FOREWORD:
“Vasudha-Iva Kutumba-Kam (Sanskrit: वसुधैव कु टुम्बकम) - The Whole World is ONE FAMILY.” The phrase has become most relevant in reference to present day world economics. In today's interconnected global economy, international trade has become a driving force for economic growth and development. Most of the developed countries are strengthening their technology base, which simply gets converted into money by transforming into demands. In this competitive world, the main emphasis of corporates is on maximizing the sales and reducing the cost of production for revenue growth with optimizing the technological advancements that are happening at a very fast pace.
The corporate houses make such engagements to take advantage of location and resources to increase production and lower cost. One critical aspect of this engagement is technology transfer – the sharing of knowledge, skills, and innovations between nations. Technology transfer plays a pivotal role in promoting economic efficiency, productivity, and sustainable development, making it an essential component of modern international trade.
The transfer of technology may take place through various mediums and stages, but the financial transaction can happen on technology transfer as outright sale or license basis. In case of outright sale many a times the transferor accepts equity in the transferee or joint venture company in lieu of cash payments and in case of license transfer the same can be lumpsum royalty or periodic or combination of both.
Where there is any commercial transaction, there involves tax implication whether direct or indirect. The intersection of international technology transfer transaction and international taxation presents a complex landscape with important implications for both countries and businesses. The taxation policies revolve around two primary aspects: royalties in case of license & Fees for Technical Services (FTS) and Consideration for Outright Sales.
This article addresses the imperative relationship between Technology Transfer and International Taxation with special emphasis on the challenges and considerations surrounding the taxation of technology transfer and its influence in worldwide technological advancements and its potential to drive economic growth while ensuring fairness in the global tax system.
❖ BASIS FOR TAXING THE TRANFER OF TECHNOLOGY:
Taxation on Transfer of Technology (TOT) is referred to the charges levied on the settlements made in favour of cross-border Technology Transfer Transaction. Intellectual Property Rights (IPR), entailing patents, copyrights, trademarks, and trade secrets are generally conveyed from the licensor situated in one nation to the licensee situated in another nation in an international technology transfer transaction. Due to this intangible nature of intellectual property rights (IP) there arises multiple conundrums while determining the appropriate tax treatment.
❖ THE EVOLUTION OF INTERNATIONAL TAXATION ON TOT
With the conventional taxation regimes, it is very difficult to quantify the monetary incentives generated by the Intellectual Property which can easily be conveyed to the nations having lenient tax regimes and lower tax slabs. This creates opportunities for tax avoidance or profit shifting, where companies may manipulate the allocation of IP rights to minimize tax liabilities, thus its open avenues for hiding illicit revenues and tax evasion.
Technology Transfer may occur in various ways, but the instrument and methodology adopted while transferring the technology is determined by the taxation norms in both nations whether it is bringing-in technology (Technology Recipient) or sending out technology (Technology Transferor). This can affect the cost of importing the technology and reduces the expected returns at the end of technology transfer. The cost-effective method of transferring technology can be implemented by bringing double taxation avoidance regime with mutually reinforcing effect.
Taxation on Technology Transfer Transactions falls under a number of headings such as, business profits, fees for services, rents and royalties, dividends and capital gains, and employees' salaries etc.
❖ IMPEDIMENTS IN A DYNAMIC LANDSCAPE OF TAXATION
While taxation regulations on technology transfer attempt to achieve a balance between fostering innovation and safeguarding economic interests, they are fraught with difficulties and have important ramifications:
I. Double Taxation: The issue of Double taxation emerges in relation to a Technology Transfer Transaction in three main ways:
- When a person is residing in two or more countries,
- When an income is deemed to have its source from two or more countries,
- When a person residing in one country receives income derived from a source in another country.
**Person can be Natural or Artificial**
It is not possible to deliver a single, unilateral solution to avoid the issues of double taxation in such circumstances, however the tax treaties such as Double Taxation Avoidance (DTAAs) Agreements and Free Trade Agreements (FTAs) consistently and effectively deliver the solution for the same. The use of DTAAs results in a tax efficient mechanism for global technology transfers. In case of India, DTAAs already exists with 85 countries and FTA with more than 50 countries with provisions for taxation of 10-20% of royalties on services.
II. Transfer Pricing:
Transfer pricing regulations are designed to make sure that business dealings between related parties—such as a parent firm and a foreign subsidiary—are carried out in the same manner as those between unrelated parties. Transactions involving the transfer of technology can be subject to transfer pricing restrictions, which mandate that the royalties or prices paid for the TOT be established in accordance with comparable market transactions.
One globally recognized approach to address transfer pricing challenges is the Arm's Length Principle, endorsed by the OECD's Transfer Pricing Guidelines. This principle advocates that transactions between related entities should be conducted as if they were unrelated parties, ensuring fair pricing and preventing profit shifting. Additionally, the use of Advance Pricing Agreements (APAs) has gained popularity as a proactive measure, allowing taxpayers to negotiate transfer pricing methodologies with tax authorities in advance to mitigate disputes.
Also, the concept of Permanent Establishment (PE) holds significance in Transfer Pricing implications of International TOT Transactions. PE refers to a fixed place of business through which a foreign enterprise carries out its business activities in another country, thereby triggering tax liabilities in that jurisdiction. The OECD Model Tax Convention includes specific guidelines on the definition and taxation of PE and aims to prevent tax avoidance by ensuring that profits are appropriately attributed to the country where the business has a substantial presence.
By identifying and properly taxing PE, countries can ensure a fair distribution of tax revenues and reduce the risk of double taxation or profit shifting.
III. Withholding Tax or TDS:
Withholding tax, also known as Retention Tax or Tax Deduction at Source (TDS), is a mechanism employed by tax authorities to collect a portion of tax directly from the source of income. While the main purpose of tax treaties is to divide up the states' taxing authority, it also plays a very crucial role in reducing the withholding tax that is charged by the technology recipient nation on payments of royalties, technical fees etc. Tax treaties also aid in establishing a strong collaboration with significant cooperation among tax authorities of different economies which ultimately lead in the development of a standard regime that lessens redundancy with domestic taxation regulations.
IV. Capital Gain Tax (CGT):
When technology is transferred between parties, any gains arising from the transaction may be subject to taxation. The capital gains tax is levied on the profit made from selling or licensing technology at a higher price than its original cost or book value. This tax applies not only to domestic technology transfers but also to international transactions, adding complexity to the already intricate global tax landscape. The taxation of capital gains in technology transfer involves considerations such as the holding period of the technology, the type of intellectual property being transferred, and any applicable tax treaties between the countries. Striking the right balance between encouraging technological innovation and ensuring equitable tax revenues presents a challenge for policymakers and businesses alike. As technology continues to drive economic growth and international collaborations, understanding the nuances of capital gains tax in technology transfer becomes paramount for enterprises seeking to navigate the dynamic world of cross-border intellectual property transactions.
V. Indirect Tax Implications On TOT:
The TOT in many countries is subjected to Indirect Tax as the same is treated as either goods or services. In India with the introduction of Goods and Services Tax (GST) has brought a significant impact on technology transfer transactions, reshaping the indirect tax landscape for businesses involved in such arrangements. As per the Section 7 of CGST ACT, 2016 Royalty Payments for Technology or Fees for Technical Services has been treated under the head of 'supply of services' and the GST applicable to it at the rest of 18%. Whereas the Upright Sale of Technology is treated as “supply of goods” and GST is applicable at the rate of 18%.
To mitigate potential risks and ensure compliance with GST regulations, businesses need expert advice from tax professionals who possess a comprehensive understanding of both technology transfer and tax nuances. By proactively addressing tax challenges in technology transfer transactions, businesses can optimize their tax position and avoid unintended consequences, thereby fostering innovation and growth in the technology sector.
❖ THE OECD MODEL OF INTERNATIONAL TAXATION ON TOT - BALANCING TAXATION AND INNOVATION
One of the key challenges in taxing technology companies lies in striking the right balance between fair taxation and encouraging innovation. Critics argue that excessive taxation on technology companies could stifle innovation and hinder the development of cutting-edge technologies that benefit society. On the other hand, proponents argue that fair taxation is essential to ensure that technology companies contribute their fair share to public finances and support social welfare programs.
The OECD model attempts to strike this balance by focusing on taxing profits in jurisdictions where economic activities and value creation occur while providing certainty and predictability to businesses through transparent rules and dispute resolution mechanisms. By promoting a level playing field and reducing tax uncertainty, the model aims to foster innovation and competition while ensuring a fair distribution of tax revenues.
The issue of double taxation emerges from the interplay between the different taxation regimes of both technology recipient & transferor nation. Organization for Economic Cooperation and Development (OECD) and United Nation (UN) jointly had a significant impact on the design of domestic tax systems that apply to international trade and played a key role in developing a framework for the eradication of double taxation issues.
Globally, there exists more than 2,500 DTAAs and other agreements of a similar nature, all of which typically resemble the OECD Model or the UN Model, which in itself based on the OECD Model but has been modified to address the peculiar requirements of developing nations.
In 2013, the OECD launched the BEPS project, a ground-breaking initiative aimed at tackling tax avoidance strategies used by multinational enterprises, including technology companies. The BEPS project sought to ensure that profits were taxed where economic activities took place and value was created, rather than allowing profits to be artificially shifted to low-tax jurisdictions.
- Key Elements of the OECD Model of International
Taxation on TOT
- Nexus and Digital Presence: The OECD model establishes a clear nexus for taxing technology companies in a jurisdiction, considering factors such as user participation, digital advertising, and significant economic presence. This approach ensures that companies with a substantial digital footprint are subject to taxation in the countries where they operate.
- Profit Allocation: The OECD model introduces new rules for allocating profits of technology companies among different jurisdictions. It focuses on aligning profits with value creation, considering factors like user data, intellectual property, and marketing efforts. This helps prevent profit shifting and ensures a fair distribution of taxable income.
- Minimum Taxation: The OECD model proposes a global minimum tax rate to prevent companies from engaging in aggressive tax planning to reduce their overall tax liabilities. This measure seeks to establish a level playing field for all businesses, including technology companies, and prevent a race to the bottom in terms of tax rates.
- Dispute Resolution Mechanisms: To address potential conflicts between countries in implementing the new tax rules, the OECD model includes effective dispute resolution mechanisms. This ensures that disputes are resolved efficiently and transparently, fostering a cooperative international tax environment.
❖ WAYS OF PROMOTING EFFECTIVE TECHNOLOGY TRANSFER
To maximize the benefits of technology transfer in international trade, policymakers and stakeholders must take proactive measures:
- Strengthening Intellectual Property Protection: Balancing the protection of intellectual property rights with the need for knowledge dissemination is crucial. Robust legal frameworks can encourage technology holders to share their innovations while safeguarding their interests.
- Capacity Building and Skill Development: Investing in education and training programs to build a skilled workforce capable of understanding, adapting, and effectively utilizing transferred technologies can empower developing nations.
- Encouraging Collaboration and Partnerships: Promoting collaboration between governments, businesses, and research institutions can facilitate knowledge exchange and foster innovation ecosystems that nurture technology transfer.
- Free Trade Agreements & Double Taxation Avoidance Agreements: International trade agreements should prioritize fair and equitable technology transfer terms to ensure a more balanced global exchange of knowledge and innovations.
❖ CONCLUDING REMARKS
One of the essential components required to encourage developing nations assimilate into and thrive in the global economy as well as achieve their socioeconomic and sustainable goals is technology transfer. The wide range of tax tools that are accessible to countries that import, and export technology may promote or impede TOT.
On one hand, nations want to make it easier for people to obtain and access advancements in science and technology and on the other hand they also want to get their equitable part of the business income that go to the proprietor of the technology that is residing overseas. The goals of both technology exporting and importing nations are somewhat identical from a taxation standpoint as all the countries seek to promote their businesses to create revolutionary technological advancements, use these innovations commercially, and export those technologies, which increases their capacity for profit. These two contrasting goals may clash, and the tax regulations that were intended to safeguard the evasion of local tax revenues, may make it difficult to convey technical knowledge overseas.
The OECD Model of International Taxation on TOT represents a significant step forward in addressing the challenges posed by the digitalization of the global economy. By introducing new rules for nexus, profit allocation, and minimum taxation, the model seeks to ensure that technology companies are taxed in a manner that aligns with their economic activities and value creation. Moreover, its emphasis on dispute resolution mechanisms and international cooperation fosters a collaborative approach to tackling tax challenges in the digital age. As technology continues to shape the world, the OECD's efforts to establish a fair and effective international tax framework will remain vital in promoting innovation, economic growth, and global tax fairness.
Multilateral collaboration, continual communication, and a dedication to establishing level playing fields for enterprises are necessary to strike a balance between promoting technology transfer, guaranteeing equitable taxes, and combating tax evasion. By striking the right balance, the international community can embrace the digital transformation while ensuring that technology companies contribute their fair share to the societies in which they operate.
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.
