Taxation of income derived from electronic commerce
E-Commerce & International Taxation. - A Fresh Review of the Concepts
Rashmin Sanghvi.
The scope of Part II of the report may be described as under :
1. What is E-Commerce?
2. What are the principles of international taxation?
3. What are the challenges posed by E-Commerce to the principles of international taxation?
4. How these challenges can be met with? What are the suggestions?
Issues are discussed briefly in the following paragraphs :
C O N T E N T S
1. Elementary Principles of Taxation.
2. Concept of Neutrality.
3. Definition of E-commerce.
4. Issues raised by E-Commerce
5. Enlarged definition / Scope of E-Commerce.
6. Fundamental Principles.
7. Machinery Provisions.
8. Categorisation of Income.
9. Permanent Establishment.
10. Residential Status.
11. Withholding of Tax.
12. Future Possible Developments.
13. Suggested Tax System to take care of E-Commerce.
14. World Government.
15. Conclusion.
A Fresh Review of the Concepts.
The India report was drafted as per the guidelines provided - within the prescribed scope of country reports. In September, 2000 at the time of Munich Congress, the General Reporters & the Country Reporters discussed the scope etc. of the reports.
Several concepts have been already accepted by the OECD, OTTAWA Conference (1998) etc.
Summary.
In the OECD deliberations so far, it has been accepted that :
1. ‘Residential Status’ does not need reconsideration.
2. Concept of ‘Permanent Establishment’ can be applied to E-Commerce.
3. ‘Categorisation of Payments’ under treaties, for ‘sharing of tax jurisdiction’ between countries is okay.
4. Determine whether an income would be ‘Business Income’ or ‘Royalty’ (or ‘Fees for Technical Services’). Business income can be taxed only in the ‘Country of Residence’. Royalty and fees for technical services can be taxed in the ‘Country of Source’ on gross basis; as well in the ‘Country of Residence’ in the normal manner. The ‘Country of Residence’ should grant relief for taxes paid abroad.
Some of these concepts probably need a fresh review in the light of tremendous technological progress. A permission was granted to me to raise the issues and present my submissions on the concepts already “accepted”.
I am obliged for the permission.
The second part of my report carries these humble, conceptual submissions. I hope to learn from the esteemed delegates’ comments on this part.
This report reflects on the business environment known in October, 2000. By October 2001 when the next IFA conference takes place; the environment may change.
E-Commerce
1. Elementary Principles of Taxation.
Income-tax is a tax on income.
Since it is a truism, people often forget it.
Let us see the important aspects of this statement.
1.1 Income-tax is levied on net profits and not on sales. Governments are too happy to collect a withholding tax on turnover and take it as a final tax.
This is contrary to elementary principles of taxation. In India, it would be at variance with the ratio of Supreme Court decision in Sanyasi Rao’s case. Discussed in Part I, paragraph 10.)
1.2 While considering the tax liability one has to consider the actions etc. of only the earner of the income (the assessee) and not the “payer” of income (buyer of goods or services).
Let us illustrate this issue.
i. A hotel provides services to its guest. For the guest, the stay at the hotel may be a business trip or a vacation. The distinction in the customer’s purpose will determine whether the customer will get the deduction of the expense in computing his income or not. However, this distinction will not affect the taxability of the income for the hotel.
ii. A manufacturer of machinery sells machinery. When a whole-seller buys the machine, it is stock-in-trade for him. When a factory owner buys the machine, it is a fixed asset for him. In both cases, the tax treatment would be different for the buyer. But the machinery manufacturer’s income is not affected by the use of the machine in the hands of the buyer.
1.3 Income-tax does not depend upon the nature of business. And definitely not on means of communication used by the assessee.
Thus, a person may sell readymade garments or mobile phones or music cassettes. He may be a manufacturer or retailer. All these things make no difference. Once his net income is computed, it will bear the same rate of tax.
Whether a person sells his goods or services in a retail shop, by catalogues, on television marketing channel or on the internet website should not make any difference either in the taxability or in sharing of tax jurisdiction by different Governments.
The means of communication for attracting customers; for transacting business and for delivery of goods have no impact on taxation.
The concept of neutrality is an aspect discussed in the next paragraph. Here, what is highlighted is: tax is on income. Not on business. Nor on means of communication. Neutrality & nature of income-tax are two sides of the same coin.
We define e-commerce as commerce carried on through internet. Internet is nothing but a means of communication. An excellent and efficient technology. But still, a means of communication only. Now if we want to have some special rules of - taxation or exemption for e-commerce; it would mean that an income will be taxed or exempted depending upon the communication channel that it selects.
This cannot be accepted by anyone.
Hence the tax principles have to be neutral - whether you call a particular business as e-commerce or regular commerce.
It has been accepted by OECD and by most people - that the tax laws should be neutral. Hence it is not elaborated any further.
3.1 Definition & Neutrality.
Once we accept that neither the law nor the rules will be changed for e-commerce, what is the need for the definition?
There is no need for going into great lengths for defining e-commerce.
3.2.1 Technology & Definition.
E-Commerce enjoys benefit of the convergence of Computer Software & hardware; telecommunication; television; satellites; wireless transmission and so on. All these technologies are constantly progressing at a frenetic rate. The combined effect of improvement in several technologies together is mind boggling. It has opened up opportunities not imagined earlier. In the year 1991, no tax expert might have thought of E-commerce. (Though Alwyn Toffler had already written on it in his book “Power-Shift”.)
All indications are that this fast change in technologies will continue for a few years. This quite likely means, in next five years, we will have means of communications and methods of doing business - which we, the tax professionals cannot even imagine today.
Businessmen will be fast to grab every new technology that improves their business, efficiency; and profits.
Tax professionals & legislators are, by their very nature, slow. They take several years before they can change a law.
When we consider both these facts, the gap between the business and law will keep increasing until the law becomes irrelevant.
The position can be resolved in the following manner - Law should provide for fundamental principles which do not change with technologies. And law should not have provisions dependent upon ever changing technologies.
Illustration - In May 2000, Indian Parliament passed the Information Technology Bill. In October, 2000; the minister Mr. Pramod Mahajan has already realised that the use of the word “Computer” in the bill is not proper. Computer is already being replaced by so many other instruments. He is searching for some neutral phrase in place of the word ‘Computer’.
3.2.2 Current Popular definition of e-commerce is -
“Commerce transacted through internet”.
For the purposes of this report, IFA has provided that business will be called e-commerce when - “Commercial transactions are placed electronically and the goods or services are delivered in tangible or electronic (digitized) form”. Electronic form covers internet, intranet or extranet.
Hence the transaction of business (agreement to buy & sell) is important. Actual business - the delivery of goods & services may be done in any manner. That will not affect whether a transaction would be called e-commerce or not.
Internet (including intranet & extranet) is understood to be a communication system consisting of - (i) Computers - hardware; (ii) Computer softwares including websites; (iii) Telecommunication - including telephone instruments, telephone cables and / or satellite links, gateways & ISPs.
Several components of this internet system are replaceable.
i. Now people communicate with mobile phones and palms. Computers and regular telephones have been replaced by the mobile phones.
ii. Some experts are already claiming that very soon, people will be communicating through the mobile phones without internet.
iii. E-mails can be transmitted even through electricity cables or television cables. Telephone cables are easily avoidable part of internet.
If the internet is dropped from “mobile commerce”, we will not be able to call it “e-commerce” under the above stated definition.
Hence we will have to change the definition.
If, in the year 2002; some new technology replaces all existing technologies; shall we again change the definition of e-commerce?
3.2.3 The issue is - technology and instruments of communication will keep changing forever. Best solution is not to define e-commerce.
3.2.4 Just describe e-commerce. This will help in focussing our discussion.
Even the description of e-commerce may be confined to academic discussions. In the law, there will be neither definition, nor description.
Then there will be no need for frequent amendments in the law.
Underlying principle is simple. Law, a slow moving giant will not be based on fast changing parametres.
4. Issues raised by E-Commerce
4.1 Developments
4.1.1 Modern Communication systems have made it possible that an assessee can do a complete business in a country without having any physical or personal presence in that country.
4.1.2 Software - websites have developed to such an extent that a contract can be entered into without the need for any human intervention. On line-booking of air tickets; on line, purchase of books, music, videos etc; are examples of contracts executed by the software itself.
4.1.3 In case of digitised services like music, films, writings etc. - even the end-products can be delivered & payment received without human intervention. Digitisation has opened up several opportunities never imagined till 1990.
Entire entertainment performances can be broadcast simultaneously to the whole world. What was earlier sold in physical forms (books, cassettes etc.) can be now e-mailed in digital forms.
This has further facilitated global business without global personal / physical presence.
4.1.4 Global, efficient and online communication (written, spoken and visual) has made it possible to have control, management and several aspects of the business of a company - truly global in nature.
4.2 Challenges
With all these developments, old principles of taxation; and assumptions that have gone into these principles have been challenged.
4.2.1 Permanent Establishment :
The concept of ‘Permanent Establishment’ is based on the assumption that to earn income in a country, physical presence in the country is necessary. (More discussion on this issue is given in paragraph 9) E-commerce makes the presence redundant. Today, a person can do business in any place without the need of his physical presence.
4.2.2 Residential Status.
Under this concept, it is believed that a company may be resident in only one country. Today globally integrated companies are possible because of the communication systems. They cannot be said to be resident of any one country. (More discussion in paragraph 10).
4.2.3 Challenges to different degrees had started even with the improvements in telephone & other communication systems. However, internet, web-pages etc. have together made things possible which were not even imagined earlier. This is a quantum jump. Now a stage has been reached where “retrofitting” of existing laws will not help. Altogether new concepts may have to be worked out.
4.2.4 While some fundamental principles of taxation may not require modifications, some principles and machinery provisions will require complete redrafting.
5. Enlarged Definition of E-Commerce.
To highlight the challenges posed by development of e-commerce, may we consider an “enlarged” definition / description of e-commerce!
5.1 "Commerce conducted remotely - without personal presence at the place of transaction”.
This would cover all commercial transactions irrespective of the medium of communication used. Business may be done through - internet, telephone, fax, television cables, radio or any other medium that may be developed in future.
The distinction between regular commerce and e-commerce would be that - under e-commerce, the assessee would not be present at the place of business. Hence all the challenges posed by e-commerce to the existing principles of taxation would still be applicable under the new definition.
Our focus of discussion is cross border commerce. However, e-commerce by itself can cover domestic as well as international commerce.
5.2 Scope of E-Commerce
5.2.1 As per the IFA definition, if business is not transacted over internet, it is not e-commerce.
As seen separately, the main tax issue raised by e-commerce is that an assessee can do business in another country without having presence in that country. This has been made eminently possible by internet. However, it is also possible without internet.
5.2.2 Illustration.
There is a tele-marketing channel company - say TCC Ltd. This company is doing marketing of several consumer goods over normal television and cable-television. The telecast is made to several countries around the world.
People place orders by telephone / fax / letters. They send remittances by banks’ telegraphic transfer or posting the cheques. Goods are supplied through courier / postal services.
5.2.3 Now this business is almost like an internet marketing. It raises the same issue of tax jurisdiction. TCC Ltd. is doing business in several countries without having physical presence there.
Why should this not be considered e-commerce?
5.2.4 One can safely assume that the constantly developing technologies will soon offer alternatives better than present internet system. Hence the scope of e-commerce must be kept as open & wide as possible.
6. Fundamental Principles : NEXUS & Sharing of Jurisdiction.
I believe, the fundamental principles accepted globally for sharing of tax jurisdiction between Governments are :
6.1 A Government has the right to tax global income of its residents. (Residential status of the assessee.)
6.2 A Government has the right to tax all income sourced within its country even by non-residents. (Location of Source of Income.)
6.3 These two principles when accepted by all Governments, by their very nature, create overlapping jurisdictions.
To avoid “Double Tax”, following mechanism is accepted.
6.4 The “Country of Source” will levy a lower than normal tax on the non-resident’s income.
The “Country of Residence” will levy tax on all income and will give relief for taxes paid at the “Country of Source”.
These fundamental principles can be applied to all kinds of incomes earned from any activities.
To put these fundamental principles into practice, some machinery provisions are required.
6.5 May we reflect on the fact that even `fundamental principles’ have not been clearly stated in the model conventions! They are simply taken for granted.
The experts in the field believe that everyone knows them.
Fact of the life is that most of the assessees, tax practitioners and tax officers; do not know what are `fundamental principles’.
Concepts of “Permanent Establishment”; and “Categorisation of Payments” are the machinery provisions developed for applying the fundamental principles.
7.1 The correct machinery provisions should have been - detailed source rules covering every different kind of income. Once the source rules are there, everything falls in place.
However, for some historical reasons, CFA in OECD did not develop elaborate source rules. They went for broad simple categories of income.
For different categories of incomes, different rules have been provided for sharing of jurisdiction.
It is evident that the underlying thought behind sharing of jurisdiction has to be the source principle. However, this thought has not been stated. The sharing of jurisdiction is linked in a simple manner with categories of income.
7.2 It has been presumed that all business income is sourced where the assessee is resident. Except where he has a permanent establishment (PE) abroad. The “Country of Residence” has the right to tax all the income. “Country of PE” has the right to tax income earned by the PE.
“Country of Residence” will tax even this income (earned by foreign PE) but will give credit for the foreign tax.
7.3 Can a businessman have his source of income in a country where he is neither resident nor does he have a PE?
This probability was never considered.
A presumption was made that the income is sourced only in the countries of residence or PE.
Hence a rule is made that the business income will be taxed in the country of residence and PE.
7.4 Where is the rental income from immovable property sourced! Very simply the country where the property is located.
This is one instance where the category of income and the source of income both give the same results. And hence there are no controversies on this kind of income.
7.5 Where is the royalty income “Sourced”?
This question has not been raised, so no one has answered it.
It was presumed that a businessman does all the research, development and experimentation in the country where he resides. So naturally that is the country of source. Hence it has been accepted that the royalty income should be taxed only in the “Country of Residence”.
How wrong can be the presumption!
Today there are so many companies that are having their complete technologies developed outside their countries of residence! These technologies are patented globally and become source for continuous royalty income.
7.6 Is the “Country of Payment” - the “Country of Source”? Of course not.
Illustration
If General Motors manufactures a car in U.S.A. and exports it to Mr. Gerald in Germany, which is the “Country of Source”? The German resident Mr. Gerald makes the payment. He uses the car in Germany. So is the “Country of Payment”, the “Country of Source”?
No. The car is made in U.S.A. ; the entire “value addition” is made in U.S.A. and hence U.S.A. is the “Country of Source”.
The “Country of Residence” for General Motors is also the “Country of Source” for the business income. Hence there is no controversy.
7.7 However, when it comes to `Royalty’ ; so many Governments have simply presumed that the “Country of Payment” is the “Country of source”. Sometimes, they even argue that the technology for which royalty is being paid ; is used in the “Country of Payment” and hence the “Country of Payment” has a right to tax it.
The fact that Gerald is using the GM car in Germany does not raise any claims that Germany should tax GM’s income. Why should similar situation raise a demand for tax jurisdiction in case of royalty?
Since “Country of Payment” is not the “Country of Source”, OECD has clearly recommended that the “Country of Payment” should not levy any tax on the royalty payment.
Almost all countries want to levy income-tax on the royalty payments being made from their country. So almost all countries have ignored the OECD recommendation and levied withholding tax on royalty payment.
7.8 If we accept that a non-resident’s income may be taxed in the “Country of Source”; then both - the presumptions - the “Country of Payment” and the “Country of Residence only” taxing the income become redundant.
Tax the income where the substance for royalty income - the source is located.
(Please see the Categorisation of Payments paragraphs.)
8.1 I do not know as a matter of fact, why income was categorised into separate heads. The only logical reason seems to be computation of income. Salary income does not need all the details required for computing business income. Computing dividend income is still a different game. So different provisions have to be made for each category of income. Hence different categories of income.
However, having computed incomes from different sources and categories ; all the incomes constitute one figure of “Total Income”. This figure has to be applied normal income-tax.
8.2 Sharing of tax jurisdiction has to rest entirely on “source of income” and “residential status of the assessee”.
[“Country of Residence” has full right to tax global income. “Country of Source” has a right to levy limited tax on income sourced within the country but earned by non-residents. Country of Residence grants relief for taxes paid at the “Country of Source”.]
8.3 However, as seen in the paragraph on “Machinery Provisions”; World community has made several presumptions. The consequence is that :
Business income is taxed in the country of residence. It is not taxed in the “Country of Source”.
Royalty income is taxed in the “Country of Payment” and “Country of Residence”.
8.4 All countries want to levy tax on moneys flowing from their countries. Hence they would like to categorise most “Payments” as “Royalties”.
But the non-resident assessees do not want to pay tax in a foreign country. So they would like to categorise most incomes as “Business” incomes.
Hence all the controversies and spending of tremendous time and energies over Categorisation of Income.
8.5 Professor Richard Doernberg, in his IFA Report on “E-Commerce and taxation” has raised the issue why categorisation at all?
“Income is Income - Distinction between different types of incomes are artificial”.
Page No. 335 in the first edition of the book.
8.6 I categorically submit that “Categorisation of Payments” should have no role in sharing of tax jurisdiction.
Only “Source of Income” and “Residential Status of the Assessee” are relevant.
8.7 The OECD TAG on Categorisation of Payments has not discussed the fundamental issue of ‘source’ of income. It has simply tried to determine in the 27 illustrations given; whether an income might be categorised as ‘Royalty’ or “Business Income”. Once it is royalty, the country of payment acquires jurisdiction to tax the income on ‘gross’ basis. If it is “Business Income”, there is no right to tax.
9. Permanent Establishment (PE)
9.1.1 Historical Background - Technology & Business Environment.
When the principles of permanent establishment were formed (the first model convention was drafted by OECD during 1956 to 1963. And for the moment we ignore the work done by League of Nations.) business world did not have computers. Nobody heard of internet. The communication and transport systems available to the common businessman were - as compared to the current systems - extremely slow, costly and inefficient. If one had to do business in another country, he had no choice except establishing a physical presence in the other country. He would open a branch, a factory or some such presence. When the first Committee on Fiscal Affairs drafted the model convention, naturally, it considered the business environment then present.
Hence we have these concepts -
“Fixed place of Business” ; “Permanent” and “Tangible existence”. The word tangible is not in the PE definition. However, OECD, TAG has opined that since a “web-site” is not tangible, it cannot be called an “equipment” and hence not a PE. Please see the draft report on “Categorisation of Payments” by TAG.
9.1.2 Change in technology.
Now E-Commerce is commerce transacted electronically. Communication messages are transmitted through electronic medium. The system is run by software. All softwares are nothing but electrons stored or arranged in specific manners.
Electrons are pure energy.
Something, by nature, contrary to the concepts “Permanent”, “Fixed”, “Tangible”.
9.1.3 Attempts at applying these PE principles to today’s e-commerce are like applying the rules and laws of a horse carriage to an automobile car. It looks illogical. However, it is a fact. When the initial automobiles were made in the nineteenth century by several companies, they were almost replicas of horse carriages. Till then, people had not conceived the idea of an automobile car. So when they first made a car, they almost put an engine onto a horse carriage. They could not think of a totally new design though the motive force and hence total engineering had changed.
(Pictures of these classic cars and short stories on the same are available on the following website: https://www.ausbcomp.com/~bbott/cars/carhist.htm In these cars, even bonnets & dickys were not there. The car engine was placed below the body of horse carriage.) Several individuals and companies went insolvent before a successful model was made.
With experience they learned.
And today we have a car totally different from horse carriages.
Applying PE principles to e-commerce is like those first automobile cars.
However, we have the benefit of other experiences. Can we design new rules conceptually and totally; because the technology is new!
If we don’t, very soon we will learn by experience.
9.2 Threshold Presence
9.2.1 There is a fundamental thinking in the concept of PE. A non-resident person doing business is not liable to tax in a country unless he has a presence in the country beyond a threshold. If he has a presence beyond the threshold, he is doing business “in the country” and is liable to tax. If he has a presence within the threshold, he is simply doing business “with the country” and is not liable to tax.
The presence within the country was required because of the business environment during the fifties and sixties as explained above.
Now the position is such that any businessman can do complete business (of several types) in another country or several countries without requiring any personal presence in those countries.
Several companies have devised complete plans around PE definition to avoid any tax in the source country and yet do substantial business in the country.
9.2.2 Illustration
A British Financial Institution (BFI) invests $100 millions in India. It appoints share brokers to buy and sell shares and securities. They are all independent agents. It appoints custodians to act as attorneys, sign transfer forms and hold securities. The custodians are independent agents.
The BFI staff sitting at London can watch on “Reuters” screen up-to-date price movements and then give instructions to the Indian brokers.
The BFI gives instructions to the bank for payments via “secure payment system” through internet. It has a subsidiary company in India doing research and analysis. All sales and purchases are made in India. Complete profits or losses are made in India.
However, there is no physical presence in India.
Should this income be taxed in India or not!
Can the threshold of physical presence be of any use when the modern communication systems make it (physical presence) redundant!
In my submission, the very concept of permanent establishment has become redundant for e-commerce - even under the enlarged definition of e-commerce (paragraph 5).
Instead, a threshold of amounts received from a country can be set up to trigger tax proceedings. (Please see paragraph 12.2 for further discussion on the concept.)
10.1 The very concept of residential status of a non-individual entity is under challenge. A company is considered to be the resident of a country where it is incorporated.
With the global, online, efficient communication systems, already there is no connection between the place of incorporation and place of actual business. In fact, the place of business maybe global. Legitimately, no country may be able to call these global companies as its resident.
Consider an illustration.
10.2 Globally Integrated Corporation.
There is a Global Software Development company - GSD Ltd. It has ten thousand software experts. It has branches in fifty different countries. The company is incorporated in Bangalore, India. Most of these software experts are senior professionals. They do not work like “employees” of the company. They work on an “autonomous” basis.
The shares of the company are quoted in ten country exchanges. Sixty percent of the shares are held by persons residing outside India. Directors of the country reside in six different countries. Most of the board meetings are held as virtual conferences. There is no one place from where the company can be said to be “controlled & managed”.
Each country unit and each functional unit is almost independent. The common factors binding all the branches together are their code of conduct, the goodwill, the quality standards; and booking of business everywhere & development of software where the key strength required for the job is available.
Two thousand software experts work in India and eight thousand experts work in the rest of the countries.
10.3 Now, is it fair for Indian Government to claim levying full income-tax on the profits earned by all ten thousand professionals around the world - (The branches in the fifty countries may have clients in hundred countries.) - on the ground that it is an Indian “Resident” company!
Just because the company was, at a historical point in time incorporated in India?
10.4 This is not a very serious tax problem at the first level.
Each branch is a ‘permanent establishment’ in the country where it is located. The concerned countries will levy full income-tax on the net profits of the branch as business income.
Now India will, as per the present law, levy tax on the incomes earned by the 49 branches also. However, quite likely after giving credits for the full corporate taxes paid abroad, there may not be much left for Indian Government to recover from the company. (Indian corporate tax @ 35% may be lower than the tax payable in several countries.)
10.5 Still, the issues that remain are:
10.5.1 Should the Indian Government have any right to levy the tax of even a single rupee on the foreign branch profits? Government of India has not contributed anything to those branches’ capacity to do business.
10.5.2 The company declares dividend. It is financed mainly by profits from business abroad. 60% of the dividend will be earned by non-residents. Does the Indian Government have a moral right to levy any tax on this dividend declaration just because the company was incorporated in India?
Which is the country where this company is resident?
Which country should have a right to tax its Global income?
10.6 In my submission, the concept of residential status cannot be applied to Globally Integrated Companies. Do away with the residential status. They should be taxed on - “net profits earned” in each country separately. This will be “source based taxation”. There will be no other country levying tax on their income & hence no double tax.
Several concepts will have to be used for determining the country wise income of the company. For example - “Transfer Pricing”, attribution / allocation of income & expenses etc.
11.1 WOT serves following purposes :
i. Quicker Time - You pay at the same time as you earn. Do not wait till the end of the year.
ii. Quicker Time - You pay at the same time as you earn. Do not wait till the end of the year.
Normally, these can be the only purposes for WOT. There can be no other purpose. And it has to be noted that in both cases, the assessee suffers some inconvenience while department gains. Balancing the two, it is better to impose WOT.
11.2 A third benefit for the department has crept in the system.
(iii) No Assessment Proceedings.
If WOT is accepted as final payment, the department does not have to scrutinise the accounts of the assessee. No need to bother whether the assessee has made profits or losses.
It becomes specially helpful in cases of non-residents. It is extremely difficult for the department to verify the statements made by a non-resident.
Hence Governments love to make WOT a final tax payment.
11.3 This is where illegality comes in.
And the balance of convenience is shattered.
Department collects income-tax irrespective of whether the assessee has made profits or not. It strikes at the root of the elementary principles that “income-tax is levied on ‘income’ and not on ‘turnover’.” And if there is no profit, there can be no tax.
The fact is that many non-residents do not protest the department’s claim because they do not want litigation in a foreign country. They take it as the cost of operating in India and forget the WOT. They consider only the net amount received by them as the turnover.
11.4 In case of E-Commerce, WOT will be more & more prevalent. It is necessary that clear guidelines placing appropriate limits on WOT are drafted.
12. Future Possible Developments :
Assume tremendous developments in e-commerce technologies.
12.1 Present design of the computer keyboard is dumb. It is primarily meant for typists, accountants and other desktop operators.
Mouse is a slight improvement over the keyboard.
There is a great promise in the concept of computer games which children play. They have hand held instruments like guns. No keyboards. When the child fires the gun, the man in the computer (software) “dies”.
Technology is already available where two children sitting in two different countries can play games on computer.
12.2 Let us anticipate that the technology will be so developed that :
(2.1 to 2.6 - six different stages are projected.)
12.2.1 A computer operator fires a gun in Mumbai, the software installed in a computer located at New York responds. (No keyboard is used.)
12.2.2 The computer is installed inside a machine called a robot.
So when the Mumbai operator gives certain instructions on the instrument held by him, the robot sitting in New York will move its parts and do a work.
A simple, truncated display on the computer screen will be replaced by actual physical action at the other end.
12.2.3 How does a person operate a robot in the factory? The same instruments will replace the keyboard.
12.2.4 Through the communication system, the distance between the robot and its control instrument will be increased. Through the online camera and video system, the personal presence will not be necessary for visually checking what the robot does.
The Video Camera need not be installed on a table top. It can be installed in the robot.
Remote operator will be able to actually see and hear what the robot at the other end is doing and what are the results of its actions.
12.2.5 Wireless Communication will replace telephones, cables etc. It will make both, the operator and the robot freely mobile.
Now a doctor operating from his hospital in Mumbai will be able to perform surgical operation on a patient lying in the New York Operation Theatre.
12.2.6 We can say that the next convergence of technologies will be amongst internet, robotics and wireless communication and remote controls.
12.3 Where is the value addition made? Does U.S.A. have a right to tax the doctor’s income as the “Country of Source”? Services are rendered from India. Services are used (utilised) in U.S.A.
12.4 Notes :
12.4.1 A lot of all these projections have already become a reality. (So actually they are not “projections”.) We have had toy robots and cars working by remote control panels for several years. Only developments required are-
a. Take the toys to commercial and medical levels.
b. The need for physical presence, “operating within eyesight” has to be replaced by Cameras and Videos.
12.4.2 At another level, American / Russian satellites going on another planet, taking photographs, landing, lifting rocks from that planet - are already historical events. What is now needed is to make this technology commercially available to the common man.
12.5 All these developments still reduce to one basic tax issue. An assessee, while physically present in one country is operating in another country - where he is not present. Where is the value addition made? Who should tax the income?
This is different from a company doing business in another country where it has no permanent establishment. In this paragraph we are discussing the situation where an individual is rendering services in one country and simultaneously, the customer is receiving the service in another country. Rendering & Utilisation of services are split by a few thousand kilometres.
13. Suggested Tax System to take care of E-Commerce.
When several controversies are yet to be resolved, talking of the final tax system to take care of e-commerce may be optimistic.
With all humility, may I make a few suggestions for the new system! These are simply, the first proposals. They need to be considered, debated & refined.
13.1 Source Base.
One solution may be, each country may levy income-tax only on the income sourced in the country. In case of income earned from several countries, the amount that can be allocated to the country may be worked out by applying all the concepts & rules of transfer pricing, allocation and attribution of incomes & expenses. (Paragraph 10.6)
13.2 Source Rules.
Detailed source rules should be prescribed. The liability to tax should depend upon whether the income is actually sourced in that country or not. It will be accepted that just the “receipt” or “payment” do not constitute “source”. (Paragraph 7.7).
13.3 Value Addition
Source rules will be elaborate. They will go deeper into where actually the “Value addition” has been made. This will be the crux of the factor determining the location of source and not a simple, broad “category” of income. (Paragraph 7).
13.4 Relevance of the Assessee.
For determining the tax liability of an assessee, the factors pertaining to the assessee shall be considered as relevant. What the payer or the customer does with the goods or services will be irrelevant. (Paragraph 1.2).
13.5 Categorisation.
Categorisation of incomes will be only for the purpose of “computing” taxable profits. It will have no significance for sharing tax jurisdiction. (Paragraph 8).
13.6 Internet & other communication systems.
The instrument used for communication will have no importance. Entire chain of communication shall be ignored. (Paragraphs 3 & 5).
13.7 Abolition of Permanent Establishment.
The concept of permanent establishment may be abandoned. (Paragraph 9) If any assessee receives any amount in excess of a threshold (say U.S. $ 10,000); a tax on gross amount @ 5% will be deducted at source and paid to the country of payment. The assessee will always have an option to file its income-tax return and claim that its income-tax liability is lower. The assessing officer will have a right - where the receipt is in excess of a threshold (say U.S. $ 1,00,000); to serve a notice on the assessee requiring him to file an income-tax return and show the correct profits. In case, the correct tax liability is more than 5% of the gross receipt, assessee will be liable to pay the correct tax. Where the deduction of tax is insufficient, it shall be the assessee’s liability to pay “advance tax”.
13.8 Residential Status.
13.8.1 The concept of residential status may be abolished. Each assessee would be liable to tax in a country only if he has a source of income in that country. (See paragraph 10.)
If an assessee sets up a company in a tax haven and does business in, say, U.S.A.; it is okay. The income earned in U.S.A. will be taxed irrespective of ‘residential status’ and ‘permanent establishment’.
Such a tax system can meet the criteria of neutrality and fairness. It can take care of growing technologies and globalisation. The whole problem of “Double Tax” will be avoided. There will be no need for “Double Tax Avoidance Conventions”.
The issue is, will the Governments let go of a tax base they already have?
There are a few countries that have adopted source based taxation. They have prospered economically tremendously.
13.8.2 Present system of international taxations gives more importance to “Residence of the assessee”. The logic could be, After all the assessee makes global income because he is provided all the infrastructure, stability & protection etc. by the country”.
For a source based tax jurisdiction system, the logic could be as under: “Earning of income is possible because of the infrastructure, stability & protection provided by the Government”.
If one of the two logics are accepted, the problem of ‘Double Taxation’ can be simplified. When both the logics are applied, the problem of overlapping jurisdiction is bound to remain forever.
Even if both the logics are accepted, one may consider:
Should we continue to give more importance to the ‘Residence of Assessee’ or should we give a fairly equal importance to both - ‘Residence’ & ‘Source’!
13.9 Option to File Return.
The assessee should have an option to file returns and claim that though he has “received” income from a country, its “source” of income lies outside the country. Hence he has no liability to pay any tax. He can claim refund of tax deducted at source. (Paragraph 7.7)
13.10 No Objection Certificate.
He can also obtain a certificate from the tax authorities, in advance - confirming that he is not liable to tax; and that no payer should deduct any tax at source.
13.11 Splitting the “Rendering” & “Performance” of Services.
A decision may be taken on allocation of tax jurisdiction when an individual (say a doctor) sitting in one country provides services to another person (say a patient) sitting in another country. (Paragraphs 12.2 & 12.3).
Dr. Neale Walsh, in his book - ‘Conversations with God’ (book2) has one whole chapter on “World Government”. He says, God would prefer to have a democratic world government on earth.
Electronic Communication will make it far easier to have a truly democratic global Government. E-communication makes global communication from all to all extremely efficient and easy.
If there is just one Government to collect income-tax, there will be no question of sharing of tax jurisdiction. No need for bilateral / multi-lateral treaties. There will be no tax havens.
Till 1947, India consisted of over 600 kingdoms. Today, there is only one Central Government collecting all the taxes. And there is no dispute about sharing of income-tax.
A similar attempt is being made by European Union.
One day, all countries may voluntarily form a single tax collecting federal authority having global jurisdiction.
In business, e-commerce has proved to be a “Great Leveller”. Large companies with huge resources are on same level as small companies with limited resources. Similarly, developed & developing countries can come almost at par for e-commerce.
I hope, similar revolution in taxation field will bring all Governments on a level playing field.
Rashmin Sanghvi.
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