We have seen unprecedented growth in the digital economy over recent years. This shift has played a substantial role in disrupting and changing old business models to suit the needs of a modern era. From online transactions, social media marketing, and e-commerce websites, digital services are increasing and improving rapidly. As a consequence, more and more users are in favor of using online systems to make their business transactions and conduct their innovative ideas. Traditional companies have also noted this change within international markets and are availing of these opportunities for their own profits. Such a rapid transformation across different global sectors has caught the eye of certain policy designs and lawmakers. In such a case, it has become necessary for these services to remain in line with the principles of tax regulations. Policymakers continue to assess the options available for these digital businesses when it comes to their taxation, just so distortive policies can be avoided, often mauled by excessive political agendas.
Digital taxes refer to policies and rules that target businesses that operate through digital means i.e.: online services. These companies often use a special tax, or a tax base, while they conduct their processes. These policies include a neutral tax policy for all businesses from around the world, like when a country extends its VAT to include digital services beforehand. Additionally, this also pertains to special corporate tax regulations which identify when companies become permanent establishments (even with a physical presence). In 2019, the European Commission proposed a digital services tax that would be imposed on revenues stemming from digital activities and their provisions to consumers. This was precluded with the introduction of a regime that would be implemented on corporate taxation of businesses that had a digital presence. The legislative proposals were submitted to the Council and are awaiting implementation.
However, the European Commission found that current tax rules are not appropriately designed for today’s global digital business boom. Hence, we can see an evident disconnect between the value of goods and the taxes paid. Their impact is enormous, according to Jeff Saviano, Americas Tax Innovation Leader, who has said, “We are going through a sea change in how national governments are taxing corporations and the level of transparency that governments — and the citizens they protect — are demanding.”
Due to this evident mismatch in the distribution of internet users and digital production, tax rules need to be changed to reflect the needs of the modern market. Businesses owe and pay taxes in accordance with the market, which continues to highlight the political challenge of changing the rules as we know it. Not only does this threaten to disrupt tried and tested business models, but also impacts which nations receive tax revenues from local digital businesses. Companies that work from across borders often find loopholes to shift their profits to low tax nations, like Ireland and Bermuda, just so their tax bill is reduced. Giant tech companies are making huge profits without paying their share of taxes simply because they have a negligible physical presence in the market. The Organization for Economic Co-operation and Development (OECD) has issued a policy note, ‘Addressing the Tax Challenges Arising from Digitalization’, which focuses on dividing up the right to tax the money made by these companies in their respective jurisdictions. While OECD is attempting to reduce the contrasting tax policies around the world, the conflict is too apparent to ignore. These policies have come about unilaterally but, ironically, require multilateral steps to circumvent a harmful tax and trade war by the end of 2020.
In Pakistan, the volume of e-commerce services is increasing day by day when compared to the retail trade. Despite this, no framework has been created to cater to the taxation of digital transactions and their operations. The country has double tax treaties (DTT) with other countries that claim that foreign enterprises are not to be subjected to income tax unless they have a permanent establishment (PE) within the nation. The Federal Board of Revenue thus introduced the concept of payment to non-residents in the following Ordinance:
The Income Tax Ordinance (ITO) 2001, section 2 (22B):
“Means any consideration for providing or rendering services by a nonresident person for online advertising including digital advertising space, designing, creating, hosting or maintenance of websites, digital or cyber space for websites, advertising, e-mails, online computing, blogs, online content and online data, providing any facility or service for uploading, storing or distribution of digital content including digital text, digital audio or digital video, online collection or processing of data related to users in Pakistan, any facility for online sale of goods or services or any other online facility.”
Of course, there are consequences of non-compliance in each country when it comes to the digital tax. However, there is an unclear penal code set by tax departments. For example, New Zealand consumers are liable to fines up to $25,000 for using VPNs in the effort to hide their true locations. Why do they do this? To avoid GST. Additionally, for businesses that do not file taxes in Pakistan, the provincial and federal tax laws need to be rationalized in order to prevent the imposition of several tariffs of the same nature. This will result in the collection of taxes on an equal amount from national business transactions, which will then be distributed based on the share of each jurisdiction.
Pakistan will do well to follow the rules of the OECD as well as their policies to impose the digital tax. In fact, with the proper assessment of national revenue ‘leaking’ from unreported economic activities, reforms can be introduced within tax treaties. These will help especially when imposing tax on non-residents, and digital companies will hence be required to file tax returns in accordance with the ITO 2001. As a result, this will assist in looking over their income within the pertinent jurisdiction and compute their liabilities as needed. Also, read about remittance importance.
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