Taxation of the Digital Economy

TABLE OF CONTENTS

ABSTRACT

ACKNOWLEDGEMENT

DEDICATION

LIST OF ABBREVIATIONS

TABLE OF CASES

LIST OF STATUTES

CHAPTER ONE: INTRODUCTION
1.1 Background to the Problem
1.2 Statement of the Problem
1.3 Hypothesis
1.4 Research Questions
1.5 Theoretical Framework
1.6 Literature Review
1.7 Research Methodology
1.8 Chapter Breakdown

CHAPTER TWO: THE INTERNATIONAL REGIME ON TAXATION OF THE DIGITAL ECONOMY
2.1 Nature and Scope of the International Regime
2.2 BEPS Project
2.3 The Digital Economy and the Beps Project
2.4 Principles Associated with the International Tax Regime
a) Effectiveness and fairness
b) Neutrality
c) Efficiency
d) Certainty and simplicity
e) Flexibility
2.5 Current Developments in Taxation of the Digital Economy
2.6 Conclusion

CHAPTER THREE:KENYA’S TAX REGIME
3.1 Introduction
3.2 History of Kenya’s Tax Regime
3.2.1 Pre-colonial Period
3.2.2 Colonial Period
3.2.3 Post Colonialism
3.3 Kenya’s Current Legislative and Policy Tax Framework
3.3.1 Income Tax
3.3.2 Capital Gains Tax
3.3.3 Value Added Tax
3.3.4 Import Duty
3.3.5 Excise Duty
3.4 Kenya’s Legal Framework on Taxation of the Digital Economy
3.4.1 Kenyan concept on source and residence
3.4.2 Local developments
3.5 Conclusion

CHAPTER FOUR:TAXABILITY OF THE DIGITAL ECONOMY
4.1Introduction.69 4.2 Key Considerations for Taxing the Digital Economy
4.3 Challenges in Taxing the Digital Economy
4.3.1. Jurisdiction
4.3.2. Characterization
4.3.3.Value Added Tax (VAT)
4.4.4.Base Erosion and Profit Shifting
4.4 Measures Introduced to tax the Digital economy
a. Corporate Tax
b. Value Added Tax (VAT)
c. Turnover Tax or Equalisation Levy
4.5 Conclusion

CHAPTER FIVE:CONCLUSION AND RECOMMENDATIONS
5.1 Conclusion
5.2 Recommendations

BIBLIOGRAPHY

ABSTRACT

This dissertation explores the concept of the digital economy, its rapid growth, and the tax challenges it has introduced, both locally and internationally. It examines the general characteristic of a sovereign state and its inherent right to tax source on income generated within its jurisdiction. The dissertation attempts to investigate the taxability of the digital economy where business is conducted without the requirement of a physical presence, a pre-requisite for tax administration. How can states and especially Kenya detect permanent establishment, for purposes of tax administration, for an economy that is heavily reliant on intangible assets and a business model based on data, network effects, and user-generated content. It therefore, focuses and looks at the scope of Kenya’s legislative and policy frameworks and its effectiveness in taxing the digital economy.

The digital economy is the contribution to the total economic output derived from many digital inputs, such as digital skills and digital applications. It works on a totally different scale as compared to traditional businesses. There is no requirement for physical existence so as to make significant amounts of revenue and, therefore, this means that there is little or no tax collected by the respective governments. Consequently, digital businesses and especially multinational digital enterprises have been able to take advantage of the tax laws and policies that were written for an industrial age and are ill suited for today’s digital economy.

The Action Plan on Base Erosion and Profit Shifting, by the Organization for Economic Co- operation and Development set out to answer the fundamental issues of BEPS (aggressive tax avoidance planning strategies), but it in itself fell short of expectations as it was not able to recommend practical, implementable solutions that would close the gaps that exist in the digital economy tax administration. The findings revealed that BEPS is not a single problem faced by all states but states face different BEPS problems and evaluate them from their own state-centred perspectives. Hence, the development of many interim measures by different states to tax the digital economy as the international community is still trying to come to a consensus on the possible, practical solutions.

The current Kenyan tax framework on taxation of the digital economy is obscure as only recent Bills tabled in Parliament try and address the issue in depth. In light of the findings of this research, it was established that the problem is not so heavy on laws and regulation on taxation of goods sold electronically, but rather, implementation of the applicable laws where they exist. The paper finally recommends possible amendments to the Kenyan legal framework and the proposed amendments are assessed by means of comparison with what has taken place in other jurisdictions.

ACKNOWLEDGEMENTS

I would like to express my sincere gratitude and appreciation to the following persons for the help they gave me and whose contribution facilitated the successful completion of my research paper.

My special thanks to my very dedicated supervisor, Prof. F.D. P. Situma, for the support, advice, constructive criticism and guidance he gave me throughout the development of the topic, research proposal and subsequently, project writing. He never retired and was always at hand to offer professional help. Thank you Prof., God Bless you.

I am also grateful to Prof. Attiya Waris for introducing me to Tax law and encouraging me to take on this dissertation topic and for her reviews and comments which helped me improve the quality of my research.

The support of my parents was immeasurable. Thank you for motivating me to keep writing. May God be gracious to you and add you more life to partake of this as well.

DEDICATION

This work is dedicated to Almighty God for enabling me to complete this task. To my loving and wonderful parents, thank you for your prayers, encouragement, unconditional guidance and unwavering support. You are awesome! God bless you. To my siblings Joel and Grace do not be afraid to dream and become. Thank you very much for always being there for me.

LIST OF ABBREVIATIONS

Abbildung in dieser Leseprobe nicht enthalten

TABLE OF CASES

1. Kenya Commercial Bank Ltd v KRA [2016] eKLR R v Commissioner of Domestic Taxes.
2. Republic v Commissioner of Domestic Taxes (Large Taxpayers Office) Ex parte Barclays Bank of Kenya Limited (2015) eKLR.
3. Okiya Omtatah Okoiti v The Cabinet Secretary, National Treasury and 3 others, Constitutional Petition No. 253 of[2018]eKLR.
4. Stanbic Bank Kenya Limited v Kenya Revenue Authority (2009) eKLR.
5. Quill Corp. v. North Dakota (1992) 504 U.S. 298.
6. Cook v Tait (Collector of Inland Revenue), 265 U.S 47 (1924)(44 S.Ct. 444, 68 L.Ed 895).

LIST OF STATUTES

1. Constitution of Kenya 2010.
2. Finance Act 2017, Act No. 15 of 2017.
3. Tax Laws (Amendment) Act, Act No. 9 of 2018.
4. Finance Bill (2019).
5. Finance Act of India, 2018.
6. Excise Duty Act 2015, Act No.23 of 2015.
7. The County Governments Revenue Raising Process Bill (2018).
8. Income Tax Act 1973, Cap 470, Laws of Kenya.
9. East Africa Community Customs Management Act 2004, Act No.1 of 2005.
10. VAT Act 2010, Cap 476, Laws of Kenya.
11. VAT Act 2013, Act No. 35 of 2013.
12. Finance Act 2018, Act No. 10 of 2018.

CHAPTER ONE INTRODUCTION

1.1 Background to the Problem

The 21st-century digital infrastructure has allowed technology giants to reach their customers faster, easier, and cheaper. Cross-border trade is done on the press of a button and these transactions are growing each day with the development of new applications at the expense of the traditional business models. This has also pushed traditional companies to develop a digital presence as nobody wants to be left behind in the revolution.

The digital economy is the contribution to the total economic output derived from many digital “inputs”, such as digital skills, digital infrastructure, and digital applications.¹ In one way, it can be viewed as the growth and development of business in the modern world supported by information technologies. Its biggest accessory is that it encompasses every aspect of life, from health to education, entertainment, banking, and business, and also politics, as citizens are able to engage with the governments as they spearhead social and political change.

Kenya’s digital economy has largely been propelled by the development of mobile money transfer, M-Pesa, a mobile money transfer service owned by Safaricom, the largest network operator in the country. This has increased the number of Kenyans using mobile money service to transfer cash, and hence, the willingness to adapt to more digital forms of operations in the day to day dealings. A survey done by TNS Research International and the Kenya ICT Board found that 18% to 24% of consumers in Kenya purchase music, movies and e-books online, signalling significant growth of the digital economy in Kenya.²

Large US technology companies, such as Google and Facebook, have also been used as a platform for Kenya’s local businesses to advertise and market their products to Kenyan consumers. An example is Darling Kenya that has several advertisements on Youtube, an online platform for video content sharing, hence generating a lot of revenue for the Youtube company, but none of that revenue is taxed in Kenya as Youtube does not have any offices in Kenya.

As it is with the emergence of a new market, the government has to collect its dues. It is argued that taxation and the emergence of the modern state is one of a symbiotic combination, because taxes make the state, and the state makes taxes.³ Therefore, taxation remains a crucial tool for running the state. It has also been argued that the state cannot run a democracy well without taxation and a taxation system cannot be run well without democracy.⁴ Taxation, therefore, remains pertinent and necessary for the running of any state, hence the government has to look for ways to raise revenue and one such source is the digital economy. The major problem is that with the internet, dematerialization leads to a situation where material assets lose their significance in favour of new intangible assets. Thus, the greatest challenge to a tax regime becomes the ability to adapt to the changing world.⁵

International tax principles require that the source and the residence of the taxpayer guide in the determination of the place where tax becomes payable, thus the need for physical presence.⁶ However, in a world where companies operate in a territory with no stores, factories or permanent establishment, direct collection of taxes becomes difficult to locate.⁷

According to Price Waterhouse Coopers (PWC), if one buys a music CD, they will pay tax on the commodity, the same way they would if they ordered it online but have it physically delivered. But if a person buys and downloads the music online from a foreign vendor, no consumption tax applies.⁸ The problem appears to be that in the digital economy, Kenyan tax laws have not kept pace with the development of e-commerce and some laws are slowly, but surely, becoming irrelevant.⁹ The principle of neutrality requires that economically similar goods and services should be taxed similarly.¹⁰ Therefore, income from the conventional ways of conducting business should be taxed in the same way as income from the digital space.¹¹

In 2012, British Member of Parliament, Margaret Hodge, accused managers of Amazon, Google and Starbucks, of using ‘aggressive tax planning structures’ “We are not accusing you of being illegal, we are accusing you of being immoral,” she said during interrogation.¹² This was just after the global financial crisis of 2008 that led to a public uproar over offshore tax evasion and corporate aggressive tax planning scandals that gave rise to unprecedented international cooperation on tax information exchange and coordination on corporate tax reforms.¹³

At the behest of the G20, the Organization for Economic Cooperation and Development (OECD) set out to develop a more consensus-based policy framework to curb base erosion and profit shifting.¹⁴ The ultimate goal was to develop a fairer global tax environment as multinational companies had successfully used the gaps in the different State tax systems to evade or reduce taxable income or shift their profits to low-tax jurisdictions in which little or no economic activity was performed.¹⁵

Consequently, in its Action Plan 1 on Base Erosion and Profit Shifting of 2013, the OECD set out to develop a regulatory framework on ‘how enterprises in the digital economy add value and make their profits and how the digital economy relates to the concepts of source and residence or the characterization of income for tax purposes.’¹⁶ The OECD defined ‘base erosion and profit shifting (BEPS) to tax planning strategies that exploit gaps in the architecture of the international tax system to artificially shift profits to places where there is little or no economic activity or taxation.’¹⁷ In its final report on the BEPS Project, the Task Force on the Digital Economy (TDFE), a subsidiary body of the Committee on Fiscal Affairs, mainly constituting non-OECD G20 countries, came up with a few recommendations to the tax challenges faced by states.

It proposed the modification of the definition of “permanent establishment” to allow for a broader concept of the exceptions to permanent establishment status. They also asked countries to adopt the principles of the International VAT/GST Guidelines in their domestic laws so as to level the playing field between domestic and foreign suppliers of intangibles and services. The VAT/GST Guidelines are principles and standards that were set by the OECD for the treatment of value-added tax of intangibles in international transactions so as to minimize the inconsistencies in the application of VAT in cross-border trade.¹⁸

According to the TFDE’s final report, a market state has jurisdiction to tax the income of Google, Alibaba or Facebook from sales of tangible products to consumers located within its territory under the modified definition of a permanent establishment. However, income from sales of digital products, like digital books and applications, and digital services to the same consumers will escape the allocation of a permanent establishment in a market state and, consequently, escape taxing rights.

Kenya’s tax laws require that for a non-resident company to account for tax in Kenya it must have a permanent establishment in Kenya and the income tax is calculated at the rate of 37.5% on the total income accrued from its operations in the country annually.¹⁹ This, however, has major limitations as digital transactions do not require any physical presence. Hence, the current challenge is how to bring these companies to tax administration.

It is also difficult for Kenya to demand income tax on the income derived from these multi-national companies as this is not the base of value creation, but where the value is consumed. Under the current international regulatory framework, multi-national enterprises can only pay tax where the value is created, but not where it is consumed. Consequently, revenue being generated in Kenya cannot be taxed by Kenya tax authorities.

Kenya has, however, taken some steps towards taxation of the digital economy. These include the legislative framework enshrined in Article 209(2) of the Constitution that gives Parliament room to enact legislation for the taxation of e-commerce. Hence, the State may, through Parliament, propose the imposition of tax on e-commerce by creating a tax base on e-commerce transactions.²⁰ The provision perhaps encapsulates the famous catchphrase “no taxation without representation” that has substantial legal and even economic significance in our time.²¹

Article 209(2) of the Constitution is not sufficient to fill the gaps in the legal framework of taxing the digital economy, as most of the major transactions that take place online are still not brought to tax. Hence, the government is deprived of the much-needed revenue for development and provision of other services required by a state. There is also no level playing field between cross-border digital companies and domestic companies, such as M-Pesa, leading to contravention of the principle of fairness in taxation.

1.2 Statement of the Problem

The problem this research addresses is the extent to which Kenya’s legal and regulatory frameworks provide for the taxation of the digital economy. The regulatory framework developed by BEPS has major deficiencies and is ineffective with regards to implementation and compliance. Can Kenya’s frameworks detect permanent establishment for an economy that is heavily reliant on intangible assets and a business model based on data, network effects, and user-generated content, and generates huge amounts of revenue without physical presence?

1.3 Hypothesis

This study proceeds on the hypothesis that Kenya lacks the appropriate legislative and regulatory frameworks for the regulation of the digital economy taxation.

1.4 Research Questions

In view of the aforesaid research problem, the questions addressed by this research are:

i. Is the digital economy taxable?;
ii. What is Kenya’s legal framework governing the taxation of the digital economy?;
iii. Is the OECD/G20 BEPS project legitimate as the international tax regulator?; and
iv. What practical long-term measures should be put in place?

1.5 Theoretical Framework

Tax, by definition, has been argued to be a violation of property rights as it takes wealth from taxpayers and transfers it to the government in a confiscatory fashion.²² Adam Smith argues that taxes in a democratic-liberal society should follow cannons of taxation, being that the taxes should be certain and not arbitrary, considerate of the convenience of the contributor, efficient and equitable in every possible manner.²³

William Barker, a key proponent of the economic efficiency theory, asserts that economic efficiency permits existence of several compatible or harmonious tax options for purposes of ensuring equity among sovereign nations by equitably dividing the tax base internationally.²⁴ In both instances, the problem of double taxation arises due to clash in taxing jurisdictions.²⁵ Boris Bitker, a contemporary proponent of the theory, opined that, in International tax law, the theory of economic efficiency is understood to advance the argument that each nation has the right to tax income that is proportionate to the value added by the relevant taxing nation.²⁶ The theory was developed to help solve problems of tax competitions among sovereign states.²⁷

The two important aspects introduced by natural law with relevance to taxation are the concept of fairness in order to maintain a stable society, and a just purpose in imposing tax. Plato, a natural law theorist, stated that both extreme wealth and poverty are always harmful to society.²⁸ Hobbes went on to state that from a natural law perspective, every individual in society is equal and, therefore, taxation should be even.²⁹

For the purposes of establishing a link between the theoretical framework and the concept of permanent establishment as a method of taxing businesses on income in the digital economy, the sourcing theory explains the links between sourcing and taxing rights on income,³⁰ and, the benefit theory links taxing rights with the benefits derived by a taxpayer in a given jurisdiction.³¹ Source tax principle states that a state independently, has legitimate tax jurisdiction as a source country, where the taxpayer is located and derives income.

The benefit theory provides that a state should levy taxes based on the benefits conferred on the individuals. The major proponents of this theory are Reuven S. Avi-Yonah, a contemporary proponent, Adam Smith and John Stuart Mill dubbed as classical proponents. This theory underlay the practice of US to tax its citizens on income obtained from a foreign source despite them not residing in the US during the relevant year of taxation.³² This reasoning was judicially codified by the US Supreme Court in the case of Cook v Tait (Collector of Inland Revenue).³³ The U.S. citizen resided permanently and was domiciled in Mexico City with his Mexican citizen wife.³⁴ The Revenue Act of 1921³⁵ imposed a top income tax rate of 8%. The Internal Revenue Service made a demand against Mr. Cook to pay his tax.³⁶ Mr. Cook paid it and sued for a refund of the US$1,193 paid. The question before the court waswhether Congress had power to impose a tax upon income received by a native citizen of the United States who, at the time the income was received, was permanently resident and domiciled in the city of Mexico, the income being from real, and personal property located in Mexico.³⁷ The Court held that the US reserves the right to tax its citizens on worldwide income no matter where they live on the basis of the benefits they receive. The rationale of the Court was that the government, by its very nature, benefits the citizen and his property wherever found , and therefore has the power to make the benefit complete. ³⁸ Thus, in return for protection offered by a sovereign state through its government, the citizens must be willing to pay taxes in order to facilitate costs incurred from such expenditures.

However, Adam Smith and John Mill recognized that the major shortcoming of this theory was that it is largely impossible to quantify in monetary terms the value of State services enjoyed by tax-payers. ³⁹ They resigned to the conclusion that taxes are a necessary evil, that which is paid for a civilized society, and are a sacrifice for the common good. ⁴⁰

The base erosion principle, which states that income derived by non-residents might be deductible against the tax base of the source country, has also been used to justify the theoretical basis for source taxation of the digital economy.

Therefore, this study proceeds on the premise that, in order to achieve equity in taxation, it is prudent to tax both online and traditional based corporations in equal measure.

1.6 Literature Review

A lot of literature has been written on the subject of taxation of the digital economy generally. However, a preliminary search has revealed that the bulk of the existing literature in texts and journal articles, addresses the issue of taxation of the digital economy globally, with little material that addresses the subject in the Kenyan context specifically.

Pertinent to this study, is Francesco Boccia and Robert Leonardi analysis on challenges facing the digital economy taxation.⁴¹ At the heart of their discussion is that the digital economy is almost 6% of the global GDP and it continues to grow at an unprecedented rate.⁴² They argue that with the erosion of a tax base, countries are taking individual action so as to maintain the adequate levels of welfare provisions. On their analysis, they looked at some of the individual countries, where the multi-national companies that dominate the digital economy operate, such as the U.S.A, Italy, and the U.K.

Tatiana Falcao and Bob Michel demonstrate how, under the current state of world affairs, a digital service provider could render its services to different jurisdictions without actually meeting any of the OECD's current substantial presence tests that would legitimize the imposition of a tax in the country of source.⁴³ The authors propose a case study to illustrate how by mere application of the non-abusive rules contained in the OECD Model Tax Convention on Income and on Capital 2014, a digital service provider could render a multitude of services to different countries without actually paying any taxes in the country where the revenue arises.⁴⁴

Yariv Brauner and Andrés Baez argue that the introduction of the withholding tax mechanism as the primary response to these taxation challenges is the best solution, which is anchored on the base erosion principle in support of a nexus-based solution.⁴⁵ On the other hand, Reuven argues that a destination-based corporate income tax is the best solution where multinational enterprises would be treated as unitary businesses and taxed based on where they sell their goods or services, in other words, on a destination basis, rather than as in current corporate taxes, primarily on an origin basis and, thus, the tax bracket will expand.⁴⁶

Peter Hongler and Pasquale Pistone propose a totally new approach to permanent establishment status based on digital presence supported by the reconstruction of the benefit theory.⁴⁷ The authors look at the TFDE’s final report modified definition of permanent establishment and the core issues that arise in the digital environment.

The OECD final report of 2015 in Action Plan 1, on addressing tax challenges, identified the broader tax challenges faced by policymakers in the digitalization era.⁴⁸ These include the concept of a new nexus, massive use of data, and characterization for direct tax purposes, which often overlap with each other.⁴⁹ The digital economy also creates challenges for value-added tax collection, particularly where goods, services, and intangibles are acquired by private consumers from suppliers abroad.⁵⁰

Various reports and journals that have been written and presented in various forums such as the United Nations Committee of Experts on International Cooperation in Tax Matters will be pertinent to this study. In addition, newspaper articles and internet sources with relevant information on the development of taxation in the digital economy shall give invaluable source to this research.

The vast amount of knowledge from these texts, journal articles, and reports will be indispensable to my research as I would be able to determine the current status of the taxation of the digital economy by states, its historical background and the challenges faced by states in tax administration, with the development of the digital world. However, there are gaps that have not been addressed in this knowledge, such as the Taxation of the Digital economy in Kenya and with this research being a specific case study to Kenya, I aim to address this gap.

1.7 Research Methodology

In the nature of the subject of this research, the research methodology used to gather information was a textual analysis of both primary and secondary sources of data. The sources of primary data utilized are international Conventions, regional legal instruments, national legislation, case law, and press releases. Secondary data includes textbooks, journal articles, internet sources, reports, and other scholarly literature concerning the taxation of the digital economy. The materials relied on are sourced from the University of Nairobi library and other online platforms such as Social Science Research Network, Google Scholar, JSTOR among others.

1.8 Chapter Breakdown

The research is organized into five chapters as shown below.

Chapter One: Introduction

- An introduction to the problem statement.
- The scope, aim, and objectives of this research paper.
- The methodology used in the study to gather and analyze data in order to achieve the research objective.

Chapter Two: International Regime on Taxation of the Digital Economy

- The nature of the digital economy and the theoretical framework that supports its taxation.
- International taxation laws, and the initiatives the international community, has put in place in regulating taxation of the digital economy.
- The legitimacy question of the OECD as the global tax regulator on the BEPS project.
- The position of non-OECD members on the implementation of the BEPS project recommendations.

Chapter Three: Kenya’s Tax Regime

- History of Kenya’s tax regime.
- Kenya’s Legislative and Policy Framework on taxation.
- Kenya’s Legal Framework on taxation of the digital economy.

Chapter Four: Taxability of the Digital Economy

- Is the digital economy capable of being taxed in the current environment?
- Key considerations for taxing the digital economy.
- Issues and challenges in the taxation of the digital economy in Kenya.
- Kenya’s interim mechanisms put in place by the Kenya Revenue Authority and their effectiveness.

Chapter Five: Conclusion and Recommendations

- Conclusion
- Recommendations

CHAPTER TWO THE INTERNATIONAL REGIME ON TAXATION OF THE DIGITAL ECONOMY

2.1 Nature and Scope of the International Regime

The current international tax regime is comprised of over three thousand bilateral tax treaties that govern the taxation of the large majority of cross-border businesses and investments.⁵¹ Scholars estimate that around 75 per cent of the language of all tax treaties is taken from a single source, the OECD Model Tax Convention on Income and on Capital (OECD Model).⁵² Thus, the OECD Model dominates the current tax treaty law.⁵³

However, standardization of international tax law with regard to tax treaties has not amounted to much harmonization.⁵⁴ Numerous differences among tax laws still exist, many of which are difficult to rationalize.⁵⁵ Some of these differences have facilitated the type of aggressive corporate tax planning that triggered the launch of the BEPS project.⁵⁶ A fundamental insight of BEPS was that countries could not proceed to make completely independent tax policies because of the interdependence of their economies.⁵⁷

It is difficult for countries to act quickly on this insight and enhance coordination of their tax policies since, at its core, the international tax regime is designed to enhance competition, not cooperation, among tax jurisdictions.⁵⁸ The current international tax regime is firmly constructed around a competition framework. Obviously, it is not institutionalized. It includes no strong supranational principles and does not have a mandatory dispute resolution device. Legal action taken pursuant to the regime is decisively unilateral and not cooperative.⁵⁹

This is not surprising since the world’s strongest economic powers and enthusiasts of market theory, following the so-called “Washington Consensus,” were instrumental in constructing the regime.⁶⁰ The international tax regime evolved with the sole purpose of perfecting such competition, rather than curbing it. However, it remained a soft legal regime with no established international forum or supranational and evolving body of law.⁶¹

Some scholars have disputed the mere existence of the regime, or perhaps the utility of referring to it as such, based on its continuous and conspicuous “softness.”⁶² Following this agenda, the academic analysis of the international tax regime has also been dominated by the perceived binary choice between competition and harmonization.⁶³ Since no one seriously wished for a global tax government, harmonization was generally rejected outright as it was believed countries would not agree to it. Consequently, the regime stuck to reliance on competition, primarily based on the unquestioned belief in the invisible forces behind markets and their vague welfare-maximization properties.⁶⁴ More sophisticated support of competition, as a basis for the international tax regime, developed on political distrust of cooperation at the international level.⁶⁵ Such an approach views even the current, soft regime, as an influential cartel that services the more powerful countries at the expense of less powerful countries.⁶⁶ Yet, the core of this critique is its distrust of the OECD, the club of rich countries that have been the caretaker of the international tax regime.

The OECD dominates the regime through its exclusive powers over the OECD Model, which permits it to set the agenda for all developments of the regime. Yet, more fundamentally, the norms contained in the OECD Model are biased in favour of residence taxation that benefits wealthier countries, such as the OECD member states.⁶⁷ Any further harmonization, as the claim goes, would have to be based on this bias, further fixating the dominance of the rich countries over all others. Critics of the competition framework respond that it assures the dominance of the rich countries and their control over the international tax regime.⁶⁸ Thus, further competition would not give a voice to the less powerful economies that do not compete on a level playing field with the rich countries and among themselves. The competition framework limits policy choices that may assist developing countries to grow, develop, and even collect sufficient revenue to sustain their policies. Only cooperation, at some level, would allow these countries to make free and rational policy choices.⁶⁹

This approach may be based on general notions of fairness or equity, yet it may also be based on interests that may be mutual to both developed and developing countries, all of which suffer from poor revenue collection.⁷⁰ Such revenue loss may be found in inappropriate tax planning that uses non-productive, so-called “tax haven,” jurisdictions to benefit few people at the eventual expense of many others.⁷¹ The BEPS project reflects a realization that more coordination, and even some harmonization, may be beneficial to both developed and developing countries.⁷²

Several recent developments have posed challenges to the international tax regime, adding to the difficulties it faces. Recent geopolitical changes have been particularly important in this regard. The general criticism of the OECD and its dominance over the international tax regime sharpened as some of the developing countries that are not members of the OECD began emerging and establishing both economic and political dominance.⁷³ Most notably, the countries of Brazil, Russia, India, China and the Republic of South Africa (BRICS), led by India and China, gained strong positions in the global market and began demanding a corresponding voice in the policymaking process.⁷⁴

The OECD anticipated the importance of communicating with non-member states long before these developments and launched an observation program for such countries.⁷⁵ Yet, the power to observe proceedings was not sufficient for countries that started viewing themselves as world leaders, especially when, for most purposes, their participation did not result in significant enough changes (subjectively) in the division of tax bases and other norms.⁷⁶ The demand for more source taxation conflicted with the opposite trend to eliminate source taxation in favour of residence-based taxation that had always been the hallmark of OECD tax policy, and a consequence of the competition framework of the international tax regime.⁷⁷ Some countries have unilaterally departed from some of the prior universal norms of the international tax regime to assert their tax jurisdiction and views of the appropriate division of tax bases.⁷⁸ At the same time, past economic powers have lost some or, in other instances, most of their power (in the case of the United States it lost its superpower). Today, even the United States cannot dominate any international tax policy discussion alone.⁷⁹

Globalization and the 2008 financial crisis caused a thirst for revenue among even the most developed countries, which then lacked the capacity to regenerate their collection powers independently.⁸⁰ The first response to this crisis focused on collection and the most traditional and conservative tax treaty measure of information exchange.⁸¹ The thought was that enhanced and inexpensive exchange of information, coupled with the destruction of bank secrecy, would eliminate most abusive tax planning and restore the power of the old international tax regime.⁸² Yet, the nature of the global market of information and contemporary tax planning prevented rich economies from implementing this solution alone. The power effectively shifted in part to the Group of Twenty (G20) organization, which includes some OECD members as well as emerging economies that do not belong to the OECD, but have an equal voice to that of the traditional powers in the G20.⁸³ The outcome was the “Global Forum.”⁸⁴

The BEPS project was the next step wherein the G20 took initiative, even if in cooperation with the OECD, following the pattern of the Global Forum.⁸⁵ The same phenomena resulted in not only political challenges to the international tax regime, but also direct challenges to the efficacy of the norms. New economic trends, including the ascent of electronic commerce, intangibles, sophisticated financial instruments in global capital markets, and multinational enterprises (MNEs) facilitated by globalization, have all dumbfounded the prevailing norms that have been established for a simpler and ‘smaller’ world. For many of these transactions, the norms became apparently inadequate, as did the structural foundations of the international tax regimes, such as the dichotomy between source and residence. These challenges to the norms of the regime have tested the efficacy of tax treaties and their future as the foundation of the regime. They also further exposed the already existing and, perhaps, inherent weaknesses of tax treaties.

Tax treaties were mainly a response to the avoidance of double taxation. Furthermore, the origins of the tax treaty project found in the work of the 1920s League of Nations can also be traced to the desire to facilitate cross-border trade and investment.⁸⁶ The basic idea was simply to eliminate tax barriers that result from conflicting claims, mainly those based on the source, on the one hand, and residence, on the other hand.⁸⁷ The actual division of the tax base did not (and still does not) follow any recognizable policy principle.⁸⁸ It was constructed from a patchwork of norms that followed efficiency-based observations, perceived fairness, and other legitimacy-based constructs. Thus, a source country could only tax income generated by a foreign person with a significant presence within its jurisdiction, yet it received essentially a free pass to tax income related to real property located within its jurisdiction.

2.2 BEPS Project

With much fanfare, the OECD announced the launch of the BEPS Project in 2013.⁸⁹ Its excitement, as well as the optimism of most stakeholders, has since waned, yet the intensity of the work on the project and its impact have not.⁹⁰ International tax policy is still as hot a topic in 2019 as it was in 2013 or 2015. This is not surprising since, at its core, BEPS is a political project. G20 politicians initiated the project in response to public outrage over large corporations’ use of tax-planning schemes, which subsequently was fueled by the media’s interest and exposure of these schemes.⁹¹ OECD was then charged with fixing the problem and fixing it quickly. This is the same OECD that had been the caretaker of the international tax regime during the last half-century and, in some ways, may be viewed as responsible for the problem, it was charged with fixing.⁹²

Against this complex background, the OECD devised a diverse action plan with a (now well-known) list of fifteen specific actions.⁹³ The plan is not cohesive, yet, together with the original OECD BEPS report, one could identify insights it provides.⁹⁴ The most important insight identified in the OECD BEPS Project for the purposes of this paper is that international coordination of tax policies is a condition for the success of any substantial reform. Unilateral action, regardless of its substance, cannot succeed by definition. This insight stands in stark contrast to the most fundamental basis of the current competition-based international tax regime.⁹⁵ It is clear that such desired coordination has to include non-OECD countries, which would at least challenge the dominance of this organization over the international tax regime.

The final report on the BEPS Action Plan Action Item 1[ ‘Addressing the Tax Challenges of the Digital Economy, Action Item 1’]⁹⁶ required a report discussing the challenges posed by the digital economy to the current international tax regime, which was never designed for it.⁹⁷ The regime failed to adapt to technological progress and to the ascent of intangibles, as it merely tweaked the rules to fit these developments.⁹⁸ The BEPS context was obvious since MNEs, whose use of tax-planning schemes triggered the launch of the BEPS Project, have heavily relied on intangibles in exploiting the tax advantages of an imperfectly regulated digital economy.⁹⁹ The goal of this item was modest, the generation of a report.

The final Action Item 1 report acknowledges the need for post-BEPS monitoring and seems to state that the digital economy taskforce will continue to exist for implementation and monitoring purposes.¹⁰⁰ It is unclear, however, whether meaningful action will be taken on any of the issues discussed. Action was taken regarding consumption taxes, and a plan for implementation is in place, yet no operative steps are planned in the income tax area.¹⁰¹ The final report mentions three possible income tax measures available for countries to adopt. However, it does not recommend nor does it strictly oppose them. One is nexus-based taxation, a withholding tax mechanism on digital transactions, and an equalization levy.¹⁰² The report asserts that other BEPS measures should improve the pressure created by the digital economy on tax enforcement, rendering special measures unnecessary. The OECD failed to explain how that would occur or which operative principles would govern such specific measures. No accountability or monitoring measures were provided or discussed.

Several countries do not trust the OECD on this matter. These countries have already enacted a variety of unilateral measures.¹⁰³ This may leave other countries with little choice but to follow. The adoption of these measures, again, will be uncoordinated and contrary to the first insight of BEPS. The lack of commitment to solving the issues through the OECD would then make matters worse, not better.

2.3 The Digital Economy and the Beps Project

The “digital economy” is an umbrella term used to describe markets that focus on digital technologies and typically involve the trading in information, goods, or services, through electronic commerce.¹⁰⁴ The digital economy is the part of the global economy that is the most integrated. The Action Plan on Base Erosion and Profit Shifting (BEPS) has set out to answer two fundamental questions related to the digital economy, namely, how enterprises in the digital economy add value and make their profits, and how the digital economy relates to the concepts of source and residence or the characterization of income for tax purposes.¹⁰⁵ However, the final outcome in terms of answering the above two questions in relation to direct taxation in the digital economy was quite modest, considering the time spent and resources involved.¹⁰⁶

In its Final Report, the Task Force on the Digital Economy (TFDE), a subsidiary body of the OECD Committee on Fiscal Affairs, in which non-OECD G20 countries participate as Associates on an equal footing with OECD countries, agreed to propose modifications to the definition of permanent establishment (PE), revised the guidance on transfer pricing, and made some recommendations on the design of controlled foreign company (CFC) rules.¹⁰⁷ The recommendations of the BEPS Project contained in the TFDE Final Report create the possibility for states to tax income from activities that include the production and sales of tangible products in their territories.

However, the related issue of the taxation of income from digital services and products through access to web platforms remains unresolved. In other words, following the TFDE’s proposals, a market state may get the opportunity to tax the income of Amazon and Apple from sales of tangible products to consumers located within its territory under the modified definition of a PE. On the other hand, income from sales of digital products, like digital books and apps, and digital services to the same consumers will escape the allocation to a PE in a market state. The impact of the TFDE’s proposals on Google and Facebook, major suppliers of internet advertising and collectors of personal data, is likely to be insignificant from the perspective of many market states.

[...]

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¹ OECD,‘ Report of Hearings on the Digital Economy’ (2013) (1) Digital Economy http://www.oecd.org/daf/competition/The-Digital-Economy-2012.pdf accessed on 29th November 2018.

² Victor Juma ‘Online Shopping Keeps Consumers out of Revenue Authority’s Reach’, Business Daily (Nairobi, 16th August 2010) https://www.businessdailyafrica.com/markets/Online-shopping-keeps-consumers-out-of-KRA-reach/539552-976992-2gr1vjz/index.html accessed on 21st December 2018.

³ Subhajit Basu, ‘To Tax or Not? That is the question? Overview of Options of Consumption Taxation of Ecommerce’ 2004(1) The Journal of Information, Law and Technology (JILT) http://www.academia.edu/8893625/To_Tax_or_Not_to_Tax_That_is_the_question_Overview_of_Options_in_Consumption_Taxation_of_ECommerce accessed on 21st December 2018.

⁴ AttiyaWaris, ‘Taxation without Principles: A Historical Analysis of the Kenyan Taxation System’ (2007) 1 Kenyan Law Review 272.

⁵ Thomas Hoeren, ‘E-Commerce in Germany: Electronic Commerce and the Law- Some Fragmentary Thoughts on the Future of Internet Regulation from a German Perspective’ (2000) 1 Computer Law & Security Report 113.

⁶ Basu (n 3).

⁷ Yoseph Eldrey, ‘Constitutional Review and Tax Law’ (2007) 56 American University Law Review 1193.

⁸ Basu (n 3) 20.

⁹ Ibid., p.20.

¹⁰ Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations ( 3rd edn, Pennsylvania State University 2005) 2.

¹¹ Basu (n 3) 4.

¹² Helia Ebrahimi,‘Starbucks, Amazon and Google accused of being immoral’, The Telegraph (London, November 12, 2012).

¹³ Fung, S, ‘The Questionable Legitimacy of the OECD/G20 BEPS Project’ (2017) 2 Erasmus Law Review 76.

¹⁴ OECD, Action Plan on Base Erosion and Profit Shifting,(OECD Publishing, Paris, 2013).

¹⁵ Ibid.

¹⁶ Ibid.

¹⁷ Ibid., p. 8.

¹⁸ OECD, International VAT/GST Guidelines, (OECD Publishing, Paris, 2017) .

¹⁹ Income Tax Act 1973, Cap 470, Laws of Kenya (Government printer, Nairobi, 1974) section 34.

²⁰ Vincent Mulondo, ‘Application of Kenyan VAT Law to E-commerce’ (Master Law Thesis, University of Nairobi 2012) 14.

²¹ Yoseph Eldrey , ‘Constitutional Review and Tax Law’ (2007) 56 American University Law Review 1192.

²² Ibid., p. 1198.

²³ Ibid.

²⁴ Carolyne Kinyua, ‘ The Implications of Territorial Jurisdiction for international Income Taxation: The Kenyan Case Study’ ( Master Law Thesis, University of Nairobi, 2017) 5.

²⁵ Ibid.

²⁶ Ibid.

²⁷ Ibid.

²⁸ Bertrand Russel, Geschiedenis van de Westerse Filosofie (Kosmos Uitgevers 2008).

²⁹ Onno I.M. Ydema, Hoofdstukken uit de Geschiedenis van het Belastingrecht (Wolters-Noordhoff 1997).

³⁰ Jérôme Monsenego, ‘ Taxation of Foreign Business Income within the European Internal Market’ (2011) 22 IBFD World Tax Journal 33-61.

³¹ Ibid.

³² Reuven S. Avi-Yonah, Global Perspectives on Income Taxation Law ( Oxford University Press, New York , 2011) 22.

³³ Cook v Tait (Collector of Inland Revenue), 265 U.S 47 (1924)(44 S.Ct. 444, 68 L.Ed 895).

³⁴ Ibid.

³⁵ The United StatesRevenue Act of 1921(ch. 136, 42 Stat. 227, November 23,1921)

³⁶ Cook V Tait ( n 33).

³⁷ Ibid.

³⁸ Ibid.

³⁹ Kinyua (n 24) 7.

⁴⁰ Ibid.

⁴¹ Francesco Boccia & Robert Leonardi , The Challenge of the Digital Economy: Markets, Taxation and Appropriate Economic Models (Palgrave Macmillan , London, 2017 ).

⁴² Ibid., p. 23.

⁴³ Tatiana Falcao & Bob Michel, 'Assessing the Tax Challenges of the Digital Economy: An Eye-Opening Case Study ' (2014) 42 Intertax 317-324.

⁴⁴ OECD , Model Tax Convention on Income and Capital (OECD Publishing, Paris, 2014).

⁴⁵ Yariv Brauner & Andrés Baez, ‘Withholding Taxes in the Service of BEPS Action 1: Address the Tax Challenges of the Digital Economy’ [2015] WU International Taxation Research Paper Series https://www.ibfd.org/sites/ibfd.org/files/content/WithholdingTaxesintheServiceofBEPSAction1-whitepaper.pdf accessed on 21st December 2018.

⁴⁶ Reuven S. Avi-Yonah, ‘The Case for a Destination-Based Corporate Tax’ (2015) 1(1) University of Michigan Law School Draft Paper http://ssrn.com/abstract=2634391 accessed on 21st December 2018.

⁴⁷ Peter Hongler & Pasquale Pistone, ‘Blueprints for a New PE-Nexus to Tax Business Income in the Era of the Digital Economy’ (2015) (15) WU International Taxation Research Paper Series http://epub.wu.ac.at/4509/ accessed on 21st December 2018.

⁴⁸ OECD, Addressing Tax Challenges of the Digital Economy, Action 1 (OECD Publishing, Paris, 2015) 98.

⁴⁹ Ibid., p. 100.

⁵⁰ Ibid., p. 120.

⁵¹ Reuven S. Avi-Yonah, ‘The Structure of International Taxation: A Proposal for Simplification’ (1996) 74 Texas Law Review 1301.

⁵² Lang M and others (eds), The Impact of the OECD and UN Model Conventions on Bilateral Tax Treaties (Cambridge University Press, Netherlands, 2012).

⁵³ Ibid.

⁵⁴ Yariv Brauner, ‘Treaties in the Aftermath of BEPS’ (2016) 41 Brook J Int'l L < http://scholarship.law.ufl.edu/facultypub/764 > accessed on 11th September 2019.

⁵⁵ Yariv Brauner, ‘An International Tax Regime in Crystallization’, (2003) 56 Texas Law Review 259.

⁵⁶ Brauner (n 4) 978.

⁵⁷ Yariv Brauner, ‘What the BEPS?’ (2014) 16 University of Florida Levin College of Law Tax Review 55 < http://scholarship.law.ufl.edu/facultypub/642> accessed 11th September 2019.

⁵⁸ Brauner (n 4) 979.

⁵⁹ Ibid.

⁶⁰ John Williamson, What Washington Means by Policy Reform, in LATIN AMERICAN ADJUSTMENT: HOW MUCH HAS HAPPENED (Washington D.C Institute for International Economics, 1990).

⁶¹ Brauner (n 4) 979.

⁶² Michael J. Graetz,‘The David R. Tillinghast Lecture: Taxing International Income: Inadequate Principles, Outdated Concepts, and Unsatisfactory Policies,’ (2001) 54Texas Law Review <https://scholarship.law.columbia.edu/faculty_scholarship/391> accessed 11th September 2019.

⁶³ Tsilly Dagan, ‘The Costs of International Tax Cooperation,’ (2003) Barllan University Faculty of Law Working Paper Number 1-03 < https://www.biu.ac.il/law/unger/working_papers/1-03.pdf> accessed 11th September 2019.

⁶⁴ Ibid.

⁶⁵ Brauner (n 4) 981.

⁶⁶ Ibid.

⁶⁷ Ibid.

⁶⁸ Brauner (n 42) 307.

⁶⁹ Ibid., p. 308.

⁷⁰ Ibid.

⁷¹ Reuven S. Avi-Yonah, ‘Globalization, Tax Competition, and the Fiscal Crisis of the Welfare State,’ (2000) 113(7) Harvard Law Review 1573 <https://repository.law.umich.edu/cgi/viewcontent.cgi?article=1049&context=articles> accessed 11th September 2019.

⁷² Organization For Economic Co-Operation & Development [OECD], addressing base erosion and profit shifting ( OECD Publishing, Paris, 2013)

⁷³ Yariv Brauner & Pasquale Pistone, (eds) Brics And The Emergence Of International Tax Coordination (eBOOK 2015) 3-4.

⁷⁴ Ibid.

⁷⁵ Brauner (n 4) 982.

⁷⁶ Ibid.

⁷⁷ Ibid.

⁷⁸ Ryan Finley, ‘Panel Expects Increased Transfer Pricing Compliance Burdens,’ (Tax Notes International, 11 February 2015) <https://www.taxnotes.com/news-documents/transfer-pricing/panel-expects-rising-transfer-pricing-compliance-burdens-china/2015/11/02/jv63> accessed 11th Septermber 2019.

⁷⁹ Organization For Economic Cooperation & Development [OECD], Designing effective controlled foreign company rules action 3 - 2015 final report ( OECD Publishing, Paris, 2015).

⁸⁰ Brauner (n 4) 983.

⁸¹ Model Tax Convention on income and on capital (Org. For Econ. Co-Operation & Dev. 2010) Art.26 [Hereinafter OECD Model Convention 2010]

⁸² Brauner (n 4) 983.

⁸³ Ibid.

⁸⁴ OECD ‘Global Forum on Transparency and Exchange of Information for Tax Purposes’, <http://www.oecd.org/tax/transparency/> (accessed 5th February 2019).

⁸⁵ Brauner (n 4) 984.

⁸⁶ Sunita Jogarajan, ‘Stamp, Seligman and the Drafting of the 1923 Experts’ Report on Double Taxation,’ (2013) 5 World Tax Journal 368.

⁸⁷ Brauner (n 4) 984.

⁸⁸ Ibid.

⁸⁹ OECD (n 22).

⁹⁰ Lee A. Sheppard, ‘News Analysis: BEPS Progress Report’, (2014) 142 TAX NOTES 1154, 1154.

⁹¹ Charles Duhigg & David Kocieniewski, ‘How Apple Sidesteps Billions in Taxes’ N.Y. TIMES (New York April 28, 2012) at A1.

⁹² Brauner (n 4) 989.

⁹³ Members and Partners, OECD, < http://www.oecd.org/about/membersandpartners/> (accessed 10th February 2019).

⁹⁴ Yariv Brauner, ‘BEPS: An Interim Evaluation’, (2014) 6 World Tax Journal 12.

⁹⁵ Brauner (n 4) 991.

⁹⁶ Organization For Economic Cooperation & Development [OECD], Addressing the Tax Challenges of the Digital Economy, Action 1-2015 Final report (OECD Publishing, Paris, 2015).

⁹⁷ Chang Hee Lee, ‘Impact of E-Commerce on Allocation of Tax Revenue Between Developed and Developing Countries’, (2004) 4 Journal of Korean Law 19.

⁹⁸ Organization For Economic Cooperation & Development [OECD], ‘Are the current treaty rules for taxing business profits appropriate for ecommerce? (2004) 18.

⁹⁹ OECD (n 22).

¹⁰⁰ Organization For Economic Cooperation & Development [OECD], Developing a multilateral instrument to modify bilateral tax treaties’, action 1 - 2015 final report (OECD Publishing, Paris, 2015) 13.

¹⁰¹ Brauner (n 4) 993.

¹⁰² Ibid.

¹⁰³ Global Tax Alert, ‘Italy Considers Introduction of Tax on Digital Activities’, (EY Apr. 27, 2015), <http://www.ey.com/GL/en/Services/Tax/InternationalTax/Alert—Italy-considers-introduction-of-tax-on-digital-activities;> (accessed on 10th February 2019).

¹⁰⁴ OECD, The Digital Economy, (Report of Hearings on the Digital Economy 2013) 5.

¹⁰⁵ OECD, Action Plan on Base Erosion and Profit Shifting, (BEPS Report 2013) 10.

¹⁰⁶ Victoria Plekhanova, ‘Addressing the Tax Challenges of the Digital Economy: A Response to Action 1 of the 2015 Final Report of the OECD/G20 Base Erosion and Profit Shifting Project1’ (PhD Thesis, University of Auckland, 2015).

¹⁰⁷ The Task Force on the Digital Economy (TFDE), Tax challenges arising from digitization, final report of the TFDE (OECD Publishing, Paris, 2018).