Rules to tax digital economy need of the hour

Having a global footprint has become a growth necessity for businesses. At the same time, the tax authorities world over are focused on increasing their share of taxes (whether fair or not), thereby adding to the complexity of managing international tax affairs.

In the Indian context, finance minister Arun Jaitley will be presenting the Union Budget on February 1, 2018, and his tax proposals will be keenly observed by the international community.

In today's digital era, formation of rules to tax digital economy is the need of the hour to provide each country with its fair share of taxes. While India was the first country to introduce an equalization levy at 6% of the amount received or receivable by a non-resident for providing specified digital services and facilities, other avenues may be explored in Budget 2018 for taxing the insufficiently taxed e-commerce income.

Further, Organisation for Economic Co-operation and Development recently approved the 2017 update to its Model Tax Convention and India provided its reservations thereon including mainly on permanent establishment (PE) clauses, where India has demanded broader taxation rights; for example, dependent agent functions leading to PE, who could be regarded as independent person. While this reflects the approach the Indian revenue authorities adopt during the audits, it remains to be seen if FM also amends the tax laws.

Recently, the US tax reforms came into effect and these have far-reaching implications in the US as well as outside the US. Reduction of corporate tax rate to 21% in the US to promote 'Make in US' leads us to expect that the FM may reciprocate by making good his promise in Budget 2016 to reduce the corporate tax rate to 25%. However, looking at the short-term impact of demonetisation on GDP growth and falling GST collections, rate cut may not apply across India Inc.

In this dynamic global environment, FM also needs to continuously explore tax tools to improve ease of doing business in India.

On this point, in April 2017, the Ministry of Corporate Affairs notified changes permitting cross-border (inbound as well as outbound) mergers. The Indian tax laws do not currently address the tax impact of outbound mergers, potentially making it non-tax neutral. One hopes that the FM utilises the upcoming Budget to provide more clarity on this front.

Even after series of clarifications issued by the CBDT in connection with the place of effective management (POEM) provisions, there are certain ambiguities for a foreign company becoming resident due to POEM provisions. For example, the applicability of concessional rate of tax on dividend from a foreign subsidiary, applicability of withholding provisions, etc. The FM should either provide clarity on these aspects or think of moving to the controlled foreign company regime adopted by many of the developed countries as earlier proposed in Direct Taxes Code.

While the government is actively liberalising foreign direct investment policy with the objective of facilitating ease of doing business and promoting the Make in India campaign, it would be interesting to watch Budget 2018 to understand how the FM achieves a balance between increasing tax revenues and attracting foreign investment.

Pramod Achuthan - Tax partner, EY India
(Anuj Deshmukh, senior tax professional, EY also contributed to the article)