India has, in its 2016-17 budget, taken a seemingly long-sighted step to tax an otherwise elusive yet significant section of the economy, i.e. the digital economy. Equalization levy, a federal levy, will be imposed on specified transactions of the digital economy.
The idea germinated from Action Plan 1 of the Base Erosion and Profits Shifting (BEPS) Project as formulated by the OECD and the G-20 nations (including India). Action Plan 1 deals with ways to resolve tax challenges arising in the digital economy and one of the suggestions (though not recommended) is that countries impose an equalization levy on digital transactions. The concept is relatively new (the BEPS action plans were finalized in October 2015), but other jurisdictions including the UK, Australia, Italy and Brazil have a comparable levy.
In India, until now, income from digital transactions such as online advertisements was regarded as not liable to tax under the Income-tax Act, 1961 (ITA) because nexus with India, in the form of a “permanent establishment”, could not be established. To consider taxation of the digital economy and take cognizance of BEPS Action Plan 1, a Committee on Taxation of E-Commerce was set up, which recommended the introduction of equalization levy on specified transactions.
The levy was introduced in Chapter VII of the Finance Bill, 2016 (and not by way of an amendment to the ITA). It is to come into force from a date to be notified by the government. Every Indian resident, and a permanent establishment of a non-resident, while making payments for “specified services” to a non-resident company is required to deduct equalization levy at the rate of 6%.
“Specified services” are presently defined as online and digital advertisements, but the central government can notify more transactions which will suffer this levy. It is likely that other varieties of e-commerce, app stores, cloud computing, participative networked platforms, high-speed training, and online payment services, which were mentioned under BEPS Action Plan 1 as well as by the committee, will be subject to this levy in the future.
The levy triggers only if the transaction is for the purpose of business or commerce and thus excludes business-to-consumer transactions. Further, if a single entity makes payments below ₹100,000 (approximately US$1,500) in the year, such payments will not have to suffer the levy.
Importantly, the liability to deduct tax lies with the Indian resident (or the permanent establishment of a non-resident) paying the non-resident service provider. Procedural compliances, liability to interest, penalty and prosecution also lie with the Indian resident. It is noteworthy that if the levy is not paid, the Indian resident cannot claim the payment as a business expenditure for the purpose of calculating its taxable income under the ITA.
The levy is not characterized as a tax on income but on specified transactions and so is enacted by way of the Finance Act and not by amending the ITA. Such characterization implies that the levy so paid cannot enjoy the benefit of double taxation avoidance agreements, and can thus possibly suffer double tax if the country of the non-resident does not give credit for such a levy. For the same reason, the provisions of transfer pricing and general anti-avoidance rules will not apply to such transactions. Further, since this is a tax not on income but on payments, it will be payable even when the non-resident is not profitable.
While the levy is a form of tax, it seems to benefit the Indian players in the digital economy, which are liable to tax in India and were competing with overseas enterprises which were not liable to tax in India.
Transactions which result in royalty fees or fees for technical services and are subject to higher income tax will henceforth be liable to the 6% equalization levy. Section 10 of the ITA provides an exemption for any income arising from providing specified services on which equalization levy is chargeable.
The levy poses challenges as well. Though it seeks to put the non-resident service provider at a disadvantage (to ensure a level playing field), it is the Indian resident which bears the entire brunt of the levy and which, apart from the procedural consequences, also faces the risk of paying interest and penalties and even prosecution.
Further, businesses that are small but above the low exemption threshold would be liable to deduct, though these may not have the commercial standing to pass on the burden to the non-resident service provider. It will also have to be seen whether, for the purpose of computing the value on which the levy is charged, any deduction is given for any service tax applicable on such transactions. The levy might also trigger litigation as to whether a transaction is one of the “specified services”.
The levy is based on the philosophy of “simplicity” and “predictability” and therefore one hopes and expects that any issues that arise on implementation are quickly dealt with by the government.
Ranjeet Mahtani is an associate partner and Stella Joseph is an associate manager at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.
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