Taxation of digital economy
Digital economy refers to economy that is based on the digital computing technologies. Although these days there is an increase in the perceive regarding the concept of the digital economy while conducting business in the markets basing on the worldwide web and the internet. In simple words, digital conomy is also known as web economy or internet economy. To be more specific it is refered to economy based on digital technology.
From the past few years, there has been a sea change in the way of conducting business. This can be better understandble with the help of an example. For example, one of the biggest provider of cab services Uber is not the owner of all the cabs that it engaged in the services of the customers. Likewise there are so many frontiers including Amazon, Paytm, Makemytrip, Flipkart etc to name a few. All of the aforseaid companies are not enagegd in providing conventional business but they contribute a lot on the digital economy and its development.
The existing rules of tax in India as well as internationally were revised few years ago considering the functions of the brick and mortar economy. However, it is undoubtedly evident that the introduction of the digital economy in the current regime of tax is quite redundant. Today, the digital businesses are making profits on alarming rate but there is no commensurate tax laws in respect of the aforseaid profits earned by the businesses. Considering the same, this can be regarded as the need of hour for not only for India but also for all countries across the globe to revamp and revise their respective taxation law as it can be clearly seen that digital economy is at its peak for the consideration of taxation.
An Overview of Taxation in India
The Direct Tax in India is administered and governed by and under the Income-tax Act, 1961. The residents and non-residents are taxed on their income earned in India and worldwide respectively. There are separate conditions to determine the residential status of the companies. The companies will be treated as a resident during a particualr financial year provided they statisfy the follwing conditions;
- The company is incorporated in India
- The company has a place of business in India.
Considering the above-mentioned two conditions, it is clear that if a company is incorporated outside Inida and does not have a place of business in India, it will be considered as a non-resident company for income tax purposes.
The taxation of the non-residents is regulated under section 5 and 9 of the Income Tax Act 1961 and also under the provsions of the Double Taxation Avoidance Agreement. Accordingly, the income generated from business is regulated under section 9 of the Income Tax Act 1961, where the income is deeemed to arise or accure in India as a result of the business having a place of business in India. Under the provisions of Double Taxation Avoidance Agreement, The profits of the business are attributed towads a Permanent Establishment which is considered as a separate and distinct entity under the regulation of Article 5 and 7 of the Double Taxation Avoidance Agreement.
The business profits can be taxed on the fulfillment of a condition which is that if there is a business connection or permanent estbalishment in India at a rate of 40%, until and unless the income can be treated as fees or royality for the technical services provided and the same will be taxed at 10% on the gross amount. Under the provsions of section 90(2) of the Income Taxc Act, a non-resident is eligible to claim the advantageous provisions that exist between the Double Taxation Avoidance Agreement and the Income Tax Act, 1961.
Considering the existing rules and regulations and accordingly address the concerns of tax in respect of digital economy the follwing two issues needs to be analyzed;
- Treatment of Income and its Characterization
- Permanent Establishment and Attribution Of Profits
Treatment of Income and its Characterization
There are some many differences while we consider the treatment of tax of a particular income based on its characterization. There are three catagories under which the income of a non-resident can be catagorized namely Fees and Royalities and Business Income. The rate of tax for each of the aforseaid income completely depends on its characterization. In case a taxpayer has provided incorrect classification of the income which is not according to the provisiosns of the international principles then in that case the taxpayer may face consequences as a result of double taxation in separate jurisdictions and also ultimately can face litigation prosecution. The aforseaid aspect is generally applied in case of non-resident taxpayer. The taxation aspect of a non-resident taxpayer on his income is provided below;
Nature of Income
In case of no Permanent Establishment
In case of having Permanent Establishment
Taxable at 10% on gross amount or rate of DTAA, whichever is lesser
Taxable at 40% on net amount
Further, in case of Wipro Ltd., the High Court of Karnataka held that the payments made to a non resident taxpayer to obtain the license for the usage of database will be regared as granting the right for the access of the database or transferring the right for the usage of copyright. Thus, the income will be taxable under the classification of royality and will not be trated as business income. There can be serveral times when the taxation authorities will have different and contradictory opinions on some of the similar payment transactions made to the non resident taxpayer for the access of a database. However, in some cases the royalty earned can be catagorized as business income and will not be treated as royality.
Similarly in the case of IMG Media Ltd, the Mumbai Tribunal held that the amount paid to an assessee in respect of deliver and capture of live audio and coverage of visulas in the IPL cricket matches will be notbe considered as Fees for technical services. It was anayzed that the BCCI has no techical expertise from the assessee which isc can help then to provide live coverage of the match on their own at the end of the IPL. Considering the aforesaid aspects the Mumbai Tribunal held that the BCCI is the owner of the program content and as there is no transer of broadcasting rights, the payments made will not be treated as royalty.
However, it is to be noted that the aforseaid rulling can be applicable on a case to case basis. Thus, it is necessary on the part of the judicial authorities to follow a approach which is consistent in nature and according to the principles which is internationally acceptable. This will ultimately will help to create conducive environment for the taxpayers. Apart from that, there are various others payments realted to data retrival, data warehousing., web hosting etc. to name a few which are still not discussed in the courts. The reason behind the same may be there are very minimum guidance and regulation or no regulation to bring these aspect in the ambit of taxation. Thus, it is a essential aspect which must be discussed in resepct of the transactions related to technology and that the user of the same may not escape to pay taxes.
The income can be featured basing on the nature of the transaction which inclues royality or Fees for technical services. Taxes can be levied basing the rate as prescribed in the above-mentioned table. However, when a income is featured as a business income, then in that case until and unless a Permanent establishment is created in India or there is a business connection in India. The income will not be taxed considering it as a foregin company or non residnet. The term business connection completely depends and refers to the source of income and the base of the same. The source of income and place for generating the business provides a right to tax the income that arise from the activities carried on in a specific country.
For example, if a foreign company based out of India and has been receiving the publishing content and advertisement fees of a taxpayer who is a indian resident on its search portal. It is worth consideration is that the business model such companies who are using this type of search engines completely rely on the intellecutal property rights. Thus, it provides then the advantage to function in any lower tax jurisdiction across the globe. Moreover, the advertising fees received from any such search engine based out of india will not be considered as fees recived for techical services and accordingly it is not taxable in India as there is no permanent establishment of the aforseaid foreign company in India. Apart from that the foregin company being a tax resident of its home country is also not liable to pay any tax in any other country in which it has been providing its services. Thus, the establishment of Permanent Establishment in India or providing and analysis of business connection in India is one of the complex thing specifically when the business model is related to digital technology. However, It completely depends on the tax authorities if they can provide a demonstartion that there is a concept called business connection and permanent establishment in India.
Attribution Of Profit
The next aspect that needs to be analysed is attribution of profits to the permanent establishment of the non resident tax payer. In addition to this, untill and unless the current rules of attribution which is globally applicable are amended substantialy, there may not be a significant tax structure on income in India. According to Article 7 of the Organization for Economic Co-operation and Development (‘OECD’) Model Tax Convention, When a person maintains books of accounts, then the permanent establishment has to be regarded as a distinct and separate entity and accordingly, the profits of the business needs to be approtioned as per the arm lenght principle. The profits cannot be determined if separate books fo accounts are not being maintained. In that case, the tax authorities may implement Rule 10 of the Income-tax Rules, 1962 and determine the profits in the either of the following manner;
- Turnover Percentage
- Proportion of Total Profit
- An other manner as the Assessing Officer thinks appropriate
Considering the above-mentioned issues, the unillateral amendments are suggested which should be adopted by both foreign jurisdictions and India. However, there are some limitations and recommendation that can be more useful for the final implementtion of the amendments. From the analysis made above, it can be seen that non resident companies do not have adequate physical existence in the source country abd thus to tighten the tax stucture in India the concept of equalization levy was introduced.
Unilateral Measures and its Evolution
At the time of G-20 Summit, the countries of G-20 mainly focused upon th need for the devision of laws realted to taxing the business model in respect of digital technology. Today, busines model related to doing digital business is a reality and there has been consequential change in doing business not only in India but also globally. Accordingly, there has been consequential in the taxation spehere especially in income tax. Considering the aforseaid facts, the Summit ordered the OECD to find a way to fill the gaps in the taxation system worldwide. Further, OECD published and suggested an action plan named Base Erosion and Profit Shifting (BEPS) In July 2013 containing 15 plans. The final report of the aforesaid action plan was published in the year 2015. In the first place, the BEPS curbed the evasion of taxes and double non-taxation and refered the same as the strategies of tax avoidance so that it can exploit the gap and mismatch the rules of tax to shift the profits to non tax jurisdictions artifically.
Out of 15 Action Plans, the first plan containing the challenges that can be posed bt the taxation of digital economy was published. The following are some of the possible options suggested to face the challenges of taxation of digital economy;
- Equalization Levy
- To Withhold the tax on some of the digital transactions
- Implementation of Nexus based approach
However, none of the aforedsaid sugegstion or option was mentioned in the report. Consequently, the OECD made an acknowledgment that untill and unless the world sensus provides a view on this issue, the countries accross the globe can adopt any of the provided options for implementation of their domestic tax regime. However, the countries must resepect the obligations as treaties while adopting any of the aforseaid options. Apart from that they can also include bilateral tax treaties after their due negotiation. Provided the modifciation of treaties may take a ample of time, most of the countries from the past three to four years have already adopted interim measures in the domestic tax regime to overcome the challenges of tax.
India introduced the concept of Equalization Levy under the Finance Act, 2016 as a part of domestic tax law. The aforesaid levy came into force from 1 June 2016. According to the provisions, when a non resident or resident taxpayer having a permanent establishment in India pays for a certain service to a non resident who does not have a permanent establishment in India, and the consideration amount aggregate execeeds 10 Lakhs in a particular financial year, then in that case, the taxes will be levied at 6% rate on the total amount of consideration.
The term Specified Service has been defined accordingly which includes digital advetisement, online advertisment and any other service related to online advertisment as notified and prescribed by the government. Furthermore, in most of the cases when a service provider who is a non-resident and does not have a permanent business in India will not agree to the imposition of the new levy, the service receiver, a resident taxpayer may opt of grossing up the consideration considering the additional economic burden. On the other hand, there also some necessary and relevant amendments in the Finance Act with the stipulation that when the receipt of service provider is considered for equalization levy, then the receipt of the same will be exempted for the preview of the Act and thus, will not be considered as a part of total taxable income.
Regulation and Compliances
Further, when the recipient of the service fails to get an credit in respect of the levy collected to the government treasury, then in that case the recipient has to pay the simple interest at 1% for such levy each month. In case the recipient of service fails to deduct equalization levy, then the service recipient will be liable to pay the penalty which may be equal to the amount of equalization levy apart from the original amount of equalization levy. An assessee who is aggrived by the order of penalty imposition by the Assessing Officer can appeal to the Commissioner of Income Tax (Appeals) within 30 days from the date of passing of order by the Assessing Officer. Apart from that the assessee can also appeal at the Appellate Tribunal within 60 days from the date of passing of order by Commissioner of Income Tax (Appeals).
Nexus based approach
In 2016, after the introduction of Equalization levy, India became one of the first countries across the globe to introduce the concept called Significant Economic Presence, otherwise known as SEP in its domestic tax regime. Accordingly, the term business connection was defined which is contained in section 9 of the Finance Act. Thus, it brought the income generated by a non resident taxpayer in the form of SEP under the tax net in India. The Finance Act, 2018, describes the SEP in the following manner;
The transaction made in respect of goods in India are above the provide value which includes digital goods
The transaction made in respect of services in India are above the provide value which includes digital services
The transaction made in respect of any property in India are above the provide value which includes downloading of a software or data
Continuous and systamatic engagement with the provided number of user on digital media platforms
Continuous and systamatic socialization of businesses from India with the provided number of user on digital media platforms
It is worth discussing that the specific value can bean aggregate basing on the value of a single transaction. The Finance Act further provides that in case of non existence of the place of business of resident or place of business of non resident. It will still provide a business connection if comes under the definition of SEP.
For qualifying as SEP, the threshold limits are yet to be decided and notified by the CBDT. The CBDT is also inviting and asking for suggestion from general public and stakeholders in this regard to prescribe a thereshold limit according to the quantum of revenue and the number users and accordingly the SEP of a non resident in India can be determined. Further, The OECD even working on the get public views on the proposals which are meant for addressal of tax challenges of digital economy. Therefore, it is necessary to devise the ruls of nexus so that the profits can be allocated to a specific jurisdiction considering the scope of value creation.