IT 2
Employment income and PAYE
1Scope and legal basis
Section 5 of the Income Tax Act charges gains or profits from employment or services rendered, and section 37 requires an employer to deduct tax from emoluments under the Pay As You Earn (PAYE) system in the Income Tax (PAYE) Rules. Employment income includes wages, salary, leave pay, sick pay, payment in lieu of leave, fees, commission, bonus, gratuity, subsistence, travelling, entertainment and other allowances, and the value of any benefit, advantage or facility granted in respect of employment, with the specific valuation rules in section 5(2) to (6). The Tax Laws (Amendment) Act 2024 and the Finance Acts of 2025 and 2026 reshaped the deductions: the Affordable Housing Levy and SHIF contributions are now deductions from income rather than reliefs, the pension and mortgage limits rose, the tax-free per diem rose to KES 10,000, and gratuity under a contract of three years or more became exempt.
2Key definitions
3Charge, computation and rates
Valuing benefits
| Benefit | Taxable value | Notes |
|---|---|---|
| Housing provided by employer | For an ordinary employee: the higher of the rent paid by the employer (or fair market rent where employer-owned) and 15% of gross emoluments excluding housing; for a director: the same, and for an agricultural employee 10% | Reduced by any rent the employee pays; where the employee's total emoluments already include a cash house allowance, the allowance is simply taxed as cash |
| Motor vehicle | The higher of 2% a month of the initial cost of the vehicle (24% a year) and the prescribed rate by engine capacity; for a leased car, the lease cost | Reduced proportionately where the Commissioner accepts restricted private use; fuel and driver provided are separate benefits at cost |
| Loan at low or nil interest | Employer pays fringe benefit tax at 30% on (prescribed rate 8% less actual rate) × loan balance | No benefit is taxed on the employee for loans made after 11 June 1998 under the FBT regime; the prescribed rate is published for each half year |
| School fees | Cost to the employer, taxable on the employee unless the employer treats the cost as non-deductible in its own tax computation | Fees for the employee's own training related to the employment are not a benefit |
| Medical | Exempt: medical cover or reimbursement provided under a scheme open to all employees, without limit; for a director who is not a whole-time service director, the limit is KES 1 million a year | The SHIF contribution the employer pays on the employee's behalf is a benefit; the employee's own SHIF is a deduction |
| Meals | Exempt up to KES 60,000 a year where provided in a canteen or by a third-party caterer to all employees; otherwise at cost | Raised from KES 48,000 by the Tax Laws (Amendment) Act 2024 |
| Per diem (subsistence) for travel on duty | The first KES 10,000 a day is exempt (raised from KES 2,000 by the Finance Act 2025); the excess is taxable unless supported by receipts as a reimbursement | Applies to travel away from the normal workstation |
| Employer pension contribution | Exempt in the employee's hands where the scheme is registered and the contribution, with the employee's own, is within KES 360,000 a year (KES 30,000 a month); the excess is a taxable benefit | The limit rose from KES 240,000 under the Tax Laws (Amendment) Act 2024 |
| Telephone, furniture, domestic servants, club subscriptions, electricity, water | Cost to the employer, or the prescribed standard rates for furniture (1% of cost a month), telephone (30% of bill), water and electricity where the employer owns the house | Aggregate non-cash benefits of KES 60,000 a year or less are not taxed |
| Share options and awards | Taxed when the option is exercised at the difference between the market value and the price paid; employee share ownership plans registered with the Commissioner defer the charge to exercise and value it at the offer date | Listed-company plans use the market price on the exercise date |
| Gratuity and terminal payments | Gratuity under a contract of service of at least three continuous years (and a contribution of no more than 31% of base salary under the Finance Act 2026 wording) is exempt for service from 1 July 2025; earlier service is taxed by spreading over the years earned, up to five years back; payment in lieu of notice and compensation for loss of office are taxable in the year received | Gratuity paid into a registered scheme within the pension limit has always been exempt |
Deductions, reliefs and the bands
| Step | Rule for 2026 |
|---|---|
| 1. Gross emoluments | Cash pay plus the taxable value of benefits, less exempt items (medical, meals to KES 60,000, per diem to KES 10,000 a day, non-cash benefits to KES 60,000 in aggregate, mileage at AA rates, passages for expatriates recruited abroad). |
| 2. Less allowable deductions | NSSF employee contribution (up to KES 6,480 a month from February 2026); SHIF contribution (2.75% of gross, minimum KES 300, no cap); Affordable Housing Levy (1.5% of gross); registered pension or provident fund contributions up to the lowest of the actual, 30% of pensionable pay and KES 30,000 a month (KES 360,000 a year), including the NSSF amount; post-retirement medical fund contributions up to KES 15,000 a month; mortgage interest on an owner-occupied home from a qualifying lender up to KES 30,000 a month (KES 360,000 a year). Disability: the first KES 150,000 a month (KES 1.8 million a year) of income of a person with a valid exemption certificate is exempt. |
| 3. Taxable pay and the bands (monthly) | 10% on the first KES 24,000; 25% on KES 24,001 to 32,333; 30% on KES 32,334 to 500,000; 32.5% on KES 500,001 to 800,000; 35% above KES 800,000. |
| 4. Less reliefs | Personal relief KES 2,400 a month; insurance relief at 15% of premiums up to KES 5,000 a month. (The affordable housing relief and the NHIF relief were repealed from 27 December 2024; the contributions became deductions instead.) |
| 5. PAYE payable | Tax after reliefs, never below zero; the employer remits by the 9th of the following month together with the AHL, NSSF and SHIF amounts, and fringe benefit tax. |
PAYE for September 2026: gross salary KES 250,000, employer pension 10%, own pension 10%, life premium KES 8,000 a month, company car of cost KES 3,000,000
Car benefit: 2% × 3,000,000 = KES 60,000 a month (assume above the prescribed rate). Gross emoluments: 250,000 + 60,000 = 310,000. Employer's pension 25,000 plus employee's 25,000 = 50,000, within the KES 30,000 monthly limit only up to 30,000, so 20,000 of the employer's contribution is a taxable benefit: gross 330,000.
Deductions: NSSF 6,480 (the employee's Tier I plus Tier II on pay above 108,000 is capped), SHIF 2.75% × 250,000 = 6,875, AHL 1.5% × 250,000 = 3,750, pension: the lower of actual (25,000 + 25,000, but the employee's own 25,000 plus NSSF 6,480 = 31,480, capped at 30,000 in total with NSSF). Take pension deduction 30,000 (which absorbs the NSSF). Taxable pay: 330,000 - 30,000 - 6,875 - 3,750 = 289,375.
Tax: 24,000 × 10% = 2,400; 8,333 × 25% = 2,083.25; (289,375 - 32,333) × 30% = 257,042 × 30% = 77,112.60. Gross tax 81,595.85.
Reliefs: personal 2,400; insurance 15% × 8,000 = 1,200 (under the 5,000 cap). PAYE = 81,595.85 - 3,600 = KES 77,995.85, remitted by 9 October 2026 with AHL (employee 3,750 and employer 3,750), SHIF 6,875 and NSSF (employee 6,480 and employer 6,480).
Net pay: 250,000 - 77,995.85 - 6,480 - 6,875 - 3,750 - 25,000 (own pension) - 8,000 (premium, if payroll-deducted) = KES 121,899.15.
Special cases
- Second employment and lump sums: an employee with two employers has personal relief applied by one only; bonuses, arrears and leave pay are taxed in the month received at the marginal rate, and back pay relating to earlier years may be spread on application.
- Non-resident employees: taxed at the same bands on Kenyan employment income but without personal relief; income of a non-resident employed by a non-resident employer for duties performed in Kenya for less than an aggregate of 183 days may be treaty-exempt.
- Employees of the national government, county governments and public bodies are within PAYE like everyone else; members of the disciplined forces have certain allowances exempted by the First Schedule.
- Pension income: monthly pensions from a registered scheme are exempt after the retirement age set by the scheme rules, as are lump sums on retirement, death or ill health (Finance Act 2025); withdrawals before that are taxed at the graduated rates after a tax-free amount of KES 60,000 for each year of membership up to KES 600,000, at the reduced withdrawal rates for members of more than 20 years.
- Directors' fees and part-time lecturing fees to a person who is otherwise employed are emoluments subject to PAYE by the payer; professional fees to a self-employed person attract 5% withholding tax and are business income.
4Compliance: returns, payment and penalties
- The employer registers for PAYE on iTax, deducts tax on every payment of emoluments using the bands and reliefs, issues a monthly payslip and an annual P9 certificate, files the monthly PAYE return (P10 on iTax) and pays by the 9th of the following month. The same return carries fringe benefit tax; the AHL, SHIF and NSSF returns are filed on their own portals but with the same deadline.
- Penalties: failure to deduct or remit PAYE attracts a penalty of 25% of the tax involved or KES 10,000, whichever is higher, plus interest at 1% a month; the employer is personally liable for tax not deducted. Late filing of the PAYE return is penalised at 25% of the tax due or KES 10,000.
- The employee files an annual income tax return by 30 June using the P9, declaring all income (including other employment, rent, business and investment income) and claiming any relief not given through payroll; PAYE deducted is a credit. Failure to file is the higher of 5% of the tax due and KES 2,000.
- Records of emoluments, benefits and deductions are kept for five years; the Commissioner audits PAYE and commonly assesses on untaxed benefits (housing, cars, school fees, undocumented allowances) and on fees paid to consultants who are in substance employees.
5Examinable focus
What KASNEB tests
A full PAYE computation appears in nearly every Public Finance and Taxation paper: a salary with allowances, a house (apply the 15% rule against the rent), a car (2% of cost), a low-interest loan (the employer's FBT, not the employee), pension contributions on both sides against the KES 360,000 limit, SHIF, AHL and NSSF as deductions, a medical benefit, a per diem, and the reliefs. Set the computation out in the five steps above, state each exemption limit you apply, and remember that AHL and SHIF are deductions from income while personal and insurance reliefs are credits against tax. Theory parts ask for the employer's PAYE obligations and penalties, the difference between a contract of service and a contract for services, and the tax treatment of terminal benefits and pensions after the 2025 changes.