Already an IBA member? Sign in for a better website experience
The IBA’s response to the situation in Ukraine
The digital transformation of the world economy over the past few years has benefited a wide variety of sectors, including financial services, trade, health, transport and education. However, it has also significantly changed the way companies do business, introducing new and more complex business models.
The digital economy encompasses:
A key characteristic of digitalisation is that it allows companies to carry on business in locations where they do not have a physical presence. Existing international tax laws are, in principle, based on a physical presence attributable to a permanent establishment in a particular country. Consequently, efficiently taxing the digital economy has become a crucial consideration for tax authorities across the globe.
The introduction of digitalised business models has intensified the two fundamental challenges of international tax:
The OECD/G20 Inclusive Framework on BEPS and its implications for Africa
In January 2019, the Organisation for Economic Cooperation and Development (OECD)/G20 Inclusive Framework (IF) on Base Erosion and Profit Shifting (BEPS) launched a process aimed at addressing some of the fundamental challenges arising from the digitalisation of the economy, including the allocation of taxing rights. Subsequently, the IF has agreed a two-pillar solution consisting of the following components.
Pillar One is aimed at a fairer distribution of profits and taxing rights among jurisdictions. It applies to MNEs, other than extractive and regulated financial services companies, with a global turnover exceeding €20bn and profit before tax/revenue above 10 per cent. The so-called residual profit – 20–30 per cent of profit in excess of 10 per cent of revenue – is to be allocated to ‘market jurisdictions’ where goods or services are used or consumed, when the MNE derives at least €1m from that jurisdiction (€250,000 in the case of countries with a GDP of less than €4bn).
Pillar Two seeks to introduce a global minimum corporate tax rate of at least 15 per cent to protect the tax bases of respective countries and to curb international corporate tax competition. MNEs meeting the country-by-country reporting threshold of €750m are subject to the Global Anti-Base Erosion Rules which, inter alia, levy a ‘top-up’ tax payment on a parent entity in respect of the low taxed income of a constituent entity.
An implementation plan to develop model legislation, guidance and a multilateral treaty in respect of the Pillar One and Two Framework are expected to be finalised in 2022 with implementation from 2023.
As of November 2021, 141 jurisdictions have joined the two-pillar framework for international tax reform. Several countries in sub-Saharan Africa, including Angola, Benin, Kenya, Mauritius, Namibia, Nigeria, Senegal, Sierra Leone, South Africa and Togo are members of the IF. However, concerns have been raised about the potential lack of benefits from the framework for the African continent.
The African Tax Administration Forum (ATAF), an African network that aims to improve tax systems in Africa, welcomes the framework as a milestone in achieving global consensus on tax challenges in digitalised economies. However, it has expressed reservations on the potential effectiveness of the proposed provisions for Africa. Its comments on the Blueprint proposals (issued in October 2020) said that the Pillar One Rules were far too complex and would only result in a very modest amount of profits being reallocated to smaller market jurisdictions.
The new Pillar One rules were subsequently simplified, but the ATAF still maintains that reallocation of profits should instead be calculated as a portion of the MNE’s total profit, instead of on its residual profit. It is of the view that this would simplify the determining of allocatable profits and ensure a fairer treatment of businesses with a current taxable presence in a market jurisdiction, as compared to those without. If the residual profit basis is to be retained, it argues that at least 35 per cent of residual profit should be allocated to market jurisdictions. ATAF is also of the view that the minimum effective tax rate under Pillar Two should be at least 20 per cent in order to effectively guard African tax bases and curb illicit financial flows from the continent.
Unilateral measures to tax the digital economy
While the OECD/G20 IF discussions on international taxation reform continued, several countries (including the UK and France) opted to introduce unilateral measures to address some of the tax challenges of the digital economy. Several sub-Saharan African countries have expanded the scope of their indirect taxes to cover digital services, but to date, only a few have implemented some form of direct digital services tax (DST) applying to non-residents with no local physical presence.
For instance, with effect from 1 January 2021, Kenya is levying a 1.5 per cent tax on income accruing through a ‘digital marketplace’, defined as a platform that enables the direct interaction between buyers and sellers of goods and services through electronic means. In Zimbabwe, the annual gross income from satellite broadcasting services in respect of the provision or delivery of television or radio programs and e-commerce operators providing or delivering goods or services to persons resident in Zimbabwe exceeding $500,000 are taxed at a rate of 5 per cent, having taken effect on 1 January 2019. Nigeria levies corporate income tax at the standard rate of 30 per cent of taxable income from widely defined 'digital services', including electronic commerce, electronic data storage, online adverts, participative network platforms and online payments, to the extent that a company that earns revenue in excess of NGN25m, has a significant economic presence in Nigeria and profit can be attributable to such activity.
ATAF guidance on drafting digital services tax legislation
In light of the apparent lack of stakeholder consensus on digital tax rules in Africa, in June 2020 ATAF announced, in a policy document titled Domestic Resource Mobilisation – Digital Services Taxation in Africa, that it was in the process of developing the Suggested Approach to Drafting Digital Services Tax Legislation (Suggested Approach) to provide African countries with a structure and framework for introducing DST, taking into consideration the specific challenges faced by African countries.
The Suggested Approach was published in September 2020. It highlights the risk for countries in merely waiting for the OECD IF’s international solution, which could significantly delay the implementation of legislation to enforce the appropriate taxing rights on the profits of digital businesses and result in material tax revenue losses for already under-funded African jurisdictions.
The ATAF is of the view that, while the revenue generated by DST may not be significant for some African countries, a DST could improve public confidence in the fairness of the tax system by taxing high-profile digital companies that do not have a local physical presence. It proposes the introduction of a DST at the rate of between 1 per cent and 3 per cent on gross annual digital services revenue earned by a MNE in a country. It also provides standard text that can be adopted by member countries in their domestic laws. The suggested legislation proposes formulas for allocating income from digital services to a particular jurisdiction based on the participation of users in a given country.
It is recognised that DSTs should not reduce the growth of the digital sector in African countries, particularly start-ups and SMEs. As DST is a tax on gross turnover, it would also apply to loss-making companies and those with low profit margins. Member countries should, therefore, consider a robust de minimis threshold, to ensure the DST only targets established and profitable digital businesses.
The IF requires countries that adopt the new international tax rules to commit to the removal of all DSTs on all companies; ATAF’s Suggested Approach advises its members to consider whether they would be willing to make a commitment to repeal their DSTs when a consensus-based international solution is achieved. Some African jurisdictions have already taken a stance in this regard. Although Kenya and Nigeria are members of the IF, they are yet to sign the agreement over concerns on the removal of DSTs and the dispute resolution mechanism.
The potential negative impact of digital taxation in Africa
Africa, with its youthful demographic profile, is a significant user of the internet, social media platforms, cloud computing and other digital services. The last decade has seen substantial development in ICT infrastructure and an increase in internet penetration on the continent. Between 2000 and 2019, the internet-connected population of Africa grew from 4.5 million to over 526 million, reaching 39.3 per cent penetration and accounting for around 11.5 per cent of the global internet population. Access to mobile telecommunications has also grown vastly since the year 2000.
Research shows that, for every 10 per cent increase in mobile broadband penetration, there is an increase of between 0.82 to 1.4 per cent in the gross domestic product (GDP) of developing countries in Africa. The digital economy is a significant driver of economic development in the region.
The growth in the digital economy provides an opportunity to governments to increase their revenue collection and expand their tax bases, which is particularly important for sub-Saharan African countries with large informal economies and limited tax bases. Furthermore, the economic slowdown caused by the Covid-19 pandemic has eroded tax revenues across the globe and forced revenue authorities to find alternative sources of taxation. As the pandemic has obliged countries to adjust to utilising unconventional digital means for education, banking, conferencing, meetings and the sale of goods, the digital services sector appears to be thriving despite the current adverse circumstances.
African policy makers are well aware of this fact; the digital economy is high on the list of untapped sources of funds for many African tax authorities. However, a delicate balance must be achieved between increasing tax revenues without stifling the growth of the digital economy. One of the barriers that inhibits internet connectivity and limits use on the continent is the high cost of internet-enabled mobile devices and data, which is exacerbated in countries with high customs duties on mobile devices and excise taxes on over-the-top (OTT) services and/or other digital mediums such as mobile money.
At a workshop on the impact of digital taxation on digital rights in Africa organised by the Collaboration on International ICT Policy for East and Southern Africa (CIPESA) earlier this year, participants deliberated on good digital taxation practices and the impact of taxation on users and national ecosystems. The workshop highlighted that poorly designed digital taxes could lower domestic tax revenue and negatively impact affordable and meaningful access to the internet.
Professor H Sama Nwana, a technology and telecommunications consultant affiliated with the UK-based Cenerva, is of the view that digital taxes in various forms are not only regressive, but they also disenfranchise poor and marginalised groups such as the informal sector, women and the youth in rural areas – who need the internet the most. Countries which have introduced digital taxes have registered a subsequent decline in the number of people accessing and using the internet and other ICT-related services, ultimately leading to less revenue generated for the government. For example, when Uganda introduced a 1 per cent excise duty on the value of all mobile money transactions as well as a tax on social media in 2018, it sparked public outcry and internet subscriptions fell drastically. It also turned out that the government did not raise the anticipated revenue, as most users turned to virtual private networks (VPNs) to access social media platforms.
A case study in a June 2020 working paper by the International Centre for Tax and Development of examined the taxation of the digital economy in Ghana, Kenya, Nigeria, Rwanda, Senegal and Uganda, with reference to the digitalised businesses of Amazon, Uber and Google respectively in these countries.
The paper found that the key problem of taxing highly digitalised businesses in African countries is not due to their lack of a local taxable presence, but to the attribution of profits. For example, Uber has registered local subsidiaries with physical offices in four of the six countries surveyed (it has a substantial presence in each of these countries). These subsidiaries are set up to provide administrative services but do not own any intellectual property rights and do not receive any revenue from users of the Uber application. They appear to be merely remunerated on a cost-plus basis for supplying support services, whereas substantial revenues are flowing to foreign affiliates subject to low taxation.
As at the date of the study, the participating countries have focused on the levying of indirect taxes on digitalised businesses. Collecting value-added tax (VAT) on digital transactions has the benefit of relative administrative ease and the existence of a legal framework, as compared to corporate taxes. All six countries surveyed have the required legal provisions to levy VAT on the supply of services in the country by non-residents. However, these countries often lack administrative measures obliging non-resident digitalised businesses to register for VAT. Kenya, Nigeria and Rwanda apply a reverse charge mechanism, which can be effective for business-to-business (B2B) services but is not viable for business-to-consumer services (B2C), which form the majority of cross-border digitalised services.
Mobile transactions tax seems to be dominant in East African countries, mainly due to the growth in mobile phone-based money services, such as M-Pesa, in the region. In Kenya, the government imposed excise taxes on mobile transactions, internet data and money transfers. Although mobile transaction taxes are relatively simple to collect, the paper cautions African countries against imposing these, as they are regressive in nature and often have a negative impact on low income earners.
The paper recommends that, ideally, African countries should focus on large MNEs such as Uber, Google and Amazon with some international coordination. However, the OECD’s unified approach at present proposes a rather complicated methodology, whereas developing countries need simplified methods. In the long term, the best way forward for African countries would be to build on the G24 fractional apportionment proposal under the IF on BEPS, which entails a form of unitary taxation that would allocate profits based on the real activities in each location (employees, physical assets and sales), to ensure a fair profit allocation between countries.
Conclusion and recommendations
Think20, the research and policy advice network of the G20, says:
‘Africa is in a unique position to seize the opportunities presented by the tax challenges of digitalisation to take a proactive role in the international tax cooperation where it would contribute to steering the direction of the global standard agenda rather than providing inputs in a pre-determined agenda; thereby seizing the opportunity for more inclusiveness in international tax governance’.
African countries need a more comprehensive solution to address some of the challenges and limitations of digital taxation. Participating at multilateral platforms such as the IF on BEPS is crucial to address digital tax challenges, but ultimately solutions will have to cater for the specific challenges faced by African economies, requiring extensive regional consultations across the continent. Strengthening regional collaboration through a unified digital tax regime is also more likely to provide better compliance, since individual African countries are relatively insignificant markets for digital MNEs and African states that are members of the IF on BEPS hold limited sway in the international tax world.
Tax models should be reviewed, taking into account the interests of both governments and consumers through collaborative efforts. It is of the utmost importance that economic impact assessment studies are performed prior to implementing changes to tax systems to understand and appreciate the potential impacts and unintended consequences that amendments may have on revenue generation and marginalised groups. Public consultation would also assist in preventing the implementation of poorly structured taxes that penalise the poor, lower connectivity and have a negative impact on economic growth.
An immediate priority for African countries should be to strengthen VAT legislation by providing definitions of what constitutes taxable digitalised services – potentially implementing a simplified collection and compliance mechanism for non-residents to register remotely through a simple portal for online registration.Excise taxes on digital services should be avoided, with the focus instead being on the taxation of the companies that are earning the income. If African countries consider it necessary to tax mobile transactions, such taxes should be progressive and based on thresholds to limit.