Tax Department’s Consultation On Digital Taxation May End Up Being An Academic Exercise, Experts Say
Technology giants like Facebook, Google, Amazon, Alibaba and other such digital companies derive considerable value from a large user base. For instance, some digital companies sell user data for targeted advertising. It’s this value that nations now want to tax.
Europe, for instance, has proposed a tax on turnover. Australia is mulling a tax on digital advertising. Singapore has announced a sales tax on digital services, starting 2020. India isn’t far behind either.
Digital advertising on foreign platforms is already under the tax net, also known as the equalisation levy. But now, India now wants to tax the business profits of digital companies, for which the taxman has reached out to various stakeholders for consultation. Experts told BloombergQuint the move will run into two problems: attribution of profits among countries i.e. who can tax how much, and treaty troubles.
Digital Services: What Gets Taxed?
Two years ago, the government imposed a 6 percent tax on digital advertising, which is attracted when an Indian resident or a non-resident with a fixed place of business in the country advertises online with a service provider with no permanent establishment in India. Permanent establishment is, in tax parlance, a fixed place of business. The levy is applicable if the transaction value exceeds Rs 1 lakh in a financial year. Reportedly, this levy has added close to Rs 3,000 crore to tax collections in the last two years.
Equalisation levy is applicable on advertising revenues and the administration of it has been smooth in the last two years, Sudhir Kapadia, partner and national tax leader at EY India, told BloombergQuint. It’s a tax on business-to-business transactions and the law has ensured there’s no double taxation, he said.
There is no income tax in the hands of a non-resident once the equalisation levy is discharged. So, it is a proxy for any kind of income tax liability that can be levied on the company concerned.Sudhir Kapadia, Partner, EY India
What About B2C Transactions?
Enter, Significant Economic Presence. In budget 2018, the government proposed to get its fair share of tax from business-to-consumer transactions by introducing the concept of significant economic presence. According to the finance minister, the idea is to tax profits of those digital businesses that don’t have a physical presence in India but derive significant economic value from the country.
India’s belief is that we follow strict source-based rules of taxation; our domestic law and treaty definitions of permanent establishment have lost their relevance because of the digital invasion, Mukesh Butani, managing partner at BMR Legal, said.
A lot of foreign luxury goods and garment manufacturers don’t have a physical presence in India. You can use an Amazon platform and order those goods, or you can go to the company’s website and order. But you can’t tax those activities in India, assuming they don’t have presence here. Under this significant economic presence, such activities will come under the tax net.Mukesh Butani, Managing Partner, BMR Legal
What Does The Tax Department Want To Know?
In one word, thresholds. The department has asked for consultation on:
- Revenue threshold of transactions with respect to physical goods or services carried out by a non-resident in India.
- Revenue threshold of transactions pertaining to digital goods or services or property, including the provision of download of data or software.
- Threshold for number of “users” with whom systematic and continuous soliciting of business activities is done through digital means.
To begin with, the phrase used in our law is significant economic presence and not just digital presence as is the case in Europe, Kapadia said. The first element on which consultation is sought is about transactions involving physical goods and so, our approach is far more overarching, he added.
The budget memorandum only talked about digital economy, but this would include all transactions of import of goods, which currently attract only customs duty. For example, EPC contracts, manufacturing, supplies from vendors etc who do not have a presence in India.Sudhir Kapadia, Partner, EY India
If India is determined to bring this, revenue threshold for digital goods and services and user threshold can be akin to what the E.U. has proposed, he said.
Europe has proposed a three percent tax on businesses with E.U. digital revenues of over 50 million euros and total global revenues of over 750 million euros. Revenues derived from online advertising, sale of user data and online marketplaces will attract this levy.
So, What’s The Problem?
The first is profit attribution. Or, how should governments determine the revenue attributable to digital activities in their country.
It's going to be very difficult for India or any other country to ascertain this since the conventional principles of permanent establishment won’t apply to digital businesses, Kapadia said. He explained that data about users in other countries, revenues collected in other countries arising from that user data isn't easy to get despite the exchange of information arrangements.
Currently, India has two provisions for attribution. Rule 10 of the Income Tax Rules which essentially says that revenues from India divided by global revenues multiplied by global profits should be the taxable base in India. This, in a brick-and-mortar space, poses enough challenges. It would be impossible to apply this principle in a digital business. Second is the arm’s length principle under transfer pricing. That can’t be the answer either since the entire functions, contractual and legal risks are outside of India in the digital business context.Sudhir Kapadia, Partner, EY India
The second issue would be tax treaties. If the treaty problem isn't addressed, this consultation will just be an academic exercise, Butani said.
When the law was passed in Budget 2018, it clearly said India is proposing this law in order to be prepared for the changes that occur in double-tax treaties, Butani said. This subordinate legislation that the department is proposing won’t be useful in situations where the non-resident tax payer is from a country that has a tax treaty with India, he added.
The definition of permanent establishment under the tax treaties don’t contemplate digital transactions. The only way is to amend the treaties using the multilateral instrument tool proposed by the Organisation for Economic Co-operation and Development. But if the treaty partner hasn’t signed up to MLI, the provision under the domestic law won’t help.Mukesh Butani, Managing Partner, BMR Legal
You're looking at a scenario where some treaties will trigger a digital permanent establishment and some treaties won’t, he said. So, how will a change in the domestic law affect the taxable position under these treaties, he added.