In the hustle of Kenya’s competitive business world, a silent threat is eroding profits and strangling cash flow. It’s not market volatility or rising costs—it’s a critical misunderstanding buried in everyday invoices: the VAT distinction between disbursements and reimbursements.

To the untrained eye, they seem identical. But to the Kenya Revenue Authority (KRA), they are worlds apart. Recent landmark rulings from the Tax Appeals Tribunal and the High Court have turned this accounting nuance into a high-stakes compliance nightmare. Getting it wrong is no longer a simple oversight; it’s a direct path to massive penalties, crushing retrospective taxes, and relentless KRA scrutiny. For law firms, consultancies, and outsourcing companies, every invoice is now a potential risk. A misclassified court fee, travel cost, or recharged salary could trigger a multi-million-shilling dispute.

While the VAT Act doesn’t provide explicit definitions, the courts have drawn a clear, bright line based on the principle of “who consumes the service?”

Disbursements (The VAT-Free Pass-Through) occur when your business acts as a pure agent, making a payment on your client’s behalf. You are merely facilitating the transaction. A classic example is a law firm paying a court filing fee for the client. The golden rule is to pass on the exact cost, with no markup. This facilitation does not constitute a taxable supply, meaning no VAT is charged. Remember: no markup, no VAT.

Reimbursements (The Taxable Supply) arise when your business incurs a cost in the course of providing your own service and later recharges it to the client. This includes billing a client for your consultant’s travel expenses or recharging staff salaries in an outsourcing contract.

These costs are considered part of your service’s value. When recharged, they are subject to the standard 16% VAT.

Recent jurisprudence has slammed the door on creative accounting. The courts now look past the labels on your invoices to the economic substance of the transaction. In a pivotal 2024 case, the High Court ruled that an outsourcing company recharging staff salaries plus a markup was making a taxable supply, not a disbursement. The profit margin was a dead giveaway. The message is clear: the KRA and the courts will dissect your contracts line by line. It doesn’t matter what you call it; it matters what it actually is.

Misclassification isn’t a simple error—it’s a serious liability. The consequences are severe and multifaceted. Businesses face retrospective VAT assessments, meaning the KRA can demand back taxes for years. This is compounded by hefty penalties and interest, turning a small oversight into a massive financial blow. The result is severely strained cash flow, disrupting operations and strategic planning. Furthermore, companies risk significant reputational damage and increased audit frequency, harming their relationship with the KRA.

Protecting your company requires proactive governance. Begin by conducting an immediate VAT health check; audit your contracts, invoicing practices, and cost-recovery models to identify and reclassify any ambiguous transactions. Crucially, enforce the golden rule for true disbursements by never adding a markup, as that instantly transforms it into a taxable reimbursement. It is essential to train your front-line teams; empower your finance, legal, and tax staff with the latest rulings and clear internal guidelines, as they are your first line of defense. Meticulous documentation is also key; maintain clear records that prove the nature of the expense and demonstrate you acted as an agent for the client. Finally, review your contract wording to ensure client agreements clearly define which costs are disbursements (pass-through) and which are reimbursements (part of the service).

In today’s environment, navigating the disbursement vs. reimbursement divide isn’t just about tax compliance—it’s about financial intelligence and resilience. Businesses that master this distinction do more than avoid penalties; they protect their profit margins, ensure predictable cash flow, and build a reputation for integrity with regulators. In the relentless pace of Kenyan business, that foresight isn’t just wise—it’s essential for survival.

Don’t let a technicality consume your profits. Understand the difference, audit your practices, and secure your bottom line.