The Finance Act 2016 has levied a new tax called “Equalisation Levy” (EL) Which is levied on the nonresident online service providers who earn from Indian customers but do not pay any taxes in India in absence of Permanent Establishment (PE). The nature of specified services is such that it does not fall within the ambit of royalties of fees for technical services. Compared to them, any Indian company engaged in similar activities would be subject to regular income-tax in India. Therefore, in order to provide a level playing field so as to equalize the incidence of tax, a new levy is imposed on specified online services. This levy is an offshoot of the G-20 Nations’ initiative of the project on Base Erosion and Profits Shifting (BEPS) Action Plan 1, Addressing Tax Challenges of Digital Economy, led by OECD. This article highlights the salient features of the EL and related issues arising therefrom. For succinct understanding the subject, the EL is explained in question-answer format.
1.0 Background
Telecommunication and Information Technology has impacted our lives significantly, commerce being no exception. The ways of doing business and business models have undergone vast and significant changes in the last two decades. E-commerce (the new term used is “Digital Economy”) is indeed an off-shoot of this technological development. 1Digital economy has obviated the necessity of physical presence in the source State for doing business. This has resulted in billions of dollars worth trade in the source States without paying any taxes. Unfortunately tax laws have not kept pace with the technological developments and hence there are gaps or opportunities for tax planning or avoidance. Therefore, the G20 Nations considered the issues arising out of “digital economy” (a term wide enough to cover all sorts of e-commerce transactions) in Action Plan 1 of the BEPS project which was released in October, 2015. However, no consensus emerged on the methodology to tax such digital transactions. The report considered the following three options to address the broader tax challenges of the digital economy:
(i) New Nexus based on Significant Economic Presence
(ii) Withholding tax on digital transactions and
(iii) Equalisation Levy
1.1 Committee on Taxation of E-Commerce
Post BEPS report, the Indian Government set up a Committee on Taxation of E-Commerce with terms of reference to detail the business models for e-commerce, the direct tax issues in regard to e-commerce transactions and a suggested approach to deal with these issues under different business models. The Committee submitted its report in February 2016 and recommended to impose Equalisation Levy (EL) on specified online transactions. The Committee suggested enacting a separate law by introducing a chapter in the Finance Act, 2016 such that it becomes a distinct tax by itself and not in the nature of income- tax. If the EL partakes the character of income-tax, then it would not serve any purpose whatsoever, as tax treaty provisions would override the provisions of the Indian Income-tax Act and unless all the treaties are renegotiated and amended, the levy would be ineffectual. Although the Committee recommended thirteen specified transactions for the levying EL, at present only online advertisement/facility for online advertisement and digital advertising space are brought within the purview of EL.
1.2 Statutory Basis
EL has been imposed vide Chapter VII of the Finance Act, 2016 containing section 163 to section 180. It is a self-contained code which extends to the whole of India except the State of Jammu and Kashmir. It has come into effect from 1st June 2016. Though it is levied under a separate chapter in the Finance Act, and not supposed to be in the nature of income tax, it would be administered by the Income-tax authorities. Many administrative provisions under the Income-tax Act, 1961 (such as appeals, survey, collection and recovery of taxes etc.) are made applicable to EL as well. I n the backdrop of the above information, let us proceed to understand the implications of EL in depth by way of questions and answers.
2.0 What is Equalization Levy (EL) and how it is levied?
Ans: In simple words EL is a tax on gross revenue of non-resident providing specified services to Indian residents subject to certain conditions.
EL is a tax levied at the rate of six per cent on the amount of consideration for any specified services received or receivable by any non-resident person from –
(i) A person resident in India and carrying on business or profession; or
(ii) A non-resident having a PE in India.
Exemptions from EL
(i) A non-resident providing the specified services has a PE in India and such services are effectively connected with such PE;
(In the above case, the profits of the Indian PE of a non-resident will be taxed in India and therefore, there is no loss of revenue and consequently no need to levy EL)
(ii) The aggregate amount of consideration for any specified services received or receivable in a previous year by any non-resident person from a person resident in India and carrying on business or profession; or a non-resident having a PE in India does not exceed Rupees One Lakh;
(It means that a payer can make payment to a number of service providers below Rupees one lakh in a previous year without deducting tax at source; similarly a non-resident service provider can receive revenue from a number of resident payers without attracting EL as long as it is less than Rupees one lakh per payer)
(iii) Where the payment for specified service by the person resident in India, or the PE in India is not for purposes of carrying on business or profession.
(The above provision would provide relief to many small service recipients from the burden of tax deduction and tax compliance. As such they would not be claiming such payment as expenditure and therefore there will not be any base erosion in India on such payments)
Section 166 of the EL Chapter provides that a resident payer has to deduct the EL from the amount paid or payable to a non-resident and it is to be paid to the credit of the Government within seventh day of the month immediately following the said calendar month.
It is also provided that even if the payer fails to deduct the amount of the levy, he has to pay nonetheless the levy to the Government.
3.0 Which specified services are covered under EL?
Ans. Section 164 (i) defines “specified service” means online advertisement, any provision for digital advertising space or any other facility or services for the purpose of online advertisement and includes any other services as may be notified by the Central Government of India in this behalf.
Section 164 (f) defines “Online” means a facility or services or right or benefit or access that is obtained through internet or any other form of digital or telecommunications network.
It may be noted that the Committee on Taxation of E-commerce has recommended the following definition for ‘specified services’:-
(i) online advertising or any services, rights or use of software for online advertising, including advertising on radio & television;
(ii) digital advertising space;
(iii) designing, creating, hosting or maintenance of website;
(iv) digital space for website, advertising, e-mails, online computing, blogs, online content, online data or any other online facility;
(v) any provision, facility or service for uploading, storing or distribution of digital content;
(vi) online collection or processing of data related to online users in India;
(vii) any facility or service for online sale of goods or services or collecting online payments;
(viii) development or maintenance of participative online networks;
(ix) use or right to use or download online music, online movies, online games, online books or online software, without a right to make and distribute any copies thereof;
(x) online news, online search, online maps or global positioning system applications;
(xi) online software applications accessed or downloaded through internet or telecommunication networks;
(xii) online software computing facility of any kind for any purpose; and
(xiii) reimbursement of expenses of a nature that are included in any of the above.
At present only online advertisement/facility and digital advertising space are brought under the purview of EL. It is believed that the coverage of the EL may expand in future.
4.0 What are the implications of EL for the non-resident service provider?
Ans: The newly inserted section 10(50) of the Incometax Act, 1961 (the Act) provides that any income arising from any specified service provided and chargeable to EL shall not form part of total income i.e. be exempt from tax. It means that where the non-resident service provider is subject to EL, it would not be required to comply with any other provisions of the Act. EL is levied at 6 per cent on gross revenue, whereas royalties and fees for technical services are taxed at the rate of 10 per cent on gross basis. It may be possible that going forward (when more services are notified for EL) some of the services may overlap and at that time it would be advantageous for the non-resident service provider to opt for EL as there would not be any litigation as to the characterization of income.
Another positive implication for the non-resident service provider is that if its income is covered under EL, then provisions of Transfer Pricing and General Anti Avoidance Rules (GAAR) will not be applicable.
5.0 What are the implications of EL for the resident tax payer?
Ans: The Levy imposes various obligations on the resident tax payer, and prescribes various penal consequences for failure to comply with them, as follows:
5.1 Deduction of EL @ 6 per cent on gross payment exceeding one lakh rupees to a non-resident for specified services; [section 165]
5.2 Deposit to the credit of Government (meaning cheque should be cleared or online payment should be within the working hours) by the seventh day of the month immediately following the calendar month in which EL is so deducted or was deductible. The EL must be credited as aforesaid even if the assessee (resident payer) fails to deduct it from the payment to non-resident; [section 166]
There is no clarity as to whether the payer needs to gross up the EL if the non-resident service provider refuses to pay the same. Section 166(3) casts the obligation on the Indian resident payer to deposit the levy irrespective of the fact whether the same has been deducted or not. So if a deductor has to remit Rs. 100/- whether he is required to pay Rs.6/- as EL or Rs. 6.38 after grossing it up, as everywhere the terminology is used “deducted”.
5.3 Disallowance of expenditure u/s. 40(a)(ib) for failure to deduct or after deduction failure to pay, EL as aforesaid; [section 40(a)(ib)]
5.4 Furnishing of annual statement of specified services to be submitted electronically in Form No. 1 on or before 30th June immediately following the relevant previous year; [section 167 read with Rules 5 and 6]
5.5 Payer is exposed to following penalties:
-Delayed payment of EL->simple interest at the rate of one per cent of EL for every month or part of a month by which such credit of the EL or any part thereof is delayed [section 170]
-Failure to deduct EL->Penalty amount equal to EL [section 171]
-Deducted EL but failure to pay to the Government->Penalty of Rs. 1000/- for every day during which failure continues maximum up to the amount of EL [section 171]
-Failure to furnish annual statement in form 1->Penalty of Rs. 100 per day for each day during which the failure continues [section 172]
Section 173 provides that no penalties shall be imposed for offences listed in section 171 and 172 if the assessee proves to the satisfaction of the Assessing Officer that there was reasonable cause for such failure.
5.6 Section 174 and 175 respectively provide right of appeal (to the assessee) to CIT (appeals) and the Appellate Tribunal in respect of grievances on account of penalties.
6.0 W hat is the nature of EL – Direct tax or Indirect tax?
Ans: 6.1 Whether EL is Direct tax?
The report of the Committee on Transactions of E-Commerce has clarified that “the EL will be outside the income-tax Act. It is not a tax on income, as it is levied on payments. It is therefore also payable by enterprises not making any net profits”. EL is in the nature of turnover tax. It is not a tax or levy on income but on gross revenue. Under the Income-tax act certain income are taxed in the hands of the non-resident on presumptive basis e.g. profits and gains of shipping business or exploration of mineral oil and natural gas etc. However in all such cases, a certain percentage of the gross revenue is estimated to be income on which the tax is levied at the applicable rate, whereas EL is levied on gross consideration itself.
However, two arguments in favour of those who feel that the EL is in the nature of income-tax or a tax substantially similar to income tax (so as to qualify for treaty relief by invoking provisions of Article 2) are as follows:
(i) EL would be governed by the Income tax authorities and many provisions of the Act are made applicable to it. In short EL is not a complete code by itself;
(ii) The Revenue secretary in an interview to Business Today magazine dated 5th June, 2016 opined that EL in essence is income tax.
Appendix 2 of the report of the Committee on Taxation of E-Commerce has listed the objectives of EL where in it is mentioned as “to reduce the unfair tax advantage enjoyed by a multinational digital enterprise over its Indian competitors, and thereby ensure fair market competition. The unfair tax advantage arises when domestic enterprises are taxed but multinational enterprises are not taxed on their income arising from India.”
From the above objective it is clear that EL may be called by whatever name or levied in whatever manner it being understood that, the objective is to tax income arising to non-resident service providers who earn from Indian resident payers.
6.2 EL and tax Treaties
The characterization of EL is indeed significant from the treaty perspective as well. If EL is held to be income-tax or a tax substantially similar to income tax, then as per 2Article 2 of a tax treaty, EL would be covered and as per section 90(2) of the Act, treaty provisions would override the provisions of EL. The only saving grace is that section 90 (2) makes a reference to provisions of the incometax act and EL is outside the purview of the Act. However, it would be interesting to see if any nonresident or a treaty partner country invokes Mutual Agreement Procedure for seeking clarity on this issue.
It may be possible that a non-resident providing service in India and who is subject to EL may invoke the Article on non-discrimination on the ground that the non-residents who supply goods to India are not subjected to EL even though their business model is the same.
Appendix 2 paragraph 13, of the report of the Committee on Taxation of E-Commerce has stated that “as the Equalization Levy is not charged on income, it is not covered by Double Taxation Avoidance Agreements or tax treaties. Thus, no tax credits under the tax treaties will become available to the beneficial owner in the country of its residence, in respect of Equalization Levy charged in India”.
Considering the limitation or possibility of nonavailability of credit in respect of EL, the Committee recommended levy of six per cent as against normal tax of 10 per cent in case of royalties and FTS.
6.3 Whether EL is indirect tax?
Indirect tax like service tax and VAT are charged on gross turnover and in that sense EL is closer to them. However, one fundamental difference is that service tax is a destination based consumption tax and is supposed to be collected from the ultimate consumer of services. Thus actually, the non-resident service providers are supposed to get themselves registered under the Indian Service tax Provisions and Rules collect service tax on all taxable services and deposit it with the Indian Government. Australia has implemented this method of indirect tax collection. In India specified services for EL are also taxed under the provisions of relating to Service tax but under the reverse charge mechanism whereby the service recipient pays service tax and the non-resident is spared from all hassles. CENVAT credit is allowed in respect of service tax so paid by the service recipient in India and therefore, the incidence of tax is reduced.
EL, on the other hand, is a levy on the non-resident service provider and not on the service recipient. EL is over and above the service tax.
Thus, EL cannot be considered as an indirect tax.
7.0 Whether EL is constitutionally valid?
Ans: Entry 92C of List-I – Union List of the Seventh Schedule of the Indian Constitution empowers Central Government to levy taxes on services. Entry 97 of the List-I of the same Seventh Schedule empowers to levy tax on “any other matter not enumerated in List II or List III including any tax not mentioned in either of those Lists.
List II of the Seventh Schedule contains the entries reserved for States. Entry 55 of the said list provides that “taxes on advertisements other than advertisement published in the newspapers and advertisements broadcast by radio or television.”
Thus, there seems to be some overlapping. It would be interesting to see the developments in this regard if the EL is challenged for its constitutional validity.
8.0 Summation
India is perhaps the first country to introduce EL soon after the BEPS report. It has been introduced as per the recommendations of the expert Committee who have evaluated various options and deliberated on the issues threadbare from various angles. The law is in its nascent stage and would evolve in times to come. The entire world is watching India closely. In the initial stage, the burden of EL will be on Indian tax payers only, as it would be difficult for a small users of such services to bargain with giants like Google, Yahoo or Face book etc.
In our view in order to reduce the burden of EL on the Indian residents, wherever it is borne by them, it should be allowed as a deductible expenditure (express clarification is desired). Also penalty and other provisions should be made more liberal as the payer is rendering service to the Government by collecting (in many cases bearing the additional burden himself) taxes and paying it to the Government.
There is no provision of Appeal in respect of disputes pertaining to EL (appeals are prescribed only for penalties). It appears that in case of disputes pertaining to EL, the aggrieved person will have to file writ petition to the High Court which may further increase the cost of litigation.
There can be no two views on the necessity to get a fair share of revenue in respect of income generated in a country. The present rules of taxation of digital economy are in favour of country of residence (C of R) and there is apparent unwillingness of the C of R (who are usually developed nations) to share their revenue with the Country of Source (usually developing nations like India). This necessitated introduction of EL in the domestic tax laws. The best part is that it is one of the recommended options in the BEPS report and thus has a wider acceptability. The success of EL can be greater if the Government is able to introduce a mechanism whereby the non-resident service providers are forced to pay their taxes directly to the kitty of the Government and thereby absolving resident tax payers from all the hassles of tax compliance.
It would be interesting to watch further developments in this regard.
