Over the past few years, India has been rationalizing its tax structure into a regime which has moderate rates of tax, reduced litigation, and a simplified tax structure without tax exemption.
With moderate tax rates it is a legitimate desire of every government to increase the national tax base. While efforts are being made as part of the changes in domestic law to expand the tax base, India has also been at the forefront of the Organization for Economic Co-operation and Development/G-20 BEPS Project, wherein large multinational enterprises (MNEs) are expected to pay a fair share of their taxes to the market jurisdictions which they exploit as consumers. While efforts were ongoing to reach a global consensus on how to tax these MNEs, the Indian government quietly slipped through an amendment to its Equalization Levy (EL)—its digital tax regime, originally introduced in 2016—as part of the legislative changes in March 2020.
It is worth noting the changes in the EL were slipped in through the back door at the time of passing of the Finance Bill 2020 by the parliament, and not at the time of presenting the initial tax proposals before the parliament as well as the general public.
These amendments have been further widened in terms of their scope and applicability as part of the legislative changes announced through Finance Act 2021 for the fiscal year 2021–22. Looking at the chronology, it would appear that the changes proposed as part of the 2021 announcements, having retrospective effect on the amendments made in 2020, have been deliberately made to overcome some of the interpretive arguments which taxpayers and tax counsels had developed to overcome the tax incidence on transactions undertaken by traditional businesses, which were not intended to be covered by the digital tax regime.
Legislative Amendments Introduced in India
The EL was introduced for the first time vide Finance Act, 2016, providing for a levy of 6% for online advertisements or for the provision of digital advertisement space or any other facility or service for the purpose of advertisement payable by, inter alia, an Indian resident carrying on business, to a nonresident service provider; irrespective of whether the service provider was liable to tax in India under the provisions of the Indian Income-tax Act, 1961 (the Act) or the applicable double tax treaty (the treaty) between India and the country of residence of the nonresident service provider.
The scope of the EL was substantially enlarged vide amendments made by the Finance Act, 2020 (by introducing Section 165A) to include e-commerce supply or services by a nonresident e-commerce operator, which would henceforth be subject to a levy of 2% on the transactions in India.
The imposition of the EL through Section 165A is a paradigm shift in the taxation of the digital economy/e-commerce transactions by making nonresidents chargeable to the EL in India with respect to e-commerce supply or services, where such nonresidents are otherwise not liable to tax in India either under the Act and/or the applicable treaty.
In other words, if the nonresident has a business connection in India in terms of Section 9(1)(i) of the Act or PE in India in terms of Article 5 of the applicable treaty, the income of the nonresident from e-commerce supply or services would be taxable in India. On the contrary, where the nonresident is not liable to tax in India on such transactions, such nonresident would be chargeable to the EL at 2% of the value of the transaction, with the exception of transactions that are subject to tax as royalty or fees for technical services.
The Finance Act, 2020, widening the scope of the EL to online sale of goods and services, provided for a levy at 2% on gross consideration received or receivable by a nonresident e-commerce operator. The back-of-the-envelope working of the EL at 2% on gross consideration seems to be based on a net profit margin at 5% from online sale of goods and services by the nonresident e-commerce operator, considering the income tax rate of 40% (excluding surcharge and cess) on the net taxable profit of nonresident taxpayers in India.
Recently, vide Finance Act, 2021, among others, the scope of transactions qualifying as e-commerce supplies or services has been enlarged by artificially expanding or deeming what would be construed as an online sale. The terms “online sale of goods” and “online provision of services” have now been deemed to include one or more of the following online activities:
- acceptance of offer for sale; or
- placing the purchase order; or
- acceptance of the purchase order; or
- payment of consideration; or
- supply of goods or provision of services, partly or wholly.
Therefore, ex facie, undertaking any one or more of the activities described in the points above could be stated to result in “online sale of goods” or “online provision of services,” having regard to the enlarged definition inserted by the Finance Act, 2021.
It is interesting to note that EL collection in the fiscal year 2019–20 was approximately $150 million, which is estimated to have increased to $250 million in fiscal year 2020–21 (despite a decline in international trade in the pandemic year) primarily owing to the expansion of the scope of the EL provisions.
The Unintended Consequence: Taxation of Import of Goods and Services in India
Before the introduction of the definition of “online sale of goods” and “online provision of services” in the Finance Act, 2021, the use of the word “online” relating to sale of goods or provision of services, in the definition of “e-commerce supply or services,” was interpreted differently.
The expression “online sale of goods” was interpreted to mean that consummation of the sale must happen online. A plausible reading of the provision was that a “sale” would effectuate when the transfer of title occurred and therefore, for a sale to be consummated online, title in goods must also be transferred online.
In the context of sale of physical goods, being in tangible form, they are incapable of being transferred online. Typically, in the case of tangible goods, transfer or sale happens on delivery or at any other time as agreed between the parties, hence the transaction could not be covered under the scope of the EL.
Now, after the 2021 amendments, the terms “online sale of goods” or “online provision of services” have been specifically defined, and therefore, the mere fact that one of the activities relating to sale of goods or provision of services is undertaken online could risk bringing the entire transaction within the scope of the EL. Therefore, the argument that sale of tangible goods is typically completed on delivery, and accordingly the mere act of ordering goods online would not make it a transaction of “online sale of goods,” has now been invalidated with retrospective effect.
The above amendment would impact several industries. The biggest impact is to companies which purchase goods online that are shipped to India. Additionally, in light of the recent decision of the Supreme Court of India in the case of Engineering Analysis Centre of Excellence Private Limited v. CIT: 125 taxmann.com 42, it has been held that payments made to nonresident computer software manufacturers/suppliers for the resale/use of the software are not taxable as royalty. The Court has treated it as a transaction of sale of copyrighted goods. Accordingly, companies engaged in sale of software, whether off-the-shelf or customised, would also attract the EL.
Similarly, online provision of services would also attract the EL. This would impact the travel and hospitality sector making reservations via a computer reservation system; the education sector involving foreign universities offering online courses; the media, communication and entertainment sector, including online subscriptions to print media, foreign publicists, social media handlers, paid gaming websites, as well as over-the-top (OTT) and social media platforms.
The newly expansive definition would lead to the following unintended consequences:
- Discrimination between traditional businesses carried on with and without the aid of online/digital platforms, for example, offline purchase of goods vs. online purchase of goods, universities providing offline courses vs. online courses.
- Presently, import of goods was taxable under customs and import of services was taxable under the reverse charge mechanism under Goods and Services Tax. Now, an e-commerce supply of goods or provision of services would additionally be subject to the EL, resulting in double taxation.
- One of the intentions of introducing the EL from the government’s perspective was to help domestic players achieve a level playing field. In the case of import of goods (where one of the activities specified in the expanded definition is satisfied), the provisions have in fact made domestic players worse off by subjecting them to double tax, as referred to in the point above.
- Effectively taxing all imports of goods in India with an additional EL would hamper the government’s initiative of making India a manufacturing hub. In a globalized world, there is bound to be cross-border trade which needs to be encouraged and not penalised with such additional taxes.
- Absence of definitions of “digital platform” or “digital facility” has left these terms open to interpretation and further uncertainty. For example, there may be a case where goods are requisitioned and delivered offline, but some communication may happen over e-mail. An issue may arise whether such correspondence between the buyer and seller would result in the characterizing of the transaction as an online sale of goods. Similarly, it is not clear whether these provisions would apply to businesses which have integrated platforms/enterprise resource planning/SAP or in most cases where these platforms are used to generate a purchase order which is communicated over an email.
- No exemption has been provided in respect of inter-company transactions. This would result in a huge tax impact on Indian subsidiary companies that place orders for goods as well as obtain routine IT and other services from their parent company situated outside India.
In light of the above, it is necessary to evaluate whether such a literal interpretation should be applied to tax import of goods in India, or whether a position could be taken that EL provisions need not apply, (a) being contrary to the intention of the law; (b) being discriminatory in nature; and (c) having limited application in cases that not only satisfy one of the conditions specified in the expanded definition but are also consummated online. This interpretation should be carefully tested on the facts of each case.
Equalization Levy on Intra-Group B2B Transactions
The BEPS Action 1 Report (the Report), recommended an “equalization levy” as one of the options available to countries, which would be intended to tax a nonresident enterprise’s significant economic presence (SEP) in a country and could be structured in a variety of ways depending on its ultimate policy objective.
The Report also stated that if the policy priority is to tax remote sales transactions with customers in a market jurisdiction, one possibility is to apply the levy to all transactions concluded remotely with in-country customers. The Report further stated that to target the scope of the levy more closely to the situation in which a business establishes and maintains a purposeful and sustained interaction with users or customers in a specific country via an online presence, the levy would be applied only where the business maintains an SEP as described above.
As an alternative, therefore, it has been suggested that the scope of the EL may be limited to transactions involving the conclusion through automated systems of a contract for the sale (or exchange) of goods and services between two or more parties effectuated through a digital platform.
To put it simply, the focus of the Report was that the scope of the levy is targeted to (a) the situation in which a business establishes and maintains a purposeful and sustained interaction with users or customers in a specific country via an online presence; (b) the levy would be applied only where the business maintains an SEP; and (c) as an alternative, on sale (or exchange) of goods and services effectuated through a digital platform.
Consequent to the OECD’s BEPS Action 1, the EU also introduced digital services tax (DST) provisions, and as per the Explanatory Memorandum to the provisions, dated March 21, 2018, revenue earned from physical sale of goods wherein a digital interface is simply used as a means of communication is excluded from DST provisions, since a DST seeks to target those services where the participation of a user in a digital activity constitutes an essential input for the business carrying out that activity and which enables that business to obtain revenues therefrom. Consequently, OECD member countries, for example, Austria, France, Hungary, Italy and Turkey, and also non-member countries, such as the U.K., included in their laws a narrow set of digital activities for the levy of an EL/DST.
The intention in introducing an EL under the OECD BEPS Action 1, therefore, was to tax those companies which have a significant digital presence in the economy of another country but are not subject to tax due to the lack of nexus under the existing international tax laws. This intention was also echoed by the Indian legislature while introducing the EL in the Memorandum to Finance Bill, 2016.
As stated in the Report, the scope of the EL is targeted to the situation in which a business establishes and maintains a purposeful and sustained interaction with users or customers in a specific country via an online presence, and the levy would be applied only where the business maintains an SEP. The business-to-business (B2B) transactions of import of products, components and parts, or of intra-group services undertaken with the group companies in the course of undertaking manufacturing operations as such do not create an SEP in India.
In our opinion, when, under an international treaty, countries have agreed for taxation of those e-commerce transactions which essentially give rise to an SEP in the country of source, a charge of a tax by an equalization levy by India in respect of intra-group or inter-company B2B transactions which are otherwise neither attributed to a permanent establishment, nor give rise to a tax incidence by way of SEP, in terms of amended Section 165A of the Finance Act 2016, may be termed as contrary to the shared understanding of BEPS Action 1.
This, in our opinion, would also be contrary to the principles enshrined in Article 26 and 27 of the Vienna Convention. Also, the overarching EL provisions in their present form, extending the scope of the levy to tax intra-group or inter-company B2B transactions, which are otherwise neither attributed to a permanent establishment, nor give rise to a tax incidence by way of SEP, may cause hardship to MNEs.
Is EL 2021 India’s Bargaining Chip?
It is clear that the amended provisions of the EL have led to an uncertain environment in India. There is a possibility that the Indian government may be looking at this legislation as a bargaining tool as part of its overall negotiations while reaching a global consensus on taxing MNEs, while giving up its position on taxing traditional businesses selling goods to India.
However, if that is not the intent, the Indian government should urgently address this anomaly.
Further, in order that the EL does not result in increasing the transaction costs for Indian businesses, the Indian government should evolve a mechanism whereby the nonresident payee of income can obtain credit of such levy in its home country.
The views expressed in the article are author’s personal views. In no way they should be interpreted to be views of the firm.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Neeraj Jain is a Partner and Shaily Gupta is Associate Partner at Vaish Associates, Advocates, India.