Tax-policy makers and implementers globally are increasingly realising that conventional tax concepts framed to cater to the traditional economy are not suited to the evolving business models in the digital economy, resulting in leakage of desired tax revenues. Adding fuel to the fire is the perceived abusive tax planning by MNCs. This has led to a need to check practices involving shifting profits to low tax jurisdictions and thus, eroding the tax base of a nation, commonly referred to as Base Erosion and Profit Shifting (BEPS). To check BEPS in the digital economy, the Organization for Economic Cooperation and Development (OECD) has released a discussion draft on March 24 which identifies and seeks to address tax challenges in the digital economy landscape.
The OECD report highlights the wide gap between the traditional tax rules and the manner in which business is conducted in the digital economy, as the current tax laws are focused primarily on physical presence by the non-resident seller/service provider or through agents while such factors are inconsequential in the digital economy. To illustrate, in the digital economy, delivery of services in India, for instance streaming of video content or provision of online platforms, can be easily done from overseas without necessitating any part of the activity being performed or any employees being hired in India, thereby avoiding a taxable presence in India although significant revenues are earned from customers in India. This is aggravated by the fact that organisations providing such services from overseas may use an entity based in a low-tax jurisdiction to earn the primary revenues from such activities and accumulate income there. Another aspect that merits attention is the inability of authorities to levy consumption taxes, primarily VAT, on a large volume of low value transactions taking place over the internet from remote locations. Further, given that transactions take place in a virtual environment with very little tangible presence, the characterisation of the transactions and thus, resultant tax implications are currently matter of litigation globally, and more so in India.
The OECD report proposes modification of current rules on taxable presence to suit the digital economy, which include a new concept of significant digital presence in another country and a virtual taxable presence. Alternatively, a more simplistic approach propounded is to levy a withholding tax on payments made in the digital economy (generally via internet banking, credit/debit cards). Since it would be impractical to impose such obligation on individual retail customers, it is suggested that the obligation fall upon the intermediary financial institutions that process these payments. The report further recognises that, based on past experience, the most effective and viable option with regard to consumption taxes is to mandate non-resident suppliers of goods and services to seek registration in the market jurisdiction and pay taxes due therein. While this would naturally increase the compliance woes of large e-commerce companies and that too in multiple countries, the report urges countries to formulate a simplified, online registration and compliance process to encourage adherence by organisations.
Countries have had divided views on whether digital economy needs to be ring-fenced and separate tax rules laid down for it. The OECD report indicates that this may not be a favourable and practical approach, as the digital economy does not work in isolation; rather every business in todays world integrates some aspects of the digital economy and there may be businesses which are a seamless blend of the digital economy and traditional economy. This approach may not entirely work, for instance, where an entity takes orders for goods online but actually supplies them physically from warehouses located in the market jurisdiction. A perspective to note and as also acknowledged in the report is that the BEPS predicament can potentially be tackled by better implementation of the current taxation framework itself and anti-abuse rules which are gaining popularity, such as concepts of prevention of treaty abuse, beneficial ownership criteria, taxation of controlled foreign companies, effective implementation of transfer pricing rules. Thus, a need for ring-fenced rules for this industry may not be warranted.
While the initiatives and improvised tax rules may address the tax issues quite comprehensively, the problem lies in the ability of countries to come together and renegotiate tax treaties entered into years ago. With the advent of an economy which operates without boundaries and also virtually, there is a strong need for nations to respect and apply tax concepts in a unified and coherent mannera consensus needs to be reached between the residence-based concept propounded by developed nations and source-based taxation practised by developing nations as well as in the apportionment of value arising from the business between the various countries involved. Supplementing the above measures with a stable tax environment, which assures MNCs of paying only a fair share of tax on a global basis and not fear double or multiple taxation, is the need of the hour.
With inputs from Anubha Mehra, associate director, BMR & Associates LLP
The author is partner, BMR & Associates LLP. Views are personal