‘Digital economy’ is based on computing technologies, and constitutes of various evolving business models such as e-commerce, online advertising, app stores, online payments modes and social media.
Essentially, digital economy involves goods and services, which are digital (e-books and music, for instance), transacted online, processed automatically and, now-a-days, paid for using e-wallets. Sounds familiar? Not surprising, considering India is one of the fastest growing e-commerce markets in the world, home to some big players such as Flipkart, Paytm and Snapdeal.
So what makes this model successful? There are a number of reasons, including advanced, evolving, inexpensive and accessible connectivity and technology solutions, which are the main enablers for the global success of this industry. Increasing popularity of digital economy, challenging international physical borders and outpacing the principles of traditional economy too add to its success.
Taxing the digital world
Consider an e-commerce giant, headquartered abroad and operating e-commerce websites across countries, including India.
In India, this e-commerce firm interacts with sellers and consumers digitally — over e-mails, website and other means — without maintaining any physical presence.
Now, an Indian trader enters into an agreement with the company for advertising his products on the site, as a measure to boost sales.
As per the domestic tax laws and tax treaties, the advertisement and sales facilitation revenue earned by the foreign e-commerce company may not be subject to tax in India, as it does not have any physical presence here. This, therefore, would result in a loss of tax revenue for the Indian government.
Paradigm shift
Now, imagine that this e-commerce company routes its transactions through a low-tax jurisdiction, i.e. where the corporate tax rate is low or nil, when compared with other jurisdictions.
This would result in double non-taxation, as income is neither taxable in the source country, nor in the country of residence!
The tax policies currently in place are essentially crafted for the traditional economy. Therefore, it is apparent that when these existing global tax policies are applied to the digital economy, it may lead to non-taxation of income; i.e. base shifting and jurisdictional arbitrage, or, in simple words, profit shifting.
In view of the increasing role of ‘digital economy’ globally, a paradigm shift in the international tax policies is the need of the hour. This would bring equilibrium on the tax front and empower nations to collect their legitimate share of taxes.
BEPS action plan 1: New international tax practices for the Digital Economy
The Organisation for Economic Co-operation and Development (OECD), an international economic organisation, has sought to address these tax challenges (of the digital economy) in its Action Plan 1 of the final reports on ‘Base Erosion and Profit Shifting’ (BEPS).
The reason OECD sought to address these issues was to respond to the growing concerns raised by political leaders, media outlets and civil society around the world about tax planning by multinational enterprises. These companies make use of gaps in current tax laws to artificially reduce their liabilities.
BEPS Action Plan 1 identifies and analyses various tax models in relation to transactions in the digital economy, such as modification to ‘Permanent Establishment’ (PE) related rules to include significant economic presence, and withholding tax on digital transactions and equalisation levy — similar to withholding taxes.
India adopts equalisation levy
In India, the Central Board of Direct Taxes (CBDT) had constituted a ‘Committee for taxation of e-commerce transactions’ to suggest the appropriate mechanism for the same purpose — to tax e-commerce transactions.
The committee, in cognition with BEPS’ action plan, suggested adopting a new code: ‘equalisation levy’. This is separate from the domestic income tax provisions. It was consequently announced in the Union Budget 2016 and made applicable from June 1, 2016.
Levy deduction
In adopting these new equalisation levy rules, India joins the ranks of countries such as United Kingdom, Italy, Australia and Brazil, who have also introduced taxes on digital transactions.
As per this new code, an Indian tax resident will have to deduct 6 per cent on payments made to a non-resident, in relation to online advertisements and related services. This is subject to a prescribed threshold of ₹100,000.
It further prescribes that the scope of this levy can be expanded to any service/ transaction, as may be further notified by the CBDT.
Therefore, in our earlier example, the Indian tax resident would now be required to deduct 6 per cent levy on the advertisement fee paid to the foreign e-commerce company.
The way forward
The digital economy is an evolving one. It is therefore imperative that international tax practices keep pace with these developments to ensure that the tax policies are at par with the transactions in the digital economy.
In India, introduction of equalisation levy as a tax on online advertisement is the first step towards taxation of the digital economy. It is expected that the ambit of these rules will expand to include other online / electronic transactions.
In order to develop a rational tax regime for digital economy in India, it is imperative that the scope of equalisation levy be expanded strategically, so that it ensures transparency in reporting digital transactions, curbs tax revenue loss to the Government and, at the same time, does not impose unwarranted tax compliance burden on corporates.