Digital economy needs tax clarity

“Digital” is an inevitable and progressive catalyst of change. Whereas internet-based online transactions have existed for some time now, the transformations at a national scale are morphing many more areas together into a “digital economy”.

The transformation is about 100% dematerialisation up to the ‘last mile’, with near 100% continuous involvement of the internet and is built upon cloud computing. In India, the recent UPI launch will accelerate last-mile integrations and lead to a national cohesive market.

The digital economy is therefore about “digital goods” and “digital services” being stored, transported, or provisioned ‘digitally’ and exchanged using ‘digital money’. Electronic hardware, networking, telecom and e-commerce are about enabling this digital economy.

Tax regime—out of sync

On the other hand, governments globally have a huge challenge from the emergence of a digital economy which has the power to disturb or outmaneuver tax systems if not accommodated adequately and in a timely manner.

On the international front, the challenge is posed by technology diluting the efficacy of borders. The equalisation levy of 6%, introduced in Budget FY17, on the advertisement fees paid to foreign digital media companies, is a corner stone of the international problem of BEPS. In yet another example, since 2015, the EU has brought all digital goods’ B2C sales under VAT, irrespective of the country of origin.

On the domestic front, the challenges are created by a piecemeal approach from the tax authorities with respect to the evolution of this new economy ever since the internet and software delivery have proliferated. The fragmented system is not able to cope with new business models that are based on innovation and ideas where “software is eating the world”—as famously said by Marc Andreessen, a general partner at the prominent venture capital firm Andreessen Horowitz .

In some countries, Netflix users evaded tax when they procured directly online, as against paying taxes when procured through a partner. In India, the same ‘SaaS’ software is taxed only under the service tax component when procured through a service partner, as against service tax plus VAT when procured directly. The confusing tax systems create immense frictions for ease of doing business for digital goods and services.

The world has recognised the problem and started moving towards pragmatic solutions. India, with its 29 states and over 250 million internet users, cannot afford to overlook the taxation issues facing a digital economy.

On the domestic front, for indirect taxation, it is an opportune time for India to solve this problem with the GST rollout.

India has rightly opted for a ‘thoroughly digital’ system for implementing GST. However, to offer infrastructure to support a authentically ‘digital GST’, it also needs to integrate the digital economy’s taxation concerns.

The GST will solve many confusions, but must address several more of them. A single rate is always a good starting point. There are several unnecessarily imposed classifications of digital goods, and differential rates must be eliminated to simplify the mechanics. Additionally, the value chain of consumption of “goods” versus “services” is quite different, and must be reflected clearly in the definitions.

Accept digital goods as reality

A generally accepted principle across the ongoing discussions in the world of taxation on digital economy is that it does not favour a new or separate tax regime for ‘digital’. We must principally agree that the digital economy’s concerns should be overlaid and accommodated into the existing and evolving legal framework.

Despite a lot of confusion on this issue, the US has a well-drafted bill defining “digital goods” and “digital services” under consideration. The bill has adopted a simple and fair definition. The term “digital good” is defined as, “Any software product or other good that is delivered or transferred electronically, including sounds, images, data, facts, or combinations thereof, stored and maintained in digital format, where such good is the true object of the transaction, rather than the activity or service performed to create such good”. A “digital service” is defined as, “Any service that is provided electronically, including the provision of remote access to or use of a digital good”. This excludes services like telecom for fair sectoral treatment.

“Digital goods” therefore, is not just about music, video, images, or e-books. In fact, software products may be a combination of complex scientific computer programs or commercial applications with a combination of data types including voice, video, images, texts, document files and so on. We must account for the many permutations and combinations, and not limit the evolution of such products.

In order to make best use of the digital economy’s opportunities while achieving the objectives of a) increasing the tax base with a simple, fair and neutral tax regime, and b) promote an environment of business growth with ease of doing business, India must consider the following four measures in its tax systems:

One, free “digital goods” from the shackles of ‘royalty income’ under the garb of attached ‘copyrights’ in the Income Tax act. This binding of ‘royalty income’ on software and ‘intangible/digital’ goods is a bottleneck to trade in a digital economy.

Two, clearly define “digital goods” and digital services” consistently across the legal framework.

Three, provide “digital goods”, or intangible goods, the status of “goods” as defined in Article 366(12) of the Constitution. The digital goods, though intangible in nature, exhibit all properties of tangible goods generally acceptable in legal parlance viz. durability (perpetual or time bound), countability (number of pieces, licenses or users etc.), identifiability (standardised), movability and storage, ownership (IP or right to use), producibility/reproducibility, and marketability/tradability using an MRP.

And fourthly, in a digital world, the tax system (both domestic and international) has to be end-to-end digital, i.e., be able to track transactions, levy a clear single tax, and collect tax digitally—including taxes on international online transactions.

There is progress on the fourth issue in different quarters, but the government needs to move fast on the first three measures in order to align the tax system with the digital economy. This can not only solve existing taxation issues in the most transparent manner, but also provide future-proof solutions and establish standards for the support of innovation and progress.

Contributed by Mohandas Pai, Aarin Capital & Sudhir Singh, iSPIRT

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