NATIONAL LAW SCHOOL OF INDIA UNIVERSITY, NAGARBHAVI, BANGALORE

PROJECT ASSIGNMENT ON
TAXATION

TOPIC: E-TAXATION IN INDIA COURSE TEACHER: JUSTISE S. RAJENDRA BABU SUBMITTED BY: - MOHD. TAUSIF ZAHIR Ist YEAR LL.M. (BUSSINESS LAW) ID NO. 429

ACKNOWLEDGEMENT
I would like to express my sincere gratitude to Justice S. Rajendra Babu and owe my foremost regards to him for giving me an opportunity to carry out this project work under his guidance. This work would not have been possible without his invaluable support and thought provoking comments. It is due to his patient guidance that I have been able to complete the task. I also extend my gratitude to the Librarian and the Library staff who made available the required materials within time. I am indebted to all those who guided me while doing the research work. Their valuable contributions have played a vital role in the completion of this project. Though I have tried out best at the same time I know that there is nothing called perfection so I would like to have all valuable suggestion for future I dedicate this project to all the people who believe that hard work and creativity needs protection and encouragement.

Mohd. Tausif Zahir LL.M. 1ST YEAR ID. NO. 429

TABLE OF CONTENT E- Taxation In India Uniqueness of E-Commerce Taxation Issues Emerging from Online Transactions The Basis of Taxation in Online Environment Constituting Permanent Establishment (PE) OECD Model Treaty Whether a website act as a PE Whether a server act as a PE If an Enterprise Hosting its Own Website Taxation Practice in India When Person is a Resident in India When Company is a Resident in India Establishing Business Connection Business Connection and Finance Act 2003 Establishing Permanent Establishment Establishing Permanent Establishment and the Finance Act, 2003 BPO as PE Taxing Digital Goods Tax on the Sale or Purchase of Goods Suits of the Sale or Purchase Taxing Digital Goods in India Conclusion Bibliography 10 10 11 11 12 12 13 14
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E-TAXATION IN INDIA E-commerce by using information technology is a new way of conducting, managing and executing business transactions. The World Trade Organization Ministerial Declaration on ecommerce defines e-commerce as the production, distribution, marketing, sales or delivery of goods and services by electronic means.1 According to the Internet Tax Freedom Act ecommerce includes any transaction conducted over the internet or through internet access, comprising the sale, lease, license, offer, or delivery of property, goods, services, or information, whether or not for consideration, and includes the provision of internet access.2 As e-commerce occurs in various forms and between various entities in the market, the question is how to tax it and if the taxing goods are digital download in the form of content or information? The Government has always been taxing brick n mortar businesses as per the statutory provisions. It establishes the boundaries of legitimate state authorities to impose a duty to collect sales and use taxes and reduces litigation concerning those taxes. So far, the brick n mortar businesses are being taxed on the principles of physical presence or substantial nexus criteria. The click and mortar sellers are required to collect sales taxes based on their substantial nexus in a state where their product is delivered. Presumably the point of sale is the state to which the goods are shipped, and thus, the consumer owes sales taxes to this state. It is important that transactions should not be immune from taxation solely because the sale is conducted through a medium distinct from that of a traditional brick-and-mortar retailer. Similarly, it is not prudent to tax these e-commerce models purely on the basis of traditional approach to brick n mortar taxation as they have their own unique features.3 Uniqueness of E-Commerce Taxation4 The lack of physical connection between a consumer in one state and a seller in another state. Ever changing location of web servers hosting the website, meant for online transactions; Relocation of businesses in tax havens. General confusion regarding which country has the right to tax the transaction, and at what rate. Non taxation of digital (intangible) goods, like software, music and data or information.

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www.wto.org Sharma Vakul, Information Technology Law and Practice 2008 Universal Law Publishing Co. at 319 Id Id

Export and import of digital (intangible) goods across international borders without paying customs duty or tariffs, thereby bypassing the existing export import policies, regulations and tax system. A parallel channel of transactions, ignoring the traditional documents based banking practices. The general lowering down of barriers to trade for the smaller business entities. Complete disregard to accounting and audit procedures.

In online environment a new tax system is required to redefine the basis of taxation like what should be the modus operandi of collecting tax and what constitutes permanent establishment. Issues Emerging from Online Transactions As e-commerce represent online transactions involving consumers and businesses is occurring instantaneously, which makes it difficult to determine who the buyer and seller are and where they are respectively located. From a point of electronic taxation following issues may emerge: Who is the customer? Where does the customer live? Did the transaction constitute sale of tangible property, the performance of a service, or the transfer of intangible property? Which jurisdiction has the authority to tax the sale? What online activities constitute sales for sales tax purposes? What constitutes a business connection/substantial nexus within a taxing jurisdiction? Can Central and/or State Government(s) technologically capable to monitor all online transactions? What kind of record retention requirements is necessary for tax purposes?

It is the nation states constitutional prerogative to levy taxes on any online economic activity and for that purpose every nation state has a right to define its own e-commerce taxation principles.5

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The foremost problem associated with internet based commerce is fixing the place of the transaction. The place where a web server is located or the place where a user initializes the transaction and the server where the payment is collected may be different. Electronic transfer of funds heightens the risk of money being sent to tax havens. The essential question is whether internet based trading is cross border. Political demarcations notwithstanding, administration of taxes would prove highly complicated in the borderless internet. Two methods are forthcoming 1. To treat all individual based trade as having originated in the country where the server is located 2. To treat business to business trade on the basis of physical presence or permanent business establishment terms widely used in double Taxation treaties.6 The Basis of Taxation in Online Environment As the organization for Economic Co-operation and Development (OECD) a 30 members organization has proposed that the basis of any online taxation system should be free, effective, certain, flexible, equitable, simple and dynamic. The Idea is to create uniform mode of taxation whether offline or online.7 Constituting Permanent Establishment The primal question, in order to understand the basis of taxation in online environment, needs to be answered is what constitutes a physical presence or substantial nexus? a. Is it downloading of the website and its contents at a particular location (buyers place of residence)? b. Is it the location of web server, hosting the website? If we looks from the point of establishing minimum contacts and purposeful availment then the nature and mode of the transaction with the resident that establishes the physical presence of the seller in the forum state. It would render the seller taxable in every possible taxable in every possible taxable jurisdiction. But if one treats presence of a web server as permanent establishment for the purpose of electronic taxation then it would be make seller solely taxable at the jurisdiction where the server is located.8 OECD Model Treaty According to the Art 5(1) the OECD Model Treaty defines permanent establishment as a fixed place of business through which the business of an enterprise is wholly or partly carried on. Art 5(2) defines certain types of activity per se permanent establishments including offices, factories and mines.
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Singh Yatindra, Justice, Cyber Laws Fourth Edition, Universal Law Publishing Co. at p 364-365 www.oecd.org Supra 2

According to the new OECD Commentary, on the OECD Model Treaty issued on January 28, 2003, a website is a combination of software and electronic data and does not in itself constitute tangible property. Paragraphs 42.1 to 42.10 have been added immediately after paragraph 42 of the Commentary on Art 5. It further clarifies: a. Whether a website constitutes a place of business b. Whether location of a server constitutes a permanent establishment - When an ISP hosts its website, or - When an enterprise owns (or leases) and operates the server on which the website is stored c. Whether the location of a computer equipment constitutes a permanent establishment when functions performed through that computer equipment exceeds the preparatory or auxiliary threshold.9 Whether a Website Acts as a PE? According to Para 42.2 an Internet website which is a combination of software and electronic data does not constitute tangible property in itself. A website 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 website is concerned.10 Whether a Server Acts as a PE? According to the Para 42.4 the distinction between a website and the server on which the website 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 website. 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.11 If an Enterprise Hosting its Own Website If the enterprise carrying on business through a website has the server at its own disposal, for example it owns (or leases) and operates the server on which the website is stored and used, the place where that server is located could constitute a permanent establishment of the enterprise. Such location may thus constitute a fixed place of business of the enterprise that operates that server.12

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Taxation Practices in India The term taxation has been defined in Article 366(28) of the Constitution of India in the following terms: taxation includes the imposition of any tax or impost, whether general or local or special, and tax shall be construed accordingly; The aforesaid Article should be read along with Article 265, which states that: no tax shall be levied or collected except by authority of law. Eligibility to tax is not the same as liability to pay tax. The former depends on the charge created by the Act and the latter on computation in accordance with the provisions in the Act and Rules.13 When Person is a Resident in India Taxation in India is based on jurisdictional nexus, source of income and status principles. The principle of jurisdictional nexus determines whether tax can be levied; source of income is about grouping the income under different heads and taxing them separately; and an assessee as defined in S.2 (7) of the Income Tax Act, 1961 means a person by whom any tax or any other sum of money is payable under the said Act. In Pradeep Jain V. Union of India14 it was held that in view of Art 5 of the constitution of India every person who is domicile in the union territory of India is a citizen of India and a citizen of India could be a domicile of any state forming part of India. When Company is a Resident in India According to Sec 2(30) under the Income Tax Act15 a person is a non-resident only if he is not a resident. For a company the residential status depends upon location of the control and management of its affairs and for individuals, it depends on their physical presence in India and. Under Section 6(3) of the said Act a company is said to be resident in India in any previous years if:i. ii. It is an Indian company; or During that year, the control and management of its affairs is situated wholly in India.

The doctrine of the control and management was laid down in De Beers Consolidated Mines Ltd. v Howe (Surveyor of Taxes16. In this case it was held that generally the control and management of a business remains in the hands of a person or group of persons and the question
13 14 15 16

Universal Radiators V. C.I.T (1993) 201 ITR 800,805 (SC) (1984) 3 SCC 654 1961 [1960] AC 455 (HL)

to be asked is wherefrom the person or group of persons controls or directs the business. The real business is carried on where the central management and control resides and not from where the business operations are carried on. Establishing Business Connection A business connection usually means an existence of business relationship between the business entities. The Act has not provided any exacting definition to the expression business connection. Nevertheless, the said expression has often been used to denote business relationship between a resident and a non-resident and hence the tax is payable on any such business income, accruing or arising, whether directly or indirectly, through or from any business connection in India.17 Also even as an agent any person in India may have any business connection with the nonresident.18 It was held by the Supreme Court in CIT v R.D. Aggarwal & Co.19 that a business connection involves a relation between a business carried on by a non-resident which yields profits or gains and some activity in the taxable territories which contributes directly or indirectly to the earning of those profits or gains. It predicates an element of continuity between the business of the nonresident and the activity in the taxable territories: a stray or isolated transaction is normally not to be regarded as a business connection. Business Connection and the Finance Act, 2003 The Finance Act, 2003 has inserted the following Explanations 2 & 3 in sub-section (1), in clause (i) of section 9 of the Income Tax Act, to be effective from April 1, 2004, to identify what constitutes a business connection. It highlights the establishment of business connection when a business activity is carried out through a person who is acting on behalf of the non-resident. The emphasis is on business activity rather than physical permanent location of business. That is, one can even extend the concept of business connection to an electronic medium as well. Establishing Permanent Establishment In order to tax e-commerce, it was felt that the expression business connection might not be enough. It led to the constitution of a high-powered committee on Electronic Commerce and taxation by the Central Board of Direct Taxation (CBDT)20 on December 16, 1999. The objective of the Committee was to examine the projected growth of E-Commerce business and whether it should be subjected to the taxation.
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Sec 9(1)(i) Of the Income Tax Act 1961 Sec 163(1)(b) of the Income Tax Act 1961 [1965] 56 ITR 20 (SC) Kanwaljit Singh committee.

Establishing Permanent Establishment and the Finance Act, 200321 The Finance Act, 2003 has inserted the section 44-DA in the Income Tax Act, to be effective from April 1, 2004, where such non-resident (not being a company) or a foreign company carries on business in India through a permanent establishment situated therein, or performs professional services from a fixed place of profession situated therein, and the right, property or contract in respect of which the royalties or fees for technical services are paid is effectively connected with such permanent establishment or fixed place of profession, as the case may be, shall be computed under the head "Profits and gains of business or profession" in accordance with the provisions of this Act. Thus, it is important to note that the legislatures have started giving due recognition to both PE and business connection for the purpose of taxing the non-residents. Also, no attempt has been made to extend either the concept of business connection or the PE to a website, server hosting a website or ISP hosting a website. It seems that the aforesaid concepts are extendable to include taxing of e-commerce. As the Finance Act of 2002 and 2003 has already adopted the concept of permanent establishment, it would be only logical if it were further extended on a case-by-case basis to cover e-commerce operations as well. BPOs as PE22 The Government of India has recently notified (September 2004) that the income tax department will apply the arms length price principle to determine the profits of a foreign company, earned out of its PE in India providing BPO services. That is, if a foreign company carries on business in India through a PE, its profits will be attributable to the business activities carried out in India and hence will become taxable in India. Further, a foreign company will be treated as having a PE in India if that company carries on business in India through a branch, sales office or through an agent who habitually exercises an authority to conclude contracts or regularly delivers goods or habitually secures orders on behalf of the principal.

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Taxing Digital Goods23 Digital goods refers to information-based products that can be digitized and delivered via electronic networks in the form of software, shareware, MP3 music, e-books, photographs, stream video, data, database etc. Uniqueness of digital goods is in terms of :(a) low cost of production, i.e. duplication or batch production; (b) online delivery of the goods; and (c) faster transaction time. Digital Downloads & Applicability of Bit Tax The concept of subjecting the digital downloads to bit tax has its own limitations as it treats all information downloads equally, whether downloading music or any database. The focus is on how many bits of content has been downloaded. A customer is required to buy from the bit-credits from the ISP to be used in downloading the digital contents. Every download is metered by the ISP and accordingly bit tax is charged and deposited with the revenue authorities. The problem with bit tax is that it is measured quantitatively rather than qualitatively. Difficulties in Assigning Tax Value to a Digital Download Value of the download Accounting transparency at the sellers end Monitoring or auditing of such electronic activity Verification of customer location Responsible for verification

Tax on the Sale or Purchase of Goods According to the Art - 286(2) Parliament may by law formulate principles for determining when a sale or purchase of goods takes place in any of the ways mentioned in clause (1) and according to Art - 269(3) Parliament may by law formulate principles for determining when a sale or purchase of goods takes place in the course of inter-State trade or commerce of the Constitution, Parliament enacted the Central Sales Tax Act, 1956.
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Situs of the Sale or Purchase It is to be noted that Section 3 of the Central Sales Tax Act, 1956 contains the principles to determine when a sale or purchase of goods takes place in the course of inter-State trade or commerce. Section 4 embodies the principles to determine when a sale or purchase of goods is said to take place outside the State and Section 5 contains the principles when a sale or purchase of goods is said to take place in the course of import or export.24 Taxing Digital (intangible) Goods in India In India, under Article 366 (13) of the Constitution the expression goods includes all materials, commodities and articles. For intangible goods, in India there is no Constitutional provision central or state tax legislation, which specifically defines it. In the absence of any statutory definition of intangible goods it would be difficult to extend the expression sale or purchase of goods to cover the intangible goods as well. In Tata Consultancy Services v State of Andhra Pradesh 25, the two member bench of S. Rajendra Babu and R.C. Lahoti, JJ. has referred the question whether the branded software which is an intangible intellectual property being product of thought, creativity and intellect be classified as goods for the purpose of the Andhra Pradesh General Sales Tax Act, to a Larger Bench. On 5.11.2004, a Constitutional Bench headed by Justice Santosh N Hedge, held that when a person goes to buy a CD containing the software, he does not pay mere for the CD but for the software contained in the CD. The contention that software is merely knowledge or intelligence, and such is not corporeal and thus not taxable is erroneous. Once the information or knowledge is transformed into physical existence and recorded in physical form, it is no longer in intangible form but a corporeal property and hence taxable.26 Earlier in CCE v Acer India Ltd27 it was held that no Central excise duty was payable on a software loaded in a hardware, i.e. computer. Although a computer may not be capable of effective functioning unless loaded with softwaresno Central excise duty would be leviable upon determination of the value thereof by taking the total value of the computer and software.

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Supra 2 2001 (129) ELT 3 (SC) AIR 2005 SC 371 (2004) 8 SCC 173

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It would be a fallacy to think that the national domestic laws and the double taxation avoidance agreements in the present form are sufficient in themselves to tackle the problem of online taxation. For example, in the absence of any statutory definition of intangible goods it would be difficult to extend the expression sale or purchase of goods to cover the intangible goods as well. Conclusion The emerging model which would allow countries to eliminate source based taxation in favour of residence based taxation for international e-commerce transactions would prevent poor countries with international e-commerce consumers to tax income made on those international ecommerce transactions. It is argued that less confusion would exist if only the business organizations country of residence had the jurisdiction to impose taxes. Regardless of whether this is true a residence based tax model would have many unfortunate consequences. The emerging model poses problems because it favors developed countries at the expense of developing countries. The non static status of the entire area of electronic commerce makes the prediction of future developments with any acceptable degree of certainty or probability impossible. Tax policy therefore must continue to develop in a manner which facilities the growth of electronic commerce and adapts to administrative issues as they arise or at least before electronic commerce creates a threat to the collective revenue base.

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BIBLIOGRAPHY BOOKS 1. Sharma Vakul, Information Technology Law and Practice, Universal Law Publishing Co. 2. Singh Yatindra, Justice Cyber Laws Fourth Edition, Universal Law Publishing Co. 3. Filzgerald Brain, cyber Law, Vol. 1 Second Series Ashgate Draft Mouth 2006 4. J. Craig William, Taxation of e-commerce, Second edition, Tolley Lexis Nexis Publishing Co.

Websites http://www.inter-lawyer.com/lex-e-scripta/articles/e-commerce-pe.htm http://www.legalservicesindia.com/articles/tax_ec.htm

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