The Digital Tax Disruption

There is a silent but herculean digital revolution currently going on in Kenya which many people can see but have not pondered the massive disruption that is underway. Currently Kenya is at the apex of technological advancement leading the pack in Africa. Technological innovations are slowly but steadily destroying the conventional way of doing business. This is evidenced by the trade wars that have been recently witnessed in Kenya which is a tip of the iceberg. From the taxi wars between conventional taxi operators and uber recently witnessed to the legal battle for online land transactions, technology is making several traditional businesses uneasy.

Among the factors that have propelled Kenya in the technological arena is the landing of fiber optic cables that have seen Kenya’s internet speeds soar to a high of 13.7Mbps, the highest is Africa as per Akamai’s state of internet report of last year. This was way ahead of the USA and Australia though they disputed this.

Smartphone penetration has also seen a steep rise with Jumia Business Intelligence putting the smartphone penetration in Kenya at 60% of the population. Additionally, mobile payment platforms have been developed and continue to be innovated hence slowly becoming the number one choice for payments in Kenya.

All these factors are a perfect recipe for growth of digital transactions. We have witnessed a massive interest in the e-commerce especially from startups in Kenya. While most of the e-commerce previously known was dominated by big US tech companies, startups in Kenya have got onto the train.

Almost every startup in Kenya has an internet based business model and they seek to eliminate the need for a physical location for the business.

The internet and smartphone penetration has catalyzed the growth of e-commerce in Kenya and the rest of the world.

While this is a welcome move, it poses great challenges to revenue authorities in Africa and indeed the rest of the world on how to target these businesses in revenue collection/administration

We have already seen action from Kenya Revenue Authority in a bid to bring to the fold the big US tech companies such as Google, Facebook and Amazon. Most companies are using Google, Facebook and other social sites as marketing platforms and paying huge sums for such services. This is a huge revenue leak for the government given that this income has been generated in Kenya hence subject to tax in Kenya.  While tax may be accounted for on major transactions, the majority of such transactions are not brought to tax. It is commendable that KRA is trying to catch up with technology.

The major challenge is that such organizations operate in many countries and hence are able to take advantage of scale and report their incomes in jurisdictions that are tax-favorable. This is perfectly legal and hence the authorities have to think harder on how to legitimately bring such incomes to tax. This is complex since transactions over the internet are intricate and require experts to design tamper proof regulations that bring such income to taxation despite their borderless nature. The digital transactions do not require physical presence for business to be conducted.

In a bid to bring such incomes to tax, Kenyan tax laws require a non-resident company that derives income from Kenya through creating a permanent establishment by virtue of its operations to account for tax in Kenya. These rules are not adequate since their activities are done online and hence have no physical presence.

Further it is difficult to bring these digital transactions to tax since there is a disconnect between where value is created and where it is consumed. Jurisdictions where the value is created would demand a share of the taxes just as the jurisdictions where the value is consumed.

One of the traditional ways that KRA has used to collect taxes from non-residents is to require residents paying for services to withhold taxes and remit them to KRA. While this may work for corporate bodies registered as businesses, individual consumers do not have the means nor motivation to withhold such taxes and they form the bulk of customers. One other suggested way has been to require the non-resident firms to appoint representatives in the country who will account for the taxes on their behalf and will be held liable for any tax liabilities.

Tax authorities should bear in mind that taxpayers and potential tax payers are willing to gladly declare and pay tax as long as the tax due is definite and clear and the process simplest to the core. This has been well demonstrated by the huge increase in the filing of returns by individuals since the introduction of the easy to use iTax system. The manual system was burdensome such that the mere thought of lining up in winding queues at Times Tower made a tax payer prefer paying the KShs 1,000 fine  (if caught) or whenever it was absolutely unavoidable.

While the VAT Act, 2013 has attempted to define transactions that fall under e-commerce and the rules regarding place of supply, some transactions due to their nature remain unclear whether they are subject to tax in Kenya or not. It is this uncertainty that needs to be cleared so that the online firms can easily and definitively determine their tax liabilities and settle them.

These uncertainties often lead to risks of double taxation since companies do not know whether to account for the tax in jurisdiction A or B. This is not good for business and hence does not provide a good incentive to be compliant. Further this leads to increased costs of compliance as the e-firms have to seek professional advice of the tax status of some of the transactions. Clear and concise regulations are able to clear the path for compliance since there will be no room for ambiguity.

In addition, the ambiguity of some tax laws gives room to divergent interpretation which leads to conflicts with the tax authorities. It is unfortunate that whilst major reforms have been undertaken by KRA, conflict resolution remains one of the most challenging issues that taxpayers have to grapple with. Simple conflicts that could be easily resolved end up taking a lot of time and the costs involved snowball to uneconomic amounts. If KRA is to succeed in tapping the income from e-commerce and bringing as many taxpayers as possible to the fold, they should revamp their communication and conflict resolution strategy. We note that positive steps have been taken by KRA including the introduction of Alternative Dispute Resolution mechanisms and documenting timelines to some responses.  As observed above, the dilemma in taxing digital transactions is not unique to Kenya. Jurisdictions around the world are creatively looking for ways to bring such incomes to tax in a fair manner.

The Organization for Economic Cooperation and Development, a global forum for countries to discuss tax issues has proposed several remedies for the tax challenges facing digital transactions.

In 2015, OECD adopted a framework to tackle international tax avoidance arising from the base erosion and profit shifting by multinational organizations. The framework came up with action plans to be implemented by member countries.

The first action plan was on addressing the tax challenges of the digital economy. In pursuit of this plan, OECD issued an interim report in March 2018 where it proposed introducing rules to determine the nexus of transactions and profit allocation. The rules will guide how allocation of taxing rights are distributed between jurisdictions where multinationals operate. This will facilitate the elimination of double taxation.

These rules will assist tax authorities determine where the value was created and where it was consumed hence leading to assignment of the correct tax revenue to the various jurisdictions according to their contribution of value to the digital transaction.

Further it proposes introduction of excise tax on supply of certain e-services. While the recommendations are not binding and have not been adopted, they can form the bedrock on which tax authorities can base their regulations on taxing the digital transactions.

Other jurisdictions like the European Union have proposed drastic legislative measures such as introducing a new tax known as Digital Service Tax. Further they propose to reform the corporate tax rules to introduce the concept of virtual permanent establishments. In this concept, profits of businesses should be taxed where they have a significant interaction with users through online channels. The threshold to determine the significance of interaction include such parameters as number of users, value of sales made and business deals signed within a given jurisdiction in a given period.

Further, in the European Union, companies can easily know the tax status of various goods and services that they are about to supply to a potential client through an automatic online platform. They enter the good or service in question and instantly get its tax status. This greatly increases tax compliance. In addition, the companies are able to determine the tax status of the potential buyer and hence accord to them the correct tax treatment. I suggest that KRA can include such a portal in its website where the VAT status of goods and services can be queried and the tax treatment of various expenses.

This will assist non-resident online businesses that are not familiar with the Kenyan tax provisions to account for taxes as a result of income from Kenya.

In India online businesses that have significant economic presence are required to pay tax in India despite the fact that they do not have a permanent establishment. The significant presence will be determined through the extent to which the company interacts with the masses in India online. For instance social media advertising and marketing will constitute a significant presence. These provisions will take effect in 2019.

In the last few days, the long awaited Income Tax Bill has been released by treasury. While not much has been included regarding taxation of digital transactions, the bill has provided for the issuance of regulations on the taxation of business income arising from transactions carried out on a digital platform.

We hope that the regulations will take into consideration the best practice from around the world on the taxation of the digital transactions.

Finally KRA can do away with the stringent documentation requirement for claiming tax credits especially for VAT. This is because e-commerce businesses operate in multiple jurisdictions and hence may not standardize their documentation to fit all jurisdictions. They should recognize the e-invoices that are increasingly becoming common.

Business models are changing and so should the modus operandi of tax authorities. Online transactions and models are evolving by the day and so should the adaptability of the authorities otherwise they will constantly be playing catch up. It is without doubt that they have to invest in modern technology every now and then and also build capacity within their human resources.

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  • Andersen Tax has found a home in Kenya and provides a wide range of tax, valuation, financial advisory and related consulting services to individual and commercial clients.

  • Andersen Tax has found a home in Kenya and provides a wide range of tax, valuation, financial advisory and related consulting services to individual and commercial clients.

  • A tax return is a form or forms filed with a tax authority that reports income, expenses, and other pertinent tax information. Tax returns allow taxpayers to calculate their tax liability, schedule tax payments, or request refunds for the overpayment of taxes.