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This article is the second part in a two-part series. In Part 1, the authors have undertaken a detailed analysis of the origin of the equalization levy (EL) in India, provisions related to the EL on e-commerce operators,and the sufficiency of definitions provided under such provisions.
In the Union Budget for the year 2016, India introduced an EL at a rate of 6% on the amount of gross consideration received by nonresidents for online advertisement and related services provided to specified persons (Ad EL) under Chapter VIII of the Finance Act, 2016 (FA, 2016), as a separate, self-contained code, not forming part of the Income-tax Act, 1961 (ITA). The Finance Act, 2020 (FA, 2020) expanded the scope of the EL to additionally apply it at a 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 specified persons (E-com EL).
Interestingly, the E-com EL provisions were not present in the Finance Bill, 2020 that was announced on February 1, 2020 but were introduced as amendments later and were passed without prior debate/discussion in the parliament. Hence, the legislative intent for the introduction of E-com EL is not known. In Part 1, the authors have discussed in detail the interpretational issues that may arise due to absence of definitions of certain terms like “electronic facility,”“platform,”“online sale,”“goods,” etc. in the E-com EL provisions. The authors have thrown light on various principles of statutory interpretations that may be useful to interpret the provisions of E-com EL.
In this, the second part of the series, the authors deal with issues regarding sufficiency of nexus, interplay with international relations, and practical challenges that may arise for e-commerce operators along, with a few illustrative case studies.
Is There Sufficient Taxable Nexus with India?
The provisions of the E-com EL are much wider than the provisions of the earlier Ad EL in so much as the provisions of the E-com EL attempt to cover transactions between two nonresidents targeting Indian customers. The E-com EL is applicable in cases where an e-commerce operator is providing services to a nonresident in the following specified circumstances:
- sale of advertisement, which targets a customer who is resident in India or a customer who accesses the advertisement through an internet protocol (IP) address located in India; and
- sale of data collected from a person who is resident in India or who uses an IP address located in India.
The EL is styled as a transaction or sales tax, in that it is a tax on advertising services rendered to a nonresident by another nonresident operator or with respect to the sale of data by a nonresident operator through their platform to another nonresident, where in neither case the taxable event (which is the sale) is in India. The definition of specified circumstances in the provisions creates further confusion as it uses the word “and” in between the two limbs, which could mean that the section only applies where the sale of advertisement by a nonresident operator to another nonresident also involves the sale of data, which does not make sense.
The question which arises here is whether parliament can enact laws which govern transactions between two nonresidents. The parliament obtains powers to enact laws from Article 245 of the Constitution of India which states:
“Extent of laws made by Parliament and by the Legislatures of States
(1) Subject to the provisions of this Constitution, Parliament may make laws for the whole or any part of the territory of India, and the Legislature of a State may make laws for the whole or any part of the State
(2) No law made by Parliament shall be deemed to be invalid on the ground that it would have extra territorial operation”
Courts have upheld the power of parliament to make extraterritorial laws, when the causation of such law is found in India or such an act has an impact, effect or consequence in the territory of India. It has also been stated that it is inconceivable in a situation of extraterritorial operation that law made by parliament in India has no relationship with anything in India. Having said that, in a case where a nonresident operator sells advertising services to another nonresident or sells data to a nonresident, the taxable event, i.e. the sale, happens outside India and the customer in India is not even privy to the contract or transaction between the two nonresidents.
Given the insufficient impact or consequence arising out of a transaction between two nonresidents in India, the question which arises is whether mere targeting of Indian customers from outside India constitutes sufficient nexus to enact law in India. Even if there was sufficient nexus for enacting law, from a tax perspective, given that the taxable event happens outside India, one may have to evaluate sufficiency of nexus with the taxable event before taxing such transactions.
Another point to be considered in relation to nonresident-to-nonresident transactions targeting Indian customers is the trigger of taxable event as provided under the provisions of the E-com EL. As stated earlier, a strict reading of the provisions concerned would mean that only a transaction by a nonresident operator with another nonresident is covered if such transaction involves both the sale of advertisement and sale of data together. At the outset, it is highly unlikely that there is a platform anywhere in the world that sells data on the platform, as that would be a privacy violation in many countries. The possibility of both happening together is even more unlikely. Even if the term “and” in the section as set out above is read as “or” it is still unlikely to make the second limb with relation to sale of data workable. It is trite law that clarity on a taxable event is essential for a valid tax, and given that the provisions of E-com EL in this regard are vague and unclear, one really comes to wonder about the sanctity of the provision itself.
The above challenges and issues may leave nonresident e-commerce operators in a fix. One of the arguments that may be adopted by nonresident e-commerce operators is that if there are two possible interpretations then the one favoring the taxpayer has to be adopted. Given that tax laws are in derogation of personal rights and considering that the provisions concerned in relation to the E-com EL are ambiguous and vague and are susceptible to two interpretations, the interpretation which favors the taxpayers, as against the revenue, should be preferred. Further, e-commerce operators can also explore the arguments in relation to the unconstitutionality of the E-com EL provisions, given the lack of sufficient nexus with India and lack of clarity on the taxable event.
Impractical Responsibilities on E-Commerce Operators?
The E-com EL applies where an e-commerce operator is providing an e-commerce supply or services to specified persons. To determine the applicability of the E-com EL, the e-commerce operators may be required to be mindful of the residential status of/manner of access to the platform by their service recipients. It may be impractical or unfeasible for e-commerce operators to keep track of the IP address or the location of each customer or user whose data is collected, processed, aggregated or sold, or to whom advertisements are targeted or presented. In addition to being impractical, tracking data flow of each customer and ensuring compliance with the provisions of the E-com EL may not be pocket-friendly for the e-commerce operators.
Further, given that the provisions of the E-com EL use the concept of residency under the ITA, the e-commerce operators may find themselves stuck in determining who is a resident of India and who is not a resident of India. Also, digital transactions take place in a non-linear fashion. A targeted advertisement may or may not lead to a sale to an Indian customer. Similarly, data collected from Indian customers may or may not be monetized. From a practical standpoint, it seems very unreasonable to expect an e-commerce operator to keep track of these transactions and comply with the provisions of the E-com EL.
International Relations Disregarded?
The Organization for Economic Co-operation and Development (OECD) Action Plan 1 Report (AP 1 Report), while stating the possible options to tackle challenges arising in taxing the digital economy, has given liberty to countries to introduce any of the options in their domestic laws or in bilateral tax treaties as additional safeguards from base erosion and profit shifting (BEPS), provided they respect their existing tax treaty obligations. As stated above, the EL does not form part of the ITA.
In the past, arguments have been made that nonresidents will not be able to obtain double taxation avoidance agreements (DTAAs) benefits against the EL, thereby violating existing tax treaty obligations and resulting in non-availability of tax credit with respect to the EL paid in India in their home jurisdiction. Given that the ITA specifically exempts income subject to the EL from income tax and the collection and recovery mechanism of the EL relies on the provisions of the ITA, theoretical arguments exist that the EL may be considered as “taxes covered” under Article 2 of the DTAAs and hence, treaty benefits may be obtained. However, this position remains untested in India.
Article 51(c) of the Constitution of India provides inter alia that the state shall endeavor to foster respect for international law and treaty obligations in the dealings of organized peoples with one another. While Article 51(c) is one of the Directive Principles of State Policy and cannot be enforced by any court, the principles contained therein are fundamental in the governance of the country and it shall be the duty of the state to apply these principles in making laws. Courts have recognized that national courts, being organs of the national state and not organs of international law, must perforce apply national law if international law conflicts with it. But the courts are under an obligation within legitimate limits to so interpret the municipal statute as to avoid confrontation with the well-established principles of international law. In this context, it may be possible to argue that the provisions of the E-com EL, in so far as they relate to transactions between two nonresidents, may have to be interpreted to avoid any conflict with principles of international law.
Further, Article 26 of the Vienna Convention on the Law of Treaties (VCLT), which contains the pacta sunt servanda principle, provides that every treaty in force is binding upon the parties to it and must be performed by them in good faith. Article 27 of the VCLT provides that a party may not invoke the provisions of its internal law as a justification for its failure to perform a treaty. Article 31 of the VCLT provides that a treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose. It is further provided that context for the interpretation of a treaty shall comprise, in addition to the text, its preamble and annexes. While India is not a signatory to the VCLT, since the VCLT contains principles of customary international law, several courts have drawn inspiration from the VCLT when it was necessitated.
As part of its BEPS project, the OECD under Action Plan 15 has developed the multilateral instrument (MLI) to modify existing bilateral tax treaties to swiftly implement tax treaty measures developed in the course of the BEPS Project. Prevention of treaty abuse is a minimum standard covered under Action 6 of the final BEPS package. Pursuant to such minimum standard under Action 6, Article 6(1) of the MLI provides for the introduction of a clear statement of intent in DTAAs to avoid creation of opportunities for non-taxation or reduced taxation through tax evasion or avoidance.
In the past, arguments were made that introduction of the EL under domestic law amounts to unilateral treaty override. In light of the MLI’s coming into force from October 1, 2019 and the clear statement of intent included in the preamble of the tax treaties, one may argue whether inclusion of the EL is to avoid the creation of opportunities for non-taxation in e-commerce transactions and hence, in accordance to the object and purpose of the tax treaty. However, the present E-com EL may fail that test as it would apply even in a situation where there is double or triple taxation of the income due to lack of carveout in the event such income is actually subject to taxation elsewhere.
Other Loose Ends
Introduction of the E-com EL will surely increase compliance cost for e-commerce operators. Further, the ITA provides exemption from income tax to e-commerce operators in relation to any income arising from any e-commerce supply or services made or provided or facilitated on or after April 1, 2021. However, the provisions related to the E-com EL are applicable from April 1, 2020. This seems to be an inadvertent error, and a clarification in this respect will be much appreciated.
Illustrative Case Studies
In this section the authors have tried to capture the problems expected to arise due to interpretational issues as highlighted above, by means of some practical illustrations.
- Case Study 1: ACo, a pharma company incorporated in Country A, operates a website to provide information about the company (details of the management, latest financial information, etc.) and display its products online.
a) Mr. Z, a person resident in India, after browsing through the website, sends an email to the customer care ID placing an order for a product displayed on the website. ACo provides order confirmation to Mr. Z and sends an e-invoice over email to Mr. Z. Mr. Z makes payment for the product online using his bank’s internet banking tool. ACo physically dispatches the product to Mr. Z’s address in India.
b) Mr. X, a nonresident of India, visits India for official purposes. While in India, Mr. X places an order on ACo’s website and makes online payment. ACo physically delivers the product at Mr. X’s address in Country A.
Applicability of E-com EL: in order to examine the applicability of E-com EL, we will need to analyze if ACo will qualify as an “e-commerce operator.” In this regard, we need to analyze whether the website operated by ACo qualifies as a “platform.” The Indian law is extremely silent on the word “platform,” so much so that there are no judicial precedents which examine the meaning of the term. In such a case, one might have to rely on principles of statutory interpretation to understand the meaning of “platform.” It seems that the term is used in the E-com EL provisions in a technical sense and one may rely on OECD reports to understand the meaning of the term. However, in the absence of any statutory backing and lack of judicial precedents, the term may be interpreted by the tax authorities very broadly, thereby leading to hardship for industry players.
In case a), even if one were to say ACo qualifies as an “e-commerce operator,” considering that the sale of goods happens physically by delivery in India, it is again unclear whether the provisions intended to cover the online sale of goods, or sale of goods online.
In case b), Mr. X is not a resident in India; however, he places the order for the product while in India. The provisions of the E-com EL are wide enough to cover situations where a person traveling to India obtains any service or goods by using an IP address located in India. However, the issue of online sale of goods versus sale of goods online remains in this example as well.
- Case Study 2: This case study deals with the structure of a typical social media platform. A social media platform sells advertisements targeting Indian customers to ACo, a company incorporated in country A. ACo is involved in retail of clothing for men and women. ACo pays consideration to the social media platform for sale of advertisements. On display of advertisements to Indian residents, some Indian residents purchase products from ACo and pay consideration to ACo online.
- Case Study 3: This case study deals with the typical structure of a search engine. Residents of India browse data on the platform of a search engine. The search engine collects data on the basis of the browsing behavior/patterns of Indian residents. The search engine sells the data to ACo, a company incorporated in country A. ACo pays consideration to the search engine for the sale of data. ACo targets Indian customers on the basis of data received from the search engine. Some Indian residents purchase products from ACo and pay consideration to ACo online.
Applicability of E-com EL
The case studies above are a typical example of a transaction between two nonresidents targeting Indian customers. As stated earlier, the social media platform/search engines may possibly contend the non-applicability of E-com EL due to lack of clarity to taxable event and lack of sufficient nexus with India. It may also be argued that on a strict reading of the provisions, the E-com EL is applicable only in cases where the transaction involves both sale of advertisement and sale of data, which is not the case above. Further, the chances of double taxation are also high in case the transaction is taxed in other country and foreign tax credit is not available against the E-com EL paid in India.
Conclusion
As discussed above, there are several issues and open points related to the provisions of the E-com EL. The introduction of the E-com EL has also caught the attention of technological giants worldwide, with the U.S. already cautioning India against such a move. The introduction of the E-com EL while the world is battling through an unprecedented crisis indicates the keenness of the Indian government to monetize tax from digital transactions even if it is at the cost of reducing ease of doing business and causing uncertainty to businesses in India.
Further, a levy like the E-com EL may be workable in a situation where businesses are doing well, but given the circumstances and the fact that most e-commerce players are not profit-making, the application of the E-com EL which does not take into account the losses of e-commerce operators may create cash flow issues for them.
Considering the first due date for payment of E-com EL is July 7, 2020, it would be rational for the government to defer the applicability of these provisions until further clarifications are provided. In the meantime, it will be useful for e-commerce operators to revisit their structures and carefully examine the applicability of the provisions of the E-com EL while keeping an eye on the international developments in this space. The Indian government seems to be taking contradictory approaches to deal with taxation of digital transactions, given that on one hand, the applicability of the significant economic presence (SEP) regime was deferred in light of the ongoing global discussions, and on the other hand, it inserted the E-com EL in the FA, 2016.
The OECD/G-20 Inclusive Framework on BEPS released a Statement in January 2020 endorsing the Unified Approach as the basis for the negotiations of a consensus-based solution to be agreed in 2020 and welcoming the significant progress achieved with respect to the technical design of Pillar Two. The Statement provides that any consensus-based agreement must include a commitment by members to withdraw unilateral actions taken by member states. Considering India is a member of the Inclusive Framework and has extended its support to the BEPS project, the timing of introduction of the provisions of the E-com EL really comes into question.
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.
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