Fintech companies in Kenya are freed from Value-Added Tax (VAT) obligations following a landmark court decision.

In a landmark decision, the Kenyan High Court has overturned a ruling by the Tax Appeals Tribunal, which had allowed the Kenya Revenue Authority (KRA) to pursue a KES 76.8 million ($568,000) claim against the digital payments company, Pesapal.

The court's ruling has significant implications for the fintech sector, as it establishes a legal precedent by classifying licensed fintech operators as providers of essential financial services, not merely technology firms.

Justice Rhoda Rutto, in her decision, wrote that the Value Added Tax (VAT) Act neither restricts eligibility for exemption based on the technology used, nor does it tie exemption to registration under the Banking Act. Instead, the Act's exemptions for financial services apply to payment providers licensed under the National Payment System Act (NPSA).

The court found that companies licensed as payment service providers (PSPs) under Kenyan law are entitled to the same VAT exemptions granted to traditional financial institutions like commercial banks. This ruling does not address the specific services listed in the VAT Act that are eligible for exemption, but it does clarify that the exemption applies based on the function of the service, not the size or type of the provider.

The court's decision places the fintech sector on an equal footing with commercial banks and mobile money services. The activities of Pesapal, such as facilitating merchant payments, processing client funds, storing balances, and executing payment instructions, were found to be functionally equivalent to and mirror those of financial institutions, albeit in a digital environment.

However, the court's ruling does not mention any potential implications for other fintech operators beyond Pesapal. Nor does it provide information regarding which fintech companies are exempted from VAT on payment services by the Kenyan Supreme Court's ruling or when the new regulation will take effect.

Initially, the KRA argued that smaller fintechs do not qualify for the VAT exemption, claiming it is based on the type of provider and not the function of the service. The authority maintained that Pesapal's licence only authorises it to offer a payment system, not financial services. KRA contended that Pesapal acts as a technological enabler, integrating with banking and mobile money infrastructure, not providing exempt financial services.

The court, however, found these arguments to be unfounded. Justice Rutto wrote that the VAT Act's intention is to capture a wide array of monetary operations, particularly those that facilitate the movement of funds. The court's ruling does not specify whether smaller fintechs are now eligible for the VAT exemption, but it does clarify that the VAT exemption applies based on the function of the service, not the size or type of the provider.

This ruling does not address the specific services listed in the VAT Act that are eligible for exemption. As such, it remains to be seen how this ruling will impact the fintech sector in the long run. Nonetheless, this ruling could shield the fintech sector from significant potential tax liabilities, potentially paving the way for further growth and innovation in the sector.