What the President Ruto, United States tax deal means for Kenya

President William Ruto, US Ambassador to Kenya Meg Whitman and Brenda Mbathi, the American Chamber of Commerce (AMCHAM) board President during the organisation’s regional business summit in Nairobi. FILE PHOTO | PCS

President William Ruto last week announced that the digital service tax (DST), which is charged at the rate of 1.5 percent on income derived or accrued in Kenya from services offered through an online marketplace, would be aligned with the Organisation for Economic Co-operation and Development (OECD) framework.

The OECD, a club of rich countries, sets the rules governing international taxation for multinationals to deal with tax cheats.

The club recently came up with what is now known as the OECD Inclusive Framework in an effort to confront the headache of profit shifting by multinationals, following complaints from developing countries.

But the two-pillar solution framework has also been controversial.

What does the deal mean for Kenya?

Should Kenya ratify the framework, it shall be able to tax all those multinationals that are making money in the country but not paying taxes.

These companies have been able to escape the taxman’s dragnet because they do not have a permanent residence here (thus not eligible for corporate income tax) and are not digital service providers, which incur a 1.5 per cent digital service tax (DST), regardless of whether they have a subsidiary or permanent residence here.

What is the OECD Inclusive Framework?

The framework applies to 40 countries which have an information-sharing arrangement.

The Treasury is a signatory to this information-sharing arrangement on cross-border transactions by multinational enterprises in the member countries.

“This is done to ensure that the taxing rights of a country are not undermined by opaqueness,” said Vincent Ongore, an associate professor of business administration and entrepreneurship, at the Technical University of Kenya.

Dr Ongore said that for long, taxing rights have been apportioned based on where income is generated and residence, making it difficult to tax fintech which do most of their transactions online, leading to the problem of traceability.

This is why the country came up with the digital service tax. But the two-pillar solution wants to get rid of DST.

What is the OECD’s two-pillar solution?

The OECD came up with a two-pillar solution to address the problem of tax avoidance by multinationals across its member countries, beyond the companies that provide a digital marketplace.

Under Pillar 1, a portion of the profits of the largest and most profitable groups is allocated to market jurisdictions.

Pillar 2 introduces a minimum corporate income tax of 15 percent, with the parent company forced to top up should the tax fall below this level.

While there have been minimum hitches on the application of Pillar 2, which is set to take effect in January next year, the mechanics for Pillar one are yet to be completed.

Why is Pillar 1 controversial?

Pillar 1 is controversial for a number of reasons. First, in the case of Kenya, its implementation will mean the country will have to abandon its DST for a tax regime that, in the words of KRA Digital Service Tax lead Nickson Omondi, is uncertain.

Keeping DST while also implementing the Pillar 1 solution will amount to double taxation for companies involved in the digital marketplace such as Google, Netflix, Amazon, Facebook, Ali Baba and Twitter.

Second, most of the companies involved are American — including Amazon, Alphabet which owns Google, Microsoft, Dell Technologies, Verizon Communications, Wells Fargo and General Electric.

These companies, and many others from other advanced economies, have a turnover of (Sh2.9 trillion) €20 billion in worldwide revenues and a profit before tax margin of at least 10 percent.

These companies will be forced to share a fraction of their profits in markets where they operate but don’t have a permanent residence, a move that might not be welcomed by their host countries.

How much more can Kenya get by ratifying the deal?

Nothing is certain. The KRA will have to monitor the activities of all the foreign companies operating either online or offline in Kenya to decide whether or not a company qualifies for taxation.

So, far, KRA is not very sure how this will pan out.

The OECD estimates that should Kenya ratify the new inclusive framework the KRA could collect between Sh3.3 billion ($25 million) and Sh5.3 billion ($40 million) in taxes.

Why did the previous administration reject it?

Under the former administration of President Uhuru Kenyatta, Kenya withheld its backing for the two-pillar framework, citing clauses in the agreement which would have seen the end of the digital service tax.

Kenya was among the countries that refused to ratify Pillar 1 until it was assured that it would earn more from the new tax compared to DST.

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