Covid has altered the realities of consumption and commerce. Unilateral taxation measures by some countries has accelerated the need for a global consensus
By TV Mohandas Pai & S Krishnan
The adoption of contactless technologies during Covid-19 is helping reduce health risks associated with activities that otherwise require person-to-person interactions. More consumers are now ordering online. Many companies, particularly in the services industry, have adopted work-from-home practices. Schools, colleges and coaching centres have switched to online. Professional bodies are using webinars and video conferences. These users of digital medium in India have expressed intent to continue to use these in the future.
Covid-19 has had a debilitating effect on the global economy. Consumption and income generation activities witnessed a steep fall. To mitigate this, most countries provided fiscal stimulus to increase liquidity in the economy. Several tax compliance and collection relaxations were offered that have further eroded revenue from taxes. Though the world is gearing up to embrace the ‘new normal’, economic growth will witness a slow recovery, at best. The economic environment has put pressure on governments to explore new sources of tax revenue.
With digital business becoming a viable proposition, the taxation of profits of digital enterprises operating within India will not be a challenge.
The challenge remains on how to apportion global profits from digital business in different countries where MNEs conduct their business. In the digital economy, value is often created from a combination of algorithms, user data, sales functions and knowledge. For example, a user contributes to value creation by sharing his/her preferences (e.g. liking a page) on a social media forum. This data is later used and monetised for targeted advertising. Under current international taxation norms, taxation rights are attributed to the location where the significant functions are performed, assets are used and the risks are undertaken. The profits are not necessarily taxed in the country of the user (and viewer of the advert), but in the country where advertising algorithms have been developed. This means the user contribution to profits is not considered when the company is taxed in a particular jurisdiction. It is reported that, on average, digitalised businesses have an effective tax rate of 9.5%, compared to 23.2% for traditional business models. There is a global consensus that the traditional definition of PE needs to be relooked and revised in accordance with the growing tech developments in the economy.
The June 2020 BMR Legal Advocates and Vidhi Centre for Legal Policy report ‘Removing Roadblocks in Taxing Business Income in the Digital Era, Building global consensus for an equitable solution’ analyses the evolution of digital business and how international taxation principles applicable to brick-and-mortar companies are not suited to tax digital business. It explains the guiding principles of tax policy, the concept and various forms of PE, how tax is imposed on income generated by MNEs from multiple countries and how this fails when tech developments allow digital businesses to cater to markets remotely with either no physical presence, or with one that only provides support functions. This report also examines the OECD proposals to tax digital business, shortcomings of those proposals, and India’s response. It does not examine the proposals of the European Commission (EC) on taxing digital business. Many EU countries have adopted different versions of this proposal.
The EC in September 2017 acknowledged the challenge of ensuring fair taxation of digital economy, but it still has not been adequately addressed, due to lack of global consensus and multidimensional nature of the challenge. In March 2018, it proposed new rules to ensure that digital business activities are taxed in a fair and growth-friendly way in the EU. Under proposed rules, a company will be considered to have a significant digital presence in a Member State if it fills one of the following criteria:
It exceeds a threshold of €7 million in annual revenues from digital services in a Member State;
It has more than 100,000 users who access its digital services in a Member State in a taxable year;
Over 3,000 business contracts for digital services are created between the company and business users in a taxable year.
This reform addresses two of the main problems that EU Member States encounter when it comes to taxing digital activities:
First, it will no longer be necessary for a company to be physically present in a Member State for it to be taxed. A significant digital presence will allow Member States to tax profits generated in their territory;
Second, factors such as user data will be taken into account in the allocation of profits, since they play an important role in companies’ value creation. The new proposal changes the system for allocating taxable profits, to better reflect the ways in which digital companies create value.
The EC also proposed an interim digital tax of 3% to be effective from January 2020 on revenues made from three types of services such as sale of online advertising space, sale of data generated from user-provided information and creating online marketplaces that allow users to interact with other users and facilitate the sale of goods and services between them. Tax revenues would be collected by the EU Member States where the users are located, and will only apply to companies with total annual worldwide revenues of €750 million and EU revenues of €50 million. The digital tax is being imposed on gross revenues from specified services at a low rate, which is a departure from the prevailing principles of taxing net income at a higher rate.
In response to the deadlock at the OECD and the EU regarding digital tax, several EU countries have either announced, proposed or implemented a digital services tax (DST) on selected gross revenue streams of large digital companies. This has served two purposes: allocating an appropriate share of tax revenues from digital services to a destination country and reducing tax inequality between domestic and digital business models.
Austria, France, Hungary, Italy, Poland, Turkey and the UK have implemented DST. Belgium, Norway, Czech Republic, Slovakia and Spain propose to enact DST. The proposed and implemented DSTs largely follow the EC proposal but differ in their structure and rates. For example, while Austria and Hungary only tax revenues from online advertising, France’s tax base is broader, including revenues from the provision of a digital interface, targeted advertising, and the transmission of data collected about users for advertising purposes. Tax rates range from 2% in the UK to 7.5% in Hungary. The equalisation levy imposed in India is a similar levy.
For the first time, an international tax issue has resulted in the possibility of trade sanctions. The USTR announced investigations into DST policies in nine countries and the EU. The policies targeted by the USTR include some that have been implemented (in Austria, India, Indonesia, Italy, Turkey and the UK) as well as some that are proposals (in Brazil, the EU, Czech Republic and Spain). The USTR previously initiated an investigation regarding DST enacted in France, and additional tariffs were proposed by the US but not implemented. France, the UK, Italy and Spain have offered to limit the scope of their proposed digital tax to only automated digital service companies.
The global economy is witnessing an unprecedented slowdown and there is a need to focus on revenue collection. The absence of a broad consensus on a mechanism to tax the digital economy could reduce tax certainty and undermine the relevance and sustainability of the global tax framework. It is imperative to continue negotiations. The implementation of unilateral measures has accelerated the debate on digital taxation and the need for global consensus on the matter. Consumer behaviour has changed, mostly permanent, leading to massive shift to digital business. Hence taxing digital business to prevent loss of revenue is imperative. No longer can it be beyond taxation nor can economies accept tax strategies to prevent tax on digital business because of legal infirmities.
Pai is chairman, Aarin Capital Partners; Krishnan is an international tax consultant