Examining The Intersection Of Permanent Establishment And Taxation In The Context Of E-Commerce In Tanzania

Paper Details 

Paper Code: RP-VBCL-05-2024

Category: Research Paper

Date of Publication: April 20, 2024

Citation:  Mr.Jackson Simango Magoge & Mr. Sayed Qudrat Hashimy, “Examining The Intersection Of Permanent Establishment And Taxation In The Context Of E-Commerce In Tanzania", 1, AIJVBCL, 67, 67-90 (2024), <https://www.vbcllawreview.com/post/examining-the-intersection-of-permanent-establishment-and-taxation-in-the-context-of-e-commerce-in-t>

Author Details: Mr.Jackson Simango Magoge, Assistant Lecturer at the University of Iringa , Tanzania &

Mr. Sayed Qudrat Hashimy, Ph.D. Scholar (Law) Department of Studies in Law, University of Mysore

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ABSTRACT

The rapid expansion of electronic commerce (e-commerce) poses significant challenges to traditional tax systems worldwide. This research paper thoroughly explores the complex terrain of e-commerce taxation in the digital age, highlighting the imperative for regulatory interventions. It delves into intricate issues such as the identification of taxpayers, determination of transaction locations, and classification of income within the digital domain. The study critically examines the concept of Permanent Establishment (PE), specifically focusing on digital triggers like servers and websites. In the context of Tanzania, the paper scrutinizes corporate income tax and addresses concerns related to online businesses evading taxation by sidestepping physical presence requirements. Throughout the investigation, emphasis is placed on the difficulties associated with taxing e-commerce in Tanzania, prompting an examination of global initiatives seeking a unified approach. Employing a doctrinal research methodology and drawing insights from primary and secondary sources, this paper contributes to the comprehension of e-commerce taxation by elucidating its complexities and underscoring the essential need for effective regulation.

Keywords: E-commerce taxation, Digital age challenges, Permanent establishmen,

Taxpayer identification, international tax regulation

INTRODUCTION

The surge in E-commerce has sparked a debate on fair tax rules for both digital and traditional commerce. Balancing this is crucial for E-commerce growth without hindering established business models.[1] This article focuses on cross-border E-commerce and Permanent Establishment in Tanzanian taxation. As the digital realm transcends borders, defining tax responsibilities becomes challenging. Current tax systems built for physical stores struggle to adapt. A balanced tax framework must accommodate E-commerce's unique traits without disadvantaging traditional businesses. Understanding Permanent Establishment is crucial. Traditionally tied to physical presence, in E-commerce, it requires reevaluation for virtual enterprises, reshaping tax policies. This article explores PE's intricacies in taxing cross-border E-commerce in Tanzania. By studying global practices, we aim to establish an effective tax framework for this evolving digital domain. The goal is the harmonious coexistence of traditional and E-commerce businesses, fostering economic growth, fairness, and adaptability in the tax landscape.

GUIDING PRINCIPLES FOR TAXATION OF E-COMMERCE

Countries around the globe have shown an ongoing interest in formulating fundamental principles to shape their tax policies. This is not a recent phenomenon. In the 18th century, Adam Smith articulated four key principles in his work "The Wealth of Nations," namely equality, convenience, certainty, and economy.[2]These principles strongly motivated authorities to implement taxes that were as fair as possible, ensuring confidence and ease for taxpayers in terms of timing and method of payment, while also being appropriately strict in relation to the revenue generated. More recently, these same principles have proven sufficient in addressing the tax challenges associated with e-commerce in the late twentieth century.[3]

The OECD employs these principles, with slight modifications, as a foundation for sound tax policy when evaluating the adequacy of tax laws in the wake of digitalization.[4] Below are the outlined principles:

·         Taxes should aim for fairness and impartiality among different business activities.

·         The costs of compliance for businesses and administrative overhead for governments should be minimized as much as possible.

·         Tax regulations should be straightforward and easy to comprehend, providing taxpayers with clear guidance on their obligations.

·         Taxes should be levied in the right amounts and at the right times, avoiding both double taxation and unintended exemptions. Additionally, measures should be in place to minimize tax evasion and avoidance.

·         Tax systems should be adaptable and responsive to keep pace with technological and commercial advancements.

·         Taxpayers in similar situations should bear a comparable tax burden.

Consequently, the emphasis placed on these principles in a country's tax policy varies depending on its legislative priorities. Nevertheless, there is a widespread consensus on the nature and structure of various taxes worldwide. For instance, many governments utilize corporate income taxation as a common means of generating revenue.

THE NEED FOR TAXATION OF DIGITAL COMMERCIAL TRANSACTIONS

Though it is indisputable that online commerce should be subject to taxation, the basis for imposing taxes on e-commerce is a complex issue. The benefit theory plays a crucial role in determining a country's right to levy taxes. According to this theory, a state's authority to tax is rooted in the overall value of benefits and services provided to its taxpayers. Consequently, the state requires recompense for the expenses incurred in furnishing public services such as a favorable legal framework, a consumer base, stable currency exchange rates, and economic stability facilitated by income-generating e-commerce endeavors(Nadeem & Saxena, 2018).[5]

Additionally, not taxing e-commerce contributes to fairness. E-commerce drives efficiency by reducing procurement costs and transaction processing expenses, ultimately leading to increased profitability.[6] Granting e-commerce tax exemptions would lead to an imbalance, as conventional businesses with lower profits would be subject to taxation, while those transitioning to e-commerce and enjoying higher profits would be tax-exempt. Furthermore, governments worry that with the growth of e-commerce, an increasing number of individuals will opt for tax-free online shopping, diverting from traditional retail methods. This shift could lead to significant revenue losses for the states.

CHALLENGES OF TAXING DIGITAL COMMERCIAL TRANSACTIONS

E-commerce presents a range of international tax challenges, primarily due to the absence of clear national boundaries and the lack of physical product delivery requirements. These complexities will be further discussed below:

Taxpayer Identification

For income to be subject to taxation, it must be attributable to a clearly identifiable entity. In the realm of e-commerce, a domain name serves as the identifier for online businesses.[7]However, even if an internet address is known, determining the responsible party behind its maintenance is not always straightforward. Pinpointing the physical location of the associated machinery is also a challenging task.

Determining Transaction Location

A significant hurdle in formulating e-commerce tax policies lies in establishing the location of a transaction. This difficulty arises from the inherently borderless nature of online transactions. Successful taxation hinges on establishing connections between individuals, governing bodies, and revenue sources. This process is contingent on tracking transactions and appropriately distributing profits. Implementing such measures in cyberspace proves to be exceptionally challenging, if not entirely impractical.[8]

Income Characterization and Digitalization

Digitization is the process of converting information into a numerical format. Once digitized, data can be transmitted instantaneously across the globe, where the recipient can either revert it back to its original form or manipulate it in various ways. With the increasing use of digitization in e-commerce, the task of distinguishing whether revenue represents sales income, services income, or royalty income for intangible products licensed becomes more challenging. This is because digitalization blurs the lines between tangible goods and services, providing greater flexibility in determining the nature of the resulting revenue.

Determining Residency

In most countries, like Tanzania, an individual's residency is typically determined by the length of their stay in the country.[9] Nevertheless, in the era of the internet, applying such a criterion becomes unworkable. With technology enabling individuals to conduct nearly every aspect of their lives in a different jurisdiction without physically relocating, the significance of physical location diminishes significantly.

Determining Effective Management Location

The complexities escalate when assessing entities rather than individuals. The effective management location is where a company's central decisions and commercial strategies are formulated. In the digital domain, identifying the precise physical location of these decisions becomes nearly impossible.[10] With the advent of video conferencing, directors from different countries can convene simultaneously, rendering the determination of the most effective management location exceedingly difficult.

Determining Permanent Establishment in the Age of Technology

A permanent establishment is established once a business starts operating through a physical location. The timing of setting up this place of business is inconsequential if the activities significantly differ from those originally planned for the location.[11] The emergence of technology and e-commerce has led to widespread internet usage, resulting in a contracting global marketplace. In this virtual landscape, the physical presence of an entity has become less significant. Technological progress, driven by the use of digital information and goods, means that a foreign enterprise can conduct business in a country without requiring a physical presence. Consequently, the conventional definition of a permanent establishment, as outlined in articles two and three, does not adequately address technological advancements that enable businesses to serve markets remotely, without a physical presence or with one limited to support operations. To exploit gaps in the law, companies establish operations in low-tax jurisdictions and utilize technology to distribute their products globally. Only automated equipment, such as computers, servers, and similar devices, may be used in the contracting state for conducting business there. This has prompted discussions on whether such automated equipment qualifies as a permanent establishment in the contracting state. Additionally, questions have arisen regarding the classification of certain intangible assets, like websites and software, that assist companies in conducting business in the contracting state, as constituting a permanent establishment.

COMPUTER EQUIPMENT OR SERVER AS PERMANENT ESTABLISHMENT

Servers are defined as devices that hold data for users on a network to retrieve.[12]Servers, which house websites, are physical pieces of equipment located in a specific place. This location may constitute a stationary business establishment for the company that operates the server.

According to the OECD Commentary on Article 5, a Permanent Establishment (PE) may be established if an entity operates computer equipment in a particular location, even if no employees from that company are necessary to operate the equipment at that location.[13]

For a fixed place of business to be established, the paramount requirement is that the server or computer equipment in question must be under the control of the enterprise. It has also been established that having complete control over computers located at subscribers' premises can qualify as a fixed place of business. This standpoint was underscored in the case of Galileo International Inc. v. Deputy Commissioner of Income Tax.It is important to highlight that the operations conducted by the server or computer equipment must not be merely preparatory or auxiliary to be considered a Permanent Establishment (PE). It has been determined that when a server autonomously enters into contracts with clients, handles payments, and delivers goods, these activities are not merely preparatory or auxiliary. Consequently, the server meets the criteria for being deemed a PE.[14] Hence, the OECD Commentary on Article 5 outlines the criteria for considering a server or computer equipment as a Permanent Establishment  as follows:

i. The server or computers must establish a fixed place of business.

ii. This server or computer equipment must be under the control of the enterprise.

iii. The enterprise's operations must be conducted through the server or computer, and it must not engage in purely preparatory or auxiliary activities.[15]

INTERNET WEBSITE/SOFTWAE AS PERMANENT ESTABLISHMENT

A website on the internet is a compilation of digital information and software that lacks physical form or a designated location for conducting business. This means it does not possess tangible assets like offices, and in some instances, machinery or equipment.[16]The platform businesses use to carry out their operations is often stored on a server. This server is occasionally managed by an internet service provider external to the company. In this situation, there isn't a specific physical business location. However, if a company conducts its operations through a website hosted on a server it owns or rents and has control over, the website might be considered a Permanent Establishment (PE) under certain conditions. This determination would also depend on the activities carried out not being solely preparatory or ancillary.[17]

If the company owns the server where the website is hosted, it must meet the condition of not exclusively performing preparatory or auxiliary functions. For instance, if the server is used primarily for activities like advertising, displaying a product catalog, or providing information to potential customers, it may not be classified as a Permanent Establishment (PE) because it is engaged in preparatory or auxiliary tasks. However, if the server is utilized for critical functions such as contract finalization, payment processing, and product delivery, these activities cannot be considered purely preparatory or auxiliary. In such cases, the location where the website is hosted on a server may be regarded as a PE.[18]

SOFTWARE

In the case of Western Union Financial Services Inc. v ADIT, The appellant, identified as a tax resident of the United States, engaged in agency agreements with multiple banks and post offices in India to facilitate its money transfer operations. As part of this arrangement, Western Union implemented specialized software on the agents' premises, granting them access to the central mainframe computers located in the United States for the purpose of verifying control numbers.

In the subsequent legal proceedings, the Income Tax Appellate Tribunal deliberated on the matter and concluded that the mere utilization of software from the agents' premises does not substantiate the notion that these premises, coupled with the software, would constitute a permanent establishment of the taxpayer within India. In essence, the tribunal emphasized that the presence of the software alone did not establish a significant enough physical presence in India to warrant the classification of a permanent establishment for tax purposes.

WEBSITE

The fundamental concept to understand is that a website is a blend of software and electronic data, making it intangible in nature. Consequently, it lacks a physical location that can serve as a place of business. However, the web server, on which the website is hosted and made accessible, is a tangible piece of equipment with a specific physical location. This location can potentially be considered a stable place of business for the company operating the server.

In the case of ITO v Right Florists Pvt. Ltd,, the individual utilized online advisory services provided by Google Ireland Ltd and Yahoo US, and payments were made without any tax being withheld. Although both Google Ireland Ltd and Yahoo US had an online presence in India through their websites, the Income Tax Appellate Tribunal determined that a website alone does not qualify as a permanent establishment. According to the Tribunal, for a permanent establishment to exist, the servers hosting the websites must also be situated in the same jurisdiction. Since Google and Yahoo's servers are not located in India, there is no fixed place permanent establishment in the country.

Furthermore, an international gaming enterprise, providing a range of online games via the internet, expressed its intention to seek a gaming license from the Danish Gambling Authority after the Danish gaming market was opened up. The company had no intention of establishing a physical office in Denmark and intended to operate the games through a Danish website from a server located outside Denmark. The Danish Tax Board verified that the gaming company does not possess a permanent establishment in Denmark and consequently, is not liable for limited taxation.[19]

Hence, unless all three of the following conditions are satisfied, internet websites or software cannot be classified as a Permanent Establishment:

i. The website or software is stored on a server situated in the source State;

ii. This server is under the control of the non-resident enterprise; and

iii. The server engages in activities that are not merely preparatory or auxiliary in nature, and therefore, do not fall within the exemption list outlined in paragraph 4 of Article 5.

TAXATION OF DIGITAL COMMERCIAL TRANSACTIONS IN TANZANIA

Corporate income tax in Tanzania is a key revenue source, levied on profits of businesses. It funds public services and promotes economic stability. With the rise of digital commerce, tax policies are evolving to capture these transactions effectively. Tanzania, like others, is adapting policies to tax digital businesses fairly. This involves considering factors like value creation location and user participation. Understanding these nuances is crucial for businesses and policymakers in Tanzania's digital economy. It ensures the tax system remains effective in an increasingly digital global landscape.

CORPORATE INCOME TAX

In some countries, there is a significant alignment in establishing a corporate income tax base. They may have a largely independent tax and financial accounting system, effectively enforcing tax law provisions on corporate transactions. Corporate Income Tax (CIT) typically relies on a broad base, encompassing all types of income generated by the corporation, regardless of their nature. Countries employing a worldwide system tax their residents on income from worldwide sources, whether within or outside their territory. In contrast, countries using a territorial CIT system only tax residents on income originating from sources within their territory. As a result, the taxation of cross-border income under domestic corporate income tax laws typically addresses two situations:

a)      Taxation of outbound investments by resident companies, determined by factors like place of incorporation or effective management.

b)      Taxation of inbound investments by non-resident companies, with the source of income being a key point of taxability. This often aligns with the concept of Permanent Establishment (PE). Taxation for non-resident companies usually involves withholding taxes at a gross rate.

REVENUE COLLECTIONS FROM CORPORATE TAX  IN TANZANIA

Corporate tax is imposed on the taxable income (profits) of various entities, including limited liability corporations, clubs, societies, associations, and other unincorporated organizations. The current corporate income tax rate stands at 30%. In Tanzania, corporate tax is a significant contributor to the country's GDP. According to the 2020/2021 National Tax Statistics Report from the Tanzania Revenue Authority, they collected 2,150,593.6 Million Tsh from Tanzania Mainland and 32,107.1 Million Tsh from Zanzibar in corporate tax. Even though there are sources of revenue, companies conducting online business operations are not currently liable for corporate tax. Additionally, some corporations with a physical presence in Tanzania are transitioning to online business models, resulting in a reduction of government revenue from these online ventures.

ONLINE BUSINESS MODELS THAT AVOID TAXES IN TANZANIA

Presently, Tanzania is witnessing a surge in the establishment of online businesses, a trend attributed to technological advancements and a growing user base of the internet in the nation. Consequently, this segment scrutinizes the frameworks of online business models that circumvent taxes in Tanzania. Within the realm of e-commerce, two main categories of business model structures are widely observed, facilitating tax avoidance, as elaborated upon below.

i)        Aggregators Model

As per the Cambridge Dictionary, an aggregator refers to an individual or entity that gathers information from the web pages of various businesses and consolidates it onto a single website.

Aggregators, in addition, are individuals or entities who own and manage a web-based software application facilitating interaction between potential clients and service providers like Cabs, Hotels, and Travel Portals. These services are offered under the aggregator's own brand name or trade name through the application and a communication device. In Tanzania, companies such as Uber, Bolt, Airbnb, and others fall under the category of aggregators. The crucial tax issue arises regarding whether the local operational subsidiaries of aggregators should be subject to taxation, especially as they often provide support functions to the parent company.[20] They contend that they primarily offer marketing and support services, and therefore do not constitute a Permanent Establishment. Consequently, these aggregators are frequently exempt from taxation under domestic legislation in Tanzania.

ii)  E-tailing Model

The process of selling products and services over the internet is referred to as electronic retailing (E-tailing). This can occur in either a Business-to-Business (B2B) or Business-to-Consumer (B2C) context, often involving online shopping platforms. Within the realm of e-commerce, there are three distinct business models falling under the e-tailing category. These are the Inventory Based Model, the Marketplace E-Commerce Model, and the Hybrid Model.

a) Inventory Based Model

This encompasses shopping websites that oversee the entire process, starting from product procurement to warehousing and shipment. In Tanzania, this inventory-based model is not as commonly favored, primarily due to its capital-intensive nature. Examples include Fulfilment by Amazon (FBA), Kikuu, Darshopping, Zudua, and similar platforms.

b) Marketplace E-Commerce Model

This model operates on the principle of zero inventory. It acts as a meeting point for buyers and sellers without serving as a storage facility. Tanzania is currently experiencing a significant surge in online shopping activity under the Marketplace E-commerce business model. Examples of platforms following this model include eBay, Kupatana, Jumia, ZoomTanzania, and others.

c) Hybrid Model

This model combines elements of both the marketplace and inventory-based models. Websites operating under this model offer the choice of either fulfilling orders independently or storing goods on the platform. Such e-commerce platforms present various challenges in terms of taxation. Amazon is an example of a company that adopts this model. They have fulfillment centers where products sold on their e-commerce sites are stored (warehoused). Amazon handles tasks such as product storage, sales collection, commission deductions, and remittance of the remaining amount to the seller. Additionally, when a product is purchased online, an invoice is generated in the seller's name and provided to the customer, while Amazon receives a commission for its services.

The definition of Permanent Establishment (PE) as outlined in the Income Tax Act does not explicitly specify whether a warehouse can be considered as constituting a PE.[21]

Despite Tanzania's adherence to the UN Models' definition of Permanent Establishment (PE), Article 5 (4) of the UN Convention provides exceptions. It states that using facilities solely for storing or displaying goods or merchandise belonging to the enterprise does not qualify as PE. Amazon could assert that their facilitation centers serve the purpose of storage and delivery, and therefore, should not be considered as PE in Tanzania. Furthermore, Amazon acts as an intermediary connecting vendors with customers. Vendors are responsible for directly sending merchandise to customers, with Amazon receiving a commission. In this context, Amazon does not actively engage in the actual business transaction. Instead, it functions as a facilitator by providing a platform for sellers. Consequently, Amazon operates solely as an online business platform without any physical presence, whether in whole or in part, making it incompatible with the concept of PE.

BUSINESS MODELS CONDUCTED ONLINE THAT CIRCUMVENT THE NEED FOR A PHYSICAL PRESENCE IN TANZANIA, THEREBY AVOIDING TAX OBLIGATIONS.

In this section, a thorough explanation is provided regarding online business models that operate without the need for a physical presence in Tanzania, consequently enabling them to avoid taxes. These models fall into two main categories: Social Media Platforms (Applications) and subscription-based websites.[22]

i)                    Social Media Websites

Social media websites are internet platforms that facilitate communication, content creation, and sharing among individuals. They also present various opportunities for business marketing. Some examples of social media platforms include Facebook, Instagram, LinkedIn, Telegram, Twitter, TikTok, WhatsApp, YouTube, and more. As per data from Datareportal until January 2021, Tanzania boasted 5.40 million social media users. This marked an increase of 900 thousand users (+20%) between 2020 and 2021.

These platforms primarily rely on user engagement for their business operations, with the size of their user base and the level of involvement playing a crucial role in their profitability and overall financial performance. Many of the activities conducted on these social media platforms are not subject to taxation as they do not qualify as Permanent Establishments (PE). The primary revenue source for these platforms comes from advertising, wherein user-generated data is converted into valuable information and sold to advertisers.There has been ongoing uncertainty regarding whether payments made by Tanzanian citizens to non-resident corporations for internet advertising or banner placement on websites can be categorized as business income or royalties. If advertising revenue is classified as royalties, there is no requirement for a Permanent Establishment to levy taxes on such income. However, if it is deemed as business income, the presence of an enterprise in Tanzania would need to be established for taxation purposes.

ii)                  Subscriptions Websites

These are business models that operate on a subscription-based strategy, providing users with digital content like information, music, and videos in exchange for a recurring fee. Examples of such websites include Netflix, Spotify, Amazon Prime, Bumble, Boom Player, Westlaw, and Hein Online. The primary challenge arises within the framework of direct taxation, specifically in how to categorize the revenue generated by these platforms.[23] There is uncertainty regarding whether income derived from subscription-based services should be classified as royalty or business income. Subscription-based websites do not necessitate a physical presence in Tanzania to cater to Tanzanian customers, allowing them to generate significant revenue through subscription fees. It's important to note that, in Tanzania, the establishment of a Permanent Establishment (PE) requires a physical presence under the current regulations. Therefore, if such revenue is classified as business income, it is exempt from the tax regime.

TAXATION OF E-COMMERCE UNDER THE INCOME TAX REGIME

In this section, we will examine the legal and operational structure governing e-commerce taxes in relation to the Permanent Establishment (PE) concept as outlined in our tax statutes. The PE concept is rooted in the taxation of corporate profits, therefore, our focus will be on Tanzanian Income Tax legislation.

INCOME TAX ACT (ITA), R.E 2019

The taxation of e-commerce in Tanzania is, in part, associated with Section 69(h) of the Income Tax Act. This section specifies that payments received by an individual engaged in the business of transmitting messages via various means such as cable, radio, optical fiber, satellite, or electronic communication, whether through apparatus situated within or outside the United Republic, have a taxable connection to the United Republic, regardless of the origin of the messages. Furthermore, Section 6 (1) of the Income Tax Act outlines the determination of chargeable income. For a resident individual, their chargeable income for a given fiscal year, stemming from employment, business, or investments, is based on the income generated from these activities during that year, irrespective of the income source. In the case of a non-resident individual, their chargeable income from employment, business, or investments is considered for the fiscal year, but only to the extent that the income is linked to the United Republic.

This position was emphasized in the Court of Appeal in the case of Commissioner-General (TRA) V. Aggreko International Project Ltd whereby the court established that sections 6(l)(b), 69(i)(i), and 83(l)(b) of the Income Tax Act collectively impose two conditions for a payment to a non-resident to be subject to withholding tax. These conditions are as follows: (1) the service for which the payment is made must be provided within the United Republic of Tanzania, and (2) the payment must have a source within the United Republic of Tanzania.[24] This implies that any income received from digital transactions by an individual is subject to taxation in Tanzania in accordance with the provisions of section 6 (1) (a) of the Income Tax Act.Therefore, this indicates that any revenue acquired by an individual from digital transactions is subject to taxation in Tanzania in accordance with the stipulations of section 6 (1) (a) of the Income Tax Act.

Taxation of Mobile Money Transfer

Section 83(1)(d) of the Income Tax Act mandates that a resident individual who disburses a money transfer commission to a money transfer agent must deduct income tax from the payment at a rate of 10% of the commission paid to the agent.

Introduction of deeming provision.

Recently, the Finance Act of 2020 introduced Section 69A in the Income Tax Act, which deems the income of a non-resident to be accruing or arising in the United Republic, either directly or indirectly. This amendment is aimed at taxing the earnings of non-resident entities associated with entities in Tanzania or having business connections here. Non-residents generating income in the United Republic of Tanzania are obligated to designate a tax representative as per the provisions of the Finance Act of 2020. Consequently, if a non-resident fails to appoint a representative, the resident individual through whom they generate revenue or conduct business may be considered a Permanent Establishment (PE).[25] This implies that multinational digital economy companies without a physical presence in Tanzania may be subject to taxation through their designated representatives.

VAT on the supply of electronic services in Mainland Tanzania.

The definition of electronic services encompasses digital goods such as software, websites, web-hosting, and access to databases, among others.) Non-resident suppliers without a physical presence are mandated to designate a representative for VAT-related matters.[26]

ROLE OF JUDICIARY IN TAXATION OF E-COMMERCE IN TANZANIA

In light of the emerging challenges in global taxation of digital commerce, courts have played a significant role in interpreting tax laws and making influential rulings regarding the notions of Permanent Establishment (PE) and e-commerce. This has not been extensively observed in Tanzania until recently. However, the Court of Appeal of Tanzania recently issued a significant decision in the case of Celtel Tanzania Limited v Commissioner-General, particularly addressing payment for the acquisition of computer software.

In this instance, the issue at hand was whether payments made by banks or other companies for the acquisition of computer software should be classified as royalties. The Court of Appeal held the perspective that payments for the license to use computer software indeed fall under the category of royalties and are therefore subject to withholding tax. This conclusion was drawn by referencing the definitions of "lease" and "royalty" as outlined in the Income Tax Act. According to the Act, a lease is defined as "an arrangement granting a person a temporary right to use another person's asset, excluding money. This encompasses a license, option agreement, rental agreement, royalty agreement, and tenancy.

Conversely, "royalty" is defined as "a compensation given by a lessee in a lease involving an intangible asset. This encompasses remittances for utilizing, or having the privilege to use, copyright, patent, design, model, plan, confidential formula or process, or trademarks.

Following an examination of the definitions provided and the title of the software purchase agreement, the Court concluded that since the agreement explicitly stated that it conferred a license to Celtel for software usage, the payments pertained to the temporary utilization of the software. As such, Celtel's payments were deemed as royalty payments, and thus subject to withholding tax, as a license falls within the scope of a lease and constitutes a royalty payment for temporary usage.

In a separate recent case, the Court upheld this stance in the matter of National Microfinance Bank Limited v Commissioner-General. The Court examined the software purchase agreement and found that one of its clauses granted NMB a non-exclusive and non-transferable license, along with the rights to utilize the computer software. Consequently, the payments made by NMB were considered as royalty payments and were therefore subject to withholding tax.[27]

CHALLENGES OF THE INCOME TAX REGIME IN TAXATION OF E-COMMERCE IN TANZANIA

Beginning in the early 1990s, Tanzania underwent notable transformations in its societal norms. This shift was marked by prominent technological advancements, particularly the introduction of computer-connected communications. This included a notable rise in internet usage and the proliferation of mobile phones. These changes brought about substantial legal challenges to established commercial arrangements, particularly in the realm of tax laws. The ensuing are the hurdles faced by the income tax system in addressing the taxation of digital commercial transactions.

1.      Income Characterization

The classification of income has consistently been a crucial and contentious aspect of income taxation, particularly when distinct tax rates are applicable to different income types. Various forms of income generated across borders are subject to varying tax treatments based on local laws and international treaties. Typically, business earnings are attributed to the country where the income-generating business is situated and taxed on a net basis. In Tanzania, Section 6 of the Income Tax Act delineates three categories of taxable income: income from employment, business, and investment. It is important to note that the issue of income characterization pertains to determining the appropriate category under which income derived from the sale of goods or services should be classified. Additionally, in Tanzania, non-residents are taxed to the extent that the income has a source within the United Republic of Tanzania (URT). Consequently, the digital environment presents a range of challenges in the context of income characterization.

In cross-border transactions involving the provision of digital products or services, discerning whether there has been a transfer of a product, the performance of a service, or the licensing of an intangible product can be challenging. The challenge arises from the fact that transactions involving digital goods and services often blur the lines between various types of income. Another complexity lies in determining whether income generated from subscription fees should be classified as business income or as royalty.

2.      Establishment of Permanent Establishment in Tanzania.

Once it is established that a non-resident's earnings qualify as business income, the subsequent step is to assess whether a Permanent Establishment (PE) exists in Tanzania. Numerous business models in the digital economy rely on intangible assets such as patents, algorithms, and the advantages of scale, notably network effects. This flexibility enables e-commerce enterprises to strategically choose where to establish their core operations. Often, businesses opt for jurisdictions that are distinct from both their parent company's location and their customer base. The applicable regulation necessitates that a non-resident individual must have a permanent establishment in Tanzania for income tax liability to arise. A person may become subject to income tax in Tanzania if they are considered a resident according to the criteria outlined in section 66 of the Income Tax Act. However, the definition of PE in Tanzania has certain gaps that need to be addressed in order to effectively tax the majority of multinational enterprises engaged in e-commerce.

3.      Determination of Individual Residence

Section 66(1) of the Income Tax Act outlines that individuals are subject to taxation based on their residency in Tanzania for a specific fiscal year. This applies if they possess a permanent residence in Tanzania and spend any portion of the fiscal year within the country. Additionally, an individual is considered a resident if they are present in the United Republic for a total of one hundred eighty-three days (183) or more throughout the fiscal year, or if they are present in the United Republic for a period exceeding one hundred twenty-two days (122) in each of the two preceding fiscal years.[28]

In the context of e-commerce, determining a person's residency poses significant challenges. It is intricate to establish residency for someone conducting business online, particularly in terms of defining the duration of presence. This is because an individual can communicate via the internet and potentially reside in multiple tax jurisdictions, without clear records of physical border crossings. As a result, the legal concept is grounded in the physical presence of an individual.

4.      Determination of residence of a Company

According to Section 66(4) of the Tanzania Income Tax Act, a company's residency is determined by its place of incorporation or central management.[29]Central management's location has been interpreted in different ways, sometimes as the place where the company's business is managed and at other times as the location where the directors exercise their management and control. In most instances, the location of a company's directors has been the key factor in determining its residency. However, in the context of e-commerce, conducting this test becomes more complex, especially when a company's directors are spread across different countries and primarily communicate through email, chat rooms, video conferences, and audio conferences. In such a scenario, the central management control test becomes less effective in determining a company's residency.

5.      The Withholding Tax Regime

When income originates in the United Republic of Tanzania (URT), it may be subject to withholding tax. Non-residents are obliged to have income tax withheld if they make payments for services derived from the URT, a requirement that individuals typically do not encounter unless they are engaged in business activities.

However, Tanzania's withholding tax system faces practical challenges in the context of online transactions and non-business individuals, such as customers of services like Netflix. In this business-to-consumer (B2C) operational model, the withholding tax mechanism is often not applicable, which enables multinational enterprises (MNEs) to avoid tax payments despite earning significant income from the United Republic of Tanzania. Consequently, entities like MNEs can generate income from the URT without being obligated to pay the corresponding taxes.

UNILATERAL MEASURES OF STATES ON TAXATION OF E-COMMERCE

As the international community grapples with finding a consensus on the most effective approach to taxing digital commercial transactions, several governments have independently implemented measures to address the issue.[30] While many of these measures are geared towards generating revenue and are administratively feasible, it remains uncertain whether they represent the optimal solution for reconciling competing claims by interested jurisdictions over their perceived rightful share of the revenue. The widespread adoption of unilateral measures by numerous nations underscores the global and comprehensive consideration of taxing digital commercial transactions, which in turn raises concerns about the potential for double taxation. Consequently, this section briefly outlines the unilateral actions taken by various countries in response to the OECD's recommendation that governments implement such measures to address the taxation of digital commercial transactions.[31]

AFRICA TAX ADMINISTRATION FORUM’S (ATAF) SUGGESTIONS

Due to perceived shortcomings in the OECD Inclusive Framework's Unified Approach, ATAF expressed concerns that African nations might be compelled to adopt a wait-and-see approach regarding the potential international solution. ATAF contends that this approach could lead to significant delays in enacting and executing legislation to secure appropriate taxation rights for governments concerning the earnings of highly digitalized companies.[32] As a result, ATAF is putting forth a suggested strategy for crafting legislation on Digital Services Tax (DST) to assist its members in determining whether it is advisable to introduce new laws for taxing highly digitalized enterprises.ATAF's proposed Digital Services Tax (DST) is envisioned as a final withholding tax on gross turnover rather than an income tax. This DST legislation is recommended to encompass a range of digital services, including but not limited to digital content services, online gaming services, cloud computing services, online advertising, data services, and services provided through online marketplaces or intermediation platforms.

Furthermore, the DST is suggested to be imposed at a fixed rate, which may vary from 1% to 3%, or as determined by each country individually. This rate would be calculated based on the consideration paid for the aforementioned services, incorporating gross turnover related to the business activities falling within the scope of the tax. It would be charged separately from any income tax, and would not be eligible for credit or any other form of income tax relief.

TABLE 1: UNILATERAL APPROACH OF DIFFERENT COUNTRIES

SN	COUNTRY	MEASURES TAKEN	DESCRIPTIONS OF MEASURES TAKEN
1	INDIA	Equalization Levy	Tax is levied on the revenue generated from offering specific services received by non-residents without a Permanent Establishment (PE) in India.
Business Connection’s definition amended	The notion of Substantial Economic Presence (SEP) was brought forth.
2	UNITED KINGDOM	Multinational Anti-Avoidance Law	This applies when a foreign entity, classified as a 'significant global entity,' engages in an arrangement for providing goods or services with the intention of gaining tax advantages.
Diverted Profit Tax	The aim was to hinder profit redirection by abolishing agreements lacking economic substance.
Established the notion of 'avoided PE,'	It resembles a constructive Permanent Establishment (PE) in that it is taxed as if it were physically present. According to UK company law, the gains redirected from an evaded PE are subject to taxation as if they were earnings stemming from a genuine PE.
3	ITALY	Amended Definition of PE	Introduce the concept of a substantial economic presence, with exemptions limited to activities that are preliminary or supportive in nature. Impose a tax on the monetary compensation for services provided through electronic means. This tax is applicable solely to business-to-business (B2B) transactions, and it is the recipient of the service who must deduct and remit the tax.
Web Tax (Digital Services Tax)
4	USA	Introduced 10% minimum tax on global intangible low-taxed income (GILTI)	A 10.5% minimum tax on Global Intangible Low-Taxed Income (GILTI) was implemented to dissuade the practice of shifting profits. GILTI is designed to estimate the earnings from intangible assets (such as patents, trademarks, and copyrights) held in foreign jurisdictions.
5	ISRAEL	Amended Definition of PE	The concept of Permanent Establishment (PE) encompasses economic activities primarily conducted online.
6	SOUTH AFRICA	Introduced 15% VAT on Digital Services	Non-resident suppliers with an annual revenue exceeding ZAR 1 million are subject to a 15% value-added tax (VAT) on specific digital services.
7	AUSTRALIA	Diverted Profit Tax	The aim was to ensure that international organizations accurately reflected their economic activities and that profits weren't funneled through arrangements with affiliated parties. This pertains to Australian enterprises employing tax avoidance strategies.
8	NIGERIA	Introduced Significant Economic Presence (SEP)	The SEP rules have been implemented concerning non-resident entities, specifically Non-Resident Companies (NRCs), which engage in the transmission, emission, or reception of signals, sounds, messages, images, or data through cable, radio, electromagnetic systems, or any other electronic or wireless devices into Nigeria for digital services.
9	HUNGARY	Advertisement Tax	Imposed on content providers in the media industry based on their revenue generated from advertising activities.
10	KENYA	Introduced Digital Service Tax (DST)	Both resident and non-resident entities providing digital services covered by the DST in Kenya are subject to a 1.5% tax on the total transaction value.
Value Added Tax on Digital Marketplace Supply (VAT-DMPS)	The non-resident digital marketplace must pay a tax of 16% on the value of taxable services provided to a Kenyan resident, which is the standard rate.

CONCLUSION

In conclusion, the ever-evolving landscape of taxation in the realm of E-Commerce presents a multifaceted challenge. Traditional tax treaty models and established criteria for defining Permanent Establishment (PE) under the Income Tax Act do not seamlessly align with the distinct nature of digital commercial transactions. The intangible nature, borderless presence, and reliance on digital assets and data make it challenging to fit these activities into the traditional PE framework.Acknowledging this misalignment, governments worldwide have taken proactive steps to address this issue. They have pursued unilateral actions to tackle the taxation of digital commerce. One significant approach involves amending the PE definition within their tax laws to encompass the realities of E-Commerce. By broadening the scope of PE to include digital activities, these countries aim to ensure that businesses engaged in digital transactions contribute their fair share of taxes, aligning taxation with their economic presence in their jurisdictions.

Furthermore, many nations have introduced specific legislation to govern the taxation of E-Commerce. These laws aim to provide clear guidance and principles for taxing digital commercial transactions, often addressing issues related to revenue attribution, value creation driven by data, and tax avoidance strategies employed by multinational tech companies. This proactive stance underscores the importance of adapting tax regulations to keep pace with the rapid evolution of the digital economy. As governments continue to refine their taxation frameworks, it is evident that the taxation of E-Commerce is an ongoing and dynamic process. This reflects the need for flexibility and innovation in tax policy to ensure that the digital economy contributes to the revenue streams necessary for the sustainable development of nations in the 21st century.

[1] "‘Action 1 - OECD BEPS’ <https://www.oecd.org/tax/beps/beps-actions/action1/> accessed 7 October 2023.

[2] "Adam Smith, Wealth of Nations -- Books I, II, III, IV, V -- MetaLibri Slides v1.0s (MetaLibri Digital Library 2007) <http://archive.org/details/SmithA_WealthNations_1.0s> accessed 7 October 2023.

[3] "‘Addressing the Tax Challenges of the Digital Economy | En | OECD’ <https://www.oecd.org/ctp/addressing-the-tax-challenges-of-the-digital-economy-9789264218789-en.htm> accessed 7 October 2023.

[4] "‘Addressing the Tax Challenges of the Digital Economy’ (OCED 2015) Action 1 2015 Final Report.

[5] "‘Taxability of E-Commerce Transactions | Dewan P.N Chopra & Co.’ (Blog - Dewan P.N Chopra & Co., Chartered Accountants, 6 April 2020) <https://www.dpncindia.com/blog/taxability-of-e-commerce-transactions/> accessed 7 October 2023.

[6] "Shariq Nadeem and Anoop Saxena, ‘The Challenges of Taxing E-Commerce’ (2018) V International Journal of Management Studies 56.

[7] "Jianli Gao and others, ‘Impact of E-Commerce and Digital Marketing Adoption on the Financial and Sustainability Performance of MSMEs during the COVID-19 Pandemic: An Empirical Study’ (2023) 15 Sustainability 1594.

[8] "Jean-Paul A Yaacoub and others, ‘Ethical Hacking for IoT: Security Issues, Challenges, Solutions and Recommendations’ (2023) 3 Internet of Things and Cyber-Physical Systems 280.

[9] "Anil Talreja, ‘Changing Tax Reforms in India – What Next?’ (2013) 24 National Law School of India Review 75, 76.

[10] "David ST Matkin, ‘Designing Accountable And Effective Economic Development Tax Incentives: A Study of Corporate Tax Credits in Kansas’ (2010) 34 Public Performance & Management Review 166, 177.

[11] "Soledad Artiz Prillaman and Kenneth J Meier, ‘Taxes, Incentives, and Economic Growth: Assessing the Impact of Pro-Business Taxes on U.S. State Economies’ (2014) 76 The Journal of Politics 364.

[12] "‘Tax Policy’ (U.S. Department of the Treasury, 28 August 2023) <https://home.treasury.gov/about/offices/tax-policy> accessed 7 October 2023.

[13] "OECD, ‘Commentary on Article 5’ (OECD 2017) 5 <https://www.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version-2017/commentary-on-article-5_mtc_cond-2017-8-en> accessed 7 October 2023.

[14] "ibid 49.

[15] "OECD (n 14).

[16] "ibid 120.

[17] ".OECD (n 14).

[18] "ibid.

[19] "‘Danish Tax Board Rules Danish Data Center Does Not Create a Permanent Establishment for Nonresident Company’ <https://taxnews.ey.com/news/2020-2390-danish-tax-board-rules-danish-data-center-does-not-create-a-permanent-establishment-for-nonresident-company> accessed 7 October 2023.

[20] "Babak Heydari and others (eds), ‘Sharing in Context – Domains, Applications, and Effects’, Reengineering the Sharing Economy: Design, Policy, and Regulation (Cambridge University Press 2023) <https://www.cambridge.org/core/books/reengineering-the-sharing-economy/sharing-in-context-domains-applications-and-effects/9C8CFD149360EA1A68C1D0EF406FDF92> accessed 8 October 2023.

[21] "‘Permanent Establishment (PE) Definition and Examples)’ (Bloomberg Tax) <https://pro.bloombergtax.com/brief/permanent-establishment-pe-intl/> accessed 8 October 2023.

[22] "Sebastian Beer and Geerten Michielse, ‘Chapter 11 Strengthening Source-Based Taxation’, Corporate Income Taxes under Pressure (International Monetary Fund) <https://www.elibrary.imf.org/display/book/9781513511771/ch011.xml> accessed 8 October 2023.

[23] "Vanistendael Frans, ‘2 Legal Framework for Taxation’, Tax Law Design and Drafting, Volume 1 (International Monetary Fund) <https://www.elibrary.imf.org/display/book/9781557755872/ch02.xml> accessed 8 October 2023.

[24] "National Microfinance Bank T. Ltd vs Commissioner General, Tanzania Revenue Authority (Civil Appeal 168 of 2018) [2019] TZCA 182 (25 June 2019) (2019) <https://tanzlii.org/akn/tz/judgment/tzca/2019/182/eng@2019-06-25> accessed 8 October 2023.

[25] "‘Treatment of Income from Different Sources’ <https://incometaxindia.gov.in/Documents/Left%20Menu/income-from-other-sources.htm> accessed 8 October 2023.

[26] "B&E Ako Law, ‘The Court of Appeal of Tanzania Rules That Payment for Acquiring Computer Software Is Royalty Subject to Withholding Tax’ (B&EAKO LAW) <https://beakolaw.co.tz/court-tanzania-payment-software-withholding-tax/> accessed 8 October 2023.

[27]National Microfinance Bank T. Ltd vs Commissioner General, Tanzania Revenue Authority (Civil Appeal 168 of 2018) [2019] TZCA 182 (25 June 2019) (n 25).

[28] "Sebastien Leduc and Geerten Michielse, ‘Chapter 8 Are Tax Treaties Worth It for Developing Economies?’, Corporate Income Taxes under Pressure (International Monetary Fund) <https://www.elibrary.imf.org/display/book/9781513511771/ch008.xml> accessed 8 October 2023.

[29] "‘Tanzania - Corporate - Corporate Residence’ <https://taxsummaries.pwc.com/tanzania/corporate/corporate-residence> accessed 8 October 2023.

[30] "‘Understanding Digital Services Taxes & the OECD’ (Bloomberg Tax, 23 August 2023) <https://pro.bloombergtax.com/brief/understanding-digital-services-taxes-the-oecd/> accessed 8 October 2023.

[31] "‘Taxation of E-Commerce | Federal Trade Commission’ <https://www.ftc.gov/news-events/news/speeches/taxation-e-commerce> accessed 8 October 2023.

[32] "‘Understanding Digital Services Taxes & the OECD’ (n 31).