Ashok Garg, (May 2000)
Development of e-commerce in last one decade has posed a real challenge, if not a threat, to the intelligence of taxmen all over the world. Even though the magnitude of e-commerce has not assumed unmanageable proportions so far, especially in developing countries like India, yet the challenge to the tax administration of every country is very much real and imminent, if the projections of growth of e-commerce in next three years or so ($ 1.5 trillions) are to be believed. Govt. of India has also woken up to the challenge and therefore formed a high-powered expert committee to examine and suggest the ways and means to tackle the likely problems of taxation of e-commerce. Last year, the Committee submitted their detailed report and recommendations which are by and large in accordance with the stand taken by American government and governments of various European countries.
Scope of this study is not to examine the concept of ‘e-taxation’ as one would examine the concept of ‘e-governance’. What we propose to do in this study is to examine the issues involved in taxation of c-commerce, their attendant problems, their magnitude and possible solutions.
Meaning & concept of e-commerce:
The US treasury white paper on the subject defines e-commerce as “the ability to perform transactions involving exchange of goods or services between two or more parties using electronic tools and techniques”. Thus E-commerce is commerce in which transaction takes place over electronic media, mainly on Internet. In simpler words- e-commerce is any form of computerised buying and selling, both by end-users (consumers) as well as by businesses as intermediate users, which facilitates choosing the goods and / or services, ordering them, delivery, payments and after sales support. E-commerce also refers to the paperless exchange of business information using a suite of electronic technologies, such as – Electronic Data Interchange (EDI), Electronic Mail (e-mail), Electronic Funds Transfer (ETF), Credit Cards, Facsimile (Fax) Electronic Bulletin Boards and Database services etc. The scope of E-commerce is no longer restricted to traditionally understood meaning of EDI and now it includes basic commercial activity of buying and selling as well.
E-commerce and its effect on nature of economic activities and tax complexities – a brief overview:
The growth of e-commerce is bringing about far reaching changes in the nature of economic activities. Commerce is becoming borderless. Intermediaries in the form of wholesalers and distributors are disappearing Direct sales to consumers are exposing large number of business to tax laws of larger number of jurisdictions. Growth of remote commerce is bound to lead to a significant increase in cross border tax issues and controversies. Growth of digital commerce will increase compliance-related problems associated with services and sale of intangibles. Bundling of services with products will aggravate the problem of valuation of intangibles. Another development is that of hollowing of corporate bodies- as the internet technology facilitates narrowing down of core competencies by leaving different activities like manufacturing, distribution, after sale services etc to third parties. Since core competencies will narrow down, relocating of such businesses in tax friendly jurisdictions would be much easier but at the same time will bring in their own shares of controversies and litigations. “Real- time transactions” and “Internet based transaction processing” will make record keeping altogether different and transaction tracking difficult. Expert groups are suggesting “zero- burden” real true compliance system, especially for transaction based taxes, in place of system of periodic reporting and compliance.
The Internet technology is also bringing about significant changes in the ways in which the business is conducted- i.e. different business models are appearing. Now we have not only on-line auctioning, but also reverse auctions, virtual communities, infomediaries aggregators and brokers. Appointment of agents and sub-agents (without botheration of their geographical locations), retailers and service providers, concept of gift certificates available on the net etc. all present new and difficult tax issues as to the identity of the actual retailer, the sourcing of consumption (for the purpose of levy of sales tax/use tax), classification of the goods or services for the purpose of sales tax (for example – the gift certificates) and the relevant sale price for transactional tax purposes. One tends to get overwhelmed by these developments. But things are not as dismal either.
Growth of e-commerce in India:
The Internet came to India in the year 1985 with the introduction of ERNET (Educational and Research Network) which was a project of the Deptt. Of Electronics. Initially it linked only IITs, but slowly some research organisations and educational institutions were also included in the list. Later on VSNL (Videsh Sanchar Nigam Ltd) started providing Internet services to individuals. Realising that no Indian Public Sector Company in India will be able to handle the growth in Internet traffic, the govt. of India permitted ISP (Internet Service Provider) business to private companies as well in the year 1998. While the world over, the Internet has already become a mass media (having crossed the limit of 50 million users), the growth of Internet in India, even though impressive has not reached the expected level. In September 2000, there were 20,45,500 Internet connections in India. Actual users of Internet in India, of course, would be higher than the above figure due to cyber cafes coming up in big and medium sized cities and also because of unauthorised and multiple users of the Internet connections. The High Powered Committee on E-commerce has estimated that in the year 2003 , the ainternet users are likely to be about 32 million.
The growth of e- commerce in India has however, not been so impressive. There are various reasons – ranging from lack of not so efficient telecom network to legal framework to handle and regulate the connected problems. The govt. of India has already enacted the law to regulate the cyber world, all the authorities envisaged in the said law are not yet in place. ( The authority for giving permission /licenses for digital signature authentication has already started functioning- though output is not very encouraging.) There are various other reasons – social, cultural and economic -which have also hindered the growth of e-commerce in India However, it appears that, while growth of retail e-commerce will take quite some time to catch -up, the business-to-business e-commerce will grow at a very fast pace as it results in cost savings and overall business efficiency. Initially, the businesses will have to maintain “dual trading environment” (paper-based and paperless) for some time which would obviously mean increased operational costs, but then there is no other option. The estimate of High Powered Committee on E-commerce that the volume of e-commerce in India in 2008 will be somewhere between US $ 5.7 billion and 13.4, appears to be somewhat non-specific – lower end being absolutely sure (IT enabled services export to North America estimated at US $ 4 billion) and the upper end being almost impossible – considering the present pace of growth. The Committee has adopted the expected CAGR (compounded Annual Growth rate)
Problems of e-taxation:
In this discussion paper, I propose to bypass the advantages and future prospects of e-commerce in India and would restrict myself to problems and solutions relating to taxation of e-commerce or to say – taxing the web.
The concern of present day governments, the world over is not to find out new sources of revenue in taxation of e-commerce, but to ensure that their rightful dues in the form of taxes is not evaded and avoided by the public with the help of new found technology of Internet. I would also like to hasten to add that opening up of the global market in such a big way also has made developing countries like India to sit up and think that their rightful share of taxes on the international trade is not lost. They know that theirs is a big market place and they should get the their share of tax on the goods/ services marketed in their country. Therefore, not only International organisations, like OECD, UNICTRL are trying to find out universally acceptable rules and procedures relating to e-commerce and their tax implications, but countries themselves are also seeking changes in their domestic tax laws and tightening of bilateral tax treaties.
It is not the case of your present interlocutor that problems of tax administration have not, or will not, increase with the increased e-commerce and newer innovations of Internet and allied technologies. What I want to highlight is that, as the technology stands today, the problems are specific to some taxes and the problem areas are also specific, as we will see in the latter part of this discussion.
Before, embarking upon studying the likely problems and difficulties of taxation of e-commerce, it will not be out of place to see, in brief, the theory and practice of taxation in any modem society. All taxes, in a modern world, can be broadly classified into three categories- taxes which are transaction based, taxes which are based on the fact of ownership or possession of some physical asset (also known as property based taxes), and taxes which are levied on income. The taxes levied on gross receipts of a business can conveniently be grouped with transaction based taxes. There are some minor taxes also, which strictly may not be put into any of the above three categories- for example- the Professional Tax. But considering their limited localised applications and their relative importance in any economy, they do not find any place in important academic works. While quantification of some of the taxes is done on some simple basis, others are quite complicated. Wherever, the levy of tax is either one-time levy or dependent on a fact or existence of an asset, which is by and large static in nature, the quantification is generally simple. But such taxes lack flexibility and do not have the necessary buoyancy. The number of disputes arising out of administration of such taxes also are not many and therefore they do not attract much of the attention of the academicians. In this category fall the taxes based on ownership of assets. the taxes which attract most of the attention and the concern, therefore, arc those which arc levied on the basis of transactions / economic activities and the resultant income.
A lot of hype has been generated about taxation of e-commerce in the last few years and problems which arc not peculiar to e-commerce only, but arc equally faced in the taxation of conventional trade / industry are presented in a manner as if they were peculiar to taxation of e-commerce only.
The main areas of concern in the matter of taxation of e-commerce vis-a-vis conventional commerce pertain to four areas- jurisdiction of the taxing authority and the government/country, characterisation of income, transaction tracking and valuation of such transactions. There are some other areas of concern as well, which mainly relate to the quantification of the tax liability. However, this worry is limited mainly to the service sector and the trade of digitized commodities and information- where not only transaction tracking is rather very difficult but the valuation of those goods and services also pose challenge to the tax administration.
The biggest problem which the Internet technology and e-commerce present before the conventional tax mechanisms is relating to jurisdictions to levy the tax. In the present Internet / digital age geographical boundaries and distances are losing their relative importance and time collapses. This technology enables commerce between anyone, anytime and anywhere. It is no gain saying that it is much easier to tax business activity that is locally based and involves the transaction in tangible goods than to tax business activity which is mobile /multi-jurisdictional and involves the sale of services or intangible goods- like digitized goods.
The jurisdiction problems relating to e-commerce, obviously, pertain to transaction-based taxes and the income-tax. In so far as they pertain to transaction based taxes – the problem arises as to the place where the transaction takes place and also the point of time when it takes place. Most countries tax the transaction where the use of goods or services takes place. The state or the local government cannot force the remote vendor, who does not have a business set up in their jurisdiction, to collect sales/ use tax for sales effected in the state’s jurisdiction. There is another problem-locating the vendor. With the growth in the remote sales- effected from different tax jurisdiction – the problem of locating the vendor is already there. It as rightly apprehended that it would worsen in the cases of net-based transaction. It would not be as bad in the case of physically delivered goods as in the case of digitised goods. On the other hand, the things could still be worse because now with the virtual corporations, the relocation of business set-ups would be extremely easy and locating and tracking them would be extremely difficult.
In the matter of taxation of income-tax, there are two clear cut methods: Source based and the residence based. Source based taxation means that income will be taxed where the economic activity giving rise to income is performed. The residence-based taxation on the other hand taxes the income on the basis of residence of the person, and in case of non-natural persons where the management and control of the business is located. Thus the taxation depends upon the determination with some certainty either the place of transaction/economic activity or the residence of the person. Till now, these principles have worked reasonably well – inspite of complexity of determination of Permanent Establishment (PE). But now things are becoming complicated with the introduction of Internet technology and e-commerce being possible between anyone, anytime and anywhere and geographical boundaries loosing their importance.
With the improved communication facilities, especially the Internet, it is not very difficult to manage the business in a different country by sitting in the home country. Determination of residence in such cases would be very difficult.
It is seen as to whether in the digital / Internet economy, the concept of Permanent Establishment will retain its importance? It is felt that the importance of the concept would remain – but the meaning of it would undergo drastic changes. In fact, this is one major of area in the field of international taxation, which is bothering the taxmen world over. Whether the presence of a computer server, which is part of the Internet, in a country would constitute PE in that country, when that server has stored only the information about the company and its products etc. One view, is that it should not constitute PE because in most of the DTAA, maintenance of an office or showroom in another country does not amount to PE, if no business as such is carried apart from goods or samples are displayed and the details of the company are made available. No final stand has been taken by most of the countries. Another view point is that if the server only makes available the information, it should not be treated as PE, however, if it receives and process the purchase orders or delivers the goods (of course, digitised goods), then it should be treated as PE in that country. The reason is obvious.
There is another problem related to international taxation and jurisdiction. The problem is related to the concept of business connection. If there exists some business connection in a country and that business connection generates income the foreign enterprise becomes liable to tax of the country in which business connection exists. The problem which is bound to arise iii the context of e-commerce is as to whether the owner of a computer server in a country can be said to have business connection with the company who has hosted its website on the said server and through which business is solicited and procured. To put it in another words, whether provision of space on servers or for that matter provision of access to Internet (say, via leased lines) would constitute business connection, so as to attract the tax liability as provided in section 9 of the Income-tax Act. These problems are not hypothetical but real and the solution lies either in the legislation by each country or in some international convention / treaty.
Characterisation of income:
Characterisation of income is important not only from the point of view of taxation of resident assessees and domestic business but also from the point of view of taxation of transnational entities. Practically, all the tax treaties (DTAA) provide for classification and characterisation of various types of income and different tax treatments are provided for them. But with the advent of digital technology, the difference in various types of income is getting blurred. It may now be difficult to determine as to whether a particular income is generated by providing technical- knowhow or by providing technical services, or whether an assessee would be entitled for concessional tax treatment of royalties in a particular situation. Whether supply of digitised goods, like software solutions, would amount to sale of goods or sale of services.
Quantification of income / value of transaction:
Whenever any businessman deals in generic goods, it is much easier to determine the value of goods, by the method of comparison with similarly placed businessman. However, in respect in services, especially personalised or professional services, it has always been difficult to estimate the value of such services. The tax administration had to be content with whatever the professional involved stated. At best, the taxman could compare them with his past or contemporary rates. If his version of value of transactions or income there from was to be determined with reference to a longer time frame, their usual practice of the taxmen has been to examine his financial affairs with reference to assets / expenditure which he made in the reference period.
Provision and supply of digitised goods stand on the same footing. Except in the case of resellers of digitised goods, determination of exact cost of goods is very difficult. Consequently, the determination of their fair market value also poses a big problem- whether the prices charged to customers is the same as declared to the tax authorities. Another important aspect of dealing in digitised goods on the net is as to the quantum / copies of the goods sold. Presently there appears to no way to determine the same. But then this problem is not strictly peculiar to the trade of digitised goods. It is equally applicable to physical goods. What makes digitized goods different from physical goods is that it is comparatively easier to investigate the matter and determine the real quantum of goods which moved physically rather than the digitised goods, especially those which are delivered in cyberspace. It is obvious that the size of the digitised goods consignment is in no way indicative of the value of the same.. Suggestion from some quarters to tax the e-commerce on the basis of bits of information exchanged on the net is too simplistic and neither logical nor equitable.
The proposal to levy tax on the hosting of websites on the basis of type and size is not the tax on e-commerce as such, but a new tax in itself and is no solution to the main problem of taxing the correct value of e-commerce transactions.
The only method, which is presently visible, is that of examination of banking transaction of the businessman concerned. It is hoped that revenue generated by his e-commerce would get credited in some bank account-whether it is collection through credit / debit cards agencies or through direct receipt of cheques etc from the buyers. However, there are several problems:
Secrecy rules of banks: Most of the international banks enjoy the legal protection in respect of maintaining the privacy of financial affairs of their constituents. Therefore, the taxmen will have to be content with whatever the businessman shows. In India, however, the banks do not enjoy this protection and are duty bound to render the details to the tax authorities. With opening up of national economies, access to international banking platforms is becoming easier and investigation of those transactions is difficult and at times impossible.
Transactions other than sale: Scrutiny of bank accounts and banking transactions would help only if the consideration for the goods sold is in the form of money. What if the consideration for transfer of goods other than money – one software exchanged for another or some service/ benefit in kind is allowed as consideration. There will be no method with the tax administration to know and tax the value thereof. This problem is however not peculiar to e-commerce only as it is applicable to conventional commerce as well, though of course, it will be bigger problem in case of e-commerce.
Thus, there will be only two tools with taxmen in respect of verification of the volume of business and income there from – asset/expenditure analysis and investigation of their banks accounts. In the absence of capacity and right of the government to peep into cyber transactions in ‘real time’, provision of auditing of computer programmes or the website contents is meaningless and would not result in any fruitful gains.
Difficulty of transaction tracking:
Technology permits retention as well as removal of transaction tracks. There is at least one dot.com company, in India, which provides server space on a server, not known to the client, on which he can keep his financial accounts duly protected by the passwords (claimed to be not known to the service provider either). The interesting part of the thing is that loading and viewing the data on the net, (on the site provided by the service provider), does not leave slightest trace on the computer from which the data is either being uploaded or accessed. There does not appear to be any law prohibiting the service provider from providing such services. It is multipurpose technology. Any prohibition, even if imposed, would be like US prohibition on export on super computers. It was quite successful but in present case it will not be much useful as the technology involved is quite common place and only benefit that may accrue is that these service providers will not be able to advertise for these services freely.
But it is thought that perhaps some law could be enforced on servers who provide the web space for e-commerce, as the number of servers would not be that large. With the help of international cooperation some monitoring may be possible. But at present it appears to be only a fond hope. Future technologies may tilt the balance either way.
Reactions of other countries:
In the United States, the federal government created a Electronic Commerce Working group in 1995 who submitted its first annual report in 1998. The US Treasury also issued (1996) a paper on the taxation of E-commerce, titled “Selected Tax Policy Implications of Global E-Commerce” Since the US federal govt. does not have national level sales tax or Value Added Tax, it focussed only on implications of e-commerce for federal income taxation .The government reports have emphasised a strong preference for dealing with e-commerce transactions within the current set of rules and procedure without new taxes. The President directed the Secretary of the Treasury “to work with State and local governments and with foreign government to achieve agreements that will ensure that no new taxes are imposed that discriminate against Internet commerce; that existing taxes should be applied in ways that avoid inconsistent national tax jurisdictions and double taxation; and that tax systems treat economically similar transactions equally, regardless of whether such transactions occur through electronic means or through more conventional channels of commerce.” In accordance with the above directive the U.S. government has decided to continue with ‘residence-based taxation’ in which each nation taxes all income of its domestic companies wherever earned (of course, after giving credit for taxes paid abroad) and to tax foreign companies on only domestically sourced income. The government has also decided to continue with determination of jurisdiction over foreign companies on the basis of existence or otherwise of P.E. (Permanent Establishment) or ‘engagement in business’. For characterising the income, they continue to classify them like manufactured goods, services, royalties, etc. And for sourcing the income to go by the principles of location of the vendor, licensee, 50-50 split, etc. However, the federal government has not come out with detailed clarifications/regulations as to whether the existing rules regarding characterisation and sourcing of income would continue to apply with various forms of digital commerce like music, video, and electronic information services. It has also not clarified as to how these rules can avoid uneven treatment of tangible and intangible transactions.
The U.S. government also passed “Internet Tax Freedom Act” in 1998. This act applies to state and local sales and use taxes and is applicable upto October 2001. The act prohibits the imposition of any new state or local sales or use tax on Internet access or online services during this period. It also prohibits imposition of any multiple or discriminatory taxes on e-commerce. For example, if canned software does not attract any sales tax, it cannot levy tax on software downloaded/delivered through Internet.
The OECD (Organisation for Economic Cooperation and Development – made up of 29 member countries) has also undertaken numerous activities since mid-90s aimed at addressing the issue of e-commerce taxation. The Committee on Fiscal Affairs constituted by OECD, in one of its discussion papers on taxation issues, (published in September 1998) indicated that “problems concerning the application of consumption taxes are generally recognised as having more immediacy than the issues concerning direct taxation.” The working group of European Commission has also expressed its concern about the threat put to Value Added Tax (VAT) by the growing number of international services which use new technologies to locate taxable transactions outside the territorial scope of their VAT system. As is common knowledge, any transaction-based tax poses altogether different types of problems in comparison to direct taxes. It is more so because VAT and similar taxes are not harmonised around the world by international treaties that encourage or compel countries to conform their laws to those in other parts of the world. The European Commission has taken the position that:
- No new taxes such as a ‘bit-tax’ are required
- The existing VAT system can be adapted to e-commerce
- Digital products should be treated as services
All services supplied to a consumer located in the European Union should be subjected to tax in the EU regardless of the place of origin of the services.
The countries should continue to use the system of consumer self-assessment for B-to-B transactions.
Further developments in the field of policy formulation regarding direct taxes, in USA, include that mere soliciting business through website would not constitute a US trade or business and mere accessibility of the foreign person’s website on servers located in USA will not be sufficient presence to constitute a US trade or business. Presence of Computer Server in USA belonging to a non-resident would not constitute or be deemed to constitute a PE. Similarly, availing services of an US service provider (like Internet Service Provider) would also not amount to business connection so as to attract US tax liability. As stated earlier the Treasury favours residence based taxation. However, it is yet to be seen as to how they will react to the complexity relating to determination of residence of corporate entities where they have multi-jurisdictional presence and the management is obviously net-based.
UK government, however, does not appear to have yet taken the final stand in the matter and though according to present laws location of a computer server would not amount to PE, yet the matter of application of this rule to websites and net servers is under consideration. (Lot of other related matters are also under active consideration of the UK govt.). However, it appears that UK will follow the agreement reached in EU.
What should be done:
The fear of academicians and techno-jurists is that mere attempt to revamp the existing taxation rules and procedures may not suffice as they will be overwhelmed by the speed with which the Internet and e-commerce will change tile nature of the global marketplace – a marketplace which will be seamless, borderless and timeless.
But the question is whether laws can be framed to tackle all the unforeseen situations? Answer is obviously no. Laws have always been far behind the changes – whether social, economic or technological. Law has been an agent of change only in very few cases. To put it simply – law is in a perpetual state of catch up To expect anything more from it is unrealistic. We can only hope and pray that governments and legislators reduce their response time to changed circumstances. Public opinion will also have to be moulded to see the reason behind more frequent changes in law. They will have to learn that laws dealing with more complex economic activities are bound to be complex – Howsoever you may wish – you cannot cure cancer with Aspirin.
Any taxation model, which is suggested to handle the e-commerce, has to satisfy the following norms:
Neutrality: The taxation mechanism should be neutral and equitable between both the forms of commerce- conventional mode of commerce as well as e-commerce. The mode of carrying on commerce should not affect the incidence of taxation either way. Neither it should result in double taxation nor in its non-taxation.
Efficiency: The taxation mechanism should be cost effective not only to the government but also to the business world. Increase in compliance cost may lead to tax evasion or may retard the growth of e-commerce.
Simplicity: The reason is obvious. Simpler laws evoke voluntary compliance and reduce litigation.
Flexibility & Effectiveness: The law framed should be able to produce the right amount of tax at the right time. It should have enough deterrent value for tax evaders and should have the least potential for tax avoidance. Though it is extremely difficult to enact a law to take care of all future developments in the field of technology and the economy, yet it should be flexible enough to be applicable to newer situations without violence to its language.
Splitting of revenue in case of clash of jurisdictions:
While developed countries would like to continue with their emphasis on residence based taxation, the developing countries (consuming economies) would like source based taxation. Both the groups have their own arguments. But the problem we are concerned here is to avoid double taxation and also minimise the controversies and litigation. One obvious solution is to split the revenues from such transactions and activities on some mutually agreed ratios. This principle can also be applied in our country as well in the matters of interstate sales or where there is possibility of disputes of jurisdiction. Things are not as simple as they appear as there are political overtones in this solutions it would undermine the freedom of federal states in the matter of their fiscal management.
Intensive technology driven solutions for monitoring tax compliance:
Increase in the number of persons/ business with whom the tax administration is required to interact would put great strain on its infrastructure and the solution does not lie in increase in the manpower, but to go in for technology driven solutions. In fact, it is easier said than done. While it is easier to achieve it in advanced countries, it is very difficult in developing economies. The experience of Indian tax administration in this regard is not something to write home about. Bureaucracies the world over are supposed to be, and in fact they are, very conservative and adoption of technology in administration is resisted in varying degrees, depending on the induction of technology in day to day life.
Greater agreements on uniformity of tax rates & Rules:
US Ex-President Clinton stated that “We cannot allow 30000 state and local lax jurisdictions to stifle the internet, nor can we allow the erosion of the revenue that state and local governments need to fight crime and invest in education.” It is, therefore, upto the politicians and legislators to decide as to whether they would stifle the Internet, by adopting rigid stands in the matters of Tax treaties or would come forward to some mutually beneficial agreements in the matters of tax rates and procedures. Creating of tax-havens does not seem to bring in long term economic growth. What can actually bring in prosperity is the enhanced level of economic activity, which can be made possible only by cooperation with others on various international economic forums. The developed countries will also have to realise that monopolising technology by one or some countries will not benefit them if the potential markets of developing countries close their borders to them or convert themselves in tax heavens. They will also embark upon developing the relevant technology, which will be enormous waste of money and manpower. They will have to think in a constructive manner and contribute in the development of economically backward countries.