[Vedangini Bisht and Shubham Chaudhary are third year students at National Law University, Delhi]
India recently passed its Finance Act 2020 to expand the scope of equalisation levy, a type of digital service tax, charged to non-residential e-commerce businesses. However, the Act (passed on March 27, 2020) has extra-territorial application, since it attempts to tax the income earned from advertisements aimed at Indian customers, or accessed through Indian IP addresses, and income earned from the sale of data, goods and services to anyone using an Indian IP address.
This post engages with the extra-territorial aspects of the equalisation levy, and aims to highlight the technical and practical difficulties that arise with the imposition of equalisation levy in its current state in India.
The first technical difficulty is the absence of a global centralised system of tax collection. Such a centralised system of tax collection is necessitated in the context of a fragile global economy. This is because a patchwork of unilateral actions by various nations impairs investments and economic growth globally. It hampers the ability of the government to invest and collect revenue and inhibits business investments due to fear of unnecessary taxation. New technologies bring with them the challenges such as tax avoidance, which is the basis of tax erosions and profit shifting. The Organisation for Economic Co-operation and Development (OECD), an intergovernmental economic organisation which spearheads the policies on digital taxation, is still in the process of arriving at a consensus on taxable nexus, and allocation of taxing rights. Taxable nexus refers to the link between the income and the source, and envisages the right of every State to tax income generated within its territory. However, the rules on allocation of taxing rights on the income generated from cross-border activities have to be acceptable to all countries, whether developed or developing.
The second concern is that the OECD has recommended the concept of ‘significant economic presence’ to be the basis of taxable nexus. Significant economic presence refers to any transaction with respect to goods, services, or property, carried out by a non-resident entity. Thus, while a company’s permanent establishment, which is a taxable presence of the company outside its state of residence, may be in one country, its significant economic presence may be in several countries. This gives rise to the issue of double taxation, and defeats the purpose of the double taxation avoidance agreements (DTAAs), which aim to avoid international double taxation. The Akhilesh Ranjan committee also identified this as an inherent limitation of equalisation levy. India has not included the use of significant economic presence as a criterion for determining taxable nexus, hence permanent establishment, in any of the DTAAs yet. However, in order to comply with OECD, India will have to look beyond the concept of permanent establishment, and restructure the principle of fair taxation to ensure that corporations are not taxed twice. Hence, to ensure fair taxation, unilateral action under any domestic law will have to be read vis-à-vis the multilateral tax agreement or tax treaties, as well as Action Plans on Base Erosion and Profit Shifting. This would require negotiating with countries to avoid the undesirable effects of double taxation, which is also highlighted in the overarching principles of tax policy as laid down by OECD.
The third difficulty arises due to the lack of clarity with respect to crucial phrases, such as ‘systematic, continuous soliciting’, and ‘users’, in explanation 2A(b) to section 9 of the amended Act. For instance, there is little statutory guidance as to who qualifies as a user of Indian IP address. It is unclear if the threshold is merely visiting a website from an Indian IP address, or that of clicking and browsing through links therein. While comments on the revenue and user thresholds were invited by the Ministry of Finance, there were no comments sought on the scope of the provisions themselves. Finally, in the absence of any Statement of Objectives for the amendments, these phrases can lead to potential confusion among the taxpayers and litigators alike.
The first practical issue in imposing the equalisation levy arises due to the fact that States normally charge taxes from non-resident entities with no physical presence or establishment in their territory, by taxing the domestic source of their revenue. This model has been used since the equalisation levy introduced in section 166 of the Finance Act, 2016; the 2020 equalisation levy is not a replacement, but an expansion of the earlier equalisation levy. The primary concern is that the present equalisation levy aims to charge foreign entities that fall under the new provision, section 165A of Finance Act, 2016, directly. However, it is unclear how the Indian government aims to achieve this. Foreign businesses are unlikely to track and store the location of all their users, due to the high cost associated with it. Thus, it becomes difficult for such businesses to calculate, and pay, the taxes owed.
The second practical issue is that there is no mechanism to enforce compliance, or penalise non-payment of the equalisation levy, by a non-resident entity. While the Act provides for the attraction of interest on unpaid taxes, penalisation, and prosecution for non-compliance, such provisions fail to deter foreign business which have no tangible assets in India. It is for this reason that many countries withhold taxes in such cases, as withholding taxes are easier to enforce.
The third issue relates to the ‘revenue rule’, which states that the courts of a country can refuse enforcement of foreign revenue or tax laws. This rule is considered a general principle of international taxation. Thus, foreign countries, unsatisfied by the applicability of the equalisation levy on their domestic businesses, may refuse the enforcement of the equalisation levy on their resident businesses. The reasons for dissatisfaction may include, inter alia, the aforementioned ambiguity regarding taxable nexus, and equivocal international consensus on allocation of country getting taxing rights in light of emerging technologies. Further, a country might disallow its resident businesses from paying taxes to a foreign country, if it believes that the foreign country lacks jurisdiction to tax the income of such businesses. A recent development in this trend is the investigation launched by the United States Trade Representative on countries that have either implemented or are planning to implement such a digital services tax, as it believes that such taxes “deviate from established international taxations norms in the form of extra-territoriality”.
The sudden introduction of the new equalization levy can be directly attributed to the Covid-19 pandemic. The Indian Government is aiming to increase its revenue from all sources possible, to ease the increased financial burden it is facing due to the pandemic. However, the it needs to expeditiously issue supplementary rules to erase the ambiguity surrounding the implementation of the equalization levy. Further, the Government must also harmonize the equalization levy with its bilateral and multilateral tax agreements, such as the DTAAs. This will ensure that the equalization levy does not cause an additional burden on businesses that are already dwindling due to the pandemic.
– Vedangini Bisht & Shubham Chaudhary
India has included the use of SEP which has been deferred to 2022 in hope that OECD comes up with a scheme for global implementation by then.