Chandana Ramachandran
Commissioner of Income Tax ( LTU),
Bangalore
chandana.r.chandran@incometax.gov.in
Ms Chandana Ramachandran belongs to the 1990 Batch of Indian Revenue Service, presently posted as the Commissioner of income Tax (Large Taxpayer Unit), Bangalore. She has served in various capacities in the department, her longest tenures being in the fields of Training, Transfer Pricing and International Taxation. She was a member of the Committee on Taxation of E-Commerce constituted by the Central Board of Direct Taxes.
| Executive Summary
Taxation of the digital economy is perhaps the most daunting challenge in the Direct Tax Policy domain. The defining characteristic of digital economy is mobility: comprising mobility of intangibles (which constitute the significant asset base of digital economy), mobility of user base and mobility of business functions. With little dependency on local personnel to carry out business functions and greater flexibility in choosing location of servers and other resources digital economy is often unencumbered by specific territorial nexuses. Tax jurisdictions are defined based on the physical nexus between the income sought to be taxed and the territorial boundaries of a country. But digital economy stretches seamlessly across national borders making it difficult to capture and quantify its profits within the physical confines of specific jurisdictions. |
INTRODUCTION
Taxation of the digital economy is perhaps the most daunting challenge in the Direct Tax Policy domain. The defining characteristic of digital economy is mobility: comprising mobility of intangibles (which constitute the significant asset base of digital economy), mobility of user base and mobility of business functions. With little dependency on local personnel to carry out business functions and greater flexibility in choosing location of servers and other resources digital economy is often unencumbered by specific territorial nexuses. Tax jurisdictions are defined based on the physical nexus between the income sought to be taxed and the territorial boundaries of a country. But digital economy stretches seamlessly across national borders making it difficult to capture and quantify its profits within the physical confines of specific jurisdictions.
It is to be remembered that rules governing assignment of taxing rights among host jurisdictions were made in the 1920s before the new business models were even conceptualized. The current framework of laws comprising
domestic laws and tax-treaties recognize a “Permanent Establishment” (defined as a fixed place of business) as the threshold for taxation rights on business income. A digital business model on the other hand can have significant economic presence in a country without a physical establishment and consequently avoid tax liability. Failure to enforce adequate taxation of digital economy leads to revenue loss impairing financing of public goods. In addition to this, unequal distribution of tax burden on digital enterprises and brick and mortar industry violates one of the fundamental principles of tax policy, viz. neutrality, causing economic distortions. As digital economy already occupies substantial economic space and is on a growth trajectory these issues need to be addressed on a priority basis.
SIZE OF DIGITAL ECONOMY
A 2010 report of the Boston Consultancy Group had postulated that the digital economy in G20 countries would grow from USD 2.3 Trillion in 2010 to USD 4.2 Trillion by 2016 . A 2018 report of the Ministry of Electronics & Information Technology, Government of India values India’s digital economy at about USD 200 Billion or about 8% of the GDP. Predicting a steep growth, the Ministry’s Report pegs the value anywhere between USD 800 Billion to 1 Trillion in nominal terms by 2025 or at 18% to 23% of the GDP. This economic value of USD 800 Billion to USD 1 Trillion is estimated to give rise to digital revenues ranging between USD 1.4 Trillion to USD 1.8 Trillion. We are talking about a significant tax base.
FUNDAMENTAL PRINCIPLES OF TAX POLICY
Raising revenue for financing public goods is the primary purpose of taxation. The means and quantum of revenue to be raised depend on the policy priorities of governments. However, taxation itself is governed by certain basic policy parameters which have emerged and been recognized over the years. These include:
1. Neutrality: Taxation should seek to be neutral between diverse business activities with minimal bias in favor of or against any economic option. A neutral taxation is expected to lead to optimal allocation of resources thereby promoting economic efficiency minimizing economic distortions and corresponding deadweight losses. This entails equal and neutral application of tax policy on all types of business while addressing specific issues pertaining to any form of economic activity standing in the way of such equal application.
2. Efficiency: Efficiency in the context of tax policy implies minimizing costs- cost of compliance to the taxpayer and costs of administration for the governments-as far as possible.
3. Certainty & Simplicity: Tax policy should strive for a stable tax regime with tax rules clear and simple which enables the taxpayer to understand his entitlements and obligations. A complex tax system often leads to aggressive tax planning and excessive litigation.
4. Effectiveness & Fairness: Practical enforceability is the hallmark of sound tax policy. If a tax administration is unable to collect legitimate taxes from an enterprise technically liable to tax, tax system is not efficient. It will also be perceived as unfair by those who actually pay taxes.
5. Flexibility: A taxation system should be flexible enough to adapt to changing needs of revenue on an ongoing basis. It should keep pace with commercial and technological developments. This requires both structural durability and the dynamic ability to respond to the ever-changing economic environment.
6. Equity: Equity as a policy consideration comprises horizontal and vertical equity. Horizontal equity demands that taxpayers in similar circumstances should share the same tax burden. Vertical equity requires that taxpayers in better circumstance should higher tax burden. In a cross-border context, equity involves inter nation equity also. In other words, each country should receive an equitable share of revenues raised from cross border transactions.
DIGITAL ECONOMY
The term Digital Technology perhaps first appeared in the title of the eponymous 1995 bestseller by Don Tapscott though Oxford Dictionary traces its first use to the year 1990. Since then, exponential growth of Information and Communication Technologies has made technologies accessible and affordable. Digital devices have become cheaper and internet connectivity faster, reliable and reasonably priced. Growing at the rate of 10% per annum digital economy is outpacing global economy. By no means a peripheral segment of economy, it is no longer possible to ring-fence digital economy for the purpose of taxation. Instead tax policy has to be re-conceptualized to suit its economic models.
The most defining feature of digital economy is its mobility which enables enterprises to relocate at minimal cost, choose optimal location for its functions and assets and access remote markets. Mobility comprises mobility of intangibles, recognized as the key business assets of digital economy, mobility of customer base and mobility of business functions. And this mobility makes it most challenging to tax.
DIGITAL ECONOMY & CROSS BORDER TAXATION
LEGAL CHALLENGES
The major legal challenges raised by digital economy include the following:
1. Absence of territorial nexus: The defining feature of digital economy is the fact that it can have significant economic presence in any domain without any physical establishment or personnel located. However, rules of international taxation recognize the existence of a permanent establishment as the basic threshold for taxation. A case in point will be the rendering of technical or business services via an online platform without the physical presence of personnel in the source jurisdiction. At present, the courts are holding that no income has accrued or arisen in India and no tax liability attracted.
2. Valuation of Data: Value creation in digital economy is often in the field of data which is the key business asset. At present, there are no defined rules to evaluate the data in quantitative terms for the purpose of taxation. Though we are all aware of the economic value of such data and its income potential, this remains largely an unexplored territory in the absence of explicit legislation.
3. Characterization of Income: Assignment of taxing rights hinges upon the characterization of income (business profits, royalty etc). Income generated by digital economy often defies such categorization. For example, passive incomes such as royalty attracts withholding taxes in the source jurisdiction, business income gets taxable only with the physical presence in the form of a permanent establishment in the source domain. Consideration paid for utilization of online advertisement facilities could be amenable to characterization either as royalty or business income.
ADMINISTRATIVE CHALLENGES
The major administrative challenges are discussed below:
1. Identification: In the absence of physical presence, the most crucial challenge is to locate and identify the digital economic activities and players in a jurisdiction
2. Determining the Extent of Activities: Next task is to determine the extent of such digital economic activities
3. Information Collection & Verification: The third task is to collect information and verify the same to quantify income generation, if any.
4. Enforcement: The final and most crucial task is the enforcement of tax law on digital enterprises
These challenges may not look important at the policy making level, but are really daunting at the field level. While the jurisdictional officer may not even be cognisant
of the first issue of identification, quantification and verification poses a very real problem. And completion of assessment of digital income and enforcement of tax collection in the absence of physical defaulters and physical assets are almost impossible.
DOUBLE TAXATION & UNINTENTED NON-TAXATION
The rules governing cross border taxation are based on exhaustive studies of business processes of the brick and mortar era when double taxation of international trade was a burning issue. Such rules do not take into account business process flowing in a seamless continuum across transnational supply chains. The income generated out of these operations cannot be segmented to discrete jurisdictions enabling countries to enforce their tax laws. As such it is not the double taxation which is the issue now, but unintended non-taxation. The question here is not just that of a few enterprises avoiding tax leading to erosion of tax bases. This avoidance naturally increases the tax burden on other enterprises leading to economic distortions and violation of fundamental principles of tax policy. Therefore, there is a need to rethink on tax policy for digital economy
The international community is seized of this widening tax gap and Tax Challenges of Digital Economy is the First Action Plan of the BEPS (Base Erosion and Profit Shifting) Reports accepted by G-20 countries including India and OECD. In 2016 India introduced Equalization Levy on Business to Business Transactions exceeding a specified limit. Other countries are following suit.
However, these initiatives have so far touched only the tip of the iceberg and our legal and policy framework sweats to keep pace with current business models, which get outdated and replaced by newer models at lightning speed. We have to take a call whether we want to play safe and stick to presumptive taxation or want to go further and evolve a whole new taxation model. With digital economy, expanding and filling up the whole economic space crowding out brick and mortar models, may be time is running out.
Notes:
SELECT BIBLIOGRAPHY
Boston Consultancy Group. (2010). The Internet Economy in the G 20, The $4.2
Trillion Growth Opportunity. Boston consultancy Group.
Committee on Taxation of E-Commerce, CBDT. (2016). Proposal for Equilization
Levy on Specified Transactions. CBDT.
Ministry of Electronics & Information Technology, Government of India. (2019). India’s Trillion Dollar Digital Opportunity. Ministry of Electronics & Information Technology, Government of India.
OECD. (2015). OECD/G20 BEPS Project Addressing the Tax Challenges of Digital Economy, Action 1-2015 Final Report. 2015.
Source- CBDT Taxalogue Magazine Jul – Oct 19 | Volume 1 | Issue 1
