Taxation of the digital economy: A Kenyan perspective

By Job Kabochi, Emily Wayua and Andrew Wanjiru - Learn more about the authors

Background Globally, the financial services sector has been at the forefront in adopting digital technology. In Kenya, the sector has experienced tremendous growth as financial institutions digitise their operations making it possible for the sector to offer new products and solutions in country and across borders.

Conventional tax systems as well as globally accepted traditional tax concepts have been called into question with the financial services sector adopting solutions such as blockchain technology, mobile applications, digital banking platforms and e-wallets among others. As a reactionary measure, various countries across the world have moved hastily to enact tax policies that bring digital transactions into the tax net. Unfortunately, this has come with its own challenges premised on the fact that businesses are now conducted across jurisdictions without necessarily having physical presence in the jurisdictions where services are provided or used as was envisioned under traditional commerce.

Challenges of taxing the 'new' financial sector based on traditional tax laws It is acknowledged that there are challenges in implementing fair taxation in the digital space using the traditional tax laws. This is partly attributed to difficulty in tracking the various levels of transactions that occur in the digital space. For instance, digitisation in the financial services sector has enabled customers to access services across the world at a click of button, which is not only difficult to track but also introduces complexity around which jurisdictions have the right to tax the services, if at all.

In addition, advancement in technology has resulted in new revenue streams that were not envisioned in the traditional taxation systems. This has triggered questions regarding the appropriate characterisation of certain transactions and payments for tax purposes in the financial sector.

Unfortunately, businesses and especially multinational companies operating in the digital economy have been met with a lot of suspicion and accusation of taking undue advantage of the lacuna in the fiscal policy. We hypothesize that it is incumbent on the private sector to partner with the public sector policymakers in shaping fiscal policy that does not stifle technological growth but also safeguards national development goals.

With each country looking out for the interest of its own citizenry, it is important that the fiscal measures adopted and implemented across the global are collaborative to avoid incidences of double taxation or double non-taxation. It is on this premise that organisations such as the Organsation for Economic Co-operation and Development (OECD) and the United Nations (UN) have taken a keen interest in the discourse around taxation of the digital economy.

In a 2015 report on taxation of the digital economy, the OECD highlighted that because the digital economy is increasingly becoming the economy itself, it would be difficult, if not impossible, to ring fence the digital economy from the rest of the economy for tax purposes. Similarly, it will not be efficient to have country-specific tax laws that are out of sync with the globally accepted tax principles.

However, bowing to revenue collection pressure, various jurisdictions around the world have opted to enact unilateral tax legislations targeted at the digital economy. These decisions are perhaps justifiable on the basis that the OECD and the members of the Inclusive Framework have taken too long to reach consensus on how to tax the digital economy. Unilateral taxes have also been heightened by protectionist and nationalist tax policies, which cast doubt on the fairness of policies developed externally by more developed trade partners.

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Kenya recently introduced the Digital Service Tax (“DST”) and published the long-anticipated Value Added Tax on Digital Marketplace Supply (“VAT-DMPS”) Regulations to operationalise provisions imposing VAT on digital market supplies. Both the DST and the VAT on digital marketplace regulations are aimed at giving Kenya the right to tax income earned by businesses without a physical presence in Kenya but which derive income from Kenya.

However, similarly to jurisdictions such as the United Kingdom (UK), Kenya has exempted Kenyan licensed financial service providers from DST. Thus, the Government has exhibited its commitment of increasing financial inclusion which is aligned to global policies around sustainable development goals.

From a VAT perspective, the supply of certain electronic services through a digital marketplace is now subject to VAT where supplied under a Business to Customer (B2C) arrangement by a non-resident entity without a physical place of business in Kenya to a Kenyan consumer. For instance, whilst core financial services remain exempt from VAT, the VAT on digital marketplace regulations have sought to tax services such as downloadable e-books, subscription-based media including news and magazines, software programs, distance learning, search engine and automated help desks.

Non-resident suppliers of B2C taxable services on a digital marketplace platform are now required to register and charge Kenyan VAT through the simplified tax registration framework. In the alternative, such suppliers are allowed to appoint a tax representative who will be responsible for their tax obligations. Business to Business (B2B) transactions remain taxable under the “reverse charge” mechanism.

Whilst enforcing digital tax widens the tax base and increases our revenue collection for the country, there is a need to strike the right balance to avoid stifling innovation by taking away the very incentive brought by digital innovation, which is a more cost-efficient means of conducting business compared to the traditional models.

Secondly, imposition of digital taxes in Kenya needs to take into account provisions of cross border protocols and existing Double Tax Treaties. They pose a risk of triggering trade wars with business partners which will endanger outbound cross border trade and erode the gains made over the years in relation to ease of doing business in Kenya.

Accordingly, as Kenya moves to enforce the unilateral tax measures enumerated above, consideration should be given to international tax practices. For instance, Kenya, as a member of the Inclusive Framework, should give consideration to the OECD’s initiatives around the taxation of the digital economy to enrich its tax policies targeted at this sector.

Lastly, it is important to ensure that the operational and implementation challenges associated with digital taxes are ironed out. The administrative processes adopted should guarantee a balance between tax collection and creating a conducive business environment for providers of digital services in sectors such as the financial services sector. This will reduce the instances of tax disputes as well as enhance voluntary compliance.

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