Note: For more information about Cherry Bansal and this critical component of taxation in India contact Birchtree Global.
Cloud computing is a trend that affects all industries in the globe. It offers businesses a flexible and scalable way to quickly outsource IT functions to third party providers, as well as using a powerful medium to conduct a borderless business. Broadly, it is a term used to describe a pool of shared resources, both hardware and software, which is available on demand. It is of course scalable and accessible anywhere in the world with an Internet connection. With the growing market for cloud computing services, cloud service providers on the one hand are struggling over how to effectively manage the tax treatment of cloud related operations and cloud service users on the other hand are worried about their tax withholding liabilities.
To establish the Tax Treatment It is important to establish the category of cloud activity. Cloud Models basically can be Infrastructure based, Platform Based or Software Based.
In Infrastructure based cloud service, both Hardware and Software are the components to service
In Platform based cloud service, more content of software is used.
In Software based cloud service, only software is there such as any application software.
Type of Taxes impacting cloud computing in India:
Now In India there are basically 3 taxes which are impacting taxation around cloud computing:
1) Income Tax
2) Service Tax
3) VAT (Value Added Tax)
In this article we have tried to cover major aspects of all the three taxes. Let’s start with Income Tax.
Income Tax impacts the cloud computing in domestic transactions as well as cross border transactions. In domestic arrangement where both the provider of service and receiver of service are Tax Residents of India , the provisions of Income Tax Act,1961 will be applicable while in cross border transaction where one party is Tax Resident of other country then together with Income Tax Act,1961 the respective Treaty will also be affecting the tax imposition. India tax laws don’t permit following the case laws, decisions made in other countries.
When a user is paying for cloud computing services , The first and foremost factor to be resolved is the categorization of the payment, Whether it is payment for a service , use of equipment or software where one is getting the right to use the software.
Liability of user of service in India: The user of the service has the onus to with hold the tax based on the category of payment and respective provisions. If the user goes wrong on Tax withholding then there are below consequences:
-Pay the Interest for Non deduction and Non deposition
-Pay the Penalty in lieu of prosecution/prosecution
-Disallowance of the payment as Expense from Business Profit
The most important factor for determining the tax impact is to establish whether the provider of the service has the Permanent Establishment (PE) in India or not.
PE issue is really a vulnerable issue in India. Except from the “fixed place of business” India has the concept of 2 types of other PEs-
India has a clause of Service PE in its treaties which makes a foreign enterprise’s PE in India if its employees or other personnel are present in India to provide services and their presence exceed a specified number of days.
India has a clause of Agency PE in treaties with some countries specifically providing that the securing of orders by a dependent agent for or on behalf of a non resident will result in an agency PE.
These provisions in the treaties make PE definition quite wide thus the taxable nexus.
WHETHER THE PLACEMENT OF SERVER CONSTITUTES A FIXED PLACE OF BUSINESS THUS CONSTITUTES A PE OR NOT?
OECD Model and UN Model has different provisions guiding this factor but the Tax Authorities of some jurisdictions takes an aggressive view over this issue for example Australia and India Tax Authorities are saying to Google /Facebook like service providers that they are generating revenues by users spread across the world therefore they should attribute their profits to all the countries and pay taxes accordingly irrespective of the place where their server is located.
ROYALTY AND FEE FOR TECHNICAL SERVICES?
Whether a payment for the cloud service is Royalty payment or fee for Technical services has to be determined in conjunction with domestic law of the source country and applicable Tax Treaty.
In some Treaties there is no clause for Fee for Technical Services. In that case the payment made as such will not be taxable in India.
In India-US Treaty, there is a Make Available Clause so if the payment qualifies as a fee for technical service but that doesn’t satisfy the make available clause then the payment will not be taxable in India.The cases related to Software Licensing are pending decision in the apex court of India and once the decision is made, we may have that ambiguity over.
Service Tax is imposed on the provision of services in India. The current rate of Service Tax is 12.36%.
The cloud computing transactions can be categorized as “Business Support Services” or “Supply of tangible goods for use”.
If it is falling in “supply of tangible goods for use” then if the service provider in India providing services out of India, it will not qualify as “Export of Service” thus taxable @ 12.36%.
The category of “business support service” is quite wide and beneficial for the assessee as it qualifies for Export of Service when the user of the service is outside India thus Exempt from Service Tax.
WHETHER SERVICE PROVIDED IN INDIA FROM OUTSIDE INDIA IS TAXABLE FOR SERVICE TAX:
The cloud computing service if provided in India is taxable on reverse charge basis where the receiver of service from outside India needs to pay the service tax. The receiver may or may not charge back this service tax to the service provider. If he charges back then the service tax amount will add to the cost of service provider as he will not be able to take the credit of service tax so paid.
WHETHER SERVICE PROVIDED OUTSIDE INDIA FROM SERVICE PROVIDER IN INDIA IS TAXABLE FOR SERVICE TAX:
It is taxable as per the category of service as explained above. If the service is provided as Business Support Service then it will qualify as Export of Service so not taxable otherwise it is taxable.
Value Added Tax (VAT)
Service Tax and VAT are overlapping each other in cloud computing transactions.
VAT is levied on the sale of goods and also leasing of the goods where the possession and control to use the underlying product is transferred to the user. The rate of VAT varies from 5% to 13.5%.
In cloud computing transactions NO Control and possession of the server is transferred rather a place is provided on the server to use against a payment but the user is not authorized to control the server.
The underlying contracts need to be drafted very carefully and it should state implicitly that there is no real or deemed or implied possession or control with the user. In some cases we have seen that the contract says that the user has the right to dictate the type of hardwares to be used. The VAT Authorities has used this clause against the assesee saying that it shows that the user has the control over the equipments of the service provider therefore, it is covered in VAT Nexus and thus taxable.