In the recent past, international tax law principles have come under greater scrutiny for failing to maintain pace with developments in the field of technology. The laws envisage that a business deriving income from cross-border transactions is chargeable to income tax in the country where such business’ residence is located. The concept of residence, in turn, is based on the traditional understanding of physical presence applicable to brick-and-mortar models. It fails to account for the developments in technology that allow businesses to cater to market jurisdictions remotely. As a result, many businesses book massive gains by digitally servicing large markets without contributing tax revenue in the market jurisdiction, which has perplexed tax administrations.
Altering the existing principles of international tax to devise a fair and equitable regime to tax such businesses has become an important international debate. Owing to size of Indian market and high internet penetration rate, many businesses in the digitised economy see a huge untapped potential. This has placed India at the forefront of global debate. We aim to decode India’s stand on the issue.
The tax challenges of digitalisation of the economy first got traction when they were identified as one of the main areas of focus of the Base Erosion and Profit Shifting (BEPS) Action Plan, leading to the 2015 BEPS Action 1 Report. The report acknowledged the need for global consensus on the issue, but failed to provide any conclusive recommendations and issued some interim recommendations, leaving countries to “choose and opt” interim measures as they deem appropriate, given that tax levies are sovereign subjects. It did, however, point out that the options were an interim solution while negotiations for consensus remain pending. The first of these steps was the development of a new nexus based on the concept of “significant economic presence” (SEP) rather than “physical presence”. The second was the imposition of a withholding tax and the third step discussed in the report was the introduction of equalisation levy.
The Ministry of Finance constituted a Committee on Taxation of E-commerce to devise a way forward for India which suggested the introduction of equalisation levy imposed on the consideration received by non-residents for providing online advertisement services. This levy was made effective in 2016.
In 2018, the Income Tax Act, 1961, was amended to introduce the concept of SEP which was to come into effect from April 2019. The Indian income tax framework otherwise taxes income that accrues or arises through a “business connection” in India, a compact that has prevailed over a century in the tax code. The amendment widened the scope of “business connection” to include SEP, which was in turn defined to cover two activities — transactions in respect of goods, services or property carried out by non-residents in India where the aggregate payments from such transactions exceed a prescribed amount. In addition, “systematic and continuous” soliciting of business activities or engaging in interaction with a prescribed number of users, regardless of the receipt of any payment was also included within the scope of SEP. Notably, expanding the scope of India’s taxing rights in its domestic law has no effect, in the absence of a corresponding amendment to the Double Taxation Avoidance Agreements (DTAAs), which contain the concept of Permanent Establishment (PE), as a prerequisite for taxation, and a term similar to business connection. Though attempts to implement by announcing subordinate legislation by way of rules was made, its implementation, wisely so, has been consistently postponed. This was also to ward off criticism, if any, to override treaty principles. Most recently, the Finance Act, 2020, postponed it to April 2021.
At the same time, the Finance Act, 2020, also exponentially widened the scope of equalisation levy, which is now imposed on revenues of e-commerce operators from e-commerce supply of goods or services in a wide variety of circumstances. This levy has been widely criticised for potentially coming in friction with the constitutional mandate on Centre-state power and international trade laws. The US Trade Representative has initiated an investigation in relation to such levies imposed by several countries including India. As further retaliation, the US also reportedly backed out of international negotiations at the OECD, through a letter sent to certain European nations, though, US administrations actions are not solely targeting India.
Interestingly, the expansion in the scope of equalisation levy was made through an amendment to the Finance Bill, which, in its original form, had no mention of such a change. The timing of this change may shed some light on the rationale behind its unexpected and sudden introduction, amidst the Covid-19 outbreak and the virtual lockdown of the global economy. An outcry for tax revenues from digital businesses during this “boom period”, a label earned by such business, provided India a perfect justification to widen the levy. Further, the fact that unilateral measures have helped propel the development of global consensus in the past, might have also been a factor accounted for by the authorities.
It is arguable if the absence of proactive negotiations for consensus and the need to mobilise revenue to tackle the health crisis justify such a hasty and ad hoc policy shift. These levies do play a critical role in bringing the issue at hand into focus. Thus, its imposition if any, must be done in a legally justifiable fashion and should be underpinned by extensive stakeholder consultations and thorough cost-benefit analysis. The impact of such levies on investments in particular sectors and the entrepreneurial ecosystem must also be factored in. Further, their scope must be reasonable, certain, and non-discriminatory.
It is critical to recognise that stakeholders involved in achieving global consensus to tax the digital economy represent vastly different economies, with varying policy priorities. The ongoing health and economic crisis has further altered the economic and political circumstances surrounding these negotiations. The Vidhi Centre for Legal Policy and BMR Legal report “Removing Roadblocks in Taxing Business Income in the Digital Era” analyses the issue at length and provides actionable recommendations to tax the digital economy in a fair and equitable manner.
Butani is a founder and the managing partner at BMR Legal; Gupta leads the tax law vertical at the Vidhi Centre for Legal Policy