The Organization for Economic Cooperation and Development (OECD) defines the digitalised economy as “all economic activity reliant on, or significantly enhanced by the use of digital inputs, including digital technologies, digital infrastructure, digital services and data”. According to a World Bank Report, the digital economy is equivalent to 15.5% of the global GDP and has been growing two and a half times faster than the global GDP over the past 15 years. This includes Electronically Supplied Services (ESS) such as the online sale of e-books, movies, music, games, and other digital content and applies to foreign companies like Amazon, Netflix, Twitter, and PayPal which use the internet to market and sell products in different countries where they have no physical presence.

6 January 23

A dilemma is posed by the corporate tax rules which are built on the principle that profits should be taxed where value is created. However, they were mainly conceived in the early 20th century for traditional ‘brick and mortar’ businesses which define what triggers a right to tax in a country (“where to tax”) and how much of corporate income is allocated to a country (“how much to tax”) largely based on having a physical presence in that country and without reflecting the value created by user participation in that jurisdiction. That means that non-residents for taxation purposes become liable to tax in a country only if they have a presence that amounts to a permanent establishment there. However, such rules fail to capture the global reach of digital activities where physical presence is not a requirement anymore in order to be able to supply digital services. To address these challenges, on 8 October 2021, 137 out of the 141 members of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (the IF), signed up to a two-pillar solution to ensure that Multinational Enterprises (MNEs) but Kenya, Nigeria, Pakistan and Sri Lanka are yet to officially endorse the approach. The proposed framework is set to be signed as a Multilateral Convention (MLC) by countries in mid-2023 and be effective from January 2023 once critical mass ( a set minimum number of countries that have signed the MLC) is reached.

The OECD reports indicate that the two-pillar approach promises to reallocate taxing rights on over USD 125 billion in profits under Pillar 1 and generate additional global tax revenue of USD 150 billion under Pillar Two. From the outset, a key impetus of the OECD/G20 Inclusive Framework’s negotiations was to stop the proliferation of “Digital Services Taxes and other relevant similar measures” (collectively “Unilateral Measures”) by replacing them with a consensus-based reallocation of taxing rights among Inclusive Framework (“IF”) members. This article seeks to address why Kenya and Nigeria opted to forego a stake in the share of this new reallocated taxing rights and instead pursue a unilateral approach. It also seeks to question the feasibility of African countries adopting such unilateral measures while considering the real risk of retaliatory trade sanctions that could result from unilateral approaches.

We begin with an overview of the OECD/G20 BEPS Pillar 1 and 2 proposals as an international framework aimed at developing consensus on the taxation of the digital economy to avoid harmful unilateral measures. We further analyse the place of African states in the deliberations of the and the reasons for Kenya and Nigeria withholding their support for the global tax reform initiative.

1. What does the BEPS Pillar 1 and 2 Provide for
Pillar 1 Amount A proposal directly seeks to address the specific concern around how governments share profits arising from the digitalisation of the economy. Pillar 1 entails two key components: Amount A (a new taxing right for market jurisdictions) and Amount B (which aims to standardise the remuneration of related party distributors that perform “baseline marketing and distribution activities”). The core part of Pillar One—Amount A—would apply only to businesses with more than EUR 20 billion in revenue and a profit margin of 10 percent, which is a select group of approximately 100 companies globally. The latter part is focused on creating safe harbours based on a rebuttable presumption to simplify the process of tax administrations assessing an arm’s length return for taxpayers’ distributor functions and reduce disputes. Pillar 2 on the other hand, aims at averting tax competition by introducing a 15% global minimum tax rate that ensures MNEs pay tax, regardless of where they are headquartered or the jurisdictions, they operate in.

2. Why Opt Out of the OECD/IF’s Two-Pillar Approach
Both Kenya and Nigeria have been leading African countries in the OECD BEPS process from 2015 when they joined as BEPS Associates prior to the formation of the BEPS Inclusive framework. Nigeria has been a member of the IF steering committee and actively participated in the discussions leading the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy announced in October 2021. It is therefore important to understand what reasons underly the opposition by countries such as Kenya and Nigeria who have been supportive of international practice for many years. Some of these reasons are listed as follows:

a) The Existence of Unilateral MeasuresThe agreement to reallocate profit under Pillar 1 includes the removal and standstill of Digital Services Taxes (DST) and other relevant, similar measures, bringing an end to trade tensions resulting from the instability of the international tax system.

This poses a dilemma for Kenya which since 2019, has been working on measures to reel in revenue from taxation of the digital economy. With its existing legal regime governing DST and Value Added Tax (VAT) on digital supplies, Kenya has already made progress in the realisation of revenues from the digital marketplace, by imposing a DST of 1.5% on gross turnover as well as VAT at 16%.

The DST and VAT framework are measures launched by Kenya in 2021 aimed at bringing to the tax net non-resident persons who accrue income in Kenya through a business carried out over the internet or an electronic network including through a digital marketplace. Kenya amended its tax laws i.e. the Finance Act of 2019 and 2020 to address the gaps in VAT law and Income Tax Act with respect to taxation of the digital economy. While the VAT Tax is an internationally agreed fiscal tool, DST has met resistance as discussed in this paper/article.

Effective 1 January 2021, Kenya implemented the DST – a tax charged on income derived or accrued from provisions of services through a digital marketplace within its jurisdiction. Under these laws, digital services include the supply of downloadable digital content, subscription-based media, software programs, supplies on online marketplaces, digital media content, data management services, search engine services, among others.

It is reported that Kenya is already realising more than USD 4 million annually from DST which is forecast to grow as more companies are brought into the tax net and possible increases in the rate to about 3% of gross turnover under consideration with registered companies complying numbering over 200, VAT has contributed over USD 40 million to the government revenue.

Kenya has already in place an enabling legislative framework for the identification of registrable persons, return filing and collection of taxes from digital economic activities either directly or through appointing a local representative, among others enabling factors.

Kenya has publicly voiced that it is dissatisfied with withdrawing its unilateral DST and committing to not impose any digital tax for the next seven years, especially given the anticipated increased collections from it.

 b) Unfairness of International Thresholds on Developing Economies
Pillar 1 applies to about 100 of the biggest and most profitable MNEs and re-allocates part of their profit to the countries where they sell their products and provide their services, where their consumers are. The writers found very scant information on empirical research on expected returns that African countries are likely to obtain from the implementation of the BEPS Pillar 1 solution. According to a report by Global Financial Integrity and ACODE it is claimed that G7 and EU countries will take home more than two-thirds of the revenue while the world’s lowest-income countries receive a mere 3% of the revenue.

The Kenya Revenue Authority notes that only 11 of the 100 in-scope companies operate within the Kenyan jurisdiction which would result in a loss of revenue from over 200 companies currently actively filing DST in Kenya as of January 2023. The OECD BEPS proposal indicates that a relevant review of Amount A thresholds will begin 7 years after the successful implementation of the new framework (whatever successful implementation entails is not described) comes into force. Various media reports indicate that Kenya is already under pressure from various quarters to drop its unilateral DST measures as has been seen by major European countries and India who entered into bilateral agreements with the US and agreed on a framework on how and when their DSTs and unilateral measures will be suspended. A statement from KRA suggests that such a decision can only be made where it is clear what Kenya would be gaining from foregone DST measures.

The Federal Inland Revenue Service (FIRS) of Nigeria, has publicly echoed the unfairness of the thresholds set by the two-pillar approach.FIRS revealed that a vast majority of the MNEs with operations in Nigeria do not meet the EUR 20 billion group revenue threshold and as such these MNEs would not be captured in Nigeria’s tax net.

Further, in FIRS’ view, when compared to domestic companies which are mandated to remit their corporate taxes once their earnings are above NGN 25 million (approx. EUR 57,000), it would be unjust for these MNEs to be subjected to corporate taxes only when they have generated at least EUR 1 million in turnover within Nigeria. Therefore, the effect of implementing Pillar 1 would be negative because MNEs that are currently paying taxes in Nigeria would not meet the threshold set, thereby causing a reduction in the country’s tax revenue.

c) Resource Constraints
More broadly, developing countries have argued that the complexity of administering the international tax reforms raises concerns with regard to tax administration. It is believed that these reforms need to appreciate that tax administrations in developing countries are more resource-constrained and as such, their capacity to enact these measures is diminished.

d) Mandatory Binding Arbitration
Pillar I proposals include proposals for enhancing tax certainty through mandatory and binding dispute resolution. This proposal has also been strongly opposed by the African Tax Administration Forum (ATAF) as it would impose a costly and resource-intensive process on African countries which have limited capacity and where there is little risk of double taxation. Kenya has cited its objection to ceding its sovereignty to the mandatory binding arbitration process proposed for resolving disputes arising from determination of its fair share of Amount A.

Further, the FIRS of Nigeria noted that in the event of a dispute between Nigeria and an MNE, Nigeria would be subject to an international arbitration panel. This process would cost Nigeria a lot more than the tax yield from such cases.

Both Nigeria and Kenya appear unconvinced by the Pillar 1 stipulation for an elective binding dispute resolution mechanism for disputes relating to Amount A for developing economies that are eligible for deferral of their BEPS Action 14 peer review and have no or low levels of Mutual Agreement Procedures (MAP) disputes. The main reason for this is that the OECD would determine the eligibility of jurisdiction for this elective mechanism.

3. Parting Thoughts: A Double-Edged Sword
While it is important to appreciate the benefits that accrue from a uniform international tax regime for the digital economy, the question remains what does Africa stand to gain or lose from participation in the OECD proposed solution on the sharing of revenues from the digital economy? While the Pillar 2 proposal on 15% minimum global tax rate remains the most politically feasible proposal, which has already wide support from leading economies including the US, the jury is still out on whether the Amount A proposal to cede US taxing rights will be approved by the fractious US Congress and be fully implemented globally. The EU has also previously acknowledged that progress at the international level is challenging, due to the complex nature of the problem and the wide variety of issues that need to be addressed, and to reach international consensus may take time.

Interestingly, the Kenyan DST approach is consistent with the European Commission (EC) Proposal for an EU Directive in 2018 in which the EU Commission put forward a proposal for a Digital Single Market solution namely the Digital Services Tax (DST), as a simple interim solution for the taxation of the revenues derived from the provision of certain digital services in the EU which was to apply on a temporary basis until a comprehensive solution was in place. The proposal included specifically a 3% tax on online advertising revenues, seller/buyer fees to transact via online intermediaries/marketplaces and revenues from the sale of user data. Although the initial proposal was rejected at the EU level for lack of unanimity, several EU—and non-EU—countries introduced DSTs as an effective way to generate revenue and modelled their proposed DSTs after the EC proposal.

The Two Pillar Solution proposes a unified solution to ensure that multinational companies that earn significant profits in a market without paying much tax there will for the first time be required to pay tax in those markets where they generate revenue. However, the proposals as currently framed do not, according to Kenya and Nigeria, present sufficient promise of a fair return from the activities of digitalised businesses operating within their jurisdictions.

However, Kenya and Nigeria now find themselves in an interesting position. On one hand, a unilateral approach that is effected through their domestic laws will give them the flexibility to expand the tax net to include non-resident companies resulting in more tax revenue for their countries. On the other hand, the rejection of the established international framework may lead to a reduction in MNEs confidence to begin operations in these countries and likely impose trade sanctions from major trading partners.

While many countries with DST already in place have called for the withdrawal of Unilateral Measures to be contingent on the implementation of Pillar 1, the United States had preferred withdrawal of Unilateral Measures immediately as of 8 October 2021, the date political agreement with respect to Pillar 1 was reached. The consensus reached indicates that the latter approach has prevailed and that no new DST measures may be introduced by those countries that do not have a DST in place pending the implementation of Pillar 1.

Over 50% of African countries are not members of the OECD BEPS Inclusive framework and it is not yet clear what direction these countries that have not signed on the Two Pillar Solution will take in the circumstances. It would seem unlikely for trade sanctions to be effective if a majority of African countries took a common position on the Pillar 1 issue.

The ATAF which has been leading the concerted input of Africa into the OECD BEPS process has put in place a draft law on DST. The ATAF Secretariat has also put out a statement that suggests an impartial approach statement indicating they neither support nor oppose the OECD reforms and for African countries to decide based on their own self-interest.
The question that remains is: which option will suitably capture the interests of Africa in the questions of share of digital economy revenues?

Should you have any questions regarding the information in this legal alert, please do not hesitate to contact James Karanja.


1. Abdullahi Ali – Associate
2. Eden Gatuiku – Trainee Lawyer