21st Century businesses in traditional industries have transformed over time, moving from regular “brick and mortar” models to operating in the digital space, focusing on the provision of online services. According to the World Bank, the digital economy accounts for 15.5% of global GDP and over the past 15 years, it is growing at a two and a half times rate to global GDP.
The events of 2020 particularly that of the COVID-19 pandemic, have increased the reliance on online technology, as individuals globally have had to stay indoors in response to various governments’ lockdown directives.
Consequently, there has been substantial increase in digital activities and significant revenue earnings from companies operating digitally or in the e-commerce space. In 2020, Amazon, for instance, had a 38% increase in revenue while Netflix recorded 37 million new subscribers. Such an increase in activities in the digital space is expected to translate to more revenue, profit and ultimately, more tax.
However, the challenge has been with the difficulty of countries establishing taxing rights over the profits of multinational enterprises (MNEs) operating in their jurisdictions. It is noteworthy that, under the rules of International taxation, “taxing rights” are allocated only to countries in which non-resident entities have created sufficient physical presence (a nexus). Therefore, a highly digital entity may be able to carry out activities globally without accounting for taxes in the jurisdiction where its income has been earned.
In response to the foregoing, the Organisation for Economic Co-operation and Development (OECD) in 2015, addressed the taxation of the digital economy in its Action Plan 1, Base Erosion and Profit Shifting (BEPS) project. According to the OECD, the digital economy does not pose any special threats, albeit it may increase the BEPS risks. While the 2015 report concluded that more work needed to be done, the G20 Ministers to OECD/ G20 Inclusive Framework on BEPS released a detailed Programme of Work in 2019, which covered the taxability of digital transactions via its two-pillar model.
Pillar One (1) endorses a unified approach, designed to adapt countries’ taxing rights to take into account new business models and reallocate taxing rights in favour of the user/market country. Pillar Two (2) on the other hand focuses on global anti-base erosion. It would ensure that countries tax profits at a minimum rate, which would ordinarily have gone untaxed or would have been taxed at a lower rate, i.e. use of a “global tax rate”.
This notwithstanding, the ambitious goal of reaching a consensus for the Pillars by mid-2021 and implementation of these plans to tax the digital space either through changes to local laws and/or treaties would take a while.
While conversations are ongoing on an international taxation consensus that addresses the digital economy, several countries have set up unilateral frameworks. Africa is not left out of the conversation on taxing digital transactions. The African Tax Administration Forum (ATAF) has proposed a digital services tax (DST) framework and content for legislation in individual African countries.
The DST framework would ensure that tax is levied (in addition to income tax) on the supply of certain specified services and charged at a fixed rate. This DST would not be creditable against a company’s income tax. Compared to income tax, DST would be relatively simpler to calculate and administer. However, this may result in double taxation for some companies, especially domestic companies that are already taxed in such countries.
In this regard, Tunisia has a 3% tax on gross income from sale of computer applications and digital services (effective 1 January 2020) and Kenya introduced a 1.5% tax on income earned through a “digital marketplace” with effect from January 2021. Nigeria also introduced in 2020 the concept of a “Significant Economic Presence” (SEP) as an additional basis of taxing a non-resident company (NRC) that operates in the digital space (i.e. digital NRC) and NRCs that provide services – consultancy, technical, management or professional that are not necessarily digital (i.e. service NRC) are captured under this new rule.
While a digital NRC is taxed at 30% of taxable profits on specified activities and in some instances where it derives up to N25million turnover from Nigeria, a service NRC only has a Withholding (WHT) tax charge of 10% on income derived from Nigeria. From a tax administration perspective, it may be easier to enforce the WHT obligations on service NRCs as the local customer in most cases would have physical presence that is accessible to the tax administrator for compliance enforcement purposes.
As countries begin to adopt unilateral measures to tax the digital economy, taxpayers and MNEs would need to observe closely the local changes as the implementation scope might vary from country to country. Also, taxpayers should prepare for additional reporting obligations and revenue segmentation as well as plan towards increased scrutiny from the tax authorities with respect to their digital transactions.
Considering that the taxing rules on the digital economy are subject to change from time to time, it is paramount that both the tax authorities and taxpayers must continually increase human capacity on tax related matters. Ultimately, MNEs and companies engaged in the digital space would need to assess the impact of all these tax measures (actual and proposed) on their bottom line and consider whether associated costs should be incorporated into their processes and/or passed on to the final customers.
Finally, given the fast-paced world of the digital economy, it appears that tax administrators may continue to play “catch-up” when coming up with specific rules on taxing digital transactions. However, creating an agile tax framework, which can be modified to meet changing circumstances, is more likely to meet the needs of all stakeholders, including tax administrators and taxpayers.
As countries begin to adopt unilateral measures to tax the digital economy, taxpayers and MNEs would need to observe closely the local changes as the implementation scope might vary from country to country.