Businesses confronting fresh limitations on tax loss deductions: a guide

The Kenyan government has announced a significant change in tax policy with the introduction of a five-year limit on the carry forward of tax losses for corporate entities, effective from July 1, 2025. This move marks a departure from the indefinite carry-forward regime that was introduced in 2021 and a return to the pre-2015 limit of five years.

The new rule aims to reintroduce discipline into the system and prevent indefinite use of tax losses to avoid tax liability. Businesses will need to demonstrate that losses are genuine and supported by a reasonable expectation of future profitability.

Taxpayers are advised to begin reviewing their historical losses, model projected profitability, and prepare to engage with the Kenya Revenue Authority (KRA) in advance if an extension is likely necessary. However, there is some debate over whether the restriction could apply retrospectively to losses older than five years from the effective date, effectively phasing out historical losses.

This change presents a dilemma for businesses whose growth strategies depend on long-term investment horizons, particularly those in manufacturing, infrastructure, and startup sectors. Companies may need to revisit financial models to ensure losses are absorbed within the five-year window, potentially involving adjustments to pricing, cost structures, or the timing of capital investments.

The inability to transfer losses between entities adds complexity to tax management for corporate groups. In-house tax and finance teams are required to take on more proactive and compliance-oriented roles when managing extension applications. The process of applying for extensions requires substantive justification and documentation, adding to the compliance burden.

The Finance Act 2025 does not include a specific transitional provision for losses incurred before July 1, 2025, leaving room for varied interpretation. One view is that the change should apply prospectively, affecting only losses incurred after this date. Another interpretation is that the rule limits the practical benefit of resulting losses, challenging businesses to align long-term growth plans with short-term tax constraints.

Large corporations with significant tax loss carryforwards, such as multinational companies, major banks, and large manufacturing firms in Kenya, will likely need to review their financial models to ensure losses are absorbed within the new five-year limit. Mergers, acquisitions, and internal restructuring may be affected by the time-sensitive factor of tax loss utilisation.

The new five-year limit on tax loss carryforwards signals a broader evolution in Kenya's tax policy in an era of fiscal tightening. Businesses must now adopt dynamic, data-driven, and forward-looking tax planning strategies to adapt to these changes. Those who delay action until the fifth year may find themselves constrained by time and limited options.