Taxation of Online Marketplaces

In a situation where the world is suffering from the COVID-19 pandemic and many people are losing jobs due to downsizing by companies facing severe cash-flow issues, some opportunities have risen as well, such as the effective usage of information technology (IT).

The eyes of the people around the world are looking towards E-commerce and online marketplaces which have been making the most out of the current scenario through increased sales. Even prior to COVID-19, businesses around the world had been taking major shifts towards E-commerce and online marketplaces. One can now expect that once this becomes the norm, it will be difficult to go back to old ways of conducting business.

Businesses in Pakistan are also going through a phase of digitalization in order to reach out to more customers. As mentioned above, this digitalization includes E-commerce and online marketplaces.

An E-commerce website is a website developed by a supplier for the purpose of supplying goods, which means that there is a transaction between two parties, a supplier and a buyer. Any risk regarding the inventory is borne by the supplier as he or she owns the goods.

On the other hand, an online marketplace is a platform provided by a third party where suppliers can sell their products to a vast range of customers using that online space. Inventory risk is borne by the suppliers themselves and not by the intermediary offering the platform. An online marketplace is just like a departmental store where products from different suppliers are stocked.

An online marketplace in Pakistan can simply be started by obtaining legal registration through incorporation as a company under the Companies Act 2017. Not incorporating a business does not mean that such business cannot be conducted by an individual or association of persons, however, registration and incorporation is always preferred in order for a company to be regulated by the Securities and Exchange Commission of Pakistan (SECP). The discussion in remaining part of the article will focus on online marketplaces and companies.

The Income Tax Ordinance 2001 vide the Finance Act 2017 introduced, for the first time, taxation of online marketplaces. A definition was inserted in subsection 38B of section 2 of the Ordinance, defining it in the following words:

“…online marketplace means an information technology platform run by e-commerce entity over an electronic network that acts as a facilitator in transactions that occur between a buyer and a seller.”

Business through an online marketplace is carried out using a commission-based model. However, it has generally been seen that a person who offers an online marketplace, uses the same platform as a supplier to market his or her own products as well, thereby giving rise to a trading-based model. Let us examine taxation for each model separately, because if a person is conducting both businesses simultaneously then the profit and loss account shall be prepared separately for each case.

Under the commission-based model, a third party, providing a platform to both buyers and sellers of a product, charges commission from the supplier for using its platform. It is possible that the receipts are received directly by that third party from which the amount of commission is retained while the remaining amount is transferred to the respective supplier. On the other hand, it is also possible that receipts are received directly by the supplier and the commission is then transferred to the third party providing the platform. However, the former arrangement is more common.

The current rate of tax on commissioned income under section 233 of the Ordinance is 12%. However, to encourage online marketplaces, the tax imposed on them is only 5% of their commissioned income. This being a minimum tax means that if a person receiving the amount of commission is from a category of prescribed persons mentioned under section 233 of the Ordinance, then the rate of tax required to be collected shall be 5% in cases where the recipient appears in the Active Taxpayers List (ATL). Otherwise, as per the Tenth Schedule of the Ordinance, the rate of tax shall be 10% of the commissioned income. If commission is being received from a person other than a prescribed person, then tax shall be charged at the rate of 0.75% of the turnover, according to section 113 of the Ordinance. These taxes shall then be compared with the corporate tax liability of 29% of taxable income, and the higher amount among all shall be chosen to be compared with the alternative corporate tax (ACT), according to section 113C of the Ordinance. The higher amount, as mentioned, shall be compared with the alternative corporate tax of 17% of the accounting income, and the higher amount rule shall be applied once again, after which we can arrive at the tax liability of the company carrying out the business of an online marketplace for a tax-year.

Under the trading-based model, a person offering an online marketplace is also the supplier of his or her own goods, which means that he or she will record the sale of goods transactions in the books of the business as well as carry the inventory risk for goods owned, contrary to the provider of an online marketplace in a commission-based model. This will involve considering two further situations:

  • whether the goods supplied are also locally manufactured, or
  • whether the goods supplied are those which are commercially imported.

In the first scenario, where goods have been manufactured by the person supplying them as well, if supplies are made to prescribed persons mentioned under section 153 of the Ordinance, 4% of the gross amount of supplies is to be deductible as tax and becomes tax liability if the person is in the Active Taxpayers List. If the person is not in the Active Taxpayers List, then as per the Tenth Schedule of the Ordinance, the rate of tax shall be twice the usual rate i.e. 8% of the gross amount.

If goods are not supplied to prescribed persons, then 0.75% of the gross amount shall be charged as minimum tax under section 113 of the Ordinance, according to which a person running an online marketplace shall be subject to 0.75% of the turnover, regardless of whether he or she is also conducting an E-commerce business along with the business of an online marketplace. These taxes shall then be compared further with corporate tax liability and alternative corporate tax (ACT) as mentioned in the preceding paragraphs, in order to determine the actual tax liability for a tax-year of the company carrying out the business of trading along with the online marketplace.

In the second scenario, where goods supplied have been commercially imported, the only difference from the previous scenario is that instead of the 4% tax charged under section 153 of the Ordinance (which is not charged if goods supplied have the same conditions as those for commercial imports), the tax charged at the import stage would be 5.5% of the import value and would be the minimum tax. The rest of the rules shall be squarely applied.

It has also been witnessed that many people involved in these businesses are either not in compliance with the tax rules or are complying incorrectly or only partially. This can result in the imposition of severe penalties and other adverse repercussions at a later stage. Therefore, it is always advisable to ensure proper compliance with the law. The Federal Board of Revenue should also take measures to bring all online marketplaces into the tax net and closely monitor their compliance in order to ensure that any potential tax revenue from this area is appropriately collected and no losses from this growing sector are incurred by the national exchequer.

The views expressed in this article are those of the author and do not necessarily represent the views of or any organization with which he might be associated.

Mohammed Muzammil Hemani

Author: Mohammed Muzammil Hemani

The writer is currently pursuing LLB and is a researcher, practitioner and corporate trainer for matters relating to taxation. He has obtained an Advanced Diploma in International Taxation from the Chartered Institute of Taxation in the UK and is also a member of the Institute of Chartered Accountant of Pakistan (ICAP). He can be reached at [email protected]