Introduction

The Covid-19 pandemic, responsible for rendering most business continuity plans paralysed, has furthered the role of digitalisation in generating opportunities and achieving economies of scale like never before, subtly underscoring the ability to provide services from remote, flexible and intermediate locations.  While the potential is far-reaching, it has also opened floodgates of issues that may have the impact of circumventing traditional regulatory frameworks as far as direct tax is concerned, by dissolving the link (nexus) between income-producing activity and a specific location.  Therefore, there is a need to constantly re-examine existing frameworks with the objective of making good the limitations on the reach of regulatory authorities empowered under relevant laws, while still accommodating and facilitating the overall trajectory of digitalisation.

In the context set forth above, to tackle the challenges posed by obsolete physical presence based permanent establishment (“PE”) rules in particular, the experts at Organisation for Economic Cooperation and Development have, in Base Erosion and Profit Shifting report under Action Plan 1, proposed several options to modify the existing PE rules[1].  India has emerged a pioneer in addressing the said concerns through introduction of a Chapter titled “Equalisation Levy” (“EL”) vide Finance Act, 2016.  In the following paper, we will attempt to summarise the concept of EL, as enacted vide Finance Act, 2016 and amended recently vide Finance Act, 2020.  Having elucidated upon the concept of EL in India, we will then attempt to objectively point out apparent obscurities and inadequacies in the said regime and its impact on doing business in India for digital companies.

Legal Position Pursuant to Finance Act, 2016 (“Specified Service Regime”)

EL was introduced as Chapter – VIII to the Finance Act, 2016 and is essentially a levy/ tax outside the purview of the Income-tax Act, 1961 (“ITA”), aimed at creating nexus between a specified income-producing activity and India.  Until the amendment in 2020, EL was only applicable on “specified services” provided by a non-resident to an Indian resident (or a non-resident having a PE in India) and was required to be withheld at the rate of 6% of the gross amount of fee payable by the Indian resident (or a non-resident having a PE in India) to the non-resident service provider in lieu of such services.  The focus of EL was only towards Business to Business (“B2B”) transactions[2] and only if the aggregate amount received/ receivable by the non-resident service provider exceeded INR 1,00,000/- in a financial year.

The Finance Act, 2016 defined “specified service” to mean online advertisement, any provision for digital advertising space or any other facility or service for the purpose of online advertisement.  It was also provided that the Government had the power to notify any other service to be part of “specified service” on which EL would be applicable, however, till date; no such notification has been issued.  Furthermore, it was also provided that EL would have no applicability where a non-resident service provider has a PE in India and the specified service concerned is effectively connected to the said PE of the non-resident service provider in India.

Though outside the scope of the ITA, applicability of EL was envisaged as a trigger for exempting the relevant transaction from the scope of ITA vide the very same amendment.  Clause (50) was inserted in section 10 of the ITA vide Finance Act, 2016, to provide exemption to the transaction from the clutches of the ITA, on which EL was applicable.

Legal Position Pursuant to Finance Act, 2020 (“Expanded EL Regime”)

Vide Finance Act, 2020, the legislature has, in its wisdom, expanded the reach of EL as contained in Chapter – VIII of Finance Act, 2016 without altering the definition of “specified service” as afore-stated.  Now, for consideration received or receivable by a non-resident e-commerce operator from e-commerce supply or services facilitated on or after April 01, 2020, EL has been made applicable at the rate of 2% of the gross amount of such consideration.  Furthermore, EL has now been made applicable to both B2B as well as Business to Consumer transactions[3].

To avoid overlapping, it has been clarified that where a service is covered by the Specified Service Regime as afore-stated, the new Expanded EL Regime would not apply[4].  The said clarification is necessitated as a result of the difference in collection and recovery of this new type of EL, as contemplated in the Finance Act, 2020, compared to EL applicable under the Specified Service Regime.  For ease of reference, the difference as afore-stated is tabulated as under:

Identical to the Specified Service Regime, the Expanded EL Regime is not applicable in a scenario where a non-resident e-commerce operator has a PE in India and the e-commerce supply or service is effectively connected to such PE.  Furthermore, in order to give effect to the Expanded EL Regime, amendments have been made to all the requisite clauses of Chapter – VIII which inter alia, include, clauses concerning compliances, interest, penalties and prosecution in case of defaults.

At this juncture, it is also relevant to point out that Finance Act, 2020 has also amended section 10(50) in order to provide exemption for income arising from any e-commerce supply or services made or provided or facilitated only on or after 01.04.2021.  The fact of the exemption being made applicable on income arising on or after 01.04.2021, while the obligation to pay EL coming in force on 01.04.2020, is indicative of an apparent anomaly in the law, since both the levy and the exemption were intended to run parallel.

Obscurities and Inadequacies in the Expanded EL Regime

The most critical anomaly pursuant to the amendments contained in the Finance Act, 2020 is the fact of a one year gap between the coming in force of the obligation to pay EL by the non-resident e-commerce operator and availability of exemption of the transaction on which EL has been paid from the clutches of ITA. The inevitable consequence of the inconsistency as afore-stated is that the income of a non-resident e-commerce operator may be subject to double taxation, firstly in the form of EL at the rate of 2% of the gross amounts received or receivable by a non-resident e-commerce operator by virtue of the provisions enacted by the Finance Act, 2020 and further, tax at the rates prescribed under domestic law or relevant Double Taxation Avoidance Agreements (“DTAAs”) , as the case may be.  This anomaly may, apart from causing hardship to the non-resident e-commerce operator, also create doubt for the service recipient as far as withholding obligation under the ITA is concerned.  Therefore, the very objective behind insertion of clause (50) to section 10 of the ITA, which was to strike the desired balance between apportioning tax base and fostering cross-border economic transactions, thereby exempting income chargeable to tax outside the purview of the ITA from the clutches of the ITA, seems to have fallen between the cracks.

Additionally, Finance Act, 2020 has sought to impose EL on transactions that involve a person buying goods or services or both using an IP address located in India or a person using an IP address located in India for accessing an online advertisement or for allowing access to data.  While the enthusiasm of the legislature to bring the income of non-resident e-commerce operators to tax in the place of “value creation” is laudable, it is worth noting that there has been no discussion whatsoever on how companies that belong to economically, structurally and geographically varied environments are expected to align their databases to reflect and cater to exhaustive compliance obligations ensuing as a result of the amendment overnight.  Failure on the part of the said companies to evidence the veracity of their claims to the subjective satisfaction of the authorities empowered under law will have the impact of exposing them to penalties[17].  This is extremely problematic and strikes at the root of the confidence of global companies in sustaining themselves in a hostile Indian regulatory framework.

Conclusion

EL, as introduced under the Indian regime, though may appear to be an attractive option to solve the challenges posed by obsolete physical presence based PE rules at the first blush, may unravel an unchartered territory capacitating double taxation in the hands of the non-residents concerned, much against the deciphered legislative intent behind the introduction thereof.  In the manner afore-stated, EL, as it exists today, has the impact of rendering the very foundation on which DTAAs are negotiated, signed and ratified nugatory.  Moreover, the set of compliances envisaged under the relevant Chapter pertaining to EL, specifically involving intricate information, seems to have been inculcated unexpectedly and hastily.  There seems to have been no deliberation on the overall global practices followed by companies operating in varied economic, structural and geographical circumstances across the globe, as far as maintaining records and alignment thereof with the scheme designed to tax them is concerned.  Consequently, in their desperation to exercise sovereignty to tax companies deriving economic value from India, the EL regime seems to be putting the cart before the horse, thereby creating inevitable barriers to cross-border transactions.  Perhaps the need of the hour is to address the lacuna in the law and to endeavour aligning the same with the objective sought to be achieved by it.  There is perhaps also a need to actively exercise caution while reacting to the apparent failure to tax digital transactions within the contours of existing legal framework.

Authors:
Anmol Anand, Senior Associate
Priya Tandon, Associate

Footnotes:

[1]  OECD/ G20 Base Erosion and Profit Shifting Project; Addressing the Tax Challenges of the Digital Economy; Action 1: 2015 Final Report.
[2]  As per section 165(1)(i) read with section 165(2)(c) of the Finance Act, 2016, EL under the Specified Service Regime is only applicable if payment is made by an Indian resident or PE of a non-resident for the purposes of carrying out business or profession.
[3] As per section 165A(1) of the Finance Act, 2016 as inserted vide Finance Act, 2020, there is no exception for B2C transactions as has been provided for in section 165 of the Finance Act, 2016 (supra note 2) under the Specified Service Regime.
[4] Section 165A(2)(ii) of the Finance Act, 2016 as inserted vide Finance Act, 2020.
[5] Section 165A of the Finance Act, 2016 as inserted vide Finance Act, 2020.
[6] Section 164(ca) of the Finance Act, 2016 as inserted vide Finance Act, 2020.
[7] Section 165(1) of the Finance Act, 2016.
[8] Section 165A(1) read with section 165A(3) of the Finance Act, 2016 as inserted vide Finance Act, 2020.
[9] Section 164(i) of the Finance Act, 2016.
[10] Section 164(cb) of the Finance Act, 2016 as inserted vide Finance Act, 2020.
[11] Section 165(1) of the Finance Act, 2016.
[12] Section 165A(1) of the Finance Act, 2016 as inserted vide Finance Act, 2020.
[13] Section 166(1) of the Finance Act, 2016.
[14] Section 166A of the Finance Act, 2016 as inserted vide Finance Act, 2020.
[15] Section 166(1) of the Finance Act, 2016.
[16] Section 165A(2)(iii) of the Finance Act, 2016 as inserted vide Finance Act, 2020.
[17] As per the Taxation and other Laws (Relaxation of Certain Provisions) Ordinance, 2020, any delay in payment of equalisation levy that is due between 20.03.2020 and 29.06.2020, shall not be subjected to penalty/ prosecution.