Transaction tax

Digital taxation proposal: why it’s complicated and not good for India


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The July 1 OECD (Organization for Economic Co-operation and Development) proposal for digital taxation is not good news for India, nor for market countries (CoM). By CoMs, we mean countries where digital companies market their services, but do not have their head office or permanent establishment (PE). This will amount to a substantial loss of tax revenue, even if it benefits the United States.

OECD countries have been trying to develop a digital tax system since 1997. For 24 years, it has been unable to come up with a viable one due to the digital “tax war” between the United States, the EU and Great Britain. This skirmish has become so intense that Donald Trump threatened the EU with a trade war. For his part, Joe Biden threatened all countries that had imposed a digital tax with economic sanctions. India included, due to its equalization tax.

The OECD July 1 statement said 130 countries had agreed to the “pillars 1 and 2” proposal. According to accepted principles of international taxation, a government can only tax a person if he or she has a “connecting factor” with the government. There are two connecting factors: the status of residence of the appraisee and the source of income.

Any government can only tax a non-resident (NR) if that NR has a source of income in the country concerned. Until now, the income of a “permanent establishment” was considered taxable. PE is defined based on physical presence. Digital businesses do not require a physical presence in the country of the market (CoM). Google and Facebook are American companies with India as CoM. They don’t need PE in India to market their services here. They are practically present in India. The only thing required by the OECD was to accept virtual presence in CoMs as a third connection factor. He refused.

Why did the OECD not accept “virtual market presence”? The biggest digital companies are in the United States. Under the current tax system, these companies avoid income tax outside of the United States. If virtual presence in CoMs was accepted as a connecting factor, they would have to pay taxes in CoMs. Under double taxation avoidance agreements, the US government would have to provide credit for this tax, resulting in a loss for the US. This is why the multinationals and the American government fought all the proposals for digital taxation.

According to the OECD proposal, a multinational will be subject to tax in a CoM if it sells physical and digital goods and services in a country, without necessarily having a physical or virtual presence in that country. It will also be taxable if it has a group turnover greater than 20 billion euros (Rs 1750 billion) and a group profit greater than 10%. A multinational will have to pay taxes if the group’s published accounts are taken into account, as the tax officer will have little leeway to investigate the figures given by the group. Only these countries will be able to impose a multinational whose group receives more than one million euros per year. It will also be liable for tax if the tax paid in the CoM is offset against the tax payable by the MNC in its country of residence. Currently, countries negotiating treaties are free to adopt the OECD or the UN model. Once the OECD proposal is accepted, they will only have the OECD option. Unilateral tax laws such as the equalization levy will then have to be abandoned. This will result in a loss of tax revenue for India and similar CoMs.

There are companies, like Telco and Unilever, that export goods. Once the goods are exported and the income is collected, the business transaction is complete. 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 au pair. This violates the basic principle of economic presence.

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