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-- E-commerce and Internet
-- Must one Net lead to another?
Must one Net lead to another?
By Nilesh M Kapadia, Chartered Accountant
Recent times have seen the birth of the "new economy". After the agricultural revolution, there was
the industrial revolution. Now there is the knowledge [or information] revolution.
The web is growing at an unimaginable pace, and e-commerce which was only a dream a few years ago, is now staring
at our faces through the net.
India did lag behind the world in the earlier two revolutions, but is at the top of the list in the current revolution.
In fact the trend is perhaps reversing in the new economy, where Indians and Indian companies are sought after
by the West. The examples of hotmail.com and indiaworld.com are not solitary instances, but an indication of things
to come in the near future.
The penetration of Internet and use of computers has increased the business possibilities in this scenario.
Widening Tax net
While the Internet is fast expanding, the netizens should take care of the tax net. The taxman is also getting
smarter, and committees have been set up to study the taxation of e-commerce in the new economy. Many of the taxing
concepts of the brick and mortar economy are no longer relevant in the current times. For example, the concept
of Permanent Establishment is perhaps no more relevant in the net age, as one can do business both with a country,
as well as in a country without being actually present there. The net has made virtual presence possible without
However, till the tax laws are made more stringent, the e-businessman can take advantage of the present laws, and
structure his net deals in the most tax efficient way.
How wide is the tax net
The taxman is now out to widen the tax net. For residents there is the one by six scheme. For e-commerce too,
the tax net as it stands today is wide enough to rope in the dream transactions, with some room for planning.
Sabeer Bhatia would have had to shell out over 1/3rd of his mullah had he been a resident of India. Everybody
is talking about the indiaworld.com deal. The owner is reported to have received Rs. 500 Crores for the portals,
and his cost for developing these were minimal. The transaction can be taxable as business income, or as long
term capital gains. The first situation will attract taxation @ 34.50%, while the latter @ 23%. Hence, we are
talking of a tax liability of Rs. 172.50 Crores !
We are not privy to the structuring of the deal between the parties. However, we are talking of a tax liability
of this magnitude. Obviously, the promoters would like to minimise this tax liability.
Getting portals out of the net
Perhaps one of the ways in which this could be done is to have the portal owned by an entity outside India. If
the asset is owned abroad, and sale consideration received there, there could be no tax liability in India. Besides,
if proper care is exercised in selecting the foreign country, one would not pay any tax there too!
Let us consider a case where a portal like indiaworld.com is owned by an offshore company incorporated in Mauritius
["Mco"]. Mco could upload and update its site from anywhere in the world. One of such places could
be India. If the work of updating the site is not carried out through a Permanent Establishment in India, but in
some other way, e.g. by appointing independent professionals who do the uploading as per pre approved criteria,
or after specific approval from Mco. Even if a PE is established in India, only so much of the income as is attributable
to such PE is taxable in India.
Coming to the commercial aspects, Mco can receive advertisement revenue by way of remittances from India, which
could be made without any withholding of taxes. Even if circular no 742 dated 2nd May, 1996 which applies to advertisements
in foreign satellite televisions, is considered as applicable in such a case, the deemed income would be only
10% of the remittance, and the tax deductible would be only 4.80% of the ad revenue. Besides, in my opinion, relying
on the AAR ruling in the case of TVM Ltd., [237 ITR 230] there is a case to argue that no tax is payable on such
remittances from India.
As regards payments to contributors for content on the net, these could be made by way of inward remittances from
Mco. These would continue to be taxable in India, unless structured as export of software, which is partially
free from tax under section 80HHF.
If such a portal functions as aforesaid, and Mco sells the portal to any entity, the sale proceeds would be received
by Mco. for sale of asset outside India. The sale proceeds would therefore be free from Indian taxes. No doubt,
Mco would be liable to Mauritius income tax thereon, which will be to the tune of 1.50% [net], after deductions
for admissible expenses. The sale of portal if considered as sale of capital asset, would give rise to capital
assets, which are not taxable at Mauritius. Further, If the Mco was set up in some other tax heaven like lsle of
Man, BVI, etc., then even if it is considered as business income, the 1.50% tax would not be payable.
Another area where the net is attracting a lot of business is share broking. If the broker is catering to FIIs/
NRIs/OCBs etc., he may have a sub broker outside India to cater to such clients. The sub brokerage charged to
such clients outside India may not be taxable in India.
Normally a main broker charges a fixed rate of brokerage to his sub broker, who in turn adds on his brokerage while
billing his client. The sub broker can be an Overseas Corporate Body outside India.["SCo"] The sub
brokerage will be earned by SCo outside India in their transactions which have been completed entirely outside
India. The only activity which takes place in India is the buying/selling by the main broker on behalf of SCo.
The main broker is in fact the principal of SCo., and cannot be considered as a dependent [or other] agent of
SCo. As such, in my view, there cannot be any question of there being any Permanent Establishment of SCo. in
This way, the sub brokerage earned by SCo. on transactions with FIIs/NRIs/OCBs will not be taxable in India, as
the same does not accrue or arise in India, nor is the same received in India. Of course, SCo will be liable to
pay tax on its country of residence, which could be as low as 1.50% on net income in Mauritius, or even Nil, if
some other tax heavens.
Ad on the net
Net is both the cause and the effect of globalisation. Multinational Corporates can advertise for their global
brands on the net from a country other than the country at which it is targeted. For example, Coke may want to
advertise on web sites having popularity in India. If these advertisements were released by Coke India, on websites
owned by Indian companies, the revenue generated by the websites would be taxable in India. But if such websites
are owned by companies outside India, the ad revenue received by them would not be taxable in India, as noted earlier.
Further, if the ads are released by Coke Inc, USA instead of Coke India, there would be no remittance from India,
and hence the question of any deduction of tax while making the remittance would not arise.
The net throws up so many possibilities for commerce, and this would involve taxation for each type of transaction,
which would need to be studied in detail. One cannot discuss each type of deal here.
However, the netizens in their gold rush should remember that the taxman will be after him, unless they plan their
affairs properly, well in advance.
It may be emphasised that each structure discussed here is a broad outline, and one would need to have commercial
justification for the location, other than mere tax advantage. In the cases of AIG [224 ITR 473] and DLJMB Mauritius
[228 ITR 268], the AAR has upheld the applicant's claim for being treated as a resident of Mauritius, inspite of
several arguments to the contrary. The main reason for this was: demonstrated commercial justification.
Hence, one needs to demonstrate commercial justification for the location, as tax administrators are getting more
and more wary of treaty shopping. The recent circular no 789 dated 13th April, 2000 issued by the CBDT provides
that the Tax Residence Certificate issued by the Mauritius Tax Authorities shall be treated as conclusive for entitlement
of Indo-Mauritian DTAA application by companies incorporated at Mauritius by the Indian Tax Authorities. However,
by way of abundant caution, commercial justification is still desirable.
About the Author
Nilesh Kapadia is a Chartered Accountant practising in Bombay, India, and am also a director of Intime Consultants
Pvt Ltd. You can get more information at www.intimeconsultants.com.
Tags: E-commerce and Internet