Equalisation Levy[1]: Background and Evolution – Birth

The evolution of digital taxation in India traces back to the pivotal Right Florists’ ruling[2], where the Hon’ble Kolkata Tribunal held that payments made for online advertising services to search engines like Google and Yahoo were not taxable in India due to the absence of a PE[3] for these entities in India. Since then, the rapid growth of Information Technology both in India and globally has led to a significant surge in the demand and supply of digital services. This development has fostered innovative business models that rely heavily on digital and telecommunication networks, thus introducing fresh tax challenges related to nexus, characterization, and the valuation of data and user contributions. Acknowledging the constraints of physical presence-based nexus rules and the challenges in taxing such transactions, the Indian government recognized the necessity of introducing laws to address these issues through a nexus-based approach.

In order to address such taxation challenges in the digital economy, the OECD[4] initiated Action Plan 1 on BEPS[5] at the G20 Finance Ministers' request. This plan suggested certain interim measures – EL was one of the measures suggested in the BEPS Action 1 final report to tackle these challenges.

India introduced the EL in 2016 vide Finance Act, 2016 as an interim measure until a global consensus, such as the OECD's Two-Pillar Solution, could be reached. The aim was to ensure that foreign digital / technology companies benefiting from the Indian market without a physical presence contributed fairly to taxes (i.e., nexus-based taxation).

Initially, the EL imposed a 6% levy on payments to non-resident companies for specific online advertisement services[6]. The responsibility for compliance, including deduction and payment to the Indian government, filing EL statements, etc. was placed on the Indian payer, with interest / penalties for non-compliance.

Notably, the EL was introduced as a separate chapter in Finance Act rather than the Income-tax Act, 1961, classifying it as a ‘levy’ rather than an ‘income tax’. This distinction meant it overrode bilateral tax treaties, and thus, foreign tax credit benefits were not applicable.

Certain exclusions applied to the EL, such as non-residents with a permanent establishment in India, income taxable as royalty or fees for technical services, transactions up to specified thresholds[7], etc. To prevent double taxation, income subject to the EL was exempt from income tax.

Expansion in Equalisation Levy to E-commerce Operators and Global Reactions – Adolescence and Midlife

In 2020, the EL's scope expanded vide the Finance Act, 2020 to include e-commerce supply or services[8] at the rate of 2%. This represented a significant expansion in scope since it applied on goods and services irrespective of whether it was digital or not. There was also a significant expansion in compliance for the non-residents unlike the 6% EL applicable on online advertisements.

U.S. Response to India's 2% Equalisation Levy and Its Implications:

The USTR[9] has consistently opposed India's 2% EL on e-commerce services, viewing it as discriminatory towards American companies. The USTR argued that the levy disproportionately affects U.S. based tech giants and deviates from international tax standards.

Following investigations under Section 301 of the U.S. Trade Act, 1974, the USTR concluded on January 6, 2021, that the levy was unreasonable, inconsistent with prevailing principles of international taxation and primarily targeted U.S. commerce[10]. Consequently, the USTR announced potential tariffs on certain imports from India. India responded[11] to the USTR's findings on January 7, 2021.

The U.S. trade body suspended the retaliatory tariffs for 180 days to allow time for multilateral negotiations. On October 8, 2021, India and the U.S. joined 134 other OECD/G20 members to agree on a Two-Pillar Solution addressing digital economy taxation challenges.

These negotiations aimed to limit unilateral digital services taxes. On October 21, 2021, a Unilateral Measures Compromise was reached, leading to a joint statement. On November 24, 2021, India and the U.S. settled their differences regarding the 2% EL. The agreement stipulated that:

• India would maintain the levy until March 31, 2024, or until the OECD's Pillar One implementation, whichever came first.
• The U.S. would terminate its announced trade tariffs against India and refrain from further actions.

This agreement mirrored similar compromises between the U.S. and countries like the UK, Austria, France, Italy, and Spain.

Abolishment of EL: Impact on India-US Trade and Other Economic Factors – Death

It was previously agreed that multinational companies would receive credit for the EL paid, offsetting their tax liabilities under Pillar One, as the EL was anticipated to be integrated into Pillar One. However, in an unexpected move, the Government decided to abolish the EL, even as negotiations for Pillar One remain underway.

Effective August 1, 2024, the Indian government announced the abolition of the 2% EL on e-commerce services vide Finance Act (No. 2), 2024, while retaining the 6% levy on online advertisement services. Further, the Indian government has proposed abolishing the 6% EL on online advertisements effective April 1, 2025, as part of amendments to the Finance Bill, 2025. This decision, pending parliamentary approval, marks a significant shift in India's digital taxation policy and is expected to impact advertisers, digital platforms, and international trade, particularly with the United States.

Relevance of current timing for the abolishment

The US had threatened reciprocal tariffs starting April 2, 2025, if the digital tax was not removed, arguing that such taxes disproportionately affect American tech companies. By abolishing the EL, India addresses US concerns over unilateral taxation, fostering international tax cooperation and potentially easing US tariff plans.

During January 2025, the Donald Trump administration had earlier withdrawn from the OECD-brokered global tax deal that included a two-pillar tax solution to address the taxation issues pertaining to the thriving digital sector.

During Indian Prime Minister's visit last month to the United States, both nations agreed to work on the first phase of a trade deal by autumn 2025, targeting two-way trade of $500 billion by 2030.

This move aligns with India's strategy to simplify tax laws and foster cooperative international trade negotiations. The EL had been a contentious issue in India-US trade relations, with the US viewing it as discriminatory. By removing the levy, India aims to ease trade tensions and facilitate smoother trade and tariff negotiations.

Furthermore, the removal of the EL has implications beyond India-US relations. It reflects a global shift towards multilateral agreements on digital taxation (i.e., OECD/G20 framework), moving away from unilateral measures that have often led to trade disputes. Countries like the UK are also revisiting their digital tax policies to align with international norms and avoid trade conflicts[12].

Government’s current stance

The Finance Minister recently reaffirmed[13] the government's dedication to this rationalization process, emphasizing that it is not linked to any specific international pressures, such as previous U.S. tariff policies. Instead, it reflects a strategic vision for India's economic diplomacy and domestic growth in line with the goals of Viksit Bharat and Atmanirbhar Bharat.

Did EL serve its purpose ?

The proposed abolishment of 6% EL comes as a surprise given that Pillar One implementation is likely to delayed and there was a fear that unilateral measures may be extended by countries.

However, as clarified by Finance Minister, the abolition of the EL is part of India's broader effort to streamline its tax system and ease of doing business (especially considering that EL cost was often pushed to Indian customer) by reducing compliance burdens and aligning with international practices. This move supports domestic growth and international collaboration, positioning India as a business-friendly environment.

From a practical standpoint, EL was always meant to be a temporary measure in order to have a seat at the negotiating table for global tax reform rather than a major revenue raising measure. Towards this goal, one could say that it has served its purpose and then perhaps some more if it results in creating a good environment for the impending tariff and trade discussions with US.

Despite the loss of the revenue of Indian Government, the overall benefits of its abolishment are expected to outweigh any potential revenue loss[14].

The authors wish to thank Meet Shah for the support in literature and research.