India Equalization Levy Expanded—a Surprise Move! (Part 1)

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While the world has been brought to a standstill by the Covid-19 pandemic, the information and communication technology (ICT) sector is playing a paramount role in keeping people across the world digitally connected. The Organization for Economic Co-operation and Development (OECD), under the Action Plan 1 Report (AP 1 Report) on addressing the tax challenges raised by the digital economy, has recognized that digital economy is the result of a transformative process brought by ICT. ICT has made technologies cheaper, more powerful, and widely standardized, improving business processes and bolstering innovation across all sectors of the economy.

While digitalization has given birth to new business models and paved the way for economic growth, innovation and societal change, it has also created unique challenges for the international taxation system. These new businesses thrive on users, reliance on data, increased speed of processing information, decreased need for local personnel to perform certain functions, as well as the flexibility to choose the locations of servers and other resources.

Tax Treaties and Interplay with Digital Businesses

Bilateral tax treaties or double taxation avoidance agreements (DTAAs) are entered between governments to assign taxing rights in case of cross-border transactions, thereby encouraging cross-border relationships, preventing double taxation as well as strengthening political ties between partner countries. The tax treaties allocate taxing rights between countries on the basis of income source or residency-based rules, while recognizing the rights of both countries to levy tax on such income.

The existing tax rules that were developed by a group of economists appointed by the League of Nations in the 1920s provide for a threshold for taxation of business profits in the form of “permanent establishment” (PE). According to Article 7 of tax treaties, business profits of an enterprise are taxable in the country of residence of such enterprise. However, in case the enterprise carries on its business in another country through a PE situated there, such other country may also tax business profits of the enterprise to the extent attributable to the PE. The concept of PE is largely conceived as a fixed place of business through which business of an enterprise is wholly or partly carried on, thereby establishing taxable nexus based on physical presence.

Interestingly, over the years, while the concept of PE has evolved to include within its ambit, inter alia, provision of services and undertaking of construction activities beyond certain threshold duration, undertaking activities acting on behalf of an enterprise, and habitually exercising an authority to conclude contracts on its behalf, constitution of PE is still dependent on physical presence.

However, in the digital era, digitalized businesses can be heavily involved in the economic life of a jurisdiction without any, or any significant, physical presence in that country, thereby creating opportunities to avoid taxes completely in the source country. This fundamental challenge arises in the context of international tax rules which were designed a century ago, long before advent of the digital economy where businesses can be conducted remotely.

OECD Response

The OECD in its AP 1 Report acknowledges that the existing international tax rules need to be modified with evolving business models. The physical presence nexus rules developed in the brick and mortar era are no longer a useful indication of taxable nexus. The AP 1 Report discussed three options to tackle direct tax challenges arising from the digital economy:

a new nexus rule based on significant economic presence (SEP);
a withholding tax on certain types of digital transactions; and
an equalization levy on certain specified services.

While none of these options were recommended, the AP 1 Report provides that countries could introduce any of them in their domestic laws or in their bilateral tax treaties as additional safeguards from base erosion and profit shifting (BEPS), provided they respect their existing tax treaty obligations. In May 2019, the OECD/G-20 Inclusive Framework on BEPS agreed a Programme of Work for addressing the tax challenges of the digitalization of the economy and arriving at a consensus-based solution by 2020.

The Programme of Work is divided into two pillars:

Pillar One addresses the allocation of taxing rights between jurisdictions and considers various proposals for new profit allocation and nexus rules;
Pillar Two focuses on the remaining BEPS issues and seeks to develop rules that would provide jurisdictions with a right to “tax back” where other jurisdictions have not exercised their primary taxing rights or the payment is otherwise subject to low levels of effective taxation.

India’s Take on Tax Challenges in the Digital Era

Historically, e-commerce transactions—sale of software, provision of advertising services, subscription to online databases, etc.—have been a source of dispute in India.

The Bangalore bench of Income-tax Appellate Tribunal (ITAT) in the case of Google India Private Limited rendered a ruling classifying payments made by the company to Google Ireland for purchase of advertisement space on Google’s AdWords program as royalties. The Bangalore ITAT distinguished this case from earlier Tribunal rulings in Right Florists, Pinstorm Technologies and Yahoo India, wherein the courts had held that payments made to a foreign company for banner advertisement hosting services would not constitute royalty.

In the case of Amadeus Global Travel Distribution, the Delhi ITAT held that nonresident companies supplying a computerized reservation system providing real time access to airline fares and enabling bookings are liable to be taxed in India to the extent of the booking fees received from Indian residents.

Recently, India has expressed several reservations in the commentary to the OECD Model Tax Convention on Income and on Capital relating to PE exposure, being inter alia reservations that a website may constitute a PE where it leads to SEP of an enterprise and that furnishing of services rather than performance of services is sufficient for constitution of service PE, etc. Thus, Indian tax authorities and taxpayers have litigated on the issues of characterization of income and establishment of taxable nexus in relation to e-commerce transactions.

India has incorporated several OECD recommendations arising from the BEPS project under the Income-tax Act, 1961 (ITA), being an active member of the G-20 and a Key Partner of the OECD.

Recognizing the work undertaken by the OECD in the AP 1 Report, the Ministry of Finance directed the establishment of a Committee on Taxation of E-commerce (Committee) to take note of the digital economy in the Indian context and identify a simple, predictable and certain solution for taxation of e-commerce transactions. The Committee recommended adoption of the equalization levy (EL) with the objective of providing greater clarity, certainty and predictability in respect of characterization of payments for digital transactions and consequent tax liabilities to all stakeholders, so as to minimize costs of compliance and administration and minimize tax disputes.

The Committee Report stated that the levy of the EL is intended to be an interim measure that may not be required once the DTAAs are modified to address the broad tax challenges that are imposed by the limitations of the existing international taxation rules. Notably, the Committee, after consideration of the OECD reports and recommendations, chose to recommend an EL only on online services and not on the sale of tangible goods through online means. Further, the focus was only on business-to-business (B2B) transactions, and business-to-consumer (B2C) transactions were not recommended until such time as an effective mechanism for collection of such taxes which did not burden consumers could be developed.

In the Union Budget for the year 2016, India introduced the EL with effect from June 1, 2016 under Chapter VIII of the Finance Act, 2016 (FA, 2016), as a separate, self-contained code, not forming part of the ITA. The EL as introduced by the FA, 2016 (Ad EL) was levied at a rate of 6% on the amount of gross consideration received by nonresidents for online advertisement and related services provided to (i) a person resident in India and carrying on a business or profession; or (ii) a nonresident having a PE in India. Income arising from provision of online advertisement services which is subject to Ad EL is exempt from income tax under the ITA. The Ad EL is applicable on payments made to nonresident service providers in excess of Indian rupees 1 lakh ($1,300) and is essentially a levy on B2B transactions, thereby covering only a small segment of e-commerce transactions.

Further, in the Union Budget for the year 2018, India introduced the SEP test to expand the definition of “business connection” under the ITA. The explanatory memorandum to the Finance Bill, 2018 stated that the inclusion of an SEP test under domestic law would enable India to negotiate for inclusion of a new nexus rule based on SEP in DTAAs.

The Finance Bill, 2020 (FB, 2020) was tabled by the Finance Minister in the parliament on February 1, 2020. While the FB, 2020 contained proposals in relation to expansion of the SEP regime, interestingly it did not contain any proposal to expand the scope of the EL. However, at the enactment stage, the scope of the EL was expanded to apply the EL on e-commerce operators (E-com EL) by way of amendment to the FA, 2016. The FB, 2020 received the assent of the President of India on March 27, 2020 and came into force from April 1, 2020. Accordingly, the provisions in relation to the E-com EL also come into effect from April 1, 2020. This came as a surprise to the industry at large, considering the unusual manner of the introduction of E-com EL directly in the Finance Act, 2020 (FA, 2020) without any prior discussion/debate during the proposal stage.

Overview of EL on E-Commerce Operators

Applicability

The E-com EL is applicable at rate of 2% on the amount of consideration received or receivable by “e-commerce operators” from “e-commerce supply or services” made or provided or facilitated by it to:

a person resident in India; or
a nonresident under certain specified circumstances; or
a person who buys such goods or services or both using an internet protocol (IP) address located in India.

The term “e-commerce operators” has been defined to mean a nonresident who owns, operates or manages a digital or electronic facility or platform for online sale of goods or online provision of services or both. Further, the term “e-commerce supply or services” is defined to mean:

online sale of goods owned by the e-commerce operator; or
online provision of services provided by the e-commerce operator; or
online sale of goods or provision of services or both, facilitated by the e-commerce operator; or
any combination of the above.

Exclusions

E-com EL will not be applicable where:

the e-commerce operator has a PE in India and e-commerce supply or services is effectively connected with such PE; or
Ad EL is leviable on such transaction; or
where sales/turnover/gross receipts of the e-commerce operator from e-commerce supply or services is less than Indian rupees 2 crores ($263,000) in the previous year.

Compliance Obligations

The e-commerce operator is liable to pay E-com EL within the applicable due dates on a quarterly basis. According to the provisions, the first due date of payment of E-com EL for the quarter ended June 30, 2020 is July 7, 2020. Apart from payment of E-com EL, the e-commerce operator is also required to furnish an annual statement in such form as may be prescribed, in respect of all e-commerce supplies or services made during the financial year.

Other Provisions

If the e-commerce operator fails to pay the whole or any part of the EL, it will be liable to interest at a rate of 12% per annum and a penalty equivalent to the amount of EL it failed to pay. Further, the provisions of the E-com EL rely on the ITA in relation to the collection or recovery mechanism of the EL and initiation of prosecution proceedings in certain circumstances.

Exemption from Income Tax

Any income arising from any e-commerce supply or services made or provided or facilitated on or after April 1, 2021 is exempt from income tax under the ITA.

The introduction of the E-com EL will have far-reaching consequences for the players in the e-commerce sector. Unlike the Ad EL, the E-com EL envisages levying tax also on B2C transactions. As mentioned above, the burden to comply with the provisions of the E-com EL is on the e-commerce operators. Accordingly, e-commerce operators will have to check applicability of these provisions, track transactions with Indian customers, and ensure timely deduction of E-com EL and filing of statements with the Indian tax authorities to avoid any punitive action.

E-Com EL—Key Challenges

At the outset, it is imperative to note that in the absence of mention of the proposal for introduction of E-com EL in the explanatory memorandum to the FB, 2020 and any prior debate/discussion on introduction of the E-com EL, the intention of the government of India behind its introduction is not known.

The Supreme Court of India in the case of Girdhari Lal & Sons has held that the primary and foremost task of a court in interpreting a statute is to ascertain the intention of the legislature, actual or imputed. Thereafter, the court must interpret the statute so as to promote/advance the object and purpose even by supplementing the written word if considered necessary. Given that the government’s intention in the introduction of the E-com EL is not known, it may be difficult to interpret and decide whether the provisions of E-com EL are attracted to a particular situation.

Are the Definitions Enough?

The provisions of the E-com EL have been drafted very loosely and do not define or explain the meaning of several words used in the statute. For example, while the provisions define the term “e-commerce operators,” they do not provide the meaning of the terms “operate,” “digital,” “electronic facility,” “platform,” “online sale,” “goods” and “online provision of services” used in the statute. While the provisions of the EL provide that the words and expressions used but not defined in Chapter VIII of FA, 2016, can derive their meaning from the ITA or Income-tax Rules, 1962 (ITR), interestingly, these words are not defined under the ITA or the ITR.

This creates interpretational issues, such that the provisions may be interpreted in a broad manner covering transactions/situations which were not intended to be covered in the first place. For example, in the absence of meaning of “online sale”/”online provision of service,” it is unclear whether the E-com EL will be applicable to transactions which include only online sales or online provision of service, or it will be applicable to situations where the actual sale or provision of service is completed offline.

The interpretational issues are further exacerbated by the fact that the intent behind the introduction of the E-com EL remains unclear. While tax statutes have to be interpreted strictly as per the language used in the law, it is a well-settled rule of construction that where the plain literal interpretation of a statutory provision produces an absurd and unjust result which could never have been intended by the legislature, the court may modify the language used by the legislature, so as to achieve the obvious intention of the legislature and produce a rational construction. Having said that, considering the language of the provisions of the E-com EL, one may contend that the intention was to tax the service of facilitating online sale of goods or services which only a typical marketplace platform can do. However, given the literal meaning of the provisions, a broader interpretation cannot be ruled out.

At this juncture, it is interesting to remind ourselves of the principles enunciated by the courts while interpreting provisions wherein certain terms were not defined in a statute. The High Court of Kerala in the case of All Kerala Chartered Accountants’ Association v. Union of India held that it is a basic canon of interpretation that each statute defines the expressions used in it, and that definition should not be used for interpreting any other statute unless in any other cognate statute there is no definition, and the extrapolation would be justified.

Further, the Supreme Court in the case of Jagatram Ahuja v. Commissioner of Gift-tax held that the words and expressions defined in one statute as judicially interpreted do not afford a guide to construction of the same words or expressions in another statute unless both the statutes are pari materia legislation or it is specifically so provided in one statute to give the same meaning to the words as defined in another statute. The Sale of Goods Act, 1930 (SOGA) defines the term “goods” to mean inter alia every kind of movable property other than actionable claims and money. There is a plethora of judicial guidance under the SOGA in relation to the meaning of “goods,” which is similar to how the term was defined under sales tax laws as well. At the same time, “goods,” defined under the current Goods and Services Tax (GST) laws, include actionable claims.

Therefore, the question whether one can apply the definition of “goods” under the SOGA or the GST laws in the context of the EL remains open. The answer may not be straightforward and one may have to look at the object and purpose of the SOGA/GST to conclude on its applicability in the context of the EL. Given that the meaning of undefined terms cannot be interpreted in the context of a term defined in another statute which is not pari materia legislation, one may also have to resort to the dictionary to understand the meaning of such terms.

In this regard, the Supreme Court in the case of Commissioner of Income-tax v. Venkateswara Hatcheries (P.) Ltd has held that it may be permissible to refer to the dictionary to find out the meaning of that word as it is understood in the common parlance. However, where the dictionary gives divergent meanings, or more than one meaning of a word, the word has to be construed in the context of the provisions of the act and regard must also be had to the legislative history of the provisions of the act and the scheme of the act. The dictionary definition provides several meanings of the word “platform” in ordinary parlance. However, the word “platform” in the context of e-commerce transactions seems to be a technical word, and therefore, ascertaining its meaning in the correct sense will be extremely important.

It seems that not only has the Indian government introduced the provisions in relation to the E-com EL in a sudden manner, it has also not analyzed and considered the practicalities of these provisions before their introduction.

What is Consideration?

Another interesting point to be noted in relation to the E-com EL provisions is that they apply on the consideration received or receivable by e-commerce operators from e-commerce supply or services to specified persons. The players in the e-commerce sector do not operate in a standardized manner, i.e. not necessarily following the same operating models or payment methods or policies. Given that the E-com EL applies on the consideration received or receivable by e-commerce operators, the impact of situations of cancellations/returns and exchanges has not been addressed in the provisions.

As returns or exchanges are very common in the e-commerce space, there should be a proper mechanism for credit or refund of the E-com EL in such situations to reduce the potential hardships for e-commerce operators. Further, it may be possible that the e-commerce operator is merely facilitating the flow of funds between the seller and the buyer on its platform in lieu of commission from the registered seller or buyer or both; in such situations it would be unfair for the E-com EL to be applied on the entire consideration received by the e-commerce operator.

The E-com EL provisions as they stand today are unclear on the above aspects.

Conclusion

This article is the first part of a two-part series. While the authors have undertaken a detailed analysis of the provisions in relation to the E-com EL in this part, the second part of the series deals with issues regarding sufficiency of nexus and practical challenges that may arise for e-commerce operators, along with few illustrative case studies to highlight the interpretational issues discussed in this Part 1.

Parul Jain is Co-head, Meyyappan Nagappan is Leader,and Ipsita Agarwalla is Member, International Tax Practice, with Nishith Desai Associates.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.