In the era of technology, no business is shackled to four corners of a room. Businesses being spread across tax jurisdictions, taxing revenues has proved to be a challenge under existing tax rules. There have been concerns across the globe about companies making profits in a particular country but not paying taxes to the local government. A plethora of changes have been proposed by tax administrators and governments across the globe to tackle this issue.
The Organisation for Economic Cooperation and Development and the G20 countries in the Base Erosion and Profit Shifting (BEPS) project have set out various recommendations to put an end to tax avoidance models adopted by businesses. India has been extensively engaged in the implementation of the recommendations. The Central Board of Direct Taxes (CBDT) has also committed to design rules and ensure successful implementation of the recommendations of BEPS project.
Expanded Scope Of 'Google Tax’?
One such change to the tax laws implemented by the Indian government, to address the challenges of the digital economy, was introduction of the equalisation levy in Union Budget 2016 to tax digital transactions. The levy is popularly known as “Google tax”. The legislation provides for an equalisation levy of 6 percent to be deducted from the amounts paid to non-residents, not having a taxable presence in India, for provision of digital advertisement services to Indian residents. Though the levy is limited to taxing online advertisement services, the Central government has powers to broaden the scope of the equalisation levy and bring to tax a wide gamut of transactions.
The levy was introduced based on a report submitted by a committee constituted to examine the options for taxation of the digital economy. The said committee had recommended the levy on digital advertisements to begin with and thereafter to expand the scope to other services. There is an expectation that additional services would be brought under the net of equalisation levy and these could include cloud computing, entertainment services such as music or video downloads, app purchases, etc. It would be interesting to see how far the government would be willing to go in this direction, especially given the recent push for digital transactions.
Clarity On Transfer Pricing
Another such development was with respect to transfer pricing. The government vide the Union Budget 2016 introduced country-by-country reporting (CbCR) which requires multinational enterprises (MNEs) to report on an annual basis income, earnings, taxes paid and certain measures of economic activity in each of the jurisdictions they operate in. A master file and country-by-country report is required to be maintained and furnished as part of the three-tier structure for documentation if the consolidated revenue of the MNE group exceeds Rs 5,395 crore. Though a threshold for CbCR has been specified, no such limits have been specified for the reporting master file. The government could do well in prescribing a limit for the master file requirement as well and it could lead to small MNEs falling out of the reporting requirements.
It is pertinent to note that in 2013, in order to reduce protracted litigation on transfer pricing aspects, new rules to offer Safe Harbour to IT, ITeS and KPO sector were introduced by the Indian government. The rules provided directives on minimum margins a taxpayer is expected to earn for certain categories of international transactions, that will be acceptable by the tax authorities as arm’s length price. Though these rules were framed to reduce litigation and compliance burden, they are unattractive given that some of the margins proposed are very high and reflect neither industry benchmarks nor the current economic environment. There is an expectation that the government could, as a part of the budget announcements, prescribe more realistic margins.
Bye, Bye POEM?
The Union Budget 2015 also amended the provisions of residency in India to provide a new test based on Place of Effective Management (POEM). The concept of POEM seeks to treat a foreign company which is effectively controlled (i.e. place where the key decisions are taken) from India, a resident in India. Thereby, bringing the global income of a foreign company to tax in India.
Ever since these provisions were introduced, there has been no clarity on issues like compliances, applicability of advance tax payment, withholding provisions, deductions etc. Thus, the Union Budget 2016 deferred the applicability of POEM by one more year.
In the absence of final guidelines and POEM being an outdated approach, it is expected that POEM will be abolished and the government will introduce the Controlled Foreign Corporation (CFC) regime. Currently, countries like the United States of America and the United Kingdom already follow CFC regime. The CFC regime proposes to tax passive income of foreign companies set up in low tax jurisdictions.
Such companies are owned and controlled by Indian residents and their passive income is accumulated overseas instead of being repatriated back to India. The CFC regime only brings the passive income to tax in India and does not treat the foreign company as a tax resident in India as opposed to the provisions under POEM.
As we begin the countdown of the Budget with many more expectations, one would need to wait and watch for the measures the government could announce. Leaving aside nuanced discussions on changes, the industry would be elated if the government moves towards bringing in stability, transparency and certainty on the tax front.
Ajay Rotti is a partner at Dhruva Advisors, with special focus on corporate tax, transfer pricing and international tax areas. The views expressed in this article are his personal and not that of Dhruva Advisors. The opinion expressed herein should not be construed as legal or professional advice.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.