Harry is on the verge of quitting his job to become an entrepreneur. But he is worried about the exorbitant cost of hardware, software, server and other IT requirements for his business. Like his famous fictional namesake, Harry wishes he has magical charms to exorcise the “soul-sucking dementors” in the form of prohibitive IT cost.
But while the boy-wizard Harry Potter uses the powerful Expecto Patronam spell to save himself, businessman Harry merely needs the Cloud, or cloud computing.
Through the Cloud, Harry can get IT services on a ‘pay-per-use’ basis in a virtual outsourcing model. He can have access to software, application platform for developing and deploying his own software and computing power, storage, and operating systems. To top it all, Harry need not own, manage or control the Cloud’s infrastructure.
And while he is heartened by all the advantages, he remains apprehensive about the associated tax costs, as there are no clear rules or legislative guidance on taxing such technology. So, Harry needs to fit a square peg in a round hole by applying yesterday’s laws to today’s technology. Cloud is a world by itself (populated by a host of vendors, suppliers, and advisors) with a gamut of tax issues.
Harry knows that the correct classification of the underlying transaction is fundamental to tax treatment. He is aware that in a Cloud, there may not be any transfer of property and, thus, the rules governing taxation of services may apply. However, there may be instances where a right is transferred to a customer, and this needs to be classified either as royalty income or as rental/ subscription fees.
If a transaction gives rise to royalty, the income is taxed if the underlying right is used in India. Traditionally, there is controversy over whether use of software involves granting of copyright or copyrighted articles. Regarding the use of servers, portals, and Web sites, the controversy centres around equipment or process royalty. The jurisprudence is divided, and the specific amendments relating to royalty as defined in the Income Tax Act have added a new dimension to the controversy. Some questions remain unanswered: Does use of software involve use, or right to use a copyright? Would mere use of space with no control over the equipment qualify as equipment royalty? Is the use of multiple servers across jurisdictions for space optimisation under Cloud a ‘process’?
On the other hand, if income from a transaction is rent or subscription, it will be taxable only if the service provider has, in tax parlance, a ‘permanent establishment’, or PE, in India on account of underlying property (such as physical location of servers). In the virtual world, would a server that has significant physical presence be considered a PE even if minimal individual intervention is required to run it? Does Cloud create a PE both for the service provider — through its infrastructure, and the end user — through the use of servers outside the home jurisdiction? Even if one can determine a PE, the attribution of profits remains tricky.
Adding to Harry’s concerns is the overlapping applicability of service tax and value added tax in the Cloud.
The Cloud heralds the dawn of a brand new era, near-magical in potential — but first, the uncertainty clouding it must be cleared.
(Naveen Aggarwal is Partner, KPMG in India)