In the context of the 2008 financial crisis, the Organisation for Economic Cooperation and Development (OECD) and the G20 set up the Base Erosion and Profit Shifting Project (the BEPS Project), to tackle tax avoidance by multinational companies. One of the action items of the BEPS Project was the need to address the tax challenges arising from the digitalisation of the economy. This is because, the traditional and current international tax framework which dates back to the 1920s, is/was based on brick-and-mortar businesses and taxation is/was tied to the physical presence of a business.
However, the digitalisation of the global economy made it possible for multinationals to operate in multiple countries without having any physical presence in those countries. In addition, these companies no longer need to generate revenues/profits from tangible goods as their businesses are modelled on commercialising intangibles. Take, for example, a streaming service such as Netflix. It doesn’t need to have any physical office in Kenya in order for Kenyan users to stream their favourite shows.
Whereas digitalisation has delivered tangible benefits to consumers, the new business models have also provided an avenue for these companies to derive income from the countries they operate in without paying their respective share of taxes, seeing how they have no physical presence in those countries.
It is against this background that the OECD/G20, under the BEPS Project, have been working on finding consensus on an international tax framework/solution. However, pending global consensus, countries such as France, Japan, India, and Turkey began to impose unilateral digital taxes and Kenya has now joined the bandwagon.
Expansive taxation plan
It is against this background that Kenya introduced a Digital Services Tax (DST) to limit the shift of income by foreign digital service providers operating in Kenya and expand the tax base to the digital sector that had arguably been out of the purview of the taxman. A tax on digital services was initially contemplated in 2019 when Parliament passed amendments to the Income Tax Act to specifically provide that any income derived from or accrued in Kenya from a digital marketplace would be subject to income tax in Kenya. The amendments also introduced the definition of a digital market place to mean a platform that enables the direct interaction between buyers and sellers of goods and services through electronic means. However, the implementation was conditioned on the publication of the corresponding regulations by the Cabinet Secretary (CS) of the National Treasury.
Months later, President Uhuru Kenyatta assented to the Finance Act 2020 which among other provisions, introduced a Digital Services Tax to be effective from 1 January 2021 at the rate of 1.5 per cent of the gross transaction value of services and payable on income earned from services performed on digital market places. However, it was not until recently when the CS published the Income Tax (Digital Services Tax) Regulations, 2020 that the DST became a reality for Kenya.
Defining digital services
DST will be chargeable on digital services that are provided to users located in Kenya. Digital services refer to any services that are performed on digital market places, which are platforms that enable the direct interaction between buyers and sellers of goods and services. This definition would include social media platforms such as WhatsApp, Twitter and Facebook. However, the regulations have expanded the scope beyond what would traditionally be considered as services by including items such as downloadable digital content and user data monetisation.
I should note that the Kenya Revenue Authority (KRA) will have wide discretion in determining whether a particular service is a digital service as the regulations provide that any service performed on a digital market place will be treated as a digital service. Common examples of digital services subject to the DST are streaming services, website hosting, cloud storage services, lead generation services (ride-hailing apps) etc.
Interestingly, online services that facilitate payments, lending, trading of commodities and foreign exchange done by licensed financial institutions and other approved institutions such as cooperative societies will be exempted from the DST. In addition, online services performed by government institutions are also exempt from DST and prices for government services are not expected to increase on account of the DST.
Who is a user?
A user of digital services will be deemed to be located in Kenya, if (1) they pay for the service from a financial institution in Kenya, (2) they access the service from an IP address in Kenya, (3) they access the service using a device in Kenya and (4) their billing or residential or business address is in Kenya. If a user meets any of the four proxies, then the income derived from the service provided to that user will be subject to DST in Kenya.
The DST is calculated by computing 1.5 per cent of the amount paid to the digital services provider or the fee paid to the digital marketplace provider, but without including any Value Added Tax (VAT) payable on the transaction. The responsibility to pay DST to KRA is on the digital service or digital market place provider. The regulations distinguish between a provider of services and a provider of a market place. For context, the owner of an e-commerce site would be a digital market place provider and the provider of a streaming service would be a digital services provider.
Digital service or a digital market place provider is required to pay the DST and file the corresponding returns on or before the 20th day following the month that the service was offered. However, for foreign digital service and market place providers, they have the option of registering for DST through a simplified registration framework, pay the respective DST and file returns directly; or they could appoint a tax representative to comply on their behalf.
For digital sector players that are located in Kenya, the DST they pay during the year will be an advance tax of their total tax liability for the year. This means that they will be able to recover the DST they remit from their tax liability for the year. However, if the DST they pay during the year will be higher than their tax liability, they could claim a refund from KRA on account of the overpaid tax or carry forward the overpaid tax and use it as a credit against their future tax liability. For foreign digital service providers, the DST they pay to KRA will be a final tax and will not be recoverable.
For local businesses, the DST will be an additional burden on their cash flows and for businesses that will be paying the new minimum tax, their cash flows are expected to take a bigger hit. The DST may also be a headache for technology startups that burn through cash in their first year’s operations as they will not be able to recover the DST they pay during their loss-making years until they break even and generate tax profits.
On the other hand, consumers may end up paying higher prices for digital services as digital service providers gross-up prices to account for the impact of the DST. I expect that once the OECD/G20 find consensus on an international solution, the DST will be repealed or modified in favour of the globally agreed framework and as such the DST is likely a temporary measure for the exchequer to shore up tax revenue to bridge the worrying budget deficit.
Lastly, considering that the KRA may not have visibility of digital transactions, enforcement will not be a walk in the park. We can only adopt a wait-and-see approach.
By Ndegwa Alex, Corporate/Tax Lawyer (firstname.lastname@example.org)