Section 9 - Options to address broader tax challenges of Digital Economy in the Indian Context
101. A large part of the follow up work on Action 1 undertaken by the Task Force of Digital Economy, after its 2014 Report related to the development and analysis of possible options that can be adopted for addressing the broader tax challenges arising from digital economy. This work is documented in Chapter 7 of its 2015 Report, which provides details of the three options that were considered by it – (i) a new nexus based on “significant economic presence”; (ii) withholding tax on digital transactions; and (iii) Equilization Levy. For the ease of reference, the relevant extracts of this chapter, relating to the details of these options are reproduced below.
9.1 Option 1: New Nexus based on Significant Economic Presence
102. As the broader tax challenges in digital economy arise primarily from the difficulties in application of existing physical presence based nexus threshold that constitutes the definition of permanent establishment, the first option to address the tax challenges in digital economy proposes that “significant economic presence” should be considered adequate fulfillment of nexus between the taxable enterprise and the taxing jurisdiction. The option would require appropriate modifications of nexus rules in the tax treaties (‘permanent establishment’) as well as domestic laws (‘business connection).
“7.6.1 A new nexus based on the concept of significant economic presence
277. This option would create a taxable presence in a country when a non-resident
enterprise has a significant economic presence in a country on the basis of factors that
evidence a purposeful and sustained interaction with the economy of that country via
technology and other automated tools. These factors would be combined with a factor
based on the revenue derived from remote transactions into the country, in order to
ensure that only cases of significant economic presence are covered, limit compliance
costs of the taxpayers, and provide certainty for cross-border activities. The following
sections describe the details of such an option, together with potential approaches for
attributing income to the new nexus.
7.6.1.1 Revenue-based factor
278. As a general matter, revenue that is generated on a sustained basis from a
country could be considered to be one of the clearest potential indicators of the
existence of a significant economic presence. This is based on the assumption that even
in multi-sided business models, and particularly those dependent on network effects,
the two markets are likely to be strongly interrelated, and as a result are likely to be
situated in the same country. To the extent that the country of the users and country of the paying customers are aligned, the value of an enterprise’s users and user data
would generally be reflected in the enterprise’s revenue in a country. In other words,
because user data serves to enhance the value of the services an enterprise offers, a
strong user network (and the attendant user data) is likely to result in enterprises either
selling more or enterprises charging more for its core products/services, or both.
Under such circumstances, the revenues earned from customers in a country are a
potential factor for establishing nexus in the form of a significant economic presence in
the country concerned. Revenues will not be sufficient in isolation to establish nexus
but they could be considered a basic factor that, when combined with other factors,
could potentially be used to establish nexus in the form of a significant economic
presence in the country concerned. In addition, the use of revenue as a basic factor
could limit the compliance costs of taxpayers and provides a high degree of tax
certainty for cross-border activities. In developing a revenue factor, consideration was
given to the following technical issues:
· Transactions covered. One approach that could be considered in defining a basic
revenue factor is to include only revenues generated from digital transactions
concluded with in-country customers through an enterprise’s digital platform.
Specifically, these transactions would involve the conclusion of a contract for the sale
(or exchange) of goods and services between two or more parties effectuated through a
digital platform where the contract conclusion primarily relies on automated systems.
Such an approach could however create incentives for particular ways of doing
business with remote customers. For example, such an approach would treat remote
digital transactions differently from mail-order transactions (e.g. catalogue shopping)
and telephone transactions (e.g. sale through call centres). Although in practice the
latter transactions are less likely to enable a business to generate a significant amount
of revenue, all three ways of transacting enable businesses to engage in sales
transactions without physical presence in the country of the customer. In addition,
businesses may leverage digital technology to reach a broader range of customers in
another country without entering into digital transactions (e.g. website displaying the
products but routing the customers to a call centre to perform the final purchase).
Accordingly, to ensure that taxpayers in similar situations carrying out similar
transactions will be subject to similar levels of taxation, it may be preferable to define
the factor so as to include all revenue generated by transactions concluded by the nonresident
enterprise remotely with in-country customers. Potential adverse effects
associated with such a broad scope would in any case be addressed by the application
of the other factors (see further below at 7.6.1.4).
· Level of the threshold. The core element of the revenue factor could be the gross
revenues generated from remote transactions concluded with customers in the country
concerned. This amount should be framed in absolute terms and in local currency, in
order to minimise the risk of manipulation. A key objective in setting the level of
threshold would be to set it at a high enough level to minimise the administrative
burden for tax administrations as well as the compliance burden on and level of
uncertainty for the taxpayer, while ensuring that nexus is less likely to be created in
cases in which minimal tax revenue would be collected. The size of the country’s
market might also be a relevant factor in setting the level of the revenue threshold.
Given the relative mobility and flexibility in choosing the location of automated
functions related to revenue-generating activities in the digital economy, the factor
could be applied on a related-group basis rather than on a separate-entity basis to
prevent any risk of artificial fragmentation of distance selling activities with customers of the same country among a variety of foreign affiliated entities. This aggregation rule
could be introduced as a rebuttable presumption, with the taxpayer being able to
demonstrate that it did not artificially fragment the distance selling activities in order
to manipulate the revenue threshold.
· Administration of the threshold. An accurate application of the revenue threshold
would depend on the ability of the country to identify and measure remote sales
activities of the non-resident enterprise. One possible approach to address this
challenge could be to introduce a mandatory registration system for enterprises that
meet the factors giving rise to a significant economic presence. On the other hand, it
could be difficult for tax authorities to know when activities are taking place and at
what scale, to identify remote sellers, and ultimately to ensure compliance. Similarly, in
the case of transactions concluded and fulfilled entirely online, it may be difficult for
enterprises to identify with certainty the country of residence of clients. In this respect,
regimes introduced to ensure compliance with VAT/GST rules by non-resident
suppliers could prove extremely useful (see also chapter 8 for additional details).
7.6.1.2 Digital factors
279. In the case of “brick and mortar” businesses, the ability to reach significant
numbers of customers in a country generally depends on a variety of factors, including
a store’s location, local marketing and promotion, payment options, and sales and
customer service employees. In the digital economy, the ability to establish and
maintain a purposeful and sustained interaction with users or customers in a specific
country via an online presence depends on analogous factors. A range of digital factors
based on the current development of the digital economy could be used as part of a test
for significant economic presence, including the following:
· A local domain name. A non-resident enterprise targeting customers or users in a
country will generally obtain the digital equivalent of a local “address” where the
non-resident enterprise establishes its store front, typically taking the form of a
localised or specialised domain name. For example, while an enterprise’s “home”
domain name might be “.com”, the enterprise’s site targeting one country would
likely use a domain name reflecting that, in order to make it more likely that a
local user would find the local site. This is reinforced by the need of enterprises to
protect their trademarks by purchasing related domain names, including a local
country domain name. In summary, while it is possible for an enterprise to do
business in a country without a local domain name, the choice to do so carries
reputational risk from potential domain “squatting” and trademark infringement
from not protecting the enterprise’s business name, trademarks and trade names
across various domains. Accordingly, MNEs doing substantial cross-border
business would very likely operate in a country via a local domain name. Whether
local domain names will remain the predominant method for accessing markets,
however, is uncertain. In the near future, merchants selling camera equipment
globally may, for example, use a generic “.camera” domain name, thus reducing
the relevance of country specific domain name.
· A local digital platform. Non-resident enterprises frequently establish “local”
websites or other digital platforms in order to present the goods or services being
offered in the light that most appeals to the local users or customers, taking into
account language and cultural norms in particular. Local websites or digital
platforms could include features intended to facilitate interaction by local users and customers with the site’s content, services and functions. Such features
include language, local marketing such as targeted discounts and promotions, and
local terms of service for users and customers that reflect the commercial and
legal context of the local environment. Although some enterprises may elect to
only operate only in one language and not attempt to undertake local marketing
or promotional efforts, establishing a local platform is often critical to attracting
meaningful numbers of local users and customers. Note, however, that local
platforms do not necessarily correspond to political boundary lines.
· Local payment options. A non-resident enterprise that maintains a purposeful and
sustained interaction with the economy of a country will frequently ensure that
local customers have a seamless purchasing experience with prices reflected in
local currency, taxes, duties and fees already calculated, with the option of using
a local form of payment to complete the purchase. Integration of local forms of
payment into a site’s commercial features is a complicated technical, commercial,
and legal exercise requiring substantial resources, and an enterprise would
normally not undertake such an investment unless it purposefully participates in
the country’s economic life. While this factor may be less relevant in countries
that share a common currency, it generally is a critical commercial requirement
in countries that have stringent banking regulations, currency controls, or low
penetration of international credit cards.
7.6.1.3 User-based factors
280. Given the importance of network effects in the digital economy, the user base
and the associated data input may also be important indicators of a purposeful and
sustained interaction with the economy of another country. A range of factors based on
users could be used to reflect the level of participation in the economic life of a country,
namely:
· Monthly active users (MAU). One factor reflecting the level of penetration in a
country’s economy is the number of “monthly active users” (MAU) on the digital
platform that are habitually resident in a given country in a taxable year. The
term MAU refers to registered user who logged in and visited a company’s digital
platform in the 30-day period ending on the date of measurement. A factor based
on MAU presents the advantage of measuring the customer/user base in a given
country both in terms of size and level of engagement. Given that little material is
publicly available on the process of defining and identifying MAU, more detailed
metrics would need to be developed in consultation with businesses and IT experts
for the purpose of using this factor, such as how to identify a unique "user" or
what level of engagement is required for a user to be considered "active".
Reliability and veracity of the information would also need to be ensured, to
address fraudulent accounts, multiple accounts, false information volunteered by
users, and “bot”-produced data, to name a few.
· Online contract conclusion. Another factor indicating the level of participation of
an enterprise in the economic life of a country is the regular conclusion of
contracts. This is the focus of the existing “dependent agent” PE test contained in
Article 5 of the OECD Model which, in broad terms, requires that this contract
conclusion be carried out in the country by a person acting on behalf of the nonresident
enterprise. In the digital economy, contracts can frequently be concluded
with customers via a digital platform without the need for the intervention of local personnel or dependent agents. For example, online platforms providing free
services to their users often specify on their websites that by accessing or using
the products and services of the company the user agrees to the “Terms of Service”
and each use of the platform results in the conclusion of a legally binding
agreement. The number of contracts concluded through a digital platform with
customers or users that are habitually resident in the country in any taxable year
could therefore be considered an important factor.
· Data collected. Another factor which could be considered to reflect an enterprise’s
level of participation in the economic life of a country is the volume of digital
content collected through a digital platform from users and customers habitually
resident in that country in a taxable year. The focus would be on the origin of the
data collected, irrespective of where that data is subsequently stored and
processed (e.g. data warehouse). The range of data captured by the threshold
would not be confined to personal data, but would cover also, e.g. user created
content, product reviews, and search histories. This core element could be
coupled with proportionality tests, such as whether the volume of digital content
collected exceeds a percentage of the enterprise’s overall stored digital content.
Information on data collected is increasingly available, reliable and up-to-date,
especially if the factor is focusing on data collected that is effectively stored by the
non-resident enterprise on a server. At the same time, businesses may not
necessarily maintain separate and comprehensive track records of the volume of
data collected and stored on a country-by-country basis. In addition, the volume
of data collected (and stored) from users in a country may not necessarily reflect
an effective contribution to the profits generated by the non-resident enterprise, as
the value of raw data is rather uncertain and particularly volatile.
7.6.1.4 Possible combinations of the revenue factor with the other factors
281. For purposes of this potential option, total revenue in excess of the revenue
threshold would be an indicator of the existence of a significant economic presence.
282. Total revenue, however, may not by itself suffice to evidence a non-resident
enterprise’s regular and sustained participation in the economic life of a country. To
be an appropriate measure of participation in the economic life of a country, the
revenue factor could be combined with other factors, such as the digital and/or userbased
factors that indicate a purposeful and sustained interaction with the economy of
the country concerned. In other words, a link would have to be created between the
revenue-generating activity of the non-resident enterprise and its significant economic
presence in the country. The choice of which factors should be combined with the
revenue factor to ascertain whether a significant economic presence should be deemed
to exist is likely to be driven by the unique features and economic attributes of each
market (e.g., size, local language, currency restrictions, banking system).
283. This concept may be illustrated by an example. If a non-resident enterprise
generates gross revenues above the threshold from transactions with in-country
customers concluded electronically through a localised digital platform where the
customer is required to create a personalised account and utilise the local payment
options offered on the site to execute the purchase, it could be considered that there is
a link between the revenue generated from that country and the digital and/or userbased
factors evidencing a significant economic presence in that country. In contrast, it
would be more difficult to find such a link where a non-resident enterprise generates gross revenues above the threshold from transactions with in-country customers
through in-person negotiation taking place outside of the market jurisdiction, if the
enterprise only maintains a passive website that provides product information with no
functionalities permitting transactions or intensive interaction with users (including
data collection).”
103. The Report also notes that to apply this nexus, appropriate modifications would be required in the rules related to attribution of profits to the entity, and observes that existing rules of attributing profits may face limitations when applied to the digital economy.56 It notes that the existing methods for attributing profits may need to be modified substantially before they can be applied to determine attributable income that would be subject to tax in the source jurisdiction on the basis of the new nexus based on significant economic presence. The Report analyses in greater detail, the possibility of applying fractional apportionment, and states that it was not pursued further because of the difficulties in its application. It also considers the option of applying a “modified deemed profit method” and suggests that the “deemed profit method” based on presumptive profits may offer a feasible and simple solution for this problem, although there would be issues that will need to be considered and sorted before it could be applied. It also suggests that “deemed profits” can be adopted as a rebuttable presumption, wherein an enterprise will have an opportunity to show that its actual profits attributable to the tax jurisdiction are lesser or not there (as in the case of a loss making enterprise).57
104. After considering these observations made in the BEPS Report on Action 1 (2015), the Committee arrived at a view that while a new nexus based on significant economic presence is fully justified and can be adopted in the domestic laws and the tax treaties, the consequent issues of attribution of profits in a bilateral tax treaty may need to be analysed in greater detail in order to find solutions that could ensure simplicity, predictability and certainty in the tax regime, without imposing costs of compliance and administration that could become prohibitive or detrimental to its application. It also becomes apparent that till these issues related to the attribution of profits are sorted out more clearly and accepted by the international community, a simpler option might be preferable, particularly in the Indian context.58 The Committee also noted that the lack of clarity and uniformity of views in respect of attribution of profits can be a significant constraint in including this option in the bilateral tax treaties.
105. The Committee, however, was of the view that necessary changes in the domestic laws to clearly provide that “significant economic presence” constitutes a business presence needs to be considered by including this option as a nexus criteria for taxing income that is “deemed to arise in India”. The Committee considers that this can be done irrespective of whether this option is included in the tax treaties, while also noting that such an option would be sufficient for taxing income unless the tax treaties also provide for such taxation of income.
9.2 Option 2: Withholding tax on digital transactions
106. The second option identified by the Task Force on Digital Economy is application of a withholding tax on payments arising from within a tax jurisdiction, on digital transactions. In essence, this option is substantially similar to the similar withholding tax that already exists in respect of payments made as interest, dividend, royalty and fee for technical services in tax treaties. Such tax can be levied at a concessional rate, on the gross amount of the payment, and offers a relatively easier solution of addressing the tax challenges of digital economy, when applied as a standalone final tax. Alternatively, it can also be combined with the new nexus based on significant economic presence, as an effective means for collecting tax, particularly in the context of B2B transactions. The Report details this option in paragraphs 292 to 298, which are reproduced below for ease of reference:
“7.6.3 A withholding tax on digital transactions
292. A withholding tax on payments by residents (and local PEs) of a country for
goods and services purchased online from non-resident providers has also been
considered. This withholding tax could in theory be imposed as a standalone grossbasis
final withholding tax on certain payments made to non-resident providers of
goods and services ordered online or, alternatively, as a primary collection mechanism
and enforcement tool to support the application of the nexus option described above,
i.e. net-basis taxation. Both approaches raise similar technical issues with respect to
the scope of transactions covered and the collection of the ensuing tax liability. In
addition, the application of a standalone final withholding tax raises specific
challenges regarding trade obligations and EU law.
7.6.3.1 Scope of transactions covered
293. The scope of transactions covered by the tax must be clearly defined, so that
taxpayers and withholding agents will know when the tax applies, and to ensure that
tax administrations will be able to ensure compliance. The scope should also be
defined as simply as possible in order to avoid unnecessary complexity and
classification disputes. The need for clarity and simplicity, however, must be balanced
against a need to ensure that similar types of transactions will be taxed similarly, in
order to avoid creating incentives for or against particular ways of structuring them.
294. For this purpose, although listing specific types of transactions covered would
provide a degree of clarity, it would also likely result in disputes over the character of
transactions, particularly as technology continues to advance. Such an approach also could lead to differences in treatment for tax purposes between economically
equivalent transactions depending on their form. For this reason, a more general
definition of covered transactions appears more appropriate. The tax could be applied,
for example, to transactions for goods or services ordered online (i.e. digital sales
transactions), or to all sales operations concluded remotely with non-residents. The
latter would have the advantage of flexibility, and would ensure tax neutrality between
similar ways of doing business, and may reduce disputes over characterisation. In
addition, if withholding is used as a tool to support net-basis taxation, a broad scope
covering all distance selling would be more consistent with the sales threshold
discussed above in the context of a nexus based on significant economic presence.
7.6.3.2 Collection of the tax
295. In practice, the liability to pay a withholding tax on outbound payments is often
shifted from the non-resident enterprise to a local collecting agent, such as the
customer or a third-party payment processing intermediary. For such a mechanism to
function efficiently, the agent responsible for withholding must have access to
information about the covered transactions sufficient to know when the tax will apply,
and must be reasonably expected to comply with its obligation to withhold.
296. In the case of B2B transactions, businesses resident in the source country may
reasonably be expected to comply with the withholding obligation. In the case of B2C
transactions, however, requiring withholding from the payor would be more
challenging as private consumers have little experience nor incentive to declare and
pay the tax due. Moreover, enforcing the collection of small amounts of withholding
from large numbers of private consumers would involve considerable costs and
administrative challenges.
297. One possible solution would be to require intermediaries processing the
payment to withhold on the payment in a B2C context. As a practical matter, however,
this presents several technical issues. For example, an intermediary would generally
not have access to transaction-identifying information enabling it to determine its
character and hence the amount of tax due. In practice, it would only see a value
without any description of the underlying transaction, in which case it would not be
able to determine with sufficient certainty when it was required to withhold. The task of
the intermediary could be facilitated if the collection regime is supplemented by a
mandatory registration system for non-resident enterprises whereby all remote sellers
of goods and services must designate a dedicated bank account for all payments
received from local customers. In the latter situation, intermediaries may be required
to withhold the tax only for payments made to these specific bank accounts. However,
the application of this approach may pose challenges in imposing compliance
obligations on intermediaries that are situated in third-countries with no connection to
the jurisdiction of the customer, thereby creating opportunities for tax avoidance
strategies.
7.6.3.3 Negative impact of gross-basis taxation and relationship with trade
and other obligations
298. The initial development and hosting of the technology required to provide
products and services online typically requires substantial up-front investment of
resources, including labour and capital. After initial creation of the technology,
however, providing products and services online frequently requires only limited
marginal costs for businesses. Where this is the case, it has been argued that payments
made in consideration for digital goods or services share common features with royalties and fees for technical services, i.e. that gross revenue is a reliable proxy for
net income. In many businesses, however, providing products and services online will
require ongoing expenditures for continued product development (including
maintenance of products and addition of new features), marketing, and ongoing
customer support due to rapid product cycles as technology and competition evolve.
Where this is the case, imposition of withholding tax on gross revenues will be an
imperfect proxy for tax on net income. One potential way to reduce the negative impact
of gross-basis taxation would be to fix the rate at a relatively low amount that would
reflect typical profit margins. Such margins could be determined, for example, on the
basis of a statistical analysis of actual profit margins of local domestic taxpayers
operating in the same specific class of industry or type of business.”
107. The Report proposes the option of Withholding Tax as a simple, predictable and pragmatic solution that avoids many of the difficulties associated with the first option, and can be applied on payments for digital services that share characteristics with royalty and fee for technical services. It also details the possible alternative ways in which it can be planned and designed to take care of the compliance issues and gross amount taxation concerns. It acknowledges that the withholding tax can be expected to be complied through the process of withholding by payers in the B2B transactions, but would pose greater challenges in B2C transactions. Regarding the hardships associated with taxing gross amount, instead of the net income, it suggests considering a relatively lower tax rate.
108. After taking cognizance of these observations, the Committee considers that the option of “withholding tax” offers a practical way of allocating partial taxing rights in respect of income from digital economy, which shares attributes that may be similar to royalty or fee for technical services, and which can be complied in respect of B2B transactions by the process of withholding. However, such a tax on income would be feasible only if it is included in the tax treaties, which take precedence over Indian domestic laws, unless it is designed as a tax on the gross payment.
9.3 Option 3: Equalization Levy
109. The third option considered by the Task Force on Digital Economy, is termed as “Equalization Levy”. The word ‘equalization’ represents the objective of ensuring tax neutrality between different businesses conducted through differing business models or residing within or outside the taxing jurisdiction. In particular, this levy seeks to bring the foreign enterprises that earn significant income from a jurisdiction that erodes its tax base.59 This option is detailed in paragraphs 302 to 308, which are reproduced here for ease of reference:
“7.6.4 Introducing an “equalisation levy”
302. To avoid some of the difficulties arising from creating new profit attribution
rules for purposes of a nexus based on significant economic presence, an “equalisation
levy” could be considered as an alternative way to address the broader direct tax
challenges of the digital economy. This approach has been used by some countries in
order to ensure equal treatment of foreign and domestic suppliers. For example, in the
area of insurance, some countries have adopted equalisation levies in the form of
excise taxes based on the amount of gross premiums paid to offshore suppliers. Such
taxes are intended to address a disparity in tax treatment between domestic
corporations engaged in insurance activities and wholly taxable on the related profits,
and foreign corporations that are able to sell insurance without being subject to
income tax on those profits, neither in the state from where the premiums are collected
nor in state of residence. As discussed below, an equalisation levy could be structured
in a variety of ways depending on its ultimate policy objective. In general, an
equalisation levy would be intended to serve as a way to tax a non-resident enterprise's
significant economic presence in a country. In order to provide clarity, certainty and
equity to all stakeholders, and to avoid undue burden on small and medium-sized
businesses, therefore, the equalisation levy would be applied only in cases where it is
determined that a non-resident enterprise has a significant economic presence.
7.6.4.1 Scope of the levy
303. If the policy priority is to tax remote sales transactions with customers in a
market jurisdiction, one possibility is to apply the levy to all transactions concluded
remotely with in-country customers. To target the scope of the levy more closely to the
situation in which a business establishes and maintains a purposeful and sustained
interaction with users or customers in a specific country via an online presence, the
levy would be applied only where the business maintains a significant economic
presence as described above.
304. An alternative would be to limit the scope to transactions involving the
conclusion through automated systems of a contract for the sale (or exchange) of goods
and services between two or more parties effectuated through a digital platform.
Although this would create an incentive to choose non-digital means of conducting
transactions, it would also focus more closely on the specific types of transactions that
have generated concern. There is no rule, however, that prevents a broader scope of
application. Indeed, focusing too narrowly on specific types of transactions may limit
the flexibility of the levy to accommodate future developments, which would limit its
ultimate effectiveness in addressing the tax disparity between foreign and domestic
suppliers of products through an online presence. The levy would be imposed on the
gross value of the goods or services provided to in-country customers and users, paid
by in-country customers and users, and collected by the foreign enterprise via a
simplified registration regime, or collected by a local intermediary.
305. Alternatively, if the policy priority is to tax the value considered to be directly
contributed by customers and users, then a levy could be imposed on data and other
contributions gathered from in-country customers and users. For that purpose, a
number of options could be available. One option would be to impose a charge based
on the average number of MAU in the country. As noted above, however, measuring
MAU accurately may prove to be challenging. Moreover, the number of MAU of a
foreign enterprise may not be directly related to in-country revenue generated by a
foreign enterprise. Setting an appropriate rate for a levy measured by active users would also be challenging, as the average value of each user to a non-resident
enterprise may vary widely. Another option would be to base the levy on the volume of
data collected from in-country customers and users. Similar to MAU, however, data
may also vary widely in value depending on its content and the purpose for which it
was gathered, and it would be challenging to identify a reliable direct connection
between the in-country revenue and the data collected from in-country customers and
users.
7.6.4.2 Potential Trade and other Issues
306. As is the case with the imposition of a gross-basis final withholding tax, a levy
that applied only to non-resident enterprises would be likely to raise substantial
questions both with respect to trade agreements and with respect to EU law. In order
to address these questions, potential solutions that would ensure equal treatment of
domestic and non-resident enterprises would need to be explored, as discussed above
in section 7.6.3.3. Depending on the structure of the levy, one option that could be
considered would be to impose the tax on both domestic and foreign entities. If this
approach were to be taken, however, presumably consideration would also need to be
given to ways to mitigate the potential impact of applying both the corporate income
tax and the levy to domestic entities and foreign entities taxable under existing
corporate income tax rules.
7.6.4.3 Relationship with corporate income tax
307. Imposing an equalisation levy raises risks that the same income would be
subject to both corporate income tax and the levy. This could arise either in the
situation in which a foreign entity is subject to the levy at source and to corporate
income tax in its country of residence or in the situation in which an entity is subject to
both corporate income tax and the levy in the country of source. In the case of a
foreign entity, for example, if the income is subject to corporate income tax in the
country of residence of the enterprise, the levy would be unlikely to be creditable
against that tax. To address these potential concerns, it would be necessary to structure
the levy to apply only to situations in which the income would otherwise be untaxed or
subject only to a very low rate of tax.
308. Another approach could be to allow a taxpayer subject to both CIT and the levy
to credit the levy against its domestic corporate income tax. Such an approach would
ensure that foreign entities with no nexus for corporate income tax purposes would be
subject only to the levy in the source country, while the tax burden of entities subject to
corporate tax would effectively be limited to the greater of the corporate income tax or
the levy”
110. The Committee observes that the BEPS Report conceptualizes Equalization Levy as a tax that is different from the Corporate Income Tax, and thus may not necessarily be subjected to the limitations of tax treaties. The Report does not prescribe any particular design that must be adhered to, but suggests that it could be a tax on the gross payment arising from digital economy. Such a tax on the gross amount of payment, would thus be very similar to the second option of withholding tax, except that it, not being a tax on income, would not be covered by the obligations of the tax treaties, and hence can be levied under domestic laws, even without changes in the tax treaties.
9.4 Various Options as Alternatives or Compliments
111. The three options identified in the work in Action 1 need not be considered in exclusion to each other. Paragraph 276 of the Report observes as under:
“Like the challenges they are intended to address, the impact of these options overlaps in
a number of respects. They have therefore been conceived in a way that allows them to be
either combined into a single option or chosen individually. More specifically, elements
of the 3 potential options could be combined into a new concept of nexus for net-basis
taxation (a “significant economic presence”), with the intent to reflect situations where
an enterprise leverages digital technology to participate in the economic life of a country
in a regular and sustained manner without having a physical presence in that country. In
this context, the application of a withholding tax on digital transactions could be
considered as a tool to enforce compliance with net taxation based on this potential new
nexus, while an equalisation levy could be considered as an alternative to overcome the
difficulties raised by the attribution of income to the new nexus.”
112. Thus, the Report on Action 1 acknowledges the possibility of combining more than one option together. This also opens up the possibility of beginning with the option that is most feasible at a given point of time, and then supplementing it with other options that subsequently become feasible. In the light of its observations as reproduced above, it becomes clear that it may be preferable to tax the income on a net basis by adopting a new nexus consisting of “significant economic presence”, and using the option of withholding tax as the means for collecting the tax, particularly in business to business transactions where such a mechanism already exists in the tax laws of many countries and can be implemented, relatively easily. The Task Force considered the option of Equalization Levy as an alternative to the first two that is simpler, avoids the difficulties arising from lack of clarity and universal consensus on how to attribute the profits to different jurisdictions, and hence as an option that may be more feasible to implement at this stage, where several issues in respect of the first option remain unclear.
9.5 Recommendations of BEPS Report on Action 1 on these options
113. These options were considered in detail by the Task Force on Digital Economy, which took note of the various issues relevant to each of these options, and concluded as under:
“357. As regards the different options analysed, TFDE has concluded that:
· The option to modify the exceptions to PE status in order to ensure that they
are available only for activities that are in fact preparatory or auxiliary in
nature has been considered by the TFDE and adopted as part of the work on
Action 7 of the BEPS Project. In order to ensure that profits derived from core
activities performed in a country can be taxed in that country, it was agreed to
modify Article 5(4) to ensure that each of the exceptions included therein is restricted to activities that are otherwise of a “preparatory or auxiliary”
character. In addition, a new anti-fragmentation rule was introduced to ensure
that it is not possible to benefit from these exceptions through the fragmentation
of business activities among closely related enterprises. These changes to the
definition of PE of the OECD Model Tax Convention are included in the report
Preventing the Artificial Avoidance of PE Status (OECD, 2015) and are now
expected to be implemented across the existing tax treaty network in a
synchronised and efficient manner via the conclusion of the multilateral
instrument that modifies bilateral tax treaties under Action 15.2
· The collection of VAT/GST on cross-border transactions, particularly those
between businesses and consumers, is an important issue. In this regard,
countries are recommended to apply the principles of the International VAT/GST
Guidelines and consider the introduction of the collection mechanisms included
therein. Implementation packages will be developed to ensure that countries can
implement the International VAT/GST Guidelines in a co-ordinated manner.
Work in this area will be carried out by the WP9, with the Associates in the
BEPS Project participating on an equal footing.
· Some aspects of the broader direct tax challenges currently raised by the digital
economy are expected to be mitigated once the BEPS measures are
implemented. This is because once implemented, the BEPS measures are
expected to better align the location of taxable profits with the location of
economic activity and value creation. This will address BEPS and restore both
source and residence taxation in a number of cases where cross-border income
would otherwise go untaxed or would be taxed at very low rates. In addition,
even in the modern digital economy many businesses often still require a local
physical presence in order to be present in a market and maintain a purposeful
and sustained interaction with the economy of that country. In this context, BEPS
measures such as the modification of Article 5(4) of the OECD Model Tax
Convention are expected to also mitigate some aspects of the broader tax
challenges. As a consequence, a quick implementation of the BEPS measures is
needed, together with mechanisms to monitor their impact over time.
· None of the other options analysed by the TFDE were recommended at this
stage. This is because, among other reasons, it is expected that the measures
developed in the BEPS Project will have a substantial impact on BEPS issues
previously identified in the digital economy, that certain BEPS measures will
mitigate some aspects of the broader tax challenges, and that consumption taxes
will be levied effectively in the market country. The options analysed by the
TFDE to address the broader direct tax challenges, namely the new nexus in the
form of a significant economic presence, the withholding tax on certain types of
digital transactions and the equalisation levy, would require substantial changes
to key international tax standards and would require further work. In the
changing international tax environment a number of countries have expressed a
concern about how international standards on which bilateral tax treaties are
based allocate taxing rights between source and residence States. At this stage, it
is however unclear whether these changes are warranted to deal with the
changes brought about by advances in ICT. Taking the above into account, and
in the absence of data on the actual scope of these broader direct tax challenges,
the TFDE did not recommend any of the three options as internationally agreed
standards.
· Countries could, however, introduce any of the options in their domestic laws
as additional safeguards against BEPS, provided they respect existing treaty
obligations, or in their bilateral tax treaties. The adoption of the options as
domestic law measures could be considered, for example, if a country concludes
that BEPS issues exacerbated by the digital economy are not fully addressed, or
to account for the time lag between agreement on the measures to tackle BEPS at
the international level and their actual implementation and application. The
options may provide broad safeguards against BEPS and ensure that a domestic
taxing right is available for remote transactions involving digital goods and
services, which is currently not the case under most countries’ domestic laws.
Countries could take this approach with the intent to address their concerns
about BEPS issues in the short term and gain practical experience with the
application of the options over time, fostering coordinated domestic law
approaches and informing possible future discussions. In addition, countries
could bilaterally agree to include any of the options in their tax treaties.
· Adoption as domestic law measures would require further calibration of the
options in order to provide additional clarity about the details, as well as some
adaptation to ensure consistency with existing international legal commitments.
Consistency with bilateral tax treaty obligations would have to be ensured, for
example by applying the options solely with respect to residents of non-treaty
countries, or in situations in which benefits of the treaty may be denied due to the
application of anti-abuse rules that are in conformity with tax treaty obligations.”
114. The Committee notes that while the Task Force on Digital Economy did not recommend any of the options at this stage, primarily since adopting them “would require substantial changes to key international tax standards and would require further work”, it also concluded that “Countries could, however, introduce any of the options in their domestic laws as additional safeguards against BEPS, provided they respect existing treaty obligations, or in their bilateral tax treaties”. It also notes that the Task Force concluded that “The options may provide broad safeguards against BEPS and ensure that a domestic taxing right is available for remote transactions involving digital goods and services, which is currently not the case under most countries’ domestic laws. Countries could take this approach with the intent to address their concerns about BEPS issues in the short term and gain practical experience with the application of the options over time, fostering coordinated domestic law approaches and informing possible future discussions.” The Committee also noted that these conclusions may have been derived as much from the political preferences of the participating countries, as much by the technical analysis undertaken as part of this work.60
115. Thus, the Committee takes cognizance of the fact that an international consensus has now emerged among G-20 and OECD Countries, which recognizes and accepts the right of a country to adopt any of the options identified in the Report on BEPS Action 1, in its domestic laws or in its bilateral tax treaties. The Committee also notes that since the Task Force did not “recommend” these options at this stage, they have not yet acquired the status of a “universally applicable standard”, which may limit the feasibility of adoption of these options in the bilateral tax treaties.
116. The Committee also notes that among the options recognized and examined by the Task Force, the option of “a new nexus based on significant economic presence” can be adopted in the Income-tax Act, 1961, but will not be sufficient for taxing income on the basis of this new nexus, unless any applicable tax treaty61 is also amended by inserting this new nexus. Similarly, the adoption of a final (or intermittent) “withholding tax on digital transactions” in the Income-tax Act, 1961, may also be rendered ineffective unless the same option is also included in the applicable tax treaty. The Committee also notes that India is committed to the obligations made by it under the tax treaties, which largely limit the application and effectiveness of adopting these options in Income-tax Act, 1961.
117. The Committee takes note of the fact that these limitations, however, do not limit the adoption or application of the third option, i.e. ‘Equalization Levy’ which has been recognized in the BEPS Report on Action 1 as being different from corporate income tax. Thus, unless it is levied on ‘income’ that may fall within the scope of taxes covered under the tax treaties that relate to taxes on income, this option can be implemented under the domestic laws. The Committee also notes that this option is put forth in the BEPS Report on Action 1 as one that can be considered as an alternative to the other two, as a simpler option devoid of the difficulties that are associated with the more intractable issue of attribution of profits.
118. In view of the conclusions drawn by the BEPS Report 1 on Action 1, the Committee is of the view that among the three options that can be adopted under domestic laws, the ‘Equalization Levy’ is the most feasible option.
9.6 Need for adopting an Option at this stage
119. The Report on BEPS Action 1 is ambivalent on whether an option should be adopted at this stage or not. It stops short of recommending adoption of an option to address the broader challenges of digital economy at this stage or suggest any immediate modifications in the Model Tax Conventions, but also makes it clear that countries that wish to do so may adopt such options either in their domestic laws in a manner that is not restrained by tax treaty obligations, and/or in their bilateral tax treaties, where other Contracting State also agrees.
120. As the BEPS Report on Action 1 also seems to recommend further work in this area, the Committee considered the need for adopting an option at this stage, along with the other alternative of leaving such action for a future date. In this consideration, the Committee notes that while the BEPS Report suggests further work, no clear framework for undertaking this work has been determined. The further work suggested in the Report62 focuses primarily on monitoring the developments in digital economy, and reviewing the same in 2020, which is another four years from now. Even after that, it is not clear as to whether it will be possible to have a combined exercise on the scale undertaken in the BEPS Project, and so, even if any further work is undertaken, it is not clear as to whether such work can be expected to lead to any actionable outcomes.
121. The Committee also takes cognizance of the fact that there are differences in the preferences and positions of countries on allocation of taxing rights, as apparent from the differences between the OECD Model and the UN Model, and notes that such differences that pertain to the issue of allocation of taxing rights between the jurisdiction of residence and the jurisdiction of source have always been difficult to lead to any agreements, or further changes in the status quo. Given this important limitation, and the fact that while making a suggestion for further work, the Task Force concluded to leave it to countries to adopt any of the options, the Committee is of the view that there appears to be no justification for not taking action at this stage. The Committee further notes that the evolution of the consensus for changing the international tax rules may actually be expedited by the adoption and implementation of the options that have now been made available to the source jurisdictions, either under their domestic laws or bilateral treaties.
122. The Committee also considered the observation made by the Task Force that the recommendations of BEPS work in other action points may mitigate some aspects of the BEPS in digital economy. The Committee notes that the BEPS Report on Action 1 clearly differentiates the “BEPS Issues in digital economy” that consist of artificial arrangements to avoid paying taxes, from the “broader tax challenges from digital economy” that consist of the limitation of existing international taxation rules for establishing a taxable nexus, and while certain recommendations like those in Action 6 of BEPS for preventing treaty abuse, or those in Action 7 of BEPS for preventing artificial avoidance of PE Status, may have some impact on the “BEPS issues in digital economy”, there is virtually nothing in the outputs or outcomes of any of the other Action Points of BEPS Project that can address the broader tax challenges related to nexus, characterization and data that formed the core of the work in Action 1 of BEPS Project. Thus, the Committee is of the view that the tax challenges that are proposed to be addressed by the options identified in the BEPS Report on Action 1 are unlikely to be addressed or mitigated by actions recommended in other Actions of BEPS, and can only be addressed by adopting one of the options identified in Report on Action 1.
9.7 Committee’s Observations
123. In view the above considerations, the Committee is of the view that there is a need to consider the feasibility of adopting the ‘Equalization Levy’ under domestic laws of India to address the tax challenges arising from the digital economy at this stage. The Committee is also of the view that adopting such a measure at this stage will bring greater certainty and predictability to all the stakeholders, enable them to take it into account while making their future business plans and pricing of products, and thereby contribute to a more stable tax environment in India for digital economy.
56. Paragraphs 284 to 291 of the BEPS Report on Action 1
57. Paragraph 291 of the BEPS Report on Action 1
58. The Committee also noted that in respect of Attribution of Profits, India has taken positions on the modified
Article 7 in the OECD Model Convention that indicate its differences with the OECD approach. While the existing
tax treaties of India are based on the UN Model, the differences in approach to attribution of income could pose
additional challenges in the Indian context.
59. The base erosion can take place either directly in a straight forward manner, by claim of deduction in respect of
payments by businesses in B2B transactions, and indirectly by reducing the resources available for the domestic
suppliers of goods and services
60. The Committee also took note of the fact that there were differences in individual preferences of the countries
participating in the BEPS Project on this issue, arising largely from their respective national interests. Countries that
benefit from existing international taxation rules that limit the taxing rights of the source jurisdiction, are more
likely to resist any changes, and supported maintaining a status quo in the work on BEPS Action 1, whereas
countries with large markets, who are losing out as a result of outdated nexus rules preferred changes in the rules.
The conclusions of the Task Force represent a compromise between the differing views of the participants, and can
be seen as the best possible solution that could be arrived as a consensus in this work at this stage. It may not be wrong to say that the conclusions of the BEPS Report on Action 1 (2015) represent a result that derived largely
from the political interactions among the participants. The Committee notes that having accepted and endorsed
the BEPS Report on Action 1, it would be preferable for India to adhere to the conclusions that have been made in
the BEPS Report on Action 1.
61. Under Section 90 (2) of the Income-tax Act, 1961, the provisions of an agreement entered into by the Central
Government with another country of specified jurisdiction, will apply to the extent they are more beneficial to the
taxpayer.
62. Chapter 10 of the BEPS Report on Action 1
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