important to distinguish between tax deductions and tax credits.
A tax deduction reduces the taxable income to which the applicable the 30 per cent tax rate is applied while a tax credit directly reduces the amount of tax that is payable.
This is how tax deductions and tax credits look like. If Barbara’s business has income of Sh10 million, she would be allowed to deduct expenses which she incurred in generating that income, in this case let us assume she incurred Sh6 million. This Sh6 million will be deductible for tax which means that the 30 per cent tax rate would be Sh1.2m; which is 30 per cent of the difference between the Sh10m and the Sh6m.