For business today, online advertising on websites and search engines has become an integral marketing tool yet, the debate on the ability to tax these transactions are underway. A decision hasn’t been made yet as ads are taxable under ‘Royalty’ or from a ‘Permanent Establishment’ perspective (PE).

Taxability of payment done for Online Marketing & Advertising Services availed in the US

For business today, online advertising on websites and search engines has become an integral marketing tool yet, the debate on the ability to tax these transactions are underway. A decision hasn’t been made yet as ads are taxable under ‘Royalty’ or from a ‘Permanent Establishment’ perspective (PE).

Concepts like – ‘Equalisation Levy’ (EL) and ‘Significant Economic Presence’ (SEP), were discussed in 2015’s action plan 1 report of The Organisation for Economic Co-operation and Development (OECD) in the Base Erosion and Profit Shifting (BEPS).

India used this as a basis to introduce provisions under the Income-tax Act, 1961 and EL provisions under the Finance Act of 2016 followed by another one in 2020. The Indian Central Board of Direct Taxes (CBDT) has recently highlighted the scope for SEP provisions to take off.

The revenue limit for a transaction is marked as INR 2 crore and the user, with whom business activities are being carried out have been flagged at INR 3 lakhs. As a result of physical absence in India, SEP provisions are introduced among others, to tax digital transactions which were otherwise not taxable.

Despite SEP’s broad definition, being part of India’s domestic law, these provisions will not overrule relevant tax treaties wherever applicable. Non-residents can claim benefits within relevant tax treaties as, Indian tax treaties follow the conventional concepts of PE taxing of business profits of non-residents. The SEP’s inclusion in the act will not be applied unless amendments are made to the treaties. In cases where non-residents from a non-tax treaty country/jurisdiction, the business income earned from India will be taxable in India.

EL was introduced at 6% from 1st June 2016 on specific services received or receivable by an individual not having a PE in India and is a non-resident. Specified services mean – any provision for digital ad space, online advertisements or a facility/service offered for online ads – including other notified services. This has led to online advertisement services being covered under the provisions of EL.

Eventually, 2020’s Finance Act expanded the horizon of EL, introducing a levy of 2% on rumination received or is receivable by e-commerce operators from other e-commerce suppliers or services. E-com supply/services are defined as the sale of goods online by an e-commerce operator or an online listing of services rendered by them or the sale of goods or listing of services online or both, managed by the e-com operator. Even a combination of the mentioned activities falls under this bracket. The new El provisions have a wider scope hence, advertising and marketing services come under the umbrella of these new provisions. This is challenged if an EL transaction is subjected to 6%, then it won’t be qualified to be taxed at 2% as per the new EL. Further, if the transaction qualifies to be taxed under the provisions of EL, then it will not be taxable under the provisions of the Act.

Income-Tax Appellate Tribunal’s Bangalore branch recently dealt with- taxability of payments made for online advertising to Facebook, for bulk email marketing services to Rocket Science Group, and  information technology (IT) facilities to Amazon Web Services (AWS) [foreign entities] under India-Ireland and India-US tax treaties. In Urban Ladder Home Decor Solutions Pvt Ltd.’s case, with respect to advertising and marketing services, the tribunal stated that non-resident entities allow the taxpayer only to use their facilities for the purpose of advertisement content creation. Further, with respect to IT facilities, the tribunal agreed that the payment was made only for using the IT facilities provided by to the non-resident entity. There was no specific license provided by these non-resident entities for use of, or right to use, any of the facilities (including software). Therefore, there was no question of transferring of copyrights to those facilities.

This meant that payments made to such non-resident entities do not come under the meaning of ‘royalty’ as defined by the relevant tax treaties. As a result, there was no need to deduct tax at source from such payments under Section 195 of the Act.

There is a fine line distinction on the debate of whether the payment for advertisement/marketing services should be taxable as royalties or not. Generally, the advertisement /marketing fee paid to foreign web-based search companies (Google, Yahoo, etc.) won’t be taxable as ‘royalty’ when the uploading and display of advertisements on the portal is the responsibility of the foreign company. Although, in some cases, agreements can be made to facilitate publishing and display of an advertisement to the targeted customer using various available patented tools and software.

In these cases, the taxpayer can access various data and use this information while selecting ad campaigns to maximise the impression and conversion of the customers. This requires the taxpayer to have a licence to use the confidential information, technical know-how, trademark, brand features, etc.

Taxability on income from online has generated challenges worldwide. The French court has issued a ruling on Google’s advertisement income transaction that, google has no PE in France and will hence not be taxed. In addition, France introduced Digital Service Tax (DST). French DST is applicable to two types of digital services i.e., the making available of a digital interface and the provision of online advertisement services. Further, various countries like the UK, Austria, Greece, Hungary, Indonesia, Italy, etc have also created provisions to tax digitalised transactions like online advertisement.

The Inclusive Framework of the OECD/G20 released a statement regarding a Two-Pillar solution to combat the tax challenges arising from ‘Digitalisation of the Economy’ on 1 July 2021. The statement provides important terms for an agreement of a two-pillar approach as reforms and calls for a comprehensive agreement by  October 2021. Pillar 1 predicts updated taxing rights to market jurisdictions, allocating a portion of residual profit based on a formulary approach. Pillar 2 reflects an agreement on a global minimum level of taxation which has the effect of stipulating a floor for tax competition amongst jurisdictions. There has been no clear picture on the issues of taxability of online marketing and advertising activities namely digital transactions in India as well on a global level. OECD is trying to settle these issues through Pillar 1 and 2 approaches. Further OECD is planning to finalise the mechanism to tax the digital economy in the next 2 years and after such a mechanism, it is suggested that unilateral measures such as EL should be removed by respective countries.

4i Advisory has years of experience of expertise in delivering Direct Tax, Private Equity, Accounting, Assurance, US-India Tax and Payroll services. Reach to our expert today – Urvesh Patel (urvesh.patel@4iadvisory.com).

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