India to battle it out with US, UK to tax digital firms

The US is pressing for taxing digital economy through the ‘marketing intangibles’ principle and the UK through a ‘user-base’ principle.

Illustration: Dominic Xavier/Rediff.com

India will press for widening the scope of permanent establishment (PE) to tax digital enterprises such as Google, Facebook, Microsoft, and Netflix at the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) Inclusive Framework meeting in June.

With G24 backing, it will fight it out with the US and the UK to push through its ‘significant economic presence’ proposal at the OECD, as 128 counties sit together to put in place a multilateral instrument to bring these companies into the tax net.

In its representation, India has pitched for ‘significant economic presence’ principle, arguing that PE should not only require a fixed place of business and that the definition of ‘nexus’ needs to be changed, to give more taxing rights to market-driven economies, or developing countries.

Meanwhile, the US is pressing for taxing digital economy through the ‘marketing intangibles’ principle and the UK through a ‘user-base’ principle.

“We are seeking changes in the digital economy taxation rules.

"The definition of nexus needs to be changed from having a fixed place of business to having a significant economic presence.

"This should give us more taxing rights. The US’ proposal of marketing intangibles is too complicated to work for developing countries, while the UK’s user-base principle is too basic. We need a broader proposal,” said a government official.

The Inclusive Framework brings together over 125 countries and jurisdictions to collaborate on the implementation of the BEPS package.

The OECD report on the subject will be finalised in 2020. India has the backing of 28 countries of G24.

Currently, when a non-resident business supplies goods and services, its profits may be taxed attributable to the operations in that country, based on its ‘fixed place of business’ or PE, according to the tax treaty.

The definition of PE is primarily based on a fixed place of business, and also includes service or construction activities carried out beyond specific duration, existence of a dependent agent, and collection of insurance premiums.

However, such a business connection with the local economy, in terms of a fixed place of business, does not exist in the case of remotely or digitally delivered goods and services.

India has argued that today a non-resident can participate in the economic affairs of a jurisdiction without being physically present in the jurisdiction.

Therefore, India’s proposal of the significant economic presence will establish the nexus between remote and digital engagement of non-resident businesses with Indian consumers, providing a basis for taxation of the resulting income.

In the Budget last year, the government proposed that the number of Indian users and a revenue threshold should be used to tax the business profits of non-resident digital companies derived from Indian consumers.

However, it will require amendment of each double taxation avoidance agreement partner, making it challenging.

Hence, a multilateral instrument will be a better option.

New Delhi has said that there is a need to rework the international tax framework regarding nexus and profit allocation rules.

These should take into account value created within the supply chain, representing the contribution of supply side, along with contribution of demand-side factors for determining corporate profits attributable in a tax jurisdiction.

According to the US’ ‘marketing intangibles’ principle proposal, the current tax allocation rules would change, so that the market jurisdiction (where users are located) would be entitled to tax some or all of the ‘non-routine’ income properly associated with such intangibles, while ‘routine’ income would continue to be allocated, based on existing transfer pricing principles.

Marketing intangibles include brand, trade name, customer data, customer relationships, and customer lists.

However, India feels that the US’ proposal may not be feasible, as it will be very difficult to compute income, considering the volume of data required for the purpose.

“Most developing countries don’t have that capacity to distinguish routine and non-routine profit or identify and put a value to intangibles of an enterprise,” said another official.

He added that UK’s user-based principle only talks about one part of the digital economy, making it too restrictive.

“It will take into account only highly digitalised businesses, where only the user is to be taken into account,” he said.

The Central Board of Direct Taxes had last month invited public comments on the proposal for amendment of rules for profit attribution to PE.