[Shantanu Lakhotia is a 4th year B.A., LL.B. (Hons.) student at Jindal Global Law School in Sonipat]
A notification issued by the Government of India on 27 May 2016 provides for a 6% equalization levy to be withheld by Indian residents, as well as a foreign company having a permanent establishments in India, from business-to-business payments to a non-resident service provider for specified digital services. These include online advertisements, digital advertising space and any other service which may be notified from time to time by the government. The scope of the tax could therefore be quite wide. On the basis that the levy is not an income tax, the Government considers it outside the ambit of India’s tax treaties and it may not qualify as a foreign tax credit in the recipient’s jurisdiction. It is necessary to point out that there is an exemption for payments of less than INR 100,000 per year. In its haste to solve the problem of non-taxation of such transaction, the Government’s actions have given rise to several issues. This post seeks to briefly summarise seven problems with equalisation levy.
1. The levy is introduced as an “alternate levy” outside the scope of the existing income tax law, which raises questions on its treaty coverage. The legitimacy and universal acceptance of the income tax statutes in general is rooted from the fact that they are subject to a centralizedmechanism which is abundantly regulated. The question about legitimacy of the characterization of ‘digital transactions’ in the levy arises, given that such levies in practice appear to be essentially indistinguishable from a tax on the broader category of business profits.
2. Government levies such as the equalisation levy are a unilateral mandate of countries. If states decide to tax on a unilateral basis without any sort of co-ordination or agreement with the counterpart corresponding state, the same income may get taxed more than once, thereby creating hindrance to free trade. It is important to bear in mind that achieving an outcome that promotes growth among countries requires ‘a consensus based approach.’ A unilateral levy would only be a cost to business, require separate administrative intervention/compliance and make the taxation system more burdensome. Therefore, equalisation levy would only create complexities for businesses with little or no effective resolutions.
3. This levy will eventually impact the small local players more severely than the giant-sized enterprises of the world such are Google and Facebook as far as online advertisements are concerned. These big foreign advertisement platforms may likely pass on the ‘extra costs’ to the ultimate customers, i.e., the small and medium-sized enterprises and start-ups, who sustain on digital advertising because the foreign company will not bear the loss and will increase its price by grossing up this tax amount. Ultimately, the loss will be borne by the Indian business owner. The equalisation levy would translate into start-ups ending up paying 6% over the GST, which they were already paying before the levy, making digital advertisement more expensive for local Indian advertisers.
4. The introduction of an equalization levy on a unilateral basis may entail a risk of international double taxation as the state of residence would not be obliged to provide relief under the applicable tax treaty.Since it is not an income tax, if a non-resident company supplying the ‘specified services’ and paying equalisation levy is also paying income tax in its residence country, it will not be able to claim income tax credit for the equalisation levy paid and this will result in double taxation. It may also not qualify as a foreign tax credit in the recipient’s jurisdiction. Hence, a global standard of such a levy should rather be adopted.
5. There are inherent problems with respect to compliance of taxation as the neither the Finance Act, 2016 nor the Central Board of Direct Taxes has provided clear guidelines how they plan to extract the tax that is levied on the residents. As a result, there is a lot confusion and unnecessary transfer of a burden. There is also a likelihood that imposing an equalisation levy could increase costs to local consumers, depending on the economics. In such cases, this is clearly not the best solution, as it simply increases the tax burden on local consumers.
6. In September 2013, the Committee on Fiscal Affairs (CFA) of the OECD had established a Task Force on the Digital Economy (TFDE), with the main goal to recognize the diverse problems that could arise with the development of digital economy and, if possible, to find a solution to such problems. In October 2015, when the OECD had come out with “Addressing the Tax Challenges of the Digital Economy, Action 1-2015 Final Report”, they had categorically stated that the TFDE had also examined three options, i.e. (i) a new nexus in the form of a significant economic presence, (ii) a withholding tax on certain types of digital transactions, and (iii) an equalisation levy. The OECD had endorsed the imposition of VAT/GST on cross-border transactions, particularly in business-to-consumer transactions. But, it said “[n]one of the other options analysed by the TFDE …. [w]ere recommended at this stage” (page 13). Apart from this, the OECD had also advised the countries adopting such other options in their domestic law as addition safeguards against BEPS to respect existing international legal commitments (page 148).
The report published on March 2014 by the TFDE specifically flagged one important issue, i.e. while domestic suppliers of similar goods are taxed on a net basis, such a provision may fall foul of the provisions of both the General Agreement on Trade and Service(GATS) and General Agreement on Trade and Tariff (GATT) that require national treatment. Although GATS provides broad exceptions for the application of provisions of tax treaties and for imposition of direct tax provisions to ensure effective imposition of direct taxes, there is no such exception in the case of GATT; and, when the digital products are considered as goods, there may be a problem. Therefore, when the Government by notification attempts to include other aspects of the digital economy to be taxed as equalisation levy, certain problems with international law may arise due to the fact that as stated in section 90(2) of the Income Tax Act, 1961, in Indian law tax treaties take precedence over domestic law. Hence, an equalisation levy substantially displaying the features of a turnover tax is likely to be incompatible with World Trade Organisation obligations of many countries, primarily pursuant to GATT.
7. The Base Erosion Profit Shifting (BEPS) Report in Action 1 recommended that further work is required in digital economy taxation and suggested that the developments in digital economy needs to be monitored. A review of such developments in 2020 was advocated. However, the Committee expressed its doubts whether, even if any further work is undertaken, it would yield any actionable outcomes. As mentioned in point number 6 above, the TFDE had mentioned three options to tax individuals; however, it is pivotal to note that the BEPS had never recommended for individual countries to adopt such methods. India did not heed to the ‘wait and watch’ approach of the BEPS Report. The mounting pressure to scale up tax revenues did not permit the exchequer to delay the tax collection adventure. The tax authorities should have been hesitant to embark on something new solely as a reaction to an ‘allegation’ of a failure to devise a taxing norm for digital transactions.
Therefore, although the digitalisation of the economy raises challenging issues, a rush to address those issues could result in a large part of the economy being subject to unilateral actions. In examining this issue, it is also useful to consider a working paper published by Brookings India which contains a detailed explanation, impact and problems with equalisation levy in India.
– Shantanu Lakhotia