India: Amending the tax framework to move towards a digital economy
Sandeep Bhalla and Prashant Bhojwani of Dhruva Advisors discuss how a range of Indian tax laws are evolving to cater to an increasingly digitalised economy.
With business models evolving on account of digitalisation, the complexities from a tax perspective have only increased. Advances in technology has made it possible for businesses to carry on economic activities with minimal physical presence in other jurisdictions. Several countries including India have taken unilateral actions by amending domestic tax law to deal with challenges posed by digitalisation, as the tax framework has not kept pace with businesses.
In India, the key tax issues have been in respect of the characterisation of income and nexus. The following amendments have been introduced by India:
Amendment to royalty definition;
Significant economic presence (SEP);
Additionally, the Indian government in April 2019 released a public consultation on the proposal for amendments to the rules for profit attribution concerning permanent establishments (PE) – though this remains to be finalised. This report suggests the adoption of a ‘user base’ as an additional factor for the attribution of profits, considering the increased role of user contribution in digital business. In the existing scenario, one also needs to consider the increasing reliance on virtual presence vis-a-vis physical presence.
Recently, the following key direct tax amendments have been made by the Indian government vide the Union Budget 2020 in respect of digitalisation:
Withholding tax on e-commerce transactions
To widen the tax base, a withholding tax is proposed to be levied on the sale of goods/provision of services through a digital platform. The e-commerce operator is required to withhold tax at 1% for sale of goods/provision of services facilitated by it through its digital platform. Such tax has to be withheld on the gross amount of sales/service. In the case of non-availability of a permanent account number (Indian income tax registration) of the e-commerce participant, the withholding tax rate would be increased to 5%.
The e-commerce operator has to withhold tax at the time of credit or payment to the e-commerce participant, whichever is earlier. Importantly, the e-commerce operator is deemed to be the person responsible for paying to the e-commerce participant.
In a typical scenario, there are three parties involved – e-commerce operator, e-commerce participant and purchaser, which are defined as follows:
E-commerce operator: a person who owns, operates, manages digital platform for e-commerce.
E-commerce participant: a person resident in India selling goods/providing services including digital products, through digital platform for e-commerce.
E-commerce: supply of goods or services, including digital products, over a digital network.
Additionally, there may be a scenario, where one e-commerce operator contracts with another e-commerce operator. This would further complicate the matter as one would have to evaluate whether there would be a cascading effect on account of withholding tax, etc.
The consequence of withholding tax default could lead to interest, disallowance of expenses, penalty, etc. in the hands of the e-commerce operator.
It is pertinent to note that the above is applicable from October 1 2020 and would lead to cashflow issues and also increase the compliance costs/burden.
Amendment to SEP
Provisions for SEP (i.e. nexus rule) were introduced in the statute in 2018. A non-resident would create a taxable presence in India, if such non-resident has a SEP in India. However, for the purposes of determining SEP, the revenue threshold of specified transactions and threshold for the number of users were not yet prescribed. Given that G20-OECD report is expected in December 2020, the applicability of SEP provisions have been deferred to the financial year of 2021-22.
Additionally, the source rule under SEP has been expanded to include the following:
Advertisement which targets a customer residing in India or who accesses advertisement through internet protocol (IP) address located in India.
Sale of data collected from a person residing in India or who uses an IP address located in India.
Sale of goods/services using data collected from a person residing in India or who uses IP address located in India.
The deferment of SEP provisions is a welcome move, which gives businesses additional time to evaluate if there are tax risks existing based on the factual matrix and to consider mitigating such risks say by restructuring its business model.
Widening of equalisation levy
In 2016, an equalisation levy of 6% was introduced on consideration payable to a non-resident for online advertisements, provision of digital advertising space or other services for the purpose of online advertisements. At present, the applicability of the equalisation levy is extended to consideration receivable by non-resident, e-commerce operators from e-commerce supply/services. For this purpose, (a) ‘e-commerce operator’ is a person who owns, operates or manages a digital or electronic facility or platform for online sale of goods/provision of services and (b) ‘e-commerce supply or services’ means online sale of goods owned by the e-commerce operator, online provision of services provided by the e-commerce operator or sale/services facilitated by the e-commerce operator.
An equalisation levy of 2% would be applicable on consideration receivable by the e-commerce operator for supply or services or facilitation of supply or service to:
Person resident in India
Non-resident under specified circumstances such as through sale of data collected from a person resident in India
Person who buys goods or services through an IP address located in India.
The payment and compliance obligations are cast on the non-resident, e-commerce operator (i.e. the recipient in this case, unlike the earlier provisions wherein the obligation was on the Indian payer). The levy shall not be applicable where the e-commerce operator has a PE in India and such supply/services are effectively connected to such PE (as such non-resident would be subject to tax in India) or where the sales, turnover or gross receipts of the e-commerce operator from such e-commerce supply is less than INR 20 million during the financial year.
There remains a disconnect in terms of the applicability date, as the above is slated to be applicable from April 1 2020 but the corresponding exemption from income tax for the non-resident e-commerce operators from “e-commerce supply or services” applies from April 1 2021. The above anomaly needs to be rectified by the government.
Digitalisation has disrupted businesses by providing opportunities for new-age businesses and evolving business models. The digital economy is swiftly becoming intertwined with the traditional economy, thus making it harder to create a clear delineation of the true meaning of a digital economy.
In an Indian context, the e-commerce market is expected to grow to $200 billion by 2026. India has been at the forefront in terms of taxing the digital economy and the factors mentioned above are significant amendments for the businesses. Globally, several countries have introduced similar tax proposals (e.g. equalisation levy) for the taxation of digital economy.
Tax law continues to evolve, while businesses need to constantly reassess their business models to assess impact, identify risks, explore planning opportunities and meet their obligations.
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