For many organizations in Kenya, staff recruitment and management can be time-consuming and administratively burdensome. To enhance efficiency and allow businesses to focus on core operations, Labour Outsourcing Companies (LOCs) have emerged to recruit and manage staff on behalf of client organizations for a fee.

In a typical arrangement, the LOC assumes responsibility for paying employee salaries and wages, remitting statutory deductions, and managing HR functions. These costs are subsequently recovered from the client, usually together with a management fee.

Labour outsourcing arrangements are governed by Labour Outsourcing Agreements (LOAs), and invoices issued by LOCs are typically structured into two components:

  •  reimbursement of labour costs and statutory contributions; and
  • a management fee for the outsourcing services rendered.

From an accounting perspective, the client company generally recognises the full outsourcing invoice as an operating expense deductible under Section 15 of the Income Tax Act, on the basis that it is wholly and exclusively incurred in the production of income.

The LOC, on the other hand, recognises the entire invoice amount as revenue, with labour and statutory costs treated as deductible expenses, and the management fee forming its profit margin.

From a tax perspective, companies and businesses benefitting from the services of LOCs have historically paid WHT only on the management fee potion of the invoices issued. This is mainly because reimbursements of labour costs and statutory deductions remitted by the LOCs on their behalf are a cost-to-cost recovery, without any profit element tied to them. In so doing, LOCs have relied on Section 13 (5) of the VAT Act, which excludes reimbursement of costs incurred by agents from the purview of VAT. However, the Kenya Revenue Authority (KRA) has increasingly taken the position that both WHT and VAT should apply to the full invoice amount, on the basis that it constitutes consideration for a taxable supply of labour outsourcing services. 

This divergence in tax treatment has resulted in multiple disputes before the Tax Appeals Tribunal and the High Court. While the Tribunal has often favoured taxpayers by treating reimbursements as disbursements, recent High Court decisions have adopted a stricter interpretation aligned with the KRA’s position.

This article examines two key High Court decisions and draws practical lessons for LOCs operating in Kenya.

On 23rd May 2025, the High Court in the case of Commissioner of Domestic Taxes v Techsavana Co. Ltd (2025) eKLR  delivered a Judgment upholding the KRA’s assessment of VAT on Techsavana’s labour outsourcing services.  The brief facts of the case are that Techsavana Ltd is a Labour outsourcing services company that was engaged by among others, Safaricom PLC to provide labourers to the company. 

The two companies entered a LOA. Under the LOA, Techsavana Ltd was to be responsible for payment of the staff salaries and wages, statutory deductions and remittances, disciplinary and leave management and general supervision of the outsourced staff. At the end of the month, Techsavana would bill all the expenses incurred in staff remuneration and statutory remittances to Safaricom and Safaricom PLC settle the expenses in favour of Techsavana, together with a management fee for the outsourcing services. In other words, the invoice to Safaricom PLC had two item itemized portions: a cost-to-cost recharge for salaries/ wages paid on their behalf by Techsavana and the management fee portion.

KRA assessed Techsavana on the entire invoice amount, including the cost-to-cost recharge. The Tribunal had agreed with Techsavana’s argument that the portion of the invoice that was a cost-to-cost recharge by Techsavana was a disbursement under Section 13 (5) of the VAT Act. The Tribunal observed that since Techsavana was not making any profits on the cost-to-cost recharge, the same did not qualify to be included as part of the VATable value of the supply.

The High Court took a different approach and in affirming KRA’s VAT assessment on the entire invoice amount, reasoned that in this transaction, Techsavana Ltd held the purse strings. The High Court meant that Techsavana was the legal employer of the outsourced staff and the entire invoice amount received from its clients was for the full cycle of outsourcing services including payment of staff costs and remuneration.

In a more recent Judgment, the High Court in the case of Commissioner of Domestic Taxes v Stratostaff E.A Ltd (2026) eKLR overturned the Tribunal’s decision that had held that VAT does not apply to reimbursements to Human Resources Firms by their clients for salaries, wages and statutory deductions paid by the HR Firms on their client’s behalf.

In arriving the above judgment, the High Court clarified that the disbursements excluded from the computation of taxable value of a supply are those paid by a person as an agent in a transaction. In Stratostaff’s case, the wording of its LOA with the clients made Stratostaff the principal employer and not an agent. Therefore, payments by its clients as reimbursement (on a shilling-to-shilling basis) for salaries, wages and statutory deduction remittances were a cost of providing the service and not a mere disbursement.

The High court emphasized that to Stratostaff, provision of staff to its clients was its tool of trade and all payments received for that service-the full invoice amount, is subject to VAT. The High Court affirmed KRA’s VAT assessment of over 342 million of Stratostaff E.A Ltd.

These decisions have significant implications for LOCs operating in Kenya. They underscore that VAT treatment will depend on the legal and factual substance of the arrangement, particularly whether the LOC acts as principal or agent in relation to the outsourced staff. 
 

Practical recommendations based on the judgments above

To minimise VAT exposure in the current regulatory environment, LoCs are encouraged to adopt a deliberate and well-documented approach that aligns legal form with economic substance. The following are some of the practical recommendations:

  1. Defining clear roles between LoCs and their Clients: To alleviate the risk of VAT assessments by KRA, LOAs must explicitly designate LoCs as their Clients’ agents and not the principal employers of the outsourced staff. The High Court in the Stratostaff Judgment above relied on the employment contracts between Stratostaff and the outsourced staff. The contracts had designated stratostaff as the employer of the outsourced staff, while obliging Stratostaff to expressly make this clear to the outsourced staff at engagement stage.

    In affirming the above position, the High court contemplated a situation where the employee salaries were not paid and observed that in the event of that eventuality, the unpaid staff would legally file a claim against Stratostaff and not Stratostaff’s clients.

  2. Structure LOAs and invoices properly: while it remains important to segregate labour costs, statutory contributions, and management fees for transparency, such segregation should not imply that labour costs are non-taxable. In the event that the LoCs adopt a wording in LOAs that designate them as principal employers of the outsourced staff, the wording of the invoice is immaterial as the entire invoice amount is now VATable. Should they adopt a wording clarifying that the LOCs are merely agents, then the invoice must segregate reimbursements for salaries, wages and statutory remittances in order for such costs to be excluded from computation of taxable value under Section 13 (5) of the VAT Act.
  3. Align tax and accounting treatment of payments to LOCs: inconsistencies between accounting and tax treatment of payments remains one of the most prevalent triggers of KRA tax audits. For instance, treating labour costs as non-taxable for VAT while recognising them as part of the LoCs revenue in its financial statements creates a contradiction that weakens the taxpayer’s plea in the event of a tax audit by the KRA.
  4. Conduct regular compliance reviews and obtain professional advice: given the evolving nature of tax jurisprudence, LoCs are encouraged to periodically review their LOAs to ensure compliance with current trends. This will alleviate huge assessments from KRA audits, which may negatively affect LOCs’ financial strength.

Conclusion

The taxation of labour outsourcing services in Kenya has entered a more stringent and substance-driven phase, shaped by evolving judicial interpretation and enhanced administrative enforcement. What was once treated by many taxpayers as a straightforward cost-recovery arrangement is now firmly viewed as a composite taxable supply subject to VAT on the full consideration. The two High Court Judgments analysed above affirm this position.

The key takeaway for businesses is that form alone is no longer sufficient. Contracts, invoicing, accounting treatment, and tax positions must all align with the economic reality of the transaction. Attempts to characterise labour costs as pass-through expenses, without meeting the strict legal threshold for disbursements, will not withstand KRA’s scrutiny. Ultimately, labour outsourcing remains a legitimate commercial model, but its VAT treatment now depends less on invoice labels and more on the legal and factual substance of the arrangement: who employs the staff, who controls them, who bears payment risk, and whether the LOC is truly acting as agent or principal.
 

Caveat

This publication has been prepared by RSM (Eastern Africa) Consulting Ltd, and the views are those of the firm, independent of its directors, employees and associates. This publication is for general guidance, and does not constitute professional advice. Accordingly, RSM (Eastern Africa) Consulting Ltd, its directors, employees, associates and its agents accept no liability for the consequences of anyone acting, or refraining from acting, in reliance on the information contained herein or for any decision based on it. No part of the newsletter may be reproduced or published without prior written consent. RSM (Eastern Africa) Consulting Ltd is a member firm of RSM, a worldwide network of accounting and consulting firms. RSM does not offer professional services in its own name and each member firm of RSM is a legally separate and independent national firm.