Tax Challenges arising from Digitalisation of Economy

1. Tax Challenges arising from Digitalisation of Economy IFA ACADEMY, NOIDA 25th May, 2019 Presentation by: Sanjeev Sharma, CIT, APA-2 ,Delhi

2. Digital Economy: Background to Tax Issues • Digital economy companies utilising tax structures to reduce overall effective tax payment • Not paying fair amount of tax on income earned in jurisdictions • G-7 Summit/G20 Summit • BEPS Project Sanjeev Sharma, IRS

3. Key Issues concerning digital economy • Nexus: connection between activities and territory • Data: Information collected form the users and use of the same for business purposes • Characterisation of Income: Business Income, Royalties, or FTS Sanjeev Sharma, IRS

4. Business Models in Digital Economy • Advances in information and communication technology helped businesses to enhance productivity, enlarge market reach, and reduce operational costs. • ICT became embedded in and central to the business models of firms operating across the economy • Changed the way their business is conducted by taking advances in communications and data processing capacity to lower transaction costs and extend their reach into global markets. Sanjeev Sharma, IRS

5. Examples of different sectors • Retail • Transport and logistics • Financial services: Banking and insurance companies • Manufacturing • Agriculture • Education • Healthcare • Broadcasting and Media Sanjeev Sharma, IRS

6. New and changing business models A. Electronic commerce (E-commerce) • Business –to-business models • Business-to-consumer models • Consumer-to-consumer models B. Online payment services: act as an intermediary • Cash payment solutions • E-wallet or cyber-wallet • Mobile payment solutions Sanjeev Sharma, IRS

7. New and changing business models C. App stores D. Online advertising: advertiser, web publisher, advertising network intermediaries E. Cloud computing: infrastructure as a service; platform as a services; software as a services; F. High speed trading G. Participative networked platforms Examples: Amazon, Facebook, Uber, Airbnb, Booking.com etc. Sanjeev Sharma, IRS

8. Revenue models • Advertising based revenue • Digital content purchases or rentals • Selling of goods • Subscription based revenue • Selling of services • Licensing content and technology • Selling of user data and customized market research Sanjeev Sharma, IRS

9. Key features of digital economy • Mobility: intangibles, users; and business functions • Reliance on data, use of so-called big data; • Network effects; • Spread of multi-sided business models; • Tendency towards monopoly or oligopoly relying heavily on network effects • Volatility due to low barriers to entry and rapidly evolving technology Sanjeev Sharma, IRS

10. Taxation of Digital Economy • July 2013: BEPS Action Plan finalised • October 2015: BEPS Action 1 report released • March 2018: Interim Report on Tax Challenges arising from Digitalisation released • July/December 2018: Meetings of Task Force on the Digital Economy • January 2019- Policy note agreed by the Inclusive Framework • February 2019: Addressing tax challenges of digitalisation: Public consultation document released • March 2019: Public comments released Sanjeev Sharma, IRS

11. BEPS Action 1: Addressing the tax challenges of the digital economy • Digital economy is increasingly becoming the economy itself, it would be ddifficult, if not impossible to “ring-fence” the digital economy from the rest of the economy for tax purposes • Implementation of measures under other Action points will to some extent take care of BEPS concerns • Broader tax challenges due to digital economy • Nexus, data, and characterization for tax purposes Sanjeev Sharma, IRS

12. Potential options as per Final Report • Modify exceptions to PE status so that activity exclusion available for preliminary and auxiliary activities only • Collection of VAT/GST Options were considered but none recommended: • A new nexus in the form of significant economic presence • A withholding tax on certain types of digital transactions • An equalisation levy However, the countries were free to introduce any of the options. Sanjeev Sharma, IRS

13. The 2018 Interim Report • Was agreed by more than 110 members of the Inclusive Framework • Analysis of business models and value creation • Potential implications for the existing international tax framework • Implementation and impact of BEPS • Interim measures • Impact of digitalisation on other aspects of the tax system • Agreement to examine key concepts of nexus and profit allocation and work towards a long term, consensus based solution Sanjeev Sharma, IRS

14. Sanjeev Sharma, IRS

15. Three features of highly digitalised business • Scale without mass: affecting the distribution of taxing rights over time by reducing the number of jurisdictions where a taxing right can be asserted over the business profits of an MNE • Heavy reliance on intangible assets: unparalleled reliance on intangibles and difficult to determine the allocation of income from intangibles among different parts of an MNE Group • Role of data and user participation: massive use of data (notably personal data) created by user participation including network effect : Existing rules do not capture value created by users Sanjeev Sharma, IRS

16. Divergent views of 113 members of Inclusive Framework • The views of jurisdictions on value created by data and user participation can be generally described as falling within three groups • FIRST GROUP: Changes required and there is a need for taking into account user contributions in digitalised businesses but no case for wide-ranging change • SECOND GROUP: Changes needed to apply to economy broadly and changes are not exclusive or specific to highly digitalised business models • THIRD GROUP: No action is needed and implementation of BEPS Package enough Sanjeev Sharma, IRS

17. Interim measures?? • Developing global and multilateral solutions will take time; • Countries are taking unilateral measures • No agreement on the need to implement interim measures • Some benefits in identifying design constraints Sanjeev Sharma, IRS

18. Framework for interim measures • To avoid multitude of varied unilateral measures • Limit potential adverse side-effects of the measures • Compliance with the international obligations • Temporary, targeted and balanced • Minimising cost and complexity • Not to inhibit innovation • Minimise over taxation Sanjeev Sharma, IRS

19. Work by the Inclusive Framework since the 2018 Interim Report • Final report in 2020 • Coherent and concurrent review of the “nexus” and “profit allocation” rules • Public consultation meeting held on 13 and 14 March 2019 in Paris • Nexus: Rules determining the right to tax a non-resident enterprise • Profit allocation: Rules that determine the appropriate share of profit of the MNE that will be subjected to taxation in the jurisdiction • Proposals under two pillars: • Pillar 1: dealing with nexus and profit allocation rules • Pillar 2: relating to remaining BEPS issues Sanjeev Sharma, IRS

20. Pillar 1 –User Contribution • Would apply to highly digitalised business • Recognise the value created by users of digital business • Revise the existing rules on profit allocation and nexus by reference to “active user contribution” Sanjeev Sharma, IRS

21. Pillar 1: Marketing Intangibles • Recognise the value created by marketing jurisdiction • Applies broadly to all types of business • Revise the existing rules on profit allocation and nexus by reference to “marketing intangibles” Sanjeev Sharma, IRS

22. Pillar 1 : Significant Economic Presence • Based on the 2015 BEPS Action 1 Report • Nexus based on a significant economic presence • Aims for simplified, easy to implement solutions Sanjeev Sharma, IRS

23. Pillar 2 Proposal • Address profit shifting that arise due to significant disparities in tax rates • Provide residence and source countries a right to “tax back” profits subject to no or very low rates of taxation in jurisdictions where those profits are derived • Tax on base eroding payments which will allow the source country to deny a deduction ( or apply withholding tax) on under-taxed payments • Income inclusion rule that will include such profits as income in the hands of related party investor Sanjeev Sharma, IRS

24. Interim measures and effect of BEPS measures • Levy of excise tax on gross consideration on supply of e-services within jurisdictions • Implementation of new international VAT/GST Guidelines • 3% digital service tax (so called GAFA tax) by France applicable to companies with digital revenue of more than EUR 750 million worldwide and more than EUR 25 million in France. Not to apply on direct internal sales to customers but to cover providers of platforms on commission basis to enable users to interact with each other for exchanging goods or services; • Advertising conducted on digital interfaces, and • Resale and management of personal data for advertising purposes Sanjeev Sharma, IRS

25. Interim measures • Pan EU law is being opposed but UK, Austria, France proposes digital services tax • Tax measure Global Intangible Low Tax Income “ GILTI” (outbound anti-base erosion provision) likely to raise the overall effective tax rate of US MNEs on their offshore income above a single digit (2017 Tax Cuts and Jobs Act) • MNEs taking proactive measures to realign their tax arrangements with real economic activity Sanjeev Sharma, IRS

26. Measures taken by India • Equalisation Levy: Finance Act, 2016- 6% levy on cross-border payments for online advertisement, provision for digital advertising space Sanjeev Sharma, IRS

27. Measures taken by India • Significant economic presence: a new nexus: broadening the scope of business connection ( Explanation 2A to Section 9 (1) (i) ) • Finance Act, 2018 • Transactions in respect of goods, services or property carried out in India, including provision of download of data or software in India; or • Systematic and continuous soliciting of business activities or digitally engaging in transactions with users in India • Monetary threshold for transaction value and number of users to be notified Sanjeev Sharma, IRS

28. Measures taken by India • Public consultation on the proposal for amendment of Rules for profit attribution to Permanent Establishment (Released for public comments on 18th April, 2019) • Users create value and profits for an organisation and hence can be equated with employees, worker, vendors etc. • Degree of user participation depends on types of e-business Sanjeev Sharma, IRS

29. Profit attribution to PE • Profits derived from India to be higher of: • Amount derived at by multiplying the revenues from India with the global operational profit margin; and • 2% of revenue derived from India • The arrived profits to be multiplied with a multiplying factor based on the prescribed weights for sales, assets, employees and users. • The weights vary with types of business models: non-digital business models; digital business with low/medium user intensity; and digital model with high user intensity. Sanjeev Sharma, IRS

30. . THANK YOU Sanjeev Sharma, IRS