The digital economy is seeing an unprecedented growth across the globe and changing and disrupting traditional business models into new ones. Online transactions, E-commerce, online advertisements and online services are increasing rapidly as more users are preferring the use of online systems for business transactions. Many traditional businesses are also transforming themselves to avail the opportunity of expanding locally and internationally.
Having said that, online business models can also create challenges for regulatory authorities trying to ensure that online businesses pay their fair share of tax. The taxing of digital goods and services is an urgent concern on the global international tax policy making agenda. Digital tax or digital service tax (DST) is imposed on digital goods and services including E-books, software, web-hosting services, online information services, etc.
Many countries are currently looking for ways to collect revenue from electronic commerce. France has started to levy digital service tax which is also being adopted by other European countries and which would hit US based giants like Amazon, Google and Facebook with activities in other countries. France imposes 3% tax on the gross revenue of companies which they earn from providing digital goods/services to French users regardless of whether these companies have a physical presence within France. In principle, profit should be taxed where value is created and for this purpose, a user’s IP address can be used to determine whether or not the user is located in France. France has also set a threshold on taxing digital businesses based on their turnover (which is €750 million worldwide and €25 million in France).
The US has also imposed DST but the concept varies from state to state: some states use their existing laws to implement DST; some states have enacted new laws specifically to tax digital goods/services; and some states impose no sales tax on these goods/services. Countries including Australia, Norway and Russia have also set new digital tax laws and others including Canada, China and the Gulf Cooperation Council (GCC) are planning to implement similar tax laws.
Companies that operate across borders usually find ways to shift their profits to low-tax countries like Bermuda and Ireland in order to reduce their tax bill globally. Giant technology companies have been making huge profits all over the world without paying their fair share of tax because they do not have any physical presence in most of the countries. The Organisation for Economic Co-operation and Development (OECD) issued a policy note titled Addressing the Tax Challenges Arising from Digitalisation in January 2019 focusing on dividing up the right to tax the income of digital companies in different jurisdictions. OECD also focused on whether transfer pricing rules and the “arm’s length” principle could be modified to take into account the changes that digitalisation had brought to the world economy. OECD is trying to reduce the disparate tax regimes around the world and negotiate for an international standard by the end of 2020 which would allow authorities to impose tax on digital service providers regardless of whether they physically exist within a territory.
OECD has also proposed to set minimum taxes for digital companies around the world in a meeting held at the World Economic Forum, in order to prevent these companies from hiding their profits in tax havens. However, efforts to set digital tax can strain political and economic relations with wealthy nations. A recent analysis by the OECD found that international tax changes under consideration would increase global taxes by approximately USD 100 billion. Most digital companies benefit from the current global tax regime which focuses on collecting tax from traditional companies (with brick and mortar operations) and does not take into account the manner in which digital companies create value. Since most giant companies are based in the US, the US has threatened to retaliate against France and other countries by increasing tariff up to 100 percent on the import of various products from these countries. However, France agreed to suspend the collection of its new digital tax and the US has agreed to hold off on its tariff while the OECD tries to negotiate these taxes.
Countries like Singapore and Malaysia became the first nations to introduce rules on cross-border supply of digital services. Singapore implemented GST (goods and services tax) at 7% on cross-border B2C and B2B digital services/supplies from January 2020, which is expected to increase the country’s tax revenue to almost USD 65.5 million per year. Malaysia introduced 6% digital tax, which is one of the lowest digital tax rates in the world. Thailand is the third Southeast Asian country to introduce tax on digital products in 2020. Other countries like Japan, South Korea and India are also exploring the possibility of extending their consumption tax rules to include supplies/services from foreign digital suppliers.
The volume of E-commerce in Pakistan in proportion to retail trade continues to increase day by day. However, no framework has been designed yet to cater to the taxation of such transactions and businesses in Pakistan. Pakistan’s double tax treaties (DTT) with other countries require foreign enterprises to not be subject to income tax unless such enterprises have a ‘permanent establishment’ (PE) in Pakistan or if payments have been defined in DDT for tax. Through Finance Act 2018, the Federal Board of Revenue introduced the concept of payment to non-residents on account of ‘fee for offshore digital services’.
The Income Tax Ordinance (ITO) 2001, section 2 (22B) defines ‘fee for offshore digital services’ in the following words:
“Means any consideration for providing or rendering services by a nonresident person for online advertising including digital advertising space, designing, creating, hosting or maintenance of websites, digital or cyber space for websites, advertising, e-mails, online computing, blogs, online content and online data, providing any facility or service for uploading, storing or distribution of digital content including digital text, digital audio or digital video, online collection or processing of data related to users in Pakistan, any facility for online sale of goods or services or any other online facility.”
This fee is also taxable under section 152 of ITO 2001 which allows the withholding agent to withhold 5% of the gross amount of fee for offshore digital services. The major difference between the tax introduced by Pakistan and the digital tax imposed by other countries is that these countries take into account the global turnover and domestic turnover of digital giants.
If we consider the taxability of indirect taxes on digital goods/services in the context of Pakistan, following the Eighteenth Amendment to the Constitution of Pakistan 1973 provincial authorities have become responsible to collect taxes on services within their jurisdiction, while income tax and sales tax on goods fall under the ambit of the federal government. The nature of services offered through a digital medium often makes it difficult to draw territorial boundaries on the provision of such services. There are no adequate safeguards in Pakistan’s tax laws to prevent the imposition of sales tax by multiple provinces or territories in the context of a single transaction and the imposition of multiple taxes on a single digital service transaction can increase the cost of digital services available locally.
Tax policymakers (such as the OECD) are working to establish rules which can offer certainty for businesses in order to promote investment and growth, while acknowledging at the same time that the world around us continues to change rapidly. Adjusting (or even restructuring) tax systems to address new challenges of the digital economy is a complex area and requires a lot of concepts to be redefined. It should involve all stakeholders to come to an agreement over a final, long-term solution and there should be international consensus over a ‘fair’ proportion of profits within different territories. One strategy that could be agreed upon would be to establish a global minimum tax that all multinational companies should pay on their profits, regardless of where the profits are booked.
In accordance with the current steps that Pakistan has taken towards digital tax, only the withholding agent as defined in ITO 2001 can withhold tax on account of ‘fee for offshore digital services’ and not for the whole revenue which companies earn from Pakistan. Moreover, a non-resident is apparently getting payments from digital companies on a net-basis while tax is being charged with a reverse-charge mechanism and borne by a local buyer obtaining digital services thereby increasing the overall cost of doing business. Pakistan’s provincial and federal tax laws should be rationalized to prevent the imposition of multiple taxes of the same nature on a single transaction, collect tax on an equal rate from transactions all over Pakistan, and then distribute tax revenues based on the fair share of each jurisdiction. Pakistan may follow the guidance of OECD and the policies of other countries to impose digital tax and address the leakage of national revenue from this economic activity. Reforms should also be introduced within our tax treaties, especially with regards to the concept of imposing tax on non-residents. Digital companies should be required to file income tax returns in accordance with ITO 2001 which may help assess their income within the jurisdiction and compute tax liability accordingly. Such policies can help boost tax collection and meet our tax targets.
Digital Taxation Framework in Pakistan – Issues and Recommendations Paper (Asia Internet Coalition – December 2019)
International Taxation in an Era of Digital Disruption: Analyzing the Current Debate (Itai Grinberg Georgetown University Law Center, 2019)
Tax challenges of the Digital Economy (Monika Šestáková – College of Management/City University Bratislava)
How Tech Taxes Became the Worldʼs Hottest Economic Debate (https://www.nytimes.com/2020/01/23/business/tech-taxes-debate)
Pakistan Income Tax Ordinance 2001
Taxation of digital goods – Wikipedia (https://en.wikipedia.org/wiki/Taxation_of_digital_goods)
Sales tax and digital goods – BDO (https://www.bdo.global/en-gb/microsites/tax-newsletters/indirect-tax-news/issue-4-2019/united-states-%C2%A0sales-tax-and-digital-goods)
Digital Tax Fight Emerges as Global Economic Threat (https://www.nytimes.com/2020/02/22/us/politics/digital-tax-economy-europe-united-states)
Statement by the OECD/G20 Inclusive Framework on BEPS on the Two-Pillar Approach to Address the Tax Challenges Arising from the Digitalisation of the Economy (January 2020)
In the digital era, tax, trade and competition rules need an Upgrade – World Economic Forum (https://www.weforum.org/agenda/2019/10/digital-tax-trade-business-consumption-e-commerce)
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