Foreign Tax Paid: Credit, Deduction and Why the Difference Matters in Kenya

People moving to Kenya from higher-tax countries often assume that tax already paid abroad will simply be set against their Kenyan bill. In Kenya that is true only in particular circumstances. The Income Tax Act, Cap. 470, distinguishes between a credit and a deduction, and which one you get depends on whether a double taxation agreement applies. This article explains the difference and why it matters.

Credit and deduction are not the same

A credit is set against the tax payable. A deduction is subtracted from the income on which tax is calculated. Take a simple illustration with invented numbers: foreign tax of 100 paid on foreign income. A credit reduces the Kenyan tax by up to that 100. A deduction reduces taxable income by 100, so the saving is only 100 multiplied by the Kenyan marginal rate. At any rate below 100 percent, the credit is worth more.

Where a credit comes from

Sections 41 and 42 of the Act give effect to double taxation agreements and provide for relief under them. A credit for foreign tax is therefore a treaty benefit. If Kenya has an agreement in force with the country that taxed you, the agreement and sections 41 and 42 govern how relief is given. If it does not, those provisions are not available.

The National Treasury publishes a list of double taxation agreements. Our article on which treaties are in force, signed but not operative or under negotiation explains why a signed treaty is not necessarily an operative one. The Treasury list shows no agreement with Switzerland, so a resident with Swiss employment income would look to the deduction, not a credit.

The fallback: a deduction

Where no treaty applies, the proviso to section 16(2)(c) allows a deduction for foreign income tax paid on income that is deemed to be derived from Kenya, where no claim is made under section 41. It is a deduction in computing income, not a credit. We would not tell a client that foreign tax can be credited against Kenyan tax outside a treaty, because the Act does not say so.

An example of the difference in practice

A resident employee receives foreign salary taxed abroad. Under section 5(1)(a) the salary is within the Kenyan charge; see our article on section 5. If a treaty exists, the employee looks to the treaty for relief. If not, the foreign tax is a deduction, so the income is taxed in Kenya after reduction by the foreign tax paid. The total tax burden across both countries can then exceed the higher of the two rates alone.

Why this matters to Class N holders

A Class N permit does not change any of this; see Does a Class N permit exempt your foreign income? for the position. The article on the Class N permit explains the immigration side. Anyone planning to hold the permit while employed abroad should model the Kenyan outcome with and without a treaty before accepting a relocation.

What to do

Identify which country taxed the income and check the Treasury list for that country. Keep certificates or assessments showing the foreign tax paid. If the position is unclear and the sums are large, consider a written ruling, discussed in our note on private rulings. Home country advice on its own relief rules is also needed, since the other country may give relief for Kenyan tax.

The Swiss case

The point arises most sharply for people employed by Swiss companies. The National Treasury list of double taxation agreements shows no agreement between Kenya and Switzerland. A resident of Kenya employed by a Swiss company therefore cannot claim a credit under sections 41 and 42 for Swiss tax, and would look to the deduction in the proviso to section 16(2)(c). The practical result is that Swiss tax already withheld at source reduces Kenyan taxable income but does not offset the Kenyan tax, so the combined burden may be higher than either country’s rate alone. Swiss and other foreign tax rules are outside the scope of this article, and a Swiss adviser should look at whether Switzerland gives any relief for Kenyan tax.

What the deduction covers

The proviso allows a deduction for income tax or tax of a similar nature, including compensation tax, paid on income charged to tax in a country outside Kenya, to the extent that the tax is payable in respect of and is paid out of income deemed to have accrued in or been derived from Kenya. Two points follow. The foreign tax must have been paid, not merely assessed. And it is limited to tax on income that is deemed Kenyan, so foreign tax on income that is not within the Kenyan charge is not covered. Keep foreign tax certificates, payslips showing withholding and assessment notices.

Home-country relief

Relief can also come from the other country. Many countries give their own residents credit for foreign tax, but a person who has become resident in Kenya may no longer be taxable on the same basis at home. Whether the home country continues to tax you, and whether it gives credit for Kenyan tax, depends on its law and any treaty, and needs separate advice. Do not assume that the two countries’ rules will cancel out.

Questions to ask before you move

Ask which country will tax the income, and on what basis. Ask whether a treaty exists and whether it is in force. Ask whether the foreign tax will be a credit or a deduction, and model the Kenyan outcome both ways. And ask whether the timing of the move can change the answer, since residence is decided for each year of income.