Double taxation is the levying of tax by two or more jurisdictions on the same declared income (in the case of income taxes) or assets (in the case of capital taxes). This double liability is often mitigated by signing of tax treaties between two countries. Simply put, a Double Tax Avoidance Agreement (DTAA) is a tax treaty signed between two or more countries to help taxpayers avoid paying double taxes on the same income. A DTAA becomes applicable in cases where a person is a resident of one nation, but earns income in another. It is an agreement between two countries that the income of a person should not be taxed both in their country of origin and in the country that they reside in. In India, the provisions related to DTAA are specified under Sec. 90, 90A and 91 of the Income Tax Act, 1961. It is important to state that the primary objective of having a DTAA in place is to encourage and attract foreign investment, in addition to expediting exchange of goods and services between the signatory countries. The Indo-Malaysia, Indo-UAE and especially, the landmark Indo-Singapore DTAAs are illustrative of this fact.

The question that arises at this juncture is: why have DTAAs proven dichotomous for the Indian government when viewed in light of the Significant Economic Presence (SEP) test? Simply put, the SEP, although in line with OECD Base Erosion and Profit Shifting (BEPS) Action Plan 1) allows the Indian government to tax the income generated by a non-resident on the basis of its Business Connection (BC) in India forming a nexus or physical connection from such SEP.

Critics have often cautioned that tax collection in the digital economy will prompt instances of double taxation of different tech companies. This will result in companies being burdened by tax assessment in numerous jurisdictions. It is precisely at this stage that the problem ensues. It is by virtue of this phenomenon that the entire purpose of double taxation is reduced to a redundancy. By broadening the periphery of “business connection” by including the notion of a SEP, undue hardship of two-fold taxation or double tax collection is liable to be caused to tech giants. The reason here being that its Permanent Establishment (PE) may be situated in one country with an SEP operating in multiple countries, thereby posing it at risk for two-fold tax assessment by the different countries that it carries out its business in.

Localisation of data servers and possible privacy violations

An OECD report titled ‘Are the Current Treaty Rules for Taxing Business Profits Appropriate for E-Commerce’ talks about how we may define ‘permanent establishment’ under the purview of digital transactions. When any site, data or programme is hosted on a local server, it establishes a physical location to its parent company that can essentially be equated to a fixed spot of business venture. This can logically constitute PE given certain other conditions (i.e. precedents set up by judgments) stand fulfilled. Aforementioned reasoning might be the basis that the draft Personal Data Protection (PDP) Bill suggests localisation of data servers so that an Indian resident making an e-commerce transaction by utilising services provided by a non-resident tech company anywhere in the world may be taxed. It is at this point that one sees a shift in India’s approach towards digital taxation. Since enlarging the scope of Business Connection to include an SEP test did not pan out as predicted and began to incur problems with the ever attractive DTAAs, Indian tax authorities decided to surpass traditional routes to taxation.

However, localisation or storing personal data such as credit card details on the server that the non-resident company uses is deeply problematic on more than one account. For starters, the PDP bill mandates that the data stored at localised servers be handed over to Indian authorities which constitutes a violation of a citizen’s fundamental right to privacy, as established by KS Puttaswamy v. Union of India. This one of its kind judgement delivered by a 9-judge Constitution Bench establishes “informational privacy” and “right to control dissemination of personal information” as facets of right of privacy. Hence, the PDP, in toto, is in direct conflict with constitutional privacy safeguards set up by Puttuswamy (supra) and it is this that makes matters murky. The PDP, in its present form, has seen several changes to the original version as recommended by retired Supreme Court judge Justice B. N. Srikrishna, who also said that the revised Bill was “a blank cheque to the state” . Given the fact that India’s digital economy is estimated to reach a staggering US$1 trillion in the next five to six years, it is only natural that the Indian government aims to generate revenue from this. The PDP allows the Central Government access to personal and sensitive data generated by its citizens and classifies it as a national asset. Imagine one’s deeply personal data as a repository all that one is: the sum of one’s parts! Much to the dismay of critics, the Central Government is allowed to store the sensitive data of citizens in order to safeguard the country’s defence and strategic interests.

What is further complicated is that the PDP grants blanket immunity to the Central Government by exempting its agencies from the provisions of the Act under the garb of protecting national interests, security of the state, public order, sovereignty and integrity of India. Section 35 of the PDP reduces state accountability to a redundancy. The doctrine of public accountability finds its roots in the need to check misuse of power by the administration because such misuse is a breach of trust reposed in the administration, that it will augment the best interests of its citizens. Accountability, here can be understood as the pivot of a system that revolves on maintaining the checks and balances between the executive and the legislature. Accountability is for increasing the trustworthiness of the State in the eyes of the public. PDP can easily be termed George Orwell’s worst nightmare for the sole reason that it approbates and reprobates

the very promise of transparency in good governance.

A jurisdictional nightmare and the bone of contention

When the notion of SEP is brought within the periphery of Business Connection, the central government will have a reasonable nexus under the Income Tax Act (ITA) to tax a non-resident’s business income accruing in India. It is from this perspective that the Government of India must modify its DTAA to incorporate E-business tax assessments. India has signed DTAA with 88 countries but only 85 DTAAs are in force. It is common knowledge that DTAAs are signed with the prime objective of encouraging foreign investments in India, by prospective investors from the other signatory country. The SEP issue would subjugate the goal of the double non-taxation (the very premise on which all DTAA are built) thereby shrinking the impetus of DTAA (in which the global tech organisations are based), signed by India with other countries. To remedy the situation, the Indian government may attempt to re-arrange this double taxation bargain with each nation independently, weighing the pros and cons of each treaty individually. Only when the other State party acknowledges inclusion of SEP, will it be incorporated in the bilateral treaty. When the timeframe for this treaty has been completed, the Government of India will have the option to exact E-trade tax collection. Until then, if India were to exact a levy based on the SEP test, numerous companies will have a significant virtual presence in countries all around the globe with its PE in one country. Applying the SEP test, such companies will be unduly liable to pay tax on the same income in several countries giving rise to the instance of double taxation thereby rendering the whole purpose of a DTAA redundant.

The way forward

It is to be noted that any measure to tax the digital economy cannot operate in a vacuum, which is why it is crucial we understand what an Equalisation Levy does. In an effort to tap into the revenue generated by the digital economy (owing to its global user base) the Indian Parliament enacted an “Equalization Levy” through the Finance Act, 2016. Essentially, an equalization levy is a tariff and is not based on ability to pay. Furthermore, it is only applicable to non-resident companies. Initially it was charged at only 6% and limited specifically to advertising services. We may understand it in terms of a direct tax withheld at the time of payment by the recipient of the services. The Indian government had increased its equalization levy to 6% on income of all digital business providers. This change extends the adjustment from online advertising services to all online trade/e-commerce done in India by organisations that do not have “physical taxable presence” in India. In conclusion, we must understand that any tax policy must be designed in such a way that it is neutral in its nature, and the equalization levy (charged at 6% of the gross consideration by the Indian Government) is clearly discriminatory. The potential for double taxation of the SEP test can create friction in international commerce. Policymakers may well desire to reassess the issue, apropos the ways in which digital taxes could impact business models of the companies that are providing significant value worldwide, during the current pandemic outbreak. The temptation to apply special taxes to tech giants right now will be strong, given the path India has adopted, when they may be more profitable than the rest of the global economy. Over the course of time, an all-inclusive, comprehensive, impartial policy should be the choice for digital taxation.