Plugging loopholes

Well intentioned plan to tax online services from abroad

A committee set up by the Central Board of Direct Taxes has recommended a tax of six to eight per cent on about a dozen services offered on digital platforms by entities that do not have any permanent establishment in India. At present, no tax is levied on transactions of non-resident entities providing online services to companies based in India. A range of online services like advertising, designing or maintaining websites, online computing and providing or maintaining e-mails could come under the tax net, if and when the recommendations are accepted. The proposal may have naturally provoked adverse reactions from those who would have to bear the new tax burden. A new tax never brings cheer to companies in any sector, particularly those belonging to the new economy, accustomed as they are to a preferential treatment from the government with respect to a wide range of policies. And if the final target of the new tax happens to be economic entities headquartered abroad without any establishment in India, the criticism is also likely to feed into the general narrative of the government continuing with an unfriendly taxation regime for foreign companies. But it is important to look at the specific tax proposal on overseas companies offering online services in India on merit and in the larger perspective of both domestic and international taxation practices.

There are three good reasons for the government to explore the new tax idea. One, the proposed taxation is in complete conformity with the international taxation policy under the newly introduced principles of Base Erosion and Profit Shifting (BEPS). The new policy, enunciated by the Organisation for Economic Cooperation and Development or OECD, is now being embraced by most countries. Once the BEPS framework is adopted by the Indian revenue authorities, the tax laws in the country would become more compatible and acceptable in a global business environment.

Two, the rapid expansion of online services business in the last few years has resulted in non-resident providers of online services enjoying a tax advantage over their competitors operating as domestic companies in India. The absence of a level playing field that such a tax system perpetuates is as harmful as its implicit encouragement to business to move overseas to enjoy the available tax advantage. If a foreign online service provider has a permanent establishment in India, it is taxed at a rate like other domestic entities. The current taxation policy, therefore, encourages even Indian online service providers to relocate to a foreign country in a bid to reduce their tax burden. Finance Minister Arun Jaitley's Budget for 2016-17 has already made a beginning in this direction by imposing a withholding tax of six per cent on annual payments of above Rs 1 lakh to such overseas providers of online advertising services that have no permanent establishment within the country. This is a sound principle of taxation and must be extended to other online services offered from an overseas establishment.

Finally, the government must learn the lessons from the vague taxation policy that was exploited by some foreign companies in recent past. This gave rise to the need for a controversial amendment of tax laws with retrospective effect, creating avoidable controversies and harming India's reputation as a place of doing business in a stable taxation environment. Such loopholes must be plugged before somebody can take undue advantage of them. The reasonableness of the proposal to impose tax on online services provided from overseas establishments arises also from such considerations.