Part 1: A Study of the Indian Tax System

From the printing press to the digital revolution, humankind has been inclined to innovate first and plan later. It goes without saying that in the modern world, technology develops faster than the law. Cell-phones and high-tech computers are common examples of technologies that have grown beyond their support structure.

Technical advances sometimes outstrip the development of legal systems and often force basic principles to be reexamined. Advances in the fields of information technology, biotechnology, e-commerce, and out- sourcing, for example, have recently created a host of celebrated legal confusions and debates. This article outlines the main issues in the international taxation of e-commerce transactions with a particular emphasis on India.

Since nearly a decade ago, because of the diminished need for a vendor to have a physical presence in the country of the customer, a frequent consequence of electronic commerce has been to shift revenues away from source jurisdictions and toward residence jurisdictions.1 The tax authorities were faced with a challenge, and to overcome it; they continued to apply principles of traditional tax dealing essentially with the physical movement of goods and services. In their objective to implement a tax to the invisible trade, governments around the world have fine-tuned regulations to extend the scope of national tax regulations. The OECD's support and guidelines help these governments ensure that the right arm's length principle is applied. This article will examine significant tax statutes in India with a particular emphasis on the tax system and the powers of tax officers, and will explore the legalities involved in the taxation of information technology and biotech companies.

I. Taxation in India

The world's 12th-largest economy at market exchange rates and the fourth largest in purchasing power, India has a quasi-federal form of government. India's Constitution is the longest and the most exhaustive constitution of any independent nation in the world. India has a three-tier federal structure, com- prised of the union or central government, the state governments, and the local bodies, all of which have the authority to levy taxes. Besides direct taxes such as the income tax, indirect forms of tax are collected such as the sales tax, VAT, service tax, stamp duty, customs, and excise duty.

A. Income Tax Act — Background

Historians have argued that modern ideas and institutions of law, medicine, and criminal justice were first tested in the colonies and later implemented in metropolitan areas.2 The tax system was first introduced in India during the British rule. Today,  the Income Tax  Act, 1961 (Act 43 of  1961) — the primary legislation dealing with taxability of income — is self-contained legislation. The Income Tax Act empowers the Central Board of  Direct Taxes to formulate rules for implementing the provisions of the ITA.3 Income tax is a tax payable under section 139 of the ITA by filing a return (form/declaration) of income,4 at the rate enacted by the Union Budget (Fi- nance Act) for every year on the total income earned in the previous year by every person (individual or company) who is a resident, nonresident, or resident who is not ordinarily resident. Residents are taxable for all their income, including income arising outside India.

The division of tax and expenditure powers is spelled out in the constitution. Article 366(29) defines tax on income as including tax in the nature of an excess profits tax.

Thus, the Indian Parliament has the exclusive power to levy a tax on income other than agricultural income. The Indian Parliament also has the power to make laws regarding any other matters not enumerated, including any tax not mentioned. While agriculture plays a dominant role in the economy, a government task force recommended that agricultural income be taxed.5 The share of revenue generated from agriculture has been declining while the IT and outsourcing services sector has become a major catalyst for the Indian economy given its effects on income generation and job creation.

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Footnotes

1 See, e.g., David Tillinghast, ''The Impact of the Internet on the Taxation of International Transactions,'' 50 Bull. Int'l Fiscal Document 11/12, 524, 525 (1996); Tillinghast, ''Taxation of Electronic Commerce: Federal Income Tax Issues in the Establishment of a Software Operation in a Tax Haven,'' 4 Fla. Tax Rev. 339 (1998).

2 See Eric Stokes, The English Utilitarians and India, Oxford: Clarendon Press (1959); and Uday Singh Mehta, Liberalism, and Empire: A Study in Nineteenth-Century British Liberal Thought, Chicago: University of Chicago Press (1999).

3 Income tax rules are amended by publishing a notification in the official gazette of the government of India. To amend the ITA, the amendment to the bill must be passed in Parliament.

4 Tax may also be payable on receipt of a notice.

5 See http://finmin.nic.in/kelkar/Full_Report.pdf.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.