KRA Guidance on the Finance Act 2026 VAT Changes: What Businesses Must Update Now

• KRA's guidance of 22–23 September 2026 explains the VAT changes in force since 1 July 2026 and urges businesses to align invoicing and accounting systems.

• Bad debt relief now requires a three-year wait instead of two, supported by invoices and evidence of recovery efforts.

• Digital payment fees for processing, settlement, merchant acquiring, gateway and aggregation services are standard-rated at 16%, reversing the Pesapal outcome. Core money transfers stay exempt, and VAT applies to the fee, not the money moved.

• Outsourcing and staffing: salaries, wages and statutory deductions are disbursements and leave the VAT base.

• Hire purchase: finance charges escape VAT only under licensed, registered Hire Purchase Act arrangements.

• Security suppliers can now recover input VAT on exempt supplies to the KDF, NIS and National Police Service.

• Returning residents' VAT-free allowance rises from USD 300 to USD 2,000, about Ksh38,850 to Ksh259,000, in line with the EAC threshold.

• Withholding tax now applies to card interchange, merchant service and card network fees, overturning the Supreme Court's Barclays decision.

The VAT amendments in the Finance Act, 2026 have applied since 1 July 2026. In late September, the Kenya Revenue Authority published guidance explaining how it reads them in practice. It also called on businesses to bring their invoicing systems and accounting procedures into line with the new rules to stay compliant and avoid penalties.

The guidance covers bad debt refunds, digital payment services, outsourcing, hire purchase, passenger allowances, tourism and a set of new exemptions. It also restates two general points that are easy to overlook:

• Registration is not a licence to charge VAT on everything. A VAT-registered business must decide, supply by supply, whether the goods or services are taxable or exempt before it invoices.

• Reclassification triggers an input tax adjustment. Where goods move from taxable to exempt, a business holding unsold stock on which it has already deducted input tax must account for that tax in the return for the period of the change. The adjustment uses the original deduction method, and any resulting excess input tax is payable to the Commissioner. This is the new section 17A of the VAT Act.

KRA's closing message is about evidence. Businesses should verify their classifications and keep proper audit trails to support every statutory tax claim.

Kenyan VAT is due when a taxable supply is made, whether or not the customer pays. Bad debt relief is how a supplier recovers VAT it has already paid over on an invoice that goes unpaid. The Finance Act, 2026 extends the period a business must wait before it can apply for that refund, from two years to three years.

What changes in practice. The relief applies where a business has accounted for VAT on a taxable supply and the customer has not paid. Every such claim now takes an extra twelve months to mature, and for that year the supplier carries the VAT as a cost of its own working capital.

Evidence KRA expects. The guidance asks businesses to keep, for the full three-year period:

• the original tax invoices;

• evidence of efforts to recover the debt, such as demand letters, collection correspondence and legal steps; and

• the financial records supporting the write-off and the refund application.

Who feels it most. The change bites hardest on businesses that sell on credit to customers with high default rates: wholesalers and distributors, contractors, utilities, and suppliers to government and county entities with long payment cycles. Credit control and invoice-level VAT tracking now matter more to cash flow than before.

This is among the most commercially significant VAT changes in the Act. It amends paragraph 1 of Part II of the First Schedule to the VAT Act, which exempts financial services. Five services supplied through software or over a platform by a payment service provider, for a fee or commission, are now carved out of that exemption:

• payment processing;

• settlement;

• merchant acquiring;

• payment gateway services; and

• aggregation services.

Fees and commissions for these services attract VAT at the standard rate of 16%. KRA's guidance confirms that the tax falls on the provider's fee or commission, not on the underlying amount being paid or transferred.

Money transfers stay exempt. The Finance Bill had also listed money transfers among the services to be carved out. The enacted Act leaves core money transfer services within the exemption, so the ordinary transfer of funds is untouched.

Who is a payment service provider. The Act defines the term to cover a person that owns, operates, manages or controls a public switched network for providing payment services. It also covers any other person that processes or stores data on behalf of such a provider or its users.

Why now. The amendment responds directly to recent litigation. In Pesapal Limited v Commissioner of Domestic Taxes, the High Court held that the services of a payment service provider were exempt financial services, not taxable technology fees. The Act reverses that outcome for the listed services from 1 July 2026, bringing fintechs and payment intermediaries firmly into the VAT net.

Knock-on effects. Merchants paying gateway or acquiring fees will see those fees rise by the VAT element. VAT-registered merchants making taxable supplies may be able to recover it as input tax; exempt and unregistered businesses cannot. Providers must now issue compliant tax invoices on these fees and revisit pricing that was set on the assumption of exemption.

For labour outsourcing agencies and employee placement firms, the Act settles a long-running dispute. Salaries, wages, statutory deductions and other employment-related costs that a supplier incurs on the client's behalf are now treated as disbursements. They are excluded from the taxable value of the outsourcing service, so VAT applies only to the supplier's own service fee.

The disputes it resolves. KRA had argued in several cases that the full contract value, payroll included, formed the taxable value. The issue reached the High Court in Commissioner of Domestic Taxes v Stratostaff E.A Limited (ITA No. E048 of 2025) and Commissioner of Domestic Taxes v Techsavanna Company Limited (ITA No. E228 of 2023). The amendment answers the question in the statute itself.

A late addition. Like the import documentation rule, this provision was not in the Finance Bill, 2026. It was introduced during the legislative process.

The commercial effect. VAT at 16% on the payroll element made outsourced labour considerably more expensive than direct employment for any client unable to recover input VAT, such as banks, insurers and other exempt businesses. Removing payroll from the base reduces that gap. It also shrinks the VAT a staffing firm must pay over before its client settles the invoice.

Getting the structure right. To benefit, contracts and invoices should separately identify the employment costs passed through and the supplier's fee. A single, bundled price will make it harder to show which part is a disbursement.

Finance charges under a hire purchase agreement can be excluded from the taxable value of the goods supplied, but only where the arrangement is regulated. Published analyses of the Act set out two cumulative conditions:

1. the supplier is licensed under the Hire Purchase Act; and

2. the hire purchase agreement is registered in accordance with that Act.

If either condition is missing, the finance charges form part of the taxable consideration and attract VAT. KRA's guidance is explicit that informal or unregulated financing arrangements do not qualify.

Who is affected. The rule matters most for retailers and dealers that sell goods such as vehicles, electronics, furniture and equipment on instalment terms, and for asset-financing platforms. Businesses offering instalment plans outside the Hire Purchase Act framework should assume VAT applies to the whole consideration, finance charges included, unless they regularize.

A related relief for lenders. The Act also adds a new exemption in paragraph 166 of Part I of the First Schedule. It covers the sale or realization of collateral, repossessed assets or secured property when a lender enforces security for loans, credit or other exempt financial services. A lender's sale of repossessed security is therefore an exempt supply.

Input VAT on supplies to security agencies. Supplies to the Kenya Defence Forces, the Defence Forces Welfare Services, the National Intelligence Service and the National Police Service are exempt. Until now, suppliers could not recover the input VAT on their costs of making them. The Act allows that recovery, and a refund where the supplier ends up with excess input VAT, provided that:

• the supplies are supported by the documentation the Commissioner prescribes;

• the input tax is directly attributable to those supplies; and

• where input tax relates wholly to these supplies, it is not subject to apportionment.

For defence and security contractors, input VAT stops being a hidden cost built into bid prices.

Returning residents. The VAT-free allowance for qualifying personal goods brought in by returning passengers rises from USD 300 to USD 2,000, about Ksh38,850 to Ksh259,000. The change aligns the VAT threshold with the USD 2,000 threshold under the East African Community Customs Management Act. It remains subject to customs rules and eligibility, so travellers should confirm their goods qualify before relying on it.

Other VAT changes to note:

The move from zero-rated to exempt deserves attention: suppliers of those goods lose the right to recover input VAT, and section 17A requires them to adjust for input tax already claimed on unsold stock.

The payments ecosystem is hit twice. Alongside the VAT change, the Act amends the Income Tax Act, with effect from 1 July 2026, to bring card-related fees into the withholding tax net:

The royalty limb applies however the payment is labelled, whether as a service fee, transaction fee, network fee, assessment fee, processing fee or similar charge. Non-resident rates remain subject to relief under an applicable double taxation agreement.

Overturning the Supreme Court. The change legislatively reverses Barclays Bank of Kenya Limited (now Absa Bank Kenya PLC) v Commissioner for Domestic Taxes (SC Petition No. 12 (E014) of 2022). There the Supreme Court held that interchange fees, merchant service fees and card network participation fees were neither royalties nor management or professional fees, and so were not subject to withholding tax.

Treaty friction. The new royalty definition is wider than the definitions in most of Kenya's tax treaties and in the OECD Model Convention. Characterization disputes and double taxation are real risks for payments to foreign card schemes. Banks, payment service providers and merchants paying scheme fees to foreign networks should check whether they must now withhold and whether a treaty reduces the rate.

All VAT-registered businesses. Review invoicing systems so that VAT is charged only on supplies that are genuinely taxable. Update item and service classifications for the new exemptions and the narrowed zero-rating. Where any line moved from taxable to exempt on 1 July, work out and account for the section 17A input tax adjustment on stock held at that date.

Businesses selling on credit. Recalibrate cash-flow forecasts for the three-year bad debt wait. Build a file for each doubtful debt from the outset: invoice, collection correspondence and write-off records.

Payment service providers and fintechs. Confirm which fee lines fall within processing, settlement, merchant acquiring, gateway or aggregation, and charge VAT on them from 1 July 2026. Check whether pricing, merchant agreements and system configuration assumed exemption. Keep core money transfer fees distinct, as they remain exempt.

Merchants and banks. Expect VAT on gateway and acquiring fees, and assess input tax recovery. Review card scheme contracts for the new withholding tax obligations, including treaty relief on payments to foreign networks.

Staffing and outsourcing firms. Restructure contracts and invoices to separate employment costs from the service fee so the disbursement treatment is clearly available. Review open disputes with KRA on this point in light of the new provision.

Hire purchase sellers. Confirm licensing and registration under the Hire Purchase Act for every instalment product. Unregulated plans should either be brought within the Act or priced on the basis that finance charges bear VAT.

Defence and security suppliers. Collect the prescribed documentation and track directly attributable input VAT so that deductions and refunds can be claimed.