In India, much has already been discussed and debated on tax planning versus tax avoidance in the context of cross-border taxation. Tax morality, a further extension to this debate, has now been occupying centre-stage globally. Today, tax and the issue of paying your fair share is one of the most prominent areas being scrutinised by governments worldwide, the general public and the media. Just like corporate responsibility and environmental issues, significant brand damage can occur if there is a perception that a company’s tax affairs are overly aggressive or ‘unfair’.
Some of the biggest multinationals had to undergo governmental scrutiny in the US and the UK on account of tax morality principles. The premise of such scrutiny was that while the tax minimisation policies of these global companies were perfectly legal, it was felt that the tendency of these policies to lead to the shifting of profits offshore to low-tax countries did not live up to the ‘morality’ aspect. While one will have to wait to see the impact of these global developments on tax morality in India, quite a few cases have been caught up in the heat of tax controversies on tax avoidance.
The tax morality debate essentially centres on the proposition that besides being compliant with the letter of tax law, corporations should also pay their ‘fair’ share of tax as a moral responsibility. While this clearly dilutes the widely-accepted principle that a person could so arrange his affairs within the four walls of the law to minimise tax liability, the real challenges are the subjective questions posed by the tax morality proposition—what is ‘fair’, and how can one determine the standards of ‘fairness’ in the context of tax? Is it reasonable to expect businesses to second-guess public perception when considering the impact of their decisions? Wouldn’t it be better to remove this burden and instead have a tax framework which, if followed, would ensure that elements of subjectivity in tax morality would not be raised?
Considering that many of these global companies facing tax morality scrutiny carry out cross-border business in a traditional way, one imagines that such challenges will increase multi-fold in the digital economy, which enables companies to reach customers in a way that wasn’t possible in a traditional economy.
The activities in a digital economy are primarily intangible: enabling multinationals to carry out transactions cross-border without establishing any physical presence in the source jurisdiction. There is an unparalleled reliance on intangible assets and data (notably personal data) which poses difficulties in determining the country in which value-creation occurs. The digital business model gives rise to a scenario where, in a traditional sense, the consumer base may have no relationship to the place where the business is actually carried on, posing prominent questions like whether and where the transaction should be taxed, and which government has the right to collect taxes (if any) on the revenues or profits from such digital business.
In the light of existing international tax laws primarily developed to keep the traditional economy within our grasp, the companies operating in the digital economy could potentially face various challenges on tax base erosion, on the rationale of housing “headquarters” of digital companies as well as the IPRs in tax-efficient jurisdictions with favourable tax policies, etc. These issues and concerns have led to the G20 requesting that the OECD come up with an Action Plan on Base Erosion and Profit Shifting (BEPS Action Plan) in order to determine whether and to what extent it may be necessary to adapt the current taxation rules in order to take into account the specific features of the digital economy and to prevent BEPS. The aim of the BEPS Action Plan is to ensure that profits are equitably taxed in the jurisdiction where the economic activities which generate them are carried out. This is easier said than done, since there is an apparent gap in the operations of the digital economy and the applicable extant of international tax laws and rules.
Back home, the jury on whether a digital presence tantamount to engaging in business operations under the domestic tax laws or the Indian tax treaties is not out, and would require adjudication at the highest forum. Legislative manoeuvres like expansion of the scope of “royalty” provisions by the Finance Act, 2012, covering a wide range of technology transactions, indicates the increasing focus on addressing challenges posed by the digital economy. Aspects like India’s reservations on the OECD commentary regarding the existence of a Permanent Establishment in the context of e-commerce transactions indicates a challenging time for taxation in the digital economy and raises the question as to whether tax morality aspects would be tested in determining if the companies operating in the digital economy have discharged their ‘fair’ share of tax revenue!
Companies operating in the digital economy need to be cautious and prepared, given the significant increase in media and public debates on tax matters. All the signs suggest that we will continue to see increased pressure for greater transparency between taxpayers and tax authorities, and more disclosure by companies as to the amount of tax payments and where those taxes are actually being paid.
By Milan K Shah
(Assisted by Manisha Arora, assistant manager, Direct Tax, PwC India)
The author is associate director, Direct Tax, PwC India