The Digital Taxation debate: A summary

In the past few years, Kenya has been targeting the digital space for taxation, for example with internet taxes, VAT on digital services, and more recently, digital services tax. The country joins the EU States that have been advocating for an international taxation regime that captures the level of transactions that currently occur in digital spaces.[1] The rationale behind this is that for years these multinational companies have been accruing profits from their countries without paying them a single cent. Some of these companies have used the approach of transfer pricing and complex company structures to avoid taxes.[2] An example of this is Apple Inc which incorporated its companies in Ireland and while the subsidiaries that had effective management of the Company, were located in the USA.[3] What this did is that Apple Inc was able to maneuver the different taxation requirements of Ireland that is the company being taxed must be the place of effective management, and for the USA which only taxes companies that have been incorporated in the States.[4] Digital taxes have not been well received by big US technology corporations[5] which argue that the industry is in its infantry stage[6] and therefore requires some form of protection from new barriers to trade.[7]

Section 4 of the Finance Act 2020 introduces a new digital service tax that targets income accrued from the digital marketplace.[8] Revenue from these digital services will be taxed at the rate of 1.5% on the gross transaction value.[9] To ensure the efficiency of the tax, the Cabinet Secretary made provisions to regulate and enforce the above amendment[10] which brings us to the new Income Tax (Digital Service Tax) Regulations of 2020.

Bearing in mind the obligation to balance between protection of emerging industries vis a vis increasing one’s tax base, this article discusses two issues: the wide scope of section 3(1i) and the lack of a turnover limit.

Wide scope of regulation 3(1i)

Regulation 3(1a-h) of the Draft regulation sets out the specific transactions that would be subject to digital taxation.[11]  These include:[12]

(a) streaming and downloadable services of digital content,

(b) transmission of data collected about users in the digital marketplace;

(c) provision of a digital marketplace, website or other online applications that link buyers and sellers;

(d) subscription-based media

(f) supply of search-engine and automated helpdesk services;

(g) tickets bought for live events, theatres, restaurants, etc. purchased through the internet:

(h) online distance teaching via pre-recorded medium or eLearning;

The regulation exempts services that are subject to withholding tax.[13]

Regulation 3(li) widens the scope of the law to cover not only multinational companies but also small micro-enterprises in this sector. It reads as follows;

“i. any other service provided or delivered through an online digital or electronic platform excluding any service whose payment is subject withholding tax under section 35 of the Act.”[14]

These big tech companies may have the capacity to fulfill the taxation obligations, but this may present itself as another barrier to trade that these emerging industries will have to face. The government must ensure the protection of these companies to ensure the growth of their economies.

The regulation 3(1i) is problematic as it renders the other clauses redundant as to what is the intention of defining unique circumstances where digital tax will be applied then continuing to state that ‘any digital transaction’ will be subject to that tax. One must recognize that these are not regular transactions where it is convenient for the law to say ‘any digital transaction’ just to increase the number of people who fall under it. These are digital transactions that are often numerous and therefore difficult to monitor. The legislation must be precise and transparent about what constitutes a digital service to ensure efficient tax compliance, which would eventually lead to an increase in the country’s tax revenue.

Turnover threshold.

An annual turnover threshold is a mechanism used to different levels of businesses depending on how much sales they did for the year. Such a limit has been used to balance the State’s interest to protect emerging industries and at the same time increasing its tax base.  The United Kingdom, for example, set a turnover cap of £500 million worldwide revenue from digital activity, and £25 million of this revenue accrued from users in the UK.[15] If the income of a corporation reaches this amount, its profits will be taxed at a rate of 2%. Therefore, what this clause does is that it charges large multibillion-dollar e-commerce companies that have earned a lot of income without paying any fees or taxes while also protecting emerging industries. Unlike other jurisdictions that have introduced digital taxes, the Kenyan regulations do not address this issue.

Conclusion.

The digital taxation debate shows Kenya’s attempts to gain revenue from the digital economy.   However, digital services tax is an income tax, making it an advance tax for companies that are already based in Kenya. From the design of regulation 3(1i), it appears that another rationale for digital services tax is to increase the government’s visibility of activities in the digital market.

The regulation however seems to have ignored the reality of the digital economy, which includes micro, small and medium enterprises, as well as global corporations. This is evident from the lack of a turnover threshold, which means that all enterprises providing digital services will be subject to the same administrative burden. Inclusion of a turnover threshold or exempting enterprises that are already paying income taxes would have better served the object of increasing tax revenue from the digital space.

[1] Bunn D, ‘The U.S. Trade Representative Expands Its Digital Services Tax Investigations’, Tax Foundation, 2020, 1. https://taxfoundation.org/us-trade-representative-ustr-digital-services-tax-investigations/ accessed on 31st August 2020.

[2] Gatuyu J, ‘Taxing a Digital Economy: Exploring Intangible Assets to Broaden Revenue Base in Kenya Justice’, Strathmore Law Review, 2019, 120.

[3] Gatuyu J, ‘Taxing a Digital Economy: Exploring Intangible Assets to Broaden Revenue Base in Kenya Justice’, Strathmore Law Review, 2019, 120.

[4] Ting A, ‘iTax-Apple’s international tax structure and the double non-taxation issue’ British Tax Review, 2014, 47, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2411297 on 31st August 2020.

[5] Bunn D, ‘The U.S. Trade Representative Expands Its Digital Services Tax Investigations’, Tax Foundation, 2020, 1. https://taxfoundation.org/us-trade-representative-ustr-digital-services-tax-investigations/ accessed on 31st August 2020.

[6] Smout A, ‘Airbnb backs OECD approach to digital services tax’, The Jakarta Post. https://www.thejakartapost.com/news/2020/08/12/airbnb-backs-oecd-approach-to-digital-services-tax.html accessed on 12th August 2020.

[7] Most-favoured-nation (MFN) treatment under article II of the General Agreement on Trade in Services prohibits treating one country’s goods or services differently from how you treat similar goods/services from another third-party state.  https://www.wto.org/english/thewto_e/whatis_e/tif_e/agrm6_e.htm WWTO Website accessed on 1st September 2020.

^[8] Section 4, Finance Bill 2020. Amendment to section 12E Income-tax Act.

^[9] Section 4, Finance Bill 2020. Amendment to section 12E Income-tax Act.

^[10] Section 3, Finance Bill 2020. Amendment to section 3(2) Income-tax Act.

^[11] Regulation 3(1a-h), The Income Tax (Digital Service Tax) Regulations, 2020.

[12] Regulation 3(1a-h), The Income Tax (Digital Service Tax) Regulations, 2020.

^[13] Regulation 3(1i), The Income Tax (Digital Service Tax) Regulations, 2020.

[14] Regulation 3(1i), The Income Tax (Digital Service Tax) Regulations, 2020.

^[15] The United Kingdom government website. https://www.gov.uk/government/publications/introduction-of-the-digital-services-tax/digital-services-tax accessed on 12th August 2020.