Why Kenya should rethink digital assets tax on crypto

Each crypto varies mainly in terms of the value but bear similar nuanced structure when it comes to the mining process, transfer and exchange.

Photo credit: Shutterstock

The Treasury has issued a public participation notice for comments on the Draft National Policy on Virtual Assets and Virtual Assets Service Providers as well as the Virtual Assets Service Providers Bill, 2024 and the Capital Markets (Amendment) Bill 2023 yet to be passed into law.

From a tax perspective there is need to rethink the digital assets tax.

In 2023, the Treasury through the Finance Act and in line with the Medium-Term Revenue Strategy and National Tax Policy introduced the digital assets tax (DAT) under Section 12F of the Income Tax Act (ITA).

However, the constitutionality of the Finance Act 2023 in its entirety was challenged in court and the effectiveness of its provisions remained in limbo until October 29, 2024 when the Supreme Court through its decision in petitions gave the green light that the Act met the constitutional muster (sic).

Section 12F read together with Schedule 3 paragraph 13 of the ITA imposes DAT at a rate of three per cent (3 percent) on income derived from the transfer or exchange value of the digital asset.

The definition of the term digital asset as per the ITA extends to non-fungible tokens (NFTs) or any other token of similar nature as well as cryptocurrencies (crypto) and their ilk.

Crypto, the focus of this article, are characterised by their reliance on distributed ledger technology (DLT) which allows them to be stored and transferred using a decentralised system spread over multiple computers unlike the fiat currencies which operate with intermediaries such as financial institutions and central banks.

Each crypto, whether its Bitcoin (BTC), Ethereum (ETH), Solana (SOL), Binance Coin (BNB), Litecoin (LTC) et al, varies mainly in terms of the value but bear similar nuanced structure when it comes to the mining process, transfer and exchange.

Unfortunately, the simplified tax regime approach under Section 12F of ITA on crypto ignores the elaborate process that is undertaken to realise the value of a crypto and the unique transactions that a crypto may be placed into.

The structure used to come up with the simplified tax regime for DAT borrows heavily from the Turnover Tax regime under Section 12C of the ITA which charges a rate of 1.5 percent of the gross sales of a business with annual revenues between Sh1 million but not exceeding Sh25 million,

Personal investment vs trade activity

Firstly, Section 12F of the ITA fails to appreciate the two main ways most people engage crypto; either as a personal investment or as a trading business activity.

As a personal investment, an investor buys and holds the crypto without selling and speculates when the right time is to sell. So, if an investor on-ramped on November 21, 2022 when one bitcoin was valued at $16,032.53 and began hodling (HODL), the investor may have decided to off-ramp on January 7, 2025 when the same bitcoin was valued at $ 100,655.53.

The passage of time without the investor engaging with any other activity qualifies as a personal investment.

On the converse, where the investor either engages in selling crypto for fiat, trading one crypto for another, or using crypto to purchase goods or services such as in-game purchases, that would qualify as a business activity.

The taxation approach under Section 12F of ITA lumps everything under one basket unlike other jurisdictions, where crypto is rife such as the UK, India and USA, who have separated the two modes.

While a counter argument can be placed that splitting the two forms of transaction may create a window for tax arbitrage, it’s my view that the said window can be sealed by explicit and adaptable rules that are able to absorb the frequent changes within the crypto space.

For instance, in most of these comparable jurisdictions, HODL of crypto for personal investment will only be taxable when selling or exchanging it and subject two conditions; the time taken to hold and the specialised capital gains rates imposed.

When crypto is used for trade as a business activity the income generated will be subject to income tax rules and a taxpayer is likely to enjoy allowable deductions such as transaction fees, professional costs among other costs.

In Kenya, if a taxpayer engages in crypto from a business activity perspective, Section 12F outrightly precludes one’s crypto business activity from enjoying the allowable deductions under Section 15 of the ITA such as Wi-Fi and electricity expenses as well as capital expenditure utilised in acquisition of computers and peripheral computer hardware and software which would be used in cryptomining.

Additionally, while in normal businesses, losses can be carried forward and offset against future taxable income, under DAT, the crypto-related losses that are incurred due to either significant volatility or during ‘crypto winters’ are not considered.

Lack of regulations

Secondly, the paucity in Section 12F is further compounded by lack of regulations that would stipulate how the value of the crypto would be arrived at for taxation purposes and provide taxable and non-taxable events.

For instance, in the US, there is a distinction between exchanging one type of crypto for another, let’s say BTC for ETH as opposed to transferring crypto between wallets that are owned by the same person.

The former, due to the difference in value, would qualify as a taxable event while the latter which does not change ownership nor create value that can be considered income, would qualify as a non-taxable event. Under Section 12F of the ITA both instances are taxable.

In the UK, if you give a spouse crypto as a gift no tax is imposed, however, where the recipient is someone other than a spouse, that will form a taxable event. In India, crypto received as a gift will be tax-exempt. However, if the value of the crypto gift exceeds 50,000 rupees, it becomes taxable. Under Section 12F no distinction is made for crypto gifts.

Imposing undue duty

Thirdly, Section 12F of the ITA imposes the duty to collect the 3 percent DAT to the owner of a platform or the person who facilitates the exchange or transfer. A realistic interpretation of this provision seems to only be applicable to centralised exchanges (CEX) like crypto.com, kraken and Coinbase due to their ability to collect and have personal information of their investors.

However, for decentralised exchanges like Uniswap and Bisq as well as peer-to-peer trading, it will be a tall order for compliance purposes.

Additionally, Section12F imposes a duty on platform or person who facilitates the exchange or transfer of crypto to file a return and remit the payment within five (5) days.

The five-day requirement while it may be meant to hasten revenue collection similar to excise duty, it fails to appreciate the decentralised nature of crypto and how it may be difficult for those platforms to verify the source or residence or permanent establishment of an investor for the purposes of taxation within five days.

The five-day rule is one of a kind in the world as all other jurisdictions have the normal annual requirement for returns to be filed and tax remitted.

Despite the catch-all approach taken for DAT implementation, up to date no specific figures have been disclosed on the amount of revenue collected under DAT.

The public notice issued by the Kenya Revenue Authority on Taxation of the Digital Economy on or around November 2024, which has been widely misreported as dealing with crypto taxes under DAT, solely focused on the Digital Service Tax (DST) imposed under section 12E of the ITA which KRA reported to have raised Sh10,806,084,095 in FY 2023/2024 from more than 350 taxpayers registered under the DST obligation and not the DAT one.

Courtesy of the Tax Amendment Act 2024, DST has been replaced by the Significant Economic Presence Tax at a rate of 6 percent from 1.5 percent.

Way forward

Therefore, as National Treasury prepares to receive annual projections by the ministries and state entities by January 31, 2025 and comments on the Virtual Asset Service Providers Bill, there is need to appreciate the novelty of crypto and to provide proper guardrails in the form of regulations on how DAT would be fairly realised without placing onerous obligations on taxpayers and making it difficult for the taxman to collect revenues.

The regulations should also be in consonance with other proposed laws touching on the crypto space such as the Virtual Asset Service Providers Bill and the Capital Markets (Amendment) Bill 2023.

Any ambiguity in the law may lead to numerous disputes and nip an emerging area of the economy in the bud before it realises its full potential.

The writer is a tax advocate

PAYE Tax Calculator

Note: The results are not exact but very close to the actual.