Digital taxation: Why it's not good for India

The July 1 proposal by the OECD (Organisation for Economic Cooperation and Development) for digital taxation isn’t good news for India, or for countries of market (CoMs). By CoMs, one means countries where digital corporations market their services, but have neither their registered office nor any permanent establishment (PE). This will amount to substantial loss of tax revenue, even as it benefits the US.OECD countries have been trying to draft a digital tax system since 1997. For 24 years, it wasn’t able to come up with a viable one because of the digital ‘tax war’ between the US and the EU and Britain. This skirmish became so intense that Donald Trump threatened the EU with trade war. On his part, Joe Biden threatened every country that had imposed a digital tax with economic sanctions. India included, because of its equalisation levy.OECD’s July 1 statement claimed that 130 countries had agreed on the ‘Pillars 1 and 2’ proposal. According to the accepted principles of international taxation, a government can tax a person only if she or he has a ‘connecting factor’ with the government. There are two connecting factors — residential status of the assesse, and source of income.Any government can tax a non-resident (NR) only if that NR has a source of income in the concerned country. So far, income from a ‘permanent establishment’ was considered taxable. PE is defined according to physical presence. Digital corporations do not require any physical presence in the country of market (CoM). Google and Facebook are US companies with India as their CoM. They don’t need any PE in India for marketing their services here. They are virtually present in India. The only thing required by OECD was to accept the virtual presence in CoMs as the third connecting factor. It refused.Why didn’t OECD accept ‘virtual presence in market’? The largest digital corporations are in the US. Under the existing tax system, these companies are avoiding income-tax outside the US. If virtual presence in CoMs were accepted as a connecting factor, they would have to pay tax in CoMs. Under double tax avoidance agreements, the US government would have to give credit for that tax, with the US, thereby, suffering a loss. Hence US MNCs and government fought all proposals for digital taxation.Under the OECD proposal, an MNC will be subject to tax in a CoM if it sells physical as well as digital goods and services in a country, without necessarily having physical or virtual presence in that country. It will also be taxable if it has a group turnover of more than €20 billion ( Rs 1,750 billion) and a group profit more than 10%. An MNC will have to pay tax if the group’s published accounts are considered — since the tax officer will have little scope to investigate the figures given by the group. Only those countries will be able to tax an MNC from where the group receives more than €1 million annually. It will also be liable for tax if the tax paid in the CoM is set off against the tax payable by the MNC in its country of residence. At present, countries negotiating treaties have the freedom to adopt the OECD or UN model. Once the OECD proposal is accepted, they will have only the OECD option. Unilateral tax laws like the equalisation levy will then have to be dropped. This will cause a loss of tax revenue for India and similar CoMs.There are companies, like Telco and Unilever, that export goods. Once goods are exported and revenue is received, the business transaction is completed. They have no economic presence in a CoM, and should not be subject to tax there. Under the new proposal, Telco, without any presence in a CoM, and Google, with a virtual presence in the CoM, will both be considered at par. This violates the basic principle of economic presence.

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