The growth of digital economy entails many benefits, but also poses various tax challenges. These include the ability of a company to acquire significant digital presence in source country without being liable to tax, the attribution of value creation through use of digital products and services, and the characterisation of income derived and effective collection of taxes with respect to cross-border digital transactions. Revenue authorities have grappled with the challenge of double non taxation of such transactions in cyberspace. MNCs have planned their affairs in a way that minimal or no profits are paid in countries where the customer is situated and profits are parked in low-tax jurisdictions or tax havens.
Finance minister Arun Jaitley has taken the first step to protect the country’s share of taxes from such digital transactions. Taking a cue from the report of the Task Force on Digital Economy on Action Plan 1 of the OECD-G20 project on BEPS, the minister, in Budget FY17, proposed an equalisation levy on certain transactions.
The Finance Bill recommends a levy of 6% on consideration paid or payable by Indian resident carrying on business or profession, or by Indian permanent establishment of a non-resident (Indian business) to a non-resident not having a taxable presence in India, for providing specified online advertisement services. Also, such services include providing digital space or facility for online advertisement or any other services as may be notified later. Exclusion is provided in cases where the aggregate consideration paid by an Indian business to a non-resident service provider for specified services does not exceed R1 lakh.
While the levy is on non-resident service provider, similar to withholding tax (TDS) provisions, the responsibility for payment is cast on Indian business to deduct and deposit the levy. Amount so deducted (or even if not deducted) is to be paid by Indian business to the government by the 7th of next month. Indian business also has to furnish annual statements/returns specifying the prescribed details for each financial year. Interest and penalty have been proposed for delay or failure of compliance with withholding provisions.
The Indian income-tax law is amended to disallow entire claim of deduction for such expenditure to Indian business, if Indian business fails to deduct or after deduction fails to pay such amount to the government before the due date of filing its I-T return. The deduction for expenditure shall then be allowed in the subsequent year in which the payment is made. In most cases, this would add to the cost of Indian business as the non-resident service provider may not agree to such deduction (or recovery). The cost of compliance may be additional.
Levy not an income tax
It is interesting to note that, in the past, when Indian Revenue attempted to tax similar payments, some courts held that such payments cannot be taxed under the I-T law. Similarly, a lot of debate has surrounded the classification of income as royalty for provision of advertising space on servers located outside India. Interestingly, equalisation levy is not income tax under the Indian I-T law, but when enacted would be a separate levy under the Finance Act. Related amendment is proposed under the I-T law to exempt from income tax any income chargeable to equalisation levy. With this amendment, characterisation of income in the hands of recipient will no longer be relevant. If it succeeds, it would help the government get around above controversies and collect tax at a flat rate in the form of equalisation levy.
Extraterritorial operation of Indian law
The consideration for specified services payable by a resident carrying on business or profession or non-resident having a permanent establishment in India is liable for equalisation levy. While some sort of nexus with India has been attempted, but if such payment is made for a business outside India, it may trigger a debate on the ‘extraterritorial’ operation of such levy.
Levy in absence of profits
The levy is independent of profits or taxability of non-resident service provider. Thus, a foreign start-up not having profits would also be subject to levy on the consideration received from Indian business. The proposed law prescribes a flat levy and does not provide for any mechanism for exemption or a lower rate.
From double non taxation to double taxation
India has entered into tax treaties with many countries for avoidance of double taxation. These provide for exemption in the resident country for income taxed in source country (or alternative provided for tax credit). Double taxation of consideration received by non-resident service provider, which is subjected to equalisation levy, may not be ruled out in the absence of any changes to the tax treaty (or any overriding multilateral instrument). The India-US tax treaty, apart from income tax, covers identical or substantially similar taxes. It has to be seen how the US Internal Revenue Service treats equalisation levy (levy outside Indian I-T tax law) for allowing tax credit under the treaty with India.
Equalisation levy appears to be a step to counter double non taxation and protecting India’s share of taxation. The aim is recovering tax from foreign corporations doing business in India. But in the current form it may impact Indian taxpayer more than foreign corporations. A deeper thought, comprehensive approach, detailed legislation and implementation at the right time would help further the objective of this levy.