Equalisation Levy seeks to cast Indian tax net wider

Budget 2016 introduced a new tax called Equalisation Levy (“EL”), aimed at taxing online transactions. EL was originally mooted by the OECD in Base Erosion and Profit Shifting (BEPS) Project Final Report on Action 1 – Addressing the Tax Challenges of the Digital Economy (the “Report”). We will examine Equalisation Levy and some key issues.

Genesis of Equalisation Levy

The trigger for the BEPS project was widespread discontent on loss of tax revenue to Governments due to shifting of profits by companies, to low-tax or no-tax jurisdictions. The BEPS project unveiled 15 Action Plans, identifying key international tax issues and potential means to address them. Key amongst these is dealt with in the Report.

The Report recognises that the all pervasive digital economy with new business models, like e-commerce, online advertising, online payment services etc. have thrown existing principles of international taxation into a state of flux. New payment models often do not permit the source country to tax income in the absence of a permanent establishment (“PE”) of the service provider. In this context, the Report inter aliasuggested EL as a means to bring to tax such income. The EL as suggested under the Report seeks to tax a non-resident enterprises’ “significant economic presence” in a country, but decries undue burden on small and medium sized businesses.

Equalisation Levy and India

India introduced EL as a knee-jerk reaction to various judicial precedents, and realisation that the extant laws cannot bring to tax certain online transactions. Rights Florist [1] case was a landmark judgment on the taxability of payments made for online advertisements on Google’s search engine. The tax officer had alleged that when payments were made by an Indian florist to Google Ireland and Yahoo USA, towards online advertisement, tax ought to have been withheld in India. The tribunal held that in a virtual transaction through a website, no PE is constituted, since the servers on which websites were hosted, were located outside India. In the absence of a PE, there would be no taxable business income in India.

Further, advertisement charges paid to Google and Yahoo were also not taxable as ‘royalty’ since the service did not involve any use or right to use industrial, commercial or scientific equipment. Moreover, in providing the advertisement services, the taxpayer was not given access to Yahoo’s/Google’s portal or server. Further, the tax officer’s characterization of the payment as ‘fee for technical services’ was also negated, for want of a human element in providing the services. Thus, Google’s/Yahoo’s receipts from online advertising were held not liable to tax in India. Yahoo India [2] andPinstrom Technologies [3] too similarly held that payments made towards online advertisements were not liable to tax.

Now, the Finance Act, 2016 imposes EL on certain “specified services”, which term, has been defined to mean ‘online advertisement, any provision for digital advertising space or any other facility or service for the purpose of online advertisement, and includes any other service as may be notified.’ The rate of EL is pegged at 6% and will be payable by a nonresident, who receives consideration for such services. The payments may be either from a resident carrying on business or profession, or a nonresident having a PE in India, essentially on B2B transactions. Thus, all online advertisements, whether viewable in India or not, will be subject to EL. A key question is whether payments made by an Indian subsidiary to its foreign affiliate towards global brand promotion, would be liable to EL, if such payment say forms part of a sales commission.

Contrary to the Report, the monetary threshold to apply EL is merely INR 100,000 (USD 1500 approx.), irrespective of whether the service provider has a significant presence in India or not. Given that advertisements are expensive, a low threshold means that every online advertisement could attract EL, though the “significant economic presence” requirement, as prescribed under the Report, may not be met.

Further, a new Section 10(50) has been inserted into the Income Tax Act, 1961 as a result of which income on which EL has been paid would be “exempt” from tax. Though the rationale for this is to avoid double taxation, remember that the EL is applicable only to a nonresident, who will not be liable to tax in India anyway. A larger question is whether EL itself is an “income tax”, since the EL laws are not enacted into the IT Act, but is a separate code in itself.

If EL is not an “income tax”, double tax avoidance agreements (“DTAA”) will not be applicable. India’s DTAAs do not allow credit for EL, against corporate taxes payable in the non-resident’s country of tax residence, resulting in double taxation of the same income. Thus, India will also fail to honour DTAA obligations.

In the absence of tax credit in its home country, the non-resident may pass the EL burden contractually on to the Indian advertiser, thus defeating the intention to tax non-residents and increasing residents’ costs.

Hasty steps

The Report had acknowledged that none of the options suggested in regard to digital economy, (including EL) were being recommended till such time that substantial changes to key international tax standards are worked out. The Report recommended broad safeguards against BEPS under domestic tax laws, by ensuring that a domestic taxing right is available for remote transactions involving digital goods and services, and to complement it with options in bilateral DTAAs through modification of the PE definition. The BEPS Project is work-in-progress, especially in the digital economy taxation realm, and workable guidelines are yet to emerge. Unfortunately, the Indian government has hastily introduced the EL, with scant regard for the OECD’s directions, the comity of nations and DTAA obligations.

The Indian tax authorities’ “tax terrorism” and extreme distrust of the taxpayer is well known. Judicial precedents and even the letter of the law are given short shrift, in a bid to garner tax revenues. Digital transactions ought to be taxed; but it could have been through calibrated amendments to the PE definition as suggested in the Report. Introducing new levies without any public consultation, may not achieve the desired objectives.