In this blog post, Nirankush Kenjige, a student at School of Law, Christ University and pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, describes tax planning by e-Commerce entities.
Tax planning means analysing the financial situation from the tax efficiency point of view so as to plan finances in the most optimised manner.[1] Various tax exemptions, deductions, and benefits minimizing tax liability is looked into by the taxpayer to reduce his tax liability. It allows the tax payer to make best of these exemptions in a financial year. Tax planning is technically a legal way of reducing tax liability. However, one must exercise much caution to ensure that the taxpayer is not indulging in tax avoidance or tax evasion.
In the Indian scenario, there are various options provided under the income Tax Act, 1961 (hereafter referred to as ‘The Act’), which provide wide range of exemptions and deductions that help in limiting the overall tax liability of the tax payer. One such set of exemptions is provided under Sections 80C to 80U of the Act. There are other exemptions too under the Act such as tax credits.
When tax planning is done within the legal framework, it is perfectly legal and is in fact, a smart thing to do.[2] Out of the available ways to escape from the liability of tax, tax planning is the only legal way to do so.
Corporate tax planning is a means of reducing tax liabilities on a registered company. Few of the common ways of doing this would include taking deductions on business transport, health insurance of employees, office expenses, retirement planning, child care, charitable contributions and such. Through the various tax deductions and exemptions provided under the Income Tax Act, a company can substantially reduce its tax burden in a legal way.[3] As is said before, with good tax planning, the direct tax and indirect tax liability is reduced at the times of inflation. A good tax planning is a result of not being ignorant of the current applicable tax laws and the judgments of the court; and also having in mind the business objective of the company. [4]
Tax planning can be classified into:
- a) Purposive tax planning: Tax planning with a particular objective in mind.
- b) Permissive tax planning: tax planning which is allowed under the legal framework.
- c) Long range and Short range tax planning: Planning done at the start and end of a fiscal year.[5]
While tax planning, an entity should have the following in mind- reduction in tax liability, maintaining economic stability, growth of the economy of the entity, litigation minimization, productive investment of the planned income.[6]
With the fast paced globalisation, and growth in technology, it is now possible for a consumer to transact businesses ‘automatically’ online. The sudden outburst of E-Commerce entities is making the world a easier place for online transactions. With negligible costs required for setting up of the entities, and has mostly operational costs only. This, coupled with high returns, is resulting in the exponential growth of e-commerce entities.
“An e-commerce business transaction is a sale or purchase of goods or services, conducted over computer networks by methods specifically designed for the purpose of receiving and placing orders in automation”.[7] An e-commerce business transaction would however exclude orders made by telephone calls, or manually typed emails from the ambit of this definition. The primary characteristic of conducting business using the e-commerce platform would be that there would be a ‘Human to Computer’ relation rather than the traditional ‘Human to Human relation’.[8]
The international tax regime, which emerged in the 1920’s, recognizes two basis for tax jurisdiction. The first is the ‘source-based taxation’, or territorial jurisdiction. In this type of source-based taxation, a country has jurisdiction to tax the income arising in its territory. The second basis for tax jurisdiction is ‘resident’ or personal jurisdiction. In resident-based taxation, the country has jurisdiction to tax its residents irrespective of where the income arises. In this system, the determination of residency for tax purposes is critical and is usually based on the personal, social, and economic ties of the person to his country.
Taxation of an international e-commerce is typically dealt with in international taxation under bilateral tax treaties to prevent companies from paying tax to both countries. The United States has, for example, such agreements with as many as 50 other countries.[9]
One of the key concepts of these treaties are ‘permanent establishments’. Companies are taxed in a country only if they have their operations in that country sufficient to be called a permanent establishment there, which means the company should have a fixed place of business. Many treaties specify that a permanent establishment exists if:
- a) The company has a fixed place of business with some degree of permanence.
- b) Carries a business through employees of the company or agents of the company who have authority to conclude contracts on behalf of the company.[10]
However, the OECD (Organisation for Economic Co-Operation and Development), made certain changes and provided that a web site, by itself or facilitated through a web-hosting arrangement, is not a permanent establishment. Further, an internet service provider cannot be considered as an agent of the company. Further, OECD settled that no human interaction was necessary for the server to be a permanent establishment, but only that the server performs a core function of the business.
Thus, companies can strategically deploy web servers as substitutes for sales offices to avoid taxation.[11]
One of the key issues in such substitution of sales offices with web servers, independent of whether a permanent establishment has been established or not, is the amount of profits that is associated with such servers. Even when a permanent establishment does not in fact exist but is deemed to exist, transfer pricing rules must be applied. Since applying the transfer pricing rule to e-commerce is challenging, it is deemed that since the risk borne and value added by an order-taking server location is generally low, the amount of profits that can be attributed to the server will also be low.[12]
Since web sites can substitute foreign sales personnel of a company, companies would appear to have two basic choices to achieve income shifting and thus tax planning. First, companies resort to using domestic servers to undertake international sales in a country of high tax-rate jurisdictions without paying the high foreign taxes, forcing domestic taxes to continue to apply. This would suggest a preference for using export sales as opposed to having foreign subsidiaries located in relatively high tax rate jurisdictions.[13]
Secondly, a non-U.S. company can establish a subsidiary in a low-tax foreign country, and then operate a web site for global sales from that location to reduce taxes on foreign sales by avoiding tax in that high-tax rate domestic jurisdiction and in high-tax rate foreign jurisdictions. This would escape the company of high tax liability in both of the high-tax liability jurisdictions. Here, as contradictory to the earlier method, having foreign subsidiary is preferred as opposed to export sales while having domestic web servers. [14]
In both of the above cases, e-commerce can aid the company in avoiding high foreign taxes on the income generated by the sales in a high tax-rate foreign jurisdiction.
The U.S corporate tax rates are relatively much lower as compare to the other countries where U.S companies carry on their businesses. Thus, it is not surprising that U.S companies do business or carry on business globally using a domestic server. This would be more practical for these companies than creating a permanent establishment and deploying a server in another country with low-tax jurisdiction to reduce their tax liability. Thus, e-commerce gives a slight advantage to the U.S companies over the other companies to shift income for tax purposes by using the domestic servers to service foreign markets.[15]
In the Indian scenario, Value Added Tax (VAT) is applicable only to the sale of goods. The tax is levied on the value additions made before the sale to consumer. Therefore, a company dealing with ‘services’, like Uber, or OLX need not pay VAT since they are just facilitators of a service.
‘Service’ practically includes almost everything. India follows a comprehensive approach of taxing service wherein all services are taxed except the services provided for in the negative list, and the exemptions under ‘Mega exemption’ and other exemption notifications.
Sales tax is levied on the sale of goods. The sales tax in India is levied by the authority of both the Central Government Legislation (Central Sales Tax) under the Central Sales Tax Act, 1956; And the State Government Legislation (Sales Tax) depending, upon whether the sale of goods is inter-state or intra-state.[16]
To reduce the payment of tax by the e-commerce entities, one must analyse the structure of the enterprise and the relationship with the customer. What is being provided to the customer- service or goods? Basically, it all comes down to analysing the business and modifying it to suit the needs to reduce the tax liability of the enterprise.
Thus, as it can be seen, though there are no significant ways of tax planning and thus, reducing the tax liability of an entity, there are a few loopholes which are being exploited by the companies to reduce their tax liabilities. These are matters of concern that must be looked into by the policy makers and reduce the effect of commerce on multinational tax planning which in-turn is affecting tax revenues.
Nirankush Kenjige
DEABL July, 2016 Batch.
[1] https://www.bankbazaar.com/tax/tax-planning.html
[2] Ibid
[3] http://baihtarinvestments.blogspot.in/2016/08/baihtar-groups-baihtar-investments-what_9.html
[4] https://www.bankbazaar.com/tax/tax-planning.html
[5] http://incometaxmanagement.com/Pages/Tax-Management-Procedure/5-1-Meaning-of-Tax-Planning.html
[6] https://www.bankbazaar.com/tax/tax-planning.html
[7] Definition provided by Organisation for Economic Co-Operation and Development.
[8] https://www.linkedin.com/pulse/taxation-e-commerce-start-ups-bharath-rao
[9] http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.199.5433&rep=rep1&type=pdf
[10] http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.199.5433&rep=rep1&type=pdf
[11] Ibid
[12] http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.199.5433&rep=rep1&type=pdf
[13] http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.199.5433&rep=rep1&type=pdf
[14] Ibid
[15] http://poseidon01.ssrn.com/delivery.php
[16] https://blog.browntape.com/2014/11/27/taxation-rules-in-the-e-commerce-sector-in-india/
