The robust growth in the digital economy has kept tax assessors on tiptoe at least for the past decade. First, it’s the fastest-growing economic sector estimated at 15.5 per cent of the world’s GDP by UCTAD’s digital economic growth report 2019, growing 1.7 times faster than the general economy.
This fact keeps all tax authorities drooling over the spoils. The ugly side of the digital economy is its lack of physical presence, complex nature of transactions cutting across borders and reliance on intangible assets. This is the new thorn in the flesh for all tax policy makers across the globe.
The challenge posed by digital economy in taxation is loss of revenue that would have been duly collected in a jurisdiction. In the world of taxation this is known as Base Erosion Profit Shifting. Google’s double Irish Dutch sandwich best illustrates what profit shifting is.
The Guardian reports that Google Shifted $23 billion to a tax haven in Bermuda using a Dutch shell company. This was to avoid triggering US and European taxes. Tax shenanigans of this nature are common with the digital giants.
A number of policy responses have been mooted to counter this tax loophole. The most recent is President Joe Biden’s push for global minimum tax that is favored by the G7 countries. This demonstrates the commitment by developed countries to stamp out the ills of tax base erosion.
The challenge is more pronounced in developing countries. It is worth noting that Kenya has made significant efforts towards taxing this nascent sector as seen in recent amendments to the taxing law, the most recent in the Finance Bill 2021.
The risk of tax base erosion and the concerted effort to exploit the potential of this grand economic sector raises one fundamental question. Why is it only a concern in taxation? We have not seen serious policy interventions on the implications of the digital economy on the entire economy.
The bigger picture that developing countries have got to see is, the digital economy presents unlimited possibilities while posing massive threat to local businesses.
Through the past industrial revolutions, policymakers in Kenya and other developing countries have emphasised import substitution. Import substitution in simple terms is replacing consumption of imported goods and services with locally manufactured ones.
The need for import substitution has never been necessary as is with the digital economy. Multinational tech giants have taken over the entertainment, advertising, transport, hospitality, education, retail and nearly all other sectors including agriculture through precision farming applications.
What is being eroded here is not just the tax base, it’s the entire economy. Local innovations are the right response needed to counter the growing dominance of multinationals. We have seen local Taxi-Apps rival international brands, that’s a glimpse of import substitution.
The digital space is vast, evergreen and very attractive to innovation. To tap in, policy and resources need to be directed towards training, IT infrastructure, legal framework especially on intellectual property rights and incubation funding to start-ups.
Successful innovations should then be supported through domestic consumption but beyond that, the strategy should be to penetrate to foreign markets. Digital content knows no boundaries provided that the quality is unparalleled.
With the right policy and support, Kenya can churn out its own multibillion tech-preneurs and the benefits will trickle down to the country through taxes and job creation.
Lecturer at KCA University
