Much has been written about the expanded scope of the equalisation levy (“Levy” or “2020 Levy”) (see here and here) under the Finance Act, 2020. At a simplistic level, this Levy is introduced to capture into the tax net transactions that escaped Indian tax for either not crossing the permanent establishment (“PE”) threshold (“insufficient nexus”) or for non-fulfillment of withholding clauses (“characterization issues”) of a treaty. However, with any enactment, policy and constitutional considerations aside (including deferment in light of the COVID–19 crises, wherein the Union Government has not indicated any policy posture in favor of deferment), it becomes imperative to analyze the provisions and work out the tax positions that may be reasonably taken while complying with those provisions. This post discusses issues that in-house tax departments may face while working through this Levy.
Issue 1: What is the nature of transactions covered under the scope of the Levy?
According to the expanded provisions, any e-commerce operator (“operator”) who is engaged in e-commerce supply or services is liable to pay two percentage points of the amount of consideration as Levy to the Indian exchequer. The Levy covers a wide range of sale, service and facilitation transactions that are conducted online through digital platform. A bare perusal of the provisions in terms of sections 163(3), 164(ca) and 165 of the Finance Act, 2020 indicate that the legislature has provided for a distinction between the operator who sells own goods vis-à-vis an operator who only facilitates sale of goods or services that are provided by third parties.
Questions arise on scope and breadth of the Levy. One of the most prominent is whether the Levy extends to services rendered physically though they have been booked online? An example may include booking hotel rooms outside India via the hotel website but paying for the room at the time of check-in. The term used in the statute is “online provision of services”; online provision of services should imply online delivery of service and not otherwise. At the stage of booking, there are no services rendered except taking the booking of the room and there is no consideration received or receivable, which may be subjected to the Levy. At a conceptual level, there is no nexus with the services rendered. The service is performed outside India and the consideration for such services are also paid outside India. In other words, there is no source in India. Therefore, a fact specific evaluation would need to be carried out to determine whether the scope of services provided by an operator falls within the ambit of the Levy.
Issue 2: Whether the Levy is on the gross amount received by the operator or is it leviable only on the portion of the amount that is due and legally vests with the operator?
As observed above, there are three distinct situations provided in the statute with regard to the three independent business models. The amounts subjected to the Levy are different for different business models. Section 164(d) of the Finance Act, 2016 defines equalization levy to mean “the tax leviable on consideration received or receivable for any specified service under the provisions of this Chapter”. Therefore, the Levy is with reference to the consideration. The Supreme Court in, Ranganayakamma v. K.S. Prakash observed with reference to the interpretation of the term consideration that “Consideration even in the Indian context would mean a reasonable equivalent or other valuable benefit passed on by the promiser to the promise or by the transferor to the transferee”. Thus, consideration connotes that benefit which is regarded as received for services provided.
Section 165A(1) of the Finance Act, 2020 charges Levy on the amount of consideration which is “received or receivable” by an operator from e-commerce supply or service. The sum “received or receivable” would refer to the sum the operator is entitled to receive, and which legally vests with the operator. The provision should not be interpreted mechanically to imply mere physical collection of the consideration. The reasoning behind this argument hinges on the agreement between the operator and the third party (who provides goods or services) which makes the operator a trustee or agent to collect the consideration on behalf of the third-party. The operator does not have any legal right on the sum and is similar to an agent who is only entitled to its commission. Additionally, the term “received or receivable” in the section may take their color and context from the words “sales, turnover or gross receipts” in section 165A(2)(iii) and its interpretation narrowed to the sums received or receivable by the operator in its own right.
Further, to contrast, the Levy as introduced in 2016 (“2016 Levy”) is on the “consideration for specified services” vis-à-vis in 2020 the consideration is flowing “from the ecommerce supply and service”. The term “for” and “from” needs to be interpreted contextually. The 2016 Levy is an obligation on the payer. As against that, the 2020 Levy is on the recipient and signifies the consideration generated from the activity. Therefore, a reasonable position may be taken that the Levy covers only that part of the gross consideration that legally vests with the operator.
Issue 3: Whether the amount paid under the Levy is creditable in the residence country?
Generally foreign tax credit will depend upon the domestic law of the resident state. For this purpose, I am assuming the resident state to be the United States.
India – US Tax Treaty
The Levy was first enacted through the Finance Act, 2016 and expanded in scope through amendments through the Finance Act, 2020. To be creditable, the Levy should form part of Article 2 – ‘Taxes covered’ under the treaty.
Before delving unto this further, I examine the preamble to the treaty first. The Preamble states the purpose of the treaty as “…or the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income has entered into force on the 18th December, 1990”. Therefore, the question arises, whether the Levy is a tax on income.
The term ‘income’ as understood in India or the US is in the widest sense. It would assume gross receipts too. For that matter, royalty, fees for included services and interest are taxed on a gross basis. The expanded Levy is on the consideration received by the operator. This consideration is their ‘income’ from selling own goods or facilitation of sale of goods or services of a third party. In fact, a significantly reduced tax rate of two percentage points may be analogous to presumptive tax, wherein the presumptive tax regime presumes expenses. The levy implied in its reduced tax rate presumes the margin so as to apply the tax rate on such margin or net income. It is unconventional in its computation, but a tax on income nonetheless. Moreover, while it is not in the nature of withholding tax, it is still a final tax on presumed margin or net income. A back-of-the-hand calculation indicates that on a five percent margin, a tax rate of two percentage points works out to be 40 percent, which is equivalent to income tax imposed on a PE. Therefore, a view is plausible that the levy is a tax on income. As to the argument of ‘Taxes covered’ – the treaty states, “[t]he Convention shall apply also to any identical or substantially similar taxes”.
In addition to the arguments above that the Levy is a tax on income and while unconventional in its computation, its underlying substance concerns taxation of margin or net income the ensuing may be considered. Following the ambulatory approach, where a new law is introduced, it needs to be seen whether the law has substantial resemblance to income tax. The insertion of section 10(50) to the Income tax Act, 1961 indicates that it is an alternative method to collect the due direct taxes. The fact that it forms part of another statute has no bearing on creditability. Furthermore, the Levy is a substitute for tax on income of non-residents who do not reach the PE threshold (discussed in detail below). While this position is litigative, there is substantial merit in the argument that the Levy should be creditable.
US Domestic law
More generally, under section 901 of the Internal Revenue Code (“IRC”), a US resident individual or domestic corporation is allowed credit against US income taxes for “income, war profits, and excess profits taxes” paid or accrued during the taxable year to a foreign country. A foreign levy qualifies as an “income tax” if it is a tax and the predominant character of the tax is an income tax in the US sense (i.e. it is not a soak up tax). Treas. Reg. § 1.901-2(b) lists out three tests to judge whether a tax is predominately in the nature of income tax:
- Realization requirement – imposed generally when income is “realized” under the IRC;
- Gross receipts requirement – based on the fair market value of amount realized;
- Net income requirement – gross income is reduced by expenses;
Nevertheless, section 903 of the Internal Revenue Code (“IRC”) provides that if the levy does not meet the requirements set forth in regulation to section 901, the foreign levy may still be creditable if it is a tax paid “in lieu of” an income tax. Treas. Reg. § 1.903-1(a) provides that the “in lieu of” income tax standard hinges on, firstly, whether the levy qualifies as a tax and, secondly, whether it is a substitute for an otherwise generally applied income tax. This substitution requirement as provided for in Treas. Reg. § 1.903-1(b)(1) is met if “the tax in fact operates as a tax imposed in substitution for, and not in addition to, an income tax or a series of income taxes otherwise generally imposed.”
In India, the Memorandum to the Finance Bill, 2016 which introduced the equalisation levy provided for the following intent and reason for its introduction: “The typical direct tax issues relating to e-commerce are the difficulties of characterizing the nature of payment and establishing a nexus or link between a taxable transaction, activity and a taxing jurisdiction, the difficulty of locating the transaction, activity and identifying the taxpayer for income tax purposes.” (page 5) Therefore, the introduction of the levy was hinged on escapement of income taxes in the source state (India) and equalisation levy was in fact a “substitute” for such escapement. This view is further corroborated by final report on BEPS Action Plan – 1 in ¶ 307, 308.
Sequitur to above, the Levy meets the criterion laid down by the substitution test. The Levy cannot apply to income that is connected to a PE. Therefore, there is mutual exclusivity between the Levy and taxes imposed on income which meet the PE threshold. A reasonable position may be taken that the Levy qualifies the “in lieu of” test under Section 903 of the IRC and is creditable in the United States under Section 901 of the IRC.
Issue 4: Whether representative assessee provisions of the Income tax Act, 1961 apply against the non-payment of the Levy?
The 2016 Levy is on the payer and, therefore, the question of representative assessee is rendered moot. Under the 2020 Levy, the obligation is on the non-resident, and hence provisions pertaining to representative assessee assumes significance. A representative assessee is a person who is deemed legal representative of another person or taxpayer under the provisions of the Income tax Act, 1961 for non-fulfillment of tax obligation of the latter.
Section 178 of the Finance Act, 2016 provides for the application of certain provisions of the Income Tax Act, 1961 to the Levy. It encompasses within itsambit Chapter XV concerning provisions related to representative assessee. Section 160 of the Income Tax Act defines a representative assessee and section 161 defines the scope and the breath of liability of a representative assessee.
A bare perusal of section 160(1)(i) read with section 163 of the Income Tax Act provides for a person to be a representative assessee of a non-resident only in cases in respect of income specified under section 9(1) of the Income tax Act. Most notably, while the Levy in the Finance Act creates an amendment with reference to chapter XV of the Income tax Act, there is no corresponding amendment in the Income Tax Act to this effect.
The Finance Act, 2016 under section 178 uses the expression “so far as may be” for application of provisions of income tax under the Levy and that might give certain leeway to the revenue authorities to argue that these provisions should apply to the extent possible. In my opinion, the argument does not survive. Without a consequential amendment to the Income Tax Act, 1961, which defines who a representative assessee is, and without falling into its catchment clause, it will be very difficult to enforce a liability on a person for non-payment of the Levy who cannot be considered as a representative assessee in the first place.
– Hardeep Singh Chawla