How Kenya can tax an emerging digital economy 

Kenya’s rapid transformation into a digital economy has given rise to businesses that are purely online.

There is this lady — let’s call her Susan. She buys and sells goods and services using online platforms such as Amazon and eBay. The transactions are being facilitated by payment gateways such as PayPal or digital currencies like Bitcoin.

The marketing of her wares takes place on Facebook, Twitter and YouTube. The business has few, or no tangible assets as Susan is making the most of shared services hosted on cloud platforms.

Whenever she requires technical or additional help, ready remote international manpower is available on LinkedIn or the multitude of online service marketplaces such as Guru, Fiverr and Elance, where she also offers her services internationally in return.

In 2017, she can even outsource customer service, not to humans, but to bots. Susan no longer subscribes to local pay TV packages and instead prefers bespoke online video-on-demand services such as Netflix.

Her vast music collection is sourced from online streaming too. But is Susan and her business really paying their fair share of income tax to the Kenyan government?

How about VAT and the other pertinent tax heads? Is the Kenya Revenue Authority (KRA) netting tax from all the platforms that serve Susan’s business but are domiciled elsewhere? Are the other parties she is transacting with online capturing the taxes appropriately in the other jurisdictions?

This is a conundrum that the KRA’s 2017 Tax Summit sought to address. The proliferation of the digital economy businesses is presenting a challenge to tax authorities the world over who are, more than ever, under pressure to ramp up revenue collection and guarantee quality public services.

The growing digital economy is invalidating traditional business models and modes of tax collection. Savvy digital players are taking advantage of the mobility and intangibility of digital goods and services to avoid tax and create an uneven playing field that is hurting competitors who are running traditional brick-and-mortar businesses and complying with traditional tax models. 

Traditional tax systems are typically designed to tax sales of goods or services at a clear-cut point of sale, and corporate and individual income earned in a clearly identifiable jurisdiction. They address questions of what is being taxed, where it is being taxed and what the taxable value is, while striving to maintain the good taxation canons of simplicity, certainty and fairness.

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In light of this digital challenge, there is a global initiative to plug the tax leakages posed by the digital space and ensure full and correctly captured taxation.

In 2012, the G-20 group of nations tasked the Paris-based Organisation for Economic Co-operation and Development (OECD) to study possible reforms to the global tax codes — specifically to deal with the challenge of base erosion and profit shifting (BEPS).

An OECD BEPS report in October 2015 took the first steps to formally suggest to governments modes of taxing the digital economy. The report is quick to acknowledge that exclusive rules for the digital economy are untenable, as this economy cannot be treated in isolation. It “is increasingly becoming the economy itself.”

BEPS aggressive tax planning opportunities identified thus far in the digital space include minimising taxation in the market (source) country through reducing functions, assets and risks or avoidance of a taxable presence by contractually allocating risk and legal ownership of intangibles, or shifting profits and maximising deductions in the case of a taxable presence.

There is also a reduction or elimination of withholding tax at source. Through low-tax jurisdictions, preferential regimes, or hybrid mismatch arrangements, there is a reduction or elimination of taxation at the level of the recipient, achieved with entitlement to substantial non-routine profits often built up via intra-group arrangements.

Ultimately, there is an elimination of current taxation of low-tax profits at the level of a parent company. In the context of indirect taxes such as VAT, the BEPS planning opportunities identified include remotely supplying digital goods and services to VAT-exempt businesses and the remote supply of digital goods and services to a centralised location for resupply within a multinational group that is not subject to VAT.

In its report, the OECD recommends a number of options for addressing digital economy taxation. The list includes changing a controlled foreign company (CFC) rules, updating transfer pricing guidelines, clearer definitions of what is a permanent establishment (a taxable presence) and rules for indirect taxes for certain digital transactions.

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Tax authorities, the KRA included, are therefore in the throes of working out modalities of addressing these concerns. Developments are being reviewed and analysed in the context of local taxation laws as they continue to be fine-tuned through international collaboration.

If managed well, digital taxation will definitely lead to increased revenue collection, which is an upside for governments.

Individuals and entities operating in the digital space should therefore consider paying more attention to these developments as they unravel, to ensure that they mitigate against any tax exposures, both in Kenya and across the borders.

Ndegwa is a Tax & Business Advisor at Anchinga & Associates. [email protected]