UN expert committee proposes new Article for taxation of Income from Automated Digital Services

The digital industry will remain vulnerable to tax challenges until an acceptable global mechanism of taxation is uniformly adopted across countries. While steps for global consensus is underway, in the interim, several countries have adopted own practices to garner their share of tax. Principally, the right to tax the new digital economy cannot be questioned. However uncoordinated independent actions by countries would lead to unsurmountable economic and fiscal challenges for global digital companies.

India is amongst the first countries to impose Equalization levy, a mechanism of digital tax being an outcome of BEPS Action 1 Report: Addressing the Tax Challenges of the Digital Economy. Several countries including France, United Kingdom, Italy, Austria, Belgium, Norway, Malaysia etc. have either implemented or are in the process of implementing digital tax over the next 1-2 years in absence of broader consensus. India had introduced Equalization Levy (EL) in 2016 covering predominantly advertising services which has recently (effective April 2020) been substantially expanded to  ‘e-commerce supply or services’ (i.e. online sale of goods owned by the e-commerce operator or provision of services provided by the e-commerce operator or facilitation of online sale of goods or services). It will be reasonable to assume that EL is a transitory levy and will be replaced by a uniform basis of taxation under the tax laws upon consensus being reached amongst nations.

In this direction, the Drafting Group of developing country members of UN Tax Committee has recently (July 2020) presented for debate draft new Article 12B (with explanatory commentary) to address tax challenges of digitalised economies for insertion in the UN Model Tax Convention. Interestingly, the draft has been jointly forwarded by India’s Joint Secretary (Foreign Tax & Tax Research), Department of Revenue on behalf of the drafting group for further consideration. Though technically, this may not represent India’s formal position, however given the close involvement at the drafting stage, it may well reflect India’s view on the acceptable mechanism for addressing the digital tax challenge and its coverage.

The Drafting Group has proposed insertion of new Article 12B – INCOME FROM AUTOMATED DIGITAL SERVICES in UN Model convention to deal with the TAX TREATMENT OF PAYMENTS FOR DIGITAL SERVICES. The proposed Article provides for the taxability of income from ‘automated digital services’ arising in a Contracting State and paid to a resident of the other Contracting State at an agreed percentage (to be established through bilateral negotiations) of gross revenue.  Alternatively, it provides an option to the recipient to subject its ‘qualified profits’ from ‘automated digital services’ to taxation at domestic law rates. ‘Qualified profit’ for the purpose has been deemed at 30% of the profitability ratio (applied on gross revenue) of the multinational group or of the ‘automated digital business’ segment, if available.

Put simply, 30% of the multinational groups ‘automated digital business’ segment profitability (or overall profitability where segment profit cannot be determined) will be deemed as taxable profit and subject to tax at applicable domestic tax rates.

Taxability in case of PE will be outside the scope and subject to general PE taxation. Likewise, income falling within the ambit of FTS will be taxable under the relevant FTS Article.

The proposed Article defines ‘income from automated digital services’ to means “any payment in consideration for any service provided on the internet or an electronic network requiring minimal human involvement from the service provider.” The explanatory commentary has illustrated the following services as falling within the purview of ‘automated digital services’

  • Online advertising services – placing advertisement on a digital interface; purchase, storage and distribution of advertising messages, advertising monitoring and performance measurement.
  • Online intermediation platform & Social media services – providing digital interface for enabling interaction between users, including for the sale, hire, advertisement, display or other offer by users of particular goods, services, user-generated content or other property to other users.
  • Digital content services- automated provision of data in digital form, such as computer programs, applications, music, videos, texts, games and software.
  • Cloud computing services – standardized on demand network access to information technology resources.
  • Sale or other alienation of user data – provision of data to a third-party customer, where the data is generated by users of a digital interface, and is collected, compiled, aggregated or otherwise processed into data through an automated algorithm.
  • Standardized online teaching services – provision of an online education programme provided to an unlimited number of users, not requiring live presence of an instructor or significant customization on behalf of an instructor to a particular user or limited group of users

On the other hand, customised services provided by professionals and online teaching services; services providing access to the Internet or to an electronic network; broadcasted services; composite digital services embedded within a physical good irrespective of network connectivity (internet of things) have not been regarded as ‘automated digital services’.

The scope also excludes online sale of goods and services other than ‘automated digital services’ i.e. the sale of a good or service completed through a digital interface where: (i) the digital interface is operated by the provider of the good or service; (ii) the main substance of the transaction is the provision of the good or service; and (iii) the good or service does not otherwise qualify as an ‘automated digital service’.

At first sight, the approach being recommended seems equitable giving flexibility for adopting revenue based gross taxation (rates bilaterally negotiated between contracting countries) or 30% taxation of ‘qualified profits’ (profitability ratio of digital business segment). Nevertheless, finer aspects would need to be addressed, specifically in relation to ‘qualified profit’ approach.

For instance, countries would need to arrive at a consensus on accepting global financial statement (accounting policies as adopted) without any flexibility for country specific adjustment for profit and revenue determination. Taxpayers could perhaps be obligated to make segment reporting for ‘automated digital business’ to capture appropriate profit of such business, prevent cross subsidization and neutralizing exceptional items. A loss scenario would need to be addressed. A consequence of ‘qualified profits’ approach will also be a skewed allocation of profit in favour of price sensitive economises which may contribute lower profits compared to developed markets commanding higher price realization for services. Further, global companies are supported by development centres and back offices around the world and pay local taxes. Imposing taxes based on ‘qualified profit’ without factoring local taxes already paid in the larger scheme of things would lead to double taxation. Some of these challenges will need to be ironed out.

From an Indian context, the proposed ambit of ‘automated digital services’ includes automated provision of computer program/software. This may well mean that the Indian tax authorities may finally get to tax software (under treaty provisions), a matter which is sub-judice before the Apex Court. But what about software sales other than through digital means? Logically, there should not be a different treatment, however the proposed scope does not specifically provide for such taxation.

Further, the ambit of proposed Article excludes sale of a good or service through a digital interface (other than those categorised as ‘automated digital services’). This would suggest that sellers/providers of goods and services, say for example a seller of books or tangible product listed on the intermediation platform will not be covered under the ambit of the Article. It may not matter whether the platform is operated by the seller itself or whether it is a third-party marketplace platform. On the other hand, if for instance, the sale is of computer program/software (whether through own or other market-place platform), the same will fall within the ambit of proposed Article (being covered under ‘automated digital services’ category). Importantly, from an Indian context, the scope is much restricted vis-à-vis the Indian EL in the current form which on literal reading applies to all online sale of goods and services whether through own operated electronic facility or third-party marketplace. The coverage proposed under the Article seems more logical than what is presently provided under the Indian EL regime.

In conclusion, there may not be a flawless solution for digital taxation given the constant technological advancement, cross border nature of business and complexity of business models. As one debates this further, more issues will be identified and would need to be addressed. Nevertheless, a framework for discussion is now in place and hopefully a consensus may not be far away – a much needed tax legislation for the digital economy.   

Contributed by Yatin Sharma. Views are personal.

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Yatin can be reached at yatin.sharma@aureuslaw.com