The Hindu Business Line : Is taxing e-commerce feasible?

THE Common Minimum Programme adopted by the United Progressive Alliance attempts to reconcile economic reform with the concerns of the Left. It includes such goals as giving a boost to investment in technology and rationalising the tax system (higher tax-GDP ratio). It talks about a cess on Central taxes to finance education. However, there is no mention of the much-debated tax on e-commerce. This may be addressed in the Budget.

Taxation of e-commerce is important with the kind of trading the Internet has encouraged in India, especially for goods and services such as railway tickets, books, and CDs. The growing volume of e-commerce transactions promises a good tax base.

Business groups around the world argue that if e-commerce was allowed to grow there will be a general reduction in transaction costs everywhere with the resulting output increases widening the tax base. States, such as Virginia in the US, which hosts e-commerce companies such as America Online, are hesitant to tax e-commerce transactions for fear of losing them to other States.

While e-commerce is taxed elsewhere, there are some problems.

Traditional tax models, such as destination-based principles, break down with e-commerce because of several reasons. First, there is the question of jurisdiction (where the vendor is located or the one in which the customer is located) has the right to tax.

Second, it is difficult for the vendor to find out where exactly the customer is located. Further, the vendor may not have any contacts in the customer's location to collect taxes, as some studies point out. Another contentious issue is that it is not clear whether e-commerce transactions are to be treated as goods or as services in the context of domestic taxation.

There are useful rules from international trade where there is no ambiguity if a product is ordered over the Internet and if it were to be delivered in the conventional manner. Any such transaction will be treated as a good and GATT (WTO) rules on trade in goods apply.

With respect to internal trade, ambiguity arises only if goods were to be transmitted electronically across the Internet (newspapers, journals, other printed matter — scanned and sent in digital form — CDs, tapes, software, and so on).

Essentially, the electronic delivery of goods can be classified as services. So, taxation of e-commerce transactions in the Indian context is relevant as it applies to sales taxes (levied on goods) and service taxes (levied on services), as well as to direct income from e-commerce.

The Government constituted a High Powered Committee (HPC) in December 1999 to examine the position of e-commerce transactions under existing taxation laws to determine any changes to be made and consider the possibility of taxing e-commerce transactions. This covered the gamut of only direct taxes. So far, indirect taxes on goods and services transmitted electronically on the Internet have not been considered. This is why.

Sales tax revenue accounts for two-thirds of total own source revenue of the States. Most States (except for Delhi, Haryana and Punjab) levy sales tax on the first sale of transactions within the State. Now, if an order for goods is placed through the Internet in Karnataka and the product distributor is in Uttar Pradesh, then taxation will be difficult, as Uttar Pradesh has only first-point taxation, and the transaction is a last-point sale.

In Delhi, this transaction is taxable. This example is only meant to illustrate the heterogeneous outcomes possible if Internet transactions are to be taxed, assuming that a physical counterpart exists to the goods ordered (that is, the goods cannot be transmitted electronically).

Also, there is no guarantee that in States that have final-point taxation the consumers will not masquerade as traders to evade tax. A more complex problem arises if services are transmitted electronically (for instance, downloads of music CDs and tapes from some remote server on payment). How can such transactions be identified and taxed, especially if the consumers are based outside the country?

Further, States are not authorised to levy a tax on services. Because of this, services (with the exception of electricity, transportation, entertainment and professional services) are exempt from sales tax. The Union Government levies tax on foreign travel, hotel expenditure, telephones, stockbrokers, non-life insurance, advertising, couriering, radio paging and a host of other services.

A milestone on the path of tax reform will be crossed on April 1, 2005, with the introduction of value added tax (VAT). VAT requires substantial work in terms of standardisation of procedures, transactions, and computerisation of records at various levels of sale and purchase in the States for which some are ready and others not.

The standardisation is necessary to enable the granting of tax credit that has been paid at the various intermediate levels of manufacture of a good. Given the substantially different tax systems the States have, the best solution is a sub-national VAT which means each State's VAT rate and structure can be different.

Further, it is not clear how and where e-commerce transactions (for example, intermediate goods) will fit in the value chain for the good or service. Also, as studies have pointed out, with the bulk of e-commerce in India being likely B2B, any tax on e-commerce will add to business costs. This will be over and above the costs businesses in India already face with poor infrastructure. So, it is neither a certain nor a clear proposition whether e-commerce transactions are taxable and, if yes, how. Most developing countries have these problems regarding e-commerce:

Unreliable Internet access and incomplete PC infrastructure penetration. For instance, the number of Internet hosts per 10,000 inhabitants for all countries in Africa was only 3.44 as of 2001, compared to 1,333 for the Americas, 29 for Asia, and 191 for Europe. A similar story is true for PC penetration.

Low average disposable income with steep inequality, as a result of which B2C transactions are almost non-existent.

Inadequate data even in cases where Internet transactions take place.

Poor infrastructure, such as roads and power, that most likely make imposition of taxes on e-commerce add to business costs, and stifle the growth of e-commerce in these countries.

The taxation of e-commerce in the Indian context at this point, is premature, and awaits the development of supporting infrastructure. One has to wait and see how the Budget will accomplish this.

(The author is Associate Professor, Business Environment Group, Indian Institute of Management, Lucknow.)

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