The proposed equalisation levy will have to stand the test of international tax laws, and the bilateral investment treaty framework
In October last year, the Central Board of Direct Taxes, as part of the pre-Budget exercise, set up a committee of senior officials, industry representatives and tax experts to look at various issues related to taxation of e-commerce transactions.
One of the recommendations of the committee, taking a leaf out of the Base Erosion and Profit Shifting action plan prepared by the Organisation for Economic Co-operation and Development countries, was to charge an equalisation levy on e-commerce transactions.
Accordingly, Finance Minister Arun Jaitley in his recent Budget speech proposed an equalisation levy cess of six per cent on business-to-business digital transactions involving global advertising and marketing companies doing business in India.
This would apply only to companies without a permanent establishment in the country. Tax experts peg the Indian earnings of such companies at around Rs 4,000 crore (Rs 40 billion), growing at an estimated 20-25 per cent annually.
If enacted, India will arguably be the first country in the world to impose such a charge on e-commerce transactions.
However, it remains to be seen whether the levy will stand the test of international tax laws and the bilateral investment treaty framework.
Why ‘equalisation levy’
Any company resident in a country has to pay both indirect taxes as well as Income Tax.
However, a non-resident company, or a company without a permanent establishment in the country where it does business, does not pay income tax.
This is true of all e-commerce companies doing cross-border transactions anywhere in the world.
“The equalisation levy tries to create a level playing field for resident and non-resident companies,” says Rashmin Sanghvi, partner, Rashmin Sanghvi & Associates, and one of the members of the CBDT-appointed committee.
So, Indian or global e-commerce companies having permanent establishment in the country do not fall under the ambit of the levy.
This is not the first time that Indian taxmen are trying to bring cross-border e-commerce transactions into the tax net.
India has previously tried to tax foreign companies on their online advertising revenues, typically by bringing them within the categories of ‘fees for technical services’ or ‘royalty’, says Shreya Rao, founder, Law Offices of Shreya Rao.
“However, the courts have tended to strike down these claims as not being acceptable under existing tax laws,” she adds.
According to Jayesh Sanghvi, partner and national leader of international tax services at EY, the introduction of the levy indicates India’s policy stance that it cannot wait for a consensus policy choice to emerge on matters relating to taxing e-commerce transactions.
“This is something that requires addressing immediately,” he adds.
However, tax and legal experts point out that there is inadequate understanding of how such a levy will work within the existing international tax framework. They also question the characterisation of the levy, and have issues around its compliance.
A character-less levy
Over a blog post Sanghvi argues that the levy has no characterisation issue.
“One does not have to determine whether it is business income, royalty, fees for technical service or any other category of income.
"There is no need to determine permanent establishment or any other nexus to India.”
Simply because a non-resident earns revenue from India, he is liable to the equalisation levy, goes his argument.
Further, as the levy is an independent tax, double tax avoidance agreements do not apply to it, he says.
On the compliance front, the responsibility to pay the tax and file returns lies with the Indian resident who avails of the service.
This is more so as the payment gateways are not equipped to differentiate between transactions where taxes are payable or non-payable.
Tax experts point out that this could lead to a situation where the non-resident service provider may refuse to bear the cost of the levy.
“I also anticipate that smaller taxpayers, such as start-ups, may face some resistance from large advertising companies on whether the tax is rightfully levied,” says Rao.
Foreign advertising companies may also dispute whether the levy can be withheld under the contractual terms of the existing agreements between the two parties, she adds.
Any impact of non-compliance has to be borne by the Indian resident who avails of the service. Smaller companies that are heavily reliant on social media advertising may again face the heat, say critiques of the levy.
Carrot or stick
Sanghvi is of the view that competition might force global advertising and marketing companies to bear the cost of the levy.
Moreover, according to the government’s proposal, small users of such advertising and marketing services -- with annual billing of less than Rs 100,000 -- are not liable to deduct the levy.
Further the rate of tax of six per cent is much lower than the normal Income Tax rates.
Sanghvi says that has been done to make it attractive for non-resident companies to bear the levy and pay lower tax than suffer a higher rate of tax under income tax.
Whether these companies will bite the bulet remains to be seen.