Budget moves on BEPS need clarity

Tax laws have not been able to keep pace with the digital economy

For years, Base Erosion and Profit Shifting (BEPS) has been denting tax revenues of nations across the world. BEPS refers to tax planning strategies used by multinational companies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity.

The Organisation for Economic Cooperation and Development (OECD) estimates that BEPS reduces the effective tax rate of large multinationals by an average of 4 to 0.5 percentage points relative to non-multinational firms. Amongst OECD and G20 countries, this ranges from 4 to 10 per cent of overall corporate tax revenues, or around $100 to $240 billion annually. To plug BEPS, OECD released 15 Action Plans on October 5, 2015.

Business models of digital economy don’t necessarily require a physical presence to earn income from a country. Unfortunately, tax laws have not been able to keep pace with these new and evolving business models.

Under the present international tax laws, typically, Digital Economy escapes taxation in the country with which it has an economic nexus. This has been recognised by the OECD. Action Plan 1 of BEPS deals with the tax challenges of the Digital Economy and suggests basically three options to address them — nexus based on significant economic presence (SEP); withholding tax on digital transactions; and equalisation levy (EL).

In 2016, India took the lead by introducing BEPS-related measures in its domestic law by bringing in EL at 6 per cent for online advertisement revenues. This year, it has introduced the concept of SEP in the definition of business connection under its domestic laws, thereby potentially bringing to tax companies having no physical presence but an economic nexus in India.

Amending domestic law

As per section 9 of the Income Tax Act, 1961, digitalised businesses that do not require any physical presence in India do not form a Permanent Establishment (PE) in India and are therefore not taxable in India. The Finance Bill, 2018 proposes to amend the Act to provide that ‘significant economic presence’ in India shall also constitute business connection. SEP shall include — any transaction in respect of any goods, services or property carried out by a non-resident in India, including provision of download of data or software in India if the aggregate of payments arising from such transactions during the previous year exceeds the amount as may be prescribed; systematic and continuous soliciting of its business activities or engaging in interaction with such number of users, as may be prescribed, in India through digital means.

Since this issue is being faced by every country, some countries have taken some measures to tax the digitalised transactions. Austria has unveiled a roadmap to tax Digital Economy by bringing in the concept of Digital PE. Italy has brought in a new tax on digital transactions, albeit with a higher threshold.

The proposed amendment in the domestic law will enable India to negotiate for inclusion of SEP in the Double Taxation Avoidance Agreements (DTAA). As clarified in the Budget, unless the above changes in PE rules are made in DTAAs, cross-border business profits will continue to be taxed as per the existing treaty rules.

Areas of confusion

However, certain issues demand clarification. As per the proposed amendment, several non-resident companies may fall under the amended definition of business connection even though their activities may not result in a PE under the treaties. It’s not clear if such companies may have to do tax filing and other attendant compliances even though they would escape taxation in India. Attribution of profits is expected to throw several challenges and will result in increased litigation.

EL is not applicable to non-residents constituting a PE. It has to be clarified if PE would include business connection, whether non-residents would have an option either to pay this levy or be taxed as a PE. Another issue lacking clarity is that the proposed definition seeks to tax even non-residents supplying physical goods, which doesn’t seem to be the intention, causing confusion and uncertainty.

India has taken the lead in amending the tax laws to being in the concept of Digital PE. It will throw open new challenges and test the enforcement capability of the Indian tax authorities, once the treaties get amended and the economic nexus becomes an important criterion to determine taxability. It will be interesting to see how the tax authorities make the test for determining economic nexus, as well as attribution, more objective than subjective, to minimise litigation.

The author is a Partner, Ashok Maheshwary & Associates LLP

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