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The emerging digital economy

Growth prospects and issues of taxation

by tbhdesk
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In the recent past, there has been an exponential growth of the digital economy in Bangladesh, underpinned by the spread of, and easier access to, the internet and the increasing use of digital communication technologies, applications, and tools. Entrepreneurial talent, various policy supports, and a host of fiscal-monetary incentives by the Government of Bangladesh (GoB) have combined to trigger this spurt in the digital economy-centric activities in the country.

As a percentage of GDP, the share of digital economy is still low — a recent Asian Development Bank study (May 2023) estimates its share in Bangladesh’s GDP to be equivalent to only about 2.6%. However, the pace of adoption of digital applications by various sectors, enterprises, and businesses has been on the rise, and in recent times e-commerce, F-commerce, and IT-enabled service (ITES) of various types are populating Bangladesh’s economic landscape with remarkable speed. Indeed, efficiency and competitiveness of production of goods are becoming increasingly entwined with the performance of the service sector economy.

Digital platform-based economy is creating income-earning opportunities, creating jobs, and facilitating delivery of public services. A new generation of young women and men who are keen to take advantage of this non-traditional, new economy, has been playing a pioneering role in ushering in this brave new world.

From the perspective of domestic resource mobilization (DRM), the growing role of digital platform-based activities has two significant ramifications: Firstly, by taking advantage of digitalization and digital technologies, an opportunity has emerged to raise the efficiency of domestic tax collection towards greater fiscal mobilization; secondly, the digital economy itself has created an opportunity for higher DRM through taxation of this newly emerging component of the evolving GDP.

Given the above, in the current context, issues of taxing Bangladesh’s digital economy have emerged as an important area of policy interest, for several reasons.

First, as was noted, Bangladesh needs to expand the tax base and explore new avenues to enhance its DRM and public expenditure capacity. As one recalls, in the 7th Five-Year Plan the target for the tax-GDP ratio was set at 14.1% at the end of the plan period (FY2019-20). In the end, it turned out to be 7%.

Low tax/revenue-GDP ratios also result in a low public expenditure-GDP ratio. With Bangladesh at 15% of GDP at present, this is the lowest in the South Asian region.

Second, as part of the IMF Programme, Bangladesh needs to raise its tax-GDP ratio from the current 7.8% to 9.4% over the next 3 years, requiring an additional tax mobilization of about Tk234 thousand crore by FY2026.

Third, the periodic re-estimation of National Income by the Bangladesh Bureau of Statistics increases the country’s GDP, mostly through inclusion of various new services-related activities, a large part of which is based on the digital platforms.

However, this is not reflected in the revenue mobilization efforts. Consequently, the denominator (GDP) is getting larger, while the numerators (tax, revenue, and most of the other indicators) fail to increase at the same pace, resulting in the fall of all key ratios. Thus, while the numbers are on the rise, to some extent the tax/revenue-GDP ratios are declining.

Fourth, there are definitional ambiguities concerning what constitutes the digital economy as also concerning appropriate and applicable HS codes. This gives rise to conflicting views as regards to which parts of the digital economy should be taxed and which should not be, and at what rates.

Fifth, in view of the growing presence of non-resident digital service providers in Bangladesh, income transfer and tax payments issues have emerged as concerns which need to be carefully examined to remove the uncertainties regarding taxation.

Sixth, policymakers need to take decisions in regards to the IT-enabled services (ITES) which are currently allowed to operate under income tax exemption (numbered at 28 at present); this is to remain effective till June 2024.

Seventh, Bangladesh should monitor developments in the WTO regarding the decision to bring an end to the moratorium on customs duties on e-transmission and will need to strategize accordingly.

Not that Bangladesh is not taxing the digital economy. A number of subsectors of the digital economy are subject to the imposition of VAT and customs duties and have been brought under the income tax net. On the other hand, a significant part has been allowed to enjoy tax exemption on grounds of promoting this nascent sector.

There is no denying that policymakers will need to carefully weigh the trade-offs and conflicting perspectives while taking decision on taxing the digital economy — the need to mobilize higher amount of taxes, issues of protection of import-substituting activities, infant industry argument, short-term versus medium-term interests of the sector, and concerns about sustainability, competitiveness, and profitability of enterprises and entrepreneurs. Consequently, sequencing, phasing, and pacing of taxation of the digital economy will need to be carefully considered.

As was noted, digital platform-based economic activities have been on an increasing rise in recent years. The B2C e-commerce market in Bangladesh is expected to reach about $10.5 billion in 2026 (Research and Markets, 2022). Country’s software industry is also a growing sector, with estimated annual IT export revenues worth $1.3bn (BASIS, 2021), although the Export Promotion Bureau (EPB) reports a lower figure of $436.7 million for FY2020-21. There are about 650 thousand freelancers in Bangladesh according to some sources.

A recent CPD study carried out by the authors on this subject proposes various options as regards the gradual phase-out of income tax waiver on ITES services as also the tax gains to be had through selective imposition of taxes on digital economy.

The CPD study found that customs duties on overseas e-transmission (a moratorium is in place in the WTO since 1998), exemption of 10% tax deducted at source (TDS) on ITES export, and tax exemption on the BPO sector could generate significant annual revenue for the GoB. If a reduced tax rate of 12% is applied on BPO sector (a major tax-exempted sector), the GoB would have collected about Tk186 crore as taxes (between 2018 and 2022).

Estimates indicate that the revenue forgone owing to the 10% TDS exemption on ITES export proceeds increased from about $17.2m in FY2019-20 to about $48.4m in FY2021-22. The total tariff income loss owing to the 1998 moratorium is estimated to have increased from about $20.73 million in 2017 to about $62.4 million in 2021 according to a study carried out by the authors for a CPD study.

To promote transparency and tax equity, it is recommended that the GoB consider imposing a sunset clause on tax exemptions for sectors that are enjoying these exemptions beyond a stipulated period. For example, ITESs making profit which have been enjoying tax exemption since 2008 could be brought under the tax net through amendments to the relevant Finance Acts, starting from 2027, and the rest of the ITES could be brought under the tax net through the Finance Acts, starting from 2030. In addition, to address the issue of taxing freelancing, which is currently tax-exempted, the NBR and the GoB may follow India’s example as under its Presumptive Taxation Scheme.

To bring non-resident tech giants under the income tax net, appropriate legal provisions will need to be put in place for such businesses to get TIN to enable these to submit tax returns. It is important that this issue be effectively addressed and incorporated this year within the provisions of the Finance Act 2023.

The GoB and the NBR should take initiatives to be the member of the OECD/G20 Inclusive Framework on Base Erosion and Profit Sharing (BEPS) to implement OECD’s two-pillar solution which addresses the issue of apportioning income of non-resident companies from various jurisdictions, in accordance with a formula. Meanwhile, the NBR and the GoB could also apply to be observers to collect relevant information prior to joining the framework.

Some ITES entities take advantage of interpretative ambiguities in the definition of ITES; this needs to be streamlined. There is a need to include a precise definition of e-commerce in the ITO of 1984, considering the likelihood of the increasing number of businesses which are going for online presence. Additionally, the NBR should consider expanding the scope of service code 99.60 to include online marketplaces; it could also think of issuing a new service code for this industry.

In view of overvaluation of digital enterprises to evade tax, by charging higher rates of depreciation, relevant agencies should come up with a framework to assess the valuation of ITES services. An appropriate valuation should be developed by taking into cognisance specificities of the particular intangible assets. A Standardized Accounting Framework may be developed for the digital economy.

Taking into cognisance the disparity between the reported export proceeds of the EPB and the actual received proceeds, steps should be taken to create a reliable export database for IT-related exports. Bangladesh Bank and the EPB should put in place suitable tools to encourage and incentivize sending of earnings through formal channels. At the same time, measures should be taken to address the complaints about double taxation when unregistered small businesses (without Business Identification Number) and individuals make overseas payments to non-resident digital service providers through banking channels.

Considering the likely lifting of the 1998 moratorium as regards e-transmission, the NBR should be adequately prepared, with the necessary technological infrastructure to capture and access imports via e-transmission. Customs duties on concerned items may then be imposed selectively. Coverage and tariffs should be determined by considering consumer welfare implications, domestic services industry interests, and revenue implications.

To develop the digital economy, the GoB should take a number of steps on an urgent basis. This could include the followings: Investing in internet infrastructure to reduce internet costs and raise speed of internet; introducing PayPal; ensuring personal data protection law through proper legal instrument; formalizing F-commerce within a legal framework; and developing a National Startup Policy. These are essential steps for stimulating the growth of digital platform-based activities and businesses in Bangladesh. A detailed assessment of tax expenditures including an appropriate definition and a methodology for measuring tax expenditure needs to be developed.

As the share of the digital economy expands, issues of taxing the digital economy will call for increasingly serious attention. A comprehensive strategy should be developed that takes into account both the potentials of the expanding digital economy in Bangladesh and sets a road map for domestic resource mobilization both through deploying digital technology for greater fiscal mobilization and taxing the digital economy for higher tax-GDP ratio. This should be seen as an important component of the transition of Digital Bangladesh to Smart Bangladesh and as a sine qua non for realizing the development aspirations articulated in Vision 2041.

Mustafizur Rahman is a Fellow, CPD. Amenda Philomina Purification is a Program Associate, CPD.

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