[op-ed snap] Taxing new spaces

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Nothing much

Mains level : Taxing digital spaces

Context

The proliferation of technology has challenged conventional notions of economic activity. This is now a serious challenge for the taxation policy. 

Taxing challenge: Physical presence

    • The existing law’s tax business profits based on its physical presence in a country.
    • Such a pre-condition was conceived in the 1920s. It is now dated since digital businesses no longer have to be physically present to operate in and interact with an economy. 

Challenge in taxation: use of intangibles

    • They are often registered in low tax jurisdictions which frustrate the efforts to appropriately tax digital companies.

BEPS report

    • The Task Force on Digital Economy at the OECD mentioned three measures
      1. an equalisation levy
      2. withholding taxes 
      3. New nexus rule
    • The first two are taxes on the gross turnover whereas the new nexus rule was to modify the taxable nexus beyond the physical presence in a country. 
    • Though it was agreed that data and user participation are critical for a platform, no consensus emerged on their economic contribution. 
    • The OECD continued to work on value-creation by various business models. 

Equalisation levy

    • In 2016, India was the first to apply an equalisation levy. 
    • 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. 
    • 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. 
    • The potential ramifications of these taxes could be over-taxation or a pass-through of costs to consumers. Such measures can give market jurisdictions greater power to tax.

Economic presence

    • In 2018, India proposed its long term solution to the problem — test for significant economic presence. 
    • The amendment was based firmly on the understanding that if a digital platform reported sales from a country or had a significant number of users it should be considered as having a taxable presence in that jurisdiction. 
    • Challenges
      • For the law to be applicable, treaties would have to be suitably amended. 
      • The more fundamental issue of what size of operations would qualify as economic presence needs to be answered. 
      • Even if a business qualifies as having an economic presence in India, how much of its profits should be taxable in India.

Redistribution of taxing rights

    • The political issue of taxing rights is more debated.
    • US President Donald Trump’s response to the French digital tax applicable to big tech companies predominantly residents of the US highlights this.
    • The OECD published a policy note which split the work plan into two pillars
      • Pillar one would examine the allocation of taxing rights
      • All anti-avoidance measures would be considered under the second pillar

Indian participation

    • Programme of Work published in May 2019 incorporates India’s key proposals
      • significant economic presence and fractional apportionment
      • the Modified Residual Profit Split
      • the distribution approach
    • The OECD released its draft for a unified approach earlier this month. 
    • The three proposals in the earlier draft have been tied together to present a complicated compromise. 
    • Also proposed is splitting up of global profits of a corporation into routine and non-routine. 
    • Then a fraction of non-routine profits would be allocated to the qualifying market jurisdictions and if there is any dispute arising from such taxation it would be resolved through mandatory or binding dispute resolution.

Challenges to this new approach

    • This would require serious effort and a harder consensus on issues such as what constitutes routine profit. 
    • The promise of an overhaul is oversold because carve-outs are anticipated for sectors such as mining and financial services. 
    • A unified approach backing the new nexus rule is only a partial win for India. 
    • The reliance placed on conventional transfer pricing could make the taxation of digital companies messier. 

Way ahead

    • India is in a unique position as it offers a wide user-base and thus a large market for digital companies. 
    • Consensus must be evaluated in light of the misalignment of economic interests between developing and developed countries. 
    • A good tax system must have the axes of certainty, simplicity, and neutrality. 
    • An alternative may be to switch to a simpler withholding tax architecture.
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