Digital economy: direct taxation challenges and policy options

Abstract

The tax jurisdiction of international transactions is presently governed by the principles of residence-based taxation and source-based taxation. It is a prerequisite that, the taxation system should be flexible and dynamic enough to effectively face the challenges posed by developments in the information and communication technologies. Ensuring all taxpayers to pay their due share of taxes is more than ever a priority in many countries due to severe fiscal consolidation and social hardship. Globally, the rapid growth of digital economy has revolutionized the ways of carrying out business transactions without any major limitations of time and territorial limits. The special characters of digital economy such as mobility of users, intangibles and business functions; reliance on big data; use of multi-sided business models; network effects; tendency towards monopoly or oligopoly; and volatility; are posing many challenges for formulating tax policies. The major challenges are with regard to establishing the nexus , attributing value to the data and characterization of income in the e-commerce transactions of digital economy. This has resulted in Multi National Enterprises minimizing the tax incidence in the market country by way of avoiding a taxable presence, shifting gross profits through trading structures, avoiding taxation by way of operating through low-tax jurisdictions, etc. An ideal tax policy should satisfy the principles of Neutrality, Efficiency, Effectiveness and Fairness, Certainty and Simplicity, and Flexibility. This paper analyses the various policy options with regard to their strengths and weaknesses vis. a vis. the existing policy framework. The policy options considered for analysis are Enhanced Residence-Based Taxation, Expansion of Source-Country Tax Base, Formulary Apportionment of Profits and the Global Tax System approach. The enhanced residence based taxation would be simple, efficient and ensures certainty but it lacks neutrality, effectiveness and fairness and flexibility. It is discriminatory against the source countries, as it would result in loss of taxing rights on the transactions of the nonresidents in their jurisdictions. The expansion of source country tax base policy alternative is found to be better alternative among all the options. Even though it requires certain modifications in the existing laws and international cooperation, if properly formulated