This article was written by Amrit Subhadarsi a student of National Law University, Odisha
NATURE OF E-TAXATION
E-taxation in cyberspace is one of the major issues in cyber law. As a result of increased globalization and integration among different countries, consumers of different classes of products ranging from books to apparel, are spreading beyond the boundaries of the countries where the service is being provided. Also, the main reason why there has been rise in e-commerce transactions worldwide is the fact that e-commerce transactions save time of the consumers and are more cost effective. While this is the benefit which accrues from such transactions, the disadvantage is that as more and more companies are resorting to selling their products and services online, increasingly governments are being concerned about the nature of taxation that will apply to such transactions. There is lack of clarity on e-taxation and a number of issues exist which need to be clarified. The solution to the lack of clarity on e-taxation is not to limit or prohibit e-commerce transactions, as it would portray the government which isn’t open to new forms of business. Spreading of business through the e-commerce route is inevitable, and the only solution is to bring out a set of standards so that there is clarity on e-taxation. There exist certain issues in regard to e-taxation such as finding out the point of commencement and end of a transaction, the entire transaction being completed without being confined to boundaries or limits, identification of a permanent establishment for taxation of the product or service supplier.
The overall aim of e-taxation is to replace cumbersome manual, bureaucratic, service systems with collaborative, efficient, process driven, secure online delivery. The traditional idea and the fundamental principle of taxation is that nations could tax economic activity undertaken within their sovereign territory when the mode of conducting business is not e-commerce, but through a separate legal entity incorporated in the other country. The fundamental principle in taxation is that when a resident of one country earns income from economic transactions in another country, both countries have a right to tax the same income. The home country has the right to tax the income on the basis of residence rule and the host country has the right to tax the income on the basis of source rule of taxation. The nature of e-taxation is such that the absence of a physical place of transacting business complicates the method of imposing tax on the business. Because of lack of tangibility to the conduct of the business and lack of confinement of the entire transaction within a limited territory, there is difficulty in applying traditional principles of taxation based on residence and the source of income. Important determinants of taxation such as location of business, place of delivery of goods and services of the business, are some of the important issues which need to be determined in cases of e-taxation. In e-taxation, the main problem which arises is that it is difficult to determine the location of production of goods and services, the area where the sale of such product or service is provided and therefore concepts of permanent residence, product classification, etc are difficult to apply. Moreover, because of the rise in e-commerce transactions, governments are increasingly losing revenue and their tax authorities are finding it difficult to cope with this problem. It is increasingly becoming difficult for tax authorities to identify the legal person upon whom tax can be imposed as in cyberspace a particular supplier can take up multiple identities.
TAXATION PRINCIPLES OF E-COMMERCE AND ITS ISSUES
Neutrality, Efficiency, certainty, fairness and flexibility
Some general principles of taxation of e-commerce transactions were developed in the OECD Ministerial Conference in 1998 such as neutrality, efficiency, certainty, simplicity, effectiveness, fairness and flexibility. The principles provide that there should be clarity with regard to taxation so that the taxpayers know where they stand. Further, clarity on tax will ensure penetration of e-commerce into the country where the service will be provided. The principles further provide that the tax rules should be such that there would be reduced chances of tax evasion and the right amount of tax would be payable. Also, taxation of e-commerce transactions should be continuously updated to keep up with the latest commercial developments. So far as the principle of neutrality is concerned, it advocates that income which is earned through the e-commerce route should be taxed in a manner which is not discriminatory with the income earned through conventional sources. If e-commerce taxation is done contrary to the general principles, then it would put the e-commerce industry at a competitive disadvantage.
The idea of permanent establishment is recognized under the traditional taxation rules in which income earned by way of business carried out in a conventional manner is taxed when it is clear as to where the business has been permanently established. So far as transactions over the internet are concerned, due to lack of defined territories, it is difficult to determine where the permanent establishment of the business has been established. The OECD Model Income Tax Convention defines a permanent establishment as “ a fixed place of business through which business of an enterprise is wholly or partly carried on.” So far as India is concerned, the term “permanent establishment” has been defined in the Income Tax Act, 1961 as an inclusive definition which resembles the definition in the OECD convention mentioned above. Permanent establishment includes a branch office, factory, mine, etc. Mere presence of the website on Indian soil, will not be sufficient to prove permanent establishment and if any business is transacted through it, such as taking of orders for sales, permanent establishment could be said to be established.
Source and Residence based taxation principles
Source and residence based taxation are two principles which are part of the conventional taxation system. Source based taxation system means that country imposes tax on the business carried out, where the business is located and the source of income arises from that country. On the other hand, residence based taxation system means that all individuals and legal entities are subject to tax in the place where they are resident. Generally, if a country is able to establish that a company operates its business within that country and the source of income arises from that country, then the company would be taxed based on the source based taxation principle. Similarly, if on the other hand, residence is established on the basis of the permanent establishment principle, then alternatively tax liability may be imposed following the residence based taxation principle.
Issues with respect to e-taxation
Taxation of e-commerce transactions
Taxation is one of the main issues in e-commerce transactions because of the problem of identification of permanent establishment. Whether a particular transaction online can be said to form a permanent establishment is a complex issue to determine, based on which tax could be imposed. However, the issue is that what amount of online transaction by the product or service supplier would amount to the business having a permanent establishment. Another issue which arises with respect to e-commerce taxation is identification of the source from where the income arises. This is because supply of products or services online transcends boundaries and there may be multiple jurisdictions where consumers might reside. Special e-commerce issues arise with electronically conveyed services and digitized products. These include whether a particular transaction being provided is classified as sale of the product or service or the product or service is provided by way of licensing. There is no means to identify the user of the domain name under which the product or service is provided and the domain name only states as to who is responsible for maintaining it.
The Goods v Services distinction
A key issue in taxing e-commerce transactions is that the distinction between goods and services is getting diminished. The difference between goods and services is important because it leads to differential treatment with respect to taxes being imposed on them. A lot of products or services are available online like software, online information, digitized images and films. A service being provided by a foreign company and performed outside the country would not be subject to any tax at all. According to the OECD, many goods being delivered in physical form are now being provided online.
An important issue is identification of a business connection so that the tax liability can be imposed. With e-commerce transactions spreading into multiple jurisdictions having multiple consumers, it becomes difficult to identify the source from where the income is generated leading to lack of clarity on tax issues. If a business is run in a particular country and a foreign enterprise uses the country’s resources in providing the service, then a business connection is clearly established, and the business can be taxed by that country. One important issue which arises is that whether owner of a computer server who lets a company host its website on that server, can be said to be having a business connection with the country. These problems are not identified in the Income Tax Act, 1961 or any international convention or treaty and therefore need to be clarified.
Characterization of income
Unless the income is classified into a particular category and its source determined, the income cannot be taxed properly. Therefore, characterization of income is important as it leads to clarity in taxation. This 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. Now with increase in the range of goods and services being provided and upgradation in technology, characterization of income became difficult. For instance, it may be difficult to determine whether supply of software solutions, would amount to sale of goods or services.
Identification of value of e-commerce transaction
These days identification of the value of e-commerce transactions is becoming a hindrance for purposes of calculation of tax liability. This is because, there are a range of products or services which are similar and each of their values cannot be determined precisely. Therefore, what the assessee determines as his liability will be the basis on which the taxman will assess the liability of the assessee. However, the disadvantage is that this opportunity may be used by the assessee to evade tax liability. Identification of value remains a problem for professional or personalized services. In this situation, the best option available with the taxman is to rely on the information provided by the assessee and compare it with the contemporary information about similarly related services.
Identification of parties
Identification of parties is one of the major issues as when contracts are entered into online, the parties are not physically present at the time of entering into the contract. Therefore, questions may arise with respect to the legitimacy and the capacity of either of the parties to enter into the contract. It may so happen, that a person may operate under a false identity and misrepresents himself or herself online. Here, the other party cannot find out the real identity of the person as generally people are ignorant about this and may provide their personal information onlinwe which can later be used against them. Determining of identification of parties can be done through decoding of protocol addresses but such processes might be very technical and also time taking.
Validity of contract
One major disadvantage in case of e-contracts is that unlike conventional contracts, where both parties are aware of each other’s identities and consideration, in e-contracts issues may arise with respect to the identity of parties and also about the nature of acceptance. For instance, whether a mere instance of downloading something from a site where the information has been posted for making an offer, would amount to a contract. Similarly, A click on the options in the website cannot be a full acceptance of the information, though a seller anticipates the placing an offer through the website.
ARGUMENTS FOR AND AGAINST E-TAXATION
Arguments in favour of e-taxation
The first argument in favour of e-taxation is based on the principle of tax neutrality, which states that all businesses should be taxed equally irrespective in the mode in which they are conducted. If e-commerce transactions are taxed in a manner which is discriminatory as compared with the conventional modes of running business, then those transactions will be at a competitive disadvantage. Conversely, if e-commerce transactions aren’t taxed at all, it will be unfair to other mainstream businesses as products and services offered by e-commerce companies will be sold cheaply.
Another argument is that if e-commerce transactions are not taxed, then the burden on low income taxpayers will be high who cannot afford such transactions and prefer to buy goods from physically present stores. If online transactions are exempted from being taxed, then the burden will pass to the low income group consumers who will have to bear higher tax liability. Hence, online transactions should be taxed.
A third argument is also given that owing to different rates of sales tax in different states, different business transactions may be taxed differently depending on the nature of business and the mode of conducting business. This might lead to a jurisdiction having more liberal laws with respect to investment and also there remains a risk that governments of the respective states might lose out on revenues. But, if e-commerce transactions are taxed in such jurisdictions then the gap which exists with respect to rates of taxation, can be reduced and hence, e-commerce transactions need to be taxed.
Arguments against e-taxation
The first argument is that internet was created for the free exchange of information electronically and therefore any tax on transactions over internet would be unjustified. Taxing sales over the internet would be fundamentally against this principle. Moreover, its also argued that many Internet consumers pay shipping and handling fees which offset whatever, sales tax savings, if any, the consumer has. Thus, taxing online transactions would not be a good idea if this logic is followed.
Another issue is that due to lack of proper regulations over e-commerce transactions and infrastructure, and also lack of supervision with respect to taxation and its enforcement, e-taxation is not encouraged. Also, cost of compliance and enforcement act as hindrances to taxation of online transactions.
It is also argued that if e-taxation is encouraged, then it would widen the digital divide between the well off and the low income group consumers who would not have access to the benefits of e-commerce owing to higher costs of transaction, which would be inevitable if taxes are imposed on such business transactions. Hence, it is argued that if e-taxation is imposed, then it would benefit the affluent class at the expense of low income group people and hence, such taxation should not be imposed.
PRINCIPLES OF E-TAXATION UNDER DIFFERENT JURISDICTIONS
Income Tax Act, 1961
Section 9 of the Income Tax Act, 1961 states which kind of business income can be taxable in India. These include, income derived from any property in India, business connection in India, any asset or source of income in India. Prior to the passage of the Finance Act, 2003, the term ‘business connection’ was not defined in the Income Tax Act, 1961 and was interpreted in a case law.The Supreme Court of India in CIT v. R.D.Aggarwal held that business connection involves a relation between a business carried on between a non resident, who yields profits from himself, and some activity in the territory which contributes directly or indirectly to the earning of those profits. The Finance Act of 2003 further broadened the scope of ‘business transaction’ to include, a dependent agent who functions on behalf of the non-resident and can enter into contracts on behalf of the non-resident. However, both the Income tax law and the Finance Act, leave the term ‘business connection’ subject to wide interpretation in the sense that both don’t address the issue whether a website available internationally would have a business connection in India if a kind of commercial activity is performed.
Taxation under US Law
Under the US law, the test of “substantial nexus” is applied to determine the tax liability as provided under the due process clause in the American Constitution. Physical presence of the business establishment is required to show substantial nexus of the business with the place where the product or service is provided. It is still unclear as to whether use of a web server of a state where the firm runs its business, would amount to substantial nexus between the firm and the state as the state’s infrastructure is being used to provide the service. In US, the Internet Tax Freedom Act, 1998 provides that sellers while providing a particular service would not pay the sales tax, but the burden is passed on to the consumers who are supposed to maintain a list of products bought and the sales tax, and then pay a use tax on their respective tax returns.
The 1992 OECD Model Convention provides for fair practices in the e-commerce sector. In 1999, the OECD committee on fiscal affairs formed a Technical Advisory Group (TAG) whose mandate was to examine the taxation of business profits in relation to e-commerce. Some of the important conclusions were, a website cannot by itself called a permanent establishment, or, an Internet Service Provider (ISP), except in unusual circumstances cannot be called as permanent establishment. Similarly, a server of a state can be said to establish a permanent establishment for the purpose of a business, if only the functions performed by the server, are more than preparatory.
It can be said that, e-commerce transactions are inevitable in today’s times as more businesses look to innovation, cost effective and time saving measures to conduct their business. The government can only regulate the e-commerce business but cannot prevent them from thriving. In such circumstances, the issue of taxation of online transactions which remains subject to wide interpretation both under US and Indian laws, needs to be clarified and India in particular, must bring changes to its Income tax law and also bring about a special legislation to regulate e-commerce transactions and their taxation aspect. This would provide clarity on the subject matter and transparent mechanism for conduct of the business through the e-commerce route. At the same time, it must be seen that the principle of tax neutrality is adhered to and there is no imposition of discriminatory tax which would not allow the e-commerce business to survive in India.
 Aparna Viswanathan, Cyber Law Indian and International Perspectives 303 (LexisNexis Butterworths Wadhwa Nagpur, Haryana, 1st edn., 2012)
 1992 OECD Model Income Tax Convention on Income and Capital, Article 5