Ideas & debate
Gross loopholes in the new tax law for digital services
Thursday, January 28, 2021
From TITUS MUKORA
Summary
- Given that the legislation is being drafted, it is therefore likely that taxpayers will face legal challenges regarding the scope of taxation, as there are gaps between the draft law as it is and the KRA's legal understanding.
- One possible solution for Kenya is the treaty article on automated digital services proposed by the United Nations.
- This proposal is easy to understand and gives a clear definition of what constitutes automated digital services without necessarily expanding the scope of taxation to unrealistic limits.
There has been a lot of media comment on the newly introduced tax on digital services. While the rationale for the imposition of taxes on digital services is widely understood, there seems to be some concern as to whether the law passed will achieve the goals desired by the Kenya Revenue Authority (KRA).
The first problem is the scope of the Digital Services Tax (DST) and the types of businesses to which it applies. The Income Tax Act, the primary act, provides that taxes on digital services apply to a digital market, which in turn is defined in the same act as a platform that enables direct interaction between buyers and sellers of goods and services electronically.
Accordingly, the tax on digital services therefore applies to a limited number of companies, namely companies that provide a platform for the interaction of buyers or sellers of third parties. It would therefore take the view that a company selling its own goods on a digital platform does not provide a platform for interaction between sellers and buyers, but rather sells its own products. When a company does not provide its own goods, but provides a platform for others to provide its services or goods to buyers, it falls under the definition and is subject to daylight saving time. Ride-hail apps that connect rider and driver would be seen as a digital marketplace, while an ecommerce company selling its own product online would not be a digital marketplace. This interpretation is in line with the definition of a digital marketplace as proposed in various other countries.
However, the current draft of the DST rules, which are secondary laws, appear to extend the application of the tax to digital services to a wide variety of activities that do not qualify as a digital marketplace or platform provider as defined in the main part of the Income Tax Act. The DST regulations seem to suggest that streaming companies providing their own content or companies selling goods online would be subject to the digital service tax.
In terms of the rule of law, it is clear that the provisions of a law cannot replace the scope of primary law. In the case of the DST rules, the scope of the tax on digital services has been extended by secondary law. Given that every business has a digitized component – if a widespread application of a tax to digital services is introduced, it will inevitably lead to a whole range of businesses being wrongly and illegally taxed under the tax on digital services from 2021 onwards.
The legislation also states that the tax on digital services only applies to companies whose income is “accrued or derived” from Kenya. The requirement that Kenyan income tax only apply to income “accrued or derived from Kenya” is not new. The principle underlying the Income Tax Act states that a company must physically exercise its dominant activities in Kenya before this income is taxed. For example, a Japanese car exporter based in Kyoto, Japan and exporting cars to Kenya is not subject to income tax in Kenya, while a company selling Japanese cars in a bazaar in Jamhuri Park is subject to Kenyan income tax.
The requirement that Kenyan income be “accrued or derived” is precisely why a global e-commerce company with no business in Kenya was not subject to tax until the law was changed – as its predominant activities were outside Kenya. If the “accrued or inferred tax” had not acted as a tax constraint, it would not have been necessary to introduce a separate “tax on digital services”. The proposed tax on digital services has therefore been restricted in its application by the express requirement in the provisions introducing the tax on digital services that such a tax is only applicable to income from or originating from Kenya. It can be argued that we are no better now than we were before the tax legislation for digital services was introduced.
Given that the legislation is being drafted, it is therefore likely that taxpayers will face legal challenges regarding the scope of taxation, as there are gaps between the draft law as it is and the KRA's legal understanding.
One final point to note. Whenever transactional or sales-based taxes are introduced into the Income Tax Act, it is likely that those taxes will not be paid by the person who earns the income, but simply passed on to the consumer. It will no longer be a tax on "income" but a tax on "consumption". Just like withholding tax on non-residents, the tax on digital services can be transferred to Kenyans through an equivalent price increase, which only increases the tax burden for Kenyans.
This phenomenon eliminates the argument that taxes are introduced through the taxation of non-resident digital companies for the sake of fairness and equity – far from being, they only make goods and services more expensive for an already overburdened Kenyan taxpayer.
One possible solution for Kenya is the treaty article on automated digital services proposed by the United Nations. This proposal is easy to understand and gives a clear definition of what constitutes automated digital services without necessarily expanding the scope of taxation to unrealistic limits. This proposal can be considered as a stop-gap measure.