Lessons Kenya can learn from taxation of the digital marketplace

In the 2019 Budget Speech, the then Treasury Cabinet Secretary acknowledged that the challenges posed by digital economy revolve around reliance on intangibles, massive use of data and widespread adoption of multi-sided business models.

It is also difficult to determine the jurisdiction in which value creation occurs. Such challenges resulted in the erosion of the country’s tax base hence low tax revenue. To address them, the CS proposed a number of tax measures aimed at taxation of income generated from the digital economy.

The digital service tax (DST) was meant to expand the tax base by bringing the digital economy, which may not necessarily have a physical presence in the jurisdiction to the tax net.

This is on the basis that resident persons and local branches of non-resident companies are taxed under the income tax regime in Kenya based on their presence in the country.

However, charging tax on digital transactions was already covered in the Kenyan income tax legislation. Under the Act, digital marketplace is defined as “means a platform that enables the direct interaction between buyers and sellers of goods and services through electronic means.”

What is currently missing are regulations to ensure unambiguous administration of this tax.

The Finance Bill, 2020 proposes to introduce DST payable on income, which is deemed to be derived from or accrued in Kenya through a digital market place at the rate of 1.5 per cent of the gross transactional value.

This would be expected to include online search engines, social media platforms, digital content streaming, online gaming, cloud computing services, and online advertising services.

In the case of residents and non-residents with local establishments, the tax will be available for offset against their income tax liability for the year.

The proposed DST adopts an advance tax mechanism for resident entities and branches, which would negatively affect their cash flow flows given that such entities will have paid instalment taxes. 

It is also likely to result in perpetual tax refunds, especially for businesses with low-profit margins or those making losses. This is because DST is based on gross transaction values.

The tax shall be due at the time of the transfer of the payment for the service to the service provider. We foresee administrative challenges, which could increase complexity and uncertainty.

Although the Data Commissioner may appoint third party processing intermediaries to withhold DST, the intermediaries may not have access to specific details of the underlying transactions, especially on low-value ones.

For certainty, the services covered should be clearly defined since the current definition is extensive and many businesses have some element of their services provided through electronic means. From a VAT perspective, the VAT Act, 2013 endeavoured to tax certain digital transactions which are categorised as electronic services.

The Finance Act 2019 empowered the CS to publish regulations to assist in implementing provisions relating to digital marketplace supplies.

The draft regulations were circulated for public participation last month. This would be an opportune time for digital marketplace players to provide their input. Globally, there is still no consensus on taxing the digital marketplace.

According to the OECD, the tax base can be determined by applying the global profit rate of the multinational group to the revenue (sales) generated in a particular jurisdiction.

The approach requires collaboration between tax administrators on the possibility of sharing of information on transactions and data of multinationals.

The EU Commission proposes to tax the profits of firms via direct tax.

This approach taxes the gross income rather than the net income of the company. Under this option, companies with low-profit margins or losses would be affected if the gross income would be chosen for the tax base.

During the G20 Summit last year, taxation of the digital economy including tech giants featured as a top agenda. These firms operate in virtual space rendering it cumbersome to bring them under the local tax radar.

The US has also been against this tax and it is likely that implementation of the tax could prompt a trade war with countries that may view it as targeting their corporates.

Treasury should ensure regulations for taxation of the digital marketplace are practical.

[Joseph Oyongo and Maureen Shaba]

-The writers are managers at Deloitte East Africa. The views expressed do not necessarily represent those of Deloitte.