Tax authorities worldwide are struggling to adapt traditional systems to a digital, borderless economy. Modern business models increasingly rely on cloud computing, Software-as-a-Service (SaaS), digital platforms and integrated payment ecosystems. These developments have fundamentally reshaped how value is created and where it is deemed to arise.
At the heart of this debate lies the definition of “royalty.” Traditionally, royalties referred to payments made for the use of intellectual property such as patents, copyrights, trademarks, and industrial know-how.
Under Article 12 of the OECD Model Tax Convention, royalties are generally limited to payments for “the use of, or the right to use” intellectual property such as copyrights, patents, trademarks, secret formulas, and know-how. Jurisdictions such as South Africa and the United Kingdom are mostly aligned with this interpretation.
The UN Model Tax Convention, which is generally more favourable to developing countries, adopts a broader source-based approach than the OECD Model. Historically, the UN Model included payments for the use of industrial, commercial or scientific equipment within the royalty definition, although this has evolved over time.
In many jurisdictions, this definition has gradually expanded to capture digital transactions that blur the line between services, access rights, and intellectual property exploitation.
India, for example, has increasingly adopted unilateral measures to expand taxing rights over the digital economy. India has historically taken a broader domestic-law interpretation of royalties, particularly in relation to software payments and digital transactions.
Kenya has also been at the forefront of this evolution. Over the years, the Income Tax Act has expanded the definition of royalties to cover software, telecommunications infrastructure, digital platforms, and cross-border technology services.
This expansion has largely been driven by disputes between the Kenya Revenue Authority (KRA) and taxpayers, particularly multinational enterprises operating in the technology, telecommunications, financial services, and digital economy sectors.
What was once a relatively narrow and well-understood concept has become one of the most contested provisions in the Kenyan tax system. Viewed against international best practice, Kenya’s approach reflects a deliberate policy choice prioritising revenue mobilisation and source taxation over strict alignment with international consensus.
In Kenya, royalty payments are subject to withholding tax (WHT). As a result, classifying a payment as a royalty carries significant commercial implications. A broader definition translates into a wider WHT net, increased compliance obligations, and potentially higher operational costs for businesses.
Against this backdrop, disputes have intensified with the rise of software licensing, cloud computing, SaaS and digital platforms. The KRA has consistently taken the position that payments to foreign technology providers constitute royalties subject to WHT, while taxpayers have argued that such payments represent ordinary service fees, business income, or outright purchases rather than royalty-bearing transactions.
Courts have emphasised that not every software payment qualifies as a royalty. The key question is whether the payer acquired rights to commercially exploit intellectual property or merely obtained limited user rights.
In a recent case involving a technology company, the High Court ruled that payments for software licences were not royalties, distinguishing between acquiring a copyright and purchasing copyrighted material.
Similarly, in another case involving a software solutions provider, the court held that payments made to an overseas software vendor for software licences did not transfer intellectual property rights and therefore did not constitute royalties.
Another landmark decision involving a leading financial institution saw the Supreme Court rule that payments made by acquiring banks to international card service providers were not royalties and thus not subject to WHT.
Collectively, these decisions curtailed KRA’s attempts to subject all software-related and payment-processing fees to withholding tax.
Faced with repeated judicial setbacks, Parliament progressively broadened the statutory definition of royalties through successive Finance Acts. The amendments expanded the definition to include software payments, satellite transmission fees, payments for industrial or scientific equipment, and certain digital marketplace transactions.
These changes reflect Kenya’s deliberate shift toward source-based taxation, ensuring that payments arising from economic activity within Kenya remain taxable even where the recipient is a non-resident.
The Finance Bill, 2026 proposes Kenya’s most far-reaching expansion of the royalty definition. The Bill expressly classifies as royalties payments relating to proprietary digital platforms, payment networks, payment card schemes, payment processing systems, switching systems, clearing systems and settlement systems.
Importantly, such payments will qualify as royalties regardless of whether they are described as service fees, transaction fees, network fees or processing fees. The proposal is clearly intended to counter taxpayer arguments that relied on contractual labels to classify payments as ordinary services rather than royalties.
The Bill also significantly expands software-related royalties to include proprietary and off-the-shelf software, licence fees, development fees, training fees, maintenance fees and support fees. Further, recurring payments under software distribution arrangements would now be treated as royalties, directly addressing earlier judicial decisions that excluded such payments.
The proposed changes carry major implications for businesses. Kenyan companies making payments to non-resident technology providers, payment processors and digital platforms will face expanded withholding tax obligations.
Where contracts prohibit tax deductions, businesses may be required to gross up payments, thereby increasing the cost of technology adoption and digital transformation. These additional costs are likely to be passed on to consumers through higher transaction charges and subscription fees.
The broadened definition may also create mismatches with foreign tax systems and treaties. Some jurisdictions may not recognise these payments as royalties, raising the risk of double taxation. Disputes are expected over whether certain fees constitute royalties under treaty provisions or ordinary business profits taxable only where the recipient has a permanent establishment.
Supporters argue that the amendments modernise Kenya’s tax framework and protect its tax base in the digital economy. Critics, however, warn that excessively broad definitions may discourage foreign investment, raise the cost of digital transformation and undermine Kenya’s ambition to be a regional technology hub.
Ultimately, Kenya’s evolving royalty definition reflects a broader global trend as tax systems attempt to adapt to digital commerce faster than international consensus develops. As the digital economy continues to evolve, the debate over what constitutes a royalty continues, and the Finance Bill, 2026 suggests that the next chapter of disputes may only just be beginning.
Karanja is a Senior Associate with the Tax Department at KPMG Advisory Services Limited. ([email protected]). The views and opinions are those of the author and do not necessarily represent the views and opinions of KPMG
