Budget 2018: While tax administrators complain that traditional factors are no longer sufficient, taxpayers believe that the sanctity of these time-tested factors cannot be disturbed.
Budget 2018: Over the last few years, there has been talk of how international tax rules have not kept pace with the digital economy, allegedly allowing large MNCs to organise their global operations in a manner that minimises tax payouts. While tax administrators complain that traditional factors are no longer sufficient, taxpayers believe that the sanctity of these time-tested factors cannot be disturbed. Countries have so far resorted to largely unilateral measures (for example, passing domestic legislation with renegotiating bilateral tax treaties). The UK enacted the diverted profits tax of 25% targeting non-UK companies seeking to avoid doing business through a permanent establishment (PE) in the UK. Italy is proposing to impose a ‘web tax’, a withholding tax by introducing a threshold of revenues and costs for digital businesses. In Budget FY17, India was quick to adopt the ‘equalisation levy’ model under which 6% tax was levied on foreign online advertising service providers. With a subsequent report suggesting expanding number of services to be covered under equalisation levy, the Budget FY19 announcement, proposing to expand the definition of ‘business connection’ (akin to PE under the Indian tax law) came as a surprise.
According to the proposal, any transaction undertaken by foreign entities in India (even if such entities have no physical presence in India or services are rendered outside the country) would be taxable to the extent of attributable income. Situations where overseas entities digitally interact with customers/users would also be taxable. However, this may pose its own challenges in implementation due to varying business needs and models. For instance, where a foreign enterprise generates revenues from transactions with Indian customers concluded electronically through a localised digital platform—where the customer is required to create a personalised account and utilise local payment options offered on site to execute a purchase—tax authorities could consider this to be a factor evidencing significant economic presence (SEP) with India. In contrast, it would be more difficult to find such a link where revenues are generated by foreign enterprises from transactions with Indian customers through in-person negotiation taking place outside of India, and the enterprise only maintains a passive website that provides product information with no functionalities permitting transactions or interaction with users.
These provisions are wide enough to cover foreign software/data service providers. It will be interesting to see how this interplays with tax provisions relating to royalty taxed at 10% on gross basis, as there are various cases earlier where tax authorities have sought to tax them as royalty. The Budget proposals also seek to include within SEP those transactions that involveinteraction with a prescribed number of users in India through digital means. The focus here seems to be on the origin of data, irrespective of where this data is stored and processed. This may potentially cover personal data, as also user-created content, product reviews, etc. Businesses may not necessarily maintain separate and comprehensive track records of the data collected on a country-by-country basis. In addition, the volume of data from users in a country may not necessarily reflect an effective contribution to profits generated as the value of raw data is rather uncertain and particularly volatile.
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Traditional rules of profit attribution may need to be revisited based on new rules of SEP and this may be in the form of ‘deemed profit method’ based on presumptive profits, based on the number of users in India. Undoubtedly, political pressures have been driving the discourse on taxation of digital economy transactions. India introducing equalisation levy, and thereafter proposing a virtual/digital PE, seems to be disjointed. Additionally, its incompatibility with Digital India as dilutes the pro-investor stand that this government is aiming for. The government can be lauded on announcing that value-based and user-based thresholds for digital/virtual PE would be framed after consultation with stakeholders, and bilateral treaty negotiations would be conducted, but there is uncertainty on whether equalisation levy would be eventually phased out. Clarity towards this end would have gone a long way, allaying fears of potential litigation and preventing a potential ‘log off’.
Partner and COO-Tax, KPMG in India