Understand Proposed Digital tax.

All through the past few months, the finance dailies have been talking about the introduction of a new regime of taxing digital transactions and the abolition of the Equalization Levy. The article is an attempt to simplify digital taxation and address some of the key points of the proposal. What is the whole discussion about?

Let's imagine that a company headquartered in the UK (UK Co) wants to sell its products or services worldwide. Digitization of business ensures that UK Co does need not have an office or place of business or even people in any other countries. UK Co has successfully established a strong customer base worldwide. However, it does not pay tax in any of the countries where its customers are based. Further, if the UK Co shifts its base or critical operations from the UK to any other low tax country, the UK loses tax revenue to another country.

The quantum of business conducted in the market jurisdictions, as well as the tax revenue lost by nations due to country shopping, is so huge that OECD (Organisation for Economic Co-operation and Development) / G20 member states have come together to tax such companies based on income generated in the market jurisdiction.

On October 8, 2021, 136 leaders of the OECD / G20 Inclusive Framework on Base Erosion Profit Shifting have agreed to the modalities of a two-pillar solution to ensure that such companies pay tax in the market jurisdictions. The detailed agreement or the Multilateral Convention (MLC) is yet to be finalized and executed. 

Key terms of the agreement

The OECD / G20 members have signed an agreement which states the following:

• Digital Tax shall be calculated under two methods - Pillar One and Pillar Two applicable to companies whose turnover and profits exceed the specified limits. 
•  Tax paid in one country shall be allowed to be credited in the home country.
• All nations shall remove the unilateral digital services taxes and other relevant similar measures concerning all companies and commit not to introduce such measures in the future.
• There would not be any new unilateral tax measures introduced by any nation between October 8, 2021, and December 31, 2023.

The two-pillar solution

Pillar One provides for the allocation of 25% of the profits of a company to the market jurisdictions if the company meets the following criteria:

• Global turnover of EUR 20 billion or more;  
• Profits before tax of 10% or more; and 
• Revenue from market jurisdictions of EUR 1 million or more (EUR 250,000 for smaller jurisdictions). 

Whereas, pillar two provides for levying at a minimum corporate tax of 15% in the home country if the company meets the following criteria:

• Global turnover of EUR 750 million; and
• Revenue from market jurisdictions of EUR 10 million and profits of EUR 1 million or more.

The two pillars apply to companies with a very high turnover, however, there is no clarity on what happens to the other companies which do not meet the turnover threshold criteria as the current agreement does not address the issue. Unilateral digital tax may likely continue to apply to such companies which are not governed under the MLC. 

The question arises whether there is a need for another two-pillar solution as India has already introduced Equalization Levy (EL) and Significant Economic Presence (SEP) to address the situation. Moreover, India is generating good revenue from the imposition of EL. With the introduction of the two-pillar solution, the aim is to tax digital transactions uniformly rather than the implementation of unilateral tax measures separately by every nation. 

Currently, India imposes digital taxation or EL at:6% on non-resident providing advertising services or advertising space to residents, provided the annual payment exceeds INR 100,000; and 2% on online sales of goods and services (exceeding INR 20 million) made by a non-resident operator to any resident Indian or using an India IP address. 

No EL is levied if the non-resident has a permanent establishment (PE) in India or if the transaction is taxed in India under any other provision (eg. software/royalty).

Taxation through SEP

A non-resident entity having a Significant Economic Presence (SEP) in India is considered to have a business connection in India. Thus, profits from SEP are taxed in India. A SEP is created if the non-resident entity's revenue from Indian transactions exceeds INR 20 million or if its user base in India exceeds 300,000.

The Indian Government’s stand on imposition of digital tax under the MLC

The Indian Government is expected to tread cautiously on digital taxation. There will be no immediate legislation abolishing EL / SEP. The Indian Government will likely maintain its status quo on EL and SEP until all the countries sign a tangible MLC. Considering the fiasco of imposing a tax on indirect transfers with retrospective effect, the Government may not tweak with (or expand the scope of) the existing provisions on EL / SEP in the interim period until December 31, 2021.

Once the MLC is signed, likely, many non-resident companies may not satisfy the high turnover/profit criteria. In that case, the Indian Government may continue with these levies for such companies not covered under the MLC.

Possible impact on enterprises 

The proposed implementation of the two-pillar solution would impact multinational enterprises (having no PE in India) engaged in digital business in India or with Indian customers. These include popular brands selling goods or services online; travel, ticket and hotel booking portals; entities in the media / OTT sectors; online education portals; aggregators; IT product/service providers and more.

However, there will be no impact on compliance with immediate effect. The member countries have agreed to the broad terms of digital taxation; the international MLC is not yet executed. Thus, the applicability of EL and SEP provisions and the compliance under these provisions continue to apply today. 

New-age businesses require innovative ways of taxation. Digital taxation is a tax on a company’s business from its market jurisdiction where it may not have a physical presence. Digital tax is here to stay, whatever may be the nomenclature under unilateral or multilateral conventions. 

Currently, non-residents may not be entitled to a credit for EL paid in India as EL is legislation separate from income tax. However, post-implementation of MLC, there could be relief from double taxation in the form of exemption of income that has already been taxed in the market jurisdiction or allowing a tax credit for tax paid in the market jurisdiction.

India continues to be a promising market for multinational enterprises. Their presence or their expansion plans in India shall not be impacted by a change in the method of taxation. Changes in tax policies can be implemented successfully as has been evident in the past.