Taxability of payment done for Online Marketing & Advertising Services
Online advertising on websites /search engines has become an important advertising and marketing tool for present day businesses. However, the taxability of such transactions has been a matter of debate before the tax authorities and courts as taxability is examined under ‘royalty’ or from ‘Permanent Establishment’ (PE) perspective.
The Organization for Economic Co-operation and Development (OECD) in the Base Erosion and Profit Shifting (BEPS) Action Plan 1 report of 2015 discussed various options, like Equalisation Levy (EL) and the concept of ‘Significant Economic Presence’ (SEP). Based on the same, India introduced the provisions of SEP under the Income-tax Act, 1961 (the Act) and two sets of EL provisions under the Finance Act 2016 and 2020 respectively.
Recently, Indian Central Board of Direct Taxes (CBDT) has notified thresholds for the provisions of SEP. A revenue threshold for the transaction has been notified as INR 2 crore, while user threshold with whom systematic and continuous business activities are done has been notified as INR 3 lakhs. SEP provisions have been introduced to inter alia tax digital transactions which were otherwise not taxable due to absence of physical presence in India.
While SEP is broadly defined, these provisions are part of India’s domestic law and it will not override the relevant tax treaty wherever it is applicable. A non-resident may avail the benefit under the relevant tax treaty since Indian tax treaties contain the conventional concept of PE for taxing business profits of a non-resident and the inclusion of SEP in the Act will not be read into the tax treaties unless they are amended. However, in case of non-residents from a non-tax treaty country / jurisdiction, their business income earned from India may become taxable in India.
The EL was introduced from 1 June 2016 @ 6 per cent on specified services received or receivable by a non-resident payee not having a PE in India. Specified services have been defined to mean online advertisement, any provision for digital advertising space or any other facility or service for the purpose of online advertisement and includes any other notified services. Thus, online advertisement services will get covered under the provisions of EL.
Subsequently, the Finance Act, 2020 broadened the scope of EL and introduced a 2 per cent levy on the consideration received or receivable by an ecommerce operator from an e-commerce supply or services. E-commerce supply or services has been defined to mean online sale of goods owned by the e-commerce operator; or online provision of services provided by the e-commerce operator; or online sale of goods or provision of services or both, facilitated by the e-commerce operator; or any combination of above activities. The new EL provisions are very wide in scope and thus advertisement and marketing services may also get covered under these new set of provisions. However, if the transaction is subject to EL @ 6 per cent then the same is not taxable under the new EL @ 2 per cent. Further if the transaction is taxable under the provisions of EL the same would not be taxable under the provisions of the Act.
Recently, the Bangalore bench of the Income-tax Appellate Tribunal in the case of Urban Ladder Home Decor Solutions Pvt Ltd dealt with the issue of taxability of payments for online advertising to Facebook, for bulk email marketing services to Rocket Science Group and for information technology (IT) facilities to Amazon Web Services (AWS) [foreign entities] under India-Ireland and India-US tax treaties. With respect to advertisement and marketing services, the Tribunal observed that non-resident entities only allow the taxpayer to use their facilities for the purpose of creating advertisement content. Further, with respect to IT facilities, the Tribunal observed that the payment made to non-resident entity was only for using the IT facilities provided by it. These non-resident entities do not give any specific license for use or right to use any of the facilities (which include software). Hence, the question of transferring the copyright over those facilities did not arise at all. Accordingly, the payments made to such non-resident entities do not fall within the meaning of ‘royalty’ as defined under relevant tax treaties. Consequently, there was no requirement to deduct tax at source from such payments under Section 195 of the Act.
There is a thin line to decide whether the payment for advertisement/marketing services are taxable as royalty or not. Normally, advertisement /marketing fees paid to a foreign web-based search company (Google, Yahoo, etc.) may not be taxable as ‘royalty’ where the uploading and display of advertisement on the portal is the responsibility of the foreign company. The taxpayer is only required to provide the banner advertisement to the foreign company for uploading the same on its portal. The taxpayer thus has no right to access the portal of the foreign company. However, in some cases, the agreement could be for facilitating the display and publishing of an advertisement for the targeted customer with the help of various patented tools and software. In such cases, the taxpayer may have access to various data and it may be using the information for the purposes of selecting the ad campaign and for maximising the impression and conversion of the customers to the ads of the advertisers. In such cases, the taxpayer may have a licence to use the confidential information, technical know-how, trademark, brand features, etc.
The issue of taxability of income from online advertisement has created challenges across the globe. With respect to Google’s advertising income transaction, the French Court had held that the Google does not have PE in France and therefore nothing will be taxed in France. Subsequently France introduced Digital Service Tax (DST). French DST applies to two types of digital services i.e. the making available of a digital interface and the provision of online advertisement services. Further various countries like UK, Austria, Greece, Hungary, Indonesia, Italy, etc. have already introduced provisions to tax digitalised transactions like online advertisement.
The Inclusive Framework of the OECD/G20 issued a statement on a Two-Pillar solution to address the tax challenges arising from the ‘Digitalisation of the Economy’ on 1 July 2021. The statement sets forth the key terms for an agreement of a two-pillar approach to reforms and calls for a comprehensive agreement by the October 2021. Pillar 1 envisages a new taxing right to market jurisdictions, allocating a portion of residual profit based on a formulary approach. Pillar Two reflects an agreement on a global minimum level of taxation which has the effect of stipulating a floor for tax competition amongst jurisdictions. There is no clarity on the issues of taxability of online marketing and advertising activities i.e. digital transactions in India as well as at the global level. OECD is trying to resolve these issues through Pillar 1 and 2 approaches. Further OECD is planning to finalise the mechanism to tax the digital economy in next 2 years and after such mechanism it is suggested that the unilateral measures such as EL should be removed by respective countries.