Follow Us :

Electronic Commerce Taxation-Current trends in India, Provision under the Law and Judicial approach

Introduction

The contemporary medium of doing the business is the electronic medium, where routine functions are performed by the enterprises through electronically operated applications instead of having a physical space in a market. The concept of physically going to a market and purchasing the product has been substituted to a large extend to purchase such products electronically. Businesses have not only adopted the method of doing business to online medium but also used the information technology tools for conducting, managing and executing business transactions. The world Trade Organization (WTO) defines e-commerce as the production, distribution, marketing, sales or delivery of goods and services by electronic means.[1] So, it would not be wrong to say that E-commerce is commerce based on bytes.[2]

With the advancement of technology the erstwhile brick and mortar world of physical commerce has been transformed into click and mortar, click and brick and all clicks[3] world of online commerce where the mode of doing business is purely online and there is no offline or physical presence of an entity. In the brick and mortar model or in traditional model of doing business the enterprises were taxed by the government on the basis of the physical location or place of doing business of the entity but how will the tax be imposed on entities under the new all click model and one thing which the government as well as these electronic commerce entities are sure of is that only because the mode of doing business is different does not mean that such entities will be immune from taxation. Also the principles governing the taxation of physically present entities could not be applied to e-commerce platforms because they have their own unique features.

The assignment categorically addresses the challenges faced by the government to levy tax upon electronically operating entities by putting emphasis on (i) how e-commerce platforms take advantage of base erosion and profit shifting methods to evade tax and how the concept of business establishment and place of effective management are interpreted in terms of taxing electronically operating businesses (ii) various provisions under the Indian Laws pertaining to residential status, business connection and permanent establishment will be discussed and third, the current judicial approach will be highlighted with the help of various case laws.

Challenges arising from digitalization

Tax is the most important asset for a government to bridge the gap between economically weaker and stronger section of the society and with the advancement of technology the methods to levy tax upon digital entities has also to be changed. One major concern is whether the shift to e-commerce will have result in tax revenues for the government, and if yes, which taxing authority would right over such revenues. Some major issues which have emerged with the development of e-commerce business are-:

  • Lack of physical presence of the business.
  • Ever changing location of the business, as it is very easy to relocate the server of the business to a different place.
  • Relocation of business to “tax heavens”.
  • Jurisdiction related issue: which country has right to levy tax?
  • Disregard to accounting and auditing procedures.

Electronic-Commerce-Taxation-–-Current-trends,-Law-&-Judicial-approach

Base Erosion and Profit Shifting (BEPS)

E-commerce platforms work on a different model and heavily rely upon intangible assets, online generated content, automation and ability to interact with customers without any physical presence. For such entities it becomes very easy to relocate their place of operation of business to a new tax territory, especially to a lower tax jurisdiction to minimize their liability to pay tax on international income. This concept is known as Base Erosion or Profit Shifting where the tax on profits is minimized by the entity by shifting profits to a country with low tax implications and such countries are known as “tax heavens”. Not having tangible assets make it very easy for e-commerce platforms to relocate their profits to tax heavens and enjoy low payment of tax on international profits.[4]

Example of Uber Technologies Inc.

Uber Technologies Inc. provides an intermediary mediation service where it connects potential drivers with potential passengers and in return charges fees for providing such intermediary service. Uber has involve its varius entities in low tax jurisdictions or tax heavens to avail benefit of low taxation on it worldwide income. Companies like uber avoid a Permanent Establishment[5] (PE) in market where the service is actually provided. In Uber’s case, a Netherlands subsidiary (Uber International C.V.) processes the global payments for all rides.

Example of Spotify

Famous audio and music app Spotify functions its “operational office” in Sweden but is “headquartered” in Luxemburg, which is again a tax heaven, therefore Spotify avoids a PE in jurisdiction where services are actually provided and rather maintain PE at low tax jurisdictions to evade tax.

Digitally operating Multinational enterprises rely heavily upon intangible assets allows them to avoid a physical presence in the source country and relocate to a low tax jurisdiction. Revenues are not reported in the countries where they are actually earned rather relocated to countries where PE is established which makes difficult for the market jurisdiction to tax the income earned in these countries. Therefore a gap is created between the digital consumer and digital corporation. These strategies to reduce tax liability is often known as Base erosion and Profit Shifting (BEPS).[6]

Place of Effective Management (POEM) and Income Tax Act, 1961

As per Income tax Act, 1961,[7] two types of companies are treated as residents of India, (i) if company is registered under companies act, 2013 (ii) if control and management of a company is completely located in India, the concept of Place of Effective Management (POEM) is introduced in India by Finance Bill, 2015 which replaces the words “control and management’ mentioned in section 6 of the Income Tax Act to “effective management and control”.

So Section 6(3) of the Income Tax Act, 1961 post Finance Bill 2015 is read as:

‘A company is said to be resident in India in any previous year, if, — (i) it is an Indian company; or

(ii) its place of effective management, at any time in that year, is in India.’
Here the term “at any time in that year”  was highly criticized as even one meeting or event pertaining to management of a company in India would bring the company under the scope of Income Tax act therefore the term “at any time in that year” was replaced by “in that year” w.e.f April1, 2017.

As per the earlier provision to tax a corporate in India, it has to be proved that its entire control and managerial process is being done in India, thus it created a loophole where corporate decide to do significant management activities  outside India to avoid the applicability of residential rule and thus evading the tax in India.

The concept of POEM is well recognized by OECD and is also used by various countries to determine the residential statues of an entity, therefore this amendment was also necessary to bring parity between  Indian Tax laws and International standards[8].

Explanation to Section 6(3) of the act[9] states that “place of effective management” means a place where key management and commercial decisions that are necessary for the conduct of business of an entity as a whole are, in substance made. Key management and commercial decisions is a subjective term and a universal meaning cannot be derived, the exact scope or meaning of key managerial and commercial decisions is also not defined in the act, therefore meaning of such term varies from case to case.

Business Connection

For a Non resident who wants to do business in India, a link has to be created through which business can be done, this link is known as business connection. Simply put, business connection is relationship between resident appointed by a non resident to do business in India. Income Tax Act, 1961 defines business connection,[10] it states that business connection is a link established between resident and non resident and the income accrued directly or indirectly through this link is subject to tax in India.

Example: Mr.X, non resident of India appointed Mr. Y, resident of India to do business in India, now Mr. X thinks that income accrued from this business will not be taxable in India as he is not a resident, but here the income will be subject to tax as income is earned through business connection.

The Finance Act, 2003 has inserted the Explanations 2 & 3 in sub-section (1), in clause (i) of section 9 of the Income Tax Act, to be effective from 1 April 2004, to identify what constitutes a ‘business connection’:[11]

As per these explanations business connection shall include any business activity carried out through a person acting on behalf of the non resident:-

1. Has authority to conclude contracts on behalf of non-resident. Example Non-resident has various property in India and resident performs the work of assigning the properties to potential lease holders, therefore business connection is established.

2. Maintains a stock in India on behalf of non resident. Example: non-resident has created a warehouse in India and the resident maintains the stock and sells goods through it, so it will be treated as business connection.

3. Secures orders in India for non-resident. Example: suppose an commission agent who accepts or rejects orders from Indian vendors pertaining to import a good from non resident and charges commission on such amount

Plain reading of the aforesaid provision depicts that a physical presence of an entity is not essential to levy tax, rather what is quintessential is the business activity, therefore one can extend the scope of business connection to include business done through electronic medium as well. Hence it would be sufficient to show for the taxation purposes that there exists a continuity of ‘mutual business interest’ between two business entities transacting business through an electronic medium.

Proviso to explanation 2 clarifies that broker, general commission agent or any other agent having an independent status will not be subject to tax if working independently in India, this provision is in parity with the approach taken in OECD Model Tax Convention[12] where independent agents and brokers were not classified under the scope Permanent Establishment. But second proviso to explanation 2[13] provides that if these agents or brokers, mainly or wholly work for the non residents than they cannot be treated as independent agents and will be subject to tax in India. This provision directly affects the outsourcing business by the non residents where non resident companies outsource there call centres in India, such link will be considered as business connection and will be taxed in India.

Significant Economic Presence(SEP)

There are various ways through which an income of the non-resident can be taxed in the source country and one of such way is through Significant Economic Presence (SEP). India being a developing nation provides large subscriber base to big technology companies and to levy tax on such companies the concept of SEP was introduced by The Finance Act, 2018 which has widened the scope of Business Connection to include Significant Economic Presence, thus bringing in the Indian operations of such foreign corporations within the ambit of the Indian Tax System.

Meaning of SEP

As per explanation 2A of Section 9 (1)(i)[14] SEP means transactions of goods and services with any person in India, including provision of download of data or software in India, if either of the following conditions is met:

The aggregate of payments arising from such transactions exceeds a specified limit, or

2. The engagement with Indian consumers exceeds a specified number

The concept of SEP specifically targeted the income earned by the e-commerce platforms and online streaming websites like Netflix or Amazon where the entities do not have physical presence but have a large amount of customer base. There are certain threshold limits provided by the government to establish Significant Economic Presence in India,[15] which are:-

  • Transaction in respect of goods and services carried out by a non resident with any person in India including provision of download of data or software in India, if the aggregate of payments arising from such transactions during the previous year exceeds INR 20 million or
  • Systematic and continuous soliciting of business activities or engaging in interaction with more than 3, 00,000 users in India

Permanent Establishment

The Central Board of Direct Tax (CBDT) on 16 December, 1999 set up a committee[16] of e-commerce and taxation to analyze the potential of e-commerce and to discuss feasibility of taxing the e-commerce activities. The Committee concluded that e-commerce should be subject to direct taxation, and that the concept of place of effective management(POEM) and source-based taxation should be preserved. The concept of permanent establishment(PE), as defined by Article 5 of the OECD Model Tax Convention[17], was, however, rejected. It was proposed that the “base erosion approach,” which levies a modest withholding tax on payments transferred to a foreign entity with a set-off option when the receiving entity’s net income is taxed in its nation, be upheld. The Committee also advised that no changes to the income tax or the Double Taxation Avoidance Agreement be made until the notion of PE is abandoned.

Changes made by Finance Act, 2003 w.r.t PE

Section 44DA[18]: This section was added by the Finance Act to elucidate the meaning of Permanent Establishment. According to this section if any royalty or technical fees is received by an Indian entity from a non resident or a foreign company where such non resident or company is doing business in India through PE or if certain professional or technical fee is charged by such non resident or foreign company than such income will be added in “profits and gains of business or profession”.

Section 163[19] (who may be regarded as an agent) was amended by adding that the individual having business connection with non-resident will be regarded as an agent. By this amendment it can be  concluded that an agent can also act as a PE  and the intent of the legislation shows that an attempt has been made to tax non residents acting through both, PE and business connection.

Equalisation Levy

It is a new concept introduced by the Finance Act, 2016[20] to tax the foreign e-commerce platforms providing online advertisement services to Indian companies. It is aimed at taxing business to business transactions. The services, especially digital services, provided by non residents not having PE in India are taxed as part of equalization levy.

Two conditions to levy equalization levy are:-

1. The payment should be made to a non-resident service provider;

2. The annual payment made to one service provider exceeds Rs. 1,00,000 in one financial year.

Currently only online advertisement services are included under the scope of equalization levy and the applicable rate is 6% of the consideration paid or to be paid.

Example: How equalization levy is charged? Mr X has advertised on Facebook to expand his business. He has to pay Rs. 200000 in FY 2020-21 in consideration to such advertisement service provided by facebook. This amount is subject to equalization levy at 6%.

Equalisation Levy as per Finance Act, 2020(EL 2.0): The scope of equalization levy is extended by the finance act, 2020 where it included all non-resident e-commerce operators providing supply or services. Therefore supply of goods or services provided by non-resident e-commerce operator is liable to pay equalisation levy at 2% of the consideration.

Salient features of Equaliation Levvy 2.

1. EL 2.0 applies to the non-resident e-commerce operator’s online sale of goods, online provision of services, or a combination of both.

2. When non-resident e-commerce operators supply to (a) individual residing in India, (b) A person with an Indian IP address (c) In some situations, a non-resident, EL 2.0 applies.

3. Equalization 2.0 attracts a Rs 2 crore threshold limit. Only if the total amount of consideration for such defined services received in the preceding year exceeds Rs. 2 crores EL 2.0 be imposed.

4. The non-resident is charged EL 2.0 at a rate of 2% on the amount of consideration received/receivable.

5. When an E-commerce operator has a Permanent Establishment in India and the e-commerce supplies or services are effectively related to that Permanent Establishment, EL 2 is not applicable.

Judicial Approach

CIT v. R D Agarwal & Co[21] : In the present case the assessee R.D. Aggarwal is a registered firm in Amritsar and work as importers and commission agents for the non residents. In the present case two non residents, one from Italy and the other from Belgium are exporters and manufacturers of worsted woolen yarn. The relationship between the assessee and the non residents is such that assessee procures orders from dealers in India and communicates the same to the non-residents and if order is accepted by the non-residents and price is paid by the Indian dealer than assessee is entitle to commission varying between 1.5%-2.5% of the price.

The Supreme Court observed that:

  • The question as to whether there is business connection is a subjective question and it varies from case to case and further observed that the term business connection is something more than mere business and single and isolated transactions cannot be treated as business connection rather relationship between the resident and non-resident should be “real” and “intimate” and a series of transactions has to be established.
  • Further observed that in present case the contract of sale was held outside the taxable territory, price was paid to the non residents outside the taxable territory and goods were also delivered outside the taxable territory. The assessee only took orders from the merchants to purchase goods and that too assessee has no option to accept or reject the order.
  • Held that activity of assessee cannot be treated as that of agents of non residents and there was no “real” and “intimate” connection between assessee and non-resident which is essential to establish a business connection, therefore in the present case assessee could not be taxed in the taxable territory.
  • Volkswagen Finance Private Limited v. Income Tax Officer International Taxation Ward, Mumbai[22] : An event for launch of Audi A8L facelift model was held in Dubai, organized in Dubai by assessee and Audi India, a division of Volkswagen Group Sales India Ltd. The event was organized to launch the above model of Audi in India and Kim Productions Inc, a corporation formed in the United States, agreed to facilitate the appearance of Nicholas Cage (hereafter referred to as ‘celebrity’) for three hours at the event in Dubai. The assessee contributed US $ 4,40,000 in addition to other costs for the appearance of the celebrity at the event. The Assessing Officer was of the opinion that this payment made to the celebrity is taxable in India, as royalty under section 9(1)(vi) of the Income Tax Act, 1961 and Article 12 of the India USA DTAA.[23]  On appeal, CIT(A) upheld the Order. The issue whether business connection is there in the present case and further the tax can be levied upon this payment in India came before ITAT.
  • ITAT observed that though event was organized in Dubai, but beyond any dispute or controversy, the benefits of this event were to accrue to the assessee and Audi India.
  • ITAT further observed that expenses, have been incurred “wholly and exclusively for the purposes of business” of the assessee, which is in India.
  • Held that there is business connection between the assessee and non-resident. Therefore held that the income embedded in payment to the celebrity for participation in the event is taxable in India.
  • Formula One World Championship Limited v. Commissioner of Income Tax, International Taxation[24] : Jaypee Sports International Ltd. (Jaypee) was interested in acquiring the rights to host, stage, and promote the Indian F-1 Grand Prix. 51 As a result, on September 13, 2011, Jaypee and Formula One World Championship (FOWC) signed a Race Promotion Contract (RPC). Under the RPC, FOWC granted Jaypee the rights to host, stage, and promote the F-1 Grand Prix of India in exchange for a payment of $40 million USD. As a result, in 2011, 2012, and 2013, F-1 races were held in India. The Supreme Court had to decide whether FOWC was a “permanent establishment” under Article 5 of the India-UK Double Taxation Avoidance Agreement (DTAA) and, as a result, whether Jaypee’s payment to FOWC was taxable in India.
  • The Supreme Court observed that the Budh International Circuit was used to conduct the F-1 Grand Prix and FOWC has complete and exclusive access to Budh International Circuit and it is not merely a place of business but a “fixed place of business”.
  • Further observed that Jaypees right to host, stage and promote the event was no independent and were subject to control by FOWC.
  • Held that Budh International Circuit was the permanent establishment of the FOWC, therefore income generated by FOWC is liable to tax under Income Tax Act, 1961.
  • Director of Income Tax v. E-Funds IT Solution Inc.[25] : In this case, an Indian firm whose complete shareholdings were held both directly and indirectly by two foreign entities. The assignments were carried out by the Indian business, which was a 100 percent subsidiary of the foreign companies. The factual matrix stated that the Indian company was subjected to taxation on both domestic and international income in compliance with the Act’s requirements. The issue was that the two foreign corporations were also charged with tax in India for income attributable to India because they had a permanent establishment in the country. Customers outside of India were receiving various forms of management and support services from the surveyed US enterprises. Their Indian subsidiary company provided support services, allowing assessees to provide services to clients in other countries.
  • The court held that In terms of service PE, article 5(2)(1) of the DTAA[26] stipulates that an organisation must provide services within India and that such services be provided by employees or other individuals. The first ingredient of article 5(2)(1) was not satisfied because no customers of assessee were located in India or had received any services in India, merely because auxiliary operations that facilitated such services were carried out in India.
  • On the role of deputed employees, the Apex Court took note of the High Court’s findings that the employees were deputed to help promote domestic work in India. The deputed employees were working under the control and supervision of E-funds India and their remuneration was borne by E-funds India only. Based on the foregoing, the Apex Court agreed with the taxpayers’ assertions that they had not established a Service PE in India.

Conclusion

With the advancement in technology the business world has gradually transferred to “all clicks model” but the changes in taxation laws is not at par with the advancement of technology. OECD and UN model of taxation has gradually contributed to provide uniformity in online tax principles and have led benchmark for countries  across the globe to lay down taxation principles as per these models. In India the concept of “Business Connection”  has been introduced where a link is identified between the non-resident and its business in India and is taxed accordingly, subject to provision under Section 9 of the Income Tax Act, 1961. Concept of “Permanent Establishment” has also seen significant development in India since past two decades and also non residents not having PE in India are taxed under the head of equalization levy. Significant economic Presence and equalization levy has recently been introduced to tax digital entities in India. The growth of these concepts in ever  changing technological world is very important and addition of new concepts and definition are obvious in these changing times. The introduction to these concepts where an entity is taxed in India despite of having a residence outside India has welcomed a plethora of litigation and in coming years this will lead to development of existing laws and introduction of various new amendments in Income Tax and Finance Act.

[1] Available at www.wto.org

[2] Vakul Sharma : Information Technology Law and Practice, 7th Edn

[3] Dr Karnika Seth: Computers, Internet and New Technology Laws, 3rd Edn

[4] Assaf Harpaz: Taxation of the Digital Economy: Adapting a Twentieth-Century Tax System to a Twenty-First-Century Economy.

[5] The concept of PE will be dealt in detail in later part of the assignment.

[6] Supra Note 4.

[7] See Section 6(3) of Income Tax Act, 1961.

[8] See OECD Model Tax Convention on Income and on Capital

[9] Income Tax Act, 1961

[10] See Section 9(1)(i) of the Income Tax Act, 1962, added by the Finance Act, 2020 w.e.f April 01, 2022.

[11] See Section 9(1), Explanation 2 of the Income Tax Act, 1961

[12] See Supra 8.

[13] See provided further to Section 9(1), Explanation 2 of the Income Tax Act, 1961.

[14] Income Tax Act, 1961.

[15] See Central Board of Direct Taxes. Notification No. 41 dated 3 May 2021.

[16] Kanwaljit Singh Committee

[17] The OECD Model Treaty defines “permanent establishment” as “a fixed place of business through which the business of an enterprise is wholly or partly carried on” [Article 5(1)].

[18] See Income Tax Act, 1961.

[19] Ibid.

[20] Refer to Chapter VIII(section 165-180)

[21] (1965) 56 ITR 20 (SC)

[22] 2020 SCC Online IAT 132

[23] USA-India Double Taxation Avoidance Agreement

[24] Delhi & Anr. (2017) 15 SCC 602

[25] (2018) 13 SCC 294

[26] Double Tax Avoidance Agreement.

Author Bio


My Published Posts

DTAAs with special reference to DTAA between India and Singapore View More Published Posts

Join Taxguru’s Network for Latest updates on Income Tax, GST, Company Law, Corporate Laws and other related subjects.

6 Comments

Leave a Comment

Your email address will not be published. Required fields are marked *

Search Post by Date
April 2024
M T W T F S S
1234567
891011121314
15161718192021
22232425262728
2930