A fresh row is brewing between the Treasury against the taxman over a proposed tax exemption for pending pension payments, which has delayed the payment of benefits for 7000 public sector workers.

According to KRA, the relief only applied to retiree benefits accruing after December 27, 2024. However, the Treasury has been citing the need to alleviate hardship while pushing for immediate release of pension benefits to thousands of beneficiaries including teachers.

The Tax Laws (amendment) Act 2024 sought to increase the take home for thousands of pensioners by pushing up tax-free limits on contributions while cushioning pensions from statutory charges.

“This amendment effectively exempts from tax payment of pension benefits, including gratuity paid out of a public pension scheme, two payments from registered pension funds and provident funds, and three payments from the National Social Security Fund,” Treasury Cabinet Secretary John Mbadi said.

“So all these payments out of these funds are now exempt from taxation. This exemption was gazetted and became effective on 27 December 2024. Consequently, all public officers, including teachers and civil servants, retiring on or after 27 December 2024, are fully exempt from income tax on their monthly pension and commuted lump-sum gratuity,” he added.

According to Mbadi, the Pensions Department took the position that pension payments made after December 27, 2024 should qualify for the exemption, regardless of the retirement date, since pensions are recognised when paid.

KRA, however, argues that tax laws apply based on when income was earned or accrued, insisting that retirees who exited service under the previous tax regime remain subject to the tax rules that were in force at the time of retirement.

“The Kenya Revenue Authority insists that a delay in the disbursement of pension gratuity does not constitute grounds for tax exemption if the officer retired under a previous tax regime,” Mbadi said.

To prevent further delays and hardship, the government has adopted an interim solution: pensions will be paid, but the taxable portion will be withheld until the legal position is settled.

“So, as we wait for the legal opinion from AG to prevent further hardship to the 7,000 affected retirees, the department has resolved to process this payment subject to the prevailing tax regime that existed prior to the amendment. So, we decided to disburse but still withheld the taxes in the event there will be a consensus, then action will be taken,” the CS explained.

He added that the Treasury has sought a formal legal opinion from the Office of the Attorney General and that if it is determined the exemption should apply, the deducted tax will be refunded to affected retirees.

Under the pre-December 27 framework, the first KES600,000 of a lump-sum pension payment is tax-free. 

Amounts above that are taxed progressively: KES400,000 at 10 percent; the next KES400,000 at 15 percent; the next KES400,000 at 20 percent; the next KES400,000 at 25 percent; and any amount exceeding KES2.2 million at 30 percent.

Monthly pensions of KES25,000 and below were tax-exempt, while amounts above KES25,000 attracted withholding tax. Effective December 27, 2024, however, all monthly pensions are fully tax-exempt.

Notably, separate provisions apply to persons with disabilities. Before the amendment, retirees registered with the National Council for Persons with Disabilities enjoyed a higher tax-free threshold of KES2.4 million on lump-sum payments. Under the new law, pension benefits for qualifying persons with disabilities are fully tax-exempt.

The Treasury said the interim payment arrangement is intended to protect retirees’ cash flow while the legal dispute is resolved and reaffirmed its commitment to timely pension disbursements.

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