This article has been written by Harsh Mishra, pursuing the Diploma in Business Laws for In-House Counsels from LawSikho.
Table of Contents
Introduction
This pandemic has accentuated the importance of e-commerce in our lives. Whatever we wish and pay for, reaches our door. Video-conferencing platforms like Zoom made it easy to attend meetings and classes from the comfort of one’s home. OTT platforms like Netflix gained prominence. The pandemic actually accelerated the pace of the digitalization of our world. But it also reflects a blatant fact that we have become dependent on these digital platforms – not just for our entertainment but also for our bare necessities. It is even more shocking that these foreign companies did not have to pay any digital tax in India for the profits they earn by using our market. 
Digital economy
It was July 2016 when the Government of India launched the scheme of Digital India Mission with an aim to improve the digital infrastructure in India. It encouraged digital payment methods, online banking, and ensured the availability of high-speed internet data at a low cost to everyone. As a result, India became the second-largest online market in the world with a total of 560 million users in 2020. Most of these internet users were converted into consumers for the digital companies during the pandemic. The majority, locked inside their homes, increased their engagement with social media as it became the only window through which they could connect with the outside world. Besides, the use of e-commerce platforms became indispensable for buying the essentials. Many were totally dependent on Amazon, Flipkart, and Zomato for home delivery of groceries, clothes, electronics, and other items. This increased the business of these tech-giants manifold. But since foreign companies like Amazon and Facebook don’t have a permanent establishment in India, they could not be taxed by the Indian government even after obtaining huge financial benefits from Indian customers. In fact, these companies don’t need a permanent establishment in India to do business here. They provide digital services which can be operated even while sitting in a foreign country. This is a global problem – how to tax the digital economy? The Organization of Economic Co-operation and Development (OECD) is already working on the “unified approach” for digital services tax and might be able to gain a global consensus on the digital tax regime by the end of this year. But meanwhile, our government has released the framework for the Indian variant of digital tax – “equalization levy”.
What is the equalization levy?
The concept of equalization levy was first introduced in India through the Finance Act, 2016. It was levied at 6 percent on the money received or receivable by a non-resident entity from a resident for digital advertising services. For example, Facebook and Google provide targeted ad services to any business which would like to reach consumers through online advertisements. The scope of this equalization levy was widened through an amendment in 2020 by including e-commerce operators within its ambit. It proposes to impose a 2 percent levy on the money received/receivable by an e-commerce operator for:
- Online sale of goods owned by the e-commerce operator; or
- Online provision of services provided by the e-commerce operator; or
- Online sale of goods or provision of services or both, facilitated by the e-commerce operator; or
- Any combination of the above-mentioned activities.
This 2 percent levy shall only be applicable when the transaction is with
- a resident; or
- a non-resident provided that he/she
- uses an IP address located in India for availing services of such e-commerce operator; or
- purchases data collected from a resident of India or a person using an IP address located in India; or
- purchases advertisement slots that target a customer who is resident in India, or a customer who accesses the advertising through an IP address located in India.
This equalization levy has a wide scope as it covers transactions with even those non-residents who may have come to India on a tour and use the Indian IP addresses to buy the online services of these e-commerce platforms.
Significant economic presence
The new rules notified by the Revenue Department have widened the scope of Significant Economic Presence (SEP) as well. This term is used for those non-resident business entities which do not have any permanent establishment in India but still draw a huge chunk of profits from the Indian market through their digital business in India. This concept waves off the requirement of a permanent establishment in a country for being taxable there. The new notification has set the threshold for determining whether a non-resident has a significant economic presence in India:
Transaction threshold
If the revenue generated by it through any transaction/s in respect of goods, services, or property with any person in India exceeds Rs. 20 million.
User threshold
If the total number of Indian users with whom it does systematic or continuous business or who are engaged with it in any way exceeds 3 lakhs.
If a foreign entity hits any of these two thresholds, it would bring them into the definition of an entity having significant economic presence and the entity could become subject to income tax under Income Tax Act, 1961 (ITA) unless they come under the regime of equalization levy which is outside the scope of ITA [exemption under Section 10(50) of the Income Tax Act,1961].
Double taxation hurdle
India has Double Taxation Avoidance (DTA) Treaties with almost 90 countries that prevent India from imposing income tax on any resident of these countries doing business in India if they don’t have any permanent establishment in India. India has introduced the concept of significant economic presence to charge tax on the business transactions of the non-residents with no permanent establishment in India. But unfortunately, India cannot impose SEP provisions on the entities which fall under these DTA treaties. These treaties need to be amended so that SEP provisions can apply to big digital companies like Facebook and Amazon which are based in the US. Hence, the implementation of these SEP provisions has been deferred to April 2022, with the hope that by the OECD would be able to reach a consensus on the digital tax regime. If this consensus is reached, India would not have to go through the hardship of amending each bilateral DTA treaty and a multilateral amendment would be possible.
DTA bypass and USTR probe
Meanwhile, India has tried to bypass the DTA treaty restrictions by introducing an equalization levy on the revenue of these digital tech companies, instead of taxing their income. The DTA treaties only prohibit the tax on income and not a levy on revenue. This is a reason why the equalization levy has been kept outside the scope of the Income Tax Act, 1961 and has been instead legitimized through the Finance Act of 2020. Now, the Indian government can tax these non-resident companies without any requirement of them having a permanent establishment in India and without falling under the ambit of DTA treaties.
Since India imposed this equalization levy of 2 percent covering a broad scope of non-resident companies doing digital business in India, United States Trademark Representation (USTR) started an investigation against India on the allegations of the levy being discriminatory to US companies. The USTR pointed out that of the 119 companies that it identified as likely liable under the digital services tax, 86, or 72%, were American. The US deemed this provision as unfair against the US tech companies. It based its opinion on the fact that the levy did not affect Indian digital businesses and non-digital businesses providing the same specified services falling under the equalization levy regime. In reaching this conclusion, USTR missed the very basic aim for bringing this new digital tax. It is for non-resident companies with no physical presence in India which are not liable to pay income tax in India. The excluded companies have their permanent establishment in India and are already subject to an income tax regime. The US companies like Google, Facebook, and Amazon need to pay their fair share of tax for the revenue they earn from the Indian market.
Enforcement conundrum
India is not alone in its endeavor to tax the digital economy. There are other countries like France, Australia, Canada, and Kenya that have introduced their respective variants for digital services tax in their own country. All have the same objective in mind – to make these digital business companies sitting outside their territory pay their fair share of tax by applying the new nexus rule. But we have seen some examples of these companies shifting the tax burden onto their customers. For instance, when France imposed a 3 percent digital service tax, Amazon France decided to increase its commission rate for businesses selling on Amazon’s platform by 3 percent. As a trickle-down effect, the final burden was borne by customers who were now paying more for these goods and services than what they had been paying earlier. These examples should be kept in mind by the Indian government while implementing this new digital tax law in India. The purpose is to collect the tax for the benefit of the people of India and not to burden them with these taxes.
Moreover, the mechanism to enforce this new digital tax on the digital companies sitting in a foreign land is unclear. The government needs to come up with a robust enforcement mechanism.
Need of the hour
The provision of an equalization levy was indeed required for foreign e-commerce companies; however, its implementation would be a challenge. This is because it would require tracking a lot of data to check any digital tax evasion by these non-resident companies. And essentially, it would be hard to access this data because these companies do not yet disclose this kind of information. According to research by the anti-poverty charity ActionAid International, India is one of the countries with the highest tax gaps involving Facebook, Google, and Microsoft. India can no longer afford to miss out on this tax amount. It can make a huge difference in the lives of many. After all, a poor child in a village needs a school more than a Netflix subscription.
Conclusion – the future
All the digital giants are based in the US and with the change of political regime in the White House, the world expects a better solution to the digital tax problems. The new incumbent’s urge to make the world’s largest 100 companies-digital and non-digital- pay corporate taxes in their market countries is not completely in line with the agenda of OECD. Though the OECD report on digital tax is scheduled to be released by the end of this year, India needs to buckle up and race ahead with a clear and efficient enforcement method for these digital tax measures.
The digital economy is growing by leaps and bounds in India. The equalization levy would definitely make it hard for India to attract foreign investment in one of the fastest-growing sectors of the Indian economy. India has faced tough opposition from the affected companies on widening the scope of the equalization levy in the middle of the pandemic. Until and unless there is clarity and certainty in the digital tax structure on the implementation side, a voluminous foreign investment into India will remain a distant dream.
References
- https://indianexpress.com/article/opinion/digital-services-tax-not-about-india-vs-us-7161267/
- https://www.politico.eu/article/washington-us-tax-digital-brussels-oecd/
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