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Characterisation of an e-commerce transaction and its taxability pose a colossal challenge for the stakeholders. E-commerce involves transactions over the Internet — generally without need for human interface — such as e-advertising, e-sales, e-delivery and so on.
In India, e-commerce has grown from $2.5 billion in 2009 to $14 billion in 2012 (Source: indiaadvisoryboard.com). The exponential growth has undoubtedly intensified discussions on the taxability of such transactions, especially as this remains under a cloud where every country intends to implement a combination of source- and residence-based taxation.
The Technical Advisory Group set up by the Organisation for Economic Cooperation and Development (OECD) in 1999 to examine the applicability of business profit rules in e-commerce and propose alternative rules, had concluded that e-commerce and other business models resulting from new technologies did not justify significant departure from existing rules.
The high-power committee constituted by the Indian Government to examine the taxability of e-commerce opined that a differential tax treatment would offer an easy tax-avoidance mechanism.
Although taxability of e-commerce remains a vexed issue, the OECD Commentary on Model Convention provides reasonable guidelines on the concept of Permanent Establishment (PE) in this context.
Web site not a PE
It fails the traditional ‘place of business’ test.Web site is a combination of software and electronic data not constituting a tangible property. In the absence of any location constituting ‘place of business’ — such as premises or machinery or equipment, namely, server — a Web site per se cannot qualify as a PE.
Server may constitute a PE
As an equipment with physical location, server may constitute a PE of the operating enterprise.
A Web site hosted on a specific server of an Internet Service Provider (ISP) at a specific location does not put the server and its location at the disposal of the enterprise.
If the enterprise doing business through a Web site has the server at its disposal in a fixed place for a sufficient period of time, and the business is not preparatory or auxiliary in nature, the location of server constitutes a PE.
The high-power committee felt that the above principle does not ensure equilibrium in tax revenue sharing between source and residence countries. Therefore, the concept of PE should be abandoned and an alternative found.
The dispute has led to litigation between the Revenue department and e-commerce players. In the Yahoo India ruling, the Mumbai Income Tax Appellate Tribunal held that Yahoo India’s payment to Yahoo Hong Kong for banner advertisement would not be taxable as royalty, as the service did not involve “use” or “right to use” any industrial, commercial or scientific equipment. Following this ruling, the tribunal again held that payment to Google Ireland was not in the nature of royalty or technical service fee (FTS) in the Pinstrom Technologies case. In its recent Right Florist ruling, the Kolkata tribunal held payments to search engines such as Google Ireland and Yahoo USA for online advertisements as not taxable in India either as royalty/ FTS or business profit in the absence of a PE in India. The tribunal emphasised that as the servers of these e-commerce payees were outside India, there was no India PE. In contrast, earlier rulings, as in Galileo’s case, held that a PE was triggered in India.
Several countries are looking for their respective share of taxes in the e-commerce pie — in the UK and the US, Revenue authorities have been alleging tax avoidance by big names.
Revenue authorities have a legitimate claim on profits derived from the respective country. However, the current taxation framework, especially the traditional concept of PE, may not be good enough for levying such tax on foreign entities. E-commerce players, too, cannot pay overlapping tax on the same income in multiple jurisdictions. The tax laws have not evolved in line with the development of technology. OECD’s report on ‘Base Erosion and Profit Sharing’ recognises that “…current international tax standards may not have kept pace with changes in global business practices, in particular in the area of intangibles and the development of the digital economy...”
In his book Erosion of a Tax Treaty Principle , Norwegian tax expert Arvid A. Skaar says, “The conclusion is that the effects of the PE concept in international fiscal law have changed, in particular during the last few decades. Rather than protecting the tax base in the source state, the PE principle today has become instrumental in ensuring avoidance of source-state taxation for some economically important business operations.”
Time is, therefore, ripe for developing the concept of PE and taxation of income from new business concepts, to prevent avoidable disputes in future.
Gaurav Bajoria, Senior Manager, and Rahul Shah, Assistant Manager, contributed to the article.
The author is Executive Director, Tax & Regulatory Services, PwC India
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