Digital Economy: The dust has to settle down

The increasing trend and demand of online facilities shows that future of the world revolves around digitisation. Be it a household activity or business operations, every activity has been automated. In the business world, surfacing of e-commerce operators (primarily foreign based) is one of prominent development in digital economy. The development of digital economy, however, has raised concerns for tax officials of various countries. It has been seen that internet and tech companies are operating their business across globe without having any physical presence in countries other than their country of residence. Digital Companies are making revenue from the customer base of many countries without paying taxes in those countries. This issue has gained gravity and Government of the countries, including India, are acting pro-active in introducing appropriate measures.

In 2015, the OECD (Organisation for Economic Co-operation and Development) published 15 Action Plan wherein each plan outlines a tax issue faced at international level and recommend instruments/measures to address such tax issues, with an intent that profits are taxed where economic activities generating the profits are performed and where value is created. Action Plan 1 talks about the issues of taxation in digital economy which inter alia enlists the issue of taxability of technology and digital companies in source country having no territorial nexus. The Action Plan also suggests various measures to address these issues. The prominent and actively adopted measure includes-

The issue has been discussed time and again amongst the countries at various forums, committees were constituted dedicatedly work on the issue, but no consensus has been reached yet. The developing countries are actively adopting these measures so as to fill the gap created due to non-taxation of these companies in source country. The Government of India has been a frontrunner in the league by making unilateral amendments to the Income-tax Act.

While Government of India was in the process of perceiving the manner to constitute permanent establishment of digital companies in India, equalisation levy (i.e. Digital Service Tax) was introduced in India as an immediate measure to avoid interim tax loss. Equalisation levy was introduced in India in two phases i.e. w.e.f. 01.04.2016 and 01.04.2020 on the non-resident engaged into online advertisement, online sale of goods and services through digital platform. This is introduced as separate ‘levy’ which does not form part of Income-tax Act, 1961.The levy is not subjected to the beneficial provisions of the tax treaty as it is not a part of Income-tax Act, 1961.

Since the levy is inescapable, it invited strong resistance from Government of other countries especially the USA and the technology giants like Amazon, Google, Facebook, Microsoft, and Adobe. It was held that the levy is unreasonable, burdensome and discriminatory against the American Companies. An investigation was conducted by US Trade Act on the levy introduced by Indian Government and it was stated in their finding report that the digital services tax (DST) burdens or restricts US commerce by negatively impacting US companies’ operations in India. As per Press Release posted by the CBDT on 07the January 2021, the Government of India will examine the determination / decision notified by the U.S. and would take appropriate action keeping in view the overall interest of the nation.

Similar type of investigations were conducted by the USA on other countries as well who introduced Digital Service Tax (similar to equalisation levy) like Austria, France, Spain, Turkey, UK etc. Although the levy has been opposed by the Government of USA, it would be interesting to know that the country adopted an identical solution for the loss of tax revenue caused to them on account of digital businesses. The USA Government has made amendments to the relevant Chapter of domestic law which provides for ‘withholding tax on non-resident aliens and foreign entities’. The amendment had big impact on the Google-owned company, You tube and their international content creators. As per changed law, You-tube will deduct tax from the revenue generated by international content creators. This amendment is widely known as ‘Youtube policy’.

While Youtube policy was being debated, a tax discussion due to amendment in the IT (Information Technology) Rules has gained all the attention. It probably gives a direction to the Indian tax officials in constituting permanent establishment of digital tech companies in India. The new IT (Information Technology) Rules introduced in India are applicable w.e.f. 25.02.2021. These rules apply to the companies operating as social media intermediaries like Twitter, Google, Facebook, WhatsApp etc. The rules require social media intermediaries to follow higher due diligence standards in context with the data or information uploaded, published or shared by their users. The rules mandate these companies to appoint a Resident Grievance, Chief Compliance Officer and a Nodal Officer. These officers should be employee of social media intermediaries, and resident in India. The rules are designed with an intent to prevent abuse and misuse of platforms and offer users a robust forum for grievance redressal. Non-resident companies (being social media intermediaries) have shown their commitment to comply with the new IT rules. While many internet and technology based companies like Google, Facebook and WhatsApp, LinkedIn, Telegram have updated their websites to reflect appointment of the Chief Compliance Officer, Twitter on the other hand has delayed the compliance.

The compliance under new IT Rules give rise to a matter of litigation between the taxpayers and tax officials of India. One of the possible interpretation could be that appointment of chief compliance officer under the new IT Rules may constitute permanent establishment of the non-resident companies in India. While the other view could be that appointment of chief compliances officer is a compliance to be made by non-resident companies and there is no business rationale attached to it. It may be considered to be activities which are auxiliary in nature. Moreover, it is to be seen that whether any profits can be attributed under Article 7 to the activities carried out by the Chief Compliance Officer of these companies in India. There are possibilities that the tax department may resort to view that runs in its favour.

To summarise the present scenario, there are plethora of efforts being taken to address the issue of taxation of digital companies which are devoid of global consensus. While one side of the coin portrays the unilateral acts of the countries to enable their right of taxation, the other side shows the efforts put in at various international forums and the special committees constituted for this purpose.

The UN Committee of Experts already released their draft proposal in August 2020 (with revised draft on 18.04.2021) wherein a new Article 12B has been proposed to be added to the UN Model Tax Convention on Income from Automated Digital Services. The new Article gives an option to the company on whether to opt for the gross-based tax or the net income approach on income arising from automated digital services. The objective of proposed Article 12B is to appropriately allocate taxing rights and establish a viable method for the imposition of the tax.

The OECD also released Pillar 1 and Pillar 2 blueprints on the proposed solution to address the issue of taxation of digital economy. Pillar 1 is based on the premise to “adhere to the concept of net taxation of income, avoid double taxation, and be as simple and administrable as possible.”Pillar 2 would allow a “right to ‘tax back’ where other jurisdictions have not exercised their primary taxing rights, or the payment is otherwise subject to low levels of effective taxation,”.

In the latest statement in July 2021 from G20/OECD Inclusive Framework on BEPS some 130 countries (including India) have agreed to a global minimum tax to curb multinational firms from dodging taxes by shifting their profits to low tax jurisdictions. The agreement is an attempt to resolve the issue of taxation of increasingly digital world economy. A detailed implementation plan is expected to be finalised by October 2021.

It is clearly evident that the economies (developing as well as developed) and the expert committees are working hard to reach an acceptable solution. It is expected to see the dust settling down soon.