Tax Implications for Digital Economy: An analysis of India and UK Taxonomies

[By Syed Alwaz Asif]

The author is a student of Dr. Ram Manohar Lohiya National Law University, Lucknow.

Introduction

The post-pandemic world has changed rapidly. Digital platforms, which were a privilege for a few, have become necessary to upgrade workers’ skills[i]. It has provided an opportunity for workers to ensure flexibility in the work that they seek to do. It has become a significant source of employment. As a result, governments are constructing digital infrastructure to give their employees newer digital capabilities. Numerous social groups, including women, people with disabilities, and younger generations, who do not frequently participate in the conventional labour market, have access to income-generating opportunities. They also gave marginalized groups in conventional labour markets, such as refugees and migratory labourers, options to explore.

Along with the benefits, these platforms have opened up a pandora’s box of challenges for the regulators. Long-standing taxation economies utilized in employment and tax law are under increasing pressure, which is why the law needs to adapt. The labour market is divided into specified categories due to legal control in these sectors, and rights and duties are associated with each category. The tests used to determine which group a person fits under are murky and too simple to evade lawful taxation for digital platforms. The relationship between the various groups under tax and labour law is particularly unclear.

These developments have significantly impacted the taxation aspect for this category of workers. This category of independent contractors is, therefore, exempt from laws governing the minimum pay, working hours, terminations, and, to some extent, employment discrimination. Thus, by structuring one’s workforce as a group of micro-entrepreneurs, one can cut indirect expenses for employers while still abiding by labour laws.

Similar economic activity can be classified into several legal forms underneath the current tax and employment law systems, creating substantial financial and regulatory incentives to choose one legal form over another. The taxation regulation provides several incentives to treat persons providing services to the engager’s business as self-employed contractors, which can help engagers avoid regulatory obligations and costs. The tax structure gives the person providing the services additional incentives to incorporate. Being recognized as a ‘gig worker‘ or offering services through a firm will allow the employee to improve his current take-home income.

Under Indian Tax Laws, any income gained from an individual’s intellectual abilities is considered earnings from a profession under section 2 clause 24 of the Income Tax Act, 1961. Even if the income from digital works is less than Rs. 2,50,000, no direct tax is charged for this bracket. The income from gig work is subject to taxation under section 28 of the Income Tax Act, 1961 under the heading ‘Profits and Gains from Business or Profession’[ii]. Independent contractors are eligible in law to claim various tax deductions such as rental expenses, repair expenditures, and Depreciation for technological assets used for work and travel expenses. A GST registration is required for independent contractors with a revenue of more than 20 lakhs and who provide services outside of their state. The amount of GST an independent contractor, must pay varies according to their services. He is accountable for 18% GST if there is no rate mentioned.

In UK taxonomies, tax disadvantage to an employee compared to a self-employed worker is more prominent[iii]. Under specific assumptions, employees and their employers pay about 70% more tax on such a sum than an equivalent owner-manager of a business and 35% more than an identical self-employed person. Significant incentives are created due to organizing activity in ways except through contract terms. Because of these disparities in tax rates, the tendency to work independently or via a personal digital services firm is detrimental to overall tax receipts[iv].

The rise of individuals working for their businesses and the consequent rise in the new form of working have tax-linked implications. Employees’ income across major jurisdictions is taxed more than self-employed. This is because employees are subject to social security insurance funds in India as well as the UK, but there is no such kind of regulation for self-employed. Many analysts justify the tax deduction that self-employed people receive on the pretext that they do not have active social security benefits.

Differential tax treatment means individuals in similar places may have grossly different tax burdens. This lacks equity and fairness and creates economic inefficiency in the tax systems.

A vital component of any competent regulatory taxation system is neutrality. Since similar activities are treated equally in a neutral system, people have no incentive to switch from highly taxed or regulated activities to those that are not. As shown above, the tax rates that apply to the same productive work vary greatly depending on whether someone provided their work through formal employment or self-employment.

Complexities Involved

The workers who are employed in Gig work have many sources of income. It creates practical complexities in filing the tax form. This leads to many individuals either skipping tax payments by mistake or failing to take benefit of tax rebates that come with their work mode. It exposes many workers to potential tax enquiry by the respective department. To buttress this, the workers have to take help from lawyers and accountants, which increases the costs that these workers have to pay to accomplish this task.

The demanding challenges are not just limited to those who pay taxes but also to Income tax authorities as far as compliance is concerned. Existing Tax infrastructure needed to be designed keeping the burgeoning Gig Economy in mind. The Income Tax authorities across multiple jurisdictions face communications issues. They had to contact just one employer or platform for tax regulation. They must contact multiple independent contractors to inform them about their tax obligations. They may also have to inform them whether they are underreporting or not reporting their tax obligations.

The state of applying different tax brackets to employees and self-employed provides explicit opportunities for tax evasion and avoidance. This puts a strain on Tax-collecting authority, leading to inefficient tax-collection systems. For Tax avoidance, individuals leverage the more significant complexities involved in business activities on digital platforms. Individuals actively avoid tax by sharing it with their spouses and shifting income for multiple years. For Tax Evasion, the current system provides that tax is deducted at source for employees by the employer, and the employer reports this to the Income-tax authority. This third-party reporting has its check and balances and also ensures that accountability is set for any kind of gross underreporting. The gig workers have a greater opportunity to declare falsely in which year the tax income arises. The gig workers can also claim their laptops and related devices as business assets to evade liability.

Alignment of Tax and Labour Law

The major problem many jurisdictions currently face due to the significant rise of digital work is that tax and labour law works poles apart. This creates practical difficulties in implementing both the laws and hurts efficient taxation systems in the countries. Multiple times, arguments have been put forth that Tax and Labour law should be harmonized      to reduce compliance and administrative costs and complexities.

Conclusion

The gig economy provides excellent growth potential.

The Estonia example serves as a promising direction towards the upgradation of tax law. In Estonia, Uber worked with the Estonian government to create an efficient electronic tax system where Uber workers can file their returns earned from Uber at a simple click of a button.

Governments must work with major digital platforms to make an efficient tax system. It would address the current complications involved across many jurisdictions.

The differential tax treatment given to employees and self-employed also needs redressal. The government in a particular jurisdiction should set up a long-term vision for where their tax system is moving forward. Aligning the tax rates for employees and self-employed redresses many complexities currently prevailing in the tax systems in the UK and the India.

Reforms that governments may consider in aligning multiple legal forms for taxation purposes should keep in mind that these reforms would sit in the middle of where many tax systems come together. Thus, a careful approach has to be adopted to avoid material disadvantages to any group operating in a different legal form. Reducing the tax differences and aligning them to multiple legal forms is the best way to deal with this new and rising problem.

In conclusion, the tax systems should be designed so that returns to capital employed and labour put-in is taxable at a specific margin, thereby removing distortions regarding base income. Furthermore, this approach can be further strengthened by making cash saved or invested deductible from taxable income at the point they are saved or invested. This approach would also provide a solution to policymakers’ conundrum to prevent tax avoidance and incentivise saving and investing simultaneously.

[i] Syed Alwaz Asif, Status of Gig economy workers: An Analysis of US, UK and Indian laws, https://cll.nliu.ac.in/status-of-gig-economy-workers-an-analysis-of-us-uk-and-indian-laws/, accessed on December 1, 2022

[ii] § 28, Income Tax Act, 1961.

 [iii] Adams-Prassl Abi, Freedman Judith and Admas-Prassl Jeremias, “Rethinking Legal Taxonomies for the Gig Economy: Tax Law, Employment Law, and Economic Incentives”, Oxford Legal Studies Research Paper No. 12/2018, https://academic.oup.com/oxrep/article/34/3/475/5047373, accessed on December 6, 2022.

 [iv] Id

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