This article is written by Abdullah Mustaqueem, pursuing a Certificate course in Advanced Corporate Taxation from LawSikho.com.
Table of Contents
Introduction
As there is a shift in the world’s economy from physical to digital, especially in recent years, which has resulted in the growth of big tech companies popularly known as “FAANG” which stands for Facebook, Amazon, Apple, Netflix, and Google. The tremendous growth of such companies has given fire to a heated debate, that these companies are not paying enough taxes due on them or rather escaping their tax burden. This has led to an issue that has attracted the attention of various nations and that is “digital tax” which has not only resulted in political debates but has also led to the introduction of equalisation levies and digital services tax for services offered digitally.
This article reviews the scope and ambit of digital tax policies introduced around the world with a focus on India and an in-depth analysis of rules and regulations associated with it and it would include the meaning of digital tax, its types, the geographic mismatch between value creation and number of users, debate on digital tax proposals of various nations and key recommendations.
What is digital tax?
Digital taxes are about the taxes and policies that specifically target certain types of businesses, which include any type of business that uses digital means to carry on its operations and which will attract a new type of tax altogether having a special rate or tax base. These policies include the extension of the existing tax base by increasing the ambit of the existing tax regime and how an enterprise not having a physical presence or permanent establishment would be liable to pay tax in a particular country. This article analyses digital tax and their policy usage in the following categories:
Taxes on consumption
Consumption taxes are levied on the sale of goods or services. Countries across the world are expanding the base of their consumption taxes so as to include the goods and services sold digitally.
Digital services tax (DST)
Digital services tax is the tax levied on the gross sales of specific types of goods. It is imposed on certain types of goods that have a number of digital users in a country and which are sold digitally.
Digital business : tax preferences
The policies are concerned with the research and development of tax and their credits such as Patents or other forms of Intellectual Property Rights which in turn reduces the tax burden. Although these preferences are available to any business, some of them specifically lend them to digital business.
Concept of “permanent establishment” for digital businesses
The policies or rules which define what would constitute a (Permanent Establishment) PE include digital companies which do not have any physical presence in a particular jurisdiction. These virtual or digital businesses derive a huge amount of revenue so they should be made liable to pay taxes and here is when these policies come into play. These policies lay down specific criteria such as sufficient nexus, business connection, or engagement with the local market.
Withholding of taxes on digital services
Sometimes certain countries adopt withholding of tax methods instead of levying corporate taxes or service taxes to tax the revenue of digital enterprise in a particular jurisdiction. It might or might not have a physical presence but a sufficient nexus or business connection is enough to attract those provisions but in no way these work as a substitute to DST or income tax.
The mismatch between digital value creation and users
As has been mentioned below, the statistics throw light upon the number of internet users by country based on the data put forth by the OECD.stat.
|
REGIONS |
INTERNET USERS (MILLIONS) |
SHARE (IN PER CENT) |
VALUE OF TRADE (IN MILLIONS USD) 
|
SHARE (IN PER CENT) |
|
NORTH AMERICA |
343 |
11% |
1,179,632 |
37% |
|
EUROPE |
508 |
16% |
8,18,529 |
26% |
|
EAST AND SOUTHEAST ASIA |
1080 |
34% |
6,25,194 |
20% |
|
SOUTH AND CENTRAL AMERICA |
206 |
07% |
99,675 |
03% |
|
OTHER REGIONS |
997 |
32% |
4,32,448 |
14% |
|
WORLD |
3133 |
100% |
3,155,478 |
100% |
The debate on digital tax
With the growth of digital businesses in the past decade, there has been considerable growth in the debate on the tax policies regarding them across the world. Where the tax should be paid and on what basis. As there are certain business models which do not require physical presence where they are operating.
Tax policies on consumption have been made in order to increase the ambit of the existing tax regime which was not able to cover the transactions largely made through digital means. Which in most cases is concerned with business not having any taxable presence in the jurisdiction where it is operating.
Digital businesses somehow have managed to escape the higher tax bracket. It might be through the use of preferential tax regimes, R&D tax relief, or patent boxes. While there is a counterargument to giving these preferences is to support innovation and attract investment in the new domain of technologies. But this has resulted in a discriminatory tax regime when compared to other businesses. To curb the discriminatory taxation of businesses, the policymakers have come up with new taxation tools that are made for some targeted preferences.
Since the majority of the digital companies are big MNCs having their presence across the globe the policymakers have realized a need for international agreement on the rules and taxability of the said businesses. Without any such agreement, these enterprises might face double taxation or the policies made by individual countries might result in contradiction.
Proposal of various countries
European Union on digital tax
The EU came up with a proposal to tax the turnover at the rate of 3 percent on the profits earned through activities such as advertising, sales, online marketplaces, and sale of user data collected through data mining. Companies having a turnover of about 850 million USD with revenues up to 58 million USD would be subject to tax.
The Digital Sales Tax is introduced to work as an interim measure to tax the said digital businesses. However, due to the opposition of several member states of the EU, the said proposal was set aside. But the EU has said that if the OECD does not reach any consensus on common tax policy then it would re-impose DST.
USA’s proposal on digital tax
The USA does not have a uniform nationwide tax policy for digital goods and businesses; rather the states have developed their own laws to address the taxability of various digital products and services and some even don’t specify goods or services in their tax code. Some states tax digital services but often exempt them as well for example – If an e-book is sold to an end-user with rights to use it is not taxed at all but if it is prewritten that is downloadable then it is subjected to tax. In California, sale of digital products such as digital images, e-books, or mobile applications there is absolutely no tax at all as there is no transfer of tangible property for personal property.
Since the US has adopted a liberalised taxation policy for digital businesses it also expects the other nations to do the same or rather adopt a policy on similar lines. This is why it has been against the equalisation levy introduced by India which will tax the agencies having a significant economic presence in India. After which the USTR has also conducted an investigation under Section 301 of US Trade Act, 1974 which authorises it to respond to foreign countries action that adversely affects US trade. Some of the concerns raised by USTR:
- It has called the DST discriminatory levied by India as it excludes the Indian domestic companies from being taxed.
- It has also exempted a company that is already a resident in India.
France’s proposal on digital tax
Likewise in the EU tax proposal on digital businesses, France DST is also levied on digital activities such as online advertising online marketplaces or sale of user data in connection with usage for marketing or advertising. As a harbinger of change in DST brought in by the EU was strongly favoured by the French govt. Although the government of France is also of a view that DST will serve as a temporary measure until an international agreement on the taxation of digital businesses is signed.
As a harbinger of change DST brought in by the EU was strongly favored by the French govt. Although the government of France is also of a view that DST will serve as a temporary measure until an international agreement on the taxation of digital businesses is signed.
UK’s proposal on digital tax
The United Kingdom has proposed a tax of 2 percent on revenues earned by search engines, advertising online, and other media platforms. The threshold required to tax the said businesses is USD 638 Million and USD 32 Million within the UK and the first 34.76 million USD. The said tax is to be introduced with effect from April 2020. Although as previously stated, this would only serve as an interim measure until there is an international agreement among the nations on how and when the said businesses are to be taxed.
India’s proposal on digital tax
- From April 2022, foreign entities that are not having any physical presence in India but earn significant revenues from India will be subjected to tax. The said tax will impact not only the big tech giants such as “FAANG” but also smaller enterprises engaged in similar transactions which have huge customer bases in India. The rate of equalisation levy will be about 2 percent on any payment made by a non-resident in connection with an Indian user.
- Although the said enterprises are going to be subjected to tax in 2022, the main legal provisions were introduced in 2018 on how the said enterprises are to be taxed and what the concept of significant economic presence (SEP) means.
- Initially, the rate of tax was 6% in 2016 but it was restricted to online advertisements only later(commonly known as “Digital advertising tax”) in March 2020 its scope was expanded so as to include e-commerce platforms or any payment made by a non-resident will attract an equalisation levy of 2 percent.
- India was also waiting for an international agreement on digital tax so that there won’t be any conflict in the future on how the said businesses are to be taxed and where. But prior to that, the CBDT has notified the criteria of SEP as per the Indian Income Tax Act, 1961.
- As per the new notification of CBDT criteria for being taxed in India includes :
- Any non-resident whose revenue is more than 2 crores with respect to goods, services, or property with any resident person in India.
- It will include transactions such as a download of data or software systems.
- Any entity having more than 3 lakh users in India.
- As per the new notification of CBDT, it is very much clear that this would increase the ambit of the existing tax regime and will also enhance the tax base in India. As the criteria suggest: 3 lakh active users which is a very small number and even the smallest of enterprises would be subject to the said provisions.
- If the said enterprises fulfill even one of the conditions as per notification then they will be subjected to be taxed in India. Although only the enterprises which belong to the non-treaty jurisdictions will be impacted by it because in other jurisdictions the concept of PE comes into play. Which says that in order for a non-resident to be taxable in India it needs to have a permanent establishment in India as per the Double Taxation Avoidance Agreement with 97 countries.
Key recommendations
Following recommendations should be considered while formulating policies on taxing of digital businesses:
- As far as consumption-based taxes are concerned, countries should aim at bridging the gap between the taxation of physical and digital businesses.
- Countries should aim at making a robust system for tracking remote sales and sale of user data.
- Countries should avoid imposing an increased tax rate on overseas enterprises when compared to a local enterprise engaged in the same businesses.
- Make policies that serve as a relief from double taxation of the said businesses.
- Decide a uniform timeline for the elimination of DST to avoid any trade wars in the future.
- Avoid R&D tax credits with high compliance costs to avoid any discrimination of taxation among the overseas enterprises.
- Should aim at the adoption of multilateral negotiations while developing new approaches for taxing of non-resident businesses.
- Adopt a multilateral approach for the treatment of digital PE regulations that should avoid double taxation of businesses.
Conclusion
As discussed earlier due to the digital boom in the last decade there has been a considerable rise in digital businesses. But the question that arises is how these businesses are to be taxed which has resulted in various policies regarding the taxation of digital enterprises. The term “Digital tax” is being used to cover the specified nature of transactions. The most common perception about the big digital giants is that they pay inadequate taxes, OECD has been working on a common tax policy for the member nations but it has not reached a consensus yet. Since there is no international agreement about digital tax various nations involved have introduced their respective tax policies resulting in a conflict among them. Like many countries involved have introduced the Digital Service Tax popularly known as DST and on a similar line India has also come up with an equalization levy 2.0 which has a broader base in order to cover even smaller enterprises and make them pay tax. But all these individual tax policies have resulted in double taxation of the said companies and it has also resulted in conflicts among the nations. So it is very exigent to introduce a common tax policy so that neither the member nations suffer nor the businesses.
References
- https://www.avalara.com/vatlive/en/country-guides/north-america/us-sales-tax/us-digital-services-sales-tax.html
- https://www.reuters.com/article/us-usa-trade-digital-idUSKBN2BI31K
- https://www.drishtiias.com/daily-updates/daily-news-editorials/digital-services-tax-1
- https://www.thehindu.com/business/us-says-indias-digital-services-tax-discriminatory/article33563991.ece
- https://taxfoundation.org/digital-tax/
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