Background

On 5 October 2015, the Organisation for Economic Co-operation and Development (OECD) released its final report on the tax challenges of the digital economy (Action 1) under its Action Plan on Base Erosion and Profit Shifting (BEPS).  The Final Report summarizes key features of evolving digital business models that the OECD considers relevant for the overall BEPS analysis; in addition, the Final Report considers the broader direct and indirect tax challenges raised by the digital economy and evaluates the options to address those challenges. It is now admitted by OECD and other concerned authorities that under the present rules of international taxation, E-commerce companies can escape taxation. E-commerce companies are growing very fast, earning substantial revenues and some of them are avoiding Income-tax in the Country of Source as well as Country of Residence. E-commerce business is growing at the fastest rate globally and no Government in the world can allow this business to go tax free.

The final report provided several options to tackle the direct tax challenges which inlcuded an option of imposition of equalisation levy.

Recent development

In line with the above suggestion, Finance Minister in his recent Budget speech proposed an Equalisation levy on the payments made to non-residents on specified services. Equalisation levy is intended to address the the disparity in tax treatment between domestic companies and foreign companies that are able to earn without being subject to income tax on those profits, neither in state where the premiums are collected nor in the state of residence.

Introduction of Equalisation levy

Chapter VIII (Equalisation Levy) has been introduced in the Finance Bill 2016, to provide equalisation levy of 6% on the consideration paid for the specified services to non residents having no permanent establishment in India.

Upside

a) Equalisation levy is a separate tax and cannot be equated with Income tax. Hence double tax Avoidance agreements are not applicable on equalisation levy. Also there will no double taxation within India as once the equalisation levy is imposed, such income will be exempt from tax under section 10(50) of the Income tax Act.

b) For the chargeability of equalisation levy, one does not have to determine the charecterisation of the income i.e. whether the said income is royalty, fees for technical services etc. If the non resident is earning income from the specified services from India, he will be liable to equalisation levy. This will lead to reduction in litigation on characterisation of income.

c) In the event where non resident insists the tax on such payment to be borne by the Indian resident, as per section 163 of Chapter VIII, there will be no grossing up of tax. Section 163 of Chapter VIII provides for deduction and payment of Equalisation Levy. Section 163 (3) provides that even if Indian resident payer does not deduct Equalisation Levy, he has to make payment of Equalisation Levy to Government of India. Thus, consider that the Indian resident has made a payment of Rs. 100 to the non-resident, he has not deducted any tax at source. He will simply pay Rs. 6 to the Government of India. This would not lead to escalation of cost due to grossing up. However, nothing has been mentioned in the Finance Bill regarding the claim of deduction of such expense by the resident payer in its return of income. A clarity on this issue by the finance ministry is still awaited.

Downside

a) The introduction of the said levy has overturned the benchmark judgement of Kolkata Tribunal in the case of ITO vs. Right Florists Ltd. (2013) 25 ITR 639 (Kol) wherein it was held that payments made for online advertisement on search engines of Google and Yahoo are not taxabe in India. Due to the presence of such judgments which were ruled in favour of the assessee, the government was unable to tax the ecommerce giants. The nub of the issue is that multi-national digital platforms don’t have “permanent establishments” in the country, which would make them liable to tax in India. Which means that the government has had to find a way of earning something from the profits that these platforms have been making.

b) The government has found a way to indirectly tax companies such as Google and Facebook by imposing equalisation levy in the absence of permanent establishment in India, a development which could set the stage for taxation of cross-border digital transactions and potentially drive up costs for advertisers. 

c) While the intention of the government may be to tax online companies, the levy could actually end up being a cost to small Indian businesess which advertise on these platforms.

d) Startups tend to be very reliant on these online advertising platforms and a levy of this sort may have a more adverse impast on them. The increased cost of buying advertising online will turn out dearer forcing some of the already bleeding start ups to bleed further. New entrants will have to plan their strategy and cash flows keeping these costs in mind.

Akhil Bhalla – Partner and Aanchal Gupta- Manager, JC Bhalla & Co. Chartered Accountants and Director, Crowe Howarth Advisory, India