Did you know that the Finance Act, 2026 introduced new rules on the tax treatment of gratuity contributions?
There are two important conditions you need to understand.
1. The 3-Year Rule
For gratuity contributions to qualify for the exemption, the gratuity must relate to a contract of service lasting at least 3 years.
A contract that is renewed or extended can also qualify if the renewal or extension takes the total period beyond 3 years.
Example:
An employee has a 2-year contract which is renewed for another 2 years.
Total contract period = 4 years
The gratuity can therefore qualify, subject to the other requirements.
2. The 31% Limit
The gratuity paid must not exceed 31% of the employee’s emoluments earned during the period of the contract.
Example:
Total emoluments earned during the contract = KES 3,000,000
31% × KES 3,000,000 = KES 930,000
Therefore, gratuity of up to KES 930,000 can qualify, subject to the requirements of the Act.
Important Distinction
The Finance Bill, 2026 had proposed additional changes to gratuity treatment, but some of those proposals were not retained in the Finance Act, 2026.
In particular, the Act did not retain the proposal to remove the 3-year requirement for gratuity contributions made through registered pension schemes.
Gratuity contributions through registered pension schemes therefore continue to be governed by the applicable pension tax rules and relief limits.
For standalone registered gratuity schemes, the Act provides that the contributions are not subject to pension relief caps.
What Should Employers Do?
Employers should review their gratuity arrangements and ask:
- Is the employee’s contract at least 3 years?
- If not, has the contract been renewed or extended beyond 3 years?
- Is the gratuity within the 31% limit?
- Is the gratuity being provided through a registered pension scheme or a standalone registered gratuity scheme?
The structure of the arrangement matters because the tax treatment can differ.
Bottom Line
The Finance Act, 2026 has provided clearer rules around gratuity tax treatment.
3 YEARS + 31% LIMIT = KEY RULES TO WATCH.
Do not look at the gratuity amount alone. Look at:
- The contract period
- Renewals and extensions
- Total emoluments
- The structure of the gratuity scheme
Tax compliance is not just about paying tax—it is also about understanding when the law allows you not to pay it.
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