Digital Lenders Say KRA Tax Dispute Still Clouds Investment Outlook

Digital lenders in Kenya continue to face significant investment uncertainty due to an unresolved tax dispute with the Kenya Revenue Authority (KRA), despite the recent enactment of the Finance Act 2026. A High Court appeal concerning historical tax claims dating back to December 2022 remains active, casting a shadow over the sector. While the Finance Act 2026 introduced some positive reforms, such as the removal of a proposed deemed dividend tax on retained earnings and enhanced bad debt deductibility, KRA's ongoing scrutiny of profit deployment and a recent Tax Appeals Tribunal ruling on the non-deductibility of loan principal as bad debt underscore the persistent challenges. This article examines the legal framework, the specifics of the dispute, and the implications for practitioners in Kenya's digital lending space.

The Kenyan digital lending sector, a vibrant and rapidly expanding segment of the financial services industry, finds itself at a critical juncture, grappling with persistent tax disputes that continue to cloud its investment outlook. Despite the recent enactment of the Finance Act 2026, which aimed to address some industry concerns, an unresolved legal battle with the Kenya Revenue Authority (KRA) over historical tax claims dating back to December 2022 remains a significant source of uncertainty. This ongoing litigation, currently before the High Court, underscores the precarious regulatory environment in which digital credit providers operate.

The Digital Financial Services Association of Kenya (DFSAK) has highlighted that while Parliament incorporated several of the industry's proposed tax reforms into the Finance Act 2026, the fundamental issues surrounding the tax treatment of retained earnings and the deductibility of bad debts are far from settled. This article delves into the statutory and doctrinal context of these disputes, analyses the impact of recent legislative and judicial developments, and outlines the critical implications for legal practitioners advising clients within this dynamic sector. The central thesis is that despite some legislative progress, the lack of definitive clarity on key tax matters, coupled with aggressive KRA enforcement, continues to impede stable growth and investment in Kenya's digital lending ecosystem.

The regulatory landscape for digital lenders in Kenya has evolved significantly, primarily driven by the Central Bank of Kenya (Digital Credit Providers) Regulations, 2022, enacted under the Central Bank of Kenya Act. These Regulations were introduced to license and oversee previously unregulated digital credit providers, addressing public concerns regarding predatory practices, high interest rates, and unethical debt collection methods. Under this framework, digital lenders are required to obtain a license from the Central Bank of Kenya and adhere to stringent conduct of business rules, including sound corporate governance and customer protection measures.

Kenya's broader tax system is governed by a suite of legislation, including the Income Tax Act (Cap 470), the Value Added Tax Act, 2013 (Cap 476), and the Tax Procedures Act, 2015, all administered by the KRA. The ongoing tax dispute with digital lenders stems from historical claims initiated by the KRA in December 2022, focusing on various aspects of their operations. These claims often revolve around the interpretation of taxable income, allowable deductions, and the treatment of specific financial transactions unique to the digital lending model. The KRA's efforts to widen the tax base and enhance compliance have increasingly targeted the digital economy, leading to heightened scrutiny of digital financial services.

The Finance Act 2026, assented to by the President on June 23, 2026, brought about several changes relevant to the sector. Notably, it removed a proposed 60 percent deemed dividend tax on retained earnings, retained tax incentives for locally assembled smartphones, enhanced bad debt deductibility for lenders, and rejected proposals that would have allowed KRA to enforce tax collection while appeals were pending. However, the Act also expanded the definitions of 'management or professional fees' and 'royalties' to capture payments for digital payment networks and processing systems, thereby increasing withholding tax exposure for digital payment service providers. Furthermore, it imposed Value Added Tax on digital financial services, including money transfer and payment processing.

The Finance Act 2026 represents a mixed bag for digital lenders. On one hand, the removal of the proposed 60 percent deemed dividend tax on retained earnings was a welcome relief, addressing a significant concern raised by the industry. This provision, if enacted, would have severely impacted the ability of digital lenders to reinvest profits into technology, lending capacity, and market expansion. The Act also introduced enhanced bad debt deductibility and prevented the KRA from enforcing tax collection during active appeals, offering some procedural safeguards.

However, the DFSAK has indicated that despite these legislative wins, KRA continues to scrutinise how companies retain and deploy profits, necessitating robust documentation to demonstrate that retained earnings are genuinely reinvested rather than used for tax avoidance. This ongoing scrutiny, coupled with the wider tax environment remaining largely unchanged for PAYE and certain withholding tax proposals, means that the sector still faces considerable compliance burdens. Moreover, the Finance Act 2026 expanded the scope of withholding tax by redefining 'management or professional fees' and 'royalties' to explicitly include payments for digital payment network services and processing systems, increasing the tax obligations for many digital financial service providers.

A critical area of contention, particularly for digital lenders, is the tax treatment of bad debts. While the Finance Act 2026 generally enhanced bad debt deductibility, a recent ruling by the Tax Appeals Tribunal (TAT) in *Commissioner of Domestic Taxes vs Premier Credit Limited* (Appeal E1149 of 2024) has provided a restrictive interpretation. The Tribunal held that for financial institutions, the principal amount of a loan is considered a capital asset, not revenue. Consequently, only the interest, fees, and penalties – which are recognised as taxable income – are eligible for tax deduction when written off as bad debts under Section 15(2)(a) of the Income Tax Act (Cap 470). This ruling directly impacts digital lenders whose core business involves extending credit, potentially limiting their ability to fully deduct losses from defaulted loan principals, despite the general 'enhancement' in the Finance Act 2026. This creates a tension where legislative intent for relief may be curtailed by judicial interpretation of fundamental tax principles.

Adding to the complexity, the ongoing High Court appeal concerning historical tax claims from December 2022 remains a significant overhang. This litigation, separate from the Finance Act 2026's prospective changes, means that digital lenders are contending with both past liabilities and evolving future tax obligations. The KRA, under the Finance Act 2026 and new administrative measures effective January 2026, has also gained expanded enforcement powers, including the ability to invalidate or re-characterize transactions deemed primarily for tax benefits and to reopen disputed transactions up to five years. This aggressive stance, coupled with eTIMS-based validation of income and expenses, signals a more intrusive and demanding compliance environment for all taxpayers, including digital lenders.

The Kenyan digital lending sector continues to navigate a complex and often ambiguous tax landscape. While the Finance Act 2026 offered some targeted relief, particularly regarding the deemed dividend tax and certain aspects of bad debt deductibility, the underlying uncertainty persists due to ongoing litigation over historical claims and the KRA's intensified scrutiny of business operations. The *Premier Credit Limited* ruling on the non-deductibility of loan principal as a revenue expense for financial institutions presents a significant challenge, requiring digital lenders to meticulously distinguish between capital and revenue components in their accounting and tax planning.

For legal practitioners, advising digital lenders now demands a multi-faceted approach. This includes ensuring robust documentation for retained earnings to justify reinvestment, meticulous adherence to the Central Bank of Kenya (Digital Credit Providers) Regulations, 2022, and a thorough understanding of the implications of the *Premier Credit* decision on bad debt provisions. Furthermore, monitoring the progress of the active High Court appeal is paramount, as its outcome will significantly shape the sector's historical tax liabilities. Continued engagement with the KRA to develop clearer, sector-specific tax guidelines remains crucial to foster the long-term certainty and stability necessary for sustained investment and growth in Kenya's vital digital financial services sector.