What is e-Commerce? How the e-Commerce Transactions are Taxed
in India?
By
K P C Rao., LLB., FCMA., FCS.,
CMA (USA)., FIPA
(Australia)
Practicing Company
Secretary
kpcrao.india@gmail.com
1.
Introduction
The development of electronic commerce can be said to be the greatest
event in the economic history of mankind, next only to the Industrial
Revolution of the early 20th Century. Whereas Europe and United
States were the main beneficiaries of the Industrial Revolution, there are
clear indications that India along with
the United States and China, would be the major beneficiary of the electronic
commerce revolution. India’s e-commerce
market was worth about $2.5 billion in 2009. About 75% of this is travel
related (airline tickets, railway tickets, hotel bookings, online mobile
recharge etc.). Online Retailing comprises about 12.5% ($300 Million as of
2009). India has close to 10 million online shoppers and is growing at an
estimated 30% estimated compound annual growth rate (CAGR) vis-à-vis a global
growth rate of 8-10%. Electronics and Apparel are the biggest categories in
terms of sales.
The India retail market is estimated at $470 Bn in 2011 and is expected
to grow to $675 Bn by 2016 and $850 Bn by 2020, CAGR of 7%. According to Forrester, the e-commerce
market in India is set to grow the fastest within the Asia-Pacific Region at a
CAGR of over 57% between 2012-16. India
e-tailing market in 2011 was about $600 Mn and expected to touch $9 Bn by 2016
and $70 Bn by 2020 – estimated CAGR of 61%. Mjunction.in is the largest B2B
Ecommerce portal in India.
The huge pool of skilled technological manpower in India is at the basis
of this indication. The Indian industry is attempting to harness technology to
succeed in achieving its business objectives. In doing so, it has been focusing
on balancing the benefits provided by new technology with the associated risks
in having one's business depend on it.
2.
What is e-Commerce?
Electronic
commerce commonly known as e-commerce, is the buying and selling of product or
service over electronic systems such as the Internet and other computer
networks. Electronic commerce draws on such technologies as electronic funds
transfer, supply chain management, Internet marketing, online transaction
processing, electronic data interchange (EDI), inventory management systems,
and automated data collection systems. Modern electronic commerce typically
uses the World Wide Web at least at one point in the transaction's life-cycle,
although it may encompass a wider range of technologies such as e-mail, mobile
devices and telephones as well. Therefore, e-commerce or electronic commerce,
in its widest sense, means consumer and business transactions conducted over a
network, using computers and telecommunications.
The OECD[1]
defines e-commerce in a somewhat more restricted manner as commercial
transactions between individuals and organisations, based on the processing or
transmission of digitised data units, sound, and visual images, which are
carried out over open networks (like internet) or over closed networks (like
minitel) with a gateway to open networks. This more specific definition would
therefore exclude electronic data interchange (EDI), carried out over closed
networks, if such EDIs are being used by themselves, without access to an open
network (e.g. credit cards used over a closed network, connecting specified
merchants with a card organisation).
Figure illustrating the process of an e-commerce transaction
(1) The consumer places an order.
The customer places an order at the
Merchant Internet storefront, using his or her payment method of choice.
(2) The transaction is processed in real-time.
The payment gateway, provides
secure, real-time connectivity from your storefront to the payment gateway platform.
Our gateway product, BluePay™, securely routes the transaction through the
financial network to the appropriate banks, ensuring that customers are
authorized to make their purchase.
BluePay™ Payment Gateway uses a
client/server architecture for performing transaction processing. The client is
installed on your merchant site and is integrated with your e-commerce
application. The client may also be pre-integrated with shopping cart solutions
and store management systems.
For transaction authorization, the
BluePay™ client software establishes a secure link with the BluePay's
processing server over the Internet using an SSL connection, and transmits the
encrypted transaction request. The processing server, which is a multi-threaded
processing environment, receives the request and transmits it to the
appropriate financial processing network.
(3) The transaction is approved or denied.
When the authorization response is
received from the financial network, the response is returned via the same
session to the client on your site. The client completes the transaction
session by transparently sending a transaction receipt acknowledgment to the
server before disconnecting the session.
(4) The transaction is confirmed.
The BluePay™ Payment Gateway
confirms that the transaction has been securely routed and processed. As proof
of a securely processed transaction, both the customer and you, the merchant,
receive a transaction confirmation number via web browser and/or e-mail.
3.
How business is
transacted through e-Commerce?
e-commerce is a method of
conducting business transactions and not a business transaction by itself.
Therefore, the contents of a business transaction done through e-commerce are
no different from that of a business transaction carried out through traditional
means. The three distinct means of doing
business in e-commerce are:
(1) Electronic advertising: Advertising is done on the open networks, through websites.
Potential customers access the websites and obtain the information they need
which enables them thereafter to proceed with the transaction is suitable
cases. If the e-commerce business is restricted to putting up a website alone,
then the rest of the transaction is completed through traditional means; i.e.
the placing of orders by telephone or mail, the making of payment by cheque and
credit card and the delivery of goods through a carrier, the telephone etc.
being referred to as intermediaries.
(2) Electronic sales: This is done through
‘smart’ resources which enable the potential customer to place an order on the
internet. The payment is effected through a closed network by means of credit
cards.
(3) Electronic delivery: This is of course possible only for goods and services that
can be fully digitised, but this range is quite wide and ever expanding. Texts,
visual materials, audio materials and computer software are digitised.
Therefore products like journals, books, music, plans, designs, drawings and
games to mention a few, would be goods available in digitised form. Besides
goods, services like diagnostic services, could also be available in digitised
form. Therefore a whole host of goods and services could be delivered
electronically.
4.
Classification of e-Commerce Transactions
Based on parties involved in a
transaction e-Commerce Transactions
may be classified as follows:
(1)
Business to Customers (B2C): Businesses selling to the general public typically through
catalogs utilizing shopping cart software. By dollar volume, B2B takes the
prize, however B2C is really what the average Joe has in mind with regards to
ecommerce as a whole.
(2)
Business to Business (B2B):
Companies doing business with each other such as manufacturers selling to
distributors and wholesalers selling to retailers. Pricing is based on quantity
of order and is often negotiable.
(3) Consumer-to-Business (C2B):
A consumer posts his project with a set budget online and within hours
companies review the consumer's requirements and bid on the project. The
consumer reviews the bids and selects the company that will complete the
project. Elance empowers consumers around the world by providing the meeting
ground and platform for such transactions.
(4)
Customer to Customer (C2C):
There are many sites offering free classifieds, auctions, and forums where
individuals can buy and sell thanks to online payment systems like PayPal where
people can send and receive money online with ease. eBay's auction service is a great example of
where person-to-person transactions take place every day since 1995.
Companies using
internal networks to offer their employees products and services online--not
necessarily online on the Web--are engaging in B2E (Business-to-Employee)
ecommerce. G2G (Government-to-Government), G2E (Government-to-Employee), G2B
(Government-to-Business), B2G (Business-to-Government), G2C (Government-to-Citizen),
C2G (Citizen-to-Government) are other forms of ecommerce that involve
transactions with the government - from procurement to filing taxes to business
registrations to renewing licenses. There are other categories of ecommerce out
there, but they tend to be superfluous.
5.
Regulatory Framework
The regulatory
environment in India, which broadly governs e-commerce, comprises of the
following laws:
(1) Indian Contract Act, 1872;
(2) Copyright Act, 1957;
(3) Trademark Act, 1957;
(4) Patent Act, 1970;
(5) Information Technology Act, 2000(As amended) ; and
(6) Indian Penal Code, 1860 etc.
6.
What way the method of e-commerce transactions is different
from traditional practice of business?
The method of carrying on a
business is widely different from the traditional practice of business on the
following counts.
(a) Firstly, traditional businesses have rested squarely on the
physical presence and delivery of goods, but in e-commerce transactions,
physical presence of goods is not required at all. Consequently, geographical
boundaries between nations hold no significance.
(b) Secondly, in such type of transactions, physical delivery of
goods is not necessary. Where the goods and services are available in digital
form, e.g. computer software, music, magazines, drawings etc. physical
transactions are replaced by transfer of bytes.
(c) Thirdly, e-commerce transactions can be completed almost
instantaneously across the world and irrespective of the time of the day.
7.
Issues involved in
Taxing of e-Commerce Transactions
Due to absence of
national boundaries, physical presence of goods and non-requirement of physical
delivery, taxation of e-commerce transactions raises several issues. These issues
have to be examined in the light of international taxation principles. International taxation arises from cross
border transactions for the reason that the author of the transactions arises
in one country (called the Home State) and the sites of the transactions is in
the other country (Host State). Income
arising out of such transaction is subject to tax in both countries by virtue
of ‘personal attachment’ to the transfer (in the Home State) and again by
virtue of ‘economic attachment’ to the income itself (in the Host State). Thus, this gives rise to double taxation of
the same income. This problem is generally solved by a Double Taxation
Avoidance Agreement (DTAA) between the two countries concerned. The key
issues arising in respect of e-commerce transactions are as follows:
(a)
How to determine economic
attachment?
In order to determine economic
attachment, the situs of the transactions should be clearly determined.
In a traditional commerce transaction, the situs of the transaction is
clearly known, because of the physical presence and the physical delivery.
Therefore, the ‘Source Rule’ as laid down in section 9 of the Income-tax Act,
1961 can be clearly applied to effect Host State taxation.
Section 9 of the Income-tax Act,
1961 provides that income is deemed to accrue or arise in Indian taxable
territory if there is a business connection. In E-commerce situations, with
transactions being completed in cyberspace, it is often not clear as to the
place where the transaction is effected, giving rise thereby to difficulties in
implementing Source Rule taxation.
(b)
How to determine existence of a
permanent establishment?
Under most
bilateral double tax treaties, a country will seek to tax corporate business
profits if they can be applied to a ‘permanent establishment’ in that country.
The basic requirement is, therefore, that there must be a place of business and
it must have some permanence.
The major taxation
problem of e-commerce is that no establishment is necessary across the border
to carry on business. With regard to tangible property, the source can be
traced, as the delivery has to cross the other territory through the customs or
postal barrier. The destination also will be known from the shipping address.
Where the seller is located in a tax-haven country, it becomes difficult to
enforce tax laws on the non-resident business. In such cases, the natural
option should be to tax the resident as the agent, especially where the
non-resident cannot be reached. The difficulty is not so much in taxing those
who are assessed and who maintain accounts but in taxing others who do business
and there is no record of their transactions, like the persons liable to pay
the ‘use tax’ in US. With the development of WAP (Wireless Application
Protocol) which integrates mobile telephony with the Internet, e-commerce will
be taken over by M-commerce (Mobile Commerce). This makes the place of origin
of business invisible thus adding complication to the existing scenario and is
a real challenge to domestic jurisprudence.
Further, how such
income is to be attributed to the permanent establishment is also a significant
matter. This is relevant to determine whether income from sales can be taxed on
host country soil. For instance, if a particular income is classified as
royalties or fees for technical services, or dividends or interests, then
irrespective of the existence of a permanent establishment, the income will be
liable to host country taxation under section 115A of the Income-tax Act, 1961.
On the other hand, if the income is classified as income from sales, then
unless there is a permanent establishment, there can be no taxation in the host
country. And if there is a permanent establishment, how much income is to be
taxable will be determined by how much of the income is to be attributed to the
permanent establishment.
(c)
Legal Impediments
Till now all cross-border
commercial transactions have to cross the customs barrier or the postal
barrier. All trade and commerce are operated in a physical world and in terms
of tangible goods. Hence, there is a check on these transactions, though
smuggling remains outside the scope of any control. Even in the present
situation, the tax authorities are unable to fully grapple with the problem of
myriad ways of tax evasion. In e-commerce transactions, the contracting parties
are in two different states (Jurisdiction) and, therefore, the question would arise
as to which state law would be applied.
(d)
Nature of contract
A contract need not necessarily be
in writing unless; the statute requires it to be so. It can be oral. This will
create problems relating to the law that will be applicable in case of dispute.
In a contract, generally the parties are free to choose the law applicable to
the contract and the same can be expressed or implied in the terms of the
contract. In some cases, the principal place of business is relevant in
deciding the law applicable. In some other case, the place where the buyer normally
resides decides the law to be applied. Where there is a clause for retention of
title until the buyer performs some act, then the matter of which lex situs will
govern the validity clause is open to question. In answering this, the Rome
Convention says that if the contract accords with the rules of anyone of the
States, its validity cannot be questioned. This would be the most satisfactory
solution and can be followed. All these problems arise mostly regarding
transactions relating to movables and those relating to immovable properties
are less difficult. There are many areas where the present domestic laws
including international laws would be inadequate to deal with the emerging new
field of e-commerce.
(e)
Taxable jurisdiction
The taxable jurisdiction of any
country covers its national boundary. Besides this the territorial jurisdiction
includes territorial sea and airspace above as per the territorial waters,
continental shelf, exclusive economic zone and other Maritime Zones Act, 1976.
Each one extends to specified nautical miles from the base line. But electronic
commerce takes place through satellite and the server can be in any part of the
globe. It can in all probability be in a tax-haven country. The
following are the limits indicated therein:
(1) Territorial Water -12 nautical miles from the nearest point of appropriate
base line.
(2) Contiguous Zone - 24 nautical miles beyond and adjacent to the territorial
waters from the base line.
(3) Continental Shelf - 200 nautical miles from the base line.
(4) Exclusive Economic
Zone is an area beyond and adjacent to the territorial waters
extending to 200 nautical miles from the base line.
(f)
Residential Status
The incidence of tax on
any assessee depends upon his residential status under the Act. All assesses
are liable to tax in respect of the income received or deemed to be received by
them in India during the previous year irrespective of (i) their residential
status, and (ii) the place of its accrual. Income is to be included in the
total income of the assessee immediately on its actual or deemed receipt. The
receipt of income refers to only the first occasion when the recipient gets the
money under his control. For all purposes of income-tax, taxpayers are
classified into three broad categories on the basis of their residential
status. viz (a) Resident and ordinarily resident (b) Resident but not
ordinarily resident (c) Non-resident.
Another condition
for taxing the income arising or accruing beyond the taxable territories is the
physical residence of the taxpayer for 182 days or more. This becomes meaningless with the Internet access. The
information highway provides numerous visits to another jurisdiction outside
the control of border mechanism.
8.
Taxation Framework
Some
of the fundamental tax-related issues cropped up in the process of evolution of
cross-border e-commerce transactions are:
(1) Need
to develop new norms and tenets of interpretation to determine the nature and
character of income from cross-border e-commerce transactions.
(2)
Need to create new definition and
meaning of permanent establishment (PE)
(3)
Need to change the basis of taxation
(for example, residence-based taxation)
(4) Need
to adhere to the principles of tax
neutrality
The Committee of Fiscal Affairs of
the OECD has been actively working on taxation issues relating to e-commerce.
The committee has developed the taxation framework conditions setting forth the
governing principles in relation to e-commerce. The key conclusion was that the
taxation principles that guide Governments in relation to conventional
commerce, should also guide them in relation to e-commerce. It was postulated
that this would be possible only by adapting and adopting the existing
principles to e-commerce situations. Key
areas in the context of international tax were identified for adapting and
adopting the existing principles are:
(a) Permanent Establishment in e-Commerce Situations
According to the principles of
international taxation, business income cannot be taxed on Host State soil,
unless there is a permanent establishment in the Host State. If there is such a
permanent establishment, then the only income which the Host State is entitled
to tax is the income attributable to the permanent establishment. Such
attributable income is determined by imagining the permanent establishment to
be an entity independent of the foreign enterprise, and dealing with the
foreign enterprise at arm’s length price. The issue therefore translates to one
of determining the transfer price between the foreign enterprise and permanent
establishment, and rewriting the transaction between the two, at arm’s length.
(b) Determination of the Nature of Income
The manner of taxation in income
arising from e-commerce transactions and also in conventional commercial
transactions, depends on the characterisation of the income. The
characterisation of income is relevant because different types of income are
taxed differently. Once this is identified, the existing rules may be adopted and
adapted to the e-commerce transactions.
In conventional commerce, when all
rights in a property are transferred it would amount to a sale giving rise
therefore to business income. On the other hand, when only limited rights in a
property are transferred, the transferor retaining substantial rights therein,
the income there from would be classified either as a royalty in the case of
intellectual properties, or a lease rent in the case of tangible properties. If
the ultimate results of the transaction is the rendering of services, the
income would have to be characterised as fees for professional services.
Similarly, in an e-commerce
situation, if licensing of a know-how is done, the payment for this would
clearly be characterised as a royalty income in terms of most double taxation
avoidance agreements and this would be so irrespective of whether this is done
by physical transfer of information or by transfer of digitised information. If
on the other hand, practically all rights in a design are transferred, whether
physically or through electronic transfer of digitised information, with no
rights being retained by the transferor, under most double taxation avoidance
agreements, the transaction would be considered to be one which is more in the
nature of outright sale of the design rather than a licence thereof. The
payment for this would then be characterised as a sale consideration rather
than as a royalty.
Most of the computer programmes
including software would clearly be considered to be covered by copyright. If
software is licensed or its use is permitted in any manner, in accordance
with Explanation 2 to section 9(1) (vi) of the Income-tax Act, the income would
be royalty in nature. The income would therefore be deemed to arise in India in
accordance with section 9(1) (vi) (b) when the payer of the same is an Indian
resident, unless it could be established that the software is used in a
business outside India. When therefore purchase consideration in respect of any
software to be used in India is paid to a non-resident who has exported
software, there are alternative views regarding the tax treatment. One view is
that the payment will be construed as income deemed to arise or accrue within
India, in terms of section 9(1)(vi); it would become income of the non -resident
subject to Indian tax in terms of section 5(2); and consequently tax would
require to be deducted by the buyer of the software in terms of section 195. In
terms of most double taxations agreements entered into by India with other
countries, again the amount would be considered royalty income accruing or
arising within India, and therefore subject to Indian withholding tax. The
other view is that such software payment cannot be treated as royalty. This has
been a subject matter of extensive litigation. Recently, the Delhi High Court has, in CIT v. Dynamic Vertical
Software India P. Ltd. (2011) 332 ITR 0222 (Delhi), held that since the
assessee had purchased the software from a foreign company, Microsoft, and had
subsequently sold the same in the market, it had acted as a dealer and
therefore, the payment to the non-resident, Microsoft, cannot be treated as
royalty.
(c) Double Tax Relief
Double
taxation refers to a situation where the same income becomes taxable in the
hands of the same company or individual (tax-payer) in more than one country.
Such a situation arises due to different rules for taxation of income in
different countries. The two main rules of income tax which may
lead to double taxation are: (1) Source of income Rule (2) Residential status Rule.
Under Source of income rule, the income of a person is subjected to
taxation in the country where the source of such income exists i.e. where the
business establishment is situated or where the assets/property is located
irrespective of whether the income earner is a resident in that country or not;
Under Residential status rule, which the income earner is taxed on the basis of
his/her residential status in that country. Hence, if a person is resident of a
country, he/she may have to pay tax on any income earned outside that country
as well. Thus, the same person may be taxed in respect of his/her income on the
basis of source of income rule in one country and on the basis of residence in
another country leading to double taxation.
The relief against such double taxation in India has been provided under
Section 90 and Section 91 of the Income Tax Act. They contain two ways of
double taxation relief.
9.
Conclusion
Despite
the divergence of method between traditional commercial transaction and
e-commerce transactions, it is essential to conform to the tenets of neutrality
of taxation. On account of the
characteristics of e-commerce namely that transactions are completed in
cyberspace, thereby making national boundaries meaningless, and considering the
level of dis-intermediation and untraceablity of the path of the transactions,
traditional Source Rules of taxation become increasingly difficult to apply.
As
techniques of e-commerce progress, the situations become more complex with
increasing dis-intermediation. Instances of these could be where traditional
transfer pricing rules cannot be applied to multiple servers which switch
signals depending on their work loads. This could give rise to increasing
emphasis on Residence Rule taxation whenever Source Rule taxation becomes
difficult to apply. Such a situation could spell diminishing revenues for
developing countries, particularly in situations of technology transfers, where
Host States are generally developing countries. e-commerce has also given rise
to a new breed of crimes called "cyber crimes," "cyber
squatting," and "virus attacks," among others. There is a strong
need for cyber policing to reduce the Internet's abuse for carrying out crimes
that are, at times, more harmful than physical destruction. It is also imperative
that the
international institutions like OECD, International Fiscal Association, should evolve more equitable tenets for cross-border
e-commerce transactions so that there can be a more equitable distribution of
tax revenues among nations. Countries that are feeling an erosion of their tax
bases shouldn't be forced to adopt desperate measures that may be short term
and, hence, likely to adversely affect the growth of their e-commerce economy.
India, in particular, should adopt measures to ensure its position as the major
beneficiary of the e-commerce revolution, along with the United States and
China.
[Published in Corporate Secretary, a Monthly magazine of ICSI, Hyderaad]
[1]
The Organisation for Economic Co-operation and
Development is an international economic organisation of 34 countries founded
in 1961 to stimulate economic progress and world trade.
No comments:
Post a Comment