Equalisation levy: tread with caution

Thanks to the internet, information and services industries today addresses a world without boundaries. In an increasingly connected world, geographic proximity or nearness to customers — importance of which is taught in most business textbooks — has lost its relevance.

This, however, poses many challenges while taxing and regulating industries even as governments struggle to augment revenue collections. The situation has reached an alarming stage after the financial crisis of 2008, bringing developed and emerging economies together to review business models and usher in more tax transparency.

The Organisation for Economic Corporation and Development (OECD), at the behest of G20 countries, prepared an action plan against the tax avoidance strategy of Base Erosion and Profit Shifting (BEPS). In its first action plan, ‘Addressing tax challenges in digital economy’, OECD proposed options to overcome tax challenges the digital economy brings.

These include a new nexus approach in the form of a significant economic presence, withholding tax on certain types of digital transactions and equalisation levy.

Globally, nations have tried to tax the digital economy through a combination of measures such as introduction of specific provisions under their domestic tax law, anti-avoidance rules and levy of consumption tax.

The UK has introduced Diverted Profit Tax (DPT) — 25 per cent on profits generated in Britain. Similarly, Turnover Tax has been introduced in Argentina at the rate of 3 per cent on off-shore foreign companies providing e-services.

Australia and Japan have also started taxing digital transactions under their domestic value-added tax/ Goods and Services Tax law which were earlier not taxable in absence of a foreign company having local presence.

In 2001, India’s Central Board of Direct Taxes set up a high-powered committee on e-commerce taxation. The panel recommended that the Government should take steps to find an alternative to the concept of Permanent Establishment (PE) as it does not ensure certainty of tax burden and maintenance of equilibrium in sharing of tax revenues between countries of residence and source for taxpayers in e-commerce.

In 2013, while analysing taxability of payments made for online advertisements in the case of Right Florists, the Kolkata tax tribunal has noted that the traditional concept of PE was conceived when internet and e-commerce were not even on the radar. In modern day, virtual presence through internet can be as effective as physical presence for carrying on businesses.

In 2015, India set up another committee on taxation of e-commerce. Taking a cue from options analysed in OECD’s BEPS Action Plan 1, it proposed an ‘equalisation levy’ on 12 digital services. This was introduced on online advertisement and some related services as a separate chapter in the Finance Act 2016.

Since, it was not a part of the Income Tax Act, equalisation levy was independent of taxability of the income embedded in the said services.

However, to avoid double taxation, the income tax Act was amended to provide that the income which is chargeable to equalisation levy shall be exempt from levy of corporate income tax in the hands of the service provider.

A person carrying on business or profession in India or a non-resident having a PE in India is required to deduct equalisation levy at the rate of 6 per cent on the consideration paid or payable for the specified services.

However, if the non-resident service provider has a PE in India, through which such services are rendered, equalisation levy shall not be applicable. Exemption has been provided for small payments where the aggregate payment for such services by the remiter during a year does not exceeds ₹1 lakh.

Introduction of equalisation levy serves the need for collection of tax on digital transactions without getting into the tedious task of amending existing income tax regulations and tax treaties.

On the other hand, it would increase cost of doing business in India for non-residents service provides, as they may face difficulty in claiming credit for this unilateral levy against the taxes paid in their home jurisdictions.

This problem is further compounded by the fact that tax rate of 6 per cent on the gross receipt would mean that profits to the extent of 15 per cent of the sales are allocated to the Indian customer base. Depending on profitability of each enterprise, this may be on a higher side as compared to a situation, where non-resident carries business through a PE in India.

Further, given that the responsibility of deduction of equalisation levy has been fastened on the remiter, there is a high probability that non-resident service provider may seek net of tax payments i.e. any tax cost may have to be borne by Indian customer.

On account of limited bargaining power, this could prove to be a setback for startups since they would be required to incur higher advertising cost, thus increasing their cost of doing business.

There are other implementation challenges as well, such as lack of mechanism for determination of nature of service, lack of clarity on the mode of determination of PE of the service provider, etc. While equalisation levy is currently levied on online advertisement, etc., its scope may be expanded over time, as recommended by the expert committee, to cover online sale of goods and services, software, movies, music, etc.

Considering the impetus of the Government on enhancing ‘ease of doing business’ in the country, it is important that we tread this path with caution.

The writer is Leader-Tax, Grant Thornton in India. With inputs from Gaurav Mittal