- March 26, 2026
- Posted by: admin
- Category: Advisor
Introduction
On 12th August 2025, the Kenya Revenue Authority (KRA) issued a public notice titled “Guidance on Tax Exemption on Payment of Gratuity.” The notice announced that the Finance Act, 2025 had amended the Income Tax Act to exempt gratuity from income tax, and provided detailed guidance on how this exemption would apply to payments made after 1st July 2025.
This article examines the KRA guidance alongside the actual text of the Finance Act, 2025, noting areas where the guidance aligns with the law and areas where questions may arise about the interpretation.
The KRA Public Notice
The Kenya Revenue Authority’s public notice, issued on 12th August 2025, states in full:
GUIDANCE ON TAX EXEMPTION ON PAYMENT OF GRATUITY
Kenya Revenue Authority informs the public that the Finance Act, 2025 amended the Income Tax Act to exempt payment of gratuity from income tax. This exemption applies to gratuity earned after 1st July, 2025. The following guidance seeks to provide further clarification on the tax treatment of gratuity earned prior to 1st July, 2025 in light of the exemption –
1. Gratuity earned or relating to periods prior to 1st July, 2025, even where payment is made after this date, is chargeable to tax. The gratuity is taxed as part of employment income and is taxable in the year it was earned. This means that where gratuity is paid to an employee, it should be spread to the period to which it relates, up to four (4) years back, and any remaining amounts relating to periods beyond four (4) years shall be deemed income of the fifth year. The gratuity will then be taxed at the applicable tax rates in the respective years.
2. In computing the taxable income for the periods outlined above, the employer shall consolidate the gratuity payable for each year with other employment income earned by the employee during the respective period and subject the consolidated income to tax at the prevailing tax rate for that year. Tax payable shall be the difference between the tax arrived at on the consolidated amount and what was paid earlier on the emoluments already received.
3. Where an employer pays gratuity relating to periods prior to 1st July, 2025 to a registered pension scheme, the gratuity amounts paid into the scheme shall not be chargeable to tax, subject to prescribed limits in the respective years of income. This shall apply to the extent that the employee had not enjoyed deduction for pension contribution in the respective years of income.
4. An employer making payment of gratuity upon retirement of an employee is still required to account for applicable taxes as guided above.
5. For gratuity paid out of a public pension scheme, which was exempted from tax by the Tax Laws (Amendment) Act, 2024, effective 27th December, 2024, the guidance above shall apply with respect to periods prior to December 2024 before the exemption came into force. A public pension scheme is defined as a pension scheme that pays pensions or lump sums out of the Consolidated Fund.
Commissioner, Micro & Small Taxpayers
What the Finance Act, 2025 Says
The Finance Act, 2025 (No. 9 of 2025) was assented to on 27th June 2025 and, per Section 1, came into operation on 1st July 2025 (with limited exceptions). The Act contains numerous amendments to various tax laws, including the Income Tax Act (Cap 470).
The amendment that mentions “gratuity” is found in Section 28(c) , which amends the First Schedule to the Income Tax Act. The amendment reads:
28. The First Schedule to the Income Tax Act is amended in Part I—
(c) in the proviso to paragraph 53
(i) by deleting subparagraph (a) and substituting therefor the following new subparagraph
(a) payment of gratuity;
(ii) by inserting the following new subparagraph immediately after subparagraph (a)
(aa) other allowances paid under a pension scheme;
Understanding Paragraph 53
To understand what this amendment does, it is necessary to read it in the context of Paragraph 53 of the First Schedule to the Income Tax Act. Paragraph 53 deals with the exemption of pension benefits. As amended, the full paragraph reads:
Payment of pension benefits from a registered pension fund, registered provident fund, registered individual retirement fund, public pension scheme or National Social Security Fund, upon attainment of the retirement age determined in accordance with the rules of the fund or the scheme:
Provided that this exemption shall also apply to—
(a) payment of gratuity;
(aa) other allowances paid under a pension scheme;
(b) payment of a retirement annuity; or
(c) withdrawals from the fund prior to attaining the retirement age due to ill health; or withdraws from the fund after the twenty years from the date of registration as a member of the fund.
Observations on the KRA Guidance
The KRA guidance makes several statements that can be examined against the statutory text.
On the existence of an exemption. The KRA guidance states that “the Finance Act, 2025 amended the Income Tax Act to exempt payment of gratuity from income tax.” The Finance Act, 2025 did indeed amend the Income Tax Act to add “payment of gratuity” to Paragraph 53. The question is the scope of that amendment.
On the effective date. The KRA guidance states that the exemption “applies to gratuity earned after 1st July, 2025.” The Finance Act, 2025 provides in Section 1 that most provisions, including those in Part II dealing with income tax amendments, came into operation on 1st July 2025. However, the amendment to Paragraph 53 does not itself specify that it applies only to gratuity earned after that date. The KRA guidance introduces this distinction between gratuity earned before and after the commencement date.
On the source of payment. The KRA guidance does not mention that Paragraph 53 requires gratuity to be paid “from a registered pension fund, registered provident fund, registered individual retirement fund, public pension scheme or National Social Security Fund.” The amendment to Paragraph 53 adds “payment of gratuity” to a paragraph that is explicitly about payments from these specific sources. The KRA guidance, however, discusses gratuity payments generally without reference to this source requirement.
On the timing of payment. The KRA guidance does not mention that Paragraph 53 requires payment to be made “upon attainment of the retirement age” or under the specified alternative conditions (ill health or twenty years of membership). The guidance instead focuses on when the gratuity was earned, not when or under what circumstances it is paid.
On payments into pension schemes. The KRA guidance correctly notes in point 3 that gratuity relating to periods prior to 1st July 2025 may be exempt if paid into a registered pension scheme, subject to limits. This reflects Section 5(4)(g) of the Income Tax Act, which has been in the law for some time and is not new to the Finance Act, 2025.
On public pension schemes. The KRA guidance correctly notes in point 5 the special treatment of public pension schemes under the Tax Laws (Amendment) Act, 2024, and applies the spreading rules to periods before that exemption came into force.
What the Law Says About Gratuity Generally
Section 5(2)(a) of the Income Tax Act defines “gains or profits” from employment to include “any wages, salary, leave pay, sick pay, payment in lieu of leave, fees, commission, bonus, gratuity, or subsistence, travelling, entertainment or other allowance received in respect of employment or services rendered.”
This provision remains in the law. It has not been amended by the Finance Act, 2025. The default position, therefore, is that gratuity is taxable as employment income unless a specific exemption applies.
The Finance Act, 2025 added “payment of gratuity” to the list of exempt payments in Paragraph 53. For this exemption to apply, all the conditions of Paragraph 53 must be satisfied: the payment must be made from one of the specified funds or schemes, and it must be made upon attainment of retirement age or under the specified alternative conditions.
Practical Considerations
For employers navigating these provisions, the following practical considerations should be carefully noted.
Where gratuity is paid from a registered pension fund upon retirement. In this scenario, the exemption in Paragraph 53 clearly applies. The payment satisfies both the source requirement (payment from a registered fund) and the timing requirement (payment upon retirement age). This is consistent with both the statutory text and the KRA guidance. Employers and employees can proceed with confidence that such payments are exempt.
Where gratuity is paid directly by an employer without being routed through a registered pension fund. This scenario presents the most significant area of uncertainty. The KRA guidance suggests such payments may be exempt if the gratuity was earned after 1st July 2025. However, the statutory text of Paragraph 53 requires payment from a registered fund. Section 5(2)(a) continues to define gratuity as taxable employment income. Employers who treat direct gratuity payments as exempt should be aware that this position may be challenged in an audit. In the event of a dispute, a court or tribunal would be bound to apply the statutory text, not the administrative guidance. Employers in this situation may wish to seek a private ruling from KRA under Section 65 of the Tax Procedures Act to obtain certainty, or consider structuring gratuity payments through registered pension funds where possible.
Where gratuity relating to pre-July 2025 service is paid into a registered pension scheme. The existing exemption in Section 5(4)(g) applies, subject to the limits in Section 22A (KSh 360,000 per year of service or 30% of pensionable income, whichever is lower). This exemption also requires that the employee had not already exhausted their pension contribution deductions for those years. Employers utilizing this pathway should maintain clear records of the service periods, the amounts allocated to each year, and the employee’s pension contribution history for those years. This is correctly reflected in the KRA guidance.
Where gratuity is paid from public pension schemes. The Tax Laws (Amendment) Act, 2024 exemption applies from 27th December 2024. For periods before that date, the spreading rules apply. This is also correctly reflected.
References
Finance Act, 2025 (No. 9 of 2025), Section 28(c)
Income Tax Act (Cap 470), Section 5(2)(a)
Income Tax Act (Cap 470), First Schedule, Paragraph 53
Income Tax Act (Cap 470), Section 5(4)(g)
Income Tax Act (Cap 470), Section 22A
Kenya Revenue Authority, Public Notice: Guidance on Tax Exemption on Payment of Gratuity (12th August 2025)
Tax Procedures Act (Cap 469B), Section 65 (Private Rulings)
This article is for informational purposes only and does not constitute legal advice. Readers should consult qualified professionals for advice tailored to their specific circumstances.
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