A. Introduction
Equalisation levy popularly known as Google tax introduced by The Finance Act, 2016 has come into effect from 1st June 2016. Relevant rules and forms have also been notified by the CBDT recently.
The move aims to indirectly tax global Internet companies such as Google, Facebook, Twitter and Yahoo in respect of payments made by Indian establishments for online advertising on international companies but cannot be taxed under current Indian laws since they are not registered in the country.
B. Litigation in India
Until recently, Indian tax authorities have been grappling for revenue from digital platforms by trying to establish the existence of a PE in India of such international digital companies or terming the payments to search engines such as Google, Yahoo, etc., as ‘royalty’ or ‘fee for technical services’ (‘FTS’). This issue has been argued before Indian Income Tax Tribunals (‘ITAT’) in various cases including Right Florists (Kolkata ITAT), Yahoo India (Mumbai ITAT) and Pinstorm Technologies (Mumbai ITAT). The Hon’ble Kolkata Tribunal ruled in favour of Right Florists Ltd. in 2013 stating that ‘such payments for online advertisement were not taxable in India because such payments would not be considered to be FTS in the absence of human intervention in the course of provision of services. It further emphasised that since the servers of these e-commerce payees were outside India, there was no PE in India’. In case of Yahoo India, the Mumbai ITAT rejected taxation of advertisement revenue from display of banner advertisement on portal as royalty.
C. International Precedents
C.1 BEPS project: The Organization for Economic Cooperation and Development (OECD) has recommended, in its Base Erosion and Profit Shifting (BEPS) project under Action Plan 1, several options to tackle the direct tax challenges which include modifying the existing Permanent Establishment (PE) rule to include new nexus based on ‘significant digital presence’; include virtual fixed place PE in the concept of PE; creation of withholding tax on digital transaction. The levy introduced in India aims at creation of withholding tax on digital transaction.
C.2 Diverted profits tax in UK and Australia: HMRC introduced Diverted Profits Tax (‘DPT’) (known colloquially as the ‘Google Tax’) wherein a charge of 25 percent was imposed on transnational companies’ profits ‘artificially diverted’ outside the UK.
Also, recently Australia has recently announced “diverted profits tax” to be implemented from July 2017 as part of a wider crackdown on multinational tax avoidance wherein a charge of 40% will be levied on diverted income.
D. Salient features of Equalisation levy in India
D.1 Scope
The equalization levy has been defined as “tax leviable on consideration received or receivable for any specified service under the provisions of this chapter.” The levy would fall under a separate, self-contained code (Chapter VIII of finance Act 2016) and would not be part of the Income Tax Act, 1961.
The levy is currently charged at the rate of 6% in respect of payment for “specified service” which includes online advertisement, any provision for digital advertising space or any other facility or service for the purpose of online advertisement and includes any other service as may be notified later. The scope of the levy may be expanded to cover a wider range of digital goods and services as time progresses.
D.2 Who needs to comply?
Every resident person and non-resident (having a PE in India) (hereinafter referred to as assessee) is required to withhold the equalization levy when making payment to a non-resident service provider in respect of specified service at the rate of 6%, if the aggregate amount of consideration in a year exceeds one lakh rupees.
Also, new section namely section 40(a)(ib) has been inserted to disallow expenses pertaining to payment for advertisement services to a non-resident without deducting the equalisation levy.
D.3 Exclusions
The equalisation levy shall not be applicable in the following cases:
(a) non-resident service providers having a PE in India, and specified services are effectively connected to the PE;
(b) the aggregate amount of consideration for specified service does not exceed one lakh rupees in a year.
(c) where the payment for the specified service is not for the purposes of carrying out business or profession i.e. only B2B transactions are covered.
D.4 When to deposit and penalty for non-deposit
The equalisation levy so deducted in a calendar month needs to be deposited with the government by 7th of the month immediately following the calendar month. In case of delay, the assessee is required to pay simple interest at the rate of one per cent of such levy for every month or part of a month by which payment of tax is delayed. Also, the assessee shall be liable to penalties under the Act as under:
−Equalization levy not deducted: The penalty is equal to the amount of the levy that the assesse failed to deduct
−Equalization levy deducted but not deposited: The penalty is equal to INR1, 000 for each day the failure continues, but not to exceed the amount of the equalization levy that the assessee failed to pay.
D.5 Furnishing of statements/annual returns etc.
The assessee is required to furnish the statement of specified service electronically in Form No. 1 on or before 30 June immediately following that financial year. However, belated statement or revised statement can be furnished at any time before the expiry of two years from the end of the financial year in which the specified service was provided. A penalty of one hundred rupees per day shall be levied in case of delayed filing. Also, if a false statement has been filed, the person may be subject to imprisonment of a term of up to three years and a fine.
D.6 Filing of Appeals against penalty order
An appeal against the penalty order shall be electronically filed before the CIT (A) in the prescribed Form No. 3 within thirty (30) days of receipt of the penalty order. Further, a sum of INR 1,000 is required to be deposited as appeal filing fee.
An appeal against the order of the CIT (A) has to be filed in triplicate with the Tribunal within sixty (60) days of date of receipt of the order of CIT (A) in the prescribed Form No. 4.
E. Areas of Concern
E.1 Impact on Indian enterprises
The levy is expected to severely raise the cost of doing business of Indian tech start-ups and small and medium enterprises that are the primary users of digital ad platform.Google and Facebook ads are the most popular and effective platforms as of now and this levy will eventually impact the small local players more severely. These foreign advertisement platforms are going to gross up and pass on the “extra costs” to the ultimate customers, i.e., the SMEs and start-ups who sustain on digital advertising.
Online advertising services are separately subject to service tax at a rate of 15% on a reverse charge basis which is to be collected and discharged by the Indian service recipient. The equalisation levy would translate into service receivers ending up paying six percent over the 15 percent service tax, thus, making digital advertisement more expensive for local Indian advertisers.
E.2 Shifting of PE to outside India
The levy offers exemption of income to foreign service providers which have been subject to equalisation levy. The online advertising entities having a PE in India or are resident in India are already subject to withholding tax of 2% with corresponding taxation of net income at 30-40%. However, the levy of only 6% and consequent exemption of entire income would encourage the entities operating in online advertising to shift their PEs outside India or to raise their billings from outside India, thereby reducing the tax cost to only 6%.
E.3 Tax Credit to Non Resident service provider
To avoid double taxation of income which has been subject to an equalization levy, such income will be exempt in the hands of the non-resident under the newly introduced section 10(50) of Income Tax Act, 1961. However, imposing an equalization levy raises risks that the same income would be subject to both corporate income tax and the levy. This could arise either in the situation in which a foreign entity is subject to the levy at source and to corporate income tax in its country of residence or in the situation in which an entity is subject to both corporate income tax and the levy in the country of source.
In the case of a foreign entity, for example, if the income is subject to corporate income tax in the country of residence of the enterprise, the levy would be unlikely to be creditable against that tax. To address these potential concerns, it would be necessary to structure the levy to apply only to situations in which the income would otherwise be untaxed or subject only to a very low rate of tax in the country of residence of the service provider.
E.4 Treaty override
Equalisation levy has been deliberately kept outside the ambit of the Income tax Act to avoid applicability of double tax treaties. Applying the principle of ‘substance over form’, by merely introducing a separate chapter would not allow India to walk away from its treaty obligations. This may defeat the entire purpose of tax treaties as, if it is that simple for any country to walk away from its treaty obligations, then any country can override the treaty by simply introducing a levy and keeping it out of the purview of their Income tax law.
E.5 Application of Non-Discrimination clause in tax treaty
Most Indian tax treaties provide that the treaty country cannot discriminate by imposing more burdensome taxes on residents of the treaty country than it imposes on its own residents in the same circumstances. The equalisation levy is levied only on payment to non-resident not having PE in India when no such levies are imposed on Indian residents. Such treatment is discriminatory and in the times to come non-resident service providers would invoke the article on non-discrimination in the relevant tax treaty before a court of law to claim relief.
E.6 Probability of Countermeasures
There is a possibility of countermeasures being adopted by foreign countries against the unilateral levy by India. For example, if US Treasury is of the opinion that these actions potentially undermine U.S. rights under the tax treaty, and lead to discriminatory treatment, the US might respond with IRC Section 891 that allows the USA to double the tax rates on companies and individuals based within countries whose governments impose discriminatory or extraterritorial taxes on US owned MNEs. Thus, Indian entities operating in US might be subject to 70-80% tax rates if US retaliates against this extraterritorial taxation. Also, similar taxes might be invoked by other countries.
F. Concluding remarks
The e-commerce/digital transactions takes place in the nebulous world of “cyberspace” wherein it is hard establishing a nexus or link between a taxable transaction, activity, a taxing jurisdiction, and identifying the taxpayer for income tax purposes.Also, identifying the location of transaction/activity is very difficult.
The equalisation levy is a welcome step towards source based taxation to address the challenges in terms of taxation of digital transactions.
Also, under section 115A of Income Tax Act, income of non residents from royalty and fees for technical services are taxed @10% plus applicable cess and surcharge. Equalisation levy is fixed at 6% only for specified services and exempts the entire income which is subject to equalisation levy thus taking the entire income from online advertising etc. out of the operation of section 115A. This would considerably reduce litigation in respect of specified services covered by the levy.
However, considering that the levy overrides the treaty provisions and discriminates against non-residents, it shall surely be debated in detail by the international community.
(Author can be reached at ca.guptarohit@gmail.com / 9873832979 for any queries )
