Industry body IAMAI urges government to allow single GST registration for digital services, seeks a level playing field for ecommerce retailers.
With the Union Budget announcement round the corner, the Internet and Mobile Association of India (IAMAI) highlighted five key tax-related challenges that the digital sector expects to be addressed.
Angel tax: The valuation of startups is a critical factor, given the intellectual property and other intangibles involved at the startup stage. Most technology startups raise money before monetisation and there is no underlying actual cash flow analysis available for traditional valuation methods. Most startups are almost always asset light and do not have assets in their books to justify their intrinsic value.
Section 56 of the Finance Act 2012 (colloquially referred to as angel tax) has resulted in numerous startups facing income tax notices claiming a lion’s share of the investments they raise as tax liabilities, with a reported 53 percent drop in year-on-year private angel investments and 80 percent drop in new startup incorporations in the year 2017 as compared to 2016.
The main issue of contention is the valuation of the company or calculating Fair Market Value (FMV) under Section 56(2). The valuation is based on valuation certificate by a valuer recognised by the government. Valuers in India look at traditional methods of valuation, which apply to mature companies with regular cash flows.
The association stated that while the digital sector is not averse to paying taxes, taxation should be on actualised gains and not notional gains. Given the high rate of failure of startups, this is a critical aspect of taxing the fast evolving tech sector, or we "run the risk of killing the goose even before it lays a golden egg"!
Taxation of ESOPs: For digital startups initiating at an uncertain stage, ESOPs are the most common and popular incentive offered to employees at the stage of scaling up of business. From the employees’ perspective, in the context of liquidity of their stock, there is an expectation that the company may go public or may be acquired by a bigger player. This allows companies to attract the best talent, who are also willing to take the risk of joining a startup.
Typically, most ESOPs have a vesting period (during which the employee should continue to be in the employment of the company) and after completion of the vesting period, the employee may exercise his option to acquire shares by paying an exercise price. Under present provisions, at the time of such exercise of options and grant of shares, the difference between the FMV (Fair Market Value) of the shares and the exercise price paid is taxed in the hands of the employee. The employer is subject to withholding tax obligations on the same.
Unfortunately, when stock is issued under an ESOP scheme in startups, there is no certainty on how much value/benefit may be realised when the employee actually is able to sell the stock, or whether the employee will at all be able to sell it, given that in most cases these are unlisted stocks!
Thus, taxation of stock issued under an ESOP scheme is purely on a notional basis, and in cases the taxable amount may be way higher than the salary payable to the employees! Currently, employers either (a) withhold from the monetary payments made to the employees (b) ask the employees to furnish a cheque for the required amount, or in worst case scenario (c) bear the tax cost themselves.
The association stated that ESOPs are an efficient way to remunerate and incentivise employees to join startups and share the risk with the founders. Keeping this in mind the high-risk scenario in which both founders and employees work in a startup, the withholding tax should be done away with and shares should only be taxed on realisation.
Multiple registration and filing under GST: Like all service sectors, the digital sector is plagued by the challenge of state-wise multiple registrations and filing burdens. What makes matters worse for the digital sector is the fact that most Indian companies are startups that simply do not have the bandwidth to undertake such exercises. IAMAI has urged authorities to take note of this factor and allow single registration for digital services, as has supposedly been proposed for banking and financial services.
Anomaly in GST rates: Internet services digitalise conventional services. For example, edutech provides education via digital platforms; healthtech allows online doctor consultancy and ordering medicines, etc. However, under GST, while education and health are tax-free, all digital services are taxed at 18 percent. Even telecom services like internet access are taxed at 18 percent, which is higher than the tax one pays for a meal in a restaurant. IAMAI wants the GST rates to be lowered/rationalised for digital services to be at par with offline counterparts for such services to be more affordable. This will help popularise these services in rural areas.
Unfair playing field for ecommerce: The onerous burden of Tax Collected at Source (TCS) imposed on online marketplaces seems to be step-brotherly treatment to one of the most popular and fast-developing digital services. TCS forces marketplaces to pay taxes on behalf of sellers, a responsibility that their offline counterparts do not have to bear. The fact that ecommerce facilitates inter-state transactions mean that these platforms have to bear the additional burden of multiple registrations and filing on behalf of the sellers as well!
The additional problem with TCS is that small-scale sellers whose annual revenues are lower than the taxable threshold too will have to register under GSTN and will have 1 percent of their revenues deducted as tax for every transaction conducted online. This alone is a big disincentive for small-scale sellers to conduct businesses online. This runs contrary to the vision of USD1 Tn Digital economy that envisages ecommerce to reach market size of $150 Billion by 2024.