Adv. Ramit Mehta, Managing Partner – Mehta Chambers, Jodhpur
Rishab Lodha, Final Year Student at Institute of Law, Nirma University.
“When there is an income tax, the just man will pay more and the unjust less on the same amount of income.” – Plato
The use of the internet has revolutionized the whole concept of brick & mortar world into a digital one. The digital economy gives rise to various concerns stretching from the issue of data protection to taxing the digital economy. Today, the international, as well as Indian tax regime is unfitted to deal with various taxing issues and complications arising out of the digital economy. The multifaceted nature and modus operandi of the business existing through the internet and computer networks have made the applicability and enforceability of tax statutes more difficult. The imposition of tax on the digital economy comprising of tech giants like Facebook, Google, Amazon, etc. has been a very important issue at the international level due to the complexity involved in the processes as the digital business is conducted using intangibles. In the recently concluded G20 Summit in 2021, the issue of taxing these giants has found a top place in its agenda.
The tax has a very important role to play in the development of an economy especially that of a developing country likes India. In the Financial Year 2018, Facebook’s revenue from Indian jurisdiction amounted to Rs. 521 crores. As per the reports, Google’s revenue from India was more than Rs. 10,000 crores. However, Facebook and Google paid a total tax of only Rs. 200 crores to the Indian Government. In light of this disproportion in the amount of revenue generated and tax paid to the Government, the taxing regime must be reassessed to introduce effective taxation for the digital economy. The article focuses on the Organisation of Economic Co-operation & Development & G20 countries’ efforts in the adoption of digital taxation along with the Indian perspective and actions taken by the Indian Government to tax these tech giants.
OECD’s BEPS Action Plan
Organisation for Economic Co-operation and Development (OECD), for the past few years, has been working on the Base Erosion and Profit Shifting Project (hereinafter referred to as BEPS). BEPS is tax-evading strategy that exploits the loopholes in tax governance to shift profits and invoicing the revenues to locations where there are no or very little taxes, or to erode tax bases by deducting payments such as interests or royalties, which results in little or no corporate tax to be paid. With the increasing use of digital platforms for conducting businesses, the tax authorities and taxpayers, both, have noticed the complexities in the determination of tax implications over the e-commerce businesses. The BEPS practices cost countries around USD 100 to 250 billion in lost revenue. 139 countries are working together within OECD/G20 Inclusive Framework on BEPS for the implementation of the BEPS Action Plan package of 15 actions to tackle tax avoidance by the e-commerce companies, develop the coherence of international tax rules, and ensure a more transparent and crystal clear tax environment.
The BEPS package provides a plan of 15 actions as set out below, that the governments should undertake to tackle tax avoidance.
- Action 1 – Tax Challenges Arising from Digitalisation
- Action 2 – Neutralising the effect of hybrid mismatch arrangements
- Action 3 – Controlled Foreign Company
- Action 4 – Limitation on Interest Deductions
- Action 5 – Harmful Tax Practices
- Action 6 – Prevention of Tax Treaty Abuse
- Action 7 – Permanent Establishment Status
- Action 8 to 10 – Transfer Pricing
- Action 11 – BEPS Data Analysis
- Action 12 – Mandatory Disclosure Rules
- Action 13 – Country-by-Country Reporting
- Action 14 – Mutual Agreement Procedure
- Action 15 – Multilateral Instrument
This action plan will act as a tool to ensure that profits are taxed where economic activities generating the revenue and profits are performed and where value is created. Below mentioned Action Plans are the most relevant for the Indian approach towards digital taxation:
Action 1 (Address the tax challenges raised by Digitalization) deals with tackling the tax challenges arising in the digital economy. A special body called Task Force on the Digital Economy (hereinafter referred to as TFDE) was set up in September 2013 to study and address the tax complications raised by the digital economy. It submitted its final report in October 2015. This report aims to tackle the complications that the digital economy raises for the application of existing international tax rules and to develop detailed options to address these rules.
Action 3 (Controlled Foreign Company) deals with risk that taxpayer can erode the tax base of their country of operations by shifting profits into a foreign company which pays little or no taxes. This action lays down the pathway for framing effective CFC rules. The main aim would be pulling back the income generated in the digital economy, which is shifted to low tax jurisdiction, for taxation in the hands of the ultimate parent company.
Action 7 (Permanent Establishment Status) provides for a review of the definition of Permanent Establishment (hereinafter referred to as PE) to prevent certain tax avoidance strategies to avoid having a taxable presence in the jurisdiction which cause cross-border income to go untaxed or be taxed at low rates.
Tax treaties generally provide that the business income of a foreign company shall be taxed only if that company has a permanent establishment in that particular jurisdiction. Article 5 of OECD Model Tax Convention defines a PE as “a fixed place of business through which the business of an enterprise is wholly or partly carried on”. Article 5(2) provides for the term PE to include a place of management, office, factory, workshop, mine, an oil or gas well, a quarry, or any other place of extraction of natural resources. .
The action proposes certain under-mentioned changes to the definition of a PE in the OECD Model Tax Convention.
- Ensuring all the exception to permanent establishment should only be preparatory and auxiliary.
- Preventing business operations from being split up within group entities to avoid having a permanent establishment in any state.
- Tightening the agency PE rule to ensure that the activities which are performed by an intermediary are intended to be concluded as regular contracts to be performed by a foreign enterprise, that enterprise will be considered to be having a taxable presence in that jurisdiction.
Action 8 -10 address this issue to ensure that transfer pricing outcomes justify the value created in the MNE group.
Commercial Transactions between different subsidiaries of the same multinational company may not be driven by the same market forces shaping relations between the two independent enterprises. The price charged by one subsidiary from another subsidiary of the parent company is known as Transfer Price.
The effect of transfer pricing is that the parent company or any of its subsidiaries may produce insufficient taxable income or excessive loss on a transaction. For instance, a group that manufactures products in high tax countries may decide to sell them at a loss or very low profit to its affiliated sales company based in a tax haven country. That affiliated company would in turn sell the product at an arm’s length price and the resultant inflated profit would be subject to little or no tax in that country.
The action ensures that transactions between the subsidiaries of the parent company are based on the arm’s length principle and transactions should be priced as if the subsidiaries were independent.
In addition to the above-mentioned measures, TFDE had also analysed and recommended measures like equalisation levy, introduction of the concept of significant economic presence & withholding taxes on certain types of transactions to deal with BEPS issues in the digital economy. However, these measures have not been recommended by OECD, the decision to implement these measures is left to the respective countries.
Indian Perspective in Taxing Digital Economy
To tax the digital economy, the Indian Government has introduced the concept of Equalisation Levy in Chapter VIII of the Finance Act, 2016. The levy is charged at the rate of 6% on payments made to foreign entities for providing digital advertising services. After this, in 2018, the concept of Significant Economic Presence (hereinafter referred to as SEP) was introduced through the Finance Act, 2018.. Thereafter, in 2020, by inserting Section 165A in the Finance Act, 2016, by amendment vide Finance Act, 2020 another equalisation levy at the rate of 2% was introduced to be charged on the amount of consideration received or receivable by an e-commerce operator for the e-commerce supply or services made or provided or facilitated by it.
Following are the major steps taken by India for taxing the digital economy:
- Equalisation Levy: Chapter VIII of the Finance Act, 2016 deals with Equalisation Levy and is enacted as a separate statute from the Income Tax Act, 1961. Section 165 of the Finance Act, 2016 provides for the equalisation levy “to be charged at the rate of 6% of the amount of consideration for any specified service received or receivable by a person, being a non-resident from a resident or a non-resident having a permanent establishment carrying out a business or profession.”
The term “specified services” has been defined under Section 164 of Finance Act, 2016 as services providing online advertisements and other online platforms that could be used as an advertising space. There are three conditions for the applicability of equalisation levy of 6%, namely, payment should be to a non-resident foreign service provider, payment should exceed Rs. 1,00,000 in one financial year & payment should be in relation to using services of online advertisement.
The Government of India further expanded the horizon of Equalisation Levy in the Finance Act, 2020 and inserted Section 165A in the Finance Act, 2016 to impose a levy of 2%, effective from 1st April 2020, “on the consideration received or receivable by an e-commerce operator from the e-commerce supply or services made or provided or facilitated by it to a:
- Person resident in India
- Non-resident, where the:
- Sale of advertising to Indian resident customer, or a customer who accesses the advertising through an IP address located in India; and
- Sale of data collected from Indian residents or from a person who uses an IP address located in India.
- Person, who buys goods or services, or both, uses an IP address located in India.”
For the purposes of this section:
“E-commerce supply or services means online sale of goods, online provision of services, facilitation of online sale of goods or provision of services or any combination thereof by the e-commerce operator.”
For the purposes of the above clause:
“Online sale of goods and online provision of services shall include acceptance of offer for sale, offer for purchase, payment of consideration or supply of goods or provision of services.”
This equalisation levy of two percent shall not be charged-
- Where the e-commerce operator has its permanent establishment in India or effective business connection with such permanent establishment;
- Where the equalisation levy is applicable under Section 165; or
- The gross receipts or turnover of the e-commerce operator is less than two crore rupees during the previous year.
- Significant Economic Presence: It is a new nexus norm that is based upon the source-based model of taxation. It will require the foreign entities with no physical presence in India to pay taxes in their income attributed to transactions that constitute “a significant economic presence”. The concept of “significant economic presence” was first introduced vide Finance Act, 2018 based on the recommendation of 2016 CBDT’s High-Powered Committee. Finance Act, 2018 amended Section 9 of the Income Tax Act, 1961 by inserting Explanation 2A which provides for the “significant economic presence” of a non-resident foreign entity to be classified as “business connection” in India and means-
- If the aggregate amount of transaction in carried out by a non-resident in India, exceeds a prescribed value [INR 20 million] during the previous year; or
- Carrying out the business activity or engaging in interaction with such number of users as may be prescribed [three lakhs].
However, SEP provision remains ineffective majorly because it will impact only those foreign entities of the nations or jurisdictions with which India does not have a tax treaty (Double Tax Avoidance Agreement). As the Double Tax Avoidance Agreement (hereinafter referred to as DTAA) only provides for the levy of tax in the presence of permanent establishment of non-residents in the source country, the department cannot tax the income of those foreign entities based on their “significant economic presence”.
Missing Fine Print & Ambiguities
India has taken various forms of unilateral measures for taxing the digital giants to increasing revenue. However, there are various anomalies in these unilateral measures. Following is the mapped-out version of inconsistencies in the provisions of equalisation levy and significant economic presence.
This levy is charged on an e-commerce operator of an electronic platform for online sale of goods or online provision of services or both. However, the provision does not identify as to what constitutes an ‘online sale of goods’ or ‘online provision of services.’ For instance, for OLX which operates a model under which the sale of goods is offline, it is not clear whether it is online sale of goods. Also, for a business model like that of Urban Clap, where the actual services are provided offline, it is not clear whether it would be considered as online provision of service.
Another problem is the absence of the definition of the word “consideration”. It is problematic because it may be probable that an e-commerce operator is simply facilitating the transaction between the seller & the consumer on its platform only for the commission from either the seller or buyer or both. Its absence may lead to charging the entire consideration of the transaction to the Equalisation levy instead of just the commission received by the e-commerce operator.
Significant Economic Presence
There remain some uncertainties in the SEP scheme too. First, it remains unspecified as to how the user threshold would be determined, i.e., whether only the resident users will be considered for meeting the requirement, or any users located in India at the time of executing a transaction or using Indian IP addresses, even though temporarily.
Second, it is also unclear as to whether the taxpayers have a choice to elect the taxing of digital/ e-commerce payments as fees for technical services (“FTS”) or business income. The Income Tax Act, 1961 provides for a much lower rate of taxation of FTS, i.e., 10% on a gross basis, whereas business profits under the SEP scheme would typically be subject to tax at 40% corporate tax on net profit for a non-resident corporate entity.
oecd-G20’s Recent Inclusive Framework Tax Deal
On 5 July 2021, out of 139 member countries of OECD/G20 Inclusive Framework on Base Erosion & Profit Shifting (IF), 131 member countries representing more than 90% of the global GDP have adopted the new high-level statement for addressing the tax challenges arising from the digital economy. The proposed solution is based on two pillars. Pillar one provides for reallocation of an additional share of profit to the market jurisdiction. Pillar Two provides for a minimum tax of at least 15% to be imposed on multinational enterprises. This solution is to ensure that the digital e-commerce companies pay taxes in all the countries from which they generated their revenue. The full-fledged framework and implementation plan are yet to be finalised by October 2021, and once it is finalised and implemented which is supposed to happen by 2023, India along with other member countries will have to restructure the current and existing digital tax regime.
Given the difference between the revenue earned by the tech giants like Google, Amazon, Facebook, etc., and tax paid to the governments in different jurisdictions the international tax regime has been evolving to bring the digital economy into the purview of effective and just taxation. Various important developments have taken place around the world regarding this issue. Indian Government’s attempts on taxing the digital economy by introducing and implementing concepts like equalisation levy and significant economic presence – such attempts, though unilateral, were necessary for bringing the digital economy into taxation.
Indian Government’s attempts to tax the digital economy through equalisation levy and SEP have been widely criticized because they intend to bypass significant international tax principles. Fortunately, there is a silver lining – all unilateral tax rules such as the SEP and equalisation levy, employed to battle the tax problems of the digital economy, are expected to be temporary tools that will eventually be replaced by or aligned with the OECD’s Inclusive Framework of Tax Deal.