On 26 June 2025, President William Ruto assented into law
the Finance Act, 2025 (the Act). The Act was gazetted on 27 June 2025 in Kenya
Gazette Supplement No. 104 (Acts No. 9).
Below is a summary of the amendments affecting payroll,
effective 1 July 2025.
1. Increase in tax-free
per diem/subsistence allowance
Reference: Section 5(2)(a)(iii) of the Income Tax Act
Section 5 of the Income Tax Act has been amended to increase
the daily tax-exempt per diem (subsistence allowance) from KES 2,000 to KES
10,000.
This applies where such an amount is received by an employee
as payment of subsistence, travelling, entertainment or other allowance, in
respect of a period spent outside their usual place of work while on official
duties.
Impact on payroll:
Employers may now pay up to KES 10,000 per day as an exempt allowance for
official duties without triggering PAYE, provided the allowance is not
excessive and meets the qualifying criteria. Any amount above KES 10,000 will
be subject to tax.
2. Expansion of the mortgage
interest tax deduction to include construction loans
Reference: Section 15(3)(b) of the Income Tax Act
The existing deduction of up to KES 360,000 per annum (KES
30,000 per month) on interest paid for the purchase or improvement of a
residential property now also includes loans taken for the construction of an
owner-occupied residence.
To qualify:
- The
loan must be borrowed from a recognised institution listed in the Fourth
Schedule (e.g. commercial banks, insurance companies, building societies).
- The
deduction applies to only one residence per individual.
- The
amount must be prorated if the property is not occupied for the full year.
Impact on payroll:
Payroll administrators must accept valid proof of interest paid on qualifying
construction loans and ensure the correct setup for tax deductions.
3. Repeal of one-third exemption
for non-citizens’ employment income in specific scenarios
Reference: Repeal of Section 15(2)(r) of the Income Tax
Act
The Act repeals the provision that previously allowed
employers to deduct one-third (1/3) of the total gains and profits from
employment paid to qualifying non-citizen employees, provided specific
conditions were met, which were:
- The
employer is a non-resident company or partnership trading for profit.
- The
employee is in Kenya solely to perform duties at a regional office
approved by the Commissioner.
- The
employee is absent from Kenya for an aggregate of at least 120 days during
the year of income.
- The
gains and profits were not deductible by the employer in computing taxable
income.
Impact on payroll:
From 1 July 2025, all employment-related gains and profits earned by
non-citizens working in Kenya will be fully subject to income tax, regardless
of their number of days present in the country. Employers may face increased
payroll costs if they choose to gross up affected employees’ remuneration to
maintain net take-home pay.
To ensure full compliance, employers should also consider
whether this change triggers any additional obligations under Kenyan tax law
and assess any applicable provisions under a relevant Double Taxation Agreement
(DTA). Customers are advised to seek independent tax advice where appropriate.
4. Employer's obligation
to apply all tax deductions, tax reliefs, and exemptions before calculating final
PAYE due
Reference: Section 37(1A) of the Income Tax Act
A new subsection (1A) has been introduced to Section 37,
requiring employers to apply all applicable tax deductions, tax reliefs, and
exemptions granted to an employee before calculating the final PAYE due.
These include, but are not limited to:
- Tax deductions:
- Employee pension
contributions
- Owner-occupied interest
- Affordable Housing Levy
(AHL) employee contributions
- Social Health Insurance
Fund (SHIF) employee contributions
- Post-retirement medical
fund employee contributions
- Tax reliefs:
- Resident personal relief
- Insurance relief
Impact on payroll:
The payroll system already applies these tax deductions and tax reliefs, where
configured in accordance with statutory rules.
5. Clarification of fringe
benefit tax rate
Reference: Paragraph 15 added to the Third Schedule of
the Income Tax Act
The Finance Act, 2025, confirms that Fringe Benefit Tax
(FBT) is to be taxed at the corporate income tax rate applicable for the year
of income. The current rate is 30%.
FBT applies where employers provide interest-free or
low-interest loans to employees, directors, or their relatives. The difference
between the actual and prescribed interest rate is considered a taxable
benefit.
Impact on payroll:
No changes are required since the system is already applying FBT at 30%. This
amendment reinstates legislative clarity following a deletion in a prior
amendment and ensures future FBT rates align with corporate tax rate changes
(if any).
6. Clarification of
tax exemption on retirement gratuity and other retirement benefits
Reference: Paragraph 53 of the First Schedule to the
Income Tax Act
The Finance Act 2025 amends Paragraph 53 of the First
Schedule to clarify the tax-exempt treatment of certain retirement-related
payments.
Previously, the provision referred to “payment of gratuity
or other allowances paid under a public pension scheme” in a single clause,
creating uncertainty as to whether both gratuity and other allowances had to be
paid under a public pension scheme to qualify for exemption.
The amendment resolves this by:
- Deleting
the original subparagraph (a) and substituting it with a standalone
exemption for the payment of gratuity; and
- Inserting
a new subparagraph (aa) to separately exempt other allowances paid under a
pension scheme.
Key clarifications
- Retirement
gratuity exemption is no longer limited to gratuity paid under a public
pension scheme only.
- Other
allowances must still be paid under a pension scheme to qualify, but the
previous restriction to “public” schemes has been removed, extending the
exemption to private schemes as well.
Impact on payroll
Retirement gratuity processed through payroll should be treated as
tax-exempt where the qualifying conditions are satisfied. The amendment ensures
consistent application across both public and private sector arrangements and
removes ambiguity that previously limited the exemption.
7. Exemption of SHIF contributions
and payouts from income tax
Reference: Paragraph 45A of the First Schedule to the
Income Tax Act
The amendment replaces references to the repealed National
Hospital Insurance Fund (NHIF) with the newly established Social Health
Insurance Fund (SHIF).
Impact on payroll:
There is no change to payroll system functionality where SHIF contributions are
already being processed. The amendment provides legislative clarity to align
with the repeal of NHIF and the formal establishment of SHIF.
8. Removal of employer obligation
to submit PAYE deduction certificate to the KRA
Reference: Repeal of Section 37(2)(c) of the Income Tax
Act
The Act repeals the requirement for employers to submit a
PAYE deduction certificate to the Commissioner. This obligation is now
redundant due to the digitisation of real-time PAYE submissions via iTax.
The associated penalty, 25% of the tax involved or KES
10,000 (whichever is greater), will also fall away.
Impact on Payroll:
Employers are no longer required to file a separate PAYE certificate. However,
timely and accurate PAYE declarations through iTax remain mandatory.
9. Amendment to the definition
of “Individual Retirement Fund”
Reference: Section 2 of the Income Tax Act
(Interpretation Section)
The phrase “subject to the Income Tax (Retirement Benefit)
Rules” has been deleted from the definition of “individual retirement fund”.
Previously, registration with both the Kenya Revenue
Authority (KRA) and the Retirement Benefits Authority (RBA) was required. Now,
only RBA approval is needed, aligning the treatment with other retirement
funds.
Impact on payroll:
This is an administrative clean-up with no payroll development or configuration
required.
10. Tax Procedures Act amendments with employer impact
a. Penalty for non-submission of returns clarified
The Act clarifies that penalties for late filing of tax returns also apply
where a return is not submitted at all.
Impact on employers:
Ensure all statutory returns are submitted on time. Failure to submit, even if
not late, now attracts penalties.
b. Waiver of penalties arising from iTax or system errors
The Act empowers the Cabinet Secretary, upon recommendation by the KRA Commissioner,
to waive penalties and interest arising from:
- Errors
generated by an electronic tax system (e.g. iTax).
- Delays
in system updates.
- Duplication
of penalties due to system faults.
- Incorrect
taxpayer registration linked to system error.
Impact on Employers:
Where penalties result from a system or administrative fault and not taxpayer
action, a waiver can be requested. Supporting evidence should be retained and
submitted to the KRA where applicable.