VOL. III ISSUE I EQUALIZATION LEVY: TAXING THE OVERSEAS DIGITAL GIANTS 2016 [25] EQUALIZATION LEVY: TAXING THE OVERSEAS DIGITAL GIANTS A bona fide endeavor, beleaguered by haste - Ayush Vijayvargiya* ABSTRACT The digital advertisement market in India is growing at a yearly rate of 28% and is pegged to become the largest in the advertisement sector. Majority of the players in this domain being non-resident entities, the Union government under the Finance Act, 2016 therefore, in a bid to tap the hitherto untapped revenue source, proposed imposition of a 6% “Equalization Levy” [‘EL’] on non-resident companies providing ‘online advertisement’ services in India principally through their websites. This paper thus seeks to expound and critique the various facets and nuances involved in its understanding. Attempts have been made in the past to club this amount under ‘fees for technical services’, alongside proposing obviation of ‘physical establishment’ requirement in s cenarios concerning digital interface. But this endeavor has always met the same fate, thereby making way for EL, which was one of the three alternatives recommended under the Organisation for Economic Co-operation and Development (‘OECD’) report on Base Erosion and Profit Sharing (‘BEPS’). Analysis and feasibility of the other two alternatives, therefore, follows as a logical corollary and finds a dedicated section in the paper. In addition, the paper does not just strive to critically appraise the imposition, but also to streamline the debate concerning nature of the levy, alongside highlighting a few lacunas in the proposed scheme. As a parting point, it emphasizes the need for comprehensive reassessment of EL on certain fronts and cautions the reader of the potential it has in terms of diverting the government from more important issues like non-adversarial tax regime, hybrid mismatch arrangements et al. DECODING THE LEVY Before the introduction of Finance Bill, 2016 [‘Bill’] 1 , it was a well-recognized position under the Indian taxation jurisprudence that non-resident companies providing ‘online * Student, 4th Year B.A. LL.B. (Hons.), NALSAR University of Law, Hyderabad. The author can be reached at [email protected]. The author would also like to thank Kartikh Suresh and Harshitha Reddy Kasarla for their valuable inputs.
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VOL. III
ISSUE I
EQUALIZATION LEVY: TAXING THE OVERSEAS DIGITAL
GIANTS
2016
[25]
EQUALIZATION LEVY: TAXING THE OVERSEAS DIGITAL GIANTS
A bona fide endeavor, beleaguered by haste
- Ayush Vijayvargiya*
ABSTRACT
The digital advertisement market in India is growing at a yearly rate of 28% and is pegged to
become the largest in the advertisement sector. Majority of the players in this domain being
non-resident entities, the Union government under the Finance Act, 2016 therefore, in a bid
to tap the hitherto untapped revenue source, proposed imposition of a 6% “Equalization
Levy” [‘EL’] on non-resident companies providing ‘online advertisement’ services in India
principally through their websites. This paper thus seeks to expound and critique the various
facets and nuances involved in its understanding.
Attempts have been made in the past to club this amount under ‘fees for technical services’,
alongside proposing obviation of ‘physical establishment’ requirement in scenarios
concerning digital interface. But this endeavor has always met the same fate, thereby making
way for EL, which was one of the three alternatives recommended under the Organisation for
Economic Co-operation and Development (‘OECD’) report on Base Erosion and Profit
Sharing (‘BEPS’). Analysis and feasibility of the other two alternatives, therefore, follows as
a logical corollary and finds a dedicated section in the paper.
In addition, the paper does not just strive to critically appraise the imposit ion, but also to
streamline the debate concerning nature of the levy, alongside highlighting a few lacunas in
the proposed scheme. As a parting point, it emphasizes the need for comprehensive
reassessment of EL on certain fronts and cautions the reader of the potential it has in terms of
diverting the government from more important issues like non-adversarial tax regime, hybrid
mismatch arrangements et al.
DECODING THE LEVY
Before the introduction of Finance Bill, 2016 [‘Bill’]1, it was a well-recognized position
under the Indian taxation jurisprudence that non-resident companies providing ‘online
* Student, 4th Year B.A. LL.B. (Hons.), NALSAR University of Law, Hyderabad. The author can be reached at
[email protected]. The author would also like to thank Kartikh Suresh and Harshitha Reddy Kasarla for
their valuable inputs.
VOL. III ISSUE I INDIAN JOURNAL OF TAX LAW 2016
[26]
advertisement’ services in India, and having Indian existence principally through their
websites2, will not be liable to pay tax on the revenues generated through offer of these
services.3 The rationale being that virtual presence, through which these services are offered,
does not qualify as Permanent Establishment [‘PE’] under Indian laws and should not be
taxed. This rationale gets further strengthened when the difficulties, between transactions and
tax jurisdictions, encountered by these service providers are taken into account.4
In an attempt to overcome these obscurities, the Union government proposed imposition of a
6% “Equalization Levy” [‘EL’] through the 2016 Bill.5 It finds mention in Chapter VIII of
the Bill and stands as a levy on the revenues generated by the non-resident online
advertisement service providers.6
The Bill was passed by the parliament with a few
amendments, not pertaining to EL, and it came to be termed as the Finance Act, 2016 [‘Act’]7
with the levy becoming effective from June 1, 2016.8 The scheme of this levy provides that
the revenue on which it can be imposed must be generated from the provision of certain listed
services like ‘Online advertisements’ and ‘digital marketing’, to the Indian residents.9 The
Union government, however, is entrusted with the authority to include other services also
within the ambit of this levy, as and when deemed necessary.10
The levy is not dependent on the nature of revenue. Since it is an independent levy, not in the
nature of income tax, even double taxation avoidance agreements are not applicable.
Furthermore, use of the prefix ‘equalization’ highlights the intention of legislators to bring
non-resident service providers and domestic ones to an equal pedestal.11
Presently, the
domestic service providers are covered under the Income Tax Act. 1961 [‘IT Act’]12
and pay
at the rate stipulated in it, while non-residents fall outside the IT Act’s ambit. Therefore, this
1 Finance Bill, No. 18 of 2016 (2016). 2 These service providers need not be confused with their Indian Subsidiary, as the latter has a separate entity for
taxation purposes. 3 Income Tax Officer v. Right Florists Pvt. Ltd, [2013] 143 ITD 445 (Kol). 4 Equalization Levy, 2016: Is it equitable?, DELLOITTE (June 2016), available at
equalization-levy-2016-noexp.pdf (last accessed on 31st August, 2016). 5 Supra, n. 1. 6 CA Rashmin Sanghvi, How to tax e-commerce businesses? - Equalisation Levy is an answer, TAXMANN (29
February, 2016); available at https://www.taxmann.com/Budget-2016-17/budget/t162/how-to-tax-e-commerce-
businesses-equalisation-levy-is-an-answer.aspx (last accessed on 31st August, 2016). 7 Finance Act, No. 28 of 2016 (2016). 8 Reuters, Rajya Sabha passes Finance Bill, BUSINESS LINE, May 11, 2016. 9 Supra, n. 7, Section 164(i). 10 Ibid. 11Memorandum explaining the provisions in the Finance Bill, MINISTRY OF FINANCE (DEPARTMENT OF
REVENUE), p.5 (Feb. 29, 2016); available at http://indiabudget.nic.in/ub2016-17/memo/mem1.pdf (last accessed
on 31st August, 2016). 12 Income Tax Act, Act 43 of 1961, (1961).
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Act seeks to enforce some parity by imposing this levy merely on the foreign providers. The
levy is collected by way of withholding tax, whereby the burden of deducting and depositing
the said amount rests upon the Indian residents i.e., the remitter of payments.13
It is a measure
undertaken to ensure ease of compliance.
It is important to note that the EL is deducted even before remitting the payments to non-
resident service providers, and the receiver merely gets the post-deduction amount.14
The
amount deducted is then deposited with the tax authorities, in adherence with the prescribed
rules and regulations.15
In case of any default by the Indian residents, penalties will be
imposed or interest charged, or both.16
Additionally, failure to deduct the levy or deposit it
with the department will also result in the concerned amount being automatically disallowed
as expenditure in computation of the defaulting resident’s taxable profits.17
In simple words,
in case of any default, the assessee would not be allowed to claim such expenditure as against
his/her business income. This will raise the total taxable income by the amount of disallowed
expenditure, thereby increasing the tax payable. Such treatment becomes important from a
taxation perspective, as once the Indian resident fails to deduct equalization levy before
making the payment to a non-resident, the latter cannot be called upon to pay anytime
afterwards.18
In its current form, EL is supposed to be levied merely on the entities generating a
considerable amount of online advertisement revenue from India. In pursuance of this
scheme, an exception has been carved out in order to shrink the liability of small
entrepreneurs. As per this exception, if the cumulative sum received for the specified services
does not exceed rupees 1 Lakh in a given financial year, the entity stands exempted from the
levy.19
Furthermore, when the non-resident has a PE in India and services provided are
effectively connected with the PE, no such levy would be imposed.20
Moreover, two provisions, namely Section 10(50) and 40(a)(ib), were introduced in the
Income Tax Act in an attempt to bring it in line with the new imposition. Section 10(50) was
13 Supra n. 7, Section 166. 14 Supra n. 7, Section 165. 15 Equalization Levy Rules, Notification No. S(O) 1095(E), (27th May, 2016). 16 Supra n. 7, Section 170. 17 Supra n. 7, Section. 18 Ranjeet Mathani, Equalization Levy: A Step Into Uncharted Territories, BUSINESS WORLD, 29th March, 2016. 19
Supra n. 7, Section 166 (1). 20 Supra n. 7, Section 165 (1) (ii).
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introduced in order to prevent the Foreign Service providers, from whom the levy is being
exacted, from getting doubly taxed in the Indian jurisdiction.21
The amendment to Section 10
acts as an assurance that the amount on which levy has already been deducted shall be
considered exempt from the tax imposition. Similarly Section 40(a)(ib) provides that any
amount already paid or still payable to the foreign service provider, wherein the equalization
levy is deductible but not deducted, the whole disbursement will be disallowed in the payer’s
books for taxation purposes.
Over the course of this paper, divided in eight parts, we would be delving into multiple facets
of this imposition. At the outset, an attempt would be made towards gauging the economic
significance of EL and the erstwhile position of Tribunals and Courts before coming into
effect of this levy. Following it, would be an assessment of the various alternatives available
to this levy, as proposed under the OECD report, and their practical feasibility. Lingering
uncertainty over the nature of this levy necessitates a detailed discussion of the arguments
advanced from various factions and hence a section would be dedicated for the same. The
subsequent segments would entail appraisal of pros and cons to this levy, and by design
would be followed by underscoring of lacunas in the entire scheme.
ECONOMIC SIGNIFICANCE OF THE IMPOSITION
A detailing of the mixed reactions to the levy, which will be elaborated in the latter part of
the paper, necessitates an inquiry into the characterization of ‘online advertisement’ and the
size of the relevant market. Online advertisement, although not legally defined anywhere, is
understood in normal parlance as a market strategy which uses the internet as an intermediary
for online traffic solicitation on the website, and ensures that marketing messages are
received by potential consumers.22
As of February 2016, the digital advertisement market in
India stood at $1,603.8 million and various reports in India have estimated it to grow to the
extent of $3372 million by 2020.23
This signifies a yearly growth of 28% for the next few
years, with the industry pegged to become the largest in the advertisement sector.
“Search and display” constitutes the largest chunk of the digital advertisement expenditure in
India. Search ads forms 38% of the overall spending on digital advertisements whereas
21 Supra n. 12, Section 10(50). 22 ROB STOKES, E-MARKETING; THE ESSENTIAL GUIDE TO MARKETING IN A DIGITAL WORLD, 294 (5th ed., 2014). 23
Digital advertisement in India (2016), STATISTA; available at
ITS 536 ITAT (2012) Mum. 35 Manages its operation from Ireland.
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not have any PE in India, making it impossible for the tax authorities to bring it within its
ambit. Hence no tax can be deducted from the payment made by Pinstorm in lieu of services
provided.
However, the most contentious issue was whether the remittance by Rights Florists would
amount to ‘fees for technical services’. There was constant unanimity over the fact that all the
advertising services under consideration, be it through sponsored results or web banner, were
highly technical in nature. But considerable uncertainty prevailed on what qualifies as
‘technical services’ under Section 9 (1) (vii) of IT Act, as this terminology has no specific
definition assigned to it.
The Tribunal disqualified the activity as not being in the nature of technical services, owing
to the non-fulfillment of requirements laid down in cases like Yahoo India Pvt. Ltd.36
, ISRO
Satellite Centre37
and Dell International Services (India) P. Ltd.38
One of the prime
prerequisites for qualifying as technical services is human intervention during the course of
service provision and this is not the case with the provision of online advertisement services
by forums like Google and Yahoo. Therefore, it was held that, in spite of the service being
technical in nature, the remittances would not qualify as FTS due to lack of any human touch
in the whole process.
Further the term ‘technical’ appears along with ‘managerial’ and ‘consultancy’ in the bare
text of the statute. It was held by the Mumbai Tribunal in the case of Kotal Securities Ltd v.
DCIT 39
, that ‘human intervention’ is the common denominator that runs across all the three
terms; and hence human intervention is quintessential to qualify as technical service under
this Act. Even the Delhi HC in the case of CIT v. Bharti Cellular Limited40
has held that if a
group of words share certain common characteristics, then such characteristics should act as a
limitation while determining of the scope of these new words. Therefore, in the absence of
any human touch involved in the entire process of advertising by Google, from provision of
services to receipt of online advertisements, it cannot be taxed as FTS.
Hence, with the Tribunal holding the remittances to online advertisement websites as
36 Yahoo India P. Ltd. v. DCIT, Range 7(3), [2011] 46 SOT 105 (Mum). 37 ISRO Satellite Centre (ISAC) Department of Space vs. Commissioner concerned DIT (Intl. Taxation), ( 2008 ) 220 CTR ( AAR ) 13. 38 Dell International Services India Pvt. Ltd. vs. CIT (International Taxation), ( 2008 ) 218 CTR ( AAR ) 209. 39
OECD, Action Plan on Base Erosion and Profit Shifting, ORGANISATION FOR ECONOMIC CO-OPERATION AND
DEVELOPMENT, (2013).
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to the recent acknowledgment by OECD that the traditional international tax infrastructure
put in place by the developed countries needs overhaul as business digitalization has lately
aggravated the BEPS concern in the regime.46
This system hitherto has worked in favour of
developed countries and most of these countries are therefore diametrically opposed to the
idea of changing fundamentals of the established structure.
The OECD also recognized that digital economy raises a range of other broader policy issues
related to taxation infrastructure, especially with respect to existence of nexus and
characterization. To redress and remedy these issues, multiple potential options were
discussed extensively and subsequently proposed in the report, namely:
Substantial economic presence as a new criterion for establishment of taxation nexus; or
Imposition of withholding tax; or
Equalization levy.
The report, however, does not recommend any of these options and merely suggests them as
alternatives that can be adopted by the countries. This approach of OECD can be rationalized
as an attempt to steer clear of any expectations that parties might associate from these
measures. Absence of such a precautionary measure might raise the possibility of
participating countries not only expecting it to mitigate the issues identified in digital
economy but also address broader tax challenges with it. Therefore the report tries to entrust
the countries with the choice to adopt any of the three stated options within their domestic
framework in the form of an additional safeguard, over and above the treaty obligations that
already exist.
The OECD, in its report, has not proposed the adoption of one of these options by the
participating countries, but has instead recommended continuous monitoring of the digital
economy till 2020.47
Deferring any concrete measure till a future date in 2020 can be ascribed
to the higher likelihood of a larger consensus amongst the concerned countries in this regard.
The OECD action plan does, however, provide three alternatives to countries, and it is critical
to examine the relative merits of each of these proposals.
1. The report proposes use of significant economic presence as a criterion for
establishing nexus, followed by consequent creation of taxable presence. Factors
46
Supra. n. 43. 47 Supra, n. 44.
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evidencing such economic presence should be something that demonstrates a
purposeful and continuous interaction of an entity with the Indian economy, through
modes like technology and automated tools. These factors need not necessarily meet
some high threshold and even revenue based or digital factors like local domain
name, local payment option and digital platform will suffice.48
An alternative for
determining such presence is by relying on user-based data like digital content
generated/received and number of users active on a monthly/quarterly basis.
However, even if the strict requirement of PE is watered down to form this loose
provision of significant economic presence, it will nonetheless require additional
modifications to be made to the domestic law as well as the other related treaties.
Moreover, without any substantial change to the norms governing profit attribution,
the increase in revenue generation would only be meager owing to very little profit
allocation to such economic presence.49
2. Another proposal pertained to withholding tax on a certain form of payments made
to the non-residents, for activities like provision of goods and services online. This
impost was not supposed to be introduced as an independent levy, but instead
charged from within the existing taxation structure. However, there exists difficulty
in tax collection procedure and enforcement of similar such rules. Furthermore this
option would not be feasible without any considerable modification in the existing
treaties, more so in the Indian context where withholding tax amounts to definitive
chargeability of the concerned income.50
3. The last alternative recommended imposition of an equalization levy; which was
eventually adopted by the Indian authorities as a part of the proposal under Chapter
VIII of the Finance Act, 2016. As per the OECD, this final proposal saves the
country from difficulties related to modification of rules to suit the nexus
requirement of significant economic presence. This report also acknowledged the
usage of this approach by a few countries already, but in a dissimilar manner. It is
used by and large as a measure to remove disparity that exists between the domestic
and foreign suppliers and ensure equal treatment to both. Although in India it seems
48 Committee on Taxation of E-Commerce, Proposal For Equalization Levy On Specified Transactions, CBDT,
DEPARTMENT OF REVENUE, MINISTRY OF FINANCE, GOVERNMENT OF INDIA (February 2016), http://www.incometaxindia.gov.in/news/report-of-committee-on-taxation-of-e-commerce-feb-2016.pdf (last
accessed on 31th August, 2016). 49
Ibid. 50 Ibid.
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to be enacted with the dual motive of (a) overcoming BEPS practices, and (b)
removing disparity that exists on the basis of residential status.
Conclusively, the report also cautioned the member countries about the probable conflicts
that the proposed options may have with certain existing trade agreements, particularly the
ones involving European Union. The report does not explicitly provide for existence of any
conflict in the Indian context, but a cursory perusal of certain major trade agreements seem to
suggest a few minor discrepancies, which shall be discussed under the subsequent heading. It
is in this backdrop that the budget 2016 has taken up equalization levy as the best alternative.
The inclusion of EL in the domestic law can be rationalized by envisaging the difficulty that
its incorporation in all the tax treaties would have caused.
NATURE OF LEVY: CLEARING THE MIST
An important aspect which draws one’s attention is the introduction of EL not as an
amendment to the IT Act, but instead separately as a distinct chapter under the Finance Act.
It’s true that it is not the first levy to have been introduced this way, and impositions like
Service Tax and Securities transaction tax have been previously brought in vide Finance Acts
of the year 1994 and 2004 respectively. However in this case, unlike before, it is effectively
the income that is being taxed. One argument for not introducing it as a part of the Income
Tax Act can be it being an imposition on the income of non-residents and not Indian
residents.
Divergent views exist with respect to the nature of this imposition. On one hand, where a case
can very well be made out calling this impost an income tax; there exist equal amount of
evidence, on the other, to prove it as a levy distinct and independent from Income Tax. This
section aims to highlight all the major substantive arguments that can be advanced in support
of both the prevalent views. This lingering uncertainty and ambiguity with respect to the real
nature of this levy necessitates a clarification or amendment from the government in the near
future.
Levy as an Income Tax
Section 164(d) of the Finance Act defines ‘equalization levy’ as the “tax leviable on
consideration received or receivable for any specified service”. The definition uses the term
VOL. III ISSUE I INDIAN JOURNAL OF TAX LAW 2016
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‘tax’ to characterize this levy, but Chapter VIII does not define the term ‘tax’;51
and Section
164 (j) provides that the terms or expression used under this chapter but not defined herewith
shall derive its meaning from the IT Act. Therefore, reliance should be placed on Clause 43
of Section 2, which defines Tax to mean “income-tax chargeable under the provisions of this
Act” amongst other meanings and interpretations. In simple words, for the purposes of IT
Act, Tax means income tax.52
Now with clause (j) providing that undefined terms in Chapter
VIII should derive its meaning from IT Act, ‘Tax’ here would also mean income tax. In light
of the imposition being unqualified, the levy cannot be restricted to mean something different
form income tax.
Had the legislature intended to give a different meaning to this levy, it would have defined it
so while framing the legislation. Legislature could have either defined the term itself
differently under Section 164, or could have made an addition to clause (j) along the lines of
“unless there is something in the subject or context inconsistent with such construction”.53
If
the latter alternative was to be adopted, one could have argued that in light of the context and
content of the charge the impost does not qualify as income tax. As there was nothing that
prevented the legislature from using such language, its absence could be construed to mean
an intended omission. Hence, as far as literal interpretation of this levy goes, it constitutes
income-tax. Furthermore, both these imposts i.e., equalization levy and income tax, function
in identical fields and are strongly intertwined. Assessment as well as the appellate authorities
is same for both the imposts and Section 178 of the Finance Act even list out various
provisions of IT Act which applies to equalization levy.
Reference made to double taxation under Section 10(50) of the IT Act54
further reinforces the
notion of this levy being Income tax. It is a widely settled fact that the concept of double
taxation creeps in only when the same income is charged twice, and that too under the same
statute. If the impost on the same income is flowing from two different statutes, then it will
not qualify as double taxation. The reason being, every legal framework has a different set of
reasons behind its promulgation and a different set of objects to be achieved. Reference made
to double taxation in the current context, therefore, indicates that income tax and equalization
51 Manish, Is equalization levy a tax?, TAXOF INDIA, (March 28, 2016); available at
https://taxofindia.wordpress.com/2016/03/28/is-equalisation-levy-a-tax/ (last accessed on 31th August, 2016). 52 Definitely including other kinds of taxes mentioned in the definition as well, but those taxes are irrelevant for
the current purposes. 53
Supra n. 51. 54 Inserted through Finance Act, 2016.
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levy are not capable of being imposed at the same time. This leads one into drawing the
inference that both the levies are one and the same.
Additionally, in lack of any other form of travaux préparatoires, one way to interpret the
legislative intent behind this levy would be to analyze the Finance Minister’s budget speech
with respect to the Equalization levy. The opening part of the 151st paragraph of the speech
makes it crystal clear that the intent of the legislature is to tap in on the e-commerce income
generated by non-resident units.55
The focus thus lies in taxing the ‘income’, and helps in
concluding that equalization levy in this sense is merely a variant of income tax.
Levy as an independent imposition
However, the aforementioned position cannot be the only conclusion drawn from the
analysis, and inferring an entirely contrary conclusion stands as an equally valid possibility.
This alternate conclusion points towards the equalization levy and income tax belonging to
different regimes altogether. Careful perusal of all the related provisions in Income tax Act
and the Finance Act helps one in framing certain arguments which further the said view,
namely:
Impost of this levy is via insertion of a separate chapter in the Finance Act. If both the
levy were indeed similar, the legislature would’ve covered it within the ambit of Income
Tax itself.
Chapter VIII of the Act seeks to create a new and independent code by itself. The said
chapter has everything including charging provision, collection related procedure and
penal measures that are triggered on failure to abide. The borrowing of some specific
provisions from income tax statute, enlisted under Section 178 of the Act, is merely a
device to strengthen this independent framework.
Liability with respect to the deduction and payment of equalization levy lies with the
Indian resident making remittances to the Non-resident service providers for the services
availed. The burden to timely deduct this tax and deposit it with the authorities lies also
with the residents making payment, and not the exchequer. Even the assessment and
penal measures are provided for against the payers, and payee merely acts as the stimuli.
55 Speech of Arun Jaitley, Minister of Finance, Notification No. : 2(9)/2016-B(D), MINISTRY OF FINANCE,
(February 29, 2016); available at
http://www.thehindu.com/multimedia/archive/02756/Budget_Speech_2756516a.pdf (last accessed on 31th
August, 2016).
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This non-resident payee owes no liability and stays unharmed by the tax collection and
compliance methods undertaken, in spite of being the income earner. This mode of
operation is unknown to Income Tax statutes, which never absolve the income earner
from tax liability. Similarly all the compliance measures are also enforced against the
income earners, unlike the case of equalization levy.
Although arguments advanced in favour of both the propositions sounds extremely plausible,
but in my personal opinion EL is more of an independent imposition, separate from Income
tax. Arguments made in favour of income tax largely place reliance on inferences drawn by
its conjoint reading with other statutes or giving undue emphasis to the omission made. On
the other hand, there are enough explicit evidences in favour of EL being an independent
imposition and there stands no need to draw any implication whatsoever. Therefore, there is a
need for pointed clarifications or amendments by the government that clears the lingering
ambiguity prevailing over this aspect of the levy. The present uncertainty over its nature only
opens the door to a plethora of other related and unanswered questions.
APPRAISAL OF THE LEVY
At this initial stage, EL is proposed to be imposed only on business-to-business transactions
[B2B] and not business-to-consumer transactions [B2C].56
Section 164 (h) of the Finance Act
defines these specific services as online advertisement, providing digital advertisement space
etc. However, this section also entrusts the government with power to expand its ambit by
notifying inclusion of other services.57
The government even holds the power to include
within the levy’s ambit e-commerce transactions like downloading of movies, albums and
books, software downloads, online news consumption and online sale of other goods and
services. There is a range of varied services which can easily be subject to this proposed levy,
whose implementation will not even require any infrastructural changes.
This excessive power entrusted with the government although might be well intentioned, but
there also exists high possibility of its negative consequences. In this light, certain similar
instances form the past are worth mentioning. As mentioned already, Service Tax was also
introduced in a similar fashion in India via Finance Bill, 1994.58
When introduced, it was
levied on merely three services at the rate of 5%. Contrast this with the current regime of a
56 Lakshit Desai, Equalization levy – a step towards taxing digital transactions, [2016] 71 taxmann.com 44,
(June 2016); available at https://www.taxmann.com/articles.aspx (last accessed on 31th August, 2016). 57
Supra, n. 7, Section 164. 58 Supra, n. 7, Chapter V.
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12.5% imposition and the presence of a negative list.59
It is not farfetched to imagine the
equalization levy also progressing in a similar fashion.
Additionally, owing to the uncertainty which looms over the reaction of the digital giants to
this levy, it is speculated that the brunt of the levy will be faced by the small and medium
sized businesses and the newly growing market of startups. These entities place high reliance
on forums like Google, Facebook and Amazon for the purpose of advertising their goods and
services.60
A key factor for which these forums are popular with small and medium
businesses is the ease with which the targeted audience can be reached through them,
eliminating the huge investment in advertisement. However, through the new levy, these non-
resident digital giants are highly likely to increase the price at which they offer services so as
to accommodate the imposition.61
This new proposal, therefore, seems to be harming some
businesses in more ways that it is benefitting a few.
For example let’s assume that before the imposition of this levy, a particular service was
provided by Google at Rs. 2,00,000. With the introduction of 6% equalization levy, Google
would only be receiving Rs. 1,88,000 as reimbursement its services. In order to make up for
these lost revenues, Google will start charging around Rs. 2,12,000 thereby leading to an
increase in cost for small resident businesses. This does not impact the revenue generation of
the non-resident companies. As a consequence, even though the intention behind imposition
of this levy was taxing the big online companies, in effect it is turning out to be a cost for the
small businesses which rely on these forums for advertisement purposes.
The legislators have carved out an exception whereby if the net proceeds remitted by an
Indian resident do not exceed Rupees 1 Lakh in a financial year, then levy would not be
imposed. 62
However, this provision does not seem to hold much practical relevance. As
exemplified above, the implementation of this levy is highly likely to lead to an increase in
the fees charged by these companies. Therefore, all the service subscribers across the board
59 Dinesh Agarwal & Ankit Shah, Service Tax Changes: Effective 1 April 2016, MONDAQ, (5 April 2016);
on 31th August, 2016). 62 Supra, n. 7, Section 166.
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will have to pay more and the cost of doing business in digital India will go up even for the
people paying less than Rupees 1 Lakh.63
This argument of price increase has to be understood with some amount of caution as it is
based on two assumptions. At the primary level it is being assumed that the non – resident
service providers would increase the price as an attempt to make up for the lost revenue.
Further, there is a second assumption that the price determination power lies with the service
providers themselves, and not with the market forces.
On the brighter side, there are some domestic players like the indigenous e-commerce
companies that this equalization levy would be helping. Earlier these E-commerce websites
used to charge commission fees for listing the products on their websites. But this fee has
slowly been phased out, and most of these e-commerce websites now generate revenues
merely off advertisements from their respective merchants. With the implementation of
Equalization levy, while the foreign services providers would be forced to either increase
their prices or take a hit in any other manner, these resident online websites like Flipkart and
Snapdeal will remain unaffected.64
The bargaining power, however, will still lie with the
Resident merchants who list on these websites. They should be encouraged to prefer domestic
websites over the other alternatives, both because they are cheaper as well as indigenous.
LACUNAE IN THE PROPOSED SCHEME
Foreign tax credit availability
A glance at the foreign trade credit clauses of the various bilateral tax treaties, to which India
is a signatory, sheds light on the ambiguity that exists in this regime. Substantial uncertainty
lingers over the issue of whether the non-residents, who have paid equalization levy in India,
can claim credit from their respective country of citizenship for the amount paid as the levy.65
This issue can be better understood through the example of the India-US tax treaty. Article 2
of the treaty defines “tax covered” and covers within its ambit “any identical or substantially
similar taxes”.66
Article 25 of the treaty titled ‘Relief from Double Taxation’, lays down that
“U.S. shall allow to a resident or citizen of the US, as a credit against the US tax, on income
63 Shrutika Verma, India’s Google tax may raise costs for Indian units of global firms, LIVE MINT, June 1, 2016. 64 Remy Nair, More digital transactions may come under equalization levy’s ambit, LIVE MINT, March 30,
2016. 65 Deepak Goel, Equalisation Levy – Is it a beginning of a new saga?, TAXMANN, [2016] 71 taxmann.com 195. 66 Convention Between The Government Of The United States Of America And The Government Of The
Republic Of India For The Avoidance Of Double Taxation And The Prevention Of Fiscal Evasion With Respect
To Taxes On Income, art. 3, 20th Dec, 1990, Notification No. GSR 990(E).
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tax paid to India”.67
It further provides that “the taxes referred to in paragraphs 1(b) and 2 of
Article 2 (Taxes Covered) shall be considered as income taxes”.
The simultaneous reading of these provisions i.e., Article 2 and 25 of the India-U.S. treaty,
brings to fore the possibility of other countries granting credit to its citizen for paying taxes
that are identical or substantially similar to income tax. Equalization levy, even if not a tax on
income, is substantially similar to income tax and the U.S. government might therefore give
credit to its citizen for the levy paid by him in India.68
Additionally, clauses like Article 2 and
25 are not merely limited to the India-U.S. tax treaty and are rather omnipresent; implying
that the same benefits can be reaped by the residents of other countries as well. No
clarification has been issued by either the finance ministry or CBDT in this regard and hence
the problem continues to persist.
Brand promotion activities
This is a critical area which might attract a lot of litigation in future. The current framework
provides no clarity on the imposition of this levy on brand promotion activities which the
parent company, not having a PE in India, might render to its Indian subsidiaries. One of the
biggest losers to this underlying uncertainty would be the big brands, which have worldwide
presence and promotional activity are centrally undertaken by the holding company, followed
by cost allocation to each such subsidiary.69
Similarly, even a significant chunk of the service
fee charged by online stores like Amazon and Flipkart might fall within the ambit of
equalization levy, as the fee charged by these digital marketplaces is already inclusive of
brand promotion charges.
For the purpose of resolving this problem, an easy way out for the government can be tagging
these services as advertisements and bringing them within the ambit of the levy, followed by
waiting for years of litigation to finish and courts finally reaching a conclusion. However, a
few fallouts to this approach would be loss of foreign taxpayers’ confidence and negative
impact on the ‘Digital India’ initiative. Therefore, the better option for the government is to
preempt this problem and define ‘services’ covered in a manner that is more inclusive, yet
67 Ibid, art. 25. 68 Supra, n. 65. 69 Neeraj Sharma, Whether Equalisation Levy is an Effective tool to tax enterprises with digital presence in
India?, [2016] 69 taxmann.com 89; available at https://www.taxmann.com/articles.aspx (last accessed on 31th
August, 2016).
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flexible.70
Composite agreement covering multi-jurisdictional provision of advertisement services
Ambiguity persist with respect to valuation of the consideration paid in lieu of services
provided in India, when the said contract pertains to a composite agreement involving
provision of services in India (inclusive of J&K) as well as abroad. Equalization Levy Rules,
201671
failed to bring clarity in this regard and thus difficulty would arise in separating the
amount charged for services in India (exclusive of J&K) as against the amount for services in
other countries and J&K. Furthermore, there is lingering uncertainty even with regards
valuation of the amount on which levy is to be calculated if consideration paid is in non-
monetary form. As “measure of value” is considered as an essential component of a tax
alongside nature, rate and individual being taxed,72
clarity in this respect is vital.
In addition to other criticisms and controversies, certain fundamental jurisdictional issues also
plague the current proposal. It is widely accepted as a settled principle in taxation
jurisprudence that legal fiction cannot be accepted as a basis for determination of
international income tax jurisdiction.73
However, the government can be said to be resorting
to this legal fiction for invoking Indian jurisdiction when they are deeming the online
advertisement spending of Indian residents to mean an actual activity in India by the non-
resident recipients of the payment.
The issue as it stands today, is whether a mere change in phraseology can alter the nature of
this otherwise ultra vires levy into a rightful exercise of jurisdiction, under the general
principle of international taxation law. Furthermore, if similar levies are imposed by other
market jurisdictions as well, then the consequential aggregate over-taxation that is likely to
result would be extremely regressive. However the Report of the Committee on Taxation of
E-Commerce74
found no possible errors with this approach.
CONCLUSION
While EL is a commendable attempt towards recovering the revenue which otherwise gets
lost owing to limitations in the taxation infrastructure, it would not be erroneous to assert that
70 Ibid. 71 Supra, n. 15. 72 Govind Saran Ganga Saran v. Commissioner Of Sales Tax, 1985 AIR 1041. 73 This principle was clearly stated by the Indian Supreme Court in Vodafone International Holdings v. Union of
India, (2012) 6 SCC 613. 74 Supra, n. 48.
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its indirectness is highly likely to impact the small and medium level businesses and startups.
This levy, passed under the influence of OECD Action Plan, seems to have been introduced
in a rush and requires a comprehensive reassessment to achieve its desired objective.
Considering the significant economic dimension of this levy, as has been elucidated in the
second part, this source of revenue should not be left untapped; but in its current shape it will
only increase litigation and further burden the overburdened judiciary.
Memorandum attached to the Finance Bill makes its exceedingly clear that EL derived its
inspiration from the OECD Action plan, wherein it was proposed as one of the ways to tax
‘economic nexus’ which otherwise goes untaxed under the existing structure. In spite of the
introduction of EL in domestic taxation framework, the legislature has failed to clarify how
the said ‘economic nexus’ is justified by this imposition. In addition, low threshold of Rs. 1
Lakh makes its ambit rather wider and covers even those transactions whose economic nexus
to India is rather flimsy.
Furthermore, nothing in the budget speech, the Memorandum to the Finance bill or the
committee report justifies the adoption of EL, as opposed to other alternatives, as the most
suitable mode of taxing these overseas online transactions by the government. The raison
d'être behind this imposition therefore remains unclear. Moreover, clarification regarding the
nature of this levy becomes imperative in light of the multilayered ambiguity that exists,
especially with respect to the phraseology used by legislature. Even though Part V of the
paper attempts to collate equally plausible arguments advanced from both the factions, but
evidentiary balance tilts towards it being an independent imposition for the reasons already
discussed. However, till the issuance of an official clarification, these claims would qualify as
mere speculations.
In addition there are a few lacunas in the proposed scheme,75
with respect to the availability
of foreign tax credit, ‘measure of value’ and assessment of centrally undertaken brand
promotion activity, which require immediate attention to provide some semblance of
certainty. Because even after these fundamental challenges are overcome by the government,
a string of smaller issues would arise during the actual implementation of the levy, which can
only be redressed over the course of time.
75 As flagged off in part VII of the paper.
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Conclusively, this act of government is neither in line with tax competitive measures, which
is the need of the hour for any developing economy, nor does it help boost investor
confidence by providing a more stable taxation regime. Instead, it is likely to divert the focus
of government from more important issues such as non-adversarial tax regime and a few
other problems flagged under the OECD action plan; with no attempts being made to attract
the government’s attention back to these important issues. Aspects like ‘limitation of interest
deduction’, ‘disclosure of abusive arrangements’ and ‘hybrid mismatch arrangements’
requires adequate attention in the recent past nor can the inclusion of transfer pricing
regulation in the domestic framework be deferred for longer.
Therefore, this step towards equalization levy is being welcomed by the community with
further hope that the determination of the government towards reforming the extant structure
would not diminish in spite of pressure from different quarters, and the aforementioned much