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Gratuity Tax Exemption

Understanding the New Gratuity Tax Rules in Kenya Under the Finance Act, 2025

The Finance Act 2025 introduces an exemption from income tax for gratuity payments earned after July 1, 2025. Following this amendment, the KRA issued instructions for the future tax treatment. We have outlined the major elements below to assist you in understanding how these changes will affect you or your company.

What is Gratuity and Its Tax Treatment?

Gratuity is a lump-sum payment provided by an employer to an employee in appreciation for their service, usually upon retirement, resignation, or termination. It is frequently calculated using the employee’s income and years of service and is found in both the public and private sectors of Kenya. Gratuity differs from pension contributions in that it is not a mandated payment but rather a voluntary benefit provided under some employment contracts or collective bargaining agreements.

Gratuity has long been considered taxable income under the Income Tax Act (Cap 470). Section 3(2) of the Act defines taxable income as “gains or profits from employment,” which includes gratuity payments. Before the Finance Act of 2025, gratuities were liable to income tax at the current tax rates in the year it earned or paid, unless particular exclusions applied, such as contributions to registered pension plans within set limitations.  Notably, the Tax Laws (Amendment) Act of 2024 established an exemption for gratuities received from public pension systems (financed by the Consolidated Fund) beginning December 27, 2024. And now, the Finance Act of 2025 provides exemptions for gratuities paid after July 1, 2025.

Key Points on Gratuity Taxation

  1. Gratuity earned after July 1, 2025.
    • Gratuity payments made on or after July 1, 2025, are exempt from income tax under the amendments of the Finance Act 2025.

Specifically, note that this refers to gratuity earned after July 1, 2025, meaning for work completed after this date.

  1. Gratuity earned before July 1, 2025.
    • Gratuity earned before July 1, 2025, is still taxable, even if it was paid after that date.

The gratuity earned before July 1, 2025, is considered employment income under Section 3(2) for the respective year of employment it was earned and is thus taxable under the respective income tax rate.

Spread for taxation: The gratuity is spread to the relevant period, up to 4 years back. Amounts beyond 4 years shall be income of the fifth year. Meaning that income for the fifth year may include amounts accumulated over four years. The tax due is calculated using the applicable tax rates for the respective years.

Calculating taxable Income

To calculate taxable income, employers must combine an employee’s gratuity with other employment income earned during the year under consideration. The tax payable then, is the difference between the tax payable on the consolidated income and any prior taxes paid on the employee’s earnings.

Gratuity paid to registered pension schemes

Gratuity paid into a registered pension scheme before July 1, 2025, is not taxable if it meets the Income Tax Act’s prescribed limits for the respective period.  This exemption only applies if the employee did not claim deductions for pension contributions in those years.

Public Pension Schemes

Gratuity from public pension plans, which is exempt from the Tax Laws (Amendment) Act, 2024 (effective December 27, 2024), is taxable for periods before December 2024, according to the instructions provided above.

What This Means for You

  • Employees: If you are receiving a gratuity payment, check if it is for work done before or after July 1, 2025. Payments for work completed after this date are tax-free.
  • Employers:  Ensure compliance by making sure that you correctly calculate and report taxes on gratuity payments, especially for periods before the exemption date.
  • Pension Scheme members: If you paid your gratuity into a registered pension scheme before December 2024, you may be eligible for tax exemption; however, you must confirm that you have not previously claimed pension contribution deductions.

 

Stay Informed

For updates and more information about gratuity taxation, you may send us your inquiry by email info@gknahashon.co.ke, or call/WhatsApp 0700 058630/0715 008 008

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