Tax for Digital Economy – Why Google & Facebook may face tax liability?

Last Updated at: December 14, 2019
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For long, international tax laws were centred around physical presence in a country, to be subject to its domestic taxation norms. In effect, many brands in the digital space such as Google, Amazon, Facebook and off late, Netflix, Instagram and YouTube were able to escape tax nets, even in countries where they had a massive paying user base, routinely contributing to their annual revenues. The OECD has released a report in this regard that contains rules to regulate where taxes should be paid and on what portion should they be taxed. In this post, we analyse these changes in tax determination, tracing reasons and ramifications on online businesses in India.

Physical presence for taxing multinational companies

As per current rules of the Organisation for Economic Cooperation and Development, a country would be able to tax a multinational company only if a nexus is established through a physical presence in the country, known as a permanent establishment and only the profits traced to such a permanent establishment in the country are taxed.

Legal and practical issues in taxing digital businesses

  • While Instagram and Google were earning from advertising revenue contributed by Indian businesses and Netflix earning subscription sales from a large base of Indian users, these companies have been able to avoid payment of taxes in India as they do not have any significant physical presence in India.
  • Most international businesses are shifting to low tax jurisdictions, frustrating efforts of developing countries such as India that have been losing out on potential tax revenue, due to complications on taxing businesses that are conducted digitally.
  • India also introduced the concept “Significant Economic Presence” that underplayed physical presence rule for taxation, and gave more importance to the economic presence in India’s territorial jurisdiction, in the 2018 Budget. However, the provisions could not be operationalised until global consensus was obtained and international tax treaties suitably modified.

India’s equalisation levy

In 2016, India became the first country to introduce an equalisation levy in order to tax digital services such as online advertising or rendering of space on an online platform for advertising purposes in India. The two conditions to be met to be liable to equalisation levy:

  • The payment should be made to a non-resident service provider;
  • The annual payment made to one service provider exceeds Rs. 1,00,000 in one financial year.

The equalisation levy is fixed at 6% of gross consideration paid. Thus, if a person pays ₹2 lacs to any advertising platform such as Facebook, Instagram or YouTube, an amount equal to ₹12000 + applicable taxes, will have to be paid to the Central Government.

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OECD’s Unified Approach to Taxation

India, being a key partner of the OECD with one of the fastest predicted growth rates made representations regarding amendments to the existing nexus rules and inculcation of economic presence rules. The three-pronged unified approach to taxation carefully balances competing interests of various countries such as user participation demanded by the UK, marketing intangibles and significant economic presence advocated by India and other emerging economies.

According to the new approach, profits will be taxed on a three-tier basis –

  • Based on a pre-determined formula for sales, all residual profits would be allocated to countries where the market lies for the business – these have come to be called “new taxing rights”.
  • Thus India, with its large consumer base stands to benefit from these new profit allocation rules of Multinational companies.
  • It also proposes a fixed rate to remuneration for baseline marketing and distribution functions that take place in the market jurisdiction, particularly for capturing advertising and other services conducted over the internet impacting domestic users.
  • The third aspect is dispute resolution for compensation and distribution of tax revenue when extra profits are made by a company beyond what is compensated to the country.

Assessing Impact of the Changes proposed by OECD

While these changes are in line with OECD’s principles to prevent base erosion profit sharing (that is, shifting of a company’s base to avoid paying higher taxes), the actual implementation of these rules remains to be seen, especially in the context of large countries like the USA and many tax havens lobbying against it. However, undeniably the new rules favour India particularly due to their focus on sales and user base.

These rules also curtail ability of large digital companies to save taxation by shifting to low tax jurisdictions, but critics argue that companies’ profits and their ability to shift them offshore will barely be affected and consequently, developing countries will only see a very small increase in their corporate tax revenues, due to complexity in the rules.

Conclusion

The three basics of a good tax structure are certainty, simplicity, and neutrality. A unified approach in taxing profits made online is only a partial win for India, as issues such as what constitutes residual profits and other rules in this regard remain to be clarified.

In the context of ever-increasing profits of emerging digital businesses and the consequent loss of revenue to smaller nations, consensus must be evaluated by OECD and other multilateral institutions in light of the misalignment of economic interests between developing and developed countries.

Tax for Digital Economy – Why Google & Facebook may face tax liability?

234

For long, international tax laws were centred around physical presence in a country, to be subject to its domestic taxation norms. In effect, many brands in the digital space such as Google, Amazon, Facebook and off late, Netflix, Instagram and YouTube were able to escape tax nets, even in countries where they had a massive paying user base, routinely contributing to their annual revenues. The OECD has released a report in this regard that contains rules to regulate where taxes should be paid and on what portion should they be taxed. In this post, we analyse these changes in tax determination, tracing reasons and ramifications on online businesses in India.

Physical presence for taxing multinational companies

As per current rules of the Organisation for Economic Cooperation and Development, a country would be able to tax a multinational company only if a nexus is established through a physical presence in the country, known as a permanent establishment and only the profits traced to such a permanent establishment in the country are taxed.

Legal and practical issues in taxing digital businesses

  • While Instagram and Google were earning from advertising revenue contributed by Indian businesses and Netflix earning subscription sales from a large base of Indian users, these companies have been able to avoid payment of taxes in India as they do not have any significant physical presence in India.
  • Most international businesses are shifting to low tax jurisdictions, frustrating efforts of developing countries such as India that have been losing out on potential tax revenue, due to complications on taxing businesses that are conducted digitally.
  • India also introduced the concept “Significant Economic Presence” that underplayed physical presence rule for taxation, and gave more importance to the economic presence in India’s territorial jurisdiction, in the 2018 Budget. However, the provisions could not be operationalised until global consensus was obtained and international tax treaties suitably modified.

India’s equalisation levy

In 2016, India became the first country to introduce an equalisation levy in order to tax digital services such as online advertising or rendering of space on an online platform for advertising purposes in India. The two conditions to be met to be liable to equalisation levy:

  • The payment should be made to a non-resident service provider;
  • The annual payment made to one service provider exceeds Rs. 1,00,000 in one financial year.

The equalisation levy is fixed at 6% of gross consideration paid. Thus, if a person pays ₹2 lacs to any advertising platform such as Facebook, Instagram or YouTube, an amount equal to ₹12000 + applicable taxes, will have to be paid to the Central Government.

Get a FREE legal advice

OECD’s Unified Approach to Taxation

India, being a key partner of the OECD with one of the fastest predicted growth rates made representations regarding amendments to the existing nexus rules and inculcation of economic presence rules. The three-pronged unified approach to taxation carefully balances competing interests of various countries such as user participation demanded by the UK, marketing intangibles and significant economic presence advocated by India and other emerging economies.

According to the new approach, profits will be taxed on a three-tier basis –

  • Based on a pre-determined formula for sales, all residual profits would be allocated to countries where the market lies for the business – these have come to be called “new taxing rights”.
  • Thus India, with its large consumer base stands to benefit from these new profit allocation rules of Multinational companies.
  • It also proposes a fixed rate to remuneration for baseline marketing and distribution functions that take place in the market jurisdiction, particularly for capturing advertising and other services conducted over the internet impacting domestic users.
  • The third aspect is dispute resolution for compensation and distribution of tax revenue when extra profits are made by a company beyond what is compensated to the country.

Assessing Impact of the Changes proposed by OECD

While these changes are in line with OECD’s principles to prevent base erosion profit sharing (that is, shifting of a company’s base to avoid paying higher taxes), the actual implementation of these rules remains to be seen, especially in the context of large countries like the USA and many tax havens lobbying against it. However, undeniably the new rules favour India particularly due to their focus on sales and user base.

These rules also curtail ability of large digital companies to save taxation by shifting to low tax jurisdictions, but critics argue that companies’ profits and their ability to shift them offshore will barely be affected and consequently, developing countries will only see a very small increase in their corporate tax revenues, due to complexity in the rules.

Conclusion

The three basics of a good tax structure are certainty, simplicity, and neutrality. A unified approach in taxing profits made online is only a partial win for India, as issues such as what constitutes residual profits and other rules in this regard remain to be clarified.

In the context of ever-increasing profits of emerging digital businesses and the consequent loss of revenue to smaller nations, consensus must be evaluated by OECD and other multilateral institutions in light of the misalignment of economic interests between developing and developed countries.

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Avani Mishra is a graduate in law from the National Law Institute University, Bhopal. She qualified the Company Secretary course with an All India Rank 1 and is a recipient of the President’s Gold Medal for her academic distinctions. She also holds a B.Com degree with a specialization in Corporate Affairs and Administration.