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E-commerce & Taxation

Establishing ‘Jurisdictional Right to Tax’ in International Taxation

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Residence-based Taxation

 All that need to be determined is the Home country location  Favours developed economies  Risk that business may fee to a tax haven •

Source-based Taxation

 All that need to be determined is the Host country location(s) i.e. economic attachment  Fair claim of the source country over all the activities occourring within its jurisdiction  Favours both developed and developing economies

Source Vs. Residence

Clash

& Double Taxation

 Source-based taxation is preferred for taxing MNCs  Creates an inefficient incentive to international investment  Double Taxation Avoidance Agreement (DTAA) to provide relief from Double Taxation

Income deemed to accrue in India

World income

Indian income Section 5 Section 9

Income of Non-resident

Taxability under Income Tax Act Taxability under DTAA Governed by Sec.9

Business Income – Business connection Royalty, Fees for Technical Services – Whether with business connection or not Governed by DTAA Business Income – Permanent Establishment • May subject to withholding tax • Profit attributable to PE Royalty, Fees for Technical Services – Subject to withholding tax

Defining PE:

“Permanent establishment” as per Article 5 of the OECD Model Tax

Convention

“A fixed place of business through which the business of an enterprise wholly or partly carried on.” Thus, there are three requirements that must be met in order to constitute PE: (i) There must be a place of business in the foreign jurisdiction.

(ii) The place of business must be fixed, i.e. the place must be established with a “certain degree of permanence.” (iii) There must be a “carrying on of the business” of the enterprise through this fixed place of business.

PE can be of several types based on asset location, agency engaged or

activities performed (Service, Construction).

A C A S E S T U D Y ON A G E N C Y PE

Royalty, Fees for Technical Services : Sec. 9(1)(vi)

• • • Income is earned from Government or an Indian concern.

Tax rate – Sec.115A - 30% - if agreement is entered into upto 31.5.1997.

- 20% - if agreement is entered into between 1.6.97 to 31.5.2005.

10% - if agreement is entered into on or after 1.6.2005.

No deduction of expenses is allowed.

If there is a PE or fixed place of profession (agreement on or after 1.4.2003)

• • • • Royalty & FTS is effectively connected with the PE Taxable under the head business & profession @ normal rates Expenses incurred wholly & exclusively are allowed as deduction Audit & Accounts are mandatory as per Sec. 44AA and 44AB.

Finance Act 2012 –

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Right to use computer software (including granting of a license) irrespective of the medium.

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It is not relevant whether right, property or information:

is in possession or control of payer.

- is used directly by the payer.

is located in India or not.

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What is not royalty?

• • Capital Gain, Outright purchase of design, etc.

E-commerce

In its widest sense, means consumer and business transaction conducted over a network, using computers and telecommunications.

Special features: 1.

Physical presence of goods is not required at all 2.

Physical delivery of good is not necessary E-commerce transactions can be completed almost instantaneously across the world and irrespective of the time of the day Anonymity

The Challenges in Taxing E-commerce

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How to determine ‘economic attachment’?

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How to determine existence of PE?

-- Place of business, permanency, and business activity—must be reconciled with the new digital reality.

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Does the presence of a server constitute a PE?

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Does the presence of website constitute a PE?

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How to attribute income to the PE?

Impediments in Taxing E-commerce

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Technological Constraints Economic Constraints Legal Constraints Political Constraints

Taxation of E-commerce

Characterisation of income

Royalty/Fees from technical services Business income Applying PE to E-commerce -- Place of the research -- Place of Importation (Where resident) the payer is -- Place of Use Identifying a Component that effectively meets the PE criteria Website Server Abondon of the Concept of PE

The Committee on Fiscal Affairs set up by the OECD has recommended following five aspects as key to formulating tax policy relating to e-commerce: ·

Neutrality; · Efficiency; · Certainty and simplicity; · Effectiveness and fairness; and · Flexibility.

The views of the OECD on what may be regarded as PE in an e-commerce situation, are as follows:

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Web site of the enterprise

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Server hosting the website of the enterprise

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Computer equipment not requiring human intervention and which undertakes complete business transactions within the given framework

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ISPs

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Telecommunication company infrastructure or postal system or local exchange number

Characterisation of e-commerce payments

Taxation of income in the source country depends on its characterisation.

Business income -- Taxed in source country only if the non-resident has a PE in the source country. The income attributable to such PE alone is taxed.

Royalty income As per the Convention provides for taxability of royalty income by the “Country of Residence” alone, most of the countries levy a withholding tax on royalty payments made by their residents.

Analysis of the categories of income outlined by the HPC (India) Electronic order processing of tangible products

The consideration arising under the transaction will be taxable under the head ‘Profits and gains of business or profession’.

Electronic ordering and downloading of digital products

The payment in question is covered by section 9(1)(vi) of the Act which defines “royalty” to be inter alia consideration for granting of license for use of secret process or granting of a license in respect of literary, artistic or scientific work.

Electronic ordering and downloading of digital products for purposes of copyright exploitation

The payment will be covered by the definition of the term ‘royalty’ as provided in section 9(1)(vi) of the Act.

Limited duration software and other digital information licenses

Limited duration use does not affect characterisation and the position. Hence, The payment will be covered by the definition of the term ‘royalty’ as provided in section 9(1)(vi) of the Act.

Single-use software or other digital product

The right to use software or other digital products one time does not affect characterisation. Hence, The payment will be covered by the definition of the term ‘royalty’ as provided in section 9(1)(vi) of the Act.

Application Service Provider ("ASP")

As the definition of ‘royalty’ under the Act includes payments for the use of or right to use industrial, commercial or scientific equipment as part of ‘royalty’, web site hosting fees would fall under ‘royalty’.

It may also fall under ‘fees for technical services’ as hosting of software product is akin to rendering of technical services.

Web site hosting

Data warehousing

Software maintenance

Since updates are extension of the original process, the part of the payment for updates will be treated “royalty” (consideration for granting of license for use of secret process or granting of a license in respect of literary, artistic or scientific work).

Payment for technical support is for rendering technical services and will be categorised as ‘fees for technical services’ under section 9(1)(vii) of the Act.

Customer support over a computer network

The payment in question will classify as payment for rendering technical services and accordingly shall fall within the purview of section 9(1)(vii) of the Act i.e. ‘fees for technical services’.

Advertising

Under the provisions of the Act, the payment would constitute ‘Profits and gains of business or profession’.

Electronic access to professional advice (e.g . consultancy)

Under the provisions of the Act, the payment in question would constitute ‘fees for technical services’ under section 9(1)(vii).

Online shopping portals

Under the provisions of the Act, the payment in question would constitute 'Profits and gains of business or profession'.

Subscription to a web site allowing the downloading of digital

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BPO Taxation

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Whether Indian operation could constitute a PE?

Non-residents/foreign companies will be liable to tax in India if the IT enabled BPO unit in India constitutes its PE [Circular No.5/2004 dated 28/09/2004 by CBDT] For this purpose amount attributable to tax would be the amount determined as per the arms’ length principle.

Problem with the Concept of Server as PE:  The U.S. Department of Treasury, however, has rejected the concept stating that, “the server is like the owner of a warehouse, which is a passive activity.”  A server may be lined with other jurisdictions and depending on the traffic, may be switched from one server to another.

 A server can also be moved, defeating the whole purpose of permanency.

 Servers can be moved into low tax jurisdiction or tax haven.

 An enterprise may employ a chain of servers instead of just one, locating each in a different jurisdiction.

HPC’s Arguments against the Concept:

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Treating the server as PE will not create certainty of tax burden, or

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Ensure maintenance of the existing equilibrium in revenue sharing between countries of residence and source.

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PE is not an indispensable concept

Despite the mounting argument for revamping the current PE rules, the OECD has maintained adherence to the principles.

Arguments in favour:

 1. The PE rules are conceptually correct. (the concept of PE is based on source-based jurisprudence of taxation. The concept of PE also finds its justification in the concept of State sovereignty over its natural resources)  2. There is little evidence supporting the tax avoidance and loss of revenue scenarios apprehended by the advent of e-commerce,  3. The PE rules are robust and flexible enough to handle the challenges of e-commerce, and  4. Transfer pricing and other remedies are available to correct any inefficiencies caused by the existing rules.

Alternate to PE: Shift from Production-based Taxation to Consumption based Taxation

Establishing nexus between transaction and real human consumption

Base Erosion Approach

 Under this approach, cross-border payments from a payer would be subject to a withholding tax regime.  The approach would supplement, but not completely replace, the current PE regime.  High tax rated would reduce substantially, but source country will have a much larger base to tax.

 For the enterprise, it would provide certainty regarding the burden of taxation.  Simple and less administrative hassles.

HPC accepted the Base Erosion Approach in theory with two exceptions: (1) it should replace rather than supplement the current PE regime, and (2) it should apply to all commerce and not be limited to e-commerce.

Virtual Establishment

VE would no longer require a physical nexus. It would no longer require a fixed place of business, but it would still require a connection of the business to the territory of the source state that is sufficiently close, effective and rational.

Problem in Attribution of Profit: Transfer Pricing Issue

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Traditional methodologies, like CUP, Resale price less margin, Cost plus profit, may fail

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Suitable for large and relatively infrequent transactions

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In Conclusion:

 Tax Neutrality  Clear framework so that tax certainty reduces high compliance and administrative costs  Introduction of GAAR may lead to lower tax avoidance in e-commerce situations  Laws for new technological challenges like cloud computing  OECD’s Action Plan on Base Erosion and Profit Shifting (2013) to address the tax challenges of the digital economy  Nicolas Colin & Pierre Collin made public a report on the ‘taxation of the digital economy’ in France  Creating a legal status for a ‘permanent virtual establishment’  “A company that provides services in a country through regular and systematic monitoring of data from online users in that country”