Taxing Data under the Equalisation Levy: Taxpayers’ Challenges

[Akshara Rao is a final year B.A., LL.B. (Hons.) student at Jindal Global Law School, Sonipat]

With the increasing dominance of the digital economy, countries and international organisations have highlighted the inefficiency of the current tax system in covering digital businesses, which are generating enormous profits from a jurisdiction without having any physical presence. Several countries have implemented unilateral measures to tax the digital economy, in the absence of a global consensus. India led this way by implementing the Equalisation Levy in 2016 which was later amended in 2020 to include, inter alia, tax on the sale of data. Several countries such as Belgium, the Czech Republic (proposed), Italy and Spain have also included the sale of user data within the scope of their digital service taxes, and France imposed its digital service tax on advertising services based on user data.

While data plays a crucial role in the digital economy, the levy lacks the required clarity to successfully tax it. Uncertainties and ambiguities in the legislation have created several challenges for taxpayers, making compliance expensive. This post will highlight the complexities of data and discuss the challenges faced by taxpayers.

The Equalisation Levy

Through section 165A of the Finance Act, 2016, India introduced an equalisation levy which imposed a six-per cent tax rate on the gross consideration received or receivable by a non-resident who provides digital advertisement services either to an Indian resident or to a non-resident with a permanent establishment in India. In 2020, the Indian government stunned the digital economy by expanding the scope of the levy to include, inter alia, the sale of data at the rate of two per cent of the gross consideration. The 2020 amendment was not mentioned in the budget proposal and the government did not release any guidelines or memorandum which could express the intent behind the amendment. The amendment only mentions that the levy is applicable when there is a “sale of data, collected from a person who is resident in India or from a person who uses internet protocol address located in India.”. This sentence is insufficient to provide any substantive or procedural clarity to a taxpayer.

Complexities of Data

The levy refers to the “sale of data collected”, i.e., the sale of raw data.  The government is right in identifying that raw data collected from user participation plays a vital role in the digital economy. However, the digital economy runs on an interplay between three complex features – raw data collected from user participation, usage of intangibles, and ability of these businesses to function in a digital space. Raw data in itself is not of any value and its deemed value depends on the other features of the digital economy. There are several stages of value creation and data can be associated with a different value at each stage. The process is usually divided into six stages: Capture, Cleanse, Combine, Curate, Analysis, and Decisioning. At the first stage, the data collected from online platforms is still in the form of raw data and  has no value yet. The data becomes usable at the second stage where errors are omitted and a unified format is adopted. This data is then combined and derived into aggregates to make it suitable for comparison. Subsequently, the data is curated to make it more flexible and suitable for analysis. After this stage, the data is ready for analysis and decision making, where the value of the data reaches its peak.

Challenges for a Taxpayer

The levy fails to acknowledge these complexities. This lack of clarity has left the legislation with uncertainties, the price of which will be borne by taxpayers whose perspectives have been disregarded. There are several challenges that have come with the legislation, some of which are discussed below.

Wide Ambit of ‘Data’

The levy merely states that ‘sale of data’ shall be taxed; it does not define or explain as to what constitutes as ‘data’. A literal interpretation of the clause refers to the raw data which is directly collected from the users. Several digital economies which have been targeted by the levy have taken a strong stand that they do not sell user data. Therefore, the levy leaves such taxpayer uncertain as to whether their functions would fall within its ambit.

Segregation of Data Value

For the purposes of taxation, even if data is understood in its processed form, it continues to impose challenges since the value associated also includes the value generated by intangibles and human intervention. Taxpayers invest several algorithms and human intervention for the data to reach its marketable form. Even after that the processed data needs to be secured and maintained by the taxpayers in compliance with several legal requirements. The whole process is so closely interlinked that it would be a challenge for a taxpayer to segregate the value between the different stages and elements.

International and Domestic Double Taxation

Due to the several stages of data processing, it is possible that data is generated, processed, stored, and maintained in different jurisdictions. Since India has introduced the equalisation levy outside the ambit of the Income Tax Act, 1961 (“ITA”), it also escapes the provisions of the Double Taxation Avoidance Agreements (“DTAAs”). Hence, the residence jurisdiction of the taxpayer could impose a corporate tax on the income which might have already been subject to the levy in India. The taxpayer would be subject to double taxation as they would not be able to claim any benefits under the DTAA such as tax credit for the levy paid in India.

In the domestic scenario, the levy was not the first attempt of the Indian government to tax data. The Integrated Goods and Service Tax (“IGST”) is imposed on Online Information and Database Access or Retrieval (“OIDAR”) services. The OIDAR services include, inter alia, services that are ‘providing data or information’. The overlap was defended on the basis that the IGST is a tax on the supply whereas the levy is intended to be a tax on the income. However, this defence fails to justify the overlap, given the fact that the levy is imposed on each supply/transaction and is not based on the income of the taxpayer. Therefore, taxpayers might be made liable to pay IGST as well as the levy on the same transaction.

Data Protection

Data protection laws have become a primary concern for several jurisdictions, including India which introduced the Personal Data Protection Bill in 2019 (“PDP Bill”). Upon implementation of the bill, taxpayers would be required to maintain the residence of certain forms of data within the Indian jurisdiction, in furtherance of the objective of data localisation. Though a laudable obligation considering the privacy rights of citizens, a taxpayer would face overlap challenges in compliance with the obligation as well as the levy. The Bill currently targets only personal data which is subcategorised into personal data, sensitive personal data, and critical personal data. There is no clear demarcation between the categories. Hence, a taxpayer would face difficulties in identifying and classifying the data accordingly.

Compliance/Administration Cost

All these uncertainties would ultimately lead to an increase in the cost of compliance. Taxpayers would need to establish new systems which meet the requirements of the levy. The systems would have to maintain an account of the data flows, collect data which was initially not collected (such as IP addresses), develop technology to sufficiently segregate data and so on. Considering the lack of clarity regarding the levy, the taxpayers would likely be incurring legal costs and might also have to appoint a legal representative within the jurisdiction.

Moreover, the Finance Act of 2016 provides severe consequences for non-compliance with the levy. A penalty equivalent to the liability may be imposed in case of non-deduction or non-payment of levy, along with initiation of criminal proceedings in case the statements furnished by the taxpayer are considered false.

Conclusion and Way Forward

Data is crucial feature of the digital economy; however, imposition of the levy on ‘sale of data’ would neither help the government nor the taxpayer. The challenges in compliance would likely lead to an increase in tax avoidance and litigation. The levy can only be understood as a step taken by the government in a rush to increase its revenue, overlooking the complexities surrounding data and its taxation.

Many taxpayers anticipated clarity from the Finance Act of 2021. However, no amendment was made pertaining to taxation of data. It has been over a year since the introduction of the levy and the government needs to bring more clarity in the legislation by notifying the much-awaited guidelines. “Data” needs to be defined and the definition must refer to the specific form of data which the government intends to tax. They must discuss the proposed amendments with stakeholders and consider the compliance costs that the levy would result in. More importantly, severe criminal penalties should not be imposed until the various ambiguities are clarified. Finally, the government must look out for the possible overlap between the ITA and the PDP Bill and ensure that ease of doing business is guaranteed while upholding the privacy of individuals.

Akshara Rao

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