The famous free encyclopedia, Wikipedia, states that the digital economy is an economy based on digital computing technologies and is perceived as conducting business through the internet and the World Wide Web. Interestingly, the evolution of the digital economy reduces the need for physical presence or ‘face-toface’ meeting to carry out transactions. This disrupts the traditional way of moving goods, capital and labour across borders and thus blurs the tax footprint.
It is important to note that the main challenges with taxation of the digital economy is the continual increase in the potential of digital technologies and the reduced need for physical presence in order to carry on business. Secondly, the growth in sophistication of information technologies has permitted companies in the digital economy to gather and use information across borders to an unprecedented level.
This raises the issue of how to attribute value created from the generation of data through digital products and services, and how to characterise for tax purposes, the supply of data in a transaction (example as a free supply of a good or as a good with value which can be sold). Thirdly, the development of new digital products or means of delivering services creates uncertainties in characterization of payments for such products and services.
All these challenges create issues around when and how the tax authorities will subject such entities to tax i.e. when will they be deemed to have earned sufficient revenue, or how to make the decision on whether they have sufficient economic presence in a particular jurisdiction, to impose tax.
In addressing these issues, Nigeria joined 9 other countries in 2019 to recognize the impact of double non-taxation and tax leakages from digital economy, through the introduction of the Finance Act 2019, which was signed into law by President Muhammadu Buhari on 13 January, 2020. The Finance Act introduces the concept of significant economic presence to respond to the challenges of taxation of digital services and the associated loss of tax revenue.
The Concept of Significant Economic Presence (SEP)
The Organisation for Economic Co-operation and Development (OECD) Report on Action 1 of the BEPS Action Plan – “Addressing the challenges of the digital economy” proposes a new concept for taxation termed a “significant economic presence”. This was based on one of OECD’S three proposals/options to expand the taxing rights jurisdictions. The options were user participation, marketing intangibles and significant economic presence (SEP). Based on the above, Nigeria adopted the SEP option included in the recently signed Finance Act 2019.
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The concept of SEP means that a non-resident company would create a taxable presence in a country (when it has a significant economic presence in that country based on factors that indicate a deliberate and sustained interaction with the economy of that country via technology and other automated tools.
Factors in determining the existence of SEP
The Finance Act does not provide the basis for establishing whether a non-resident company has a SEP in Nigeria. Rather, it provides that Nigeria’s Honourable Minister of Finance, Budget and National Planning (“the Minister”) will determine what constitutes SEP of a non-resident company through an Order.
Therefore, we have highlighted some factors proposed by OECD1 that the Minister may consider in coming up with the guidelines to establish the existence of a SEP for a non-resident company (NRC), who carries on digital services in Nigeria.
The amount of revenue generated by an NRC is considered as one of the distinct potential indicators of the existence of a significant economic presence in a country. The core element of the revenue factor could be the gross revenue threshold generated from the transactions concluded in Nigeria. The amount should, however, be high enough to minimise the compliance and administration burden and low enough to ensure that sufficient taxes are collected.
For example, the European Commission proposed that there is a significant digital presence in a member state if the revenue from providing digital services to users in a jurisdiction exceeds €7 million (approximately N2.3billion ) in a tax period. The Italian government, in imposing its newly introduced Digital Service Tax, also set an annual revenue threshold of €5.5 million (N1.8 billion) within the Italian territory . Also, France introduced a 3percent of turnover as digital tax on digital services conducted in France. This include advertising revenue, commission earned by platforms and revenues from resale of personal data. The French Government targets digital companies with global annual sales of more than €750 million and sales in France of at least €25 million (NGN8.3 billion).
Once the revenue threshold is set by the Minister, then digital NRCS who fall within this threshold will be required to register as taxpayers.
The use of a Nigerian website address may indicate that an NRC places some significance on its activities in the country. In addition, where the websites are established to include features (such as language, local marketing, local terms of services) intended to facilitate interaction with Nigerian users and customers, then a SEP may have been triggered.
Finally, the use of local forms of payment by an NRC is an indication of SEP in the country. For example, the integration of local forms of payment into a website’s commercial features is a complicated technical, commercial, and legal exercise requiring substantial resources. Hence, a non-resident company would normally not undertake such an investment unless it purposefully participates in the country’s economic life.
It is important to ascertain the level of interaction with the economy of Nigeria, through digital platforms, in order to determine the existence of SEP. Consequently, OECD suggested a range of factors that could be used to reflect the level of participation in the economic life of a country. Examples include monthly active users, online contract conclusion, data collected etc. Monthly
to OECD, refers to the registered users who logged in and visited a company’s digital platform in the last 30- days. The more the number of users, the higher the possibility of a SEP.
Another factor in establishing SEP is the number of online contracts concluded through a digital platform with customers resident in Nigeria. Therefore, the number of contracts concluded should be monitored to determine whether an NRC has a SEP in Nigeria. Also, the volume of digital data collected from a country in a year can also assist to determine the existence of SEP, this is regardless of where the data is stored and subsequently processed.
For example, the European Commission proposed that there is a significant digital presence in a Member State if there are more than 100,000 users of a digital platform or if the number of business contracts for digital services exceeds 3,000 in a particular year.
Finally, OECD suggests that the most appropriate means of establishing SEP is a combination of the revenue-based factors and any of the other two factors discussed above.
Conclusion
The introduction of a framework for the taxation of digital economy in Nigeria is a step in the right direction as this will provide a level playing field for both the traditional brick and mortal stores and digital businesses. It will also ensure that these companies pay their fair share of taxes where economic benefit is derived.
It is therefore essential that the threshold set in determining SEP is sufficiently high to safely exclude small cases where profits attributable to a digital presence would not even cover the tax compliance cost for a permanent establishment. In addition, the registration process and compliance administration should not be burdensome to ensure ease of compliance by the MNES.
The Federal Government must also put in place the appropriate infrastructure to track the income generated by these MNES from Nigeria to ascertain when the revenue threshold is met. The Nigerian Government should also be ready to make the necessary investment in the technology, relevant digital tools and human resources ( IT experts) that will assist in ascertaining SEP.
Finally, while we wait for the Minister to determine what will constitute SEP in Nigeria, companies that currently play in the digital space may need to clearly delineate their revenue from economic activities in Nigeria to ensure that they can clearly show whether they would qualify to have SEP in Nigeria. Also, Nigerian affiliates of such companies may come under scrutiny when the SEP Order is passed as they may be the reference point for such digital companies with the tax authorities. Similarly, other companies such as banks, financial technology companies, payment service companies, data management, research and intelligence companies, delivery companies etc. who are involved in the value chain for providing digital services may also play a role in the final determination of what constitute SEP in Nigeria.
Olalere and Bello are managers at KPMG in Nigeria
