The economy today is truly digital; from
business and entertainment, to food and travel, everything is accessible online.
To veterans in business, everything digital is a revolution and is often termed
Industry 4.0; to a school kid, it’s the way of life that they were born into.
Commerce and business is no longer limited by territorial
boundaries.
The digital economy is growing at an exponential rate while countries
are still debating mechanisms for taxation of the digital economy. On the
entertainment front, films moved from reels to disks and have now become content
that is streamed. Music moved from records to tapes to disks to downloads and is now streamed live. It is important to note
that while the modus of conducting business has changed, it is still the
same products and services that are supplied, albeit in a different
form.
Digital means of communication and social interaction are giving rise
to new businesses that did not exist very long ago. Many of these businesses
that have developed only in the last two decades have taken over a considerable
share of market segments and form a significant part of the economy and tax
base. Their growth in India has also reached proportions that make them
significant actors in the Indian economy1
.
Laws that are currently in place are at the behest of metrics that
were designed to tackle the then available modes of conducting business.
Developments in businesses with the aid of technology only means that they
function in a niche area where there is little or no governance and
countries have started expressing the view that they are not getting their fair
share of revenue and there is a demand for taxing rights across the
world.
Debates and deliberations on taxing the digital economy have been
taking place throughout the world; international organisations like the OECD and
the UN and even others that are meant for regional co-operation have involved
stakeholders and other key parties in the debates; they even adopted a
Multi-Lateral Instrument (MLI) – and yet, any consensus on arriving at a
suitable legal framework remains elusive.
Important and interesting questions are inevitable on who gets such
rights; or whether a number of nations who participate in the transactions
should pool such taxing rights; what would be the profits that would be
available for taxation, etc.– all these are questions in search of
answers.
When these questions are attempted to be answered, one realises that
the existing laws are woefully inadequate and the elusive consensus in the OECD,
the non-participation of the USA in the entire discussion and the new initiative
from the UN only amplify the cacophony of confusion. Unilateral initiatives such
as digital taxes, equalisation levies and cross-border wars have only made
things more difficult.
__________________________________________________________________________________________________________________________________
1 CBDT, Proposal for
Equalization Levy on Specified Transactions, Report of the Committee on
Taxation of E-Commerce (2016)
POSSIBLE SOLUTIONS
In this article, an attempt has been made to think out of the box and
explore new solutions based on some past tested practices, apart from ensuring
that taxing rights are adequately conferred without compromising the tax credit
through the DTAA.
Solution
No. I: Theory of
Presumptive Taxation – Payment for Digital Business
Presumptive taxation exists for certain businesses through provisions
in the domestic statutes. In India, section 44BB of the Income-tax Act, 1961
provides that where a non-resident provides services or facilities in connection
with or supplying plant and machinery used or to be used in prospecting,
extraction, or production of mineral oils, the profit and gains from such
business chargeable to tax shall be calculated at a sum equal to 10% of the
aggregate amounts paid or payable to such non-residents. This presumptive
taxation has been extended to the business of operating aircraft (section 44BBA)
and to civil construction and erection of plants under certain turnkey projects
(section 44BBB). An interesting feature of these presumptive taxation provisions
is that an assessee can claim lower profits than the
profits specified in the presumptive mechanism provided he maintains books of
accounts and other records and furnishes a tax audit report u/s
44AB.
This presumptive taxation can have the following
features:
(i) It can be a
provision in the domestic statute and apply to non-residents who are engaged in
identified digital businesses which involve B2C transactions;
(ii) The MLI route
should be adopted to ensure that the source State gets a right to tax digital
business in addition to the resident State without diluting the eligibility to
claim set-off of taxes in the said State;
(iii) ‘Digital business’
can be defined to mean the activity of supply of goods or services over the
internet or electronic network either directly or through an online platform,
and includes supply of digital goods or digital services, digital data storage,
providing data or information retrievable or otherwise in electronic form. This
category should be a separate category apart from Fees for Technical Services
and Royalty;
(iv) ‘Digital goods’ can
be defined to mean any software or other goods that are delivered or transferred
or accessed electronically, including via sound, images, data, information, or
combinations thereof, maintained in digital format where such software or other
goods are the principal object of the transaction as against the activity or
service performed or rendered to create such software or other
goods;
(v) ‘Digital service’
can be defined to mean any service that is provided electronically, including
the provision of remote access to or use of digital goods, and includes
electronic provision of the digital service to the customer;
(vi) The tax would be on
the deemed income which in turn would be a specified percentage of the payments.
A percentage of the amounts paid or payable by the customer to the overseas
supplier of digital goods or services can be identified as income deemed to
accrue or arise in a market jurisdiction;
(vii) A clear definition
of the businesses covered in this segment would be required to ensure
transparency, compliance, ease of business, simplicity in tax administration,
etc.;
(viii) While the tax would
remain a tax on income, there can be two models for collection:
- The first model
would require the non-resident to obtain a special and simple registration in
the source jurisdiction and pay tax at the presumptive rates;
- The second model
would require that the tax be paid by the bank or financial institution or
payment gateway or financial intermediary. This identified party shall pay the
tax at the time of remittance of the payment itself. Assuming that USD 100 is
payable for digital goods or services, that the presumed income is 10% and the
tax rate 20%, the identified intermediary would be
bound to release only USD 98 and remit USD 2 as taxes on behalf of the
non-resident. This amount should be available as credit to the non-resident
under the DTAA;
(ix) It has to be ensured
that the payment by the identified intermediary is not in the nature of
withholding taxes but payment of taxes on behalf of the non-resident. This will
ensure that issues with reference to grossing up of payments are
avoided.
Solution No. II: Theory of Apportionment based on FARE
One of the methods that can be debated and examined in order to
arrive at a solution for taxing digital transactions would be based on the
theory of apportionment. Apportionment as a concept exists in many indirect tax
laws across the world. Typically, in GST input tax credit is apportioned in the
context of taxable and exempt supplies. While FAR is an established
principle which covers Functions, Assets and Risk, FARE would cover
Functions, Assets, Risk and Economic Presence.
In the context of property taxes, the Oregon Supreme Court in the
case of Alaska Airlines Inc. vs. Department of
Revenue2 upheld the position adopted by the Revenue
where the assessment was based on the presence, as reflected in air and ground
time, of aircraft property in that State. The taxes were proportionate to the
extent of the activities of the airlines’ units of aircraft properties within
the State. While engaging in these activities, the airlines enjoyed benefits,
opportunities and protection conferred or afforded by the State’s search and
rescue services, opportunities for further commerce and the protection of Oregon
criminal laws, and so could be made to bear a ‘just share of State tax burden’.
The taxes were fairly related to services provided by the State.
In the USA, questions arose as to the right of States in the context
of taxes and a four-pronged test was laid down by the US Supreme Court in the
case of Complete Auto Transit Co. vs. Brady3
wherein it was observed that this Court in a number of decisions has sustained a
tax against Commerce Clause challenge when
(i) The tax is applied
to an activity with a substantial nexus with the taxing State,
(ii) The tax is fairly
apportioned,
(iii) The tax does not
discriminate against interstate commerce, and
(iv) The tax is fairly
related to the services provided by the State.
This four-pronged test is an interesting test which can be the
starting point for working out provisions for taxing the digital economy.
The traditional concept of exclusive taxation by one State or double
taxation with credits which is established through DTAA may have to give way to
a new system wherein there will be a fair apportionment of tax between the
source State as well as the residence
State.
The challenges would be to identify a fair apportionment between the
countries. There could be complications where multiple countries are involved.
Insofar as the US is concerned, there are statutory apportionment formulae which
are based on property, payroll and sales.
The Functions, Asset, Risk (FAR) Test can be expanded to a Functions,
Asset, Risk, Economic Presence (FARE) Test. The Economic Presence could, of
course, mean Significant Economic Presence and would be a combination of revenue
thresholds and number of transactions. Accordingly, FARE would represent the
following.
- Functions can cover the access and penetration
in the market;
- Assets deployed could cover the website, the
artificial intelligence solutions, the technology platforms which are used in
the transaction delivery mechanism to the market instead of focusing on their
physical location;
- Risks inherent to digital businesses such as
privacy, security, vulnerability of data, etc., can be given adequate
weightage;
- Economic Presence could be based on threshold
in terms of sales or volume of transactions.
In this model, countries will have to debate and arrive at a
consensus on what would constitute Significant Economic Presence. The solutions
so arrived at should be implemented through a Multi-Lateral Instrument
(MLI).
It may be possible to apply Solution No. II for B2B
transactions and Solution No. I for B2C
transactions. Further, B2C should not be confined merely to customers but
should be comprehensive enough to cover businesses that are
end-users.
Solution
No. III: Theory of
Access – ePE (Digital PE)
A building site or construction, installation or assembly project or
supervisory activities in connection therewith constitutes a PE under Article 5
based on breaching a period threshold. Similarly, an installation or structure
used for exploration or exploitation of natural resources constitutes a PE when
it breaches a particular period threshold. The period differs between the UN
Model and the OECD Model.
Where the number of days or months can be the basis for determination
of PE, it should be possible to arrive at a new concept of ePE (Digital PE) based on the number of users who have
accessed the goods or services provided by a non-resident through digital
means. In effect, this would seek to identify nexus to a market jurisdiction
based on access exercised by the customers in that jurisdiction through
electronic means for procurement of goods and services. A new definition or an
additional category to the existing Permanent Establishment definition will have
to be agreed upon and developed.
Care must be taken to ensure that a digital PE is clearly linked with
the breach of the number of users threshold. There must
not be any reporting requirements or compliance requirements from a user’s
perspective but a non-resident business which transacts in a market jurisdiction
digitally will have to report the number of users of its website linked with
transactions consummated. A customer-driven reporting may not work given the
fact that the customer can access the website through multiple devices and from
anywhere in the world. Once a PE is established the normal principles for
attribution of profits will come into play.
This is based on the premise that any supply of goods or services by
way of electronic commerce would necessarily involve intermediaries such as
banks, payment gateways, internet service providers, etc. The number of
transactions consummated in a particular jurisdiction can be easily identified
based on data provided by the various institutions. One of the key elements in a
transaction of procurement of goods or services through the internet is the
payment. This payment is also made online.
For example, if this logic is extended, one possible solution for
taxing digital entertainment in the country where it is downloaded or
viewed is to identify that the income arises or accrues or deems to arise or
accrue in the country in which the said digital content is downloaded or
streamed. Insofar as download or streaming of entertainment content is
concerned, there would be data points such as a customer having a registration;
having a user ID and password; network login details; payment for the content
and downloading / streaming data.
There are two challenges in this solution, namely,
(i) Identification of
profits attributable to the country in which the content is downloaded or
streamed; this could be addressed by a deemed agreed percentage, and
(ii) Illegal download or
streaming of content, payment through non-banking channels, payment through
unregulated virtual currencies, free services.
Solution
No. IV: OIDAR – The
Direct Tax Twin
Drawing an analogy from India’s GST provisions which identify OIDAR
(online information database access and retrieval) services that are supplied to
a non-taxable online recipient, or even the same model, can be emulated from a
direct tax perspective. Insofar as OIDAR services which are automated and
provided by a supplier who is a resident of another nation are concerned, the
said supplier can be required to pay income tax in the nation where the
recipient resides. Care should be taken to ensure that the levy retains the
character of direct tax and does not convert itself into a consumption tax. The
identification of taxability can be linked with the GST provisions but the tax
should be only on the profits. Nations can agree upon a certain percentage of
the receipts / payments on account of such supplies to be deemed as the income
accruing or arising in the recipient country. This would also meet the
requirement of nexus to the market jurisdiction. Tax credit has to be
ensured.
Solution
No. V: Tax
Collection at Source (TCS)
Section 206C provides that a seller at the time of debiting the
amount payable by the buyer to the account of the buyer, or at the time of
receipt of amounts from the buyer, whichever is earlier, has to collect as
income tax a specified percentage of the amount in respect of specified goods.
For example, a seller of scrap will have to collect 1% as TCS from the buyer.
The amount collected represents the income tax payable by the buyer. The buyer
will get the credit of tax so collected against his income-tax liability. This
model can be examined and modified in the following manner:
(i) Any person who
facilitates payment for supply of digital goods or services shall be liable to
collect tax at source at a specified percentage. This tax shall be collected as
income-tax and should be available as credit to the non-resident supplier of
goods and services;
(ii) Person facilitating
payment would mean the bank or financial institution or financial intermediary
or e-wallet service provider;
(iii) To illustrate, if a
non-resident supplies digital content and the resident uses his credit card for
making payment of USD 100, the bank becomes responsible for making the payment
by way of TCS. Assuming that TCS is notified at the rate of 1%, the bank, at the
time of transfer of funds to the non-resident supplier, will deduct 1% being the
tax, apart from any other applicable transaction charges;
(iv) The supplier will have
to obtain a simplified registration in the market jurisdiction and will have a
tax account which will reflect the payments by way of TCS;
(v) The system should
automatically generate a certificate for payment by way of tax in the market
jurisdiction which would be available for claiming credit of taxes in the
country of residence under the treaty.
The
solutions referred to above are ideas which can be debated and developed into
effective and sustainable solutions. A solution to be effective has to be
certain and simple with uniform application. The aspirations of the market
jurisdiction in seeking taxing rights and the concerns of nations which are
worried about losing revenue will have to be balanced to ensure that the new
system that is created benefits one and all. At the end of the day, the levy of
taxes should not end up in scuttling new ideas and growth in the digital
environment.
