CA Shrutika Shedshale

Section 165 of Finance Act 2016, imposes an equalization levy of 6% on specified services provided by a non- resident to:

– Resident person carrying on business and profession

– Non-resident having permanent establishment in India

Currently digital advertising services are notified. The procedural aspects of this levy are similar to withholding tax i.e. onus of collection and payment of equalization levy is on the recipient of on line advertisement services. CBDT has also notified Equalization Levy, 2016 rules effective from 1st June 2016. The Rules lay down procedure for implementation, payment, returns and appeals relating to Equalization Levy.

The question is why do we need a completely new levy on thiscategory of services?

It is a well-accepted fact that traditional direct taxation and Double Tax Avoidance Agreements (DTAA) provisions are insufficient to ensure that rightful amount of taxes are collected on overseas digital transactions. The existing DTAA provisions, allow the source country to tax business profits only when a permanent establishment is present in the source country. With advancement in communication technology, it is possible to have an economic presence in another country without having any fixed place of business in that country. Thus, digital services go untaxed in the source country. Creative structuring of business processes among different group entities can ensure that most profits are recorded in a country with no or very low income tax. In such cases profits on digital transactions escape taxation completely.

Equalization levy is one measure to warrant that digital services are taxed and source country gets its rightful share of tax. But, the next question is, is it a good measure?

Equalization levy is simple to understand and implement. Hence the chances of litigation will be less. It will be effective from the perspective of tax collection at India.

Arguments against Equalization Levy:

  1. Double Taxation: Equalization levy is a new levy and different from corporate income tax. In a scenario where the service provider is paying rightful tax on business profits, this levy will be an additional tax on same income.Presently, when a source country taxes certain income, the residence country grants credit for taxes paid at source country. Since, Equalization levy is a new type of tax, credit may not be available for this levy and will result in double taxation.Many overseas digital service providers may not accept the deduction for this levy since they will not get credit and ultimately the resident business will have to gross up their payments, which will increase the cost of services.
  1. Discrimination: Equalization levy is imposed on a gross basis. This levy is imposed only on non- resident service providers while resident online service providers will be subject to corporate income tax on net profits.This clearly results in discrimination between resident and non- resident service providers. The existing DTAAs do not permit discrimination between resident and non-resident tax payers.

Double Taxation concern will get resolved if equalization levy is considered as another form income tax.

Article 2 of most DTAA states that the convention applies in Indian Income Tax and surcharge thereon. But, it further provides, that the convention can also apply to new taxes which are by nature similar to income tax. So, it needs to be explored whether the equalization levy will be regarded as a new and another form of income tax. Equalization levy has been introduced because existing direct tax provisions are inadequate.It is a tax on income and not on consumption. Hence, equalization levy has high potential to qualify as tax which can be covered by Article 2 of DTAA. If equalization levy qualifies as income tax, DTAA provisions of credit will apply and in effect, double taxation issue will end.

But, if equalization levy is treated as income tax for DTAA purposes, tax payers may contend that this levy is levied only on non- residents and hence is discriminatory. One may take shield of Article 26 of DTAA (Non- Discrimination) and avoid this levy. A solution to this problem can be to have this levy applicable to resident tax payers as well. Another solution can be that DTAA provisions can be suitably modified to so as to allow credit for equalization levy and but specifically exclude it from non- discrimination provisions.

Equalization levy may be a quick and easy way to tax digital transactions but is prone to many other complications and hence may not be the right solution from a long term perspective. This is also evident from the fact that though Equalization levy was discussed by OECD in its Action Plan for taxation of digital economy, it did not finally recommend this measure.

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February 2024