In today’s world, you can order a cab ride and read several news stories without having to search for a taxi on the streets or buy a newspaper.
The more comfortable world we live in is thanks to the digital or web economy, which has been growing exponentially. In 2018, the Nigerian Investment Promotion Commission predicted that this economy would generate $88 billion and 3 billion jobs by the end of 2021.
Even though the government is known for gross overestimates, the growth seen by the major multinational enterprises (MNEs) that power the digital economy is promising.
Amazon - one of such companies, grew its net income by a whopping 1846% in five years and more than doubled its revenue from $107 billion in 2015. Its $280 billion revenue generated last year is more than double of Nigeria's economy.
Despite this growth and large profits, various governments have struggled to tax them effectively. There was a debate last year on Amazon paying as little as 1.2% of its $13 billion profit in federal income taxes to the US. This is compared to an average of 14% paid by the average American. The federal corporate tax rate is 21%, but Amazon was able to get several tax breaks.
This situation has led to the erosion of the domestic tax base of most economies. Think about it, as the economy moves from traditional companies that are more easily taxed to these digital firms, the tax base could fall.
As of September last year, the digital economy largely consisted of 16% of the global economy and is growing rapidly.
Already, there are allegations that resident businesses providing similar services with digital enterprises bear the burden of corporate taxes while the MNEs go untaxed, leading to unfair competition.
This happened four years ago in South Africa where Vodacom and MTN testified against WhatsApp and other tech platforms for robbing them of profits and paying no tax to the government. Multichoice has also recently voiced similar concerns against Netflix.
Driven by this understanding, most countries have begun taking unilateral action to tax these digital multinationals.
In 2019, the US and France were on the brink of a trade war because President Macron decided to impose a digital service tax on US-based tech MNEs. The global debate that ensued from the US-France situation made it clear that the world is confused as to how best to impose such taxes. The efforts have to be globally coordinated, to be effective.
What is so difficult about taxing the digital economy?
A principle known as permanent establishment (PE) status is the basis for the international tax rule on cross-border activities, designed in the 1920s.
It requires that a business only be taxed in a country where it creates sufficient physical presence. Since most companies in the digital economy can operate in a country without setting up appearances, the rule does not capture them.
It was necessary in the 1920s (after WWI) when corporations were beginning to do business outside their country of origin.
At that time, countries signed Double Tax Agreements (DTAs), so that regardless of the countries they operate in, only one country can receive taxes from them, aka tax residency.
Evidently, it did not envisage the creation of businesses without a permanent establishment status (i.e. no sufficient physical presence). Today, digital multinationals use this rule to prevent double taxation. Unfortunately, they also use it to avoid paying taxes.
Asides the physical establishment gap, there is an additional problem with profit attribution. Countries are finding it difficult to know the profit these multinationals get from their economic activities.
The concept of profit attribution has also been the subject of a global debate due to a lack of universally accepted definition/formula to determine what it should be.
In simple terms, however, it refers to the profit that can be attributed to an MNE from its economic activity in a particular market/jurisdiction. How do we know how much profits Facebook makes in Nigeria vs Dubai?
OECD, Nigeria and digital economic taxes
In finding solutions to these challenges, the Organisation for Economic Cooperation and Development (OECD) identified some options for taxing the digital economy.
The first was centred around establishing a Significant Economic Presence (SEP), which Nigeria developed a policy on — it was further clarified two months ago when the country released the SEP order.
According to the federal government, these MNEs are deemed to have significant economic presence or become taxable when the foreign corporation's digital transactions make ₦25 million and above in a year; uses the .ng domain name or registers a web address in Nigeria.
In addition, if such a business has interactions with persons in Nigeria by customising its platform to target persons in Nigeria, they would be classified to have SEP.
Netflix, Amazon, Uber, etc. are examples of companies that would be captured by this policy. However, this is different for businesses that are tax resident in a country that has a double tax agreement with Nigeria. In this case, such a business will not be subjected to the SEP Order. This is because a DTA defines permanent establishment differently.
For example, the SEP order will not apply to any corporation that has a tax residence in the UK- one of the 14 countries Nigeria has a DTA with. But, it would apply to an organisation that is tax resident in the US or the British Virgin Islands (since Nigeria does not have a DTA with either country).
Nigeria’s efforts to effectively tax the digital economy is laudable, as it might help in diversifying the government’s revenue and increase its low tax to GDP ratio (6% in 2019, below the continental average).
The SEP policy clarifies what it takes to establish a significant economic presence to be taxed, but does not address the profit attribution issue in taxing non-resident MNEs. There lies the problem with the efficacy of the SEP Order for the purpose of taxing the digital economy.
Much ado about the SEP
In theory, the new SEP Order suggests that Bezos’s Amazon could be taxed in Nigeria (despite not having a physical office in the country) just as Konga is taxed. However, it is important to understand that it may still not happen.
As discussed above, taxing the digital economy requires global coordination and a resolution of the twin problems of physical establishment and profit attribution.
Research conducted by the International Centre for Tax and Development reveals that the issue with taxing the digital economy in Nigeria is due to a lack of comprehensive rules for profit attribution of MNEs and not so much the absence of permanent establishment.
India’s recently designed SEP policy used a formula that combines sales, assets and payroll of its multinational enterprises to attribute profit, making it effective and easy to administer.
In Nigeria, it is difficult to imagine how the SEP policy will be administered and how the FIRS intends to enforce this rule on MNEs without a clearly defined profit attribution rule.
To achieve the goals of the SEP policy, access to the financial information of the MNEs is important.
Fortunately, Nigeria has the Country-by-Country Regulations 2018 (“CbyC Regulations”) which places an obligation on MNEs to provide this information.
Therefore, effective enforcement of the CbyC Regulations will be critical if the SEP policy is to succeed. The Nigerian government will also be required to simplify the process of attributing profits of the MNEs and make it cost-effective to encourage compliance.
While Nigeria is to be applauded for taking its fate into its hands, it should be noted that taxing the digital economy is a global problem, which still needs a coordinated approach to curb any tax avoidance tactics of these corporations.