Kenya: embracing the two-pillar approach

By Samuel Okumu, Tax Consultant, Rödl & Partner Limited, Nairobi

The OECD and Kenya Revenue Authority organized a three-day workshop in Naivasha, Kenya during the last week of January to take stock of efforts Kenya has made in rolling out the recommendations advanced by the OECD/G20 Inclusive Framework on base erosion and profit shifting (BEPS). One of the workshop’s major highlights was a pledge the two organizations made to step up their collaborative efforts to adopt the framework’s two-pillar approach to address taxation challenges of the digital economy.

Progress in adoption of 2015 BEPS Action 1 report

The discussions on adoption of the two-pillar approach was preceded by an update on the implementation of the 2015 BEPS Action 1 report. It is worthy to note that it took Kenya a period of six years to draft legislation and craft appropriate architecture to adopt the 2015 BEPS Action 1 report. The value-added tax (digital marketplace supply) regulations and the income tax (digital service tax) regulations were essentially in effect from  January 1, 2021. The digital service tax created a new nexus for nonresident enterprises with significant economic presence in a country based on identified interaction with the Kenyan economy through digital technology and automation. Initially, the tax was conceptualized as a withholding tax in draft regulations; it was later set up to target both resident and nonresident entities. However, this was rectified six months later to realign it to the recommendations under the 2015 BEPS Action 1 report. Similarly, the VAT (digital marketplace supply) regulations were an effort to apply the principles of the international VAT/GST guidelines through the introduction of collection mechanisms for digital supplies in B2C transactions. The statistics on the uptake of these taxes, and contribution to the consolidated fund, are expected at the end of the government’s fiscal year in June 2022.

This begs the question regarding whether the time is ripe for Kenya to consider a changeover to the two-pillar approach barely a year after implementing recommendations under the 2015 BEPS Action 1 report. Should Kenya first wait to reap from its current infrastructure, or jump to the two-pillar approach that promises to reallocate taxing rights on over USD 125 billion in profits under Pillar One, and generate additional global tax revenue of USD 150 billion under Pillar Two?

Basics of Pillar One and Pillar Two approaches

The two approaches are a paradigm shift from the application of an equalization levy and withholding tax on digital transactions provided by nonresident enterprises, such as digital service taxes, as recommended under the 2015 BEPS Action 1 report.

Pillar One adapts the international income tax system through changes to the profit allocation and nexus rules applicable to business profits. Basically, it expands the taxing rights of market jurisdictions (which is mostly where the users are located) where there is purposeful and sustained participation of a business in that economy through activities in, or remotely directed at, that jurisdiction. It also improves tax certainty by introducing innovative dispute prevention and resolution mechanisms.

On the other hand, Pillar Two provides a systematic solution that is designed to ensure that internationally operating businesses pay a minimum level of tax regardless of where they are headquartered or the jurisdictions they operate in under what is termed as income inclusion and undertaxed payments rules (the GloBE rules).

The options for Kenya

Last year, Kenya announced a move to adopt a ‘digital economy blueprint’ that will focus on improving digital government, digital business, infrastructure, innovation-driven entrepreneurship, and digital skills and values. Such developments guided last year’s revenue target for the new digital taxes from some 1,000 businesses and individuals at KES 5 billion (US $44 million). It is imperative that the actual revenue performance of this tax regime be assessed and subjected to a cost-benefit analysis before jumping into the two-pillar approach.

Whereas the technical officials of the Centre for Tax Policy and Administration at the OECD have been successful in convincing 137 out of the 141 fold of OECD and G20 countries, Kenya should thoroughly benchmark its share of the mentioned expected revenue under the two-pillar approach against the actual performance of digital tax revenue in the current fiscal year. This is because a lot of time and resources have already been dedicated to trailing the gun at nonresident players in the digital economy. Any further efforts should be justified by proven past performance. The enactment of enforcement measures like denial of service to non-compliant, nonresident digital economy- players should be implemented and effects to the national kitty monitored. The Kenya Revenue Authority also should learn from the importance of stakeholder engagement before blindly joining the rest of the fold in supporting the two-pillar approach.

We look forward to reports on the performance of digital taxes and further commentaries on Kenya’s possible share of the promised revenue target.

• Samuel Okumu is a senior tax consultant at Rödl & Partner Limited in Nairobi.