Tax Reforms

[op-ed snap] The challenge of taxing value-creation in India


Mains Paper 3: Economy| Effects of liberalization on the economy, changes in industrial policy and their effects on industrial growth.

From UPSC perspective, the following things are important:

Prelims level: Not much

Mains level: Taxing Digital services in India


  1. French finance minister Bruno Le Maire announced the introduction of a GAFA tax—named after Google, Apple, Facebook, Amazon—on large technology and internet companies in France from 1 January 2019.
  2. What distinguishes technology companies from traditional businesses is user participation in creating value, which, in turn, translates into revenue.
  3. Although using consumer data to improve businesses is not exclusive to the digital economy, the unique ability of digital businesses lies in their power to analyse big data collected via constant user interaction and data mining.

Why needed?

The rationale behind devising a separate framework to tax online service providers is this:

  • Existing tax norms that are framed envisaging brick and mortar business models are not suitable to regulate online services.
  • This is because the digital economy is characterized by a unique system of value creation resulting from a combination of factors such as sales functions, algorithms and personal information of users.

Indian perspective

  • The need for India to consider the adoption of an accurate methodology to assess value created in India through user contributions so that digital service providers in India can be taxed more effectively.

Present Scenario

  1. The Finance Act, 2016, accommodated a 6% equalisation levy (EL) in lieu of specified digital services provided to residents in India. However, EL can only be imposed on advertising services.
  2. The Finance Act, 2018, the Income Tax Act was amended to expand the meaning of business connection to “significant economic presence”, which includes digital services.
  3. It defines any entity that have significant economic presence in India if it
  • provides data or software in India exceeding a payment threshold (yet to be notified) or
  • engages in systematic and continuous solicitation of business activities to a prescribed number of users digitally.

Issues from Indian Perspective

  1. When it comes to taxing value created by Indian users of foreign digital service providers, it is not clear whether the assessment of attributability is based on value creation per se.
  2. As the basis of attributability to Indian services/activities is not clear, this can raise a serious problem at the time of assessing income tax. For instance, ride-for-hire companies such as Uber use data of users as inputs to develop their surge pricing algorithm.

Equalisation Levy

  • Equalisation Levy was introduced in India in 2016, with the intention of taxing the digital transactions i.e. the income accruing to foreign e-commerce companies from India. It is aimed at taxing business to business transactions.

Applicability of Equalisation Levy

  1. Equalisation Levy is a direct tax, which is withheld at the time of payment by the service recipient.
  2. 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.

Issues in General

  1. OECD has been unable to devise a definite method of assessing the value that users generate in a source country.
  2. Due to this anomaly, the GAFA tax and other proposals floated in the EU, UK and France impose an approximate digital tax of 3% on the revenue generated by entities that operate in the digital economy above a certain threshold.
  3. This resulted mostly from the slow ongoing process of quantifying user contribution and political pressure to resist further delay of taxing these entities.
  4. The lack of consensus is exacerbated due to a difference in the interests of developed (residence) countries and developing (source) countries.
  5. The imposition of an EL instead of a more precise assessment of user contribution poses several questions regarding its enforceability.
  6. For example, countries like France have suggested imposing such an interim tax only on high profit big-tech businesses like Google and Amazon, making net valuation the metric for determining threshold
  7. An even bigger challenge is the assessment of value of user contribution in the source country is subjective.
  8. It creates greater friction between the government of the source country and where the entity is established and thereby undermine the efficacy of double taxation agreements.

Way Forward

  • It is imperative, therefore, that policymakers deliberate upon the possibility and feasibility of adopting a methodology to assess value creation objectively to tax digital players more effectively in the source country.
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