Taxation systems in major developing economies, such as India, have been inherently familiar with underlying concepts of traditional real economy and physical cross-border trade. The traditional residence-based and source-based concepts of taxation may not be sufficient enough to envisage the presence of a digital economy largely due to its unique amorphous nature. Digital economy is a concept that often defies traditional concepts and prototypes, overrides traditional edicts of taxation and is very often viewed suspiciously by tax authorities. Such is the resultant bewilderment that tax authorities in their zeal to tax such transactions, emanating from a digital economy trespassing borders, may not hesitate to make unreasonable assumptions not found in regular assessments.
Dispute surrounding taxation in connection with (a) valuation of intangibles in case of innovative startups (inextricably a byproduct of the digital economy), (b) commission/income derived from digital transactions in India consummated through global payment gateways, (c) attribution of profits to India operations of a global business operating electronically without physical presence, etc. are some of the instances that are testimony to the challenges surrounding taxation of digital economy in India.
OECD Model Tax Convention is based on residence-based principle while the UN Model Double Taxation Convention is based on a combination of residence-based and source-based principles. India follows residence-based taxation for its residents while foreign entities are taxed in India according to the source principle.
To tax a foreign entity in India, jurisdiction over such entity and taxable income are essentially established through permanent establishment (PE) [under relevant article of tax treaty], income characterization and relevant tax slabs under Indian tax law. Digital economy functions with significant economic presence (SEP) in a (source) country without any assets located in such source state (e.g. Airbnb, Facebook, Google, Uber, etc.) and this has considerably abjured the conventional ‘brick and mortar’ definition of PE. All three model conventions – UN, OECD and US –apply PE as the main apparatus to establish tax jurisdiction over a foreign entity. India is no exception to this dilemma where one can certainly feel the palpable presence of global internet-based businesses in our daily lives yet one may not be able to successfully tax the income generated by these global businesses from Indian market because of the inability of traditional taxation mechanisms to extend jurisdiction over these new-age digital economies.
Since 2015, OECD’s Base Erosion and Profit Shifting (BEPS) project has been discussing and debating taxation of digital economies and a two pillar approach has been adopted – Pillar One dealing with ‘Unified Approach’ and Pillar Two dealing with ‘Global Anti-Base Erosion’. Following these developments, as an active participant in these discussions, India introduced the ‘Equalization Levy’ in 2016 in its domestic income tax law. Equalization Levy deals with imposition of tax on cross-border supplies of services and intangibles. Further, the concept of SEP was introduced (vide an amendment in Section 9 of the Income-tax Act, 1961) to expand the definition of ‘business connection’ in India for a foreign entity irrespective of whether or not such foreign entity has a physical presence or PE in India. The concept of a ‘Non-resident taxable person’ has also been introduced in India’s GST legislation to cover a person who occasionally undertakes transactions involving supply of goods or services or both, whether as principal or agent or in any other capacity, but who has no fixed place of business or residence in India. A ‘Non-resident taxable person’ would need GST registration.
While BEPS framework is still evolving, there are significant differences in approaches mainly with the US on adopting unified approach for taxation of multinational technology firms, e.g. unilateral v/s multilateral taxation approach, tax neutrality, artificial structures and anti-avoidance, parameters for PE, etc. Keeping aside its own views and differences on taxation of digital multinational enterprises, India has already started taking unilateral steps to implement such taxation in its domestic tax law.
The writer is the Managing Partner at Acuity Law.