As the businesses have been changing their ways, models and functions to suit and survive in this fast changing world, so do the Governments across the world seek to change their taxation laws and rules, with an objective to optimize their tax collection and obtain a fair share of tax on profits generated from their territory.
Traditional Rules of taxation
In the traditional businesses, tax laws and rules on cross border transactions emphasized a lot on physical presence and functions/ activities carried out by a Multinational Enterprise in a particular country to tax whole or part of its revenues in that country.
Concerns of Base Erosion in Digital Economy
However, with advent of digitization, businesses are now able to sell goods or provide services online in a country, without having any physical presence, employees or agents in that country. Online platforms, portals and their user interface have been made so easy that buyers can themselves access such platforms/ portals using internet and purchase goods or services.
The above situation has apparently resulted in an imbalance between taxing rights of a market country vis-à-vis seller country. Though Multinational Enterprises are able to generate revenues/ profits from market countries, they are not able to tax such revenues/ profits under traditional rules of taxation both under domestic tax laws and tax treaties.
Additionally, there is a global concern of Multinational Enterprises arranging their affairs and setting up their Digital platforms (from where goods and services are sold online) in low tax jurisdictions, resulting in overall tax base erosion.
OECD’s efforts to address challenges of base erosion in Digital Economy
Realizing concerns & difficulties of countries in taxing digital transactions, the Organisation for Economic Cooperation and Development (‘OECD’) included the ‘Tax Challenges Arising from Digitalisation’ as Action 1 in its ambitious BEPS project of creating a ‘Inclusive Framework on Base Erosion and Profit Shifting’ for countries across the world.
It may be noted that arising out of the same BEPS project through other Action Plans, 94 countries (notably including India but excluding the US) have signed a “Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting”, which will have effect of changing tax treaties of signatory countries (subject to condition of covered tax agreements and reservations of countries) by a single stroke of pen in a uniform and unified manner, to address some global concerns of base erosion and profit shifting.
However, even OECD till date has not been able to finalize a ‘Unified Approach’ to find a comprehensive, consensus based solution to the two challenges arising from digitalisation, and intends to deliver this solution before the end of 2020 .
This issue was discussed in detail in “OCED’s 2015 Final Report: Addressing the Tax Challenges of the Digital Economy under OECD/ G20 BEPS Project”, wherein OECD opined that in case of Digital Transactions, Countries having market economy/ user base could consider charging Equalization Levy “as an alternative to overcome the difficulties raised by the attribution of income to the new nexus”.
Digital Services Tax introduced in other Countries
On account of delay and difficulty in arriving at a consensus and multilateral agreement on taxation of digital services, various countries have either recently implemented or shown intention to impose Digital Services Tax (‘DST’) on digital transactions undertaken by users of these respective countries or on account of sale of user data of such countries.
In 2019, France introduced a 3% DST on digital services such as provision of digital interface allowing users to contact and interact with each other or for online advertisement or for sale, stocking or exchange of user data, etc., but excluding direct sale of goods & services online, online content/ streaming, communication services and payment services, and even intra-group services.
In March 2020, the UK also passed legislation levying a 2% DST on revenues of large businesses providing internet search engines, social media platforms and online marketplaces to UK users. However, UK DST law also excludes sale of own goods & services online, financial marketplaces, etc .
Similar legislations for charge of Digital Services Tax have already been implemented in certain other countries such as Austria, Italy, Hungary, Indonesia, Tunisia & Turkey and proposed in various other countries such as Belgium, Brazil, Canada, Czech Republic, Israel, New Zealand, Norway, Poland, etc.
Equalization Levy, 2016:
India’s first shot to tax Digital transactions India became the first country to introduce Equalisation Levy (“EL16”) in its domestic tax law vide Finance Act, 2016. The scope of EL16 was however limited to certain specified ‘online advertisement and other related services’ on B2B transaction and responsibility of deduction/ payment of such EL was on Indian payers at the rate of 6% of gross amount paid to non-resident service providers for specified services.
Finance Act, 2020 – India makes substantial expansion in scope of tax on Digital Transactions
However, Finance Act 2020 has brought the biggest change so far, in Indian tax laws regarding taxation of digital transactions.
Firstly, Explanation 2A and Explanation 3A were introduced to Section 9(1)(i) of Income tax Act, 1961 to formally introduce provisions similar to ‘digital permanent establishment’ as Significant Economic Presence. Explanation 2A effective from 01.04.2022 provides that any non resident entering into any transaction with a person in India including provision of download of data or software in India or systematic & continuous soliciting of business interacting with Indian users, it will be deemed to constitute a ‘business connection’ in India. Further, Explanation 3A effective from 01.04.2021 provides that any income arising to a non-resident from advertisements targeting Indian customers; or sale of data collected from Indian customers; or sale of goods/ services using data collected from Indian customers or earning any of such income from a customer using Indian IP address will be considered to be ‘income attributable to the operations carried out in India’.
Additionally, scope of Equalization Levy has also been expanded with effect from 01.04.2020, whereby 2% Equalization Levy (“EL20”) is proposed to be charged on all e-commerce supply and services made by non-resident e-commerce operators to an Indian resident, or to a non-resident in specified circumstances (such as sale of online advertisement targeting Indian customers and sale of Indian user data) or to any person buying goods or services using Indian IP address.
For this purpose, e-commerce supply or services by non-resident e-commerce operator inter-alia includes: (a) Online sale of goods owned by e-commerce operator, (b) Online provision of services provided by e-commerce operator; or (c) Online sale of goods or provision of services or both, facilitated by e-commerce operator.
Thus, EL20 introduced by India is much wider in scope vis-à-vis DST introduced by France, UK and other countries across the world. Other countries seek to charge Digital Services Tax only on online advertisement, sale of user data and providing multilateral digital user interface, while providing exclusion for sale of own goods & services, provision of online streaming services, intra-group services, online payment services, etc.
However, EL20, in its present form is widely worded to cover all form of online supplies and services, including sale of own goods, online services (including streaming services), online payment services, intra-group services provided online, etc. in addition to online marketplaces.
EL20 is applicable on all B2B as well as B2C transactions and the responsibility of depositing Equalization Levy and making all related compliances is bestowed upon non-resident e-commerce operator having aggregate consideration (which is subject to EL20) exceeding INR 20 million.
Further, for Financial Year 2020-21, there is no exemption under Income Tax Act for transactions already subject to EL20 (though from FY 2021-22 onwards, transactions subject to EL20 are exempted from Income Tax). Additionally, there is no appeal mechanism against charge of EL20 under the law nor any tax treaty benefit is available in respect of EL20.
Considering its wide applicability, ambiguity on exemption from income tax, appeal mechanism, etc., various taxpayers have made representation to the Indian Government requesting deferment of this new law and issuance of clarifications on various aspects relating to new Equalization Levy. However, Indian Government has not yet provided any relaxation from applicability of new Equalization Levy already applicable w.e.f. 01 .04.2020 and also issued list of tax officers responsible for implementing the EL20.
Considering wide implications of new Indian Equalization Levy law, non-residents providing goods or services to Indian users online using digital platform must evaluate the applicability of new Law and related compliance requirements. It must be kept in mind that EL20 is much wider in scope vis-à-vis DST implemented/ proposed in other countries and thus must be evaluated independently. With responsibility matrix already been defined, it is expected that Indian tax authorities may start enforcing the new law soon.
By Rakesh Nangia, Founder & Managing Partner, Nangia & Co LLP, co-authored by Shailesh Kumar, Partner, Nangia & Co LLP