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Rashmin Sanghvi & Associates

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E-Commerce International Taxation Possible Solutions


This Paper formed the basis of Panel discussions at

Foundation for International Taxation
12th International Taxation Conference

“E-Commerce International Taxation Possible Solutions”

Panel Discussion

1st December, 2006

Panellists :

1. Mr. B. M. Singh, Member, CBDT, India.

2. Ms. Carol Dunahoo, Ex Competent authority, IRS, USA, present partner, Baker & McKenzie LLP., USA.

3. Mr. Girish Dave, Director General, International Tax, India.

4. Mr. Nishith Desai, advocate; partner, Nishith Desai & Co.

5. CA Mr. V. N. Srinivasa Rao, Partner, E & Y.

6. CA Mr. Rashmin Sanghvi.


& some terms used in this paper.

Assessee : The person liable to tax. Outside India, instead of this term, the term “Tax Payer” is used.

COS Country of Source of Income.
COR Country of Residence of the Assessee.
COM Country of Market.
COP Country of Payment.
COC Country of Consumption.
DTA Double Tax Avoidance Agreement, Convention or Treaty.
FII Foreign Institutional Investor. (Mutual funds etc.)
FIT Foundation for International Taxation.
FIS Fees for Included Services.
FTS Fees for Technical Services.
IFA International Fiscal Association.
NR Non-Resident.
OECD Organisation for Economic Cooperation & Development.
PE Permanent Establishment.
TDS Tax Deduction at source. Deduction of Income-tax by the payer of the income. Even payment of purchase price is exposed to TDS liability. This is same as the term “With holding Tax”.

I.1 Issues for Debate :

1. Can the concept of PE be applied to E-Commerce! If not, what is the alternative!

2. Is Categorisation of Income correct concept for “taxing rights allocation amongst countries”! Or should we consider the “Source of Income” and allocate taxing rights according to the source!

3. Comments on Tax Base erosion.

4. Can we distinguish between: (i) Country of Consumption (COC) or the Country of Market (COM) on the one hand; and (ii) the Country of Source (COS) on the other hand!

5. Is it fair to say that – Country of Consumption does not get any right to tax non-resident assessee’s income! If it should get a right to tax the non-resident’s income; should it be for goods as well as services imported! If neutrality is maintained between goods & services, what happens to article (7)!

6. Can we say that the Country of Consumption should get full right to levy consumption tax (indirect tax) and no rights to levy the income –tax (direct tax)! Income tax may be levied by the Country of Source and the Country of Residence.

Please refer to OECD TAG reports :

(i) OECD Consumption tax TAG, report on: Implementation issues for Taxation of E Commerce: 1st August, 2003.

(ii) “Are The Current Treaty Rules For Taxing Business Profits Appropriate For E-Commerce?” Dec., 2005.

7. What is the final solution which the taxing officer can adopt in making assessments & the Appellate authorities can adopt for passing appellate orders! You may assume that necessary modifications in the draft model convention may be carried out. (Then only a complete discussion at academic level can be carried out.) Every panellist may have his own views on a solution.

8. Comments on OECD papers relevant for the subject.

I.2 E-Commerce - A Summary

1. In International Taxation, “Which Government has JURISDICTION to tax” is an important issue. Several provisions have been devised for answering the issue. These provisions are summarised for quick reference in Part II as - “Main Principles” and “Machinery Provisions”.

Three concepts need modernisation in the light of E-Commerce: Residential Status, Permanent Establishment & Categorisation of Income. In this discussion, we will cover only the PE & Categorisation. Residential status may take another full discussion.

2. For determining jurisdiction, two connecting factors have been accepted universally: “Residence of the Assessee”; and the “Source of the Income”. If one of the two Connecting factors exist, the Government has a jurisdiction to tax. Otherwise, not. We are not discussing here the Residence issue.

3. PE : In case of Business Income, it has been accepted that the Source of the income lies within the Country of Residence (COR). However, when the assessee has a Permanent Establishment (PE) in another country, the PE is considered as a source. To the extent of income attributable to the PE, the Country of Source gets a right to tax the assessee.

In essence, the PE is a thresh hold. If a non-resident business assessee’s presence in the Country of Source (COS) is above the thresh hold, it is liable to tax in the COS. In other words, when a non-resident has a PE in a particular country, that country acquires jurisdiction to tax the non-resident assessee.

4. PE by definition relies on a fixed place of business or an agent. In E-Commerce, a non-resident businessman does not need a fixed place of business or an agent in another country. From a tax haven, it can operate around the world without having any fixed place of business in any country outside the tax haven. It can avoid global taxes. But the Governments may not tolerate such evident tax avoidance.

Concept of PE cannot be applied to E-Commerce. All attempts at applying the historic concept to the modern way of business are bound to fail.

To evolve a concept which can be applied to both – the traditional as well as the Electronic Commerce, one has to go a few steps towards the root. Have a simpler principle.

PE will continue to be useful for determining tax jurisdiction where it can be established. If PE cannot be established for E-Commerce, there is another solution. Indirect tax.

5. Categorisation of Income: Similarly, the Categorisation of Income (COI) is a much abused & misunderstood concept. Taxing or not taxing an income just because of the category of income is incorrect. The determining factor is “Source of Income” and not COI. The allocation of taxing rights amongst countries based on COI is the root cause of tremendous litigation. When a tax officer wants to tax a non-resident, he would try to categorise the payments to the non-resident as royalty or FTS. On the other hand, the assessee would try to categorise all amounts received as business income. Constant litigation is assured.

6. Professionals around the world debating this issue have been put on notice by the U.S. Government and the Indian Government as well as judiciary. Time is running out for debates. People are asking for a solution. In the absence of a global solution, local authorities are taking the International taxation rules making in their own hands. See Part II, paragraph 1 and the illustrations in that paragraph.

7. Tax Base : Indian Government’s tax base is as under. (i) In case of Indian residents, Indian sourced income - full tax; foreign sourced income, a right to tax, subject to the Source Country’s prior right to tax. (ii) In case of non-residents of India, only the income sourced in India.

When a non-resident of India does not pay any tax in India on his foreign sourced income, there is no base erosion. It was never the tax base of India. When the Indian Government tries to tax a non-resident’s foreign sourced income; it is as improper as a Non-resident trying to avoid Indian tax on Indian sourced income.

Tax base is the other side of the same coin. The first side being connecting factors discussed in paragraph (2) above.

8. A probable solution is : [paragraphs (8) to (11)]

Develop another concept to compliment PE. In other words, where the PE concept can be easily applied, use it. Where it cannot be applied, don’t stretch or twist logic to get a desired result. Have a principle based, uniform & fair approach.

9. Principles involved for the solution :

A Government can tax a non-resident businessman on his profits sourced in its country. For determining the source, the activities of the businessman can be examined & not the activities of the customer or market.

“The income” is: net profit component within the value addition made by the assessee. Value addition made by entities or forces other than the assessee is not relevant.

10. “Country of Source” is the country in which value addition is made by the assessee. Value addition by the market or the consumer is not a characteristic of the assessee and hence they do not determine the COS.

The Source taxation should be available for jurisdiction to all the countries where value addition is made by the assessee, and the profits are earned by the assessee. This principle is evident in article (7), taxation of business income.

11. When Service Provider & Service Consumer are located in separate countries, how do you allocate the value addition!
There can be detailed theories on Market vs. Supply side levying the income tax.

One can devise principles for the same involving the attribution & transfer pricing principles. The matter can be highly complex though possible.

More practical solution may be :

The “Country of Consumption” (COC) may levy indirect tax like import duties, and may not levy any income–tax. This principle is accepted in case of import of goods. The “Country of Residence” and the Country of source may levy income-tax. All other principles including PE principles to apply normally.

Note: COC is different from COS.
Country of Payment (COP) is not the Country of Source.
Country of Market (COM) is not the Country of Source.

12. OECD. There are problems in filing returns for cross border income from E-Commerce; and there are problems in tax assessment. Some fundamental changes in the existing rules are required for E-Commerce tax allocation amongst different countries. Some existing rules need to be refined, modified or scrapped.

The options are :

1. Continue with the same regulations. Someday, things will be sorted out.

2. Examine all issues; make required modifications. Meet with the challenges as we proceed further.

This paper suggests the second alternative. Important issues are examined and placed open for debate. Author’s preference amongst available options is given and the logic for the same is also given. Author wants to learn more from the debate at the conference.

OECD’s reports/research papers are extremely useful. These are relied upon. Each paper needs one full day of study and discussion. Hence only some issues are taken in a brief manner. At some places the author agrees with the reports and some places disagrees. These are clearly stated in this paper. The main reports are :

1. Are the current Treaty Rules for taxing Business Profits appropriate for E-Commerce? Final Report. December 2005. It is available on OECD website: https://www.oecd.org/dataoecd/58/53/35869032.pdf

2. Implementation Issues for Taxation of E-Commerce. Mainly on the consumption tax or indirect tax. There are several reports covering the consumption tax.

If we combine the results of both the reports, the conclusion (drawn by the author) is : All consumption taxes (indirect taxes like sales tax, VAT, service tax) may be levied by the Country of Consumption (COC). COC should not levy income-tax on the non-resident exporter. The Income-tax may be levied by the COR and COS. COS is a country where the assessee has done some value addition to the product or service sold by him. [This is repetition of the conclusion given in paragraph (11), in some different words.]

If income –tax is levied on the non-resident for one supply of goods or services, for the same supply, no indirect tax should be levied & vice versa.

13. High Powered Committeeappointed by CBDT, Government of India had discussed certain concepts of E-Commerce taxation. The thought process at which the committee left; is continued further. However, for any weaknesses in this paper the only person responsible is the author. The thought process is largely parallel with OECD except for the following three matters :


Categorisation of Income.


The one hour panel discussion can only raise some ideas for the delegates to consider. This paper may prove helpful for a study of the issues after the conference is over. Comments if any, are most welcome at : [email protected]. This paper will be revised after discussions at the conference and a final paper will be placed on the website : www.rashminsanghvi.com

I.3 Scope & Logic of the discussion :

1. We are only discussing the tax issues in COS for a NR. Even within the issues for COS, many issues may have been left out or not dealt with fully. The only reason for this restriction is time constraint. Issues arising in the COR may take another paper.

2. This is a discussion on: “What should be the law”. Hence it is not a discussion on interpretation of existing laws & treaties. Precedents – case laws may not be of much help. One may call this, a discussion on Jurisprudence of income-tax on E-commerce.

I.4 Some assumptions & basic facts & notes :

For the sake of the paper, we take following facts. Most of these may apply to all countries. But some facts may be specifically relevant for India.

1. We are considering the tax issues and the Income-tax Act as applicable in India. We take some facts of business in India and U.S.A. But any other country may also be considered. It won’t change the arguments.

2. All amounts are expressed in Indian rupees. But one can assume any currency.

3. This discussion is not about tax planning or tax evasion. We are discussing neutrally whether a kind of income may be taxed in India or not. The discussion is neither in favour nor against anyone – tax authorities or tax payers.

4. India has started with Value Added Tax (VAT). It is replacing sales tax in many commodities. Eventually it is hoped that VAT will unify all the indirect taxes. It will be a long way. In the meanwhile, service tax – an indirect tax parallel to sales tax is imposed on services. It is increasing the revenue beyond the expectations of the Government. The Service tax Act is under evolution. Principles are still to be crystalised.

5. In India, imports of goods are liable to customs duty but not liable to income tax (i.e., the foreign exporter is not exposed to Indian income-tax). No one even questions this position. Service tax is levied on imports of services.

6. Substantial issues and matters have been taken from my earlier presentations. Chief being my ‘India Report’ on E-Commerce Taxation submitted for the IFA Congress in the year 2001 at San Francisco, U.S.A. It is a part of the IFA Cahier, 2001.

7. My knowledge on Service Tax & indirect taxes is more limited than my knowledge on direct taxes. Hence my observations on indirect taxes are limited to broad principles at macro level.

8. Familiar names are used in this paper just for easy referencing. Once a company name is used, one does not have to give more details of its business. However, all matters discussed here are purely imaginary and have no relevance with actual facts of any company named in this article.

9. The statement of these principles amount to going to the roots of international Taxation. I may have made a few errors. Let us all together sort out & propose a final system for taxing E-Commerce.

This issue is under discussion for more than ten years. Many people have proposed many ideas for a solution. Let us examine one more idea. Even this idea must have been discussed elsewhere. Because of some objections, the idea has not been further explored. Today, we may further explore the idea. The discussion has to be continued until an acceptable solution has been found.

Several assumptions, statement of principles of international taxation; and other ideas which amount to ‘building blocks’ have been included in this discussion paper. These help for reaching some new solutions. The discussion may be more useful if all these building blocks are considered. They are given at the end of the paper.

10. I AM THANKFUL to the following persons for their valuable contributions & discussions at the time of drafting the paper :

All the Panellists for their tremendous contributions.
Chartered Accountants: Mr. Nitin Karve, Mr. Rutvik Sanghvi for discussions with them.
Special thanks to Mr. Naresh Ajwani for his valuable contributions.

Part I completed.

Next: Part II Conceptual Statement of the problem…


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