The Missing Fine Print in the 2020 Equalisation Levy on Digital Transactions in India
A case for rationalising unilateral measures in the absence of a global solution to tax the digital economy
The onset of the COVID-19 pandemic has deeply affected the global economy which has seriously impacted government revenues. Given the imposition of national lockdowns, even as traditional businesses have suffered, the digital economy has remained comparatively unaffected. In fact, several tech giants have reported increased quarterly revenues as national lockdowns witnessed a shift to online activity.
However, the unique features of businesses in the digital landscape pose significant challenges in taxing their income. While income tax laws impose levies based on the place of residence of taxpayers and/or their source of income, such laws were conceptualised with brick-and-mortar businesses in mind. However, in the digital economy, these conventional concepts are blurred – as a result businesses have opportunities to circumvent tax laws and set operations to minimise tax liability.
There is now a global consensus on the need for a comprehensive mechanism to adequately tax the digital economy, and the OECD (Organisation for Economic Co-operation and Development) and the UN have been working on a resolution. The slow pace of multilateral negotiations and increasing public anger over the inability of governments to tax the ever-growing profits of digital giants have led to a proliferation of various forms of unilateral measures in taxing the digital economy with a view to make up for the revenue forgone owing to the lockdowns, along with the need to generate enough revenue for the purposes of providing a stimulus to physical economies.
Issues with Unilateral Measures to Tax the Digital Economy
However, there are inherent problems with these unilateral measures discussed extensively by legal scholars and practitioners alike. It is essential to try and ensure a degree of international harmony and convergence on common standards while introducing unilateral measures to mitigate adverse impacts and pave the way towards a multilateral approach.
The Government of India too expanded the scope of its Equalisation levy in April 2020 to now potentially include a 2% tax on all kinds of digital transactions (‘2020 Equalisation Levy’). The move was particularly surprising. Unlike standardpractice, the proposal to expand the scope of Equalisation Levy did not find a place in the Finance Bill, 2020, or in the explanatory memorandum that was placed before the parliament on February 2, 2020. However, at the enactment stage, the scope of the Equalisation Levy was expanded.
Thus, unlike the Equalisation Levy as implemented in 2016 (‘2016 Equalisation Levy’), which underwent some legislative scrutiny and stakeholder discussions, the expansion of the scope of the 2020 Equalisation Levy has been devoid of any such processes.
In this blog, we map out the various inconsistencies under the 2020 Equalisation Levy and suggest a potential way forward until a global consensus is attained.
Equalisation levy is chargeable on a non-resident who owns, operates or manages a digital or electronic facility or platform for ‘online sale of goods’ or ‘online provision of services or both’. However, it does not identify what constitutes an ‘online sale of goods’ or ‘online provision of services’. Thus, it becomes unclear as to whether a business model would fall under the scope of the Equalisation levy 2020 or not.
For example, for a business model like that of Urban Company (formerly Urban Clap) where the actual provision of services is completed offline, it is unclear whether it would constitute as an ‘online provision of service’. Similarly, for a facilitator like OLX which operates a model under which the sale of goods is actually concluded offline, including further negotiations and payment for goods, it is unclear whether its business model would fall under the scheme of 2020 Equalisation levy.
These ambiguities are further exacerbated by the fact that there is no explanatory memorandum to explain the intention of the government in introducing the 2020 Equalisation levy. This is likely to either result in unintended leakages, or unintended inclusions. Thus, the scope must be clearly delineated in order to provide certainty to the taxpayer along with avoiding unnecessary litigation in the future.
Tax on Consideration as Opposed to Revenue or Net Profits
Unlike Digital Services Taxes (DST) enacted by several European countries which use the in-scope revenues to calculate the taxable liability of a non-resident, the provisions of Equalisation levy tax the consideration (payment) received or receivable by non-resident e-commerce Operators. While taxes on gross revenues have been criticised world over, there still are well defined parameters to ascertain when revenue may be recognised. On the other hand, the phrase ‘consideration’ has not been defined under either the Finance Act or the Income-tax Act. This is problematic for two reasons.
First, it may be possible that an e-commerce operator is merely facilitating the flow of funds between the participants on its platform in lieu of commission from the registered seller or buyer or both. In the absence of the definition of the word ‘consideration’, it may lead to an anomalous conclusion of charging the entire consideration exchanged during such a transaction to the 2020 Equalisation levy as opposed to just the commission received by the e-commerce operator.
Second, the impact of situations of cancellations/returns and exchanges has not been addressed in the provisions, which may result in double counting. Given that the levy would apply irrespective of whether a business is profitable or not, having the same transactions twice will be particularly burdensome for some business models since exchanges are very common in the B-2-C models which often run on low operating margins and highinvestments. Therefore, there should be a proper mechanism envisaged in order to eliminate these anomalies.
Compliance and Administration
The Equalisation levy 2020 requires the non-resident e-commerce entities to track both the IP addresses, as well as the residential status of their end user in order to ascertain whether a transaction would be amenable to the 2020 Equalisation Levy. This creates an additional compliance burden upon MNEs (Multinational Enterprise/s) for which they may not have readily available infrastructure. Further, since the term ‘resident in India’ has not been defined under the Finance Act, 2016, the definition under the Income tax Act must be utilised. Given that residential status under the income-tax act in itself is a complex calculation, the requirement for an MNE to track the residential status of the end user seems unreasonable.
Further, as noted in the previous section, the increased prevalence of virtual private networks (VPNs), which protect data privacy by disguising the IP address and location of the end user, will make enforcement and administration of the 2020 Equalisation levy particularly challenging. VPN usage will likely result in a significant portion of Equalisation levycompliance location tracking being incorrect.
The 2020 Equalisation levy requires an e-commerce operator to track both the IP addresses as well as the residential status of the end-user. This is likely to contribute to situations where multiple digital taxes are leviable on the same transaction. For instance, a transaction which results in the digital services being enjoyed by an Indian resident in the United Kingdom would be amenable to the UK DST, the equalization levy, as well as the corporate income taxes that the MNE may have to pay in their residence jurisdiction. Unlike the United Kingdom, the Indian legislation does not envisage such situations and does not provide for a credit in such situations.
The Akhilesh Ranjan Committee report also made this observation. It stated that the intention behind the Equalisation levy is to create a level playing field. However, the imposition of the Equaliastion levy based on the premise of MNEs targeting persons resident in India, as well as persons using Indian IP addresses may result in over-taxation, instead of just creating a level playing field. Hence, the Indian legislation needs to envision such instances in the law and provide for credit accordingly.
Transactions Between Non-Residents Targeting Indian Users
The provisions of the 2020 Equalisation levy also attempt to cover transactions between two non-residents targeting Indian residents or a customer using Indian IP addresses. While Article 245 of the Constitution of India empowers the Government to enact laws that have extraterritorial reach, the proposition in the Equalisation levy is problematic in the manner in which it has been drafted. For a transaction between non-residents to fall within the scope of the Equalisation levy 2020, the same consideration must qualify as payment for sale of data as well as sale of advertisements. While the two are isolated incidents which are unlikely to occur simultaneously due to data privacy laws, the intention of the legislature behind treating both of them as a composite supply to fall under the tax net is unclear. Further, given that both these isolated incidents have to happen simultaneously within the tax net, it gives room to MNEs to further restructure so as to fall out of the tax net by splitting a composite supply into two isolated incidents. Given the hurry in which the amendments were introduced, this may well be a drafting error amenable to clarification in the near future. However, until a clarification is issued, it is trite law that where two interpretations emerge, the ones favoring the taxpayer shall prevail.
Way Forward – Applying Common Standards to Unilateral Measures
In these times, while the need for unilateral measures cannot be disputed in the absence of a multilateral solution, there needs to be some common standards that should apply in order to make unilateral measures fair and equitable from a taxpayer’s perspective. Some recommendations are highlighted below.
- Providing certainty to the taxpayer
Currently, the design of scope of activities covered the Equalisation levy 2020 is very widely worded that results in multiple ambiguous interpretations leaving businesses with the tough call to determine whether they would fall within the scope or not.
For example, even though India’s Finance Minister Nirmala Sitharaman, in a meeting held with The Gems & Jewellery Export Promotion Council (GJEPC) in August 2020, clarified that the e-trade of rough diamonds would not attract the 2020 Equalisation Levy and assured the delegation that a clarification will be issued on this soon, no notification or clarification has been issued as of yet leaving such traders at the mercy of tax officials.
In this regard, the scope as envisioned by OECDs Pillar 1 Blueprint is something that countries may take inspiration from while designing the scope of their unilateral taxes. A general definition, a definitive positive list and a definitive negative list is a better way to avoid ring-fencing, unintended leakages or inclusions, along with providing certainty to the taxpayer.
- Providing credit where multiple digital taxes are levied on the same transaction
While double taxation will always persist where unilateral measures are concerned, all countries should envision a mechanism for the treatment of revenues which become amenable to multiple digital taxes. For instance, in the UK, where a transaction becomes amenable to multiple digital taxes including the UK DST, only 50% of the revenue from such transactions is charged to the UK DST.
Additionally, all countries as residence jurisdictions should allow for digital taxes to be deductible as an expense while computing their corporate tax liability.
- Providing alternate mechanisms to calculate taxable revenues
The disadvantages of gross basis taxation have been highlighted by tax practitioners, scholars, and the industry alike. Hence, countries should allow for an alternate mechanism for the calculation of taxable revenues, in order to account for costs and expenses to a certain extent. In this regard, the UN’s method of fractional apportionment of revenues could be an interesting proposition to be looked into even for the purposes of unilateral measures. Additionally, the UK’s approach of treating revenues of each in-scope services as against their worldwide operating margins to calculate their taxable revenues could also be a sigh of relief for MNE’s that work on low operating margins and high investments.
- Providing for easily administrable and consistent compliance mechanisms
These digital taxes emanate from the idea that digital businesses gain substantial value from the user jurisdiction, and hence the user countries must get their fair share of tax. However, to identify this substantial value that has been derived from its users, countries have used different parameters. While India uses both IP address and residency as a parameter for all types of transactions, the EU uses the habitual location of the user as a determinant. As noted above, this confusion is likely to increase compliance costs for MNEs, along with increasing the number of instances where multiple digital taxes are leviable on the same transaction. Therefore, countries need to adopt a coherent mechanism for recognising when the end user is based out of their jurisdiction to avoid these anomalies.