Equalization Levy: India’s Experiment with Taxation of the Digital Economy

[Mohit Agarwal and Vibhore Batwara are fourth-year law students from the Institute of Law, Nirma University (ILNU), Ahmedabad, India]

An expanded version of equalization levy (EL) has come into force in India from 1 April 2020. EL found no reference when the Finance Bill was initially introduced in the Parliament in February, nor was there any anticipation or any consultation with the impacted industry. EL is a tax imposed on payments made for digital services to a foreign beneficial owner, who enjoys an unfair advantage over its domestic competitor, thereby equalising its tax burden by subjecting it to the national tax legislation without disturbing the tax treaty. The expanded levy seems to be in furtherance of the Government’s attempt to increase revenue from the non-resident digital players, as their business profits remained non-taxable in India on account of the conventional permanent establishment criteria. 

E-commerce Taxation and India

Taxation of digital economies has been an arduous task for regulators due to its inherent qualities like mobility, reliance on data and network effects that help them defy conventional principles of taxation. The OECD’s BEPS initiative has recognised this fundamental issue and placed the digital taxation problems in the Action Plan 1. The BEPS initiative is a landmark reform in international taxation, but under Action Plan 1 the inclusive framework had failed to reach the consensus on adopting a single system to tax the digital economy in 2014 and had deferred the process to the year 2020. Meanwhile, under Action Plan 1, they suggested three measures for the regulators to tax business models relying on a digital base – (i) the test of significant economic presence (SEP), (ii) withholding tax on digital transactions and (iii) EL.

India’s efforts to tax the digital economy have been quite proactive.[1] It is the first country that has adopted EL as a tool to tax e-commerce transactions in 2016 itself after the recommendation of the Akhilesh Ranjan Committee. The committee, after giving due deliberation to all the three alternatives suggested by OECD, decided to proceed with EL due to its relative ease in adoption as well as administration. The EL is not considered as a tax on income, and hence it will not be covered under the tax treaties. With its structure being similar to indirect tax it provides greater certainty and predictability in taxation.  

From Google Tax to Amazon Tax?

The intention behind EL is to create an equal playing field between residents and non-residents competing in the same space. When introduced in 2016, the EL was famously labelled as a ‘Google Tax’ because it was applicable only on online advertisement, digital advertisement space or facility or service for online advertisement, but now its scope has been widened to include nearly all e-commerce transactions.

Under the 2020 regime, all the non-resident e-commerce operators [2] are liable to pay a 2% tax on the consideration received from provisioning of e-commerce supply, services or even facilitation of such supply or services when it is made to an Indian resident, non-resident (under specified circumstances) [3] or to any person who uses an Indian IP address for availing such supply or services. The EL will not be applicable if the transaction is covered by the 2016 levy, net consideration received is less than Rs. 20 Million or if the operator has a permanent establishment (PE) in India (in such case tax will be charged on a net basis rather than gross basis, similar to royalty and fee for technical services).

One key difference between the 2016 levy and the present levy is regarding the shift of responsibility in compliance from resident service recipient to the non-resident e-commerce operator, which has raised doubts regarding enforcement in case of non – compliance.

Concerns with EL

The EL is subjected to major policy matters, which could be in violation of international tax principles and be a concern to the industry as well.  

Double Taxation

The core problem with such a unilateral measure is double taxation of income – the historic issue in international tax law. To prevent double taxation at the domestic level, income earned from transactions upon which levy is applicable is exempted from taxation.[4] However, from an international perspective, the levy is not considered as a tax, and hence treaty benefits might not be available.  Thus, for the amount paid in the source country, no benefit will be available in the resident country, unless specifically provided by the resident country.

Possible Treaty Violation

Moreover, the levy has still not been challenged for treaty violation since its introduction but the same does not preclude it from future challenges. For example, under the heading of Taxes Covered of the US – India DTAA, Article 2(2) states that ‘The Convention shall apply also to any identical or substantially similar taxes which are imposed after the date of signature of the Convention in addition to, or in place of, the existing taxes.’, where EL can form part of ‘substantially similar tax’. Another important issue for consideration is that intentionally avoiding tax treaty coverage may be in violation of one of the core principles of public international law – pacta sunt servanda.

Consideration and Refund

The scope of levy is wide due to the broad definition of the e-commerce operator (owns, operates or manages) and e-commerce supply (sale and even facilitation).  The levy is chargeable on a gross basis at 2%, upon the consideration received by the e-commerce operator. However, it has not been specified whether the consideration received is to be considered as the actual amount of sales or just the commission which the operator receives. E-commerce businesses operate on different models, and generalising all of them under one head can become a concern for the industry. Moreover, treatment of refund is also not provided under the legislation but the same may find clarity once the return form is released.

Challenges with Enforcement

Another core issue concerns the means of enforcement for collection of levy if service consumption itself occurs outside India. Unlike the US, India does not have a FATCA law which ensures compliance in fiscal matters even in foreign territories. The EL has proposed to cover even non-resident to non-resident transactions in case of sale of advertisement by the operator to another non-resident entity which targets Indian customers and sale of data of Indian residents. For example, Indian residents visit the UK as tourists and usually use Uber. Uber UK collects certain time and location data and sells it to Airbnb for a consideration exceeding the threshold of the levy. In such a case, EL shall be payable by Uber UK as it has received the consideration for sale of data collected from a person resident of India.[5] What means the Indian authorities will use for enforcement in case of non-compliance is uncertain.

Conclusion           

The present levy seems to suffer from certain drawbacks both from the policy and drafting perspectives. The drafting ambiguities may be taken care of in future with the rules, forms or clarification from the Central Board of Direct Taxes (CBDT). Regarding the policy concerns, when India introduced the levy in 2016 it received a fair share of criticism from the international community, as resorting to unilateral measures would distort the digital economy. However, following India’s efforts, various jurisdictions have come up with their own domestic tax. Italy introduced a web tax, the UK came up with a diverted profit tax  and France brought the controversial digital service tax. Tax revenue from digital services has a huge prospect; hence, no country can be reasonably expected to not use its sovereign right to tax. Foregoing such revenue is simply a transfer of wealth from one country to another.

However, such unilateral measures impact the economy and distort the business decisions, which are against principles of taxation. France’s attempt to tax caused political tensions between the US and France with threats of tariffs from both sides. In response to India’s recent expansion of the levy, several industrial associations have written to the US Trade Representative asking for removal of the levy. Hopefully the French issue has been settled as of now as France has agreed to defer collection of the tax, and both the UK and France have agreed that if consensus is reached at the OECD then it will supersede the domestic legislation.

Though the OECD has assured that talks amid reaching the consensus will not stop even during such troublesome times, still the responsibility on it has increased with more and more countries adopting unilateral measures, which can severely impact the digital economy as a whole.

Mohit Agarwal & Vibhore Batwara

[1] EL was introduced in 2016 itself and SEP was also incorporated in 2018 (though its implementation has been deferred to 2022).

[2] Section 164 (ca) of the Finance Act, 2016: ‘a non – resident who owns operates or manages digital or economic facility or platform for online sale of goods or online provision of services or both’.

[3] Section 165A (3) of the Finance Act, 2016 defines specified circumstances as:

1. sale of advertisement, which targets a customer, who is resident in India or a customer who accesses the advertisement though internet protocol address located in India; and

2. sale of data, collected from a person who is resident in India or from a person who uses internet protocol address located in India.

[4] Section 10(50) of the Income Tax Act, 1961.

[5] Section 165A (1) and (3) of the Finance Act, 2016.

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