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Tax Storm Around Cloud Computing

Published on Fri, Jul 04,2014 | 22:14, Updated at Fri, Jul 04 at 22:14Source : 

By: Pallavi Singhal, ED - Tax &  Regulatory Services, PwC India

The emerging trend of information technology has led to new concepts that not only allow companies greater access to global markets, but also offers innovative ways of doing business. One such concept gaining ground and changing the way business is conducted is ‘cloud computing’.  

Cloud computing is a ‘disruptive innovation’ that is gaining utmost popularity and is expected to grow globally at a rate of CAGR of 30% reaching $270 billion in 2020*. It offers businesses a flexible and scalable way to outsource IT functions to third party providers.  Typically, clouds are on a ‘pay-as-you-go’, or ‘as needed’ basis, with any unused resources scaled down and shifted back into the pool for others to use. Cloud computing has brought a sea change in traditional business models by making applications more mobile and collaborative. Cloud creates the possibility for an organisation to conduct seamless business without any physical presence.

Cloud computing offers its services through three fundamental models namely ‘Infrastructure as a Service’ (IaaS), ‘Software as a Service’ (SaaS) and ‘Platform as a Service’ (PaaS) that deals with diverse technology needs of businesses. Cloud services can be implemented through private, community, public or hybrid cloud. Cloud models do away with the need of setting up its own network infrastructure and other resources and thereby considerably reducing both capital and operational costs. On the downside, cloud computing throws up challenges on privacy, security, data integrity and other issues attributable to electronic transactions.

Do contemporary tax rules address the taxability of the virtual business models? With cloud computing, physical presence is not a prerequisite and service offerings may be fragmented across multiple jurisdictions which creates difficulty in ascertaining the situs of the transaction. This raises issues relating to residency, source and whether or not there is taxable presence in a particular country to grant a taxing right. Traditional taxation rules based on territorial nexus does not address such complexities and may allow a business to penetrate a country’s market without creating a physical presence, and therefore avoid being subject to income tax there. To plug the loopholes, it is believed that the international tax rules as a whole require change in order to cope with modern business practices. With increase in digital transactions and the pressure from countries for a solution to tax conflicts over jurisdiction, OECD has formulated Base Erosion Profit Shifting Report (BEPS) wherein one of the agenda is solving digital tax issues. The idea behind is to largely curb the benefit of current rules that are still grounded in a bricks and mortar economic environment rather than today’s digital environment.

Closer home in India, there are no specific rules in relation to taxation of virtual models. In absence of rules, there are a number of direct and indirect tax challenges that arise on account of such models. The taxability of cloud service providers would depend on characterization of the underlying transaction i.e. whether the income is ‘royalty’ or ‘fees for technical services’ or whether the service provider has a taxable presence in India. Also, the service recipients need to consider the withholding tax implications given the adverse consequences in case of non-compliances. Old rules don’t seem to address the complexities of the virtual world. Framework for determining the tax treatment of income from online transactions requires to be reviewed to address the complexities of the evolving models.

From an Indian indirect tax perspective as well, the cloud ‘service’ should be, on a base case, leviable only to service tax. However, given the involvement of goods in the model, the taxability is dependent on whether the transaction results in “transfer of right to use” the underlying goods, i.e. transfer of possession and effective control of the underlying goods to the customer.  This issue has been given a twist by the Courts recently, wherein the test of possession is being diluted and the Courts have accepted transactions involving ‘implied possession’ as sufficient for VAT to be applicable.  

The cloud model clearly does not involve physical possession of the computer hardware or software but the allocation of such assets for use by customers is being viewed to result in an ‘implied possession’ of them.  In order to determine this, the contractual documents shall play an evidential role and be a key to the determining process.  Aspects like intention of the parties, level of control of the underlying assets by the customer, service level objectives, responsibilities for maintenance of assets and software support/upgrades, software licensing terms, etc are some areas which could be reviewed to begin with.  Another important fact to be determined for the levy of VAT shall be the situs of the transaction.  In light of this, it would be prudent for companies in India to examine these aspects closely.

The levy of service tax on such transactions shall be applicable only when the transaction does not involve “transfer of right to use” the underlying goods and therefore this aspect shall require primary focus.  Cross border cloud service shall also require addressing the applicability of reverse charge service tax for Indian cloud users under the regulations for place of provision of services.   

Internationally, cloud models are treated as a ‘service’ and the regulations for place of supply determine their territorial jurisdiction for this levy. The onset of a Goods and Services Tax (GST) in India should be used as an opportunity to bring certainty to these transactions, similar to those involving software licenses in India which are also reeling under dual levies of VAT and service tax.

Given the above, it is pertinent for both cloud service providers and users to closely monitor the tax related implications. If not addressed, organisations striving for efficiency may be subject to complex tax issues.


With inputs from Vikash Dhariwal, senior manager, Tax and Regulatory Services, PwC India


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