Expert Speak Details


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CA. Sudha G.Bhushan, Head of International Transaction Advisory Services, Taxpert Professionals


New ways of business giving rise to new ways of Taxation - Significant Economic Presence

Challenges pertaining to taxation of digital transactions

The evolution of business models in general, and the growth of the digital economy in particular, have resulted in non-resident companies operating in a market jurisdiction in a fundamentally different manner today than at the time international tax rules were designed. For a long time, nexus based on physical presence was used as a proxy to regular economic allegiance of a non-resident. However, with the advancement in information and communication technology (ICT) in the last few decades, new business models operating remotely through digital medium have emerged. For example, while a non-resident company has always been able to sell into a jurisdiction without a physical presence there, advances in ICT have dramatically expanded the scale at which such activity is now possible. In addition, traditionally for companies to expand opportunities in a market jurisdiction, a local physical presence in the form of manufacturing, marketing, and distribution was very often required. These in-country operations would have engaged operations such as procurement, inventory management, local marketing, branding and other activities that earned a local return subject to tax in the market country. Advances in business practices, coupled with advances in ICT and liberalisation of trade policy, have allowed businesses to centrally manage many functions that previously required local presence, rendering the traditional model of doing business in market economies obsolete. Under these new business models, the non-resident enterprises can carry on business and interact with customers in another country without having any physical presence in that country resulting in avoidance of taxation in the source country. Therefore, the existing nexus rule based on physical presence no longer holds good for taxation of business profits in source country. As a result, the rights of the source country to tax business profits that are derived from its economy are unfairly and unreasonably eroded.

In general terms, the main policy challenges raised by the digital medium/economy fall into three broad categories[1]:

 

• Nexus: The continual increase in the potential of digital technologies and the reduced need in many cases for extensive physical presence in order to carry on business, combined with the increasing role of network effects generated by customer interactions, can raise questions as to whether the current rules to determine nexus with a jurisdiction for tax purposes are appropriate.

 

• Data: The growth in sophistication of information technologies has permitted companies in the digital economy to gather and use information across borders to an unprecedented degree. This raises the issues of how to attribute value created from the generation of data through digital products and services, and of how to characterise for tax purposes a person or entity’s supply of data in a transaction, for example, as a free supply of a good, as a barter transaction, or some other way.

 

• Characterisation: The development of new digital products or means of delivering services creates uncertainties in relation to the proper characterisation of payments made in the context of new business models, particularly in relation to cloud computing.

Challenges pertaining to taxation of digital transactions has thus become a global phenomenon.

The need is felt world over to save the erosion of tax base arising out of these new business models.

OECD[2] issued 14 Action plans to combat the Base Erosion and Profit Shifting (“BEPS”). Action Plan 1 discusses the Tax Challenges arising out of Digital Economy and has analysed various potential options to address the challenges in the Digital Economy.

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The launch of BEPS Action Plan 1 has accelerated the pace at which global economies are adopting ways of taxing digital businesses. European Union (EU) proposes to establish a taxable nexus of a digital business based on revenue, number of users / contracts for digital services. Saudi Arabia has officially endorsed the Virtual Service PE concept. Effective from 1 Jan 2019 France introduced “Google Tax”. Italy proposes to impose a 3% 'Levy on Digital Transactions (LDT)' on services provided by the use of electronic networks or the internet. Hungary has introduced an Advertisement Tax that covers a broad range of transactions relating to advertising services, based on the destination of the advertisements and the location of the targeted audience. To some extent, this is similar to India's approach of levying Equalisation Levy on certain specified digital advertising transactions. Malaysia has amended its definition of royalty under its domestic tax provisions to include payment for "visual images or sounds" transmitted through Information and Communication technology. Israel Tax Authority have prescribed various illustrative ‘digital factors’ to constitute Significant Economic Presence for foreign e-commerce and online services companies that operate in Israel.

The OECD's Interim Report 2018, A Brief on the Tax Challenges Arising from Digitalisation states that global practices can be broadly divided into four approaches:


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The Indian Prespective

As seen above, globally, the countries are making amendment in their domestic laws to be in line with the Global Tax Practices and also to save their tax base. Going ahead with it, India also in its recent years has made varied amendments to be consistent with the Base Erosion Profit Shifting Plan of the OECD. Aligning the Indian tax laws with Action Plan 1 of the OECD-BEPS project, 'Equalisation Levy' was implemented in India in 2016, and a new economic based nexus in the form of a 'Significant Economic Presence (SEP)', was brought in India in 2018.

 

Significant Economic Presence

The Finance Act, 2018, had introduced the concept of ‘Significant Economic Presence’ (“SEP”) as digital advances have changed the way business is done, making it possible to deliver services without a physical presence in. SEP was introduced in the Income-Tax Act, 1961 from April 1, 2018. It expands the scope of income of a non-resident which accrues or arises in India that results in a ‘business connection’ in India for that non-resident. The resulting income, attributable to the SEP, is taxable in India.

In Section 9 of Income Tax Act,1961 (“the Act”) w.e.f. 1st April, 2019, the following explanation is inserted —

For the removal of doubts, it is hereby clarified that the significant economic presence of a non-resident in India shall constitute "business connection" in India and "significant economic presence" for this purpose, shall mean—

(a) transaction in respect of any goods, services or property carried out by a non-resident in India including provision of download of data or software in India, if the aggregate of payments arising from such transaction or transactions during the previous year exceeds such amount as may be prescribed; or

(b) systematic and continuous soliciting of business activities or engaging in interaction with such number of users as may be prescribed, in India through digital means:

Provided that the transactions or activities shall constitute significant economic presence in India, whether or not,—

(i) the agreement for such transactions or activities is entered in India; or

(ii) the non-resident has a residence or place of business in India; or

(iii) the non-resident renders services in India:

Provided further that only so much of income as is attributable to the transactions or activities referred to in clause (a) or clause (b) shall be deemed to accrue or arise in India.

While the Government is yet to notify the various aspects of implementation of SEP. It can be seen that the SEP covers all transactions in respect of goods, services or property, whether tangible or intangible, irrespective of the mode through which it is transacted. The scope of provisions includes transactions pertaining to provision of downloading of data or software.

One of the attribute of Digital economy is that it has given rise to completely new business models which earn via advertisements. One version of this model offers free or discounted digital content to users in exchange for requiring viewing of paid-for advertisements. Other models rely on providing advertising through mobile devices based on location or other factors. A third type concerns social media websites or platforms who typically build up a large online user community before monetising their captive audience through advertising opportunities.[3] The second parameter of SEP “systematic and continuous soliciting of business activities or engaging in interaction with such number of users as may be prescribed, in India through digital means” seeks to cover this type of purely digital transactions.

While it is rational step to save the tax base by the tax authorities and bring the tech companies to tax net there is lot of clouds that needs to be cleared for effective implementation of any of these anti abuse provisions. At the same time, the taxpayers should be mindful of the developments and take cognizance of the tax impact and related compliances.

 

About the Author:

Sudha is a qualified Chartered Accountant and a Company Secretary with more than a decade of experience in the Foreign Exchange Management Act, RBI, Transfer pricing and International taxation matters. She is a noted speaker and author.

 

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Disclaimer: Above expressed are the personal views of the author, and the publisher or the author disclaim all, and any liability and responsibility, to any person on any action taken on reliance of it.

 



[1] OECD/G20 Base Erosion and Profit Shifting Project. Action plan 1: Addressing the Tax Challenges of the Digital Economy

[2] OECD is Organisation for Economic Co-operation and Development (OECD).

 In response to the concern of base erosion and shifting of profits at the request of the G20, in July 2013 the OECD developed an Action Plan on Base Erosion and Profit Shifting (BEPS) (OECD, 2013) which identified 15 actions to address BEPS in a holistic manner.

[3] OECD/G20 Base Erosion and Profit Shifting Project. Action plan 1: Addressing the Tax Challenges of the Digital Economy

 


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