VAT on Outsourced Labour Services in Kenya: New Tax Rules for 2026
The Finance Act, 2026 introduced an important change to the Value Added Tax (VAT) treatment of labour outsourcing, employee placement and staffing services in Kenya. The amendment clarifies how employee-related costs should be treated when calculating the taxable value of outsourced labour services.
Effective 1 July 2026, salaries, wages, statutory deductions and other qualifying employee-related costs incurred by labour outsourcing providers are treated as disbursements made on behalf of their clients.
The change affects staffing agencies, payroll outsourcing companies, security firms, cleaning contractors and other businesses that provide outsourced personnel.
What Has Changed Under the Finance Act 2026?
The Finance Act, 2026 amended Section 13 of the Value Added Tax Act, Cap. 476, by introducing subsections 13(5A) and 13(5B).
Section 13(5A) provides that where a supplier provides labour, outsourcing or employee placement services and incurs employee-related costs, those costs are deemed to be disbursements made on behalf of the client.
Section 13(5B) defines employee-related costs to include salaries, wages, statutory deductions and other related costs.
Previously, the treatment of employee costs in outsourcing arrangements created VAT disputes, particularly where staffing companies invoiced clients for both employee costs and their management fees.
The amendment provides a specific statutory basis for treating qualifying employee-related costs as disbursements rather than part of the taxable value of the outsourcing service.
How Is VAT Calculated Under the New Rules?
Under the revised framework, VAT applies to the outsourcing provider’s service fee rather than qualifying employee-related costs treated as disbursements.
For example, consider a company providing outsourced personnel to a client under the following monthly arrangement:
| Description | Amount (KES) |
|---|---|
| Employee salaries | 500,000 |
| Statutory deductions and other qualifying employee costs | 100,000 |
| Outsourcing management fee | 100,000 |
| Total invoice before VAT | 700,000 |
Under the new treatment, the VAT calculation is based on the KES 100,000 management fee rather than the entire KES 700,000 invoice.
Assuming the standard VAT rate of 16% applies:
| Description | Amount (KES) |
|---|---|
| Employee-related disbursements | 600,000 |
| Management fee | 100,000 |
| VAT at 16% | 16,000 |
| Total invoice | 716,000 |
The example assumes all the employee-related costs qualify under Section 13(5A) and are properly supported.
Which Businesses Are Affected?
The amendment is particularly relevant to companies whose business models involve supplying employees or personnel to other organisations.
These include staffing and recruitment agencies, security companies, cleaning contractors, payroll outsourcing providers, business process outsourcing companies and firms providing temporary or contract workers.
Businesses purchasing outsourced labour services may also benefit because the VAT charged on qualifying employee-related costs is no longer included in the taxable value under the new provision.
What Should Outsourcing Companies Do?
Businesses should review their service agreements, invoicing arrangements and accounting systems to distinguish employee-related costs from their service fees.
Invoices should clearly identify qualifying employee-related disbursements separately from management fees or other taxable charges. Supporting records should include payroll schedules, payment records, statutory deduction records and relevant client agreements.
It is also important to distinguish genuine employee-related costs from general business overheads. The amendment does not automatically make every expense reimbursed by a client a disbursement.
When Did the New VAT Rules Take Effect?
The amendment was introduced through Section 26 of the Finance Act, 2026 (Act No. 19 of 2026), which amended Section 13 of the VAT Act.
The relevant provision took effect on 1 July 2026.
The new treatment applies from that date. Businesses should therefore distinguish transactions relating to periods before and after commencement when reviewing historical VAT returns and outstanding tax assessments.
Need Assistance with VAT and Payroll Compliance?
We provide professional tax consultancy, payroll outsourcing and business compliance assistance in Kenya. Contact us for assistance with VAT treatment and payroll compliance.
