The Expanded Definition of Royalty in the Finance Bill 2025 is one of the most notable tax changes proposed for the Kenyan financial year beginning July 1, 2025. This amendment targets the digital economy, specifically software distribution arrangements. According to the proposal, transactions involving the regular payment for the use of software through distributors will now be categorized as royalty payments. As a result, these transactions will be subject to Withholding Tax (WHT), even if the distributor does not have the rights to commercially exploit the software.

Understanding the Change

Previously, software resellers who purchased software for resale were not subject to royalty-related WHT, especially if they did not obtain rights to reproduce or modify the software. This position was backed by a 2017 High Court ruling in the case of Seven Seas Technologies Limited vs the Commissioner of Domestic Taxes.

In that case:

  • The High Court clarified that resellers merely acquire software copies.
  • It ruled that such purchases do not qualify as royalties.
  • The judgment was grounded in international tax standards, particularly the OECD Model Tax Convention.

Now, the proposed law will override that decision.

What the Expanded Definition Covers

The new definition proposes that royalty will include:

  • Software distribution agreements where the distributor pays regularly for the software.
  • Ongoing user rights even if the distributor cannot modify, reproduce, or commercially exploit the software.
  • Any recurring payments for access to or use of software features.

By expanding this definition, the government intends to capture a wider tax base from the fast-growing digital and software economy.

Implications for Software Distributors

If passed, the Expanded Definition of Royalty in the Finance Bill 2025 will create significant implications for software distributors in Kenya.

Key effects include:

  1. Increased Tax Burden
    • Distributors must now deduct WHT on payments made for software access.
    • Resident and non-resident rates apply, increasing the cost of doing business.
  2. Compliance Challenges
    • Businesses must track and withhold taxes on payments they previously treated as normal business expenses.
    • The need to file WHT returns increases administrative work.
  3. Potential Double Taxation
    • In cases where foreign suppliers are already taxed in their home countries, there could be disputes over double taxation unless tax treaties are in place.
  4. Review of Contracts
    • Existing contracts may not include clauses for WHT.
    • Distributors will need to renegotiate terms or bear the WHT burden themselves.

Legal Conflict with Previous Ruling

The proposal directly contradicts the 2017 ruling in the Seven Seas Technologies case. In that decision:

  • The court followed the OECD Model Tax Convention.
  • It held that software resellers do not exploit copyright.
  • Therefore, their payments did not qualify as royalty.

By ignoring this precedent, the 2025 Bill could create legal uncertainty. Businesses that relied on the earlier ruling may face retrospective tax risk unless the law is clearly applied prospectively.

International Perspective

Globally, many countries distinguish between software sales and royalty payments:

  • Royalty applies when the buyer receives rights to copy, modify, or license the software.
  • No royalty applies for simple resale of software without copyright rights.

The Expanded Definition of Royalty in the Finance Bill 2025 deviates from this model. It could place Kenya out of step with international best practices and discourage software companies from partnering with local distributors.

What Businesses Should Do Now

In preparation for this change, businesses should take the following steps:

  1. Review all software agreements
    • Identify any recurring payments.
    • Check if software usage rights are clearly defined.
  2. Consult tax advisors
    • Understand how the change affects your current and future obligations.
    • Plan for WHT filings from July 2025.
  3. Update financial models
    • Incorporate WHT into your pricing and budgeting.
    • Adjust projections for cash flow and tax liabilities.
  4. Engage with policymakers
    • Industry players should voice concerns through business associations.
    • A dialogue with the Treasury or Kenya Revenue Authority may influence final amendments.

The Expanded Definition of Royalty in the Finance Bill 2025 signals the government’s intention to tax the digital economy more aggressively. While it aims to broaden the tax base, it creates confusion by conflicting with a binding court decision and international norms. Businesses, especially those in software distribution, must stay vigilant, adapt contracts, and prepare for increased compliance obligations from July 1, 2025.

By taking early action and seeking professional advice, you can reduce exposure to penalties and stay ahead of these important legislative changes.