Prime Minister Narendra Modi recently stated that digital connectivity should become a basic right of every Indian. There can be little doubt that information technology must form one of the central pillars of India’s economic transitionto a middle-income country. As India’s online footprint has increased, so has the role of e-commerce, among the fastest growing industries in the country. The industry is expected to cross $6 billion in revenues by 2015, not including ticketing and travel, according to Gartner Research. It must then follow that e-commerce should be encouraged to play a key role in building requisite supply chain efficiencies across India. The opposite however seems to be the case.
Through a spate of notices and warnings issued by tax departments across the country to many large e-commerce firms, it has become clear that the industry faces an existential threat. The all too familiar refrain from the taxman is that e-commerce platforms, directly and indirectly, facilitate tax evasion and therefore erode the revenue base. Various commercial tax departments are struggling to meet advance tax collection targets. According to some officials, state taxes in the form of VAT levied on brick and mortar retailers have taken a hit owing to the e-commerce platforms. This has resulted in a country-wide backlash, with commercial tax officers in hot pursuit of e-commerce companies, in order to make them accountable for ‘projected’ losses.
The preferred model for e-commerce businesses in India is the ‘marketplace’ model, through which a majority of both domestic and international firms currently operate. Using this model, e-commerce firms simply provide warehousing facilities and an online platform, while outsourcing logistics operations. Registered sellers on the platform are responsible for filing VAT for all taxable products sold. The e-commerce companies in turn, charge a service fees to the sellers using the online marketplace. The crux of the tax departments’ perspective lies here. They would rather that the e-commerce companies file VAT on behalf of their sellers – the motivation lying perhaps in simplifying tax administration by transferring compliance to a single entity
The above argument reveals two distinct facts. The first is that despite the positive rhetoric from the new government at the Centre, doing business in India continues to be a function of the discretion of state tax departments. Nokia India became aware of this stark reality recently. In 2014, it had to stop operations at its factory outside Chennai owing to a tax dispute. Nokia India employed around 8,000 people at this factory – one of Nokia’s largest globally. Despite the immense socio-economic benefits of such an investment, the tax department could not but help take a myopic view on taxation of royalty payments made by Nokia India to its parent company in Finland. The second is that tax policy is only as good as tax administration. Without the requisite manpower or technology to be able to cross-verify VAT receipts of retailers from additional places of businesses such as e-commerce platforms, tax departments are mulling shifting the burden of administration on the e-commerce platforms themselves by asking them to file VAT.
Nevertheless, consumer demand for e-commerce in India is surging, and a number of domestic and international investments have responded to this trend. As a result, the industry is constantly evolving, and so must the regulatory and policy regime that governs it. It should not be the case that new industries are penalised because the government is unable to understand them. It is incumbent upon not just tax administrations but the larger political and bureaucratic apparatus to respond to the central questions that loom in the e-commerce space today. Perhaps the foremost of these questions, aside from the harsh tax treatment meted out, is related to the extant limitations on Foreign Direct Investment (FDI) in e-commerce. That is, what is the difference between domestic and international e-commerce companies operating in India?
The Department for Industrial Policy and Promotion, through a circular issued under the erstwhile UPA government, has put a blanket ban on FDI in business to consumer (B2C) e-commerce. This has led to both Indian and foreign firms adopting the aforementioned marketplace model, which essentially makes them business to business platforms. Thousands of small and medium enterprises use such platforms to grow their business. The insatiable appetite of the Indian consumer for e-commerce has meant that foreign capital has been used to expand Indian investments in the sector. In fact no e-commerce company in India can function in an industry that has a long gestation period before break-even without infusion of substantive capital. This is equally true for many other industries where successive governments have chosen protectionism at the cost of long term economic-growth they seem to value so much.
At the end of the day, the policy framework for FDI in e-commerce or any other industry must be guided by the answers to a few basic questions. The first: Is the investment is creating jobs for Indians? The second: Are additional tax revenues are being collected, not just directly through the investment, but also as a multiplier of the investment? The third: Do domestic companies in a particular sector require foreign capital unavailable through shallow domestic capital markets? And lastly: Is the Indian consumer better-off as a result of the investment? If the answer is a clear affirmative to all, foreign companies must have every right to do business in India. In the case of e-commerce this means that better Centre-state policy coordination should be a prerequisite to tax departments unilaterally policing the sector.