Banks have secured relief from a tax claim on interest earned from borrowers who delay loan repayments after the Tax Appeals Tribunal ruled that default interest is not subject to excise duty.
The ruling gives lenders grounds to challenge similar tax assessments by the Kenya Revenue Authority (KRA), potentially reducing their tax bill on income earned from overdue loans.
The tribunal ruled in favour of M-Oriental Bank, finding that default interest charged to customers who fail to repay loans on time constitutes ‘interest on loan’ or ‘return on loan’, which are excluded from excise duty.
Default interest is increased or penalty interest rate that a lender charges when a borrower misses a payment, goes into arrears, or breaches a term in a loan or credit agreement
The case arose from a KRA audit of M-Oriental Bank covering 2019 to 2023, after the taxman assessed the lender for excise duty, penalties and interest on its default interest income.
Bowmans Kenya tax analysts said the tribunal’s September 18, 2026 decision provides a key guidance to financial institutions on the treatment of default and penalty interest under the Excise Duty Act.
‘The judgment reinforces that default and penalty interest on loans should not attract excise duty,’ Bowmans said in its analysis of the ruling.
‘Financial institutions that have received excise duty assessments on default or penalty interest should review those assessments in light of this decision and the growing body of consistent judicial authority.’
KRA had argued that default interest charged by M-Oriental Bank constituted ‘other fees’ earned from its licensed financial activities and was therefore subject to excise duty.
The taxman’s position would have cost the lender millions of shillings, given that the KRA assessment was on amounts totalling about Sh1 billion, inclusive of penalties and interest.
Financial institutions are required to pay 20 percent excise duty on ‘other fees’ under the Excise Duty Act. However, the law expressly excludes interest on loans and returns on loans from the definition of fees subject to the tax.
‘Other fees include any fees, charges or commissions charged by financial institutions relating to their licensed activities, but does not include interest on loan or return on loan or any share of profit or an insurance premium or premium based or related commissions specified in the Insurance Act or regulations made thereunder,’ reads the act.
The tribunal rejected KRA’s interpretation of the law, holding that default interest falls within the excluded categories of interest on loans and returns on loans. The ruling also considered changes to the tax law during the period covered by the dispute.
The Finance Act, 2019 amended the definition of ‘other fees’ from November 7, 2019 to expressly exclude fees or commissions earned in respect of a loan from excise duty. That exclusion was later removed by the Finance Act, 2021, with effect from July 1 of the same year.
The tribunal found that default interest remained outside the excise duty charge because it constituted interest on a loan or return on a loan.
The decision adds to the growing judicial guidance limiting KRA’s attempts to impose excise duty on default interest. A previous High Court decision involving SBM Bank Kenya also found that excise duty does not apply to default interest.
KRA’s argument has been that interest for late payment of loans is ‘interest,’ and therefore excluded from definition of ‘other fees’ under the Excise Duty Act.
However, the court held that the default interest charged by banks is ‘interest’ and not ‘other fees’ for purposes of the Excise Duty Act and is therefore not subject to excise duty.
In the case of SBM, which was decided in March this year, the court said that while the Excise Duty Act did not have a definition of ‘interest’, any such ambiguity arising from interpretation must be resolved in favour of the taxpayer.