International Communications Income: A Vexed Tax Issue
The term communications is of wide import and encompasses a range of telecommunication including voice & data, entertainment & e-commerce services, besides a host of enablers who make it happen such as satellite transponder service providers, undersea & surface optic-fiber pipeline cables & servers.
With the surge in technological advancement maturing at even faster speed, governments across the world are constantly looking at aligning its tax policies, particularly the ones that deal with cross-border aspects. Bilateral agencies such as OECD & UN are expected to play a pivotal role in shaping treaty policies and tax treaties between countries will have to provide for suitable mechanism to deal with the resolution of disputes arising out of cross-border income where source and resident nations assert their right to tax the same income.
The challenges seem bigger considering the growth of telecommunications income in emerging economies and what the world will witness in growth markets in the next decade.
Global network linked to domestic
Before we dwell into key areas of controversy, it's important to understand the basics of communications business, which by its very nature is spread across national boundaries and in instances of satellite communications, located in earth's orbit or in international waters for undersea cables. Take for instance, mobile telephone network - international roaming becomes a reality as the local subscribers service provider has to enter into an international roaming agreement with multiple players - this results in a web of agreements between GSM players based on standard model between the operators. Moving to a lesser regulated business of entertainment, television viewers receive digitized content due to up linking with aid of a satellite transponder. Similarly, an alternative mode for carrying voice and data is underwater sea cables. The issues can be multifarious given the very nature of business and lead to chaotic tax situations.
Source versus resident tax system
Besides most advanced nations flexing muscle to recover their fair of taxes, the debate is more pronounced in emerging markets who believe in strict source-based rules and India ensures that it is not left behind. Take for instance, whether an international satellite service provider whose footprint is spread across India, will establish an economic nexus (and hence constitute a permanent establishment - a taxable unit) due to commercial exploitation of a large customer base being based in source country is a debatable issue. Similarly, would payments made by Indian communications companies for leasing capacity for carrying voice and data via underwater sea cables and pipelines result in income to the service provider? These vexed issues are currently subject to tax differently depending on source country and resident country rules. The OECD nations are more prone to taxing such income in the resident countries, whereas, non-OECD countries including India veer on the side of source taxation rules - as the economic nexus theory partly supports such views. If that be the case, what assumes significance is a set of principles that would guide such source based taxation and in the event, the communications service provider is taxed in the source and resident nations, what mechanisms are in place by way of bilateral treaties to alleviate pain of double taxation. Unless treaty and non-treaty partners evolve a set of rules, resolution of economic double taxation would be an impairment for free trade and investment.
Where does India stand?
IFA Boston participants were least surprised with the advancement and contribution Indian policy makers and the judiciary have made towards the subject. India has maximum tax judgments and most views and reservations on OECD 2010 model convention on the subject. Not surprising, Chinese SAT (tax administration) seemed more inclined to follow Indian sourced based principle, given an isolated administrative circular and one Court case of Pan-am Satellite. China and India have a common problem to defend its tax base.
Having said that, China certainly imparts certainty on key principles. All forms of rentals for satellite, fiber optic are classified as Royalties and taxed in the source country i.e. China. If income is not classified as royalty, it would be viewed as service income and taxed in the resident country as business income (and not China for non-residents) unless it is attributable to a Permanent Establishment (PE). Similarly, Chinese source rules for taxing royalty income is relatively lenient compared to India, particularly given the broad definition India has given as a result of retrospective amendments in the 2012 budget. Whereas, each nation is bound by its territorial jurisdiction and nothing precludes India from legislating tax laws that have extra territorial application,the very nature of communications income at times is boundary less and could result in retaliation by nations whose residents are treated with strict source rules in India.
Will courts have the last say or will policy makers take the lead?
Views of Indian policy makers are well known and enough noise has been made by the tax fraternity and foreign investors anyways. Early this year, the Delhi High Court delivered a landmark decision in the case of the Asia Satellite, which held that leasing of satellite transponder capacity was a mere service and couldn't be taxed as Royalty. An immediate reaction was amendment to domestic law provision in the 2012 budget. In another landmark case pursuant to the passage of the budget, the same high court held that the definition of the term 'royalty' has to be viewed in the context of tax treaty provisions and not domestic law.
Whereas all of this is fun for tax professionals, it's least amusing for investors. Indian policy makers will have to take a firm position keeping in mind competing objectives of tax base erosion, address enigma of source and resident taxation and lastly, aligning itself with principles promulgated by bilateral agencies.
The author is part of Taxand India and was a panel member at the IFA Boston congress. Views are entirely personal.
First published in the Business Standard, 29 October 2012