We are pleased to present the latest edition of Tax Trends, SKP's Direct Tax Newsletter. This edition covers the period from April to June 2018. As we write this, the due date of 31 July is fast approaching for tax filing for individuals and other non-corporate entities not having to get their accounts audited. The due date this time assumes additional importance as there is now a mandatory fee of INR 5,000 payable as per Section 234F of the Income Tax Act if the return is filed after 31 July. The fee increases to INR 10,000, if the return is filed after 31 December. However, if the total income of the person does not exceed INR 500,000, then the fees payable would be restricted to INR 1,000. This is in addition to interest payable under Section 234A. Of course, this has created a furor as the Indian taxpayers have never been penalized for late filing of the tax returns. In fact, a writ petition has been filed before the Kerala High Court challenging its constitutional validity, besides representations by Bombay Chartered Accountants' Society along with other Chartered Accountant Associations.

This quarter witnessed some high profile judgments being delivered regarding Permanent Establishment (PE) and royalty taxation. The taxpayers involved in these cases were Mastercard, Nokia and Google.

The issue in the case of Mastercard was with respect to the existence of PE and the taxation of the transaction processing fees received from Indian Banks. Mastercard's wholly owned subsidiary was providing support services and owned the Mastercard Interface Processor (MIP) which was compensated on cost plus basis. Mastercard had applied for an Advance Ruling where the Authority for Advance Rulings (AAR) ruled that Mastercard had a fixed place PE in the form of MIP and the Indian subsidiary. It also had a Dependent Agent PE and the Service PE as the employees of Mastercard visited India for business meetings. The AAR also held that transaction processing fees and other charges would constitute royalty on account of use of equipment (MIPs), use of process (transaction processing) and use of software (embedded in MIPs) and since Mastercard had a PE, the royalties would be effectively connected to PE and would be taxed accordingly.

In the case of Nokia, again the issue of PE and profit attribution were discussed. In this case, Nokia Finland used to supply the telecom equipment to customers based in India and its subsidiary, Nokia India entered into contracts with Indian customers for the installation of such equipment. The overall responsibility of such installation was with Nokia Finland. The tax authorities held Nokia India to be a PE of Nokia Finland as it virtually projected the presence of Nokia Finland in India. There was a divergent view amongst the members of the Tribunal, but the majority of the judges ruled that there was no PE in India. The minority judge had held that Nokia India is a virtual projection of Nokia Finland and it also laid down the formula for attribution of profits.

In case of Google, Google India (Indian subsidiary) had entered into distribution agreement with Google Ireland under which Google India was appointed as a non-exclusive distributor of AdWords program to Indian advertiser. Under this arrangement, Google India purchased the advertising space from Google Ireland and sold the same to Indian advertiser. Assistance and training were also provided to the Indian advertiser. A separate agreement was also entered into by Google India with Google Ireland for providing IT enabled services. The tax authorities held that payment made by Google India to Google Ireland for the purchase of advertising space was nothing but royalty for the use of IP, customer database and google trademark. The contention was upheld by the Tax Tribunal.

SPOTLIGHT

Food for thought: Is India's SEP concept in line with OECD's recommendations on taxation of the digital economy?

The Organization for Economic Cooperation and Development (OECD), together with G20 countries, introduced the Base Erosion and Profit Shifting (BEPS) Action Plans principally to curb tax evasion and double non-taxation. Briefly, BEPS refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax jurisdictions.

BEPS contains 15 Action Plans, of which Action Plan 1 deals with addressing challenges posed by taxation of the digital economy. It discusses and analyzes potential options to address the challenges posed by taxation of the digital economy which are:

  • New nexus in the form of a Significant Economic Presence (SEP);
  • Withholding tax on certain types of digital transactions; and
  • Equalization levy. Some of the proposals of the BEPS Action Plan, like equalization levy, Country-by-Country-Reporting, limiting interest deduction, etc. were already implemented by India in its domestic tax laws.

However, none of the aforesaid options were eventually recommended by the Action Plan 1. Notwithstanding the above, it was inferred that the countries could introduce all or any of the aforesaid options in their domestic tax laws or in their tax treaties as interim measures against BEPS provided the countries respect existing tax treaty obligations.

Basis the Action Plan 1, the G20 Countries directed OECD to deliver an interim report on the implications of taxation of digital economy by April 2018 and a final report in the year 2020. India being pro-active, introduced in its domestic tax law the concept of equalization levy with effect from 1 June 2016 and SEP as additional safeguards against BEPS in February 2018 while the OECD released the said Interim Report in March 2018.

Besides providing in-depth analysis on tax challenges posed by taxation of digital economy, the Interim Report also provides for certain common considerations that are required to be followed by India and other countries who have introduced these interim measures in their domestic tax laws against BEPS so as to avoid any uncertainty in deciphering taxation of digital economy across jurisdictions.

Through this article, we make an attempt to analyze whether India has introduced these interim measures in line with the recommendations by OECD in the Interim Report read with Action Plan 1 and whether India's SEP is in line with other countries such as Israel and Slovakia (see Table 1 below)

Has India introduced interim measures in line with recommendations by OECD?

Countries (such as India, Israel, Slovakia, etc.) that are in favour of introduction of interim measures duly acknowledge that challenges such as possibility of over taxation, compliance and admin costs, impact on welfare, uncertainty, inefficiency, etc. may arise on account of adopting horde of different onesided measures by these countries.

Thus, it is all the more imperative to set out common considerations on the design of such interim measures so as to limit any possible adverse consequences associated with these challenges posed by the interim measures. These common considerations vis-à-vis India's approach have been discussed below:

Table 1:

Common Considerations Interim Report Recommendations India's Position Remarks/Status
Compliant with international obligations An interim measure must not come into conflict with tax treaties. Given that the interim measures are introduced in the domestic law, the provisions of the tax treaties would override the former in case of a conflict between the two. India is in line with the recommendations of OECD.
Temporary An interim measure is introduced in the absence of a global consensus which provides for a common solution to offset the digital tax challenges.

Thus, when a global consensus is determined, it should be implemented in a coordinated manner and the interim measure should not jeopardize its implementation.		 On a plain reading of the domestic tax law with respect to the interim measures, India has not provided any guidelines for implementation of interim measures vis-à-vis global consensus.

Thus, the applicability of the interim measures after reaching a global consensus is still a grey area which the government would be required to address post 2020 when the final report is released		 It appears that India is not in line with the recommendations of OECD.
Targeted As the interim measure does not intend to provide an exhaustive solution across all jurisdictions, it should not seek to cover all transactions wherein digitalization poses or seems to pose some risk.

The scope of the interim measure should be well defined and focused on a particular set of digital transactions only.		 The interim measures so introduced in India seeks to cover all transactions within its ambit.

Currently, it does not provide any exceptions (i.e., transactions not covered) in the domestic law. As a result of which, there could be the potential collateral impact on other elements of the domestic as well as the international tax system.		 It appears that India is not in line with the recommendations of OECD.
Minimize over-taxation The key objective of the interim measure is to strike a right chord between the adverse impact of the challenges posed by the digital economy and the risk of over-taxation of taxpayers.

This can be achieved by levying a lower rate of tax commensurate with the profit margins of the taxpayer and the scope of the interim measure specifically intimating the type of transactions it seeks to cover.		 The concept of SEP has been included within the meaning of business connection as enshrined under Section 9(1)(i) of the Income Tax Act.

Currently, a country earning income from India is taxed at the rate of 40% in the absence of a tax treaty between the two.

Thus, it is likely that a company having SEP in India would be taxed at the rate of 40% in lines with that of the company having a business connection in India.

The tax law does not specify the nature of transactions it seeks to cover within its ambit. Thus, the scope of the interim measures is not clear at the moment. It would be interesting to see how the government would implement		 It appears that India is not in line with recommendations of the OECD as far as lower rate of tax is concerned. Of course, it seeks to tax only the income attributable to the transactions carried out in India and on a net basis.
Minimize impact on start- ups, business creations or small businesses The interim measure should be adjusted in such a manner that the impact on business creations, start-ups and small businesses is minimal since they (in)-directly assist in improving the economic growth and productivity of the country.

Thus, it is imperative that the interim measure is required to have a threshold which is designed as per the requirements of the start- ups, business creations and small businesses such that the tax burden due to interim measures does not make them unviable.		 India has not provided any negative list which would exclude start-ups, business creations, small businesses and other like ventures from the scope of the interim measures.

However, it is expected that India would prescribe the threshold for applicability of SEP in terms of quantum of revenue and the number of users in India which will be decided post-consultation with the stakeholders.		 India is more or less in line with the recommendations of the OECD.

Once India specifies the threshold, it will automatically exempt start- ups, business creations and small businesses from the applicability of SEP
Minimize cost and complexity The compliance and administration cost should always be the primary focus for taxpayers as well as tax administrators especially when such measures are supposed to be temporary in nature.

Ideally, administration of tax due to such measures should be engrained in the domestic tax law itself so that proper weight is given to it by the taxpayers as well as the tax administrators.		 India has not introduced any special provisions with respect to the administration of tax arising from such measures.

This would inadvertently lead to an increase in litigation and administration costs of the Indian tax administrators.		 It appears that India is not in line with recommendations of the OECD.

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