Digital Taxation
1. The proliferation of technology has challenged conventional notions of economic activity.
2. This is now a serious challenge for policy, particularly for taxation.
How has digital taxation become a challenge?
1. The existing laws, tax business profits based on its physical presence in a country.
2. Such a pre-condition is no more relevant as digital businesses no longer have to be physically present to operate in and interact with an economy.
3. These platforms use hard to value intangibles.
4. They are often registered in low tax jurisdictions which frustrate the efforts to appropriately tax digital companies.
Which are the measures, drawbacks, responses, and challenges?
Measures
1. Organization for Economic Co-operation and Development (OECD) mentioned three measures — an equalization levy, withholding taxes, and a new nexus rule.
2. The first two are taxes on gross turnover.
3. The new nexus rule was to modify the taxable nexus beyond the physical presence in a country.
Drawbacks
1. It was agreed that data and user participation are critical for a platform. But no consensus emerged on their economic contribution.
2. As OECD continued with the value-creation by various business models, large tech companies were paying very low effective tax rates.
1. In response to this, individual countries started to apply digital taxes unilaterally, instead of arriving at a consensus.
2. In 2016, India became the first country to apply an equalization levy.
3. The levy was introduced outside the scope of the Income Tax Act and is applicable to a small set of companies operating in digital advertising.
4. France and Hungary have implemented digital taxes, while Belgium, Italy, the UK, and Spain have proposed similar taxes. These would apply to a wide range of digital services.
Challenges
1. Unilateral taxation could potentially lead to over-taxation or a pass-through of costs to consumers.
2. The tenability of these rules needs to be seen under the EU’s state aid or WTO rules.
3. Such measures can give market jurisdictions greater power to tax.
Why is India’s solution not complete?
1. In 2018, India proposed its long-term solution to the problem — test for significant economic presence.
2. The amendment was broadly similar to EU’s proposal.
3. According to this, if a digital platform reported sales from a country or had a significant number of users, then it should be considered as having a taxable presence in that jurisdiction.
4. This is not a complete solution because:
a) For the law to be applicable, treaties would have to be suitably amended.
b) The size of operations that would qualify as economic presence needs to be answered.
c) How much of its profits should be taxable in India needs to be answered.
What is the fundamental issue now?
1. The more fundamental political issue is the redistribution of taxing rights.
2. An example of this tension is French digital tax applicable to big tech companies that are predominantly residents of the US.
1. To garner consensus, the OECD released its draft for a unified approach recently. The OECD in 2019 published a policy based on two pillars.
2. Pillar one would examine the allocation of taxing rights.
3. All anti-avoidance measures would be considered under the second pillar.
4. India’s key proposals — significant economic presence and fractional apportionment, the Modified Residual Profit Split, and the distribution approach — were included in this policy.
Routine and Non-routine profits
1. The other proposals include splitting up of global profits of a corporation into routine and non-routine.
2. A fraction of non-routine profits would be allocated to the qualifying market jurisdictions.
3. If there is any dispute arising from such taxation it would be resolved through mandatory or binding dispute resolution.
4. This would require serious effort and a harder consensus on issues such as what constitutes routine profit.
When will the solution be fair to India and others?
1. India is in a unique position as it offers a wide user-base and thus a large market for digital companies.
2. A unified approach backing the new nexus rule is only a partial win for India.
3. Reliance on conventional transfer pricing could make the taxation of digital companies more complex.
4. While the idea of consensus is critical for international relations, it has to be evaluated in light of the misalignment of economic interests between developing and developed countries.
5. A good tax system is often evaluated along the axes of certainty, simplicity, and neutrality.
6. The suggested measures undermine these principles.
7. A possible fair alternative may perhaps be to switch to a simpler withholding tax architecture.
