What Kenyan Employers Need to Know

Outsourced payroll arrangements often involve a service provider receiving funds from a client to pay employees, remit statutory deductions and administer payroll. Historically, uncertainty has arisen over whether VAT should apply to the entire amount transferred to the payroll provider or only to the provider’s service fee.

The Finance Act 2026 provides important clarification on this issue.

WHAT HAS CHANGED?

Employee-related costs incurred under labour outsourcing, employee-placement and similar arrangements may be treated as disbursements made on behalf of the client. These amounts may include:

• Gross salaries and wages
• PAYE and other employee deductions
• Employer and employee NSSF contributions
• Social Health Insurance Fund contributions
• Affordable Housing Levy
• Other properly documented employment-related costs

Where the arrangement satisfies the applicable requirements, these payroll costs should not form part of the taxable value of the outsourced payroll service. VAT would instead apply principally to the separate service or management fee charged by the payroll provider.

A PRACTICAL EXAMPLE

Assume an employer transfers the following amounts to its payroll provider:

Description	Amount (KES)
Salaries and statutory obligations	2,000,000
Payroll management fee	100,000
Total funding required before VAT	2,100,000

Where the KES 2 million represents properly documented payroll costs paid on behalf of the client, VAT would principally be charged on the KES 100,000 management fee — not on the entire KES 2.1 million.

THE CALCULATION At the standard VAT rate of 16%, VAT on the management fee would be KES 16,000. Total amount payable: KES 2,116,000

This treatment prevents VAT from being imposed on funds that do not represent income earned by the payroll provider.

THE TREATMENT IS NOT AUTOMATIC

Simply describing an amount as a “reimbursement” or “disbursement” is not sufficient. The contractual terms, invoicing, accounting records and actual flow of funds should support the treatment.

Employers and payroll providers should ensure that:

1. Payroll costs and service fees are clearly separated in the contract and invoices.
2. The client remains responsible for the underlying employment costs.
3. Payroll funds are transferred solely for paying employees and statutory bodies.
4. No markup is added to amounts treated as disbursements.
5. Payroll schedules, bank-payment evidence and statutory payment confirmations are retained.
6. The provider’s accounting records distinguish client payroll funds from operating revenue.

Risk of getting this wrong:  if payroll funding and service fees are combined without adequate supporting records, the entire amount may be exposed to VAT disputes, incorrect revenue recognition and avoidable tax assessments.

WHY THIS MATTERS

The clarification is particularly important for businesses using outsourced payroll, labour-placement or Employer of Record arrangements. It can:

✓ Prevent VAT from being charged on salary and statutory funding

✓ Improve transparency in payroll contracts and invoices

✓ Support accurate revenue recognition by service providers

✓ Reduce the cost of outsourced payroll services

✓ Strengthen the audit trail for tax and financial reporting purposes

Businesses should now review their payroll service agreements, invoicing structure and accounting treatment to ensure that payroll disbursements are properly distinguished from taxable professional fees.

At CFOD Hub, we help businesses structure outsourced payroll arrangements, maintain reliable payroll controls, and meet their accounting and statutory compliance obligations — across local payroll, expatriate payroll, statutory filings and Employer of Record (EOR) services. Is your outsourced payroll arrangement correctly structured for VAT purposes? Let us help you review it.

This article provides general information and should not be treated as tax advice for a specific transaction.