Digital technology has changed the way we live, work and do business. Today, the number of internet users is close to 3.7 billion, and is growing exponentially every minute. Therefore, it is not surprising that five out of the top 10 companies in the US are tech companies. These enterprises have not only disrupted the way we consume information and buy goods and services, but their business models have also disrupted debate and discussion in the tax and transfer-pricing world, and are challenging the traditional principles of taxation established over decades. Traditional taxation was based on the notion that any value creation is manifested by the physical presence of people, establishments, factories, offices, etc. Accordingly, companies were taxed based on the determination of the value created by their presence in different countries. In a multi-country business model, such physical presence was the basis of split of tax revenues among various countries. These principles are obviously inadequate in the digital world, where a few people in a remote location could be running large virtual businesses in India without a physical presence in the country. This led to a global debate that multinational enterprises with a wide access to markets, but without a significant physical presence in these, were not paying their ‘fair share’ of taxes in the jurisdictions in which they generated profits, or where the bulk of their users resided.
India has been at the forefront of this debate, and has set the ball rolling by introducing the concept of ‘significant economic presence’ in the recent budget. It has proposed that foreign enterprises should be taxed in India if they breach specified thresholds of revenue or number of users in India, even if they do not have a physical presence in the country. India wants a public debate on what the thresholds should be, before the law comes into effect. The fundamental question at the heart of this debate is ‘where is the value created?’ Some people would argue that having access to a volume of raw data or number of users does not create value; the value driver in a digital business is its use of advanced computing technologies and complex algorithms that process and analyse a large amount of data. Such technology is the result of significant effort and investment-related risk. However, even if some value was to be attributed to the market and access to raw data, it would be insignificant compared to the value derived from technology.
Further, many businesses in the technology space sustain losses for years before they achieve a sustainable market share. Therefore, depending on the facts, while a business enterprise might have a ‘significant economic presence’ in India, it might lead to a situation of attribution of losses to India. The other challenge is that India can tax the value derived from access to the market and data, but only if the home country of a digital enterprise agrees to the split under its tax treaty with India. The US, home to Silicon Valley and the largest technology driver in the world, has clearly spelt out its intention of opposing any such move around the world. If it does not agree once again, India’s proposal will not yield any meaningful revenues, unless it decides to undermine its bilaterally agreed treaty with the US. This can be risky in today’s globalised world, where the US can retaliate and create tax risks for Indian companies operating in the US. Furthermore, if treaty partners do not agree to a split, and a country still wants to tax a portion of the profits generated, this could lead to double taxation in both the countries.
Consequently, the evolution of a global consensus on taxation of digital companies is critical for enterprises being able to avoid the issues above, which could stifle the growth of the sunrise sector in India. James Surowiecki, an American journalist, once said that while technology has made our lives easier, it often seems to make things harder, leaving us with a fifty-button remote control or cars with dashboard systems worthy of a space shuttle. And while, no doubt, digital technology has transformed our lives, policymakers need to engage with relevant stakeholders and ensure that rules on taxing ‘significant economic presence’ do not end up like the fifty-button remote control!
By Jitendra Jain
Executive director,–tax & regulatory, PwC India. Views are personal.