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INSIGHT: Kenya—Taxation of the Digital Economy

July 21, 2020, 7:01 AM

In 2019, Kenya introduced tax measures to tax the digital economy. Like most jurisdictions, the tax was set to widen the tax base and generate additional revenues, as the income from the digital economy went untaxed due to the nature of the businesses involved. Following the amendments made in 2019, the National Treasury is set to release regulations on mechanisms of the digital tax in 2020.

This article reviews the current digital tax provisions, the proposed regulations, and how Kenya intends to tax the digital economy.

Income Tax Measures

The tax measures introduced simply highlighted that income derived in Kenya through transactions across a digital marketplace shall be subject to income tax and value-added tax (VAT). A “digital marketplace” is defined as a platform enabling direct interaction between buyers and sellers of goods and services via electronic means. The implementation of this tax at the time was ambiguous, as it was not outlined how the tax would be accounted for or paid. Further, the measures did not address two salient issues on the taxation of the digital economy, namely nexus rules and profit allocation.

The tax provisions did not highlight whether the tax would be implemented as withholding tax payable on gross revenues earned, or as corporation tax payable on the taxable profit. In the case of a withholding tax there was no clear rate outlined. In the case of corporation tax then, nexus rules had to be applied for nonresidents, such as determining if there was a taxable presence or permanent establishment for foreign entities.

However, this will pose a challenge, as the concept of a permanent establishment in Kenya is mainly based on an entity’s being physically present or having a physical representative in the country. Currently, the Kenyan tax provisions on permanent establishments, particularly in the context of these types of businesses in the digital economy, would not establish a taxable presence.

The Organization for Economic Co-operation and Development (OECD) has released a proposal for a Unified Approach under Pillar One: in it the recommendations for nexus rules are that revenue thresholds be used to determine whether an entity has performed significant economic activities and generated taxable income within a given jurisdiction. This has been the case with countries like France, which has implemented the digital services tax and relied on revenue thresholds in determining a taxable presence.

Once a taxable presence has been determined, the next hurdle would be how best to allocate the revenues between jurisdictions, which was also not addressed in the tax measures introduced by Kenya.

Finance Act 2020

The Finance Act 2020, (the Act) which was enacted into law upon assent on June 30, 2020, provided guidance on the above questions. The Act included specific income tax measures relating to digital services tax which shall take effect as at January 1, 2021:

  • the tax shall take the form of withholding tax which shall be payable at 1.5% of the gross revenues earned by either a resident or nonresident person;
  • the tax shall be payable at the time of transfer of payment to the service provider;
  • the Commissioner General will appoint a digital services tax agent to collect and remit the tax; and
  • the tax shall be used to offset against the tax payable by the resident or nonresident supplier for that particular year of income.

The measures provide clarity on the rate to be used, and how the tax will be accounted for and remitted to the Kenyan Revenue Authority (KRA). The onus is therefore placed on the buyer or the appointed digital services tax agent to remit the tax owed upon payment to the seller. It is highly likely that financial institutions or entities facilitating payment services shall be appointed as digital services tax agents. The seller may opt to gross up their fees such that the burden falls on the buyer who will bear the additional withholding tax costs, essentially making these goods or services more expensive.

It is also expected that like other countries, such as France, which have opted to implement the tax, Kenya will face a backlash from countries such as the U.S.

VAT Measures

As it stands, income derived from transactions carried out across a digital marketplace is subject to VAT. Based on this provision, we can deduce the VAT treatment that would be applicable. For instance, in the event a taxpayer meets the VAT threshold of an annual turnover of $50,000, they would be required to register for VAT. In the event they do not meet the threshold, the taxpayer can voluntarily register for VAT. Alternatively, in the case of a nonresident, a local tax representative can be appointed to register and account for the tax on their behalf. Once the taxpayer has registered for VAT they can then account for the tax accordingly. The prescribed VAT rate will be 14% and the applicable requirements for accounting for VAT will be applied.

Draft VAT Regulations

The National Treasury has released draft VAT regulations on digital market supply for public participation and tabling in Parliament. If implemented, tax measures may be adopted as outlined below.

Scope

The proposed regulations only provide for the supply of services across a digital marketplace. The digital services will include the supply of downloadable digital content, subscription-based media, software programs, supplies on online marketplaces, digital media content, data management services, search engine services, among others, and include any other supply as determined by the Commissioner. This captures a large amount of digital-based services or content and leaves the rest at the discretion of the Commissioner.

Registration

The proposed regulations also highlight two instances in the case of a supply of services which are a business-to-business (B2B) where both entities are registered and business-to-consumer (B2C) where the supplier is a registered person and the consumer is not a registered person. This means that in both instances, the supplier has to be a registered person. The proposal further highlights that a nonresident person should be registered if:

  • in a B2C transaction the supplier is based outside Kenya and the recipient in Kenya; or
  • the supplier either conducts business in Kenya, or the place of supply is in Kenya, or the recipient is in Kenya, or the supplier has a business based/registered in Kenya, or the payment to the supplier originates from Kenya.

The key determinants for registration are therefore if the payment, place of supply or recipient is in Kenya. In the case of the place of supply this includes if the recipient of the supply, payment proxy or residence proxy are based in Kenya. The proxies include intermediaries who either facilitate supply of services, invoicing or collection of payments. This includes financial institutions, local representatives/offices, and agents, among others.

The registration will be completed online through a form provided by the Commissioner General. Alternatively, the proposed regulations provide that a local representative can be appointed to register and account for the tax. Following registration, the verification, filing, accounting and other related processes, such as de-registration of the nonresident person, shall also be done electronically. This will likely be done via the I tax platform which is Kenya’s electronic tax system.

Another key proposal is that the supplier shall be required to register within 30 days of the regulations being passed. This is a short timeline, particularly for nonresidents who may not be familiar with Kenya’s tax systems or laws, and who may opt to use a local representative.

Mechanisms of Accounting for VAT

A reverse charge mechanism will be applied in the case of a B2B transaction. The proposed tax point when VAT shall be due will be the earlier of the payment, invoice or supply. If the supplier has a locally based intermediary, the onus of accounting for VAT shall fall on the intermediary regardless of whether the supplier is registered or not.

The time lines and other filing requirements shall be similar to any other supply as outlined in the VAT Act. However, the supplier will not be required to issue a valid tax invoice provided the invoice issued shows the value of the supply and tax deducted. The supplier will also not be allowed to deduct input tax, which goes against the provisions of the VAT Act, more so where the input VAT was validly incurred. This also contradicts the principles of the VAT mechanism, specifically the destination principle, and international best practices which stipulate that the burden of VAT should fall on the final consumer.

In the case of overpaid tax, following an amendment by the taxpayer the amount shall be offset against any taxes payable. This contradicts the treatment of other supplies, where an over-payment would result either in an offset or a refund to the taxpayer.

Offenses and Penalties

Failure to comply with any of the proposed regulations will result in penalties. The proposed penalty will be that the taxpayer will be barred from operating in the digital marketplace in Kenya. Although this may be aimed at promoting compliance it will be difficult for the KRA to implement, as the KRA do not regulate these entities or their operations within the digital environment.

It will be interesting to see how effective this penalty will be, given the nature of these businesses. This follows a situation where other countries have attempted to introduce this tax and have faced repercussions in the form of sanctions, such as France which faced sanctions from the U.S. as a result of “targeting” big tech companies originating in the U.S.

Outlook

The digital economy if properly taxed would provide a good source of revenue for Kenya. However, key considerations should be made before introducing blanket provisions to capture any and all transactions under the ambit of digital tax.

First, Kenya should ensure, while taxing the stakeholders, not to hamper small and emerging entrants into the market. Most countries that have introduced the tax have opted to focus on the big players in the market by putting in place a high revenue threshold as part of their nexus rules. Kenya could consider following the same route.

Second, it would be prudent to ensure that the legislation governing digital taxation is clear and leaves minimal room for ambiguity for the taxpayer. For instance, there are various provisions that contradict the VAT Act outlined in the VAT regulations, such as the output–input mechanisms.

Third, Kenya should consider the current proposed guidelines and best practices around digital tax, specifically the OECD guidelines on Action Plan 1 of the Base Erosion and Profit Shifting Project . The OECD specifically advocates fusing a unified approach to tax the digital economy, as opposed to unilateral tax measures.

Taxpayers operating within the digital economy should be aware of the related current and upcoming tax provisions in order to plan accordingly and ensure compliance.

Lynnet Mwithi is a Manager with Taxwise Africa Consulting LLP.

The author may be contacted at: lmwithi@taxwise-consulting.com

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.