In this article, Karan Gehlot, Master of Laws, Queen Mary University of London discusses Multinational enterprises and tax administrations in India.

There is no doubt that in past several years there are many multinationals enterprises that have been paying very low taxes in countries where they have a high level of sales. With the advancement of technology and internet, many companies have started their business online. The problem arises where e-commerce business is providing goods and services in international countries and those services cannot be taxed when buyers and sellers are taxed when purchasing physically. Moreover, the major problem which has been faced by different countries is regarding digital content which sold via the internet. In practice, the EU will find it very hard to force the non-EU seller to pay EU taxes. There are many activities which are rapidly increasing because of which EU is facing loss.

THREE TAX ISSUES

Sales Tax

There is a general agreement that sales tax is ought to be charged in the country of consumption, the consumption normally takes place where the purchaser of things is. Until the internet came it was quite easy. In 1995 when the internet came, pretty much every e-commerce taxation was free of sales tax because of the way that whether the tax law rules applies or not. Tax law rules assumed that importers would be businesses, so there were good rules for taxing businesses, but they assumed that consumer wouldn’t import, so there were no rules on taxing consumers who imported [digital] things for their own consumptions physical items were taxed (if noticed as they were imported) but only if over a certain value. For instance, Amazon’s Jersey sales used this low-value exception. So, the result in 1996 and 1997 was that, if the person wanted to buy a CD or DVD if he bought if from UK seller, he has to pay VAT, if he bought from a non-UK seller the person didn’t have to pay tax at all.

Income Tax: The second problem is when do you tax an e-commerce foreign company?

For instance, there is Orinoco Ireland Ltd. doing business analysis (it is going to be taxed it in Ireland), but imagine Orinoco Ireland owns the Trademark i.e. “Orinoco.co.uk” and make sales from that. So, is that enough to give the UK power to play incorporation tax by saying that, it looks Orinoco is doing business from the UK, so the UK government will treat as if they earning money in the UK and will be charging corporation tax? In the physical world, it is pretty easy to find out, if the company is doing business because it will have staff, premises, systems etc. in the country then the government of that country will charge the person for the business which he has been doing there.

Transfer Pricing

The basic principle is that, if the person has got the deal between the related people (members of the group), then the tax purpose is to treat the price as a market value, not at the price what parties say. But, there are huge problems for e-commerce companies as most of the pricing is for Intellectual Property Rights, for example, Google California corporation Copyright is owned by Bermuda corporation, so every Google corporation has to pay a market value for using the Google Trademark. Market value is competitors i.e. more than one buyer and seller but in google there in no competitor. The only competitor is Amazon (one supplier and buyer). Therefore, there is no market.

APPLICABILITY AND ENFORCEMENT

Enforcement happens at the national border, so if the person imports well outside national border then there is a chance that the customs authority will stop the goods as its new port of goods and will charge VAT on it. Along with VAT, the customs officer also hands over the collection of VAT to the UK post office which charges the person 18.50 for the privilege of paying taxes. But, how do customs authority know whether the package coming is an import or a gift? In the United Kingdom, 2 out of 3 imports gets charged.

When e-commerce started the equivalents of Amazon was selling books and CD and the major problem was services of “Digital Products”, the big thing then was music downloads and presently it is movies i.e. NETFLIX.

In the area of the digital product, the way VAT law worked since changed is that services apply at the places where service supplier resides which is outside the EU, hence there is no VAT outside EU. So, initially, when digital services came there was no VAT, which resulted in many problems for Europe’s content in the digital industry, because ‘why would any person would buy from EU seller by paying 15-20 percent of VAT’ when they have an option of buying from US seller by paying no VAT. Therefore, a foreign company has 15-20 % of advantage over the local problem. Moreover, the new system requires foreign company to charge at buyer’s VAT rate, but this creates logistical and enforcement problems.

In addition to this, enforcement problems are severe in identifying and taxing supply of goods cross-border and there is no easy enforcement for digital products. The only thing State can do is to block the source of the product.

SOLUTION FOR BETTER TAX REGIME SYSTEM IN EU DIRECTIVES 2002

1. If the person is non-EU supplier digital product into the EU, the person has to register in EU country and collect VAT on all the supplies in an EU country and the person has a choice of the state of registration.
2. SUPPLIERS OBLIGATION: The supplier has a number of obligations. He has to identify where the buyer is coming from. Back in 2002, if the supplier spends a lot of money of geographic location, they can identify almost 70-80% where their customer is coming from. But still, 20-30 percent is wrong as the technology couldn’t do it reliably.
3. CONSUMER TO BE CHARGED AT COUNTRIES VAT RATE: If the buyer is the consumer, then the consumer would be charged at that country’s VAT rate. So, the supplier has to know all the VAT rates for all the 28 members state built into his technology. Every EU country has different VAT rates for different kinds.
4. COUNTRY OF REGISTRATION SHARES OUT TAX COLLECTED: That accounts for taxes for country registration. Suppose if the person is giving all the taxes to Luxembourg along with the tax records and Luxembourg share track records with everybody else. If it works, this would be a fair solution for all the countries to get their tax shares accordingly.

The problem from e-commerce perspective is that why would an e-business would have to pay taxes to Luxembourg. For instance, United States corporations do not like to pay tax and if the person has to obey too many supplier obligations, but why would he do that. The person would if because if he has a plan to set up a subsidiary in EU at some time or if he thinks that his global reputation will suffer by being the tax defaulter in the EU. BUT, if he has a market for 5% global sales and not following with tax laws then he is criminal in all 28-member state.

5. Taxing Foreign Jurisdiction: The one thing is clear that selling just to residents is not enough, the fact that, if the person has made some sale in other jurisdiction does not give a right to the country to tax the profit person has made there. The physical world principle was, a tax can only be collected if the person has made the sale through branch or agency because it had premises and staff to engage in the activity. But clearly, e-commerce does not require any branch or agency.

OECD MODEL TAX CONVENTION

OECD (Organization for Economic Cooperation and Development), deals with model tax convention. Article 5 of OECD, lays down that the person will get taxed if he has “Permanent Establishment” in the jurisdiction, that could be his branch or agency. Hence, OECD needed to extend the idea of permanent establishment to cope with e-commerce and other forms of automated trading. So, the drafters of OECD extended the definition to include the Sole use of Trading Equipment. For instance, if a bank sets up an ATM network in the country and the ATM network is for banks sole use than it has the permanent establishment. If it shares other banks ATM, then it’s not a permanent establishment. Therefore, Article 5 says, PE (permanent establishment) includes a server for e-commerce, if the person has exclusive use for e-commerce.

OECD TRANSFER PRICING GUIDELINES

1. BEPS: Base Erosion and Profit Shifting. Base Erosion means, fewer people to attack and Profit Shifting means, moving the profits to another country so it can’t be taxed. The countries are worried about BEPS.
2. The only way of dealing with BEPS is “profit split method”. This method is used to evaluate controlled transactions to determine if the allocation of profits and losses between the related parties were conducted at arm’s length based on the relative value of their contributions to the profit or loss. In other words, when the person looks at the profits and says they have not looked at royalties at all, but they actually allocate profits of trading to Intellectual Property assets and trading. For example, when Amazon sells the DVD, the tax authorities say that 90% of that DVD is based on DVD and 10% of it is based in Amazon. In practice there would be an agreement between tax authorities and Amazon, to have a specific number.
3. The second option is let’s not treat Intellectual Property as asset, but let’s treat it as Capital Investment: as we look at e-commerce business, it’s brands and Trade name are similar to shops that are physically present in commercial business, so if business invests in shops than they a particular tax treatment of capital investments and IP should be treated in the same way.

CONCLUSION

There is a real problem of tax and globalisation. Globalisation allows companies to compartmentalise, open subsidiaries to different places. On the other hand, an online stuff i.e. e-commerce creates a problem at larger extent. Therefore, there is a fundamental mismatch and tax laws are currently being wasted on geography. In my opinion, the world might get in next 50 years or 100 years’ times, it’s going to move away from taxes on a current basis. The only solution is global agreement on fairness and it would take 50 years for the world to work on a global agreement on fairness.

[1] Karan Gehlot, Master of Laws, Queen Mary University of London.