Report on the Digital Asset Tax Roundtable: Compliance Challenges,Opportunities & Way Forward

Background:

The Digital Asset Tax Roundtable, held on October 23, 2024, in Nairobi, served as a critical forum for discussing the implications of Kenya's emerging tax regulations on digital assets. Organised by the Virtual Asset Chamber of Commerce in collaboration with the Kenya Blockchain & Crypto Conference, the roundtable gathered various stakeholders, including representatives from the Kenya Revenue Authority (KRA), to address the legal and compliance challenges posed by the evolving digital economy. The discussion emphasised the complexities surrounding the Digital Asset Tax introduced under the Finance Act 2023, effective September 1, 2023, and examined potential pathways for streamlining compliance and safeguarding business sustainability.

Key Issues Discussed

Mr. Omondi from KRA covered the Scope of Taxation under Kenya's Current Tax Regime:

• Section 12F of the Income Tax Act - Digital Asset Tax

Effective from September 1, 2023, this section introduced the 3% tax on digital assets, including cryptocurrencies. This tax is incurred by crypto asset traders in their swap or trading activities. In practice, a trader sending a crypto asset will end up incurring a 3% tax deduction for such a transaction. The exchange has the obligation of withholding the said tax.

• Digital Service Tax

Initially introduced on July 1, 2021, as a 1.5% tax on income earned by non-resident digital service providers, the DST was later expanded to encompass resident entities involved in digital services.

• Value Added Tax (VAT)

Exchanges are further required to pay 16% VAT on their same commissions.

• Corporate Income Tax (CIT)

Resident exchanges are also required to pay CIT on their income.

• Capital Gains Tax and Exemptions

Although the 8th Schedule of the Income Tax Act covers capital gains tax, digital assets such as cryptocurrencies and securities listed on the Nairobi Securities Exchange (NSE) remain exempt.

Practical Challenges and Concerns Raised by Private Sector Stakeholders

1. A 3% blanket tax that taxes traders whether or not a profit is being made seems unfair and regressive to the sector.

The private sector concern was that, although the Digital Asset Tax functions similarly to a transaction tax, its basis under income tax laws raises a constitutional argument about taxing gross transaction values instead of net income, potentially impacting loss-making transactions.Basically a blanket tax that taxes traders whether or not a profit is being made seems unfair and regressive to the sector. This is a subject of an ongoing tax petition which is part of the bunch of petitions against the Finance Bill 2023.

In countering this argument, Mr. Omondi gave a case example of a blanket tax that uses the same model - Turnover Tax (Section 12C) which applies at a 1.5% flat rate on businesses with gross annual income below KES 25 million.

1. Crypto Asset Companies are unable to open bank accounts in Kenya

Furthermore, the Central Bank of Kenya Act cautionary notice restricting banks from supporting crypto asset companies raises concerns of practicality. To date, crypto asset companies cannot legally hold bank accounts in any Kenyan bank. There have been several cases of those attempting to open such accounts having their accounts shut down and funds seized in certain cases.

1. Transactional Peculiarities

A recurring theme was the difficulty of reconciling daily transactions within the statutory five-day tax payment window. While KRA is working towards technological solutions that would facilitate real-time tax compliance, there remains a need for regulatory flexibility, particularly concerning the categorization of digital asset transactions.

For instance:

• Asset swaps (exchange of one digital asset for another) are currently treated as taxable events, which may not reflect the economic reality of such exchanges.
• In practice this tax is withheld in the native token (e.g BTC, ETH etc) will KRA be receiving the withheld in such native tokens? If not, who will incur the cost of conversion given the volatile nature of some of these tokens?
• Say an exchange that withheld the tax now converts the withheld amount to KES for tax settlement, will that conversion event be deemed a transfer subject to taxation?
• Will these taxes fuel innovation or stifle it? South Africa has received over 300 applications for its virtual asset sandbox, positioning itself as a hub for the sector. Will Kenya's tax landscape make it a competitive destination, or will innovators look elsewhere?

There were concerns that high tax rates and compliance costs could push cryptocurrency businesses out of the country, reducing Kenya's competitiveness as a regional fintech hub. The need for policy adjustments to avoid stifling innovation was emphasised, including potential tax exemptions or concessions for businesses operating within regulatory sandboxes.

Participants also highlighted the recent KRA proposal for an automated tax collection system that would integrate with cryptocurrency exchanges. While this could simplify compliance, S.A. Kakai, Policy and Regulatory Engagement Lead at the Virtual Asset Chamber of Commerce, stressed the need for a comprehensive legal framework that balances tax obligations with the operational realities of businesses. Would this move be potentially considered hostile thus driving investment and innovation away from the country? The implementation details for the automated system and the legal parameters surrounding its use remain under development.

4. Legal Interpretations of Relevant Provisions

Key legal provisions discussed included:

• Section 65 of the Tax Procedures Act (CAP 469A)

Allows taxpayers to seek private rulings from the Commissioner for unique transactions. Clarifying the scope of this section could accommodate the unique nature of digital asset transactions.

• Section 66 of the Tax Procedures Act

Addresses public rulings, which can guide general industry compliance. KRA is urged to issue guidance on aspects such as the tax treatment of cryptocurrency transactions to alleviate legal uncertainties.

• Section 35 of the Income Tax Act

Governs withholding tax obligations, typically applied to income sourced from betting or contractual payments. Participants questioned whether this provision could be applied to exchanges acting as intermediaries in crypto transactions, potentially creating a double-taxation scenario.

• OECD Crypto Reporting Framework

Mr. Omondi mentioned the potential adoption of the OECD Crypto Reporting Framework as a means to standardise reporting obligations and information sharing across jurisdictions. This approach could ease compliance burdens by harmonising tax treatment and data-sharing mechanisms.

6. Regulatory Coordination and Market Development

Hillary James, a regulatory sandbox expert raised the issue of fragmented regulation, with uncertainty over which regulatory body oversees virtual assets; whether the Capital Markets Authority (CMA) or another agency. Kenya's regulatory sandbox initiatives have seen blockchain-based projects, particularly in Real-World Asset (RWA) tokenization, but broader regulatory guidelines for virtual assets remain unclear.

Recommendations and Next Steps

Pro-active and Deliberate actions from the private sector.

The Virtual Assets chamber shall initiate a formal inquiry to the commissioner under section 65 and 66 of the ITA raising key concerns for the commissioner to issue interpretative guidance or rulings on the taxation of specific digital asset transactions, including swap events and the use of digital assets as payment. Separately, the Virtual Assets chamber shall also engage with the Joint Financial Sectors Regulatory Forum on various other issues above and beyond tax such as licensing and sandboxing Technical Committee can expedite the issuance of tax clarifications.