Direct and Indirect Tax on Digital Services

Some contents of this post might have outdated. Do read this post with this other article: Digital Service Tax: Now it’s here in Nepal

Preface

Defining the taxing right on an individual is pretty easy. A person can be seen where he is standing. If that individual wants to immigrate to another country, which is fine and legal, and the individual will settle in the new country. Camp down, start a life, live there, buy a house and have a lifestyle based there. And these attributes make it easy to define the taxing rights of the countries on an individual.

With companies, it’s a little harder. Because with a company, it’s got an economic reality, it’s a legal person, but where is it? Is it where it is registered? Is it where its shareholders are? Is it where it has its main building? Don’t Know. One can always debate that.

Stick that into digital economy and oh my god, it becomes even harder. Sometimes ago, when a company sets up, you would want to know where its premises were, you would want to know what it did, you would want to know if it had a factory and where, you would want to know where it stored its goods and that would be enough. But most of these questions don’t even apply to even huge digital enterprises. They don’t have to have premises, they don’t have to have anything, anywhere. And how would you apply tax rules to those? That’s hugely challenging and the work on that is going on.

These challenges raise questions as to whether the current international tax framework continues to be appropriate to deal with the changes brought about by the digital economy and the business models that it makes possible, and also relate to the allocation of taxing rights between source and residence jurisdictions.

Ottawa Taxation Framework Conditions

Neutrality: Taxation should seek to be neutral and equitable between forms of electronic commerce and between conventional and electronic forms of commerce. Business decisions should be motivated by economic rather than tax considerations. Taxpayers in similar situations carrying out similar transactions should be subject to similar levels of taxation.
Efficiency: Compliance costs for taxpayers and administrative costs for the tax authorities should be minimised as far as possible.
Certainty and Simplicity: The tax rules should be clear and simple to understand so that taxpayers can anticipate the tax consequences in advance of a transaction, including knowing when, where and how the tax is to be accounted.
Effectiveness and Fairness: Taxation should produce the right amount of tax at the right time. The potential for tax evasion and avoidance should be minimised while keeping counteracting measures proportionate to the risks involved.
Flexibility: The systems for taxation should be flexible and dynamic to ensure that they keep pace with technological and commercial developments.

Taxation of Digital Services could revolutionize what we define as a taxable activity

The digital economy is the result of a transformative process brought by information and communication technology (ICT), which has made technologies cheaper, more powerful, and widely standardised, improving business processes and bolstering innovation across all sectors of the economy.

Because the digital economy is increasingly becoming the economy itself, it would be difficult, if not impossible, to ring-fence the digital economy from the rest of the economy for tax purposes. The digital economy and its business models present however some key features which are potentially relevant from a tax perspective.

These features include mobility, reliance on data, network effects, the spread of multisided business models, a tendency toward monopoly or oligopoly and volatility. The types of business models include several varieties of e-commerce, app stores, online advertising, cloud computing, participative networked platforms, high speed trading, and online payment services. The digital economy has also accelerated and changed the spread of global value chains in which MNEs integrate their worldwide operations.

Current Position on digital economy from OECD definition of PE

Website

There has been some discussion as to whether the mere use in electronic commerce operations of computer equipment in a country could constitute a permanent establishment. That question raises a number of issues in relation to the provisions of the Permanent Establishment. Whilst a location where automated equipment is operated by an enterprise may constitute a permanent establishment in the country where it is situated (see below), a distinction needs to be made between computer equipment, which may be set up at a location so as to constitute a permanent establishment under certain circumstances, and the data and software which is used by, or stored on, that equipment. For instance, an Internet web site, which is a combination of software and electronic data, does not in itself constitute tangible property. It therefore does not have a location that can constitute a “place of business” as there is no “facility such as premises or, in certain instances, machinery or equipment” as far as the software and data constituting that web site is concerned.

On the other hand, the server on which the web site is stored and through which it is accessible is a piece of equipment having a physical location and such location may thus constitute a “fixed place of business” of the enterprise that operates that server. The distinction between a web site and the server on which the web site is stored and used is important since the enterprise that operates the server may be different from the enterprise that carries on business through the web site. For example, it is common for the web site through which an enterprise carries on its business to be hosted on the server of an Internet Service Provider (ISP). Although the fees paid to the ISP under such arrangements may be based on the amount of disk space used to store the software and data required by the web site, these contracts typically do not result in the server and its location being at the disposal of the enterprise, even if the enterprise has been able to determine that its web site should be hosted on a particular server at a particular location. In such a case, the enterprise does not even have a physical presence at that location since the web site is not tangible. In these cases, the enterprise cannot be considered to have acquired a place of business by virtue of that hosting arrangement. However, if the enterprise carrying on business through a web site has the server at its own disposal, for example it owns (or leases) and operates the server on which the web site is stored and used, the place where that server is located could constitute a permanent establishment of the enterprise if the other requirements of the Article are met.

Computer Equipment

Computer equipment at a given location may only constitute a permanent establishment if it meets the requirement of being fixed. In the case of a server, what is relevant is not the possibility of the server being moved, but whether it is in fact moved. In order to constitute a fixed place of business, a server will need to be located at a certain place for a sufficient period of time so as to become fixed within the meaning of paragraph 1 of PE definition.

Another issue is whether the business of an enterprise may be said to be wholly or partly carried on at a location where the enterprise has equipment such as a server at its disposal. The question of whether the business of an enterprise is wholly or partly carried on through such equipment needs to be examined on a case-by-case basis, having regard to whether it can be said that, because of such equipment, the enterprise has facilities at its disposal where business functions of the enterprise are performed.

Where an enterprise operates computer equipment at a particular location, a permanent establishment may exist even though no personnel of that enterprise is required at that location for the operation of the equipment. The presence of personnel is not necessary to consider that an enterprise wholly or partly carries on its business at a location when no personnel are in fact required to carry on business activities at that location. This conclusion applies to electronic commerce to the same extent that it applies with respect to other activities in which equipment operates automatically, e.g. automatic pumping equipment used in the exploitation of natural resources.

Computer Equipment but used for auxiliary activity

Another issue relates to the fact that no permanent establishment may be considered to exist where the electronic commerce operations carried on through computer equipment at a given location in a country are restricted to the preparatory or auxiliary activities covered by paragraph 4 of definition of PE. The question of whether particular activities performed at such a location fall within paragraph 4 needs to be examined on a case-by-case basis having regard to the various functions performed by the enterprise through that equipment. Examples of activities which would generally be regarded as preparatory or auxiliary include:

providing a communications link—much like a telephone line—between suppliers and customers;
advertising of goods or services;
relaying information through a mirror server for security and efficiency purposes;
gathering market data for the enterprise;
supplying information.

Where, however, such functions form in themselves an essential and significant part of the business activity of the enterprise as a whole, or where other core functions of the enterprise are carried on through the computer equipment, these would go beyond the activities covered by paragraph 4 of definition of PE and if the equipment constituted a fixed place of business of the enterprise, there would be a permanent establishment. What constitutes core functions for a particular enterprise clearly depends on the nature of the business carried on by that enterprise.

ISPs operating their own servers

For instance, some ISPs are in the business of operating their own servers for the purpose of hosting web sites or other applications for other enterprises. For these ISPs, the operation of their servers in order to provide services to customers is an essential part of their commercial activity and cannot be considered preparatory or auxiliary.

A last issue is whether paragraph 5 of definition of PE may apply to deem an ISP to constitute a permanent establishment. As already noted, it is common for ISPs to provide the service of hosting the web sites of other enterprises on their own servers. The issue may then arise as to whether paragraph 5 may apply to deem such ISPs to constitute permanent establishments of the enterprises that carry on electronic commerce through web sites operated through the servers owned and operated by these ISPs. Whilst this could be the case in very unusual circumstances, paragraph 5 will generally not be applicable because the ISPs will not constitute an agent of the enterprises to which the web sites belong, because they will not conclude contracts or play the principal role leading to the conclusion of contracts in the name of these enterprises, or for the transfer of property belonging to these enterprises or the provision of services by these enterprises, or because they will act in the ordinary course of a business as independent agent, as evidenced by the fact that they host the web sites of many different enterprises. It is also clear that since the web site through which an enterprise carries on its business is not itself a “person” as defined in Article 3, paragraph 5 cannot apply to deem a permanent establishment to exist by virtue of the web site being an agent of the enterprise for purposes of that paragraph.

e-tailers operating their own servers

A different example is that of an enterprise (sometimes referred to as an “e-tailer”) that carries on the business of selling products through the Internet. In that case, the enterprise is not in the business of operating servers and the mere fact that it may do so at a given location is not enough to conclude that activities performed at that location are more than preparatory and auxiliary.

What needs to be done in such a case is to examine the nature of the activities performed at that location in light of the business carried on by the enterprise. If these activities are merely preparatory or auxiliary to the business of selling products on the Internet (for example, the location is used to operate a server that hosts a web site which, as is often the case, is used exclusively for advertising, displaying a catalogue of products or providing information to potential customers), paragraph 4 will apply and the location will not constitute a permanent establishment.

If, however, the typical functions related to a sale are performed at that location (for example, the conclusion of the contract with the customer, the processing of the payment and the delivery of the products are performed automatically through the equipment located there), these activities cannot be considered to be merely preparatory or auxiliary.

Abuses to present position

The Committee of Experts notes that the OECD Commentary, draws a distinction between a contract with an Internet Service Provider and one with a place of business at the disposal of the enterprise. In this regard, the Committee recognizes that some businesses could seek to avoid creating a permanent establishment by managing the contractual terms in cases where the circumstances would justify the conclusion that a permanent establishment exists. Such abuses may fall under the application of legislative or judicial anti-avoidance rules.

Some Approaches to Tax the Digital Services

Modification in the “Exception to PE”

It was agreed to modify the list of exceptions to the definition of PE to ensure that each of the exceptions included therein is restricted to activities that are otherwise of a “preparatory or auxiliary” character, and to introduce a new anti-fragmentation rule to ensure that it is not possible to benefit from these exceptions through the fragmentation of business activities among closely related enterprises. For example, the maintenance of a very large local warehouse in which a significant number of employees work for purposes of storing and delivering goods sold online to customers by an online seller of physical products (whose business model relies on the proximity to customers and the need for quick delivery to clients) would constitute a permanent establishment for that seller under the new standard.

Modification in the definition of “Agency PE”

It was also agreed to modify the definition of PE to address circumstances in which artificial arrangements relating to the sales of goods or services of one company in a multinational group effectively result in the conclusion of contracts, such that the sales should be treated as if they had been made by that company. For example, where the sales force of a local subsidiary of an online seller of tangible products or an online provider of advertising services habitually plays the principal role in the conclusion of contracts with prospective large clients for those products or services, and these contracts are routinely concluded without material modification by the parent company, this activity would result in a permanent establishment for the parent company.

Revision in “Transfer Pricing Guidelines”

The revised transfer pricing guidance makes it clear that legal ownership alone does not necessarily generate a right to all (or indeed any) of the return that is generated by the exploitation of the intangible, but that the group companies performing the important functions, contributing the important assets and controlling economically significant risks, as determined through the accurate delineation of the actual transaction, will be entitled to an appropriate return. Specific guidance will also ensure that the transfer pricing analysis is not weakened by information asymmetries between the tax administration and the taxpayer in relation to hard-to-value intangibles, or by using special contractual relationships, such as a cost contribution arrangement.

Introduction of “Digital CFCs”

The recommendations on the design of effective CFC include definitions of CFC income that would subject income that is typically earned in the digital economy to taxation in the jurisdiction of the ultimate parent company.

Collection of “Indirect Taxes”

The collection of VAT/GST on cross-border transactions, particularly those between businesses and consumers, is an important issue. Countries are thus recommended to apply the principles of the International VAT/GST Guidelines and consider the introduction of the collection mechanisms included therein. This indirect tax discussed above is not indirect taxes of the seller’s country (which is normally zero-rated) but indirect taxes of buyer’s country.

Introduction of “Significant Economic Presence”

None of the other options, namely (i) a new nexus in the form of a significant economic presence, (ii) a withholding tax on certain types of digital transactions, and (iii) an equalisation levy, were recommended at this stage. This is because, among other reasons, it is expected that the measures developed in the BEPS Project will have a substantial impact on BEPS issues previously identified in the digital economy, that certain BEPS measures will mitigate some aspects of the broader tax challenges, and that consumption taxes will be levied effectively in the market country.

The distinction between Service Fee and Royalties

Royalties and Know-hows

“Royalties” relate to payments for the use of, or the entitlement to use, rights of the kind mentioned, whether or not they have been, or are required to be, registered in a public register, in general, to rights or property constituting the different forms of literary and artistic property, the elements of intellectual property specified in the text and information concerning industrial, commercial or scientific experience. The definition covers both payments made under a licence and compensation which a person would be obliged to pay for fraudulently copying or infringing the right. Rents in respect of cinematograph films are also treated as royalties, whether such films are exhibited in cinemas or on the television. It may, however, be agreed through bilateral negotiations that rents in respect of cinematograph films shall be treated as business profits and, in consequence, subjected to the provisions of Articles 7 and 9 of DTAA. In classifying as royalties payments received as consideration for information concerning industrial, commercial or scientific experience, paragraph 2 is referring to the concept of “know-how”. In the know-how contract, one of the parties agrees to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. It is recognised that the grantor is not required to play any part himself in the application of the formulae granted to the licensee and that he does not guarantee the result thereof.

How do they differ from services?

Royalties and Know-how contract differs from contracts for the provision of services, in which one of the parties undertakes to use the customary skills of his calling to execute work himself for the other party. The need to distinguish these two types of payments, i.e. payments for the supply of know-how and payments for the provision of services, sometimes gives rise to practical difficulties. The following criteria are relevant for the purpose of making that distinction:

Contracts for the supply of know-how concern information of the kind that already exists or concern the supply of that type of information after its development or creation and include specific provisions concerning the confidentiality of that information.
In the case of contracts for the provision of services, the supplier undertakes to perform services which may require the use, by that supplier, of special knowledge, skill and expertise but not the transfer of such special knowledge, skill or expertise to the other party.
In most cases involving the supply of know-how, there would generally be very little more which needs to be done by the supplier under the contract other than to supply existing information or reproduce existing material. On the other hand, a contract for the performance of services would, in the majority of cases, involve a very much greater level of expenditure by the supplier in order to perform his contractual obligations. For instance, the supplier, depending on the nature of the services to be rendered, may have to incur salaries and wages for employees engaged in researching, designing, testing, drawing and other associated activities or payments to sub-contractors for the performance of similar services.
Examples of payments which should therefore not be considered to be received as consideration for the provision of know-how but, rather, for the provision of services, include:
- payments obtained as consideration for after-sales service,
- payments for services rendered by a seller to the purchaser under a warranty,
- payments for pure technical assistance,
- payments for a list of potential customers, when such a list is developed specifically for the payer out of generally available information (a payment for the confidential list of customers to which the payee has provided a particular product or service would, however, constitute a payment for know-how as it would relate to the commercial experience of the payee in dealing with these customers),
- payments for an opinion given by an engineer, an advocate or an accountant, and — payments for advice provided electronically, for electronic communications with technicians or for accessing, through computer networks, a trouble-shooting database such as a database that provides users of software with non-confidential information in response to frequently asked questions or common problems that arise frequently.

Mixed Contracts

In the particular case of a contract involving the provision, by the supplier, of information concerning computer programming, as a general rule the payment will only be considered to be made in consideration for the provision of such information so as to constitute know-how where it is made to acquire information constituting ideas and principles underlying the program, such as logic, algorithms or programming languages or techniques, where this information is provided under the condition that the customer not disclose it without authorisation and where it is subject to any available trade secret protection.

In business practice, contracts are encountered which cover both know-how and the provision of technical assistance. One example, amongst others, of contracts of this kind is that of franchising, where the franchisor imparts his knowledge and experience to the franchisee and, in addition, provides him with varied technical assistance, which, in certain cases, is backed up with financial assistance and the supply of goods. The appropriate course to take with a mixed contract is, in principle, to break down, on the basis of the information contained in the contract or by means of a reasonable apportionment, the whole amount of the stipulated consideration according to the various parts of what is being provided under the contract, and then to apply to each part of it so determined the taxation treatment proper thereto. If, however, one part of what is being provided constitutes by far the principal purpose of the contract and the other parts stipulated therein are only of an ancillary and largely unimportant character, then the treatment applicable to the principal part should generally be applied to the whole amount of the consideration.

Computer Software: Service or Royalty?

Software may be described as a program, or series of programs, containing instructions for a computer required either for the operational processes of the computer itself (operational software) or for the accomplishment of other tasks (application software). It can be transferred through a variety of media, for example in writing or electronically, on a magnetic tape or disk, or on a laser disk or CD-Rom. It may be standardised with a wide range of applications or be tailor-made for single users. It can be transferred as an integral part of computer hardware or in an independent form available for use on a variety of hardware.

Whether payments received as consideration for computer software may be classified as royalties poses difficult problems but is a matter of considerable importance in view of the rapid development of computer technology in recent years and the extent of transfers of such technology across national borders.

The character of payments received in transactions involving the transfer of computer software depends on the nature of the rights that the transferee acquires under the particular arrangement regarding the use and exploitation of the program. The rights in computer programs are a form of intellectual property. Research into the practices of OECD member countries has established that all but one protects rights in computer programs either explicitly or implicitly under copyright law. Although the term “computer software” is commonly used to describe both the program—in which the intellectual property rights (copyright) subsist—and the medium on which it is embodied, the copyright law of most OECD member countries recognises a distinction between the copyright in the program and software which incorporates a copy of the copyrighted program. Transfers of rights in relation to software occur in many different ways ranging from the alienation of the entire rights in the copyright in a program to the sale of a product which is subject to restrictions on the use to which it is put. The consideration paid can also take numerous forms. These factors may make it difficult to determine where the boundary lies between software payments that are properly to be regarded as royalties and other types of payment. The difficulty of determination is compounded by the ease of reproduction of computer software, and by the fact that acquisition of software frequently entails the making of a copy by the acquirer in order to make possible the operation of the software.

A more definitive analysis is made in my another blog here.

What is OECD’s position on Digital Service Taxes?

In regard to OECD BEPS Action Plan 1, as of now, the official position of the OECD is that, “[t]here is no consensus on either the merit or need for interim measures,” such as country specific digital services taxes like India’s DST. Despite these long-running and ongoing negotiations, India has chosen to move forward with its own taxes on digital services. The first such effort began in 2016, with India’s implementation of a 6% tax on digital advertising. That 6% levy applies to gross revenue received by non-Indian residents for online advertisements and related services provided to Indian residents. The Indian purchaser of the covered digital advertising services is responsible for withholding and remitting the digital advertising tax to the Indian government.

Countries that have implemented DST

Over the past two years, various jurisdictions have taken under consideration or adopted taxes on revenues that certain companies generate from providing certain digital services to, or aimed at, users in those jurisdictions. They are referred to as Digital Services Taxes or DSTs. Available evidence suggests the DSTs are expected to target large, U.S.-based tech companies. These jurisdictions include:

Austria: In October 2019, Austria adopted a DST that applies a 5% tax to revenues from online advertising services. The law went into force on January 1, 2020. The tax applies only to companies with at least EUR 750 million in annual global revenues for all services and EUR 25 million in in-country revenues for covered digital services.
Brazil: Brazil is considering a legislative proposal entitled the ‘‘Contribution for Intervention in the Economic Domain’’ or CIDE. If adopted, CIDE would apply to the gross revenue derived from digital services provided by large technology companies.
The Czech Republic: The Parliament of the Czech Republic is considering a draft law that would apply a 7% DST to revenues from targeted advertising and digital interface services. The tax would apply only to companies generating EUR 750 million in annual global revenues for all services and CZK 50 million in in-country revenues for covered digital services.
The European Union: The European Commission is considering a DST as part of the financing package for its proposed COVID–19 recovery plan. The EU DST is based on a 2018 DST proposal that was not adopted. The 2018 EU proposal included a 3% tax on revenues from targeted advertising and digital interface services, and would have applied only to companies generating at least EUR 750 million in global revenues from covered digital services and at least EUR 50 million in EU-wide revenues for covered digital services.
India: In March 2020, India adopted a 2% DST. The tax only applies only to non-resident companies, and covers online sales of goods and services to, or aimed at, persons in India. The tax applies only to companies with annual revenues in excess of approximately Rs. 20 million (approximately U.S. $267,000). The tax went into effect on April 1, 2020.
Indonesia: Earlier this year, Indonesia adopted an electronic transaction tax that targets cross-border, digital transactions. Further implementing measures are required for the new tax to go into effect.
Italy: Italy has adopted a DST. The measure includes a 3% tax on revenues from targeted advertising and digital interface services. This tax applies only to companies generating at least EUR 750 million in global revenues for all services and EUR 5.5 million in in-country revenues for covered digital services. The tax applies as of January 1, 2020.
Spain: Spain is considering a draft DST. The measure would apply a 3% tax to revenues from targeted advertising and digital interface services. This tax would apply only to companies generating at least EUR 750 million in global revenues for all services and EUR 3 million in in-country revenues for covered digital services.
Turkey: Turkey has adopted a DST. The measure applies a 7.5% tax to revenues from targeted advertising, social media and digital interface services. The tax applies only to companies generating Ö750 million in global revenues from covered digital services and TL20 million in in-country revenues from covered digital services. The Turkish President has authority to increase the tax rate up to 15%. The law went into effect on March 1, 2020.
The United Kingdom: The United Kingdom is considering a DST proposal as part of its Finance Bill 2020. The measure would apply a 2% tax on revenues above £25 million to internet search engines, social media, and online marketplaces. The tax applies only to companies generating at least £500 million in global revenues from covered digital services and £25 million in incountry revenues from covered digital services. The bill is in the final stages of adoption by Parliament, and if passed, payments would be due from affected companies in 2021.

USA’s Investigation on DST

Section 302(b)(1)(A) of the Trade Act of 1974, as amended (Trade Act), authorizes the U.S. Trade Representative to initiate an investigation to determine whether an act, policy, or practice of a foreign country is actionable under section 301 of the Trade Act. Actionable matters under section 301 include, inter alia, acts, polices, and practices of a foreign country that are unreasonable or discriminatory and burden or restrict U.S. commerce. An act, policy, or practice is unreasonable if the act, policy, or practice, while not necessarily in violation of, or inconsistent with, the international legal rights of the United States, is otherwise unfair and inequitable. In light of concerns with the DSTs adopted or under consideration by the jurisdictions discussed above, the U.S. Trade Representative has initiated Section 301 investigations with respect to DSTs adopted or under consideration by Austria, Brazil, the Czech Republic, the European Union, India, Indonesia, Italy, Spain, Turkey, and the United Kingdom.

USA’s Findings from the Investigation on DST

Unclear and Ambiguous

Investigation has found the text of the DST to be unclear and ambiguous. This creates uncertainty for companies regarding key aspects of the DST, including the scope of taxable services and the universe of firms liable to pay the tax. Countries has published no official guidance to resolve these ambiguities. This amounts to a failure to provide tax certainty, which contravenes a core principle of international taxation. The OECD recognized “certainty” as a “broad taxation principle[] that should apply to e-commerce” as early as 2003. More recently, in 2014, the OECD proclaimed that “certainty” is one of the “fundamental principles of taxation.” DSTs provides no such certainty to stakeholders, and thus, contravenes this fundamental principle.

Contradicts the “definition of PE” and “taxability of Business Profits”

The DST taxes companies with no permanent establishment in countries, contravening the international tax principle that companies should not be subject to a country’s corporate tax regime absent a territorial connection to that country. However, no physical presence in the country is required for the DST is to apply. Investigation suggests that this taxation of revenue absent a physical presence in India is inconsistent with principles of international tax policy.

The international tax system reflects the principle that companies are not subject to a country’s corporate tax regime in the absence of a territorial nexus to that country. This is reflected in international tax treaties, which typically establish that a company need not pay a country’s corporate income tax unless it has a “permanent establishment” in that country. DSTs adopted by countries flips this rule on its head. Rather than limit the DST’s applicability to companies with permanent establishments in the particular country, the DSTs applies only to companies without permanent establishments in such country. This is not consistent with international tax principles.

Treaty rules provide that business profits derived by an enterprise are taxable exclusively by the state of residence unless the enterprise carries on business in the other state through a PE situated therein. In the latter situation, the source state may tax only the profits that are attributable to the PE. The PE concept is thus used to determine whether or not a contracting state is entitled to exercise its taxing rights with respect to the business profits of a non-resident taxpayer. Special rules apply, however, to profits falling into certain enumerated categories of income, such as dividends, interest, royalties, and capital gains.

Contradicts the “taxation regime”

It is commonly accepted that there are two aspects to a state’s sovereignty: the power over a territory (“enforcement jurisdiction”) and the power over a particular set of subjects (“political allegiance”). This binary nature of sovereignty was strongly rooted in the minds of the people during the 19th and 20th century and exercised a significant influence in the fashioning of one State’s jurisdiction to tax. Conscious that taxes ought to be confined to taxable subjects and objects that have some sort of connection with the imposing State, policy makers reached the conclusion that a legitimate tax claim ought to be either based on the relationship to a person (i.e. a “personal attachment”) or on the relationship to a territory (i.e. a “territorial attachment”).

Contradicts the “taxation norms”

The DST taxes companies’ revenue rather than their income. This is inconsistent with the international tax principle that income—not revenue—is the appropriate basis for corporate taxation. The DST creates an additional tax burden for U.S. companies in digital service industry. Several aspects of the DST exacerbate the tax burdens to U.S. companies, including the DST’s extraterritorial application, its taxation of revenue rather than income, and its low domestic revenue threshold (which allows countries around the world to tax U.S. firms that do relatively little business in those countries).

Unintended “Expansive Definition”

The unusually expansive scope of taxable digital services under the DST makes the tax particularly burdensome for U.S. companies. DST adopted around the world is an outlier: it taxes numerous categories of digital services that are not leviable under other digital services taxes adopted around the world. This brings more U.S. companies within the scope of the DST, and makes the measure significantly more burdensome.

The DSTs forces U.S. companies to undertake costly measures to comply with the tax’s new payment and reporting requirements. This includes the reengineering of existing systems to collect and organize new and different types of information. USTR’s analysis indicates that compliance costs could run into the millions of dollars for each affected company.

Creates “Double Taxation”

The DST burdens U.S. companies by subjecting them to double taxation. The DST also burdens U.S. companies by subjecting them to double taxation. U.S. companies that pay the DST in India will still be subject to U.S. corporate income tax, creating two layers of taxation. Take, for example, hypothetical Company A discussed above. To recall, Company A earned US$100 million from India-connected services, and incurred US$95 million in India-related costs. Company A must pay US$2 million (2% of Indian revenue) to India pursuant to the DST, leaving it with just US$3 million in remaining profit. Company A must then also pay U.S. corporate income tax on its residual US$3 million. Avoiding double taxation of this sort is the focus of prominent model tax treaties as well as the U.S.-India Tax Treaty.

“Discriminates” digital and non-digital services

The DST is discriminatory because it targets digital services, but not similar services provided non-digitally. Under the DST, if a company were to sell a movie to consumers in such countries, and deliver that content digitally, the proceeds of the sale would be taxable. If a second company were to sell that very same movie to the very same consumer in the particular country, but do so in a store on a DVD, that sale would not be taxable under the DST. This differential treatment of like transactions is a textbook example of discrimination. The OECD has several times cautioned against this discriminatory ‘ring-fencing’ approach, whereby digital companies are taxed, but non-digital companies that provide the same or similar services are excluded. For instance, in March 2019, the OECD issued a document pursuant to the Inclusive Framework on BEPS where it agreed that “it would be difficult, if not impossible, to ‘ring-fence’ the digital economy from the rest of the economy for tax purposes because of the increasingly pervasive nature of digitalization.”

“Uncertainty” in design

The adjustable nature of foundational aspects of the DST creates considerable uncertainty. Specifically, because the DST’s revenue thresholds can change, companies cannot be sure if they will be subject to the tax. And because the tax rate can change at the President’s discretion, companies cannot be certain of the amount of tax they might have to pay. This failure to provide tax certainty contravenes a core principle of international taxation.

Goes “Against FAR Test” and “Arms Length Test” and disregards the “Value Created by Intangibles”

Arms length test gives unique value in transaction that is greater than arm’s length transaction which should be attributable to the main country. As noted in the BEPS Action Plan, “the spread of the digital economy also poses challenges for international taxation. The digital economy is characterised by an unparalleled reliance on intangibles, the massive use of data (notably personal data), the widespread adoption of multi-sided business models capturing value from externalities generated by free products, and the difficulty of determining the jurisdiction in which value creation occurs. This raises fundamental questions as to how enterprises in the digital economy add value and make their profits, and how the digital economy relates to the concepts of source and residence or the characterisation of income for tax purposes. At the same time, the fact that new ways of doing business may result in a relocation of core business functions and, consequently, a different distribution of taxing rights which may lead to low taxation is not per se an indicator of defects in the existing system. It is important to examine closely how enterprises of the digital economy add value and make their profits in order to determine whether and to what extent it may be necessary to adapt the current rules in order to take into account the specific features of that industry and to prevent BEPS.”

Subjective argument to allocate “Inter-nation Equity?”

As a theory, inter-nation equity is concerned with the allocation of national gain and loss in the international context and aims to ensure that each country receives an equitable share of tax revenues from crossborder transactions (OECD, 2001). The tax policy principle of inter-nation equity has been an important consideration in the debate on the division of taxing rights between source and residence countries. At the time of the Ottawa work on the taxation of electronic commerce, this important concern was recognised by stating that “any adaptation of the existing international taxation principles should be structured to maintain fiscal sovereignty of countries, […] to achieve a fair sharing of the tax base from electronic commerce between countries…” (OECD, 2001: 228). However, such arguments have been a subjective argument and equity allocation is largely a vague term for the purpose of allocation of inter-nation equity.

Taxation on “Income or Consumption or Both?”

In principle only private individuals, as distinguished from businesses, engage in the consumption at which a VAT is targeted. In practice, however, many VAT systems impose VAT burden not only on final household consumption, but also on various entities that are involved in non-business activities or in VAT-exempt activities. In such situations, VAT can be viewed alternatively as treating such entities as if they were end consumers, or as “input taxing” the supplies made by such entities on the presumption that the burden of the VAT imposed will be passed on in the prices of the outputs of those non-business activities.

More and more jurisdictions therefore consider ways to implement a destination-based approach for both B2B and B2C cross-border supplies of services, thereby relying on a system that would require suppliers to collect and remit the tax in line with what was recommended by the OECD’s E-commerce Guidelines. As self-assessment methods are unlikely to offer an effective solution for collecting the tax at destination in a B2C-context, a system that requires suppliers to collect and remit the tax may appear the only realistic alternative. This was notably the conclusion of the OECD’s Consumption Tax Guidance Series, which provided guidance for the implementation of the E-commerce Guidelines (OECD, 2003b-c-d). This guidance indicated that countries may consider it necessary for non-resident vendors to register and account for the tax in the jurisdiction of consumption, and it recommended the use of simplified registration regimes and registration thresholds to minimise the potential compliance burden. However, such solution to indirect taxes brings compliance and administrative burden to non-resident companies and contradicts principle of recovery of indirect taxes.

Features of digital economy

There are a number of features that are increasingly prominent in the digital economy and which are potentially relevant from a tax perspective. While these features may not all be present at the same time in any particular business, they increasingly characterise the modern economy. They include:

Mobility, with respect to (i) the intangibles on which the digital economy relies heavily, (ii) users, and (iii) business functions as a consequence of the decreased need for local personnel to perform certain functions as well as the flexibility in many cases to choose the location of servers and other resources.
Reliance on data, including in particular the use of so-called “big data”.
Network effects, understood with reference to user participation, integration and synergies.
Use of multi-sided business models in which the two sides of the market may be in different jurisdictions.
Tendency toward monopoly or oligopoly in certain business models relying heavily on network effects.
Volatility due to low barriers to entry and rapidly evolving technology.

Administrative Challenges in Digital Economy

There is a pressing need to consider how investment in skills, technologies and data management can help tax administrations keep up with the ways in which technology is transforming business operations. The borderless nature of digital economy produces specific administrative issues around identification of businesses, determination of the extent of activities, information collection and verification, and identification of customers. These issues are outlined below, while possible ways to address them are outlined in the later sections of this chapter. Further, operational work is underway within the Forum on Tax Administration to develop a strong voluntary compliance culture and expand the use of modern technology for self-service delivery purposes (OECD, 2014).

Identification: While global business structures in the digital economy involve traditional identification challenges, these challenges are magnified in the digital economy. For example, the market jurisdiction may not require registration or other identification when overseas businesses sell remotely to customers in the jurisdiction, or may have issues with implementing registration requirements, as it is often difficult for tax authorities to know that activities are taking place, to identify remote sellers and to ensure compliance with domestic rules. Difficulties in identifying remote sellers may also make ultimate collection of tax difficult.
Determining the extent of activities: Even if the identity and role of the parties involved can be determined, it may be impossible to ascertain the extent of sales or other activities without information from the offshore seller, as there may be no sales or other accounting records held in the local jurisdiction or otherwise accessible by the local revenue authority. It may be possible to obtain this information from third parties such as the customers or payment intermediaries, but this may be dependent on privacy or financial regulation laws.
Information collection and verification: To verify local activity, the market jurisdiction’s tax administration may need to seek information from parties that have no operations in the jurisdiction and are not subject to regulation therein. While exchange of information can be a very useful tool where the proper legal basis is in place, this is predicated on knowledge of where the offshore entity is tax resident and information retained or accessible by the reciprocating tax authority. This can create challenges for a market jurisdiction revenue authority seeking to independently verify any information provided by the offshore entity.
Identification of customers: There are in principle a number of ways in which a business can identify the country of residence of its client and/or the country in which consumption occurs. These could include freight forwarders or other customs documentation or tracking of Internet Protocol (IP) and card billing addresses. However, this could be burdensome for the business and would not work where customers are able to disguise their location.

Worldwide adopted digital service structures to minimize tax burdens

Avoiding a taxable presence

In many digital economy business models, a non-resident company may interact with customers in a country remotely through a website or other digital means (e.g. an application on a mobile device) without maintaining a physical presence in the country. Increasing reliance on automated processes may further decrease reliance on local physical presence. The domestic laws of most countries require some degree of physical presence before business profits are subject to taxation. In addition, under Articles 5 and 7 of the OECD Model Tax Convention, a company is subject to tax on its business profits in a country of which it is a non-resident only if it has a permanent establishment (PE) in that country. Accordingly, such non-resident company may not be subject to tax in the country in which it has customers.

Companies in many industries have customers in a country without a PE in that country, communicating with those customers via phone, mail, and fax and through independent agents. That ability to maintain some level of business connection within a country without being subject to tax on business profits earned from sources within that country is the result of particular policy choices reflected in domestic laws and relevant double tax treaties, and is not in and of itself a BEPS issue. However, while the ability of a company to earn revenue from customers in a country without having a PE in that country is not unique to digital businesses, it is available at a greater scale in the digital economy than was previously the case. Where this ability, coupled with strategies that eliminate taxation in the State of residence, results in such revenue not being taxed anywhere, BEPS concerns are raised. In addition, under some circumstances, tax in a market jurisdiction can be artificially avoided by fragmenting operations among multiple group entities in order to qualify for the exceptions to PE status for preparatory and auxiliary activities, or by otherwise ensuring that each location through which business is conducted falls below the PE threshold. Structures of this type raise BEPS concerns.

Minimizing the income allocable to functions, assets and risks in market jurisdictions

In many cases, an MNE group does maintain a degree of presence in countries that represent significant markets for its products. In the context of the digital economy, an enterprise may establish a local subsidiary or a PE, with the local activities structured in a way that generates little taxable profit. Examples of digital economy structures that can be used to minimise the tax burden in market jurisdictions through contractual allocation of assets and risks include using a subsidiary or PE to perform marketing or technical support, or to maintain a mirrored server to enable faster customer access to the digital products sold by the group, with a principal company contractually bearing the risks and claiming ownership of intangibles generated by these activities. Alternatively, functions allocated to local staff under contractual arrangements may not correspond with the substantive functions performed by the staff. For example, staff may not have formal authority to conclude contracts on behalf of a non-resident enterprise, but may perform functions that indicate effective authority to conclude those contracts.

Maximizing deductions in market jurisdictions

Once a taxable presence in the market country has been established, another common technique to reduce taxable income is to maximise the use of deductions for payments made to other group companies in the form of interest, royalties, service fees, etc. For example, an affiliate in a low-tax jurisdiction may, due to a favourable credit rating, be able to borrow money at a low rate. It may then lend money to its subsidiaries in high-tax jurisdictions at a higher rate, thereby reducing the income of those subsidiaries by the amount of the deductible interest payments. Alternatively, an affiliate may use hybrid instruments to create deductible payments for a subsidiary in a source country that result in no inclusion in the country of residence of the affiliate. Payments (including underpayments) for the use of intangibles held by low-tax group companies or for services rendered by other group companies can also be used to reduce taxable income in the market country.

Avoiding withholding tax

A company may be subject to withholding tax in a country in which it is not a resident if it receives certain payments, including interest or royalties, from payers in that country. If allowed under a treaty between the jurisdictions of the payer and recipient, however, a company in the digital economy may be entitled to reduced withholding or exemption from withholding on payments of profits to a lower-tax jurisdiction in the form of royalties or interest. Structures that involve treaty shopping by interposing shell companies located in countries with favourable treaty networks that contain insufficient protections against treaty abuse raise BEPS concerns.

Eliminating or reducing tax in the intermediate country

Eliminating or reducing tax in an intermediate country can be accomplished through the application of preferential domestic tax regimes, the use of hybrid mismatch arrangements, or through excessive deductible payments made to related entities in low or no-tax jurisdictions. Companies may locate functions, assets, or risks in low-tax jurisdictions or countries with preferential regimes, and thereby allocate income to those locations. While functions are often located in a particular jurisdiction for non-tax reasons such as access to skilled labour or necessary resources, as business functions grow increasingly mobile, taxpayers may increasingly be able to locate functions in a way that takes advantage of favourable tax regimes.

In the context of the digital economy, for example, the rights in intangibles and their related returns can be assigned and transferred among associated enterprises, and may be transferred, sometimes for a less-than-arm’s length price, to an affiliate in a jurisdiction where income subsequently earned from those intangibles is subject to unduly low or no-tax due to the application of a preferential regime. This creates tax planning opportunities for MNEs and presents substantial risks of base erosion. Heavy reliance in the digital economy on intangibles as a source of value may exacerbate the ability to concentrate value-creating intangibles in this way.

Eliminating or reducing tax in the country of residence of the ultimate parent

Broadly speaking, the same techniques that are used to reduce taxation in the market country can also be used to reduce taxation in the country of the ultimate parent company of the group or where the headquarters are located. This can involve contractually allocating risk and legal ownership of mobile assets like intangibles to group entities in low-tax jurisdictions, while group members in the jurisdiction of the headquarters are undercompensated for the important functions relating to these risks and intangibles that continue to be performed in the jurisdiction of the headquarters.

Modification of the existing rules to add a force-of-attraction rule dealing with electronic commerce

According to this alternative, paragraph 1 of Article 7 of the OECD Model Tax Convention would be amended to include a so-called “forceof-attraction” rule which would deal with electronic commerce operations. The aim would be to ensure that a country may tax profits derived from selling in that country, through an enterprise’s website, products similar to those sold through a PE that the enterprise has in the country.

Position of Nepal

A million dollar Question

Does Nepal have any domestic laws that creates a Digital PE in Nepal for digital services provided by non-residents in Nepal?

Answer: No, Nepal doesn’t have any such provisions. The meaning of the Permanent Establishment is the same as those interpreted by OECD. The recommendations suggested by BEPS Action Plan 1 has not been adopted in Nepal.

Unique Provision in Section 70

Business Taxable under Section 70

दफा ७०(२): तार, रेडियो, अप्टिकल फाइबर वा भू–उपग्रह सञ्चारको व्यवसाय सञ्चालन गर्ने गैर बासिन्दा व्यक्तिको कुनै आय वर्षको कर योग्य आयमा नेपालमा स्थापित संयन्त्रबाट गरिएको नेपालमा उत्पत्ति भएको वा नभएको खबर वा सूचनाको सम्प्रेषणबाट प्राप्त रकमहरू समावेश गर्नु पर्नेछ ।

स्पष्टीकरण: यस दफाको प्रयोजनको लागि “गैर बासिन्दा व्यक्ति” भन्नाले नेपाल बाहिर मुख्य कार्यालय रहेको सम्बद्ध निकायहरूको समूहभित्र रहेको बासिन्दा निकाय सम्झनु पर्छ ।

Section 70(2): The taxable income of any non-resident person who carries on a business of cable, radio, optical fiber or satellite communication in any income year shall consist of the amounts derived from the dispatch of news or information through any device established in Nepal, whether originated in Nepal or not.
Explanation: For purposes of this Section, “non-resident person” means a resident entity within the group of associated entities with head offices outside Nepal.

Source of Income under Section 70

दफा ६७(६): देहायका भुक्तानीहरूको स्रोत नेपालमा रहेको मानिनेछ ः–

(ज) तार, रेडियो, अप्टिकल फाइबर वा भू–उपग्रह जस्ता सञ्चारको माध्यमबाट खबर वा सूचना सम्प्रेषण गर्ने व्यवसाय सञ्चालन गर्ने व्यक्तिले त्यस्ता खबर वा सूचना नेपालमा उत्पत्ति भएको वा नभएको जे भएपनि नेपालमा स्थापित संयन्त्रहरूबाट खबर वा सूचनाको सम्प्रेषणका सम्बन्धमा सो व्यक्तिले प्राप्त गरेको भुक्तानी,

Section 67(6) The following payments shall be deemed to have source in Nepal:
(h) Payments received by a person who carries a business of dispatching information or news through means of communication such as wire, radio, optical fiber or satellite in respect of dispatch of news or information through networks established in Nepal, irrespective of whether or not such news or information is originated in Nepal,

Computation on Taxable Income

दफा ७०(३): दफा ७०(१) वा दफा ७०(२) बमोजिम कुनै गैर बासिन्दा व्यक्तिको कर योग्य आयमा समावेश गरिने रकमहरूमा अनुसूची १(२)(७) मा तोकिएको दरले कर लाग्नेछ । तर,
(क) सो व्यक्तिको कुनै बाँकी कर याग्य आयका सम्बन्धमा दाखिला गर्नुपर्ने कर गणना गर्दा ती रकमहरूलाई गणना गर्नुपर्ने छैन,
(ख) ती रकमहरूको गणनासँग सम्बन्धित खर्चहरू सो बाँकी कर योग्य आय गणना गर्दा कट्टी गर्न पाइने छैन, र
(ग) ती रकमहरूका सम्बन्धमा यस दफा बमोजिम सो व्यक्तिबाट दाखिला गर्नुपर्ने कर रकमबाट सो व्यक्तिले कुनै पनि कर मिलान गर्ने सुविधा पाउने छैन ।

Section 70(3): Tax shall be levied on the amounts to be included in the taxable income of any non-resident person pursuant to Section 70(1) or Section 70(2), at the rate specified in Schedule (1)(2)(7). Provided that-
(a) Those amounts need not to be computed in computing the tax payable in respect of any due taxable income of that person,
(b) The expenses related with computation of those amounts shall not be allowed to be deducted in computing that due taxable income, and
(c) That person shall not be entitled to any facility of tax adjustment from the amount of tax payable by that person.

Tax Rate Applicable

Schedule (1)(2)(7): Tax shall be levied at the rate of five percent on the taxable income of any non-resident person in respect of the income mentioned in Section 70 in any income year. Provided that tax shall be levied at the rate of two percent in the case of a non-resident person providing water transport, air transport or telecommunication service that does not so depart or transmit from Nepal as not to reach another foreign country.

अनुसूची १(२)(७): कुनै आय वर्षमा ऐनको दफा ७० मा उल्लिखित आयको सम्बन्धमा कुनै गैर बासिन्दा व्यक्तिको कर योग्य आयमा पाँच प्रतिशतका दरले कर लाग्नेछ । तर नेपालबाट अर्को विदेशी मुलुकमा पुग्ने गरी प्रस्थान नहुने जल यातायात, हवाई यातायात वा दूरसञ्चार सेवा उपलव्ध गराउने गैर बासिन्दा व्यक्तिको हकमा दुई प्रतिशतका दरले कर लाग्नेछ ।

Rationale

६७(६)(ज) तार, रेडियो, अप्टिकल फाईवर वा भू-उपग्रह जस्ता सञ्चारको माध्यमबाट खबर वा सूचना संप्रेषण गर्ने व्यवसाय सञ्चालन गर्ने व्यक्तिले त्यस्ता खबर वा सूचना नेपालमा उत्पत्ति भएको वा नभएको जे भएपनि नेपालमा स्थापित संयन्त्रहरूबाट खबर वा सूचनाको संप्रेषणका सम्बन्धमा सो व्यक्तिले प्राप्त गरेको भुक्तानी, यस खण्डको व्यवस्था विशेष गरी सूचना एवं खबर सम्प्रेषणसँग सम्बन्धित छ । सूचना तथा खबरको उद्गम विन्दु तथा त्यसको सम्प्रेषण गर्ने व्यक्तिको पहिचान गर्न कठिन हुन्छ । यस्ता सूचना तथा खबरको सम्प्रेषण सम्प्रेषक आफै मात्र संलग्न नभई बीचमा अन्य व्यक्तिहरूको समेत संलग्नता हुन्छ । यस अवस्थामा सूचना तथा खबर सम्प्रेषणको स्थान यकिन गर्न कठिनाई रहन्छ । यस्तै कठिनाईलाई मध्यनजर गरी ऐनको यस व्यवस्थाले नेपालमा रहेको संयन्त्र मार्फत खबर वा सूचना सम्प्रेषण भएको छ र उक्त सूचना वा खबर बापत भुक्तानी गरेको छ भने त्यस्तो भुक्तानीको स्रोत नेपालमा रहेको मानिन्छ ।

Tests for application of Section 70

It applies to a person who:

Carries on a business of cable, radio, optical fiber or satellite communication
(The business here is the business of transmission of information through means of cable, radio, optical fiber or satellite, but not any business that makes use of such network for providing digital services)
Types of communication network:
1. Radio network (Simplex and Duplex)
2. Networking Cables (Coaxial Cable, Optical Fiber Cable, Twisted Pair Cable)
3. Satellite Communication
Has equipment in Nepal for dispatching information
(The business must have an effective business in Nepal in a form of PE through the presence of equipment and its head office should be situated outside Nepal. The location of such equipment in Nepal constitutes effective business in Nepal as a Fixed Place PE, and this provision overrides the application of Fixed Place PE for taxation purpose.)
Dispatches information through the equipment whether or not such information is originated in Nepal
Is a resident entity in Nepal and has its head office outside Nepal

Dissection of Examples from Income Tax Directive

उदाहरण ३.३.१२: मानौं, दक्षिण अफ्रिकामा सञ्चालन भएको Cricket को प्रत्यक्ष प्रसारण सोही देशको Qmar Africa Channel ले गर्दोरहेछ । उक्त Qmar Africa Channel ले प्रसारण गरेको Cricket को प्रत्यक्ष प्रसारण गरी नेपाली दर्शकसमक्ष पुर्‍याउन नेपालको Fly Cable Tv लाई अधिकार दिएको रहेछ । यसरी Fly Cable Tv ले आफ्नो ग्राहकलाई सेवा पुर्‍याउने गरेको रहेछ । यसरी Cricket को प्रत्यक्ष प्रसारण गर्ने अधिकार प्राप्त Qmar Africa Channel लाइ Fly Cable Tv ले आफ्नो नेपालमा जडान भएको संयन्त्र प्रयोग गरी प्रसारण गरे बापत दिइने भुक्तानीको स्रोत नेपाल रहेको मानिन्छ ।	Test 1: No Test 2: No Test 3: No Test 4: No Conclusion: Section 70 doesn’t apply
उदाहरण १४.४.२: मानौं, सुपर स्टार टि.भि.नेटवर्क गैर बासिन्दा व्यक्ति रहेछ । उक्त नेटवर्कले आफूद्वारा प्रसारण गरिएको सबै कार्यक्रम नेपालका दर्शकसामू प्रसारण हुनको लागि काठमाडौंमा एउटा संयन्त्र स्थापित गरेको रहेछ । उक्त स्थापित संयन्त्रमार्फत नेपालका टि.भि. केवुल अपरेटरलाई आफ्नो कार्यक्रम सम्प्रेषण गर्ने गरेको रहेछ र यसरी सम्प्रेषण बापत टि.भि.केवुल नेटवर्कबाट निश्चित रकम शुल्कको रूपमा लिने गरेको रहेछ । सुपर स्टार टि.भि. नेटवर्कले यसरी टि.भि. केवुल अपरेटरबाट प्राप्त रकम यस दफाको प्रयोजनको लागि सुपर स्टार टि.भि. नेटवर्कले आफ्नो आयमा समावेश गर्नुपर्दछ । माथिको उदाहरणमा समावेश हुने आय सुपर स्टार टि.भि. नेटवर्कको दफा ७०(२) प्रयोजनको लागि करयोग्य आय मानिन्छ र दफा ७०(३) बमोजिम त्यस्तो रकमबाट ती रकमको गणनासँग सम्बन्धित खर्च करयोग्य आय गणना गर्दा कट्टी गर्न पाइने छैन । यसरी गणना गरिएको करयोग्य आयमा ऐनको अनुसूची-१ को दफा २ को उपदफा (७) बमोजिम पाँच प्रतिशतका दरले कर लाग्नेछ ।	Test 1: Yes Test 2: Yes Test 3: Yes Test 4: Maybe Conclusion: Section 70 applies
उदाहरण १४.४.३: मानौं, नेपालमा दर्ता भएको एचएसविसी नेपाल बैंक लिमिटेड एचएसविसी बैकिङ नेटवर्क अन्तर्गतको बासिन्दा बैक हो । सो बैंकले आफ्नो नेटवर्कका बैंकहरूमा सूचना प्रसार गर्ने एक उपकरण एचएसविसी नेपाल बैंक लिमिटेडको कार्यालयमा जडान गरेको रहेछ । सो उपकरणबाट एचएसविसी नेटवर्कका सबै बैंकमा सूचना प्रवाह हुँदो रहेछ । यस्तो अवस्थामा सो उपकरण नेपालमा जडान भएकाले एचएसविसी समूहले प्राप्त गर्ने वा प्राप्त गरेको मानिने रकममा दफा ७०(२) बमोजिम नेपालमा कर लाग्दछ ।	Test 1: No Test 2: No Test 3: Yes Test 4: No Conclusion: Section 70 doesn’t apply (Rubbish Example)

Value Added Tax

How does VAT work?

VAT is an indirect tax. VAT is applicable on the consumption of the goods and services and this form of indirect tax is paid by the consumer while acquiring the goods or services. When a resident supplier supplies any goods or services to consumer in Nepal, the applicable VAT on such goods or services are charged in addition to the price of the goods or services and paid for by the consumer. However, when the consumer obtains goods or services from non-resident supplier the VAT on goods is collected at the point of customs and VAT on services is collected on a reverse charging mechanism.

How does Reverse Charge VAT work?

In case of obtaining digital services, the recipient of service is located in Nepal. So, for the purpose of Value Added Tax, the place of supply is Nepal and the service recipient in Nepal would be treated as importing service from foreign person and is liable to deposit VAT in reverse charge basis. The recipient of service in Nepal would self-declare the value of the service (generally supported by contracts and invoices) and charge 13% VAT and deposit them to the Revenue Office. The VAT deposited in this reverse charge mechanism is generally allowed for credit in the next tax period.

However, as a matter of practice and other difficulties, individuals importing such services do not deposit VAT in reverse charge basis. This gives the offshore based digital service provider an advantage from the local suppliers of such service. However, unlike in other countries, to offset such advantage to offshore based digital service provider, Nepal doesn’t have additional indirect taxes (like OIDAR Taxes in India) which requires offshore based service provider providing services to recipients of services in Nepal to deposit VAT in Nepal.

Examples from VAT Directive

दफा ८(२): नेपाल बाहिरको कुनै व्यक्तिबाट सेवा प्राप्त गर्न दर्ता भएको वा दर्ता नभएको व्यक्तिले यो ऐन र यस ऐन अन्तर्गत बनेको नियम बमोजिम कर लाग्ने मूल्यमा भुक्तानीका बखत वा सेवा प्राप्त भएको वखतमध्ये जुन पहिले हुन्छ सो समयमा कर निर्धारण र असुल उपर गर्नु पर्नेछ ।

विदेशबाट सेवा प्राप्त गर्ने व्यक्तिको कर निर्धारण (Reverse Charge System):

कर लाग्ने वस्तु वा सेवा आयात गर्दा मूल्य अभिवृद्धि कर लाग्ने व्यवस्था ऐनको दफा ५ को उपदफा (१) को खण्ड (ख) मा रहेको छ । कर लाग्ने वस्तु विदेशबाट पैठारी गर्दा कारोंव्रार मूल्यमा भन्सार कार्यालयमा मूल्य अभिवृद्धि कर दाखिला गर्नुपर्दछ । नेपाल बाहिरको नेपालमा दर्ता नभएको कुनै सेवाप्रदायक वा आपूर्तिबाट कुनै व्यक्तिले कर लाग्ने सेवा आपूर्ति गरेको अवस्थामा विदेशी सेवा प्रदायक वा आपूर्तिकर्तालाई प्रतिफल भुक्तानी गर्दा भुक्तानी गर्ने मूल्यमा प्रचलित दरमा (हाल १३ प्रतिशत) मूल्य अभिवृद्धि कर गणना गरी तोकिएको राजस्व खातामा दाखिला गर्नु पर्ने व्यवस्था ऐनले गरेको छ । अन्तर्देशीय सेवा आपूर्तिमा सम व्यवहार (Equal Treatment) कायम गर्नु यस व्यवस्थाको उद्देश्य हो कुनै सेवा स्वदेशी आपूर्तिकर्ताबाट खरिद गर्दा कर लाग्ने तर त्यही सेवा विदेशी आपूर्तिकर्ताबाट खरिद गर्दा कर नलाग्ने अवस्था रहेमा त्यसले स्वदेशी सेवा प्रदायकको प्रतिष्पर्धात्मक क्षमतामा हास आउने तथ्यलाई दृष्टिगत गरी विदेशबाट पैठारी हुने सेवामा कर लाग्ने व्यवस्था ऐनले गरेको हो । सामान्यतया पैठारी हुने सेवा भन्सार बिन्दुमा घोषणा नभई पैठारी हुने र सो कारणले भन्सार बिन्दुमा कर दाखिला नहुने कारणले ऐनमा यस किसिमको व्यवस्था गरिएको हो । यसरी दाखिला भएको कर दर्तावाला करदाताले दाखिला गरेकोमा कर कट्टी दावी गर्न पाउंदछ यस सम्बन्धमा मूल्य अभिवृद्धि कर ऐन २०५२ को दफा ८ को उपदफा (२) मा यस्तो व्यवस्था रहेको छ।

उक्त करारोपण सम्बन्धी व्यवस्था देहायको अवस्थामा लागू हुन्छ:
१. कुनै विदेशस्थित व्यक्तिले नेपालस्थित व्यक्तिलाई सेवा आपूर्ति गरेको हुनु पर्दछ ।
२. आपूर्ति हुने सेवा विदेशबाट आपूर्ति भएको हुनु पर्छ ।
३. आपूर्ति हुने सेवा कर योग्य सेवा हुनुपर्दछ
४. आपूर्ति भएको सेवा भन्सार कार्यालयमार्फत आयात नभएको हुनु पर्दछ ।
५. सेवा आपूर्ति गर्ने व्यक्ति नेपालमा दर्ता भएको हुनु हुँदैन ।

उदाहरण २.१२: मानौं कुनै विदेशी व्यक्ति वा संस्थाले नेपालमा TOEFL (Teaching of English as a Foreign Language), IELTS (International English Language Testing System), GRE (Graduate Record Examination), GMAT(Graduate Management Admission Test), SAT (Scholastic Assessment Test), PTE(Pearson Test of English), ESOL Examination (English for Speaker for Other Langauge) वा यस्तै अन्य कुनै परीक्षाको लागि तयारी कक्षा संचालन गर्दछ । सो वापत प्रशिक्षार्थीहरुबाट निश्चित सेवा शुल्क संकलन गर्द छ । मूल्य अभिवृद्धि कर ऐन, २०५२ बमोजिम यस्तो सेवा करयोग्य सेवा हो । यस्तो सेवा आपूर्ति गर्ने विदेशी व्यक्ति मूल्य अभिवृद्धि कर प्रयोजनको लागि हुनुपर्दछ । दर्ता यदि नेपाल बाहिरबाट यस्तो सेवा प्रदान गरेको भएमा सेवाग्राहीले भुक्तानी गर्दा Reverse Charge को रुपमा भुक्तानी गर्ने मूल्यमा कर गणना गरी बैंक दाखिला गर्नु पर्दछ ।

उदाहरण २.१३: अल्फा ईन्टरनेशनल प्रा.लि ईन्टरनेट र दुर संचार सेवा प्रदायक कम्पनी रहेछ । उक्त कम्पनीले आफ्नो सेवा खरिद गर्ने प्रयोजनको लागि सिंगापुर स्थित Skynet कम्पनीसँग प्राविधिक सेवा खरिद गरेको रहेछ । सो वापत उक्त कम्पनीलाई मासिक एक लाख अमेरिकी डलर बरावरको रकम भुक्तानी गर्ने गरेको रहेछ । उक्त कारोवार करयोग्य भएकोले अल्फा ईन्टरनेशनल प्रा. लि. ले भुक्तानीका बखत वा सेवा प्राप्त भएको बखत मध्ये जुन पहिले हुन्छ सो समयमा एकलाख अमेरिकी डलर वरावरको रकमको १३ प्रतिशतले हुने मूल्य अभिवृद्धि कर दाखिला गर्नुपर्दछ । त्यस्तो खरिदमा तिरेको कर निजले आफूले बिक्रीमा संकलन गरेको करबाट कर कट्टी दावी गर्न पाउँछ ।

उदाहरण २.१४: मानौं नेपाल सरकार खानी तथा भूगर्भ विभागले क्यानाडाका दुई वैज्ञानिकहरुलाई नेपालको भौगर्भिक, जैविक अध्ययन गरी विभिन्न खनिज पदार्थको व्यवसायिक उत्पादन सम्भाव्यता अध्ययन गरी प्रतिवेदन पेश गर्ने गरी कार्यादेश दिएको रहेछ । उक्त कार्यको लागि रु. १ करोड अमेरिकी डलर भुक्तानी दिने गरी सम्झौता भएको रहेछ । ती वैज्ञानिकहरुले अध्ययन गरी प्रतिवेदन पेश गरेका रहेछन् । यस्तो अवस्थामा निज वैज्ञानिकहरुले प्रदान गरेको सेवा करयोग्य सेवा हो। उक्त वैज्ञानिकहरुले यस्तो सेवा नेपालमा नियमित रुपले आपूर्ति गर्दैनन् यस्तो सेवा कहिलेकाँहि आपूर्ति हुने गर्दछ । प्रस्तुत सन्दर्भमा करयोग्य कारोवार रकम १ करोड अमेरिकी डलर भए तापनि उक्त वैज्ञानिकहरुले नेपाल वाहिर वसी सेवा प्रदान गरेको अवस्थामा मूल्य अभिवृद्धि कर प्रयोजनको लागि ऐनको दफा ८ को उपदफा (२) बमोजिमको सेवा आपूर्ति गरेको मानी भुक्तानीका बखत वा सेवा प्राप्त भएको बखतमध्ये जुन पहिले हुन्छ सो समयमा नेपाल सरकार, खानी तथा भूगर्भ विभागले १ करोड अमेरिकी डलर बरावरको रकमको १३ प्रतिशतले हुने रकम राजस्व खातामा जम्मा गर्नुपर्दछ साथै आयकर प्रयोजनको लागि आयकर ऐन, २०५८ वमोजिम स्रोतमा कर कट्टी समेत गर्नु पर्दछ ।

उदाहरण २.१५: मानौं, नेपाल सरकार, विद्युत विकास विभागले कोरियाका वैज्ञानिकहरुलाई नेपालमा जलविद्युतको व्यवसायिक उत्पादन सम्भाव्यता अध्ययन गरी प्रतिवेदन पेश गर्ने गरी कार्यादेश दिएको रहेछ । उक्त कार्यको लागि १० लाख अमेरिकी डलर भुक्तानी दिने गरी सम्झौता भएको छ । ती वैज्ञानिकहरुले अध्ययन गरी प्रतिवेदन पेश गरेका छन् । निज वैज्ञानिकहरुले प्रदान गरेको सेवा करयोग्य सेवा हो । उक्त वैज्ञानिकहरुले यस्तो सेवा नेपालमा नियमित रुपले नभई कहिलेकाही आपूर्ति हुने विषय हो । करयोग्य कारोवार रकम रु १ करोडभन्दा बढी भए तापनि उक्त वैज्ञानिकहरुलाई नेपालमा मूल्य अभिवृद्धि कर प्रयोजनको लागि दर्ता गर्ने व्यवस्था नभएको हुंदा यस्तो सेवा ऐनको दफा ८ को उपदफा (२) बमोजिमको सेवा आपूर्ति गरेको मानी भुक्तानीका बखत वा सेवा प्राप्त भएको वखतमध्ये जुन पहिले हुन्छ सो समयमा नेपाल सरकार, विद्युत विकास विभागले १० लाख अमेरिकी डलर बराबरको रकमको १३ प्रतिशतले हुने रकम राजस्व खातामा जम्मा गर्नुपर्दछ। साथै आयकर प्रयोजनको लागि आयकर ऐन, २०५८ बमोजिम स्रोतमा कर कट्टी समेत गर्नुपर्दछ ।

उदाहरण २.१६: मानौ, नेपालको कुनै बासिन्दा एअरलाईन्स कम्पनीले आफ्नो हवाईजहाज तथा हेलिकप्टरको इन्जिन, गेयर बक्स लगायत महत्वपूर्ण पार्टसहरु नेपाल नागरिक उड्डयन प्राधिकरणबाट स्वीकृति प्राप्त बिदेश स्थित संस्थामा मर्मत सम्भार तथा ओभरहलको लागि पठाउँदा भन्सार कार्यालयमा भन्सार महशुल धरौटी राखी पठाउने र सो मर्मत भई आउँदा भन्सार विन्दुमा मूल्य अभिवृद्धि कर समेत बुझाएको अवस्थामा मूल्य अभिवृद्धि कर ऐन (संशोधन सहित), २०५२ को दफा ८ को उपदफा (२) बमोजिमको मूल्य अभिवृद्धि कर निर्धारण र असुल उपर गर्नुपर्दैन ।

उदाहरण २.१७: मानौ, नेपालको कुनै बासिन्दा एअरलाईन्स कम्पनीले आफ्नो कम्पनीमा कार्यरत पाइलट, इन्जिनियर लगायतका प्राविधिक कर्मचारीहरुलाई नेपाल नागरिक उड्डयन प्राधिकरणले निर्धारण गरेको मापदण्ड बमोजिम विदेश स्थित तालिम केन्द्रहरुमा त्यहाँको नियमित कार्यक्रम अनुरुप सञ्चालन भएको तालिममा सहभागी गराउँदा उक्त सेवाको उपभोग नेपालमा नभएको हुँदा उक्त सेवा वापतको भुक्तानी रकममा मूल्य अभिवृद्धि कर ऐन (संशोधन सहित), २०५२ को दफा ८ को उपदफा (२) बमोजिम मूल्य अभिवृद्धि कर निर्धारण र असूल उपर गर्नु पर्दैन ।

उदाहरण २.१८: मानौ, नेपालको कुनै वासिन्दा एअरलाईन्स कम्पनीले सुरक्षित हवाई सेवाको लागि आवश्यक सूचना, सञ्चार तथा Navigation Tracking लगायतमा प्रयोग हुने सूचना प्रविधिमा आधारित नेपालमा प्रयोग हुने Online GPS Data सेवाहरुको प्रयोग वापत बिदेश स्थित कम्पनीलाई गरिने भुक्तानीमा मूल्य अभिवृद्धि कर ऐन (संशोधन सहित), २०५२ को दफा ८ को उपदफा (२) बमोजिम मूल्य अभिवृद्धि कर असूल र निर्धारण गर्नुपर्ने हुन्छ ।

उदाहरण २.२१: मानौं काठमाडौं स्थित शैक्षिक परामर्शको सेवा प्रदायक कम्पनी श्री एविसि इन्ष्टिच्यूट प्रा.लि.,ले USA बाट संचालन हुने Pearson Test of English (PTE) परीक्षा वापत लाग्ने परीक्षा शुल्क र उक्त सेवा प्रदान गरे वापत सेवा शुल्क लिने कार्य गर्दै आएको रहेछ । उक्त प्रा.लि. ले विद्यार्थीहरुबाट परीक्षा शुल्क वापत प्रति व्यक्ति १०० अमेरिकी डलर र सेवा शुल्क वापत रु.१,०००।०० लिने गरेको रहेछ । मूल्य अभिवृद्धि कर ऐन, २०५२ को अनुसूची १ समूह ६ को खण्ड (ग) मा विद्यालय वा विश्वविद्यालयले प्रदान गर्ने शिक्षण सेवालाई मात्र कर छुट हुने वस्तु तथा सेवाको सूचीमा राखेको हुंदा सो बाहेकका भाषा परीक्षा लगायत जुनसुकै परीक्षा वापतको परीक्षा शुल्कमा मुल्य अभिवृद्धि कर लाग्ने हुँदा उक्त प्रा.लि. ले अमेरिकाको संस्थालाई विद्यार्थीकों तर्फबाट पठाउने परीक्षा शुल्कमा मुल्य अभिवृद्धि कर असुल उपर गर्नुपर्ने हुन्छ । उक्त परीक्षा शुल्क वापत लिइने अमेरिकी डलर १०० बराबरको नेपाली रुपैयाँ तथा विद्यार्थीलाई सेवा प्रदान गरे वापत लिने सेवा शुल्क रु १,०००।०० समेतको रकममा १३ प्रतिशतका दरले मूल्य अभिवृद्धि कर असूल उपर गर्नुपर्दछ । उक्त परीक्षा संचालन सम्बन्धी सेवा नेपाल बाहिरबाट नेपालमा प्रदान भएको हुँदा प्रा.लि’ ले परीक्षा शुल्क भुक्तानी गर्दा मूल्य अभिवृद्धि कर ऐन, २०५२ को दफा ८ को उपदफा (२) बमोजिम Reverse Charge को रुपमा भुक्तानी गर्ने मूल्यमा भुक्तानी गर्दाका वखत वा सेवा प्राप्त भएको बखत मध्ये जुन पहिले हुन्छ सो समयमा कर निर्धारण गरी असूल उपर गर्नु पर्दछ । सो सेवा प्रदान गर्ने गैर बासिन्दा व्यक्तिलाई भुक्तानी हुने रकममा आयकर ऐन, २०५८ को दफा ८८ को उपदफा (१) बमोजिम १५ प्रतिशतले अग्रिम कर कट्टी गर्नुपर्ने हुन्छ । नेपालभित्र आपूर्ति हुने कर छुट हुने सेवाको सम्बन्धमा निम्न उदाहरणले थप प्रष्ट पार्नेछ ।

Overview on India’s Position on DST

Unilateral laws like India’s DST undermine progress in the OECD by making an agreement on a multilateral approach to digital taxation less likely. If unilateral measures proliferate while negotiations are ongoing, countries lose the incentive to engage seriously in the negotiations.

The companies subject to the DST must pay the tax on revenue they derive from “ecommerce supply or services.” The DST defines “e-commerce supply or services” as:
(i) online sale of goods owned by the e-commerce operator; or
(ii) online provision of services provided by the e-commerce operator; or
(iii) online sale of goods or provision of services or both, facilitated by the ecommerce operator; or
(iv) any combination of activities listed in clause (i), (ii) or clause (iii).

This definition is extremely broad. As such, India’s DST applies to revenue derived from nearly any type of digital activity that generates revenue. This includes categories of digital services that are not taxable under most other countries’ digital services taxes, such as streaming video services, digital sale of a company’s own goods, cloud services, and the provision of software-as-a-service.

Importantly, the DST does not apply to certain digital advertising services, which are taxed separately under the 2016 digital advertising tax (discussed in Section II(A) above). Specifically, the following advertising-related services are not taxable under the DST: “online advertisement, any provision for digital advertising space or any other facility or service for the purpose of online advertisement,” which a non-Indian resident receives from “(i) a person resident in India and carrying on business or profession; or (ii) a non-resident having a permanent establishment in India.” Thus, for example, if an Indian company were to pay Google (a U.S. company) to advertise on Google’s search engine, that revenue would be subject to the 2016 digital advertising tax, and therefore not subject to the DST. However, if Airbnb (a U.S. company) were to pay Google to advertise to Indian users on Google’s search engine, that revenue would be subject to the DST.

India’s DST also only applies to digital services that have a nexus to India. More specifically, digital services are leviable under the DST only if they are provided: (i) to a person resident in India; or (ii) to a non-resident in certain “specified circumstances”; or (iii) to a person who buys such goods or services or both using an internet protocol address located in India. Regarding point (ii) above, the DST defines “specified circumstances” as: (i) sale of advertisement, which targets a customer, who is resident in India or a customer who accesses the advertisement though internet protocol address located in India; and (ii) sale of data, collected from a person who is resident in India or from a person who uses internet protocol address located in India.

Revenue Models of Digital Economy

The diversity of businesses in the current digital economy is illustrated by the variety of ways in which businesses turn value into revenue. The most common revenue models include the following:

Advertising-based revenues. One version of this model offers free or discounted digital content to users in exchange for requiring viewing of paid-for advertisements. Other models rely on providing advertising through mobile devices based on location or other factors. A third type concerns social media websites or platforms who typically build up a large online user community before monetising their captive audience through advertising opportunities.
Digital content purchases or rentals. Users pay per item of download – for instance, e-books, videos, apps, games and music would fall into this category.
Selling of goods (including virtual items). This category, which overlaps to a degree with (i), would include online retailers of tangible goods but could also cover online gaming, where users are offered a free or discounted introductory product but are also offered purchasable access to additional content or virtual items to enhance the experience.
Subscription-based revenues. Examples include annual payments for “premium delivery” with online retailers, monthly payments for digital content including news, music, videostreaming, etc. It could also include regular payments for software services and maintenance such as anti-virus software, data storage, customer “help” services for operating systems, and payment for access to the Internet itself.
Selling of services. This category overlaps with (iv) but would include traditional services which can be delivered online such as legal services (e.g. e-conveyancing), financial services (e.g. brokerage), consultancy services, travel agency etc. It would also include a large range of B2B services linked to enterprises who provide core Internet access and act as Internet intermediaries (web hosting, domain registration, payment processing, platform access, etc.).
Licensing content and technology. Again, this category overlaps with (iv) and (v) but might typically include access to specialist online content (e.g. publications and journals), algorithms, software, cloud based operating systems, etc., or specialist technology such as artificial intelligence systems.
Selling of user data and customised market research. Examples include Internet service providers (ISPs), data brokers, data analytics firms, telemetrics and data gained from non personal sources.
“Hidden” fees and loss leaders. There may be instances in integrated businesses where profits or losses may be attributable to online operations but because of the nature of the business, cross-subsidy with physical operations occurs and it is difficult to separate and identify what should be designated as “online revenue”. An example might include online banking, which is offered “free” but is subsidised through other banking operations and fees.

Features of Digital Economy

Mobility, with respect to (i) the intangibles on which the digital economy relies heavily, (ii) users, and (iii) business functions as a consequence of the decreased need for local personnel to perform certain functions as well as the flexibility in many cases to choose the location of servers and other resources.
Reliance on data, including in particular the use of so-called “big data”.
Network effects, understood with reference to user participation, integration and synergies.
Use of multi-sided business models in which the two sides of the market may be in different jurisdictions.
Tendency toward monopoly or oligopoly in certain business models relying heavily on network effects.
Volatility due to low barriers to entry and rapidly evolving technology

Typical Tax Structures in Digital Economy

Ecommerce

Definition

Electronic commerce, or e-commerce, has been defined broadly by the OECD as “the sale or purchase of goods or services, conducted over computer networks by methods specifically designed for the purpose of receiving or placing of orders.

The goods or services are ordered by those methods, but the payment and the ultimate delivery of the goods or service do not have to be conducted online. E-commerce can be used either to facilitate the ordering of goods or services that are then delivered through conventional channels (indirect or offline e-commerce) or to order and deliver goods or services completely electronically (direct or on-line e-commerce). Although e-commerce covers a broad array of businesses, this section provides an illustration of some of the more prominent types.

Business-to-business models

The vast majority of e-commerce consists of transactions in which a business sells products or services to another business (so-called business-to-business (B2B). This can include online versions of traditional transactions in which a wholesaler purchases consignments of goods online, which it then sells to consumers from retail outlets. It can also include the provision of goods or services to support other businesses, including, among others: (i) logistics services such as transportation, warehousing, and distribution; (ii) application service providers offering deployment, hosting, and management of packaged software from a central facility; (iii) outsourcing of support functions for e-commerce, such as web-hosting, security, and customer care solutions; (iv) auction solutions services for the operation and maintenance of real-time auctions via the Internet; (v) content management services, for the facilitation of website content management and delivery; and (vi) web-based commerce enablers that provide automated online purchasing capabilities.

Business-to-consumer models

Business-to-consumer (B2C) models were among the earliest forms of e-commerce. A business following a B2C business model sells goods or services to individuals acting outside the scope of their profession. B2C models fall into several categories, including, for example, so-called “pureplay” online vendors with no physical stores or offline presence, “click-and-mortar” businesses that supplemented existing consumer-facing business with online sales, and manufacturers that use online business to allow customers to order and customise directly.

Consumer-to-consumer models

Consumer-to-consumer (C2C) transactions are becoming more and more common. Businesses involved in C2C e-commerce play the role of intermediaries, helping individual consumers to sell or rent their assets (such as residential property, cars, motorcycles, etc.) by publishing their information on the website and facilitating transactions. These businesses may or may not charge the consumer for these services, depending on their revenue model. This type of e-commerce comes in several forms, including, but not limited to: (i) auctions facilitated at a portal that allows online bidding on the items being sold; (ii) peer-to-peer systems allowing sharing of files between users; and (iii) classified ads portals providing an interactive, online marketplace allowing negotiation between buyers and sellers.

Pictorial

Direct tax consequences in state S

SCo is allocated minimal taxable income, based on the position that SCo’s risk and function profile is limited to routine services provided to RCo Regional OpCo.
All revenues derived from the online sales of products to customers in State S are treated as income of RCo Regional OpCo, due to its role as the counterparty to the transactions. Because RCo Regional OpCo has no physical presence in State S, and SCo has no interaction with State S customers, State S does not tax the profits derived from these activities either because it has no right to do so under its domestic law or because the relevant double tax treaty prevents it from doing so in the absence of a permanent establishment (PE) of TCo in State S to which the income is attributable.

Direct tax consequences in state T

State T imposes corporate tax on the profits earned by RCo Regional Holding. However, by virtue of a preferential regime available in State T for income derived from certain intangibles, RCo Regional Holding is entitled to a rate substantially less than the generally applicable corporate tax rate for the royalties included in its taxable profits.
State T imposes corporate tax on the profits earned by RCo Regional OpCo from its online sale activities. RCo Regional OpCo’s income, however, is almost entirely offset by the royalty payments made to RCo Regional Holding for the right to use the intangibles necessary to operate the regional websites, and the management fees paid to RCo for co-ordinating sales and procurement.
The payments made by RCo Regional OpCo are not subject to any withholding since the royalty income is paid to RCo Regional Holding, a company resident in State T, and the management fee is paid to RCo, a non-resident company whose business profits may not be taxed in State T under the relevant tax treaty. No withholding is imposed under the relevant double tax treaty on the payments by RCo Regional Holding to RCo.

Direct tax consequences in state R

State R imposes corporate income tax on the profits derived by RCo, including the buy-in payment received for the transfer of existing intangibles to RCo Regional Holding. However, because of the absence of a significant track record of RCo’s performance at the time of the transaction, RCo may take the position that the value of those intangibles was very low, so that the actual amount of gain subject to corporate tax in State R would be very small.
RCo also receives annual payments from RCo Regional Holding under the cost sharing arrangement, which may be at a rate much lower than the amount of royalties received by RCo Regional Holding. In addition, depending on the domestic law of State R, RCo may be entitled to R&D tax credits for a significant fraction of its expenditures, thereby significantly reducing its tax liability for corporate tax purposes.
Under its controlled foreign company (CFC) rules, State R would under some circumstances treat royalties received by RCo Regional Holding as passive income subject to current taxation in the hands of RCo. However, because RCo Regional OpCo is treated as a transparent entity for tax purposes in State R, the income of RCo Regional OpCo is treated as having been earned directly by RCo Regional Holding and is therefore treated as active income taxable in State R only when paid to RCo. This result would also be reached if State R imposed tax only on a territorial basis and did not have CFC rules.

VAT consequences

With respect to value added tax (VAT), the treatment of the business-to-business (B2B) transactions is relatively straightforward, with the VAT levied either through the supplying business charging the tax or the recipient business self-assessing it. The input tax levied would generally be recoverable by the businesses through the input tax credit mechanism.
The VAT treatment of the supplies to private consumers (business-to-consumer (B2C)) in State S will generally be different for supplies of physical products and supplies of digital products. Supplies by RCo Regional OpCo of physical goods stored in SCo’s warehouse to consumers in State S would be subject to VAT in State S. State S may allow SCo to account for State S VAT on behalf of RCo Regional OpCo (e.g. as a fiscal representative). If the physical products would be shipped to consumers in State S from abroad, e.g. from State T, then these supplies would be zero rated in the exporting state and would be subject to VAT at the time of importation into State S. Depending on the value of the goods and the thresholds operated by State S, they may qualify for a VAT exemption under the relief for importations of low value goods. Also the supplies of digital products to final consumers in State S should in principle be subject to VAT in State S, in accordance with the destination principle. However, State S will have considerable difficulty enforcing the payment of the VAT on these supplies, as the supplier is not resident in State S and collecting the tax from the final consumers is ineffectual. While certain jurisdictions operate a mechanism requiring non-resident suppliers to register and remit the tax on supplies to resident private consumers, it is recognised that it is often challenging for tax authorities to enforce compliance with such requirements.

Online Advertising

Definition

Online advertising uses the Internet as a medium to target and deliver marketing messages to customers. Internet advertising offers a number of advantages over traditional advertising. For example, many Internet advertisers have developed sophisticated methods for segmenting consumers in order to allow more precise targeting of ads. Many Internet advertising publishers have also developed ways for clients to monitor performance of ads, tracking how users interact with their brands and learning what is of interest to current and prospective customers. Online advertising takes a number of forms, the most prominent of which are display ads, in which an advertiser pays to display ads linked to particular content or user behaviour, and search engine ads, in which an advertiser pays to appear among Internet search results.

Online advertising involves a number of players, including web publishers, who agree to integrate advertisements into their online content in exchange for compensation, advertisers, who produce advertisements to be displayed in the web publisher’s content and advertising network intermediaries, who connect web publishers with advertisers seeking to reach an online audience. Advertising network intermediaries include a range of players, including search engines, media companies, and technology vendors. These networks are supported by data exchanges, marketplaces in which advertisers bid for access to data about customers that has been collected through tracking and tracing of users’ online activities. These data can be analysed, combined, and processed by specialist data analysers into a user profile.

Pictorial

Direct tax consequences in state S

SCo is allocated minimal taxable income, based on the position that SCo’s functions are limited to those of a service provider.
All revenues from sales of advertising in State S, including advertising purchased by State S residents and other regional customers, are treated as the revenues of TCo. The lack of authority for SCo staff to legally conclude contracts and the use of standardised contracts and on line contract acceptance by TCo result in TCo not being considered to have a PE in State S. As a result, State S does not tax the profits derived from these activities either because it has no right to do so under its domestic law or because the relevant double tax treaty prevents it from doing so in the absence of a PE of TCo in State S to which the income is attributable.

Direct tax consequences in state T

State T imposes corporate tax on the profits earned by TCo from its various activities in the T/S region. TCo’s income, however, is almost entirely offset by the royalty paid to YCo for its sublicense of the technology used by TCo to provide Internet services.
This payment is not subject to withholding under the relevant double tax treaty.
State T does not impose corporate income tax on XCo, due to it not being a resident under State T’s domestic legislation.

Direct tax consequences in state Y

State Y imposes corporate income tax on the profits of YCo, but those profits are limited to a small “spread” between the royalties received by YCo and the royalties paid by YCo to XCo.
State Y does not impose any withholding on the payment of royalties under its domestic law.

Direct tax consequences in state X

State X does not impose a corporate income tax.

Direct tax consequences in state R

State R imposes corporate income tax on the profits derived by RCo, notably the buy-in payment received in consideration for the transfer of pre-existing technology to XCo and the annual payments received under the cost sharing arrangement. However, because of the absence of a significant track record of RCo’s performance at the time of the transaction, RCo may take the position that the value of those intangibles was very low, so that the actual amount of gain subject to corporate tax in State R would be very small. Further, the annual payment – compensation for the costs supported by RCo for developing the intangibles without any markup – could potentially be at a rate much lower than the amount of royalties received by XCo. Finally, depending on the domestic law of State R, RCo may be entitled to R&D tax credits for a significant fraction of its expenditures, thereby further reducing its tax liability for corporate tax purposes.
Under its controlled foreign company (CFC) rules, State R would under some circumstances treat royalties received by XCo as passive income subject to current taxation in the hands of RCo. However, because YCo and TCo are considered for tax purposes as transparent entities in State R, the latter’s CFC rules would disregard the royalty transactions concluded between XCo, YCo and TCo. The income of YCo and TCo would be considered as having been earned directly by XCo, and would be treated as active income that would be taxable in State R only when paid to

VAT consequences

With respect to VAT, the treatment of the B2B transactions is relatively straightforward with the VAT levied either through the supplying business charging the tax or the recipient business self-assessing it. The input tax levied would generally be recoverable by the businesses through the input tax credit mechanism. The exception would be where the business is engaged in making exempt supplies and therefore not entitled to recover the tax.
The online services provided free of charge by TCo to consumers in the S/T region have in principle no VAT consequences, unless it is considered that TCo is providing consumers with Internet services for non-monetary consideration, in which case the customers’ State may claim VAT on the fair market value of that consideration.

Cloud computing

Definition

Cloud computing is the provision of standardised, configurable, on-demand, online computer services, which can include computing, storage, software, and data management, using shared physical and virtual resources (including networks, servers, and applications). Because the service is provided online using the provider’s hardware, users can typically access the service using various types of devices wherever they are located, provided they have a suitable Internet connection.

The resources to which cloud computing customers are granted access are not stored on a single computer. Instead, they are on many networked computers that are available to everyone who has access to that “cloud” of computing resources (which, depending on the cloud, could be a single organisation, a community of organisations, the general public, or some combination thereof). The system copies each user’s data and software to other servers, which allows it to allocate requests for hardware resources to whatever physical location is best able to satisfy the demand efficiently. Each user has access to a large amount of computer resources when needed, and only when needed. This redundancy ensures that the failure of one machine will not lead to loss of data or software.

The cloud model is composed of five essential characteristics:

On-demand self-service: A user can unilaterally act without requiring human interaction with each service’s provider.
Broad network access: Capabilities are available over the network and accessed through standard mechanisms that promote use by heterogeneous client platforms (e.g. mobile phones, laptops, and PDAs).
Resource pooling: The provider’s computing resources (e.g. storage, processing, memory, network bandwidth, and virtual machines) are pooled to serve multiple users using a multitenant model.
Rapid elasticity: Capabilities can be rapidly and elastically provisioned.
Measured service: resources use can be monitored, controlled, and reported providing transparency for both the provider and consumer of the utilised service.

The most common examples of cloud computing service models are:

Infrastructure-as-a-service (IaaS)

In the most basic cloud-service model, providers of infrastructure as a service (IaaS) offer computers – physical or (more often) virtual machines – and other fundamental computing resources. IaaS clouds often offer additional resources such as a virtual-machine disk image library, raw (block) and file-based storage, firewalls, load balancers, Internet Protocol (IP) addresses, virtual local area networks (VLANs), and software bundles. The customer does not manage or control the underlying cloud infrastructure, but has control over the operating system, storage, and deployed applications, and may be given limited control of select networking components (e.g. host firewalls).

Platform-as-a-service (PaaS)

Platform as a service is a category of cloud computing services that provides a computing platform and programming tools as a service for software developers. Software resources provided by the platform are embedded in the code of software applications meant to be used by end users. The client does not control or manage the underlying cloud infrastructure, including the network, servers, operating systems, or storage, but has control over the deployed applications.

Software-as-a-service (SaaS)

A common form of cloud computing in which a provider allows the user to access an application from various devices through a client interface such as a web browser (e.g. web-based email). It can be provided either to business customers (B2B) or individual customers (B2C). Unlike in the old software vendor models, the code is executed remotely on the servers, thereby freeing the user of the necessity to upgrade when a new version is available – the executed version is always the latest, which means that new features go instantaneously to market without friction. The consumer generally does not manage or control the underlying cloud infrastructure, including the network, servers, operating systems, storage, or individual application capabilities, with the possible exception of limited user-specific application configuration settings.

X-as-a Service (XaaS)

Content-as-a-service (CaaS)

Where rights are obtained and software is provided to allow content to be embedded by purchasers, content can be purchased as a service. This has been used particularly in the case of user-created content.

Data-as-a-service (DaaS)

Data from multiple sources can be aggregated and managed by a service provider, so that controlled access to that data can be granted to entities that may be geographically and organisationally removed from each other, without each entity needing to develop or acquire the infrastructure necessary to prepare and process that data.

Pictorial

Direct tax consequences in state S

SCo is allocated minimal taxable income, based on the position that its risk and function profile is limited to routine marketing and customer care services. All revenues from sales of cloud computing services in State S are treated as income of TCo, due to its role as the counterparty to the transactions with local customers and administrator of the websites. State S does not tax the profits derived from these activities because it has no right to do so under its domestic law or because the relevant double tax treaty prevents it from doing so in the absence of a PE of TCo in State S to which the income is attributable.

Direct tax consequences in state T

State T imposes corporate income tax on the profits derived by TCo from its sales activities but TCo’s income is largely offset by the royalty paid to RCo for its license of the technology used in providing the cloud computing services to customers, as well as by the management fees paid to RCo for its co-ordination services.
Although the income from the royalties and fees paid by TCo is attributed to the PE in State Y, State T does not impose any withholding on those royalties and fees under the terms of the relevant tax treaty between State T and State R, as it considers the payment to be received by RCo, a resident of State R.

Direct tax consequences in state Y

State Y imposes corporate income tax on the profits attributable to PE Y at a low rate. In addition, by virtue of a preferential regime available in State Y for income derived from certain intangibles, the income attributable to the PE Y is entitled to a rate substantially less than the generally applicable corporate tax rate for the royalties included in its taxable profits.

Direct tax consequences in state R

State R imposes corporate tax on the profits derived by RCo on a territorial basis. As a result, and in accordance with the relevant double tax treaty, all the royalty income and management fees derived by RCo are treated as attributable to PE Y and, as such, excluded from RCo’s corporate tax base in State R. The capital gain derived by RCo from the transfer of the existing technology to PE Yis not taxed in State R under the rules applicable to cross-border transfers of assets in the R/Y region. Further, RCo may be entitled to R&D tax credits for a significant fraction of its R&D expenditures, thereby reducing its tax liability in respect of the management fees.
State R’s domestic law does not provide for any CFC regime.

VAT consequences

For VAT purposes, as in the previous examples, the VAT on the B2B transactions will be levied either through the supplying business charging the tax or the recipient business self-assessing it. The input tax levied would generally be recoverable by the businesses through the input tax credit mechanism. The exception would be where a business is engaged in making exempt supplies and therefore not entitled to recover the tax.
In respect of B2C transactions, TCo’s supplies to final consumers in State S should in principle be subject to VAT in there. However, States S will often have considerable difficulty in enforcing the collection of VAT on cloud services acquired from abroad by resident final consumers

App stores

Definition

App stores will typically include both applications developed by the business operating the app store (typically, an operating system developer, device manufacturer, or telecommunications network provider), or by a third-party developer. Applications may be downloaded for free or for a fee. Free applications may be supported by advertising. In addition, applications are increasingly moving to a “freemium” model, in which basic functionality is provided for free, but customers may pay for additional content or features.

An application store will typically feature applications produced by developers in multiple countries. In addition, while many app stores are targeted at customers in particular geographic markets, applications are often cross listed on multiple app stores targeted at multiple geographic regions.

Pictorial

Direct tax consequences in state S

SCo is allocated minimal taxable income, based on the position that the function profile of this local affiliate is limited to providing routine marketing and promotion services, with no direct selling activity to State S customers.
All revenues from sales of applications in State S and State R are treated as income of TCo, due to its role as the counterparty to the transactions with local customers and administrator of local app stores. State S does not tax the profits derived from these activities either because it has no right to do so under its domestic law or because the relevant double tax treaty prevents it from doing so in the absence of a PE of TCo in State S to which the income is attributable.

Direct tax consequences in state T

State T imposes corporate tax on the significant profits earned by TCo, but at a rate which is roughly 50% of the rates of State R and State S.
No withholding is imposed on the various service fees paid by TCo to RCo and SCo under the relevant double tax treaty.

Direct tax consequences in state R

State R imposes corporate income tax on the profits derived by RCo, notably the capital gain derived from the sale of the technology to TCo and the service fee received for its R&D activities. However, because of the absence of a significant track record of RCo’s performance at the time of the transaction, RCo may take the position that the value of those intangibles was very low, so that the actual amount of gain subject to corporate tax in State R would be very small. In addition, depending on the domestic law of State R, RCo may be entitled to R&D tax credits in State R for a significant fraction of its expenditures, thereby reducing its tax liability for corporate tax purposes.
State R imposes corporate tax on a territorial basis and does not have any CFC rules. As a result, RCo is exempt from tax both on income earned by TCo and on dividends received from TCo.

VAT consequences

For VAT purposes, as in the previous examples, the VAT on the business-to[1]business transactions will be levied either through the supplying business charging the tax or the recipient business self-assessing it. The input tax levied would generally be recoverable by the businesses through the input tax credit mechanism. The exception would be where a business is engaged in making exempt supplies and therefore not entitled to recover the tax.
In respect of B2C transactions, TCo will generally be considered as the supplier of the applications to the consumers for VAT purposes, rather than the third party developers of these applications. The transactions between TCo and the third party developers will then be treated as business-to-business supplies, although the turn-over of many third party developers may remain under the VAT-registration threshold, in which case these transactions may effectively not be subject to VAT.
TCo would be required to collect and remit State T VAT on sales of any services to private consumers in State T. Supplies to consumers abroad will either be zero[1]rated in State T or will be subject to State T’s (low) VAT rate. Supplies to such final consumers in other states should in principle be subject to VAT in these final consumers’ state. These consumers’ states, however, will often have considerable difficulty enforcing the collection of VAT on supplies of applications to consumers within their jurisdiction. This may result in consumers in these states being able to acquire the applications free of VAT or at a lower (foreign) VAT rate than if they had acquired the product domestically.

Payment services

Paying for online transactions traditionally required providing some amount of financial information, such as bank account or credit card information, to a vendor, which requires a high degree of trust that is not always present in the case of an unknown vendor, particularly in the case of a C2C transaction. Online payment service providers help address this concern by providing a secure way to enable payments online without requiring the parties to the transaction to share financial information with each other.

A payment service provider acts as an intermediary (typically using a software-as-a-service model) between online purchasers and sellers, accepting payments from purchasers through a variety of payment methods, including credit card payments or bankbased payments like direct debit or real-time bank transfers, processing those payments, and depositing the funds to the seller’s account. Electronic payment systems offer a number of benefits for users, such as (i) protection against fraud, since the seller and buyer do not exchange sensitive information; (ii) faster delivery of payment compared with traditional payment methods; and (iii) in many cases, the ability to transact in multiple currencies.

Payment service providers typically charge a fee for each transaction completed, which can be either a fixed charge or a percentage of the value of the transaction, though some payment service providers also charge monthly fees or setup fees for certain additional services

A number of other alternative online payment options are in use as well, including:

Cash payment solutions, in which a customer buys online, and pays in cash with a barcode or payment code at participating shops or settlement agencies, offering a way for customers unwilling to use other online payment methods to make online purchases in a secure manner.
E-wallets or cyber-wallets, which are previously charged with credits and can be spent online as an alternative to the use of a credit card. These are often used for micropayments because the use of a credit card for frequent small payments is not economical.
Mobile payment solutions, which encompass all types of technologies that enable payment using a mobile phone or smartphone, including, among others, mobile card processing using card readers connected to smartphones, in-app payments for virtual products, and near-field communications solutions which use short-range wireless technology to exchange information.

High frequency trading

High frequency trading uses sophisticated technology, including complex computer algorithms, to trade securities at high speed. Large numbers of orders which are typically fairly small in size are sent into the markets at high speed, with round-trip execution times measured in microseconds. The parameters for the trades are set with algorithms run on powerful computers that analyse huge volumes of market data and exploit small price movements or opportunities for market arbitrage that may occur for only milliseconds. Typically, a high-frequency trader holds a position open for no more than a few seconds. In other words, high frequency trading firms profit mostly from small price changes exploited through small, but frequently executed trades.

Because trades are conducted entirely electronically, high frequency trading generally does not require personnel in the country where the infrastructure used to make trades is located. The implementation and execution of successful trading strategies depends on several factors, including the development of algorithms for trading, as well as writing programmes to monitor losses and performance and to automatically shut down trading to avoid fast-accruing losses. In addition, high frequency trading depends on the ability to be faster than competitors, which means that it is extremely sensitive to latency. As a result, the location of the server is extremely important to the business, with servers located close to the relevant exchange providing a meaningful advantage over servers located farther away. As a result, financial institutions offer installation of trading engines directly adjacent to their own infrastructure, minimising network latency

Participative/Collaborative Networks

A participative networked platform is an intermediary that enables users to collaborate and contribute to developing, extending, rating, commenting on and distributing user-created content. User created content (UCC) comprises various forms of media and creative works (written, audio, visual, and combined) created by users. A range of different distribution platforms have been created, including text-based collaboration formats such as blogs or wikis, group-based aggregation and social bookmarking sites, social networking sites, podcasting, and virtual worlds. In general, UCC is created without the expectation of profit.

The participative platform featuring the UCC, however, may monetise the UCC in a variety of ways, including through voluntary contributions, charging viewers for access on a per item or subscription basis, advertising-based models, licensing of content and technology to third parties, selling goods and services to the community, and selling user data to market research or other firms.

Social networking applications are possibly the best known participative networked platform but the same model is also used in other areas, like fashion design, toy design, and computer games just to name a few. Collaborative production methods are not yet widespread in practice for product development, but some firms are using them intensively and with success. The most common practice is to involve customers via social media and through feedback.

The users of a participative networked platform contribute user-created content, with the result that the value of the platform to existing users is enhanced as new users join and contribute. In most cases, the users are not directly remunerated for the content they contribute, although the business may monetise that content via advertising revenues (as described in relation to multi-sided business models below), subscription sales, or licensing of content to third parties. Alternatively, the value generated by user contributions may be reflected in the value of business itself, which is monetised via the sale price when the business is sold by its owners. Concerns that the changing nature of customer and user interaction allows greater participation in the economic life of countries without physical presence are more frequent in markets in which customer choices compounded by network effects.

The sharing economy is not new, but advances in technology have reduced transaction costs, increased availability of information, and provided greater reliability and security. Recent years have seen the emergence of numerous innovative sharing applications using different business models and focusing on one particular service or product, such as cars, spare rooms, food, clothes, and private jets. Most individuals who participate in the sharing economy do not do so mainly to make a living, but to entertain relationships with others, to serve a cause that inspires them, or simply to make ends meet. Because the supplementary income is a net benefit and often does not involve much quantitative cost-benefit analysis, amateur providers have a tendency to share their available resources at a lower price than what a professional might have billed, thus bringing down overall prices, including those of the professionals.

While the sharing economy concerns “collective consumption”, crowdsourcing and crowdfunding are manifestations of “collaborative production”. Both large companies and entrepreneurs make increasing use of these practices, for example, for capital peer-to-peer lending. The term crowdfunding is increasingly being used for different types of platforms, enabling lending, donations or reward-based funding, and equity crowdfunding (investment).

Content Networks

The definition of content in that regard is quite large: it includes both copyrighted content produced by professionals, enterprise-generated content, and non-copyrighted user-generated content (such as consumer reviews or comments in online forums). The importance of content flows from the fact that it is important to attract an audience and provoke interactions between users. In addition, more content updated more frequently increases a website’s visibility in search results. Content has hence been a driving force behind the advertising industry: it has become a key asset to attract an audience and monetise it with advertisers. Content has also become a way to advertise in and of itself, with classification into three categories: owned content (content distributed by the brand on its own channels), paid content (content distributed by other media in exchange of a payment by the brand), and earned content (content willingly created and shared by customers without direct payment by the brand, such as customer product reviews, videos, and social media sharing).

Wikipedia and YouTube, has proven that an entire experience can be built around content primarily generated by individual users. Further, the emergence of the social networking phenomenon, and the success of major applications in which links and interactions between users matter more than any primary content put forward to attract an audience show the same path. Even advertising relies increasingly on user-generated content, through the concept of earned content, one of the pillars of content marketing. The sophistication of techniques designed to customise services, including cookies (technical tools used by businesses to collect user data, notably for commercial purposes such as behavioural advertising), targeting and retargeting, and collaborative filtering, is also relevant. The amount of content available online has become so vast that relatively few businesses have succeeded online by offering premium content, unless they can leverage that content through a service that prevents competition on volume.

Virtual currencies

Recent years have been marked by the appearance and development of “virtual currencies”, meaning digital units of exchange that are not backed by government-issued legal tender. These currencies have taken various forms. Some virtual currencies are specific to a single virtual economy, such as an online game, where they are used to purchase in-game assets and services. In some cases, these economy-specific virtual currencies can be exchanged for real currencies or used to purchase real goods and services, through exchanges which may be operated by the creators of the game or by third parties

Addressing challenges in Digital Economy

A new nexus based on the concept of significant economic presence

This option would create a taxable presence in a country when a non-resident enterprise has a significant economic presence in a country on the basis of factors that evidence a purposeful and sustained interaction with the economy of that country via technology and other automated tools. These factors would be combined with a factor based on the revenue derived from remote transactions into the country, in order to ensure that only cases of significant economic presence are covered, limit compliance costs of the taxpayers, and provide certainty for cross-border activities.

Revenue-based factor

As a general matter, revenue that is generated on a sustained basis from a country could be considered to be one of the clearest potential indicators of the existence of a significant economic presence. This is based on the assumption that even in multi-sided business models, and particularly those dependent on network effects, the two markets are likely to be strongly interrelated, and as a result are likely to besituated in the same country. To the extent that the country of the users and country of the paying customers are aligned, the value of an enterprise’s users and user data would generally be reflected in the enterprise’s revenue in a country.

Transaction Covered
Level of the threshold
Administration of threshold

Digital Factor

In the case of “brick and mortar” businesses, the ability to reach significant numbers of customers in a country generally depends on a variety of factors, including a store’s location, local marketing and promotion, payment options, and sales and customer service employees. In the digital economy, the ability to establish and maintain a purposeful and sustained interaction with users or customers in a specific country via an online presence depends on analogous factors.

A local domain name
A local digital platform
Local payment options

User based Factor

Given the importance of network effects in the digital economy, the user base and the associated data input may also be important indicators of a purposeful and sustained interaction with the economy of that another country.

Monthly Active Users
Online Contract Conclusion
Data Collected

A withholding tax on digital transactions

A withholding tax on payments by residents (and local PEs) of a country for goods and services purchased online from non-resident providers has also been considered. This withholding tax could in theory be imposed as a standalone gross-basis final withholding tax on certain payments made to non-resident providers of goods and services ordered online or, alternatively, as a primary collection mechanism and enforcement tool to support the application of the nexus option described above, i.e. net-basis taxation. Both approaches raise similar technical issues with respect to the scope of transactions covered and the collection of the ensuing tax liability.

Scope of transactions covered
Collection of Tax
Negative impact of gross-basis taxation and relationship with trade and other obligations

Introducing an “equalisation levy”

To avoid some of the difficulties arising from creating new profit attribution rules for purposes of a nexus based on significant economic presence, an “equalisation levy” could be considered as an alternative way to address the broader direct tax challenges of the digital economy. This approach has been used by some countries in order to ensure equal treatment of foreign and domestic suppliers. For example, in the area of insurance, some countries have adopted equalisation levies in the form of excise taxes based on the amount of gross premiums paid to offshore suppliers. Such taxes are intended to address a disparity in tax treatment between domestic corporations engaged in insurance activities and wholly taxable on the related profits, and foreign corporations that are able to sell insurance without being subject to income tax on those profits, neither in the state from where the premiums are collected nor in state of residence.

Scope of the levy
Potential trade and other issues
Relationship with corporate income tax

Collection of VAT in the digital economy

Cross-border trade in goods, services and intangibles (which include for VAT purposes digital downloads) creates challenges for VAT systems, particularly where such products are acquired by private consumers from suppliers abroad. The digital economy magnifies these challenges, as the evolution of technology has dramatically increased the capability of private consumers to shop online and the capability of businesses to sell to consumers around the world without the need to be present physically or otherwise in the consumer’s country. This often results in no or an inappropriately low amount of VAT being levied on these flows, with adverse effects on countries’ VAT revenues and on the level playing field between resident and non-resident vendors. The main tax challenges related to VAT in the digital economy relate to(i) imports of low value parcels from online sales which are treated as VAT-exempt in many jurisdictions, and (ii) the strong growth in the trade of services and intangibles, particularly sales to private consumers, on which often no or an inappropriately low amount of VAT is levied due to the complexity of enforcing VAT-payment on such supplies.

Exemptions for imports of low valued goods

The Low Value Imports Report identifies four broad models for collecting VAT on low value imports and it assesses their likely performance. These models are: (1) the traditional collection model; (2) the purchaser collection model; (3) the vendor collection model; and (4) the intermediary collection model. The distinction between these collection models is essentially based on the person liable to account for the VAT. The traditional collection model is the model that is generally applied currently for the collection of duties and taxes at importation, and that is often combined with a VAT exemption for imports of low value goods. The other three models present possible alternative approaches for a more efficient collection of VAT on the importation of low value goods.

The traditional collection model

The traditional collection model, where VAT is assessed at the border for each imported low value good individually, is generally found not to be an efficient model for collecting the VAT on imports of low value goods. This is certainly the case in the absence of electronic data transmission systems to replace the existing paper based and manual processes.

The purchaser collection model

A model relying on the purchaser to self-assess and pay the VAT on its imports of low value goods is not likely to provide a sufficiently robust solution for an efficient collection of the tax. Although the purchaser collection model is likely to involve only limited compliance burden for vendors, the level of compliance by purchasers is expected to be low and this model would be highly complex and costly for customs and tax administrations to implement and operate.

The vendor collection model

A model requiring the non-resident vendors to charge, collect and remit the VAT in the country of importation could improve the efficiency of the collection of VAT on low value imports and thus create opportunities for governments to remove or reduce import exemption thresholds if they wish to do so. While a vendor collection model would create additional burden for non-resident vendors, these can be mitigated by complementing this model with a simplified VAT registration and compliance regime similar to the one suggested in the context of the OECD International VAT/GST Guidelines on B2C supplies of services and intangibles (B2C Guidelines). When a vendor supplies both goods and services into a particular jurisdiction, the registration system applied under the B2C Guidelines could be used for both kinds of supplies. This would reduce the administrative and compliance costs of the vendor registration.

The intermediary collection model

A model where VAT on imports of low value goods would be collected and remitted by intermediaries on behalf of non-resident vendors could improve the efficiency of the collection of VAT on such imports and thus create opportunities for governments to remove or reduce import exemption thresholds, assuming that such intermediaries would have the required information to assess and remit the right amount of taxes in the country of importation. The VAT collection by intermediaries would involve minimal compliance burdens on vendors. It may, however, come at an additional cost that may be passed on to the purchaser. This model may be particularly effective when the VAT is collected by intermediaries that have a presence in the country of importation (e.g. express carriers, postal operators and locally implemented e-commerce platforms). The intermediaries’ understanding of local tax and customs rules and procedures could provide benefits to both vendors and tax administrations. Four main types of intermediaries are identified:

Postal operators
Express carriers
Transparent e-commerce platforms
Financial intermediaries

Remote digital supplies to consumers: The vendor collection model

Economic Challenges in the digital economy

The conclusion is that all three of the tax options would be expected to have similar economic incidence:

In the case of a perfectly competitive market for digital goods and services, the incidence of the various options (and associated tax increase) is likely to be borne in part by labour, depending on the labour market conditions in the various countries in which foreign suppliers are located, and in part by consumers in market countries, assuming that the affected suppliers account for a significant share of worldwide market output, and depending on the availability of replacement suppliers with similar pre-tax costs and the availability of substitutes for the affected digital goods and services.
If the market is imperfectly competitive, however, the various options (and associated tax increase) are likely to be borne by the equity owners of the affected foreign suppliers to a greater or lesser extent, depending on the degree to which firms are price-setters.

Archives

Categories

Meta

Preface

Ottawa Taxation Framework Conditions

Taxation of Digital Services could revolutionize what we define as a taxable activity

Current Position on digital economy from OECD definition of PE

Website

Computer Equipment

Computer Equipment but used for auxiliary activity

ISPs operating their own servers

e-tailers operating their own servers

Abuses to present position

Some Approaches to Tax the Digital Services

Modification in the “Exception to PE”

Modification in the definition of “Agency PE”

Revision in “Transfer Pricing Guidelines”

Introduction of “Digital CFCs”

Collection of “Indirect Taxes”

Introduction of “Significant Economic Presence”

The distinction between Service Fee and Royalties

Royalties and Know-hows

How do they differ from services?

Mixed Contracts

Computer Software: Service or Royalty?

What is OECD’s position on Digital Service Taxes?

Countries that have implemented DST

USA’s Investigation on DST

USA’s Findings from the Investigation on DST

Unclear and Ambiguous

Contradicts the “definition of PE” and “taxability of Business Profits”

Contradicts the “taxation regime”

Contradicts the “taxation norms”

Unintended “Expansive Definition”

Creates “Double Taxation”

“Discriminates” digital and non-digital services

“Uncertainty” in design

Goes “Against FAR Test” and “Arms Length Test” and disregards the “Value Created by Intangibles”

Subjective argument to allocate “Inter-nation Equity?”

Taxation on “Income or Consumption or Both?”

Features of digital economy

Administrative Challenges in Digital Economy

Worldwide adopted digital service structures to minimize tax burdens

Avoiding a taxable presence

Minimizing the income allocable to functions, assets and risks in market jurisdictions

Maximizing deductions in market jurisdictions

Avoiding withholding tax

Eliminating or reducing tax in the intermediate country

Eliminating or reducing tax in the country of residence of the ultimate parent

Modification of the existing rules to add a force-of-attraction rule dealing with electronic commerce

Position of Nepal

A million dollar Question

Unique Provision in Section 70

Business Taxable under Section 70

Source of Income under Section 70

Computation on Taxable Income

Tax Rate Applicable

Rationale

Tests for application of Section 70

Dissection of Examples from Income Tax Directive

Value Added Tax

How does VAT work?

How does Reverse Charge VAT work?

Examples from VAT Directive

Overview on India’s Position on DST

Revenue Models of Digital Economy

Features of Digital Economy

Typical Tax Structures in Digital Economy

Ecommerce

Definition

Business-to-business models

Business-to-consumer models

Consumer-to-consumer models

Pictorial

Direct tax consequences in state S

Direct tax consequences in state T

Direct tax consequences in state R

VAT consequences

Online Advertising

Definition