Taxation with digitization

Abstract

As Kautilya points in Arthashastra that revenue is the core important component in the running of any administrative system. Even before the coming of the Westphalian system, the kingdoms and feudal societies used to raise funds for administration through taxation. Taxation primarily has been the sovereign right of the state on its subjects. With the limited advent of communication systems, the system of taxation was confined to the persons and entities residing within the borders of a kingdom or an estate. Slowly, with the advent of nation-states, each nation-state developed its system of laws and regulations to tax persons and entities. The system of taxation in most countries is based on the concept of residence. For instance, the Indian taxation system relies on the concept of residence of a person (i.e.) a person residing in the country for more than 180 days is subjected to the Indian Direct tax laws. Therefore any person/entity operating from the country for more than 180 days is subjected to Indian Income-tax laws. As economies interacted more, more and more entities operated across borders. This brought challenges to the taxation of such entities who are operating across several borders at different points in time. Carrying out different parts of their operations based on productivity and efficiency across several borders. This led to the challenge of how much is to be taxed where and also on the other hand protect the entity from paying taxes multiple times for the same activities. The concept of permanent residence and effective management of businesses were thereafter incorporated as part of taxation systems to enable entities to pay taxes in such countries and also prevent themselves from multiple taxations on the same income. With the advent of digital technology, the interactions in terms of production and transactions are no longer confined to the physical space. Further, there is no single common business model like the conventional business models where the revenue is generated based on the provision of goods or services. The businesses work in a virtual space thereby creating one of the major challenges in taxation (i.e.) determination of jurisdiction where the income is to be subjected to taxation. This raises several fundamental questions which arise in the domain of taxation, which are as follows: 1. How is the entity/individual operating its business to generate revenues? 2. What is the source of such revenue - who pays for it? 3. How is value created in terms of services provided by the entity? 4. Most importantly where is the value generated, received, and finally paid - to characterize the nature of income and source of taxation for the entity. It is in this backdrop the paper attempts to understand the shifting of conventional businesses into digital space and the challenges it poses for taxation.