(i)
US Treasury - The paper recognises the difficulty of identifying
source of the income in e-commerce era and suggest residence based
taxation.
However,
residence based taxation may not be acceptable to developingcountries
as the same will erode their tax base substantially.
(ii)Australian
Tax Office - The tax office has come out with a very detailed
and elaborate discussion report on the tax and the internet.
Some of the interesting findings of the report are as under.
a) E-Commerce is emerging, the emergence
is rapid and needs to be monitored . Legal infrastructure, effective
and secured payment systems and band width capacity are at present
barriers to growth of E-Commerce.
b)E-Commerce
will increase the number of participants engaged in International
trade and reduce the average transaction size. Successful commercial
web sites will require considerable investment. With maturity,
the commerce will be dominated by large corporations.
c)There
may not be immediate appreciable impact on tax collections.
However, E-commerce will increase the scope for tax planning.
The impact of E-Commerce on tax administration varies according
to the industry, the tax type and the nature of income. Some
of electronic payment system have significant evasion potential.
(iii)
OECD - Committee on Fiscal Affairs (CFA) - The Committee circulated
the discussion paper and has so far held two meetings thereafter.
The Committee has suggested certain changes in the commentary
to article 5 relating to Permanent Establishment and article 12
relating to Royalties.
4.1.2
DIVERGENT VIEWS
The above papers identify and analyse various issues which
may arise because of E-Commerce. None of the paper concludes the
issue. There is more or less global agreement as regards broad
issues arising out of E-Commerce. However, there is no agreement
as regards its solution. It is desired that the solution to the
E-Commerce tax issues should be within the framework of the existing
laws and treaty network.
4.1.3
GENERALLY ACCEPTED TAXING PRINCIPLES
Any
tax policy addressed to E-Commerce should adhere to the following
generally accepted taxing principles and any agreement between
the various countries should be be fair and equitable - to both
taxpayers and the governments, to provide certainty and stability,
protect the revenue base of governments and not hinder the growth
of the business.
(i)Neutrality
Tax incidence should be neutral, equitable and fair between conventional
means of business and electronic business otherwise it can lead
to tax driven migration of business from one form to another.
The taxpayers carrying on similar business transaction either
through conventional means or through e-commerce should be subject
to similar basis of taxation.
(ii)Efficiency
Cost of collecting tax and compliance cost on the part of tax
payers should be minimum
(iii)Certainty
& Simplicity
The tax rule should be clear and simple and there should be certainty
regarding when and where the tax is to be paid and how much of
the tax isto be paid.
(iv)Effectiveness
and fairness
The system should avoid double taxation and should be effective
so as to discourage tax evasion.
As far as International tax is concerned, the allocation of rights
between various countries should take into account each country's
role in generatin underlying income.
(v)Flexibility
The system should be dynamic and flexible so as to ensure growth
in revenue with increase in the trade.
The
following tax issues may crop up because of E-Commerce.
4.2
IDENITIFYING SOURCE OF INCOME
The
two legal internationally accepted bases of taxation are
(i) Residence based tax system and
(ii) Source based tax system
Generally,
a resident of a country is liable for tax on its world income,
while a non-resident is taxed only on income sourced in the country.
In
India, the Income tax Act, recognises this principle and accordingly
persons resident in India are taxed on their worldwide income
while non-residents are taxed only on income which is received
or deemed to be received in India or on income which accrues or
arises or which is deemed to accrue or arise in India.
In
view of this, when a resident of a country earns income from a
source in another country, he is subject to double taxation i.e.
in the source country as well as in the country of residence.
Normally
the double taxation is relieved either by exemption method or
by tax credit method. Under exemption method, the
income is not taxed again in the country of residence. Under tax
credit method, the country of residence gives credit for the taxes
paid in the source country.
Country
of residence is the place where taxpayer has the
close nexus. While source country is the country where income
has close economic connection.
In
the above scheme of taxation, source of income play crucial role
since the country of source has a right to tax income and residence
countries' relieve double taxation.
Generally
source of income is located where the economic activities creating
the income occur.The nature of an item of income is important
for determining source because source of income flows from its
nature. In the era of E-Commerce, many of the goods and services
transacted may be 'intangible' in nature and hence, it may often
become difficult if not impossible to apply source concepts to
link an item of an income with a specific geographical location.
The intangible transactions blur many of existing distinction
between domestic and foreign business, and between on-shore and
off shore transactions.
The link between the service provider's location and service consumer's
location will weaken and hence, it may be difficult to define
the jurisdiction to which the transaction may be subject to.
For
example, it is now possible for a doctor to remotely diagnosis
certain disease or to guide a surgery. The same analogy applies
to other professional like CA. Lawyers etc.
Example
A
UK Software company (UK Co.) participates in the exhibition at
Delhi. An Indian company (Ind. Co.) expresses willingness to purchase
the software of UK Co. provided certain features of the software
marketed by US Software Company US Co.) are incorporated in the
said software. The representative of the UK Co. in India access
the web site of the US Co. (web site being located on a server
situated on Netherland) and ask for the specific information etc.
The payment for the said information is effected directly by UK
Co. from UK to US Co. at its US Office. The Indian representative
of the UK Co. engages the services of a software consultant in
India for modification of its program so as to tailor made it
as per the requirement of Ind. Co.. The representative of the
UK Co. effects payments to the software consultant in India. The
Ind. Co. places the order of the software to UK Co. at its Head
Office through Internet and the modified software is delivered
to Ind. Co. on the net.
image
1
We
may have to examine the taxability of the income arising out of
the following payments.
(i)Payments
by UK Co. to US Co. for supply of information.
(ii)Payments
by representative of UK Co. to software consultant in India.
In
this case the software consultant may be resident of India or
may not be.
The services may be provided in India or it can be provided through
net.
The
payment may be effected by UK Co. directly and can be made abroad.
(iii)
Payments made by Ind. Co. to UK Co. for purchase of software.
Whether
UK Co.'s representative in India who participated into trade fair
in Delhi can be treated as a PE of UK Co.. ?Generally, the use
of facilities solely, for the purpose of storage, display or delivery
of the goods belonging to the enterprises shall be deemed not
to constitute a permanent establishment (PE). So display of goods
at a trade fair may not constitute a PE.
The representative in India, even though had no authority to conclude
contract on behalf of UK Co. has engaged himself in
(i)Interaction
with Ind. Co., engagement of software consultant in India interaction
with him
(ii)Interaction
with US Co.
The
activity of the representative may last even after the fair is
over. He may be involved in training and after sales support to
Ind. Co.
The
above role may be critical in determining the taxability of the
above flows irrespective of the fact that payment to US Co. and
the software consultant in India are directly made by UK Co. The
revenue authorities may try to attribute source into India because
of the activities of the representative of UK Co.
The
example is a mixture of E-Commerce and traditional means of carrying
on business and highlights the pitfalls to be avoided in order
to prevent litigation.
4.3
PERMANENT ESTABLISHMENT (PE)
A
key feature of most Double Tax Avoidance Convention (DTC) is that
business profits derived by a non resident can be taxed in the
source country only if they are attributable to a Permanent Establishment
operating in that country.
The concept of PE represent preference for residence based taxation
by making existence of a PE a pre condition for taxation of business
income. The above concept heavily relies on physical presence
test. It pre supposes that unless an enterprise has physical presence
in the other state, it cannot participate actively in the economic
life of the other state. However, in the era of E-Commerce it
may become difficult if not impossible to apply this concept as
it is.
Article
5 of the OECD Model Tax Convention gives a definition of the concept
of permanent establishment. Paragraph 1 of that article states
that a permanent establishment is a `fixed place of business through
which the business of an enterprise is wholly or partly carried
on. So there are three essentials of a PE
(i)
There should be a place of business
(ii) The place of business must be fixed
an
(iii) The Business must be carried on through
the said fixed place
Paragraph
2 gives illustrative list of what constitutes a permanent establishment.
Paragraph 3 specifies the term PE in relation to building sites
or construction or installation projects. UN Model Convention
extends this rule to cover certain services. Paragraph 4 indicates
that where a place of business is used exclusively for the performance
of certain types of activities, which are generally of a preparatory
or auxiliary nature, it will not constitute permanent establishment.
Paragraph 5 and 6 provide rules according to which an agent may
constitute a permanent establishment of the enterprise for which
he is acting. An agent, if of a dependent nature constitutes a
PE, if he has, and habitually exercises an authority to conclude
contracts on behalf of the enterprise he represents. An agent
acting in the ordinary course of his business would not generally
constitute PE of the enterprise he represents. Paragraph 7 provides
that the mere fact that one company controls another does not
make the second company a PE of the first one
The
following issues or questions arise
1.
Whether a web site/server can be treated as a place of business
and if yes whether it can be said to be fixed ? There would not
be any physical presence of the foreign enterprise owning the
web site in the country.The following different scenario may emerge
(i) The web site is used solely
to advertise the products and no transaction can be carried through
the net. In such a case, the web site won't satisfy the three
essentials of a PE.
(ii) The web site can be used
by the customers to place the order.
(a) The Order is processed
in the country of residence of the Co.
(b) The Payment is
effected through web site or not through web site.
(c) The Delivery is
effected on the net or in conventional method.
In
such a case the purchasing of goods through the internet can be
treated as akin to a transaction of ordering goods through mail
order system.
2.
Whether the activities carried out through the web site constitute
carrying on of business activities or ancillary or auxiliary activity
which would not result into permanent establishment ?
The
E-Commerce provides the facility whereby through the automated
functions, the enterprise is in a position to undertake a significant
amount of business activity in a source jurisdiction with little
or no physical activity or participation in the economic life
of the country.
While
deciding the above two issues, it is interesting to read commentary
to the OECD Model convention, the views of Committee of Fiscal
Affairs of OECD on E-Commerce and the "Pipeline case"
in Germany.
OECD
MODEL CONVENTION
Para
10 of the OECD Model commentary to Article 5 states that 'A PE
may nevertheless exist if the business of the enterprise is carried
on mainly through automatic equipment, the activities of the personnel
being restricted to setting up, operating and controlling and
maintaining such equipment. Whether or not gaming and vending
machines and the like set up by an enterprise of a State in the
other State constitute a PE, thus depends upon whether or not
the enterprise carries on a business activity besides initial
setting up of the machines. A PE does not exist if the enterprise
merely sets up the machines and then leases the machines to other
enterprises. However a PE may exist if the enterprise that sets
up the machines also operates and maintains them for its own account.
This also applies if the machines are operated and maintained
by an agent dependent on the enterprise'.
Thus, for a PE to arise in the country through the presence
of automatic Equipment, the enterprise must carry on a business
activity in that country. The learned author,
Klaus Vogel states : "The activity need not necessarily be
performed by a human being. Vending machines and other automated
devices may very well be permanent establishments if the enterprises
engages in business beyond the mere installation of such machines.
Even fully automated pumping stations and similar facilities should
be considered PE".
THE
VIEWS OF CFA ON E-COMMERCE
"The
determination of whether the site constitutes a `fixed place of
business' must take account of various possible scenarios. For
instance, a server may be located in a building situated in a
country where the nterprise has no other presence. Alternatively,
it could be located on a portable computer used in different places
within that building or moved from city to city by itinerant employee.
Further difficulties would arise where a number or mirror web
sites on different servers located in different locations could
be used so that a customer could be directed to any site for any
function depending on electronic traffic. Another possibility
would be to have only one web site, which is electronically transferred
in total every three months to a new server in a different building,
city or country. The ownership of the web site and of the server
would also be relevant for instance, the enterprise could own
the web site but lease the server from a service provider, lease
both the web site and server from the service provider or lease
the web site and server and share various functions with the service
provider".
PIPELINE
CASE
In
the 'Pipeline Case' the German court held that German stretch
of pipeline owned by a Dutch Company constituted a German PE of
Dutch Company. In the said case, the Dutch company regulated the
flow of oil through remote control from Netherlands. The Dutch
Company had no employees or dependent agent in Germany. The court
held the pipeline as a fixed place of business that served the
business activities of the Dutch company and hence constituted
a PE.
3.
Whether the data base of digital contents can be said to constitute
stock of goods and if yes whether the database can be said to
be maintained solely for the purpose of storage, display or delivery
?
For
a business, which sells information instead of goods, a computer
server might be considered the equivalent of a warehouse.
4.What
is the relationship between an enterprise owning a web site and
the internet service provider ? Whether and to what extent the
later may be treated as an agent of the former ?
Whether
an agent constitutes PE of the principal or not depends on the
fact that whether he is an independent agent or dependent
agent. An independent agent generally does not constitute PE if
he acts on behalf of the principal in the ordinary course of his
business. A dependent agent may constitute a PE if he has an authority
to conclude contracts on behalf of the principal and he habitually
exercises such authority.
The ISP is merely a link between web site owner and the user and
may not be treated as agent of the web site owner. Even if he
is treated as an agent, one will have to determine whether he
is dependent agent or an independent agent. Even if an agency
relationship were deemed to exist, in most cases the service provider
is likely to be considered as an independent agent since he would
be acting on behalf of several web site owners.
5. Even
if it is held that there is a PE, how to determine income attributable
to the PE since there will not be a branch or a fixed place of
business in the traditional sense of the term. Further, the site
could be accessed from anywhere in the world.
All
these issues need a careful examination of Article 5 of the OECD
Model Convention. (OECD M C is regarded as standard and authentic,
worldwide) The need was felt to review the existing OECD Commentary
on Article 5. Towards this end, the OECD Committee on Fiscal Affairs,
which is responsible for updating OECD Model Tax Convention (MC),
appointed a sub-group known as OECD Working Party No.1.
The
`Technical Advisory Group' assisted the Working Party, which was
set up by the OECD Fiscal Committee to monitor the application
of existing treaty norms for taxation of business profits in the
context of E-Commerce. Taking into consideration the suggestions
of the Technical Advisory Group, the Working party has prepared
a draft proposal, intending to add seven new para to the OECD
Commentary on Article 5.
The
draft does not address the issue of how much income should be
attributed to electronic commerce operations carried on through
computer equipment in circumstances where there would be a permanent
establishment. The issue of attribution of income to a P.E. is
currently being examined by the Steering Group on Transfer Pricing.
Proposed new paragraphs to be added to the OECD Commentary on
Article 5 are as follows (Reference to paragraph numbers indicates
the Paragraph numbers of the OECD Model Convention and/or its
Commentary)
(i) There has been some discussion
as to whether the mere use of computer equipment located in a
country through which electronic commerce operations are carried
on in that country could constitute a permanent establishment.
That question raises a number of issues in relation to the provisions
of the Article.
(ii) First, whilst fixed automated equipment
operated by an enterprise and located in a country may constitute
a permanent establishment in that country ( see paragraph 10 [
of the existing Commentary ], a distinction needs to be made between
computer equipment, which could thus constitute a permanent establishment
in these circumstances, and the data and the software which are
used by that equipment. For instance, an Internet web site may
be seen as a combination of software and electronic data which
is stored on and operated by a server. The web site itself does
not involve any tangible property and therefore cannot itself
constitute a `place of business' as there is 'no facility such
as premises or, in certain circumstances, machinery or equipment'
as far as only the software and data constituting that web site
are concerned. On the other hand, the server through which that
web site is operated is a piece of equipment which itself needs
a physical location and may thus, if it is fixed within the meaning
of paragraph 1, constitute a 'fixed place of business' of the
enterprise that operates it.
(iii) That distinction is important
since the enterprise that operates a server on which a web site
is hosted is often different from the enterprise that carries
on business through that web site. Unless the server itself may
be said to be a fixed place of business of the latter enterprise,
e.g. where a server situated at a particular location is rented
to the enterprise that carries on business through the web site,
the mere operation of the web site of that enterprise from a server
located in that country cannot constitute a permanent establishment
for that enterprise. For example, it is common for the web site
through which an enterprise carries on its business to be hosted
on the server of an Internet Service Provider (ISP). In that case,
the server and its locations are not at the disposal of the enterprise,
even if the enterprise has been able to decide that its web site
should be hosted on that particular server; in fact, the enterprise
does not even have a physical presence at that place since the
web site does not even have a physical presence at that place
since the web site does not involve any tangible asset. Thus,
the enterprise cannot be considered to have acquired a place of
business by virtue of that arrangement (the possible application
of the provision of paragraph 5 is discussed below).
(iv) Second, it is not relevant whether
the equipment used for electronic commerce operations in a particular
country is or is not operated and maintained by personnel who
are residents of that country or visit that country for that purpose.
Automated equipment that does not require on site human intervention
for its operation may still constitute a permanent establishment.
(v) Third, computer equipment may
only constitute a permanent establishment if it meets the requirement
of being fixed. In the example referred to in paragraph 2, what
matters is not the possibility of the server being moved around,
but whether it is in fact so moved. Therefore, in order to constitute
a fixed place of business, a server will need to be located at
a certain place for sufficient period of time so as to become
fixed within the meaning of paragraph 1.
(vi) Fourth, as already noted, it is common
that access to the Internet is provided by Internet Service Providers
which, among the services that they provide, host web sites of
other enterprises on their own servers. In that case, the issue
may arise as to whether paragraph 5 may apply to deem such ISP's
to constitute a permanent establishments of the enterprises that
carry on electronic commerce through web sites operated through
the servers owned and operated by these ISP's. While this could
be the case in very unusual circumstances, paragraph 5 will generally
not be applicable because the ISP's will not constitute agents
of the enterprises to which the web sites belong, because these
ISP's will not have authority to conclude contracts in the name
of these enterprises and will not regularly conclude such contracts
or because they will constitute independent agents acting in the
ordinary course of their business, as evidenced by that fact that
they host the web sites of many different enterprises. It is also
clear that since the web site through which an enterprise carries
on its business is not itself a 'person' as defined in Article
3, paragraph 5 and cannot be a deemed permanent establishment
to exist by virtue of the web site being an agent of the enterprise
for purposes of that paragraph.
(vii) Finally, no permanent establishment
may be considered to exist where the electronic commerce operations,
carried through computer equipment located in a country, are restricted
to the preparatory or auxiliary activities covered by paragraph
4. The question whether particular activities performed through
computer equipment fall within paragraph 4 needs to be examined
on a case-by-case basis, having regard to the various functions
performed by the enterprise through the software and electronic
data stored or operated through that equipment. Where the functions
performed through the computer equipment include activities that
form in themselves an essential and significant part of the commercial
activity of an enterprise as a whole, these would go beyond the
activities covered by paragraph 4 and if the equipment constituted
a fixed place of business of the enterprise (as discussed in paragraphs
1 to 5 above), this equipment would therefore be a permanent establishment
of the enterprise'.
The
draft will be reviewed in the light of the suggestions and comments
received by OECD.
4.4.1
CHARACTERISATION OF PAYMENTS
The variety and hybrid nature of internet product and modes
of delivery make the tax classification of payments for digital
products particularly difficult.It will become difficult to characterise
whether particular transaction is sale, lease, provision of services
or royalty. Characterisation will be very important because all
the four categories of transactions may have different
tax consequences.
Inconsistent
classification in two countries may lead to double taxation.It
will become increasingly possible to transmit images of certain
products
Electronically, i.e. newspaper, magazines, photographs,
music, movies etc.
Customers
may be
(i) allowed only to view
(ii)
allowed to download
(iii)
allowed to modify downloaded product or incorporate them into
their own products.
(iv) Modified versions may be allowed
to be used only by the customer or he may be allowed to sell the
same.
In
all the above cases it will be difficult to conclude whether the
payments are for the use of, or for the right to use a copyright
etc. or are payments for purchase of goods or services.
It
could be argued sometimes that the transaction involving digitised
information could involve substantial difference and so could
justify a different tax treatment i.e. purchase of book in physical
form and purchase of book in digital version. The customer purchasing
physical copy of a book is unable to make changes in the contents
of the book, while the customer downloading a digital version
of a book may be able to alter its contents.
WTO
declaration on custom recognises that electronic delivery of the
goods should be treated as provision of services and not subject
to custom duty.
4.4.2
REVISED OECD COMMENTARY ON ARTICLE 12
OECD
- Committee on Fiscal Affairs has published revised commentary
on Article 12 which deals with software payments. This commentary
discusses the application of the definition of royalties in relation
to one type of digitised products i.e. software and the principles
that underlie this changes may be relevant in considering how
that changes are relevant in case of other E-commerce transactions
involving digitised contents; i.e. movies, music, pictures, text
etc.
