Equalization levy has been defined as follows in section 164 (d) of the Finance Act, 2016 [Finance Act, 2016, available at http://www.cbic.gov.in/resources/htdocs-cbec/fin-act2016.pdf ] as follows:
“Equalisation levy means the tax leviable on consideration received or receivable for any specified service under the provisions of this Chapter (Chapter VII, Finance Act, 2016)”
The Finance Act, 2016 incorporated the recommendations of the Akhilesh Ranjan Committee [Proposal for Equalization Levy on Specified Transactions, February 2016, Report of Committee on Taxation of E-commerce, https://incometaxindia.gov.in/News/Report-of-Committee-on-Taxation-of-e-Commerce-Feb-2016.pdf] (Hereinafter referred to as “Equalisation Levy Report, 2016”). It defined Equalisation Levy as follows ( Page 86):
“Equalization Levy is intended to be a tax imposed in accordance with the conclusions of the BEPS Report on Action 1 that has been endorsed by G-20 and OECD, on payments made for digital services to foreign beneficial owner, who enjoy an unfair advantage over their Indian competitors providing similar services by digital or more traditional means, with the objective for equalizing their tax burden with other businesses that are subjected to income-tax in India, without disturbing the existing tax treaties.”
This measure was introduced by the means of Finance Act, 2016 on the basis of the recommendations given in the Equalization levy report. On a general basis, any changes in taxation are introduced by the means of amendments to the Income Tax Act, 1961 (Hereinafter referred to as “IT Act”), Central Goods and Services Tax Act, 2017 (Hereinafter referred to as “CGST Act”), Integrated Goods and Services Tax Act, 2017 (Hereinafter referred to as “IGST Act”) or any other legislation or treaty for taxation. This route however was not followed for the introduction of the Equalization levy for the following reasons, as listed in the Equalization Levy report, 2016 (Page 86):
Equalisation levy was not introduced through tax treaties because of the divergent opinions of the nations on it. The lack of consensus amongst the nations to implement the levy would have it nearly impossible for the levy to be incorporated in the regulatory framework through the treaties.
It was not introduced through the Income Tax Act, 1961 because it is not a tax. It is a tax on a transaction. It is a levy imposed on the revenue generated through which escapes from domestic legislation and the treaties.
Due to its nature i.e. tax on transaction, it was through the Finance Act, 2016 on the lines of the service tax and securities transaction tax.
Equalization levy was introduced to counter the problem of the escapement of revenue generated through electronic services from the taxation. However, every e-commerce service is not covered within the ambit of equalization levy. The scope of equalization levy has been defined in the Finance Act, 2016. It is an exhaustive definition, in the sense, that it does not give scope for liberal and expansive interpretation of the scope of the levy. Only the services explicitly mentioned in the Act are covered within the ambit of equalization levy.
Since, the provisions leading to the introduction and implementation of equalization levy were introduced by the Finance Act, 2016 and not through amendments in any legislation for taxation, the amendments for equalization levy, in the Finance Act, 2020 were through the means of amendment to the Finance Act, 2016. However, in order to implement and support the equalization levy smoothly certain ancillary provisions were introduced by the means of amendments to various taxation legislations such as the Income Tax Act, 1961, Central Goods and Services Act, 2017, Integrated Goods and Services Tax Act, 2017 and Customs Act, . This article aims to elaborate upon the reforms introduced for the taxation of the digital economy in India by the means of all these legislations and hence, it is divided into the following parts, covering one legislation each i.e. Reforms and Amendments made through the Finance Act, 2016 and Finance Act, 2020 [i] Amendments to the Income Tax Act, 1961 [ii] Amendments to the CGST Act, 2017 and IGST Act, 2017 [iii], followed by the concluding remarks.
Finance Act, 2016 and Finance Act, 2020
For the reasons mentioned above, Equalisation levy was introduced through the Finance Act, 2016. Further reforms to the provisions were incorporated by the Finance Act, 2020, through amendment to the Finance Act, 2016. This section deals with the need for equalization levy [i] scope of equalization levy [ii] and the amendments made to the provisions of equalization levy through the Finance Act, 2020 [iii].
Need for the Introduction of Equalization levy
The multi-national enterprises and various individuals have been benefitting out of the loopholes in the DTAAs and the domestic tax legislations regarding the regulation of digital economy. The BEPS Action Plan 1 was devised to analyze the situation and come up with solutions for tacking the challenges posed by the digital economy. This Action Plan 1 was primarily relied upon by the committee set up by the Government for regulation of taxation of e-commerce in India, in its report, “Proposal on Equalisation Levy”. This committee opined that Equalization levy was required to be introduced for attaining the objective of providing greater “clarity, certainty and predictability” in terms of the taxation of the digital services and to reduce the cost of compliance. Despite the DTAAs, withholding tax and various other provisions under the IT Act, the measure of equalization levy was required to tax the income earned over services and transactions over digital platforms. It is important to understand that equalization levy is different from the provisions in the DTAAs and the domestic legislations for taxation in India and is required for taxation of digital transactions which escape the tax net. There are a few questions which are often raised regarding the veracity of equalization levy. It is important to understand the discussion regarding these aspects in the Equalization Levy Report, 2016, to get a clarity regarding the nature of the equalization levy:
Difference between Equalization levy and withholding tax:Withholding tax, under the IT Act, is considered to be an effective measure for tacking the problem of tax evasion. Thus, the introduction of Equalization levy with a similar objective under Finance Act, 2016 was questioned in terms of its purpose and efficiency. The Akhilesh Ranjan Committee observed in its report that withholding tax is different from Equalisation levy because of Withholding tax is a tax on income, while Equalisation levy is a tax on the consideration paid.
Scope of equalization levy:Equalisation levy was covered under chapter VII of the Finance Act, 2016. It was first implemented at the of 6% on the consideration for the services received/ receivable by a non-resident from a person being resident of India and carrying on business or profession [i] or a non-resident having a permanent establishment in India [ii] [Section 165, Finance Act, 2016]. Equalisation levy was implemented on consideration received/ receivable for specified service, i.e. online advertising, any provision for online advertising space or any other facility or service for online advertisement (and any other service specified by Central Government in this regard). Online has been accorded a wide and exhaustive definition by the Act i.e. it includes any facility or service or right or benefit or access that is obtained through the internet or any other form of digital or telecommunication network. [Sections 164 (i), 164 (f) Finance Act, 2016]
Exceptions to the collection of Levy: An exception from liability to pay Equalisation levy was carved out for following cases/ persons [Section 165 Finance Act, 2016]:
The non-resident providing the specified service has a permanent establishment in India and the specified service is effectively connected with such permanent establishment. The rationale of this exception can be understood to be that the non-residents having the liability of a permanent establishment should not be benefitted from this provision as the tax rates for permanent establishments are very high and not creating an exception for permanent establishments might benefit them with lower tax rate.
The aggregate amount of consideration for specified service received or receivable in a previous year by the non-resident from a person resident in India and carrying on business or profession, or from a non-resident having a permanent establishment in India, does not exceed one lakh rupees. This threshold was introduced in line with the proposals of the Equalisation Levy Report, 2016 i.e. the small payments by MSMEs or for personal purposes should not be adversely affected by the Equalisation Levy. [Explanatory notes to Finance Act, 2016: Circular No.- 3/2017, para 32, available at https://www.incometaxindia.gov.in/communications/circular/circular03_2017.pdf ].
If the payment for the specified service by the person resident in India, or the permanent establishment in India is not for the purposes of carrying out business or profession. This exception was carved out again in compliance with the recommendations of Equalisation Levy Report, 2016 i.e. the payments not made for business purposes should not be taxed by Equalisation Levy.
Despite the implementation of the Equalisation Levy, certain services were left out of its purview. With the implementation of the Equalisation levy the need for modification and improvement was felt. Thus, certain amendments were made to the Finance Act, 2016 and other provisions relating to Equalisation Levy for the purpose of solving the problems and challenges arising from its implementation.
Changes brought in the Provision of Equalization levy
Finance Act, 2020, [available at http://egazette.nic.in/WriteReadData/2020/218938.pdf] has made several amendments in the Finance Act, 2016. The provisions have been amended to incorporate changes for better administration:
Scope: The services provided by the e-commerce operators have also brought within the ambit of the Equalization Levy. The following changes were incorporated:
The scope of the Chapter VII of the Finance Act, 2016 was modified to include the consideration received or receivable for the e-commerce supply or services made after April, 1, 2020.[Section 153, Finance Act, 2020]
E-commerce supply or services includes online sale of goods by e-commerce operator, online provision of services by e-commerce operator, sale of goods or provision of services through a platform operated by the e-commerce operator or any combination of these activities. [Section 164 (cb), Finance Act, 2020]
E-commerce operators have been defined as a non-resident who owns, operates or manages digital or electronic facility or platform for online sale of goods or online provision of services or both [Section 164 (ca), Finance Act, 2020]
Equalization levy at the rate of 2% has been made applicable to the consideration received or receivable for the services provided by the e-commerce operators to a person resident in India, a person who buys goods, services or both using an Internet Protocol located in India or a non-resident if the non-resident is involved in sale of advertisement, targeted at customer who is resident in India or who has access to the advertisement through a internet protocol address located in India or is involved in sale of data, collected from a person resident in India or. Person who uses and internet protocol which is located in India [Section 165A, Finance Act, 2020].
Exceptions to the Equalization levy:The e-commerce operator providing services or supplying goods will not be charged equalization levy, if it has a permanent establishment in India and such supply or services is related to the permanent establishment, if the service or supply is chargeable under section 165 of the Finance Act, 2016 or if the sales, turnover or gross revenue of the e-commerce operator is less than ₹ 2 crores during the previous year. [Section 165A, Finance Act, 2020].
Compliance requirements:The equalization levy paid at the rate of 5% for all other specified services, except the services or supply from e-commerce operator, has to be given by the customers to the Central Government. While, in case of the supply and services of e-commerce operators, the equalization levy has to be deducted by the e-commerce operators themselves and has to be given to the Central Government. [Section 166, Finance Act, 2016; Section 166A, Finance Act, 2020]
In essence, Finance Act, 2020 has amended the Finance Act, 2020 to incorporate equalization levy provisions for taxing e-commerce operators.
Amendments in The Income Tax Act, 1961
The aspects of direct taxation are discussed in reference of the amendments to the Income Tax Act, 1961 by the Finance Act, 2020. The concept of Significant Economic presence was first introduced in the Income tax Act, 1961 by the means of an amendment through the Finance Act, 2018. Income Tax Act, 1961, CGST Act, 2017 and IGST Act, 2017 were amended by the Finance Act, 2020 to incorporate further reforms. This part is sub-divided in various sections which elaborate upon the amendments in reference to significant economic presence.
The concept of Significant Economic Presence was first introduced by the Finance Act, 2018 [Section 4, Finance Act, 2018, available at http://egazette.nic.in/writereaddata/2018/184302.pdf ]. It amended section 9 of the IT Act. Explanation 2A was inserted in section 9, to clarify that significant economic presence of a non-resident would constitute business connection. The Finance Act, 2020 amended the Finance Act, 2018 Significant Economic Presence. The explanation 2A inserted by Finance Act, 2018 was scraped and new explanations 2A and 3A was inserted in section 9 of the IT Act, which are as follows:
“Explanation 2A.—For the removal of doubts, it is hereby declared that the significant economic presence of a non-resident in India shall constitute “business connection” in India and “significant economic presence” for this purpose, shall mean—
(a) transaction in respect of any goods, services or property carried out by a non-resident with any person in India including provision of download of data or software in India, if the aggregate of payments arising from such transaction or transactions during the previous year exceeds such amount as may be prescribed; or
(b) systematic and continuous soliciting of business activities or engaging in interaction with such number of users in India, as may be prescribed:
Provided that the transactions or activities shall constitute significant economic presence in India, whether or not—
(i) the agreement for such transactions or activities is entered in India; or
(ii) the non-resident has a residence or place of business in India; or
(iii) the non-resident renders services in India:
Provided further that only so much of income as is attributable to the transactions or activities referred to in clause (a) or clause (b) shall be deemed to accrue or arise in India.”
“Explanation 3A.––For the removal of doubts, it is hereby declared that the income attributable to the operations carried out in India, as referred to in Explanation 1, shall include income from––
(i) such advertisement which targets a customer who resides in India or a customer who accesses the advertisement through internet protocol address located in India;
(ii) sale of data collected from a person who resides in India or from a person who uses internet protocol address located in India; and
(iii) sale of goods or services using data collected from a person who resides in India or from a person who uses internet protocol address located in India.”;
(iv) after Explanation 3A as so inserted, the following proviso shall be inserted with effect from the 1st day of April, 2022, namely:––
“Provided that the provisions contained in this Explanation shall also apply to the income attributable to the transactions or activities referred to in Explanation 2A.”
The threshold for SEP has not been notified by the Government yet. The transactions of the e-commerce operators which trigger the equalization levy, also lead to generation of income under this explanation. However, in order to avoid taxation of the non-resident e-commerce operators, an exception has been created under the Income Tax Act, 1961. Any income arising from any specified service, chargeable to equalization levy is not included in computing the total income, for the purpose of Income Tax Act, 1961. [Section 10 (50), Income Tax Act, 1961] The report of OECD regarding taxation of Digital Economy is likely to be released by December, 2020 and thus, the threshold will be set after considering the OECD report.
Challenges in Implementation of Equalisation Levy
These amendments for the taxation of the digital economy, though well-intended, have led to certain challenges in implementation of the same. They are:
Constitutional Validity of Equalisation levy: Constitutional validity of Equalization levy is in question because of the mode of legislation of the equalization levy and the power of the conflict in the subject matter of the states and Centre. Article 265 of the Constitution of India states that:
[The Constitution of India, available at: http://legislative.gov.in/sites/default/files/COI-updated.pdf]
“No tax can be imposed except with the authority of law.”
There are three lists under Schedule VII of the Constitution of India i.e. Union List, State List and Concurrent List. The Central government can legislate upon the subjects in the Union list, the State Government can legislate on the subjects in the state list and both Central and state government can legislate on the subjects of the concurrent list, but in case of contradiction, the law legislated by the Central Government will prevail. Equalization levy is being questioned on two fronts i.e. the incorporation through Finance Act, rather than Income Tax Act and the potential encroachment of the powers of the State government by the central government. The first issue has been dealt with in the earlier section. Entry 97 of List I covers “any other matter not enumerated in List II or List III including any tax not mentioned in either of those lists”. Thus, the fact that “Equalization levy” or “tax on advertising” is not mentioned in the List II or List II can be the basis for the Centre to legislate on this subject matter. But, the Entry 55 of List II covers “Taxes on advertisements other than advertisements published in newspapers and advertisements broadcast by the radio or television”. [The Indian Equalisation Levy: Inelegant but not Unexpected, Shreya Rao, NLS Business Law Review, 2016, available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2850608 ]
In order to resolve this deadlock, it is pertinent to understand the purpose of equalization levy. The primary purpose of equalization levy is to tax transactions on online mode. This includes multiple transactions, such as supply of goods, provision of services, advertising, marketing, promotional services and payment for reserving space on online medium for advertising. “Advertisement (other than through newspaper, radio or television)” is not the essence of the targeted transactions. It happens to be one of the subject matters on which the Centre legislated ancillary. It cannot be challenged on the basis of the pith and substance doctrine as the pith and substance of the area of legislation is within the powers of the Central government and the incidental encroachment upon the subject matter of the state cannot be a ground for declaring the legislation unconstitutional.
Potential challenge under National Treatment on Internal taxation and Regulation under GATT: The exclusion of domestic e-commerce operators from the definition can trigger the problem of national treatment i.e. if a tax is implemented only on foreign e-commerce operators. It can be argued that the services provided by domestic e-commerce operators are taxed separately from the services provided by the foreign e-commerce operators. This principle is applicable exclusively in case of the imports and thus, if any products are supplied by the e-commerce operator (non-resident) to Indian residents, are taxed by equalization levy and same products supplied by domestic e-commerce operator are not subject to it, the national treatment principle under GATT can be violated and this action can be challenged at WTO. In order to avoid this, India will have to incorporate the provision, creating an exception in all its Double Taxation Avoidance Agreements. Alternatively, if significant economic presence and equalization levy are proposed and accepted by the nations in the next negotiation on BEPS Action Plan 1, it can be a possible safeguard for India. [Article III, General Agreement on Tariffs and Trade, 1947, available at https://www.wto.org/english/docs_e/legal_e/gatt47.pdf ]
Treaty Override: Since, Equalisation levy is not accepted to be a part of the Double Taxation Avoidance agreements or the Multilateral Instrument, it is difficult to implement it against various nations. The nations are unlikely to agree to equalization levy or even if they do, it might be a long and tedious process. Hence, it is safe to say that it can be implemented against various nations only if it is a part of the domestic law. Thus, the potential solution was to implement it through domestic law, it is accepted by all the nations and becomes a part of the DTAAs and the international law. An exception can be created to the DTAAs, only if the domestic tax is a tax on income. Thus, India’s approach to not to include the equalization levy as ‘income tax’ but ‘transaction tax’ can be perceived as a potential means of treaty override. [Equalisation Levy- A Case of Treaty Override? Part II, Mr. Rahul K Mitra (Partner KPMG), May 9, 2016, available at https://www.taxsutra.com/experts/column?sid=607]
Applicability of Equalisation Levy in certain cases: Clarification is required in terms of applicability of equalization levy in certain cases as the law is silent on that. For example, the applicability of equalization levy is unclear if the total transaction amount satisfies the threshold, but the discounted sale price is below the threshold value or when the products supplied by the non-resident e-commerce operator are returned by the customer and the equalization levy is already paid, the provision for rebate of the equalization levy is absent from the legislation. Thus, clarificatory provisions should be released by the CBDT in this regard. [New Burden on Foreign E-Commerce Companies: The Problem of two Hows, Payaswini Upadhyay, March, 31 2020, available at: https://www.bloombergquint.com/law-and-policy/new-tax-burden-on-foreign-e-commerce-companies-the-problem-of-two-hows ]
In conclusion, it can be said that equalization levy was a much required step for preventing the tax evasion by non-resident e-commerce operators, but the mechanism adopted for the incorporation of this provision has led to potential problems. However, the entire scenario can drastically change on the basis of the OECD report on taxation of the digital economy, which is slated to be released in December, 2020. However, before the implementation of this levy the unique situation created by COVID-19 has to be considered. In light of the pandemic, majority of the work has been shifted online and various services are being provided online now. The implementation of the extra 2% levy might be deterrent the to the required services provided online and harm the economy and people further. Thus, the implementation of the Equalisation levy on e-commerce operators should be deterred till this extraordinary problem is resolved.