There is global consensus regarding the need for a comprehensive mechanism to tax cross-border transactions in the digital economy and OECD, the UN and the EU are working on a resolution.
By Vinti Agarwal and Vidushi Gupta
In the last few decades, business operations have seen a paradigm shift because of digitalisation. This has led to the development of new business models that depart from the traditional practices, and rely largely on technology. The unique features of businesses in this landscape pose significant challenges in taxing their income. While income tax laws impose levies based on the place of residence of taxpayers and/or their source of income, such laws were conceptualised with brick-and-mortar businesses in mind. Given that, in the digital economy, these conventional concepts are blurred, businesses have opportunities to circumvent tax laws, and set operations to minimise tax liability.
Since most cross-border transactions are governed by Double Taxation Avoidance Agreements (DTAAs) that override domestic laws, there isn’t much that countries can unilaterally do to bring these digital businesses under their tax net. There is global consensus regarding the need for a comprehensive mechanism to tax cross-border transactions in the digital economy and OECD, the UN and the EU are working on a resolution. The Centre amended the Income Tax Act in 2018, and introduced the concept of ‘Significant economic presence’ (‘SEP’) which is effective from April 1, 2019.
The Indian income tax framework currently taxes income that accrues or arises through a business connection in India. The amendment widens the scope of ‘business connection’ and includes SEP within its ambit. SEP has been defined as:
Transactions in respect of goods, services or property carried out by non-resident in India including the provision of download of data or software in India, if aggregate payments from such transactions during previous year exceeds such amount as may be prescribed; or
Systematic and continuous soliciting of business activities or engaging in interaction with such number of users as may be prescribed.
An amendment to the domestic law of a country will not have an impact on DTAAs as the latter override the former. However, if the amendment in question is, indeed, made applicable from April 1, 2019, its application will be limited to countries with which India does not have DTAAs viz. the Bahamas and Hong Kong.
India attempting to tackle the problem of taxing the digital economy is a welcome step, but the implementation of the SEP provision, in its current form, will create more problems.
A primary concern is the absence of rules, or other supplementary guidance to help interpret the provisions and define its scope. It is relevant to note that income tax can be levied in India on the transactions mentioned in the first part of the definition only if the non-resident provider generates a certain revenue. However, there is no such corresponding revenue requirement under the second part.
Despite its deviation from the OECD’s suggestion, the sheer scope of the definition may not have been such a concern, had it been supplemented with guidance on the interpretation of crucial phrases such as ‘systematic, continuous soliciting’, and ‘users’. While the introduction of an exhaustive definition, or a straitjacket formula could be difficult, given the dynamic nature of businesses in the digital economy, at least an illustrative list of activities that the government seeks to include within this definition is imperative. Without any indication as to the intention with which these amendments are introduced, they would not satisfy the intended purpose and would lead to potential taxpayer harassment and litigation. ‘User’ is a crucial concept, and its interpretation would result in the inclusion of fresh businesses in the tax net. However, there are no guidelines regarding the level of engagement at which one would qualify as a user. For instance, would merely visiting the website once qualify one as a user, or would one have to click on certain links to fall within its ambit? It is relevant to note that the government had invited comments as well as suggestions from stakeholders on the revenue threshold and the user threshold. However, comments on the scope and interpretation of the provision were not sought.
Lastly, the provision states that only that income that is attributable to the transactions or activities constituting significant economic presence will be said to be deemed to accrue or arise in India. However, no mechanism has been devised for attribution of profit. Before the provision becomes effective, rules must be framed for its effective enforcement.
In order to facilitate compliance, and enable a smooth transition for businesses, the SEP provision should be made effective only after investing sufficient thought into its nuances.
Research Fellows (Tax Law Vertical), Vidhi Centre for Legal Policy (Views are personal)