ADDRESSING THE AMBIGUITY IN TAXING BUNDLED DIGITAL SERVICES: A CRITICAL ANALYSIS OF KENYA'S DIGITAL SERVICE TAX FRAMEWORK. Submitted in partial fulfillment of the requirements of the Bachelor of Laws Degree, Strathmore University Law School By Lisa Ntabo Moraa 146066 Prepared under the supervision of Mr. Allan Mukuki January, 2024 Word count: 20565 TABLE OF CONTENTS ACKNOWLEDGEMENT........................................................................................................iv DECLARATION........................................................................................................................v LIST OF CASES.......................................................................................................................vi LEGAL INSTRUMENTS....................................................................................................... vii LIST OF ABBREVIATIONS.................................................................................................. ix ABSTRACT................................................................................................................................x CHAPTER 1............................................................................................................................... 1 1.0 INTRODUCTION TO DIGITAL SERVICE TAXATION.......................................... 1 1.1 BACKGROUND TO THE PROBLEM......................................................................2 1.1.0 The Origin of Digital Service Tax........................................................................... 2 1.1.1 Digital Service Tax in Kenya and Proposed Transformations................................. 3 1.2 STATEMENT OF THE PROBLEM...........................................................................4 1.3 PURPOSE OF STUDY................................................................................................ 4 1.4 HYPOTHESIS.............................................................................................................. 4 1.5 RESEARCH QUESTIONS..........................................................................................5 1.6 RESEARCH OBJECTIVE..........................................................................................5 1.7 JUSTIFICATION OF STUDY.................................................................................... 5 1.8 METHODOLOGY....................................................................................................... 6 1.9 SCOPE AND LIMITATION OF STUDY.................................................................. 6 1.10 THEORETICAL FRAMEWORK............................................................................7 1.10.1 Introduction............................................................................................................7 1.10.2 Tax Theories...........................................................................................................7 i) Ability to Pay Theory................................................................................................ 7 ii) Benefit Principle....................................................................................................... 8 iii)Tax Neutrality...........................................................................................................9 1.10.3 Conclusion........................................................................................................... 11 1.11 LITERATURE REVIEW.........................................................................................11 1.11.1 Introduction.......................................................................................................... 11 1.11.2 Understanding Digital Service Bundling and Consumer Behaviour................... 12 1 1.11.3 Policy and Economic Implications of Bundling Mechanism and Digital Services. 14 1.11.4 Bundling in the Context of Agricultural Digital Services....................................16 1.11.5 Challenges in Taxing Bundled Digital Services...................................................18 1.11.6 Conclusion........................................................................................................... 19 1.12 CHAPTER BREAKDOWN.....................................................................................20 1.13 CONCLUSION......................................................................................................... 20 CHAPTER 2............................................................................................................................. 21 2.0 ANALYSIS OF KENYA’S DIGITAL SERVICE TAX FRAMEWORK.................. 21 2.1 Introduction.................................................................................................................. 21 2.2 Legal Basis of Kenya’s DST Framework..................................................................... 21 2.3 Scope of Digital Service Tax Framework.....................................................................23 VAT and Its Interaction with DST.................................................................................. 25 2.4 Implementation and Enforcement Mechanism of DST and its Impact........................ 26 Registration..................................................................................................................... 26 Compliance..................................................................................................................... 27 Impacts............................................................................................................................27 2.5 Digital Service Tax in Bundled Services...................................................................... 28 2.6 Appreciation and Limitation of the Digital Services Tax.............................................29 2.7 International View on Digital Service Tax................................................................... 30 2.8 Conclusion.................................................................................................................... 31 CHAPTER 3............................................................................................................................. 32 3.0 GAPS IN KENYA’S DIGITAL SERVICE TAX FRAMEWORK............................32 3.1 Introduction.................................................................................................................. 32 3.2 Gaps in Digital Taxation...............................................................................................33 Definition of a Tax Gap.................................................................................................. 33 3.3 Legal Gaps in the DST Framework..............................................................................34 3.4 Administrative and Implementation Challenges.......................................................... 35 3.5 Policy and Economic Gaps...........................................................................................38 Economic Gaps............................................................................................................... 38 3.8 Conclusion.................................................................................................................... 39 2 CHAPTER 4............................................................................................................................. 39 4.0 COMPARATIVE ANALYSIS OF DIGITAL SERVICE TAX FRAMEWORK: INDIA AND AUSTRALIA’S VIEW ON TAXING BUNDLED SERVICES................. 39 4.1 Introduction.................................................................................................................. 39 4.2 Conceptual Framework.................................................................................................40 4.3 An Overview of India’s Goods and Service Tax.......................................................... 41 4.4 Treatment of Bundled Digital Services........................................................................ 43 4.5 Strengths and Weaknesses of India’s GST framework.................................................46 4.6 An Overview of Australia’s Goods and Service Tax....................................................46 4.7 Treatment of Bundled Services in Australia's GST......................................................48 4.8 Positive and Negative Impacts of Australia’s GST...................................................... 49 4.9 Lessons Drawn in the Analysis of Kenya’s DST, India, and Australia’s GST concerning Bundled Digital Services................................................................................. 50 4.10 Conclusion.................................................................................................................. 51 CHAPTER 5............................................................................................................................. 52 5.0 RECOMMENDATIONS AND CONCLUSION......................................................... 52 5.1 Introduction.................................................................................................................. 52 5.2 Key Findings in Taxation of Bundled Digital Services in Kenya............................... 52 5.3 Policy Recommendations for Kenya's DST Framework..............................................53 5.4 Conclusion.................................................................................................................... 56 3 ACKNOWLEDGEMENT Firstly, I thank God Almighty for His unfailing love, guidance, and good health throughout this dissertation process. His grace has been my source of inspiration, perseverance, and clarity. I extend my profound gratitude to my dissertation supervisor, Mr. Allan Mukuki, for his invaluable guidance, patience, constructive feedback, insightful suggestions, and unwavering support which have been instrumental in shaping this dissertation. To my Mom and Dad, your steadfast love, prayers, and encouragement have been my greatest motivation. Thank you for believing in me and your unwavering support, which has made this milestone possible. This dissertation would not have been without the combined support and encouragement of God, my supervisor, and my family. 4 DECLARATION 5 LIST OF CASES Foreign cases 1. Microsoft Corporation v Communities of European Communities (2007) Court of First Instance (Grand Chamber), European Court. 2. South Dakota v Wayfair (2018), The Supreme Court of the United States. 3. Quill Corp. v. North Dakota (1992), The Supreme Court of the United States. 4. G.A. Infra Pvt. Ltd. (Applicant) vs. Authority for Advance Rulings (2019), Authority for Advance Rulings (AAR), India 5. M/s Sarj Educational Centre vs. West Bengal Appellate Authority for Advance Ruling (2019), West Bengal Appellate Authority for Advance Ruling, India Kenyan cases 1. Digital Box Limited v Commissioner of Domestic Taxes(2017) eKLR 2. Bluejay Limited v. Commissioner of Legal Services and Board Coordination(2024)eKLR 3. Republic v Kenya Revenue Authority Ex Parte Funan Construction Limited (2015)eKLR 4. Fleur Investments Limited v Commissioner of Domestic Taxes & Kenya Revenue Authority(2024)eKLR 5. Total Kenya Limited v Kenya Revenue Authority(2018)eKLR 6. Republic vs Commissioner of Domestic Taxes Mkopa Limited(2024)eKLR 6 LEGAL INSTRUMENTS Kenyan Legislation 1. Clause 8, Finance Bill (2024) 2. Proposed amendment) Section 12E, Income Tax Act(1974) 3. Article 209, Constitution of Kenya (2010) 4. Article 210, Constitution of Kenya (2010) 5. Section 4, Finance Act (2020) 6. Section 9, Finance Act (2020) 7. Regulation 2, The Income Tax (Digital Service Tax) Regulations (2020) 8. Section 12E, Income Tax Act, 1974 9. Section 3, Income Tax Act,1974 10. Section 2, Income Tax Act,1974 11. Regulation 3(1), The Income Tax (Digital Service Tax) Regulations (2020) 12. Regulation 3(2), The Income Tax (Digital Service Tax) Regulations (2020) 13. Regulation 3(1), The Income Tax (Digital Service Tax) Regulations (2020) 14. Regulation 3(3), The Income Tax (Digital Service Tax) Regulations (2020) 15. Regulation 3, The Income Tax (Digital Service Tax) Regulations (2020) 16. Regulation 4, The Income Tax (Digital Service Tax) Regulations (2020) 17. Section 7, Finance Act (2020) 18. Regulation 6, The Income Tax (Digital Service Tax) Regulations (2020) 19. Section 7(1)(d), Value Added Tax (2013) 20. Section 8, Value Added Tax (2013) 21. Section 34, Value Added Tax (2013) 22. Section 5(2), Value Added Tax (2013) 23. Section7, Value Added Tax (2013) 24. Section7(2), Value Added Tax (2013) 25. Regulation 7(1), The Income Tax (Digital Service Tax) Regulations (2020) 26. Regulation 9, The Income Tax (Digital Service Tax) Regulations (2020) 27. Section 15A, The Tax Procedures Act (2015) 28. Section 19, Finance Act (2020) 29. Section 5(1), Kenya Revenue Authority Act (1995) 7 30. Section 10, The Income Tax (Digital Service Tax) Regulations (2020) 31. Section 35, Income Tax Act (1974) 32. Section 12E, Income Tax Act (1974) 33. Regulation 6, The Income Tax (Digital Service Tax) Regulations (2020) 34. Section 43, Income Tax Act (1974) 35. Section 3(1) (ca), Income Tax Act (1974) 36. Section 3, Income Tax (Digital Service Tax) Regulations (2020) India Legislation 1. Section 2(102), Central Goods and Services Tax (CGST) Act, 2017 2. Section 8, Central Goods and Services Tax (CGST) Act, 2017 3. Section 2(17), Integrated Goods and Services Tax (IGST) Act, 2017 4. Section 9(3)(4), Integrated Goods and Services Tax (IGST) Act, 2017 5. Section 13, Central Goods and Services Tax (CGST) Act, 2017 6. Section 15, Central Goods and Services Tax (CGST) Act, 2017 7. Rule 27-31, Central Goods and Service Tax (CGST) Rules,2017 8. Section 14, Central Goods and Services Tax (CGST) Act, 2017 Australia Legislation 1. Section 5(9), New Tax System (Goods and Services Tax) Act, (1999) 2. Section 38, New Tax System (Goods and Services Tax) Act, (1999) 3. Section 23(15), New Tax System (Goods and Services Tax) Act, (1999) 4. Section 84(5), New Tax System (Goods and Services Tax) Act, (1999) 5. Section 9(80), New Tax System (Goods and Services Tax) Act, (1999) 8 LIST OF ABBREVIATIONS 1. DST -Digital Service Tax 2. BEPS -Base Erosion and Profit Shifting 3. MNCs-Multinational companies 4. OECD-Organization for Economic Cooperation and Development’s 5. KRA-Kenya Revenue Authority 6. SEPT-Significant Economic Presence Tax 7. LMICs-Low- and middle-income countries 8. DAISI-Digital Agricultural Innovations and Services Initiative 9. IMF- International Monetary Fund 10. GATT- General Agreement on Tariffs and Trade 11. GATS- General Agreement on Trade in Services 12. RTAs- Regional Trading Arrangements 13. VAT- Value Added Tax 14. VPB -Virtual Product Bundling 15. GST- Goods and Service Tax 16. HSN-Harmonized System of Nomenclature- HSN code 17. CGST- Central Goods and Services Tax 18. IGST -Integrated Goods and Services Tax 19. ESCO-Energy Service Company 20. ATO- Australian Tax Office 21. BAS- Business Activity Statement 9 ABSTRACT This research thoroughly examines the ambiguity within Kenya’s Digital Tax framework on the taxation of bundled digital services. Bundled digital services offer multiple services as a package to consumers, they often combine taxable and non-taxable elements in the digital market. The core issue lies in the lack of clear definitions and classifications for taxable elements in a bundled package. Kenya’s DST framework currently applies a blanket approach treating all listed digital services within the Incomes Tax Act as taxable regardless of the compositions in which these services are offered. As a result, there exists confusion for businesses and inefficient revenue collection. It is thus important to define taxable and non-taxable entities in a bundle more precisely to ensure tax fairness and administrative efficiency. This paper, therefore, addresses the following key question: How can Kenya’s DST framework be refined to more effectively tax bundled digital services? The study adopts a doctrinal methodology analyzing legal cases, tax reports, and relevant acts. A comparative analysis will also be adopted comparing the digital tax framework of India and Australia. There is a clear distinction between taxable services in India’s goods and Service Tax framework and the periodic review mechanisms in Australia making these countries more relevant studies on addressing the complexity of taxing bundled digital services. Some key findings have determined that the unclear broad-based approach of Kenya’s DST hardens compliance for those business ventures offering various streamed services, cloud storage, and even e-commerce. Business enterprises find difficulties defining their liabilities for tax obligations without appropriate guidance; hence, they file taxes inconsistently with increased compliance costs. The government thus loses potential revenue. The research recommends clarity about the definition of bundled services and putting in place mechanisms that allow periodic reviews to adapt to the rapidly changing digital economy. These reforms will be key in improving equity, reducing compliance burdens, and simultaneously assure Kenya of sustainable revenue from the growing digital sector. 10 CHAPTER 1 1.0 INTRODUCTION TO DIGITAL SERVICE TAXATION The digital economy’s rapid growth has changed how businesses operate and deliver services. This has prompted governments to introduce tax regimes like Kenya’s Digital Service Tax (DST) to capture revenue from digital transactions.1 However, taxing the digital economy presents enforcement challenges due to the complex nature of these transactions.2 Kenya introduced its DST in 2021, imposing a 1.5% tax on gross income from digital services provided to Kenyan users, even for foreign companies with no physical presence in the country. The recent trend by digital providers is the provision of bundled services that combine taxable and non-taxable elements (e.g. software packages with free upgrades) or which combine many taxable digital elements as one package. The major challenge arising is calculating tax liability from these bundles. For example: If a multinational e-learning platform offers a subscription in Kenya for KES 3000 per month, this subscription includes access to live online classes which are taxable, recorded courses on demand available for a fixed duration which is taxable, and the provision of physical textbooks which are not taxable under the Section 12E of the Income Tax. There exists ambiguity in revenue allocation because KRA might tax the entire subscription as a digital service. Companies could exploit the bundling to minimize taxable digital revenue by artificially inflating the value of physical textbooks. Kenya’s DST does not clearly distinguish taxable and non-taxable elements in bundled digital services which leads to an inconsistent application of tax. This lack of clear definitions and classifications within Kenya’s DST framework creates a gap and inefficiency in tax administration and compliance. This dissertation will follow this structure, Part I examines Kenya’s DST framework and focuses particularly on taxing bundled digital services. Part II will identify gaps in definitions, classifications, and periodic review mechanisms, which complicate compliance and undermine effective revenue collection. Part III compares Kenya’s framework with those of India and 2 Kapkai P, Muthee I,Ngala B, Musa N ,Wanyeri A & Gathoni E, Enforcement of the Digital Economy Taxation, 4 African Tax and Custom Review 1,2021,2 1 United Nations Publications, Digital Economy Report,2024, xxiv 1 Australia- jurisdictions with clearer definitions and review systems, lessons will be drawn from these international jurisdictions to inform policy recommendations. Part IV will conclude the research with proposals and recommendations to enhance clarity, fairness, and efficiency in Kenya’s DST framework, alongside recognizing trends likely to emerge from these reforms. 1.1 BACKGROUND TO THE PROBLEM 1.1.0 The Origin of Digital Service Tax Digital Service Tax (DST) arose in response to global concerns about multinational companies (MNCs), especially giant tech firms, not paying their fair share of taxes in countries where they generated a lot of revenue from users but had no physical presence.3 As digital platforms grew, governments realized that previously existing tax systems were ill-equipped to capture profits created by users in different regions due to the nature of digital transactions.4 This led to the Organization for Economic Cooperation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) project, which aimed to address these challenges and ensure taxes were paid where economic activity occurred. The OECD proposed reallocating tax rights and the idea of a global minimum tax for taxing digital services, it later began advocating for interim measures like DST.5 In Europe, countries like the UK, France, Spain, and Austria began implementing DSTs to capture revenue generated from local users by foreign digital platforms.6 Their main goal was to allocate a share of MNC profits to the countries where the gain is from user transactions. These proposals have led to the introduction of unilateral solutions, most notably the Digital Service Tax (DST) which imposes taxes on revenue from digital services.7 Though these unilateral measures have faced 7Cui W, The Digital Service Tax: A Conceptual Defense, Proceedings. Annual Conference on Taxation and Minutes of the Annual Meeting of the National Tax Association, National Tax Assosciation,2018, 4 6 KPMG, Digital economy impact checklist: Update on Digital Services Tax developments,Spain, 2019, 3 SEE ALSO, Johnston S , Austria Proposes 5 Percent Digital Advertising Tax, 2019, 5 KPMG, Digital economy impact checklist: Update on Digital Services Tax developments, Spain, 2019, 3 SEE ALSO, Johnston S , Austria Proposes 5 Percent Digital Advertising Tax, 2019, 4 4 Enache C, Taxation around the world,2024,4 3 Stotzky R, Fano A, Taxation in the Digital Economy: Digital Services Taxes, Pillar One, and the Path Forward Bipartisan Policy Center,2023 2 criticism, they reflect a growing recognition that digital platforms possess unique factors that challenge existing tax frameworks.8 1.1.1 Digital Service Tax in Kenya and Proposed Transformations Through the Finance Act of 2020, Kenya introduced DST effective January 1, 2021, at a rate of 1.5% on the gross transaction value from digital services provided to Kenyan users. The tax applies to various services, including streaming, online advertising, and data monetization.9 Both resident and non-resident service providers must register and remit taxes, moreover, non-residents file online every month. Initial revenue collections were low with KES 0.34 billion (USD 3.4 million) collected in the 2020/2021 financial year, falling short of the target. However, collections improved to KES 1.84 billion (USD 18.4 million) in 2021/2022 and KES 2.57 billion (USD 25.7 million) in 2022/202310, this indicated better compliance among service providers. However, major tech firms like Google and Netflix have voiced concerns over the complexity of tax compliance and potential double taxation.11 If these issues remain unresolved it could chase away digital service providers and investors from the industry. These issues have prompted Kenya Revenue Authority (KRA) to reconsider the DST framework, by revising rates or provisions to enhance digital investments while ensuring tax compliance. The rejected Finance Bill 2024 proposed replacing DST with a Significant Economic Presence Tax (SEPT ), taxing 30% on 20% of gross profits based on economic activity rather than physical presence.12 Although SEPT aimed at broadening the tax base, it failed to address gaps in defining bundled digital services and compliance complexity it thus faced criticism for increasing compliance burdens. Kenya’s DST requires clearer definitions and classifications for bundled services as the current ambiguities undermine tax equity. This study proposes a detailed tax guide matrix to address the gaps and enhance the framework. 12 Clause 8, Finance Bill (2024) See also proposed amendment Section 12E, Income Tax Act(1974) 11 Aloo H, U.S tech giants push Kenya to drop 30% digital tax, The Africa Report, 4 June 2024 10 Indenje D, Kenya’s Digital Tax Tightrope:Balancing Revenue with Growth,KICTANet, 2024. 9Wambui R, Demistifying Digital Service Tax’ Kenya Revenue Authority Blog 2021 < https://www.kra.go.ke/news-center/blog/1074-demystifying-digital-services-tax >- link on 06 December 2024 8 Organisation for Economic Co-operation and Development, Tax Challenges Arising from Digitalisation – Interim Report 2018: Inclusive Framework on BEPS, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, 2018 [hereinafter OECD 2018 Report]. See especially Chapter 2. 3 https://www.kra.go.ke/news-center/blog/1074-demystifying-digital-services-tax 1.2 STATEMENT OF THE PROBLEM Regulations 3(1) and 3(3) of the Income Tax (Digital Service Tax) Regulations provide a clear and detailed distinction between taxable and non-taxable components relating to digital services. However, the framework does not take into account circumstances where digital service providers provide bundled services. This vulnerability continues to create room for manipulation and misinterpretation of taxes by service providers which affects effective collection of taxes. Digital service providers can assign higher values to non-taxable components like free delivery while assigning low values to taxable elements. This lack of compliance contravenes principle of taxation such as fairness and efficiency. Therefore this study will seek to examine the effects of lack of incorporation of bundled services in the Digital Service Tax framework while it proposes necessary recommendations. 1.3 PURPOSE OF STUDY The main aim of this study is to critically analyze Kenya’s DST framework specifically on the taxation of bundled digital services to identify specific gaps and propose actionable recommendations. This research examines definitions, categorization challenges, and tax compliance issues within the DST framework. The research will further compare Kenya’s approach to those of other jurisdictions such as India and Australia, which have developed more refined tax mechanisms for digital services. By exploring Kenya’s DST challenges and examining international practices, this study contributes to the ongoing discourse on digital service taxation, providing policymakers with insights to improve DST efficiency and fairness. 1.4 HYPOTHESIS The lack of clear definitions, classifications, and periodic review mechanisms within Kenya’s DST framework creates significant gaps in the taxation of bundled digital services, which results in inconsistent tax compliance and administrative difficulties. These loopholes hinder the effectiveness of DST in distinguishing between taxable and non-taxable components leading to an unfair tax burden for digital service providers. 1.5 RESEARCH QUESTIONS 1. What is the legal framework on taxation of digital services? 4 2. What specific gaps and ambiguities exist within Kenya’s Digital Service Tax (DST) framework on taxation of bundled services? 3. What lessons can be drawn from India and Australia which have successfully addressed taxing bundled digital services? 4. What policy recommendations can be proposed to refine Kenya’s DST framework in taxing bundled services? 1.6 RESEARCH OBJECTIVE 1. To examine the legal framework that justifies taxation of digital services. 2. To identify specific gaps in Kenya’s Digital Service Tax framework and its effects on tax compliance. 3. To conduct a comparative analysis between India, Australia, and Kenya to draw lessons on how to successfully tax bundled digital services in Kenya. 4. To propose policy recommendations to improve Kenya’s DST framework to better accommodate complexities associated with bundled services. 1.7 JUSTIFICATION OF STUDY This research addresses a gap in understanding the taxation of bundled services under Kenya’s DST framework. By analyzing the existing framework and identifying its ambiguities, the study contributes to digital taxation knowledge in the context of Kenya’s unique challenges and needs. The research provides practical recommendations for policymakers, tax administrators, and digital businesses. For policymakers, the research offers insights into refining the DST to enhance tax clarity and compliance. The dissertation also provides a clearer understanding of DST requirements for digital service providers, reducing compliance burdens. In conclusion, the research aims to support a fairer, more effective tax regime for Kenya’s growing digital economy. 5 1.8 METHODOLOGY This dissertation adopts a doctrinal research approach and a comparative analysis to examine gaps and ambiguities in Kenya’s Digital Service Tax framework to propose actionable reforms. The doctrinal research will focus on thoroughly interpreting legal texts, such as Kenya’s Finance Act 2020, DST Regulations, and related judicial decisions, to identify gaps and inconsistencies in taxing bundled services. Comparative analysis is also used to benchmark Kenya’s framework against those of India and Australia, these jurisdictions have clearer mechanisms established for defining and taxing bundled services while implementing periodic reviews. Data for this study is sourced from Kenyan statutes, International guidelines (OECD), BEPS Action Reports, and scholarly works by authors such as Lukas Erbrich and Tereso S. Tullao Jr. Kenya Revenue Authority complements these reports and other public documents. Comparative insights from India and Australia inform practical recommendations to meet Kenya’s unique context. This methodology ensures a structured approach to addressing research objectives while acknowledging limitations for example limited data availability. These limitations will be mitigated by relying on publicly available reports, and relevant jurisdictions for comparison, and recommending periodic review mechanisms for the DST framework. 1.9 SCOPE AND LIMITATION OF STUDY The research focuses on Kenya’s DST framework specifically, taxation of bundled digital services, in particular, the lack of clear definitions and guidelines for distinguishing taxable from non-taxable components. This study is limited by the availability of data on DST compliance among digital businesses in Kenya. In addition, the analysis is focused on Kenya and does not fully cover the broader international tax landscape beyond selected comparative jurisdictions 1.10 THEORETICAL FRAMEWORK 1.10.1 Introduction This research is grounded in fundamental principles within the tax theory. Scholars have emphasized the necessity of these principles in developing a fair and efficient tax policy. The 6 hypothesis posits that the insufficiencies within Kenya’s Digital Tax (DST) framework hinder compliance and undermine tax equity. By clearly defining and categorizing bundled services, this study explores how the mentioned theoretical constructs impact the effectiveness of Digital Service Tax. This research focuses on the Ability to Pay principle and Benefit principle to allow for the evaluation of fairness and accountability in Kenya’s Digital Service Tax framework, ensuring providers contribute equitably based on their financial capacity and the benefits they receive from users.13 Moreover, The dissertation further incorporates Tax Neutrality to emphasize the need for consistent treatment among service providers and promote economic efficiency, ultimately guiding recommendations for a more effective and equitable tax system.14 1.10.2 Tax Theories i) Ability to Pay Theory This principle is grounded in the tax equity theory and was notably advanced by Richard Musgrave.15 He emphasizes the role of this principle when designing tax structures with specific benefits from public services that are difficult to ascertain. The ability-to-pay principle asserts that taxes should be distributed based on individuals' economic capacity, emphasizing equity over direct benefit from public services.16. The principle is based on the concept of sacrifice, where individuals’ contributions are assessed based on the burden they experience when paying taxes. According to this theory when one’s wealth increases, the additional value derived from each currency unit diminishes, making it more equitable for the wealthier to bear a larger burden.17 This research concedes with Musgrave’s analysis for the following reasons the tax burden should be distributed among individuals based on their economic capacity. He emphasizes the 17Kendrick M, The Ability to Pay Theory of Taxation,29 The American Economic Review,1,1939,92-101 16 Musgrave R, Musgrave P, Public Finance And Theory in Practice, 5 ed, McGraw-Hill Book Co Singapore, 223 See also See John Stuart Mill, Principles of Political Economy, edited by W. J. Ashley, London: Longmans, 1921, 804. 15 Musgrave R, Musgrave P, Public Finance And Theory in Practice, 5 ed, McGraw-Hill Book Co Singapore, 223 14 Donald R, The Lindahl solution for economies with public goods, 3 Journal of Public Economics 1,1974, 23-42 See Also Jonathan G, Public Finance And Public Policy, 5ed, Worth Publishers Incorporated, 2016, 243-246 13Kenton W, Ability To Pay Overview and Examples in Tax law, 2020 7 importance of defining all forms of income comprehensively when used as a measure of ability to pay. Musgrave’s analysis provides a key framework for addressing equity issues in Kenya’s DST on bundled digital services. Musgrave's Ability-to-Pay Principle provides a critical framework for addressing equity issues in Kenya’s Digital Service Tax (DST) on bundled digital services. The principle emphasizes horizontal equity, requiring that entities with similar revenue capacities to face similar tax burdens, and vertical equity, mandating higher contributions from providers with greater economic capacities. However, Kenya’s DST framework lacks clear guidelines for apportioning taxable and non-taxable components within bundled services, this leads to inconsistent applications that undermine fairness. Furthermore, the absence of comprehensive definitions for income and revenue from such services hinders accurate tax assessments. Based on Musgrave’s insights, this dissertation proposes mechanisms to enhance equity, such as adopting clear apportionment rules, defining income comprehensively, and introducing tax structures to ensure larger providers contribute more proportionately. These measures would align the DST framework with the principles of fairness and equity, addressing its current ambiguities. ii) Benefit Principle The benefit principle of taxation was proposed by classical economist Adam Smith and later refined by others. Adam Smith argues that taxpayers should contribute to public revenue in proportion to the benefits they receive from government services.18 While he applied these principles to older forms of taxation, their relevance still extends to modern contexts like digital economies. In the context of digital services, taxpayers get different degrees of benefits from infrastructure, regulatory frameworks, and public services that enable the digital economy to thrive. The lack of clear definitions and periodic review mechanisms in Kenya’s DST undermines the alignment between taxation and benefits received. Smith's emphasis on equity and proportionality provides a foundational argument for refining Kenya’s approach to taxing digital services to ensure fairness. Following Smith's ideas on these aspects, Ernst Lindahl took the development of Smith's arguments one step further, and the benefit principle was integrated with public goods.19 In 19Peyton H, Equity: In Theory and Practice,Princeton University Press,1994, 103 18 Smith A, Wealth Of Nations, Wordsworth Classics of World Literature. England,2012, 330 8 that direction, Lindahl's model derives from the idea that everybody's taxes should be directly determined by his marginal gain or profit that he accrues from the public goods themselves and therefore reach an appropriate allocation of resources from society's perspective.20 In the context of bundled digital services, Lindahl's equilibrium points to the need for appropriate mechanisms that would clearly identify and apportion tax liabilities in respect of benefits derived from taxable and non-taxable components of such bundled services. The application of Lindahl's insight in the Kenyan DST framework therefore requires periodic reviews to ensure that tax policies are in step with emerging patterns of benefit distribution in the digital economy. For instance, since many digital services have value-conferring elements in asymmetric ways for users, failure to address such nuances risks imposing disproportionate tax burdens that could stifle innovation and economic growth. This research is in line with Adam Smith and Lindahl’s preposition, basing the dissertation on this principle allows for a critical analysis of Kenya’s DST through a dual lens, the proportional contribution of services, and equitable tax apportionment. This theoretical framework will guide the evaluation of the ambiguity in defining bundled digital services and the absence of mechanisms to adjust tax policies in response to market changes. Aligning Kenya’s DST with the benefit principle enhances its effectiveness in ensuring that tax is fair and conducive to economic efficiency. The dissertation will provide practical recommendations for reforming Kenya’s DST by incorporating the benefit-based principle by comparing jurisdictions that have successfully incorporated the principle into their digital tax regimes. iii)Tax Neutrality Tax neutrality is a concept in public finance proposed by economist James Mirrlees. Mirlees advocates for a tax system that balances efficiency and equity while minimizing distortions in economic behavior. Mirrlees explored how tax systems could be structured to achieve desired social outcomes without distorting individual incentives.21 He argued that while some distortions in consumption and labor supply are inevitable, there is no justification 21 Feldstein M, The Mirrlees Review, 50 Journal of Economic Literature 3,2012,781-790 20 Donald R, The Lindahl solution for economies with public goods, 3 Journal of Public Economics 1,1974, 23-42 See Also Jonathan G, Public Finance And Public Policy, 5ed, Worth Publishers Incorporated, 2016, 243-246 9 for distorting production. This has implications for tax policy design, suggesting that optimal tax rates should be flatter than the previously assumed high marginal tax. Adam Smith’s argument is in line with James Mirrlees's, which emphasizes that a tax system should not interfere with the natural functioning of markets.22 Tax neutrality is relevant to the taxation of bundled digital services under Kenya’s DST framework. Bundled services include a mix of taxable and non-taxable components and the ambiguity in defining these bundles risks violating neutrality. Unclear tax guidelines could lead to over-taxation of certain digital services while undertaking others, thus distorting the market competition and influencing providers’ pricing or service offerings. This lack of neutrality could discourage innovation in the digital sector by creating an uneven playing field where businesses face inconsistent tax burdens.In addition, the absence of periodic review mechanisms in Kenya’s DST increases the risk of neutrality violations. As the digital economy evolves, outdated tax rules may impact certain services or sectors, leading to inefficiencies that undermine economic growth. The dissertation will utilize the principle of tax neutrality to assess the DST framework’s effectiveness and propose reforms to reduce distortionary effects. First, the study will analyze the current ambiguity in defining taxable and non-taxable components of bundled services that create distortions in the digital market. This analysis will highlight cases where tax policy has unintentionally favored certain services or providers in market competition. This principle will also serve as a criterion for evaluating Kenya’s DST framework against international practices. By comparing Kenya’s approach with other jurisdictions that have implemented neutral and efficient digital taxation systems, the dissertation will adopt a strategy to harmonize market dynamics while avoiding distortions. 1.10.3 Conclusion The ambiguity in Kenya’s DST particularly how it addresses bundled digital services creates an obstacle to achieving equity and efficiency in taxation. These ambiguities result in 22 Smith A, Wealth Of Nations, Wordsworth Classics of World Literature, England,2012, 330 See also Ralph T, Erik Lindahl, 62 Ekonomisk Tidskrift 1,1960,5-8 10 inequitable tax burdens, inconsistent treatment of businesses, and reduced economic efficiency. By applying the above principles, it becomes clear that clearer definitions, guidelines, and periodic reviews of the DST framework are necessary. These reforms will reduce distortions ensuring a level playing field and enhancing the predictability of tax obligations for digital businesses in Kenya for efficient tax administration. 1.11 LITERATURE REVIEW 1.11.1 Introduction The taxation of bundled digital services is a relatively new and dynamic problem for the tax authorities, as such transactions reflect a range of service types, each with different taxation characteristics. Kenya’s government gets its revenue through the Digital Service Tax (DST) but it still struggles with defining and categorizing bundled services. By analyzing these themes applied to the context of prior literature, this literature review provides information on how Kenya’s DST framework can be improved and discusses other dimensions of bundled digital services and their tax characteristics. Key themes covered include the behavioral aspects of consumption of bundled services, the implications of bundling for policy and the economy in the digital environment, and compliance and fairness issues that bundled services raise for tax systems. Lastly, the literature presents regional and global approaches to digital service taxation to help the reader gain a comparative understanding of the issue for the Kenyan environment. Lukas Erbrich, Tereso S. Tullao Jr., Jennifer Burney, and other sources including Agrilinks empirically analyze bundled digital services and stress the importance of definition, fairness, and regularity within DST categories. These themes, develop the dynamics of taxing bundled digital services for understanding and highlight the gaps of knowledge that will set the future study of Kenya’s DST approach. The analysis of these articles will guide the study in determining how Kenya's DST framework can be better formed to fit the current and changing environment of recessed digital services while at the same time being fair in its taxation. 11 1.11.2 Understanding Digital Service Bundling and Consumer Behaviour Lukas Ebrich discusses the growing popularity of bundling in digital services, particularly in industries like music, video streaming, and digital journalism.23 Bundling is where multiple products or services are offered together, is shown to increase consumers' willingness to pay, attract higher subscription rates, and boost engagement. Ebrich argues that in digital journalism, bundling attracts consumers who value variety and convenience over committing to individual content providers.24 He terms this approach as the ‘Spotify for News’ which provides access to multiple news sources at a single price, this shows modern consumer preferences for flexibility and accessibility.25 In addition, bundling helps address price sensitivity by lowering the perceived cost of accessing multiple services, this is a key factor in competitive markets. Younger consumers prefer cross-publisher bundles over single subscriptions since the latter is restrictive in the array of services that they receive.26 Ebrich’s research highlights how bundling expands the audience base, increasing consumer satisfaction, and reducing customer churn by aligning with digital consumers' demand for variety and more convenience. Similarly, Stefan Holzweber agrees with Ebrich’s findings, he highlights how tying and bundling practices in digital markets shape consumer behavior and market dynamics. He emphasizes that there exist consumer biases in these markets.27 For example, in the Microsoft case, many users opted for pre-installed software like Internet Explorer because they lacked the willingness to seek alternatives.28 Consumers perceive bundling as economically beneficial. Holzweber notes that bundling offers cost savings or simplifies access to multiple services, making it appealing to users. This preference for convenience often leads consumers 28 Microsoft Corporation v Communities of European Communities (2007) Court of First Instance (Grand Chamber), European Court. 27 Holzweber S, Tying and bundling in the digital era, 14 European Competition Journal 2-3, 2018, 18 26 Ebrich L, Wellbrock C, Lobigs F, Buschow C, Bundling Digital Journalism: Exploring the Potential of Subscription-Based Product Bundles, 12 Cogitatio Press,2024, 4 25 Ebrich L, Wellbrock C, Lobigs F, Buschow C, Bundling Digital Journalism: Exploring the Potential of Subscription-Based Product Bundles, 12 Cogitatio Press,2024, 4 24 Ebrich L, Wellbrock C, Lobigs F, Buschow C, Bundling Digital Journalism: Exploring the Potential of Subscription-Based Product Bundles, 12 Cogitatio Press,2024, 4 23Ebrich L, Wellbrock C, Lobigs F, Buschow C, Bundling Digital Journalism: Exploring the Potential of Subscription-Based Product Bundles, 12 Cogitatio Press,2024, 2 See Also Adams J, Yellen Y, Commodity bundling and the burden of a monopoly, 90 The Quaterly Journal of Economics 3,1976, 475-498 12 to favor bundled services, even when unbundled options might meet their needs.29 The perceived value in bundling can reinforce the market position of firms that control access to key bundled services.30Through these observations, Holzweber provides a nuanced view of how consumer behavior and market dynamics interact with tying and bundling, particularly in the digital era. Echoing both authors, Richard Thaler supports that bundling affects consumer preferences, he highlights that consumers do have a bias when toward bundled services.31 Dan Ariely also supports this by stating that consumers can purchase things out of perceived value other than utility.32 Guillaume Roels is of a contrary view on bundling digital services, he argues that the concept of bundling can be a strategic approach to product differentiation however it might also stifle competition by allowing firms to dominate and bar potential market entrants.33 This perspective suggests that when a single firm bundles products and offers them exclusively, it can create barriers for new competitors, this limits consumer choices and potential higher prices in the future. He highlights that bundling is not inherently beneficial it can be used as a tool to extract surplus from consumers. This view raises concerns about the implications of bundling practices on consumer welfare.34 This study acknowledges the authors' insights that bundling leverages the modern consumer preference for variety and convenience, addressing cost concerns while increasing the perception of value. That is particularly true in subscription-based markets where competition and price sensitivity are major barriers to engagement. Ebrich’s and Holzweber's analysis provides a strong foundation for discussing the ambiguity in taxing bundled digital services under Kenya’s DST framework. His findings on consumer behavior such as the preference for variety and the economic appeal of bundled services support the argument that taxation policies need to distinguish between bundled and single services. By incorporating 34 Roels G, Khodabakhshlan A, Karmarkar, Competitive Bundling and Offer Design in a Symmetric Bertrand Duopoly Service Science, 15 Informs 4, 2023, 250-265 33 Roels G, Khodabakhshlan A, Karmarkar, Competitive Bundling and Offer Design in a Symmetric Bertrand Duopoly Service Science, 15 Informs 4, 2023, 250-265 32 Ariely, D, Predictably Irrational: The Hidden Forces That Shape Our Decisions. New York: HarperCollins, New York, 2008,138-153 31 Thaler R,Nudge: Improving Decisions About Health, Wealth, and Happiness. New Haven, Yale University Press,2008, 293 30 Holzweber S, Tying and bundling in the digital era, 14 European Competition Journal 2-3, 2018, 3 29 Holzweber S, Tying and bundling in the digital era, 14 European Competition Journal 2-3, 2018, 23 13 these insights, I can argue that the current lack of clarity in Kenya’s DST might inadvertently stifle innovation or misclassify bundled services, thus undermining its effectiveness in the rapidly evolving digital economy. This analysis will help demonstrate how other jurisdictions could handle similar issues paving a proposed tailored policy recommendation for Kenya. 1.11.3 Policy and Economic Implications of Bundling Mechanism and Digital Services Tullao’s insights on the policy and economic implications of bundling mechanisms in digital services explain that bundling allows service providers to combine digital services with other offerings creating a seamless user experience. This approach enhances consumer adoption and drives revenue streams for businesses.35 However, the bundling mechanism complicated tax policies, as existing frameworks are often inadequate to address the layered nature of bundled services. Tullao also highlights the economic implications of bundling, particularly for emerging markets. He notes that bundling increases market competitiveness by enabling businesses to offer diverse packages and cater to a broader audience.36 However, this diversification can blur the lines between taxable and non-taxable services. Ambiguities in classifying bundled services can unfairly burden businesses incorporating taxable components or overlook potential tax revenue from certain digital transactions. Furthermore, Gilles Le Blanc adopts a qualitative research methodology and empirical case study to explore the implications of bundling. Gilles Le Blanc explores the policy and economic dimensions of bundling, especially in telecommunication and digital services, shedding light on its implication for market efficiency, competition, and regulatory frameworks. He argues that bundling aims to enhance consumer satisfaction and offer comprehensive service packages.37 Economically, bundling enables firms to achieve significant cost savings and economies of scale, especially with digital services, companies can streamline operations and reduce transaction costs.38 However, bundling also increases 38.Leblanc G,Bundling Strategies, Competition and Market Structure in the Digital Economy, 41 Communication & Strategies 1,2001, 200 37 Leblanc G,Bundling Strategies, Competition and Market Structure in the Digital Economy, 41 Communication & Strategies 1,2001, 190 See Also Khodabakhshian A, Bundling under Competition: Duopoly and Oligopoly, Published PhD,University of Carlifornia, Los Angeles, 2019, 18 36 Tullao T, Croce D, Resurgence of Bundling Mechanisms in Digital Services Trade, Working Paper Seies No. 8, 073,2021, 14 - link on 8th November 2024 35 Tullao T, Croce D, Resurgence of Bundling Mechanisms in Digital Services Trade, Working Paper Seies No. 8, 073,2021, 5 - link on 8th November 2024 14 https://animorepository.dlsu.edu.ph/res_aki/12 https://animorepository.dlsu.edu.ph/res_aki/12 switching costs for consumers raising barriers to entry of smaller competitors. This can consolidate the market power of big firms and stifle the innovation of small players.39 Bundling presents problems for sector-specific regulation and competition law from a policy standpoint. Stricter regulatory control and coordination are required due to dominant businesses' potential to use bundling to expand their market clout across multiple sectors. Furthermore, the combination of competitive markets with monopolistic services creates complications that need flexible regulatory solutions. Pricing transparency and unambiguous service terms are crucial for safeguarding customers, as bundling frequently takes advantage of their need for ease and convenience. Bundling has also become a potent entrance technique due to the convergence of industries including media, telecom, and the internet. This can change market dynamics and raise worries about using dominance in one area to influence others. Joseph Stiglitz gives an opposing view that information asymmetry also appears in highlighting how bundling can obscure the true costs from consumers making it a better marketing strategy for service providers40 thus large firms can use this to create monopoly dominance.41 This research acknowledges the authors' assessment of the complexities introduced by bundling especially in the Kenyan context. The ambiguity in classifying bundled digital services is indeed a significant challenge that can lead to inconsistent taxation, undermining the effectiveness and fairness of the DST framework. The argument that bundling provides economic benefits is valid but failure of the current tax structure to address complexities could lead to economic distortions, such as unintended tax burdens or missed revenue opportunities. Le Blanc’s insights provide a foundation for understanding the complexities of taxing bundled digital services under the DST framework which is the main focus of this study. The findings emphasize the need for transparent policies that account for innovation and ensure fair competition. The study of empirical case studies and theoretical models in this research serves as a guide for developing a structured analysis of how bundling impacts taxation, consumer 41 Krugman P,Competitiveness: A Dangerous Obsession,73 Foreign Affairs 2, 1994, 28-44 40 Stiglitz J,Weiss A, Credit Rationing in Markets with Imperfect Information, 71 American Economic Review 3,1981,393-410 39 Leblanc G,Bundling Strategies, Competition and Market Structure in the Digital Economy, 41 Communication & Strategies 1,2001, 187 15 behavior and market dynamics will help recommend tax policies that balance efficiency without affecting the growth of Kenya’s digital economy. Tullao’s suggestions lay the foundation of my dissertation. The issue of ambiguous tax definitions is at the core of this research. He calls for a more nuanced approach that aligns with the objectives of proposing a more precise effective taxation mechanism for Kenya’s DST framework. This perspective will support the analysis of how bundling complicates the application of DST and informs the policy recommendations. 1.11.4 Bundling in the Context of Agricultural Digital Services Abdul Latif’s article from Jameel Poverty Action Lab highlights the potential of digital and bundled services in agriculture, framing research to address gaps in how these services impact small-scale farmers. The initiative (DAISI) prioritizes exploring adoption rates, outcomes, and performance factors of bundled agricultural services to inform policy and practice, especially in regions like sub-Saharan Africa and South Asia.42 Amartya Sen argues that bundled services are key in the provision of essential services, especially to marginalized groups.43Diane Coyle supports this argument claiming that technology is now advanced and its ability to provide more than one service at once can help rural communities through effective bundling mechanisms.44 Concerning Kenya’s Digital Service Tax (DST), this theme underscores the need for a framework that accommodates the economic and social benefits of bundled services. As bundles help fight multiple constraints for farmers, equitable tax treatment becomes important to prevent hindering access to essential services. Incorporating these findings advocates for Kenya’s DST framework to provide clearer guidelines and potential tax exemption for socially beneficial bundles, ensuring the DST policies do not hinder agricultural development. 44 Coyle D.Cogs and Monsters: What Economics Is and What It Should Be. Princeton University Press, Princeton,2019, 192 43 Sen A, Development as Freedom, Knopf, New York, 1999,366 42 Digital Agricultural Innovations and Services Iniative (DAISI). Poverty Action Lab --link on 8th October 2024 16 https://www.povertyactionlab.org/initiative/digital-agricultural-innovations-and-services-initiative-daisi There is an increasing awareness that the bundling of digital services can be a vital strategy for enhancing access to essential resources for smallholder farmers and improving fundamental needs in rural communities. According to Larsen, bundled digital services—delivered via mobile platforms or through multi-channel approaches such as combining radio with mobile—have shown significant potential to boost agricultural productivity, resilience, and food security in low- and middle-income countries (LMICs).45 By providing a unified platform offering various services, including financial, advisory, nutritional, and weather-related information, bundling addresses persistent challenges like digital literacy and infrastructure limitations. These bundled services promote inclusiveness by targeting women, youth, and other marginalized groups often excluded from accessing agricultural innovations.46 Abate Gashaw opposes Latif’s positive framing of bundled digital services in agriculture. He critiques the effectiveness and scalability of bundling digital services for smallholder farmers. He argues that while bundling has potential to enhance access to essential resources, there are barriers that limits its success.47 He highlights that high cost and lack of digital literacy and infrastructure challenges bar the widespread adoption of these services.48 This perspective contrasts with Latif’s view on bundled services suggesting that without addressing these challenges, benefits of bundling may not be realized. Moreover he emphasizes that the complexities in bundling can confuse farmers on which services are most beneficial for their needs. This can result to lack of trust in digital platforms limiting effectiveness and adoption.49 This holds clear implications for Kenya’s DST framework. A thoughtfully designed, Kenya's DST can foster equitable access by adopting tax policies that encourage, rather than discourage, the deployment of such beneficial services. However, the current DST framework lacks clarity on the taxation of bundled services, potentially increasing tax burdens on critical 49 Kieti J, Waemaa T , Baumüller H , Ndemoc E, Omwansaa T, What really impedes the scaling out of digital services for agriculture? A Kenyan users’ perspective, 2 Smart Agricultural Technology 100034, 2022, 5 48 Kieti J, Waemaa T , Baumüller H , Ndemoc E, Omwansaa T, What really impedes the scaling out of digital services for agriculture? A Kenyan users’ perspective, 2 Smart Agricultural Technology 100034, 2022, 5 47 Kieti J, Waemaa T , Baumüller H , Ndemoc E, Omwansaa T, What really impedes the scaling out of digital services for agriculture? A Kenyan users’ perspective, 2 Smart Agricultural Technology 100034, 2022, 5 46 Larsen L, Frontiers of Ecology and The Enviromnment, 13 Ecological Society of America (United States) 9, 2003, 488 45 Larsen L, Frontiers of Ecology and The Enviromnment, 13 Ecological Society of America (United States) 9, 2003,490 17 agricultural bundles. This dissertation emphasizes the need to differentiate between purely commercial digital bundles and those with developmental impacts, recommending that Kenya’s DST framework consider exemptions or favorable tax treatment for bundled services aimed at rural and agricultural sectors. Resolving these tax ambiguities can help Kenya build a more inclusive digital economy that supports sustainable development in underserved communities. 1.11.5 Challenges in Taxing Bundled Digital Services Lyla Latif's research on fairness in digital taxation looks at how underdeveloped nations, such as Kenya, confront considerable opportunities and challenges when it comes to taxing the internet economy through consumption taxes like VAT.50 While these taxes can extend the tax base and raise revenue, they also provide administrative and compliance concerns. The IMF's Fiscal Monitor (2021) echoes this sentiment, discussing options for successfully taxing the digital economy while taking into account the issues created by bundled services.51 Thomas Piketty raises concerns that poorly structured tax systems can increase economic disparities.52 Tereso S. Tullao, Jr.'s paper highlights the complexities introduced by bundling mechanisms in digital services trade, particularly in the context of taxation and international trade policies. Bundling, where goods are sold alongside services such as delivery, online shopping, and transportation, creates significant challenges in applying trade policies. A primary issue is determining the appropriate tax jurisdiction and rules for transactions that span multiple regions.53For example, a product consumed in one country might involve services delivered from several others, complicating tax enforcement and compliance. Existing frameworks like the General Agreement on Tariffs and Trade (GATT) and the General Agreement on Trade in Services (GATS) struggle to address these intricate transactions. Issues such as rules of origin and preferential treatment under Regional Trading Arrangements 53 Tullao T, Croce D, Resurgence of Bundling Mechanisms in Digital Services Trade, Working Paper Seies No. 8, 073,2021, 25 - link on 8th November 2024 52 Picketty T, Capital in the Twenty-First Century, Harvard University Press, Cambridge, MA, 2014,330 51 International Monetary Fund, Fiscal Monitor:Addressing the Crisis,2021 50 Latif L,The Evolving Thunder: The Challenges Around Imposing the Digital Tax in Developing African Countries,University of Nairobi, Centre for Financial Studies, Nairobi, 2022,34-50 18 https://animorepository.dlsu.edu.ph/res_aki/12 (RTAs) become problematic when goods and services cross borders as interconnected packages.54 Moreover, digital platforms often generate additional economic value through the collection and monetization of user data used to apportion where profits are gained, this adds another layer of complexity to tax systems due to the nature of the transactions. The ability to monetize data not only reduces operational costs through economies of scale but also raises critical questions about tax jurisdiction and the fair allocation of revenue among countries.55Without adequate policies, this data-driven economic model risks exacerbating global inequities, increasing tax evasion, and fostering a race to the bottom in tax rates, which could undermine fiscal capacities. Tullao emphasizes the urgent need for international cooperation to create adaptive tax frameworks that reflect the realities of digital services trade, ensuring fair taxation and reducing ambiguities.56 In the context of Kenya’s Digital Service Tax (DST) framework, Tullao’s insights underscore the importance of addressing ambiguities in taxing bundled services. Kenya needs clear guidelines to distinguish between commercial bundles and those with developmental purposes, such as services aimed at underserved communities in agriculture or education. Establishing a fair and coherent DST framework would encourage service providers to offer valuable services to marginalized groups, reduce uncertainty, and foster both economic growth and social equity. By addressing these gaps, Kenya can ensure its tax system supports its digital economy while promoting inclusivity and sustainable development. Michael Porter argues that a competitive advantage framework with clear tax policies can enhance market efficiency promoting innovation rather than creating barriers.57 57 Porter M, Competitive Advantage: Creating and Sustaining Superior Performance, Free Press, New York,1985,392 56 Tullao T, Croce D, Resurgence of Bundling Mechanisms in Digital Services Trade, Working Paper Seies No. 8, 073,2021, 14 - link on 8th November 2024 55 Mooji R, Klemm A,Perry V, Corporate Income Taxes under Pressure Why Reform Is Needed and How It Could Be Designed,International Monetary Fund,2021,388 54 Vincent W, Trade Rules for the Digital Age, Cambridge University Press, 2008, 2 19 https://animorepository.dlsu.edu.ph/res_aki/12 1.11.6 Conclusion The authors and articles examined reveal a shared recognition of both the potential and challenges presented by bundled digital services in low- and middle-income countries. Authors like Larsen, Tullao, and others agree that bundled digital services, particularly in sectors like agriculture, enhance accessibility, economic productivity, and inclusivity for marginalized groups. However, they consistently highlight that the lack of a clear tax policy for these bundles leads to legal and operational ambiguities, especially when combined with developmental and commercial services. This consensus underscores the legal gap you are addressing in Kenya’s Digital Service Tax (DST) framework: the need for clear, nuanced guidelines that distinguish between bundles with purely commercial value and those serving essential developmental purposes. This gap creates uncertainty, potentially deterring providers from offering valuable bundled services to underserved communities. Establishing a more precise DST framework would ensure fair taxation that supports both economic growth and social equity in Kenya’s digital economy. 1.12 CHAPTER BREAKDOWN This dissertation will be structured as follows: Chapter 1: Introduces the research topic, problem, research methodology, and objectives. It further provides a theoretical framework linked to the objectives and literature review. Chapter 2: Analyzes Kenya’s DST framework and its scope, focusing on its application to bundled digital services. Chapter 3: Identifies gaps in Kenya’s DST framework and its implication on bundled services. Chapter 4: Compares Kenya’s approach to those of other jurisdictions, particularly India and Australia Chapter 5: Offers recommendations and conclusions, proposing reforms to improve Kenya’s DST framework 20 1.13 CONCLUSION This chapter introduced the research topic, identified the key problem, and outlined the research questions and objectives. It highlighted the ambiguity within Kenya’s Digital Service Tax framework in taxing bundled digital services and analyzed Kenya’s approach compared to other jurisdictions. The chapter outlined the study's scope, significance, and expected contribution, providing an overview of the structure and anticipated conclusions. Overall, the study aims to propose practical policy recommendations for a more effective and equitable DST framework in Kenya. CHAPTER 2 2.0 ANALYSIS OF KENYA’S DIGITAL SERVICE TAX FRAMEWORK 2.1 Introduction Kenya’s Digital Service Tax (DST) was introduced as part of the OECD's broader strategy to capture revenue from the rapidly growing digitized business landscape.58 While Kenya’s DST is a significant step towards modernizing tax collection, its application to bundled digital services remains underdeveloped. Bundled digital services, which often combine taxable and non-taxable components, present unique challenges in taxation, including defining taxable elements, apportioning value, and ensuring compliance. This chapter analyses Kenya’s DST framework, focusing on its application to bundled digital services. It begins with an overview of the legislative and regulatory context, highlighting the aim and scope of DST. This chapter then examines the framework’s approach to bundled digital services, thus identifying ambiguities in definitions and enforcement. Challenges, such as revenue apportionment and the risk of double taxation, are also analysed to understand the framework’s limitations. Highlighting these issues, this chapter lays the groundwork for identifying gaps in Chapter 3 and proposing comparative insights in later chapters. 58 Congressional Research Service,The OECD/G20 Pillar 1 and Digital Service Taxes: A Comparison, 2024, 4 21 2.2 Legal Basis of Kenya’s DST Framework Article 209 of the Constitution of Kenya provides for the government's authority to impose tax on income, capital, and wealth and on goods and services in the national government.59 It also provides for the legal requirement on how the tax should be imposed, its assessment, collection, and enforcement under Article 210.60 The Constitution also provides that the taxation framework introduced should be efficient, effective, and fair. These constitutional obligations are justified by reference to the Finance Act and Income Tax (Digital Service) Regulations. In addition, the legal framework ensures that the government can fairly tax the digital economy while protecting the rights of both users and providers. Kenya's DST was legislated in the Finance Act 2020 and commenced on 1st January 2021.61 The Finance Act 2020 amended Section 12 (A) of the Income Tax Act by inserting Section 12E of the Act, which provides for the taxation of digital services. DST is rated at 1.5 % on the gross transactional value for digital services under the Act.62 Thirdly, the subsidiary legislation justified by Section 130 of the Income Tax Act is the Income Tax (Digital Service Tax) Regulations, 2020, which came into force in January 2021 and offset the rules in the taxation of digital services. Regulation 2 defines key terms that play a key role in understanding where the context of Kenya's DST lies. A digital service means any service delivered or provided over a digital marketplace.63A digital market provider is a person who provides a digital marketplace platform for digital transactions. On the other hand, a digital service provider is the person providing the services in the digital market.64A platform means any electronic application that allows digital service providers to access service users, directly or indirectly, through websites and mobile applications.65 Digital Service Tax is the tax payable on income or gains derived or accrued in Kenya from services offered through the Internet or any electronic network, application, or website.66 66 Section 12E, Income Tax Act, 1974 65 Kenya Revenue Authority Publications, Demystifying Digital Service Tax, 2021. 64 Regulation 2,The Income Tax (Digital Service Tax) Regulations (2020) 63 Regulation 2,The Income Tax (Digital Service Tax) Regulations (2020) 62 Section 9, Finance Act (2020) 61 Section 4, Finance Act (2020) 60 Article 210, Constitution of Kenya (2010) 59 Article 209, Constitution of Kenya (2010) 22 This applies to income derived or accrued in Kenya for both residents and non-residents from the provision of services through the digital marketplace. This, therefore, implies that the income is deemed to have accrued or derived in Kenya regardless of the place of the taxpayer.67 The concept of permanent establishment comes under Kenya's income tax, which refers to a fixed place of business where business is conducted wholly or partly.68 This makes it easy to tax such businesses. The use of the internet as a medium of transacting business made this tax a reality, to ensure that the income accruing in Kenya from service providers who are foreigners with no permanent residency was chargeable to tax.69 Moreover, DST is an advance tax for resident and non-resident persons having a permanent establishment in Kenya and a final tax for non-residents without a permanent establishment in Kenya.70 Advanced Tax refers to income tax paid in installments during the financial year on estimated income rather than a lump sum at the end of the year. On the other hand, final tax refers to tax that is considered fully paid upon its assessment and does not require any further payment or declaration.71 2.3 Scope of Digital Service Tax Framework Kenya's DST applies to a wide array of digital services people and businesses utilize daily. The rules apply to streaming and downloadable services of digital content; transfer of data collected about users which have been generated from such users' activities on a digital marketplace, however, monetised; provision of a digital marketplace, website or other online applications that facilitate a link between buyers and sellers; subscription-based media including news, magazines and journals; electronic data management including website hosting, online data warehousing, file-sharing and cloud storage services; supply of search-engine and automated helpdesk services including supply of customised search engine services; tickets bought for live events, theatres, restaurants, etc. through the internet: online distance teaching via pre-recorded medium or eLearning, including online courses.72 72 Regulation 3(1),The Income Tax (Digital Service Tax) Regulations (2020) 71 Yaniv G, Tax compliance and Advanced Tax Payment, 52 National Tax Journal 4,1999,755-764 70 Regulation 3(2),The Income Tax (Digital Service Tax) Regulations (2020) 69 Regulation 3(1),The Income Tax (Digital Service Tax) Regulations (2020) 68 Section 2, Income Tax Act,1974 67 Section 3, Income Tax Act,1974 23 The DST regulations also apply to any other service provided or delivered through an online digital or electronic platform but exclude such services subject to withholding tax under the Income Tax Act.73 This means that payments made for sales promotion, marketing, and advertising services chargeable to withholding tax under the Income Tax Act will not be subject to DST. DST therefore spans a wide definition of digital services to ensure that no service is excluded. Another exemption from chargeable services is the services offered by licensed financial service providers undertaking online services that facilitate payments, lending, or trading of financial instruments, commodities, or foreign exchange.74 This is because licensing requirements demand that the sector players be established in Kenya, thus creating a requisite element for taxation. The DST Regulations state that a person is subject to DST if the person provides or facilitates the provision of a service to a user located in Kenya. It is, therefore, necessary to consider when a user is treated to be located in Kenya.75 The regulations give four criteria of determination under Regulation 5: a) Assess the digital interface from the device situated in Kenya b) Payment of the service using a credit/debit facility by a Kenyan company c) Acquire the services using an IP address registered in Kenya or an international mobile phone country code assigned to Kenya d) have a business, residential or billing address in Kenya. The DST does not say whether the above requirements are disjunctive or conjunctive; however, this research reasons that they are disjunctive, provided that any thresholds are met, the person becomes chargeable. As earlier stated, the Finance Act 2020 introduced DST to be chargeable on the gross transactional value.76 There is a need to define the gross transactional value to ascertain the scope of the DST. It is noted, however, no such definition is highlighted in the regulations. The DST regulation hints at distinguishing between the gross transactional value of services provided by the iDigital service provider, who receives the payments as consideration for the service offered and ii) the digital market provider who commissions a fee paid to the users of a platform. DST 76 Section 7, Finance Act (2020) 75 Regulation 4,The Income Tax (Digital Service Tax) Regulations (2020) 74 Regulation 3, The Income Tax (Digital Service Tax) Regulations (2020) 73 Regulation 3(3),The Income Tax (Digital Service Tax) Regulations (2020) 24 clearly differentiates between the two providers, establishing a bright line between direct providers and providers of platforms on which buyers and sellers of digital services interact.77 VAT and Its Interaction with DST In Kenya, the Value Added Tax also applies to digital services, especially those provided by resident and non-resident entities. Section 5(2) of the Value Added Tax Act includes the services provided over electronic means subject to DST, including streaming, digital publications like e-books, online advertising, software apps, cloud-based services, and online subscriptions and services.78 VAT is to be charged where the customer is located rather than where the service is provided.79 This means that if a non-resident service provider provides a digital service to a customer in Kenya, it is assumed that the service was provided in Kenya. Resident and non-resident service providers that offer digital services to consumers in Kenya must register for VAT if their taxable services exceed the threshold set by KRA.80 Non-residents may appoint VAT agents and charge VAT on their services despite not having a physical presence.81 The VAT rate on digital services is 16%.82 Imported digital services are zero-rated according to the Second Schedule of the Act. Zero rating exemption means that when the services are supplied, digital providers are not to add tax when supplying.83 Moreover, non-resident suppliers must charge VAT to Kenyan customers but are not required to collect VAT from non-customers.84 If Kenyan residents provide digital services to customers outside Kenya, those services may be zero-rated for VAT purposes.85 DST and Value Added Tax are distinct taxes that apply to different aspects of digital transactions, but they overlap in certain situations. DST taxes the digital service provider’s income while VAT focuses on the supply of goods and services. Moreover, VAT is charged on 85 Section7(2),Value Added Tax (2013) 84 Section 5(2), Value Added Tax (2013) 83 Section7,Value Added Tax (2013) 82 Section 5(2), Value Added Tax (2013) 81 Section 5(2), Value Added Tax (2013) 80 Section 34, Value Added Tax(2013) 79 Section 8, Value Added Tax (2013) 78 Section 7(1)(d), Value Added Tax (2013) 77 Regulation 6,The Income Tax (Digital Service Tax) Regulations (2020) 25 the value of the digital services provided to consumers in Kenya, regardless of whether it's a resident or non-resident. While DST targets the income generated from digital services. In cases where both taxes apply, service providers are required to account for each tax separately, ensuring the correct application based on the nature of the transaction and service provided. This analysis will focus on taxing digital services according to the Income Tax Act and Digital Service Tax Regulations articulation. 2.4 Implementation and Enforcement Mechanism of DST and its Impact Registration A resident or non-resident with a permanent establishment in Kenya providing a digital service in Kenya shall apply to the Commissioner for tax registration in respect of the Digital Service in the prescribed form.86 A non-resident person without a permanent establishment in Kenya who provides digital services to a user in Kenya may register under a simplified tax registration under regulation 9 online registration in a form prescribed by the Commissioner.87 The applicant files the necessary documents with the commissioner, who in turn assigns a personal identification number for filing and paying tax returns. A non-resident without a permanent establishment in Kenya who fails to register under Regulation 9 has to appoint a tax representative under Section 15A of the Tax Procedures Act, 2015.88 The Finance Act 2020 also makes provision for the appointment of digital service tax agents. These persons appoint digital service tax agents and provision is made for such agents to deduct, collect, and remit the digital service tax collected.89 In addition, the Kenya Revenue Authority is the institution of the government that is depended upon to deduct, collect, and remit DST collected given authority under the Kenya Revenue Authority Act, 1995.90 The DST Tax Regulation provides a digital service tax collection platform that DST agents will use to collect and remit DST to KRA, known as iTax. The tax is payable by the digital service provider or the person who collects the payment for digital services.91 This is significant 91 Section 10,The Income Tax (Digital Service Tax) Regulations (2020) 90 Section 5(1), Kenya Revenue Authority Act (1995) 89 Section 19,Finance Act (2020) 88 Section 15A,The Tax Procedures Act (2015) 87 Regulation 9,The Income Tax (Digital Service Tax) Regulations (2020) 86 Regulation 7(1),The Income Tax (Digital Service Tax) Regulations (2020) 26 where a digital service tax agent is designated as an agent for the state. In fact, the above position contrasts with withholding tax where the focus of paying is on the payor.92 The income tax declares that the DST will be payable when non-residents pay for the service.93 The DST Regulations propose that a non-resident person appoint a tax representative and will be required to remit the tax due the 20th of the month following the end of the month the service was offered.94 When a person ceases to provide digital services in Kenya, it shall apply to the Commissioners for deregistration in the prescribed form. Compliance Failure to comply with DST can lead to penalties, fines or prosecution to deter evasion. Penalties involve failure to file returns or remit taxes.95 The Kenya Revenue Authority (KRA) ensures compliance with Digital Service Tax through registration requirements, third-party tax collection, and strict enforcement mechanisms. KRA mandates registration for all digital service providers regardless of the location. Additionally, KRA conducts audits and investigations to verify transactions and ensure that taxes are filed well and paid. KRA also collaborates with international tax authorities to enhance global compliance.96 Impacts However, its enforcement has a lot of challenges, especially regarding the tracking of non-resident digital providers. The broadness of the definition of "digital service" creates ambiguity that may lead to potential non-compliance or even double taxation. Other complications arise from reliance on international cooperation with platforms such as Google and Netflix and the complexity of Double Taxation Agreements. Further, the enforcement mechanism in the case of non-compliance might be too weak to work effectively, especially when dealing with foreign companies that have no tangible presence in Kenya. This weakens the enforcement framework. 96 Kenya Revenue Authority, Tax Investigation Handbook, 2015,10-24 95 Section 43,Income Tax Act (1974) 94 Regulation 6,The Income Tax (Digital Service Tax) Regulations (2020) 93 Section 12E,Income Tax Act (1974) 92 Section 35, Income Tax Act (1974) 27 2.5 Digital Service Tax in Bundled Services Bundled digital services are defined as different digital offerings packed in one bundle to enhance user value.97 A bundled service or product can be a collection of several products or services, such as software, online courses, or subscription-based media content, provided as one product, normally at a more favorable price than purchased separately. One of the interesting features of bundling is how the concept spans across industries. The meaning of "bundled" could be different for various contexts. It means, in agriculture, the delivery of advisory, financial, or market access services bundled through digital platforms. This bundling could also include pure digital or hybrid models that feature in-person consultations.98 In digital journalism, bundling entails cross-publisher offers, providing content from multiple sources for a fixed monthly fee.99 There are various kinds of bundled digital services. Wholly digital bundles are purely digital services, such as software subscriptions like Adobe Creative Cloud or digital content providers like Netflix. Hybrid bundles combine digital and nondigital components. Examples might include the online advice aspect for agricultural applications via an app, together with an in-person consultative service component provided by experts.100 VPBs (Virtual Product Bundling) bundle related digital products or services, such as software suites like Microsoft Office.101 In media, cross-publisher bundles grant the subscriber access to several publishers for one subscription, raising subscribers and revenues.102 Finally, sector-specific service bundles are a set of services that target very specific needs-for example, agricultural bundles that include financial services, weather updates, and market insights to 102Ebrich L, Wellbrock C, Lobigs F, Buschow C, Bundling Digital Journalism: Exploring the Potential of Subscription-Based Product Bundles, 12 Cogitatio Press,2024, 2 See Also Adams J, Yellen Y, Commodity bundling and the burden of a monopoly, 90 The Quaterly Journal of Economics 3,1976, 475-498 101 Liberto D,Bundling: Definition as Marketing Strategy and Example, 2024 100 Abdul Latiff Jameel Poverty Action Lab, Evidence for digital and bundled services: Framing a research agenda for the Digital Agricultural Innovations and Services Initiative, 2022. 99 Ebrich L, Wellbrock C, Lobigs F, Buschow C, Bundling Digital Journalism: Exploring the Potential of Subscription-Based Product Bundles, 12 Cogitatio Press,2024, 2 See Also Adams J, Yellen Y, Commodity bundling and the burden of a monopoly, 90 The Quaterly Journal of Economics 3,1976, 475-498 98 Abdul Latiff Jameel Poverty Action Lab, Evidence for digital and bundled services: Framing a research agenda for the Digital Agricultural Innovations and Services Initiative, 2022. 97 Liberto D,Bundling: Definition as Marketing Strategy and Example,2024 28 enhance the productivity of small-scale farmers.103 These examples show how digital service bundles can be used in many creative ways across industries to deliver value. The Digital Service Tax in Kenya has, under its framework, issues related to taxation on bundled services under the Income Tax Act and the Digital Service Tax Regulations, 2020. A bundled service is bound to have various elements included within it that are liable to tax and others that may be exempt, with no definition or basis provided by law on how such would be treated. This creates uncertainty on the part of the taxpayer as to whether a whole bundle is taxable or only that part that can be taxed. If rules are not stipulated regarding how many different components should be separated, businesses might overpay the tax or experience compliance issues. This calls for fairer and more accurate levying of bundled digital services with greater clarity. 2.6 Appreciation and Limitation of the Digital Services Tax The Digital Service Tax is an innovation in Kenya in capturing tax revenues from the fast-growing digital economy, particularly from non-resident digital service providers. This ensures that businesses deriving their income from Kenyan consumers contribute to the national tax base to address the challenge of taxing these digital transactions, which existing tax systems often miss. It targets, among others, revenues from online advertising, digital marketplaces, and streaming services in line with global trends where many countries have introduced taxes on digital services to bridge revenue gaps in the digital era. The DST also creates a fair playing field since foreign digital service providers usually escape taxation without such a tax. Yet, they make revenue within the borders just like local businesses operating in Kenya. Nevertheless, there are also several limitations with DST. To begin with, one of the biggest concerns about double taxation is when similar digital services are charged at a base, thus increasing Value Added Tax to the consumer or business. Besides, the imposition of a tax of 1.5% on the gross transaction value has a potential depressing impact on low-margin enterprises through diminishment in their profitability, thereby discouraging investment into Kenya's digital economy. Moreover, the DST Regulations do not consider that a number of 103 Larsen L, Bundled Digital Service: Introduction,Agrilinks, 2024 29 platform owners are simultaneously direct service providers to customers and, therefore, the Regulations should make them hybrid digital service providers. It may be implied, though, that the gross transaction value would be determined following the specific payments. Other limitations include the administrative burden this will impose on non-resident digital service providers, who have to register and comply with Kenyan tax laws. This may prevent smaller foreign businesses from trying to penetrate the market. Without guidelines or dispute resolution mechanisms concerning the application of the DST, this exacerbates the reality that such periodic reviews and refinements are required to make this regime effective and equitable. 2.7 International View on Digital Service Tax Implementing the digital service tax into Kenyan law is justified under Section 3 of the Judicature Act, which gives authority to include foreign laws in Kenya’s law. Digital service Tax is the tax levied on revenues raised from digital services. The tax mainly aims at non-resident companies that conduct businesses in the country without necessarily having a physical presence in the country.104 Developing countries see the digital economy as a potential source of revenue. Meanwhile, the OECD has been working through periodic reports and engagements to arrive at a multilateral approach to tax digital services. In contrast, DST is a relatively recent phenomenon that most developed countries have implemented. Most of the countries which implemented digital taxes showed an increase in their tax revenues. In the case of South Dakota v. Wayfair, the United States Supreme Court authorized the states to impose requirements on out-of-state sellers to collect sales tax on the sale of goods to residents of such states even in cases where the seller did not maintain a physical presence within that state.105 This judgment overturned an earlier Quill Corp. v. North Dakota decision that held only businesses with a physical presence were supposed to collect sales tax.106 This ruling was essential to the establishment of Digital Service Taxes in various jurisdictions. The decision in the Wayfair case realized the increasing significance of online 106 Quill Corp. v. North Dakota (1992), The Supreme Court of the United States. 105 South Dakota v Wayfair (2018),The Supreme Court of the United States. 104 Asen E,What European OECD Countries Are Doing about Digital Services Taxes. Tax Foundation, Washington D.C, 2020. 30 commerce and digital platforms that, under the physical presence nexus rule, had not previously been required to collect sales taxes. Throughout states and countries worldwide, a review of their tax regimes began to capture revenues derived from digital services even when companies provided them without a physical presence in a jurisdiction. It, therefore, catalyzed the global movement to digital taxation and acted as a precedent for the inclusion by countries such as Kenya that have crafted frameworks for taxing digital services with regard to the economic realities. The OECD put forward a two-pillar approach to take up the tax challenges of the digital economy. Under Pillar One, there will be a proposed reallocation of taxing rights to the country of consumption, irrespective of the residence of the multinational business or physical presence thereof.107 Pillar Two is a global anti-base erosion proposal aimed at ensuring a minimum level of tax for companies operating multi-nationally, no matter where their headquarters are.108 While still waiting for the finalization of the OECD's multilateral DST proposal, many developing countries have gone ahead and implemented DSTs unilaterally. If it is to be effective, DST should be neutral and tax-efficient.109 Tax neutrality, as earlier stated, refers to a situation where taxes do not affect the decisions of taxpayers. It also involves applying digital taxes in a way that each mode of trade is not rendered more attractive than the other-for instance, making cross-border trading look more attractive compared to local trading. Efficiency, on its side, implies that the tax system should be straightforward to administer and enforce from the perspective of both taxpayers and authorities.110 2.8 Conclusion To summarise, Kenya's DST framework is a significant step toward modernising the taxation system to capture revenue from the digital world. However, more is needed to tax bundled digital services. This lack of clarity leads to ambiguities in the application of the DST. A more sophisticated strategy, including specific categorisations, is required to produce a more 110 Bloomberg Tax, Global Value-Added Tax Crackdown Costing Companies Millions,2020. 109 Bunn D,The U.S. Trade Representative Expands Its Digital Services Tax Investigations,Tax Foundation,2020. 108Deloitte, Statement on two-pillar approach to tackling tax challenges of digitalization issued, 2020. 107Deloitte, Statement on two-pillar approach to tackling tax challenges of digitalization issued, 2020. 31 equitable and effective taxing system. Furthermore, Kenya must implement a framework that is consistent with international norms to remain competitive and appealing to both local and foreign digital service providers. The comparative analytical insights and recommendations presented in the following chapters will guide the necessary changes to Kenya's DST framework. Building on this research, chapter 3 further exposes the gaps in the DST framework, identifying major flaws that impede its effectiveness. This chapter will examine the need for more clarity in definitions, the absence of periodic review processes, and other issues that must be addressed to improve DST's application. CHAPTER 3 3.0 GAPS IN KENYA’S DIGITAL SERVICE TAX FRAMEWORK 3.1 Introduction Kenya’s Digital Service Tax framework was established to address the unique challenges the digital economy poses.111 However, its implementation has revealed gaps, particularly in its approach to taxing bundled digital services. These gaps include the absence of clear definitions for bundled services, a lack of a standardised mechanism for allocating taxable value among components, and no periodic review processes to adapt to evolving digital business models. These deficiencies have led to administrative inefficiencies, compliance challenges, and a risk of double taxation or losses.112 This chapter explores these gaps in detail by analysing the legal, administrative, and economic framework they exist in. Real-world examples such as Safaricom’s data and streaming bundles and Netflix’s subscription models demonstrate the practical challenges businesses face under Kenya’s DST. Highlighting these shortcomings establishes the need for reforms. It sets the foundation for a comparative analysis in chapter 4, where insights from other jurisdictions will guide recommendations to improve Kenya’s approach to taxing digital services. 112 Organisation for Economic and Cooperative Development, OECD Economic Outlook, 2020, 39 111 KICTANet, Understanding Digital Taxation in Kenya: A Pathway to Fair and Inclusive Policy Reforms,2024, 1 32 3.2 Gaps in Digital Taxation Definition of a Tax Gap Tax authorities often find a notable difference between expected tax revenue and what is collected, which is known as a tax gap.113 In digital taxation, gaps refer to deficiencies in the legal, administrative, and implementation frameworks that hinder effective taxation. Legal gaps occur when the tax law lacks clarity or does not address specific challenges the digital economy poses.114 Administrative gaps arise as a result of inefficiencies in tax collection.115 Implementation gaps occur when the legal provisions cannot be applied in practice.116 A good tax system is built on principles proposed by the OECD117, including neutrality, efficiency, certainty, simplicity, effectiveness, fairness, flexibility, and equity to ensure fairness, functionality, and adaptability to modern challenges. Neutrality requires equal treatment of all business activ