Cryptocurrency tax could hinder trade in digital assets

Cryptocurrency upheaval could be a blessing in disguise for the future of blockchain technology. [iStockphoto]

The Finance Bill, 2023 proposes to introduce Digital Asset Tax (DAT) at a rate of three per cent on the income derived from the transfer or exchange of digital assets.

The Bill defines a digital asset as anything of value that is not tangible and includes cryptocurrencies, token code and numbers held in digital form, which can be exchanged with or without consideration and can be transferred, stored or exchanged electronically.

DAT is one of the ways that the government is exploring to expand the tax base, especially considering recent press reports that millions of Kenyans are involved in cryptocurrency trading.

However, if implemented as proposed, the DAT will lead to multiple instances of double taxation.

For instance, a typical trade in cryptocurrencies involves an initial transfer of fiat currency into stablecoin (which is pegged to fiat currency), followed by the exchange of stablecoins for cryptocurrencies, exchange of one cryptocurrency for another before eventually the cryptocurrencies are exchanged for cash.

The proposed DAT would tax the same transaction on several instances before conversion to cash. Additionally, DAT singles out digital assets for special and disadvantageous treatment compared to other asset classes.

For instance, when trading in shares, only the gains from the trade are taxed. This treatment is also extended to business income which is taxed on the profit and not turnover.

The proposed DAT taxes digital assets on their turnover irrespective of whether the transfer results in a loss. This is especially important considering the volatility in digital assets trade.

The imposition of DAT on turnover rather than profit is similar to the ill-fated attempt to introduce the minimum tax, which the Court of Appeal declared unconstitutional as it discriminated against persons in a loss-making position.

DAT singles out digital assets for special and disadvantageous treatment compared to other asset classes. [File, Standard]

The only turnover-based tax that has been successful in Kenya is turnover tax, and this is only because taxpayers can opt-out if they believe that their tax affairs are best handled under the normal tax provisions.

Some countries such as India and Indonesia have unsuccessfully tried to introduce a similar form of tax, but this had a chilling effect on the market.

In 2022, Indonesia introduced tax which was applied on a withholding tax basis at the rate of 0.1 per cent of the gross value of cryptocurrency transactions.

Following the introduction, trading volumes on local cryptocurrency exchanges fell by approximately 60 per cent. The significantly higher tax rate is likely to have a chilling effect on the trade in digital assets and could drive many of the transactions underground.

Another important consideration is the administrative burden that DAT will impose on the platform owners who are required to remit the DAT deducted into Kenya Revenue Authority (KRA) accounts at authorised banks within 24 hours of the transaction.

This is likely to be a tall order given guidelines issued by the Central Bank of Kenya (CBK) against the trade in cryptocurrency. As a result of these guidelines, many cryptocurrency platforms are unable to open and operate bank accounts locally.

The decision to provide for the taxation of digital assets by the government while there is an active advisory against the trade by a government regulator is contradictory, and it may be time for the government to put in place a mechanism for safe trade and equitable taxation of digital assets.

The views and opinions are those of the author and do not necessarily represent the views and opinions of KPMG