Rahul Mitra is a Partner, Aditya Hans is a Partner, Ranjeet Mathani is a Partner, Ashish Jain is a Senior Associate, and Nischal Agarwal is a Senior Associate at Dhruva Advisors LLP.
The final global approach on the taxation of the digital economy may be expected by 2020; however, in the interim, the OECD has given substantial guidance on its thought process and the application of the arm’s length principle with regard to complex digital business models. The OECD Interim Report, 2018, highlights how value creation analysis could be undertaken by applying different concepts; (1) value chains, (2) value networks, and (3) value shops, depending on the level of digitalization in the business model. As far as Indian outbound companies are concerned, they are taking due care to undertake robust value creation analysis for their business and to determine key value-driving activities in the overall business chain.
This will help to establish how to segregate routine and non-routine activities. After remunerating for the routine activities by applying one-sided TP methodologies like CPM, RPM or TNMM, the non-routine profits are split between the value-driving activities identified by way of the value creation analysis.
Substantial guidance has been issued by various international forums22 on considering profit splitting factors when applying PSM for determining the returns of non-routine activities. Indian headquartered companies operating in the digital space are learning from the discussions taking place in the international forum23 and leading economies like the UK24 and New Zealand25 with respect to the taxation of the digital economy, the existence of a virtual PE, and attributing profits to such a PE.
However, in the absence of any guidance on attributing profits to data and user participation, the taxpayers’ allocation of non-routine profits is limited to trade and marketing intangibles.
With amendments made to business connection provisions (with regard to significant economic presence) for establishing a digital nexus for non-resident digital corporations in India, the Indian Government has made its stance clear on these issues in line with the BEPS project. Most non-resident companies still operate within the shield of existing tax treaties, however, that seems to be short lived, as it is only until the Indian Government re-negotiates tax treaties with their counterparts.
However, as of now, non-routine profits are being attributed only for trade and marketing intangibles developed or created by inbound companies in India until a consensus is reached regarding the allocation of taxing rights with respect to value creation by data and users in India.
With regard to the isolation of digital activities in order to prepare segmental financial information, we have observed that it would be quite challenging as digitalization becomes a very integral part of many businesses and therefore, segregating digital activities from non-digital activities to determine separate profitability seems unfeasible. On the contrary, undertaking a detailed value creation analysis to understand the value contributed by digitalization would be a more apt measure to determine profits attributable to digital contributions.
The possible measures of undertaking value creation analysis and, in turn, determining the fair share of profits by applying economic models have been deliberated above.