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Abstract

Rapid business and technological digitization throughout the nation cause tax authorities to lose sight of how to oversee taxpayer compliance with tax regulations and collect all due taxes. By 2026, the e-commerce sector is estimated to be over $ 200 billion, and the Indian government’s part of the pie would result in significant income growth. Globalization and market liberalisation, in particular concerning a problem like taxing e-commerce, have made it difficult for international taxation arrangements to keep up. Although these virtual companies are active all over the globe and generate money, they only pay taxes to the nation where their headquarters are situated. The notion of ‘Equalization levy’ or sometimes known as ‘Digital taxes’ was launched in India on internet advertising in 2016 to undertake such non-taxable revenue under tax regimes and profits from other nations. There have been further adjustments made to have all non-resident E-commerce businesses pay taxes on income produced in our nation. This article aims to understand the concept of Digital Taxation, its need, benefits, and challenges in India and how could such challenges be resolved.  

Introduction

The concept of a Permanent Establishment has undergone a radical transformation with the advent of digitization. United Nations (UN) models, United States (US) models and Organization for Economic Cooperation and Development (OECD) models have all been used as tools to establish tax jurisdiction for international economic activity, including multinational corporations. The expected Permanent Establishment definition has become hazier with the growth of digital economic activity. As Tom Godwin put it, “Uber, the world’s biggest taxi firm, owns no cars.”[1] Now, corporations may get economic benefits from all around the globe without owning a single asset. Alibaba, a merchant, does not have its inventory, while Facebook, a popular media producer app, does not own any material.[2]

As a result of the implementation of the Equalization levy in 2016, India saw a sea change in digital taxes. Base Erosion and Profit Shifting (BEPS) is an initiative of the Organization for Economic Cooperation and Development (OECD) to tax electronic commerce activities. Chapter VIII, named “Equalization Levy,” was included in the Finance Act of 2016. Equalization Levy was a consequence of suggestions by the Committee on E-Commerce Taxation, which was constituted by the Central Board for Direct Taxes, the Department of Revenue, and the Indian Ministry of Finance.

The OECD committee’s suggestions were implemented by the government, and a new chapter was added to the Finance Act of 2016. The Equalization Levy is defined in Section 164(d) of the Finance Act 2016 as “equalisation levy” is the tax levied on consideration received or payable for any specified service or e-commerce supply or services under the requirements of this Chapter. Because the Government of India has not yet notified any other service as being within the jurisdiction of this chapter, this tax was exclusively levied on Online advertisements.[3]

Despite the committee’s recommendations that the above definition includes a wide range of services, the Government only mandated that it apply to digital advertising instead. On the amount of consideration for services mentioned in the section, the tax rate was set at 6% and the item’s worth is more than one lakh rupees. For the time being, it only applies to services provided by non-resident Indians when doing business with an Indian resident. By revising the Finance Act of 2016, the government plans to extend the Equalization Levy’s application in the year 2020. With the implementation of the Equalization Levy on April 1, 2020, almost all digital e-commerce transactions in India will be subject to tax. Non-Indians who do business with Indian residents are subject to a 2% charge on the amount of consideration received via e-commerce transactions.

Digital Services Tax

Transnational firms that sell products or services on the internet pay a digital tax or equalisation levy, which is a tax on such revenue. The implementation of the Digital Tax has resulted in major changes to the way business income taxes are calculated. The goal of Digital Tax is to tax consumers and users of online services in the place where they are located. Taxes are now imposed at the company’s headquarters under the current tax framework. Taxation on revenue generated rather than profits earned is another significant reform desired by Digital Tax. A multinational corporation’s headquarters may be located in a country with lower taxes, allowing the company to pay less in total tax.

The tax policy authorities throughout the globe are imposing taxes on foreign corporations that generate a lot of money from local sales and business operations. International tax rules need to be updated, and the OECD is working hard to make that happen for the digital economy. To avoid concerns such as tax credit of Equalization levy in other countries without beneficiary obligation, tax neutrality, and so on, it was not included in the Indian Income Tax Act. Finance Act 2018 was amended as a result of the 2018 changes, which added the idea of Special Economic Presence (SEP). The SEP encompasses the range of revenue that a non-resident derives through a ‘business tie’ he has in India. The income that can be traced back to the SEP is liable to taxation in India.

Need of Digital Tax

The Current tax regulations (both international and domestic) were formulated decades ago using brick-and-mortar economy capabilities as a guideline. It has become obsolete with the advent of the Digitalized economy. The profits from digital enterprises across nations are rising, yet no rules exist to tax them appropriately. The government’s recognition as the ‘catalyst,’ innovation allows organisations to take advantage of the lope-holes that existed between various tax systems to decrease dutiable revenues or relocate profits to a low-tax jurisdiction. As a result, all governments must revise and update their tax legislation in light of the digital economy’s theft of tax revenue. However, ‘Digital Economy’ is distinct from e-commerce in this context. For Example, the Indian government may seize all companies with a physical presence in India. However, digital companies such as Facebook and Amazon provide online services that are not available in India.[4] The Digital tax is a solution to this issue since it maximizes revenue-based taxes on digital businesses in local authorities. Any income earned by global digital businesses in these nations must be subjected to this Digital service fee or Google tax, whichever term applies. There are additional informal names for the tax paid on internet service revenue (Google tax, Internet tax, online shopping through amazon, online ads in Google, etc).

Implementation of Digital Tax in India

There have been some nations that have taken unilateral steps toward taxing the digital economy as the OECD works to create an agreement on an inclusive framework to solve tax difficulties associated with digitalization. A new Equalization Levy was implemented in India in 2016 on the internet advertising and associated services income received by non-residents. The idea of SEP was introduced into the Indian tax law in 2019 as a result of an amendment. Although the Finance Act 2020 was passed, India’s government delayed its implementation, claiming a lack of effective mechanisms in the country’s international tax agreements. The inclusion of an Equalization Levy on international e-commerce operators’ sales of products and services in India, which was not originally part of the Union Budget 2020-21 recommendations, surprised everyone. This tax came into effect on April 1, 2020, and currently covers a broad range of expenses. Due to the equalisation levy, India’s digital economy would have both good and bad effects.[5] Therefore, it becomes important to understand both these aspects and see if such a drastic change is required in India at the moment.

Benefits of Digital Tax after Implementation

Digitalization equalizes the playing field for national and foreign enterprises, rather than giving overseas players an unfair competitive edge over MSMEs and start-ups in India. It alters the nature of innovation, product creation, and income generation for both taxpayers and the government. In the past, companies without a physical presence in India, but with a digital presence, were exempt from local tax legislation. No company can evade tax laws or relocate their headquarters to heavenly places if they don’t have a physical presence in India yet generate revenue from Indian clients.[6] Taxpayer services are becoming better as data becomes more readily available and analytics advances. New possibilities exist for tax administrations to make the tax system easier to understand for taxpayers and to operate more efficiently. The government also receives money from taxes collected from non-resident e-commerce operators via Digital tax.

Challenges of Digital Tax after Implementation

When a new tax system is implemented, it typically has an impact on both supply and demand in that industry. Internet search firms (such as Yahoo) and social media companies (such as Facebook and YouTube) are on the supply side of the digital economy, as are digital marketing companies (such as Web chutney) whose networks underpin the whole digital network. The demand side, on the other hand, is dominated by domestic firms. According to a report advertisement expenditure “grew by 15.5% in 2016 to Rs.57,486 crore with digital ad rising at the quickest rate of 47.5% to Rs. 7,300 crore and accounted for 12.7% of total ad spending.”[7]

Digital Taxation in India A Need of Present Time

One may argue that the equalisation tax is a kind of one-sided nation-state leadership. If governments decide to assess on a one-sided basis without any type of co-appointment or agreement with the partner state, the same revenue may be taxed more than once, which would obstruct free commerce. Nations must develop using a “consensus-based approach” at all times. A one-sided tax would be a burden on businesses, necessitating more administrative effort and complicating the tax code. To put it another way: an equalisation levy will just complicate things for companies more and provide few if any useful answers.[8]

Start-ups that spend a lot of money advertising their products or services to reach a broader audience would be harmed by the equalisation burden since it will raise ad expenses, which will put a stop to new ideas and inventions. The consumer base and expansion of new businesses will be hampered as a result of the high advertising costs. According to this theory, “At a time when India is riding on a start-up and digital wave, Government has opted to penalize those who try to embrace the new digital medium.”[9]

As a result of the equalisation tax, new businesses would have to pay an additional 6% in GST on top of what they were previously paying before the tax was implemented, making digital advertising more costly for Indian marketers. As the Internet and Mobile Association of India (IAMAI) put it, “SMEs and digital startups would have to bear an extra expense of Rs 429 crore because of the equalisation fee, which will be passed on to advertisers through ad platforms.”[10] They pay 14.5% service tax to utilise ad networks, thus this is an almost 50% increase.

It’s possible that the equalisation tax could deter international firms from doing business in India since they won’t be able to claim a tax deduction in their home country, resulting in double taxation. Due to their enormous digital market presence and influence, the equalisation tax might backfire if foreign corporations transfer the tax burden to Indian players.

There are inherent problems with tax collection consistency, since neither the Finance Act, 2016 nor the Central Board of Direct Taxes has specified how they plan to collect the taxes levied on property owners and occupiers alike. In this way, there is a lot of confusion and a needless transfer of responsibility. Equalization levies may also pass costs on to local consumers if the economics are favorable. Such a model is undesirable since it shifts the tax burden to local consumers.

Two Pillar Solution

In October 2020, the OECD issued the Final Reports on all 15 aspects of the BEPS Action Plan. Conclusions and Recommendations of the OECD’s Action 1 on Tax Challenges in the Digital Economy (DE) were presented in this report. In the ever-changing digital world, it said, unique laws established only for the digital economy would be impossible. Since then, ongoing efforts have been made to alleviate the digital economy’s tax difficulties. The OECD has recommended 2 pillars that will help an economy to deal with challenges arising out of Digital Taxation:

Re-allocation of Tax Rights – For multinational enterprises (MNEs) like digital corporations, Pillar One will guarantee a more equitable division of revenues and taxation rights across nations. MNE taxation rights would be reassigned from their home nations to markets where they conduct commercial operations and generate profits, regardless of whether the enterprises in those areas have a physical presence. A total of USD 100 billion in profit is estimated to be transferred each year to market jurisdictions under Pillar One.[11]

Global Anti-base Erosion Mechanism – With the adoption of a worldwide minimum corporation tax rate that nations might employ to preserve their tax bases, Pillar Two aims to put a floor under competition over corporate income tax. For Pillar Two, a 15 percent worldwide corporate income tax is anticipated to yield USD 150 billion in extra global tax collections per year.[12] Stabilization of the international tax system and enhanced tax certainty for taxpayers and tax administrations would also provide further advantages.

Conclusion

E-commerce transactions that transcend national borders were subject to the equalisation levy because of this. However, it seems that start-ups and mid-sized enterprises, who face the tax burden in a practical sense, will be hit harder than established e-commerce firms of both domestic and foreign origin, to provide a fair playing field for both. Due to the Google Tax and the equalisation levy, firms are having to rethink their business models. The technology sector and e-commerce will undoubtedly be impacted by the Digital Tax, but it is unclear how it would influence companies who utilise incorporated Digital components in non-Digital goods. To regain public support for treating multinational corporations fairly, the government must remain actively involved in finding solutions to problems. Some people are angry because governments are embracing unilateral measures that might violate already-existing trade agreements. It’s made worse by the fact that there isn’t enough information about things like the sort of organisation that was impacted by digital taxes or how to allocate taxable earnings more fairly. It is not acceptable for nations to tax foreign corporations unilaterally because they believe the present regulations need to be reformed. Despite the difficulties, the equalisation tax might be seen as an important move by the government to obtain control and money from India’s digital economy.

[1] Vijay Shekhar Jha, ‘Taxation of Digital Economy in India: Issues & Challenges’ [2019] SSRN Electronic Journal.

[2] Sourabh Virani, ‘Equalisation Levy: Impact and Consequences’ (TaxGuru, 2021) <https://taxguru.in/income-tax/equalisation-levy-impact-consequences.html> accessed 31 October 2021.

[3] Dr. R Sarvamangala and Farzana A., ‘A COMPREHENSIVE ANALYSIS OF DIGITAL TAXATION IN INDIA’ (2021) 11 SJCC Management Research Review.

[4] Shivali Pradhan, ‘DIGITAL ECONOMY AND ITS IMPACT ON INDIAN TAXATION’ (2019) 53 TAX BULLETIN DECEMBER.

[5] Virani, Supra note 2.

[6] Amit Puri, ‘Digital Taxation: How A Consensus-Based Approach May Benefit Indian Economy’ (Business-standard.com, 2021) <https://www.business-standard.com/article/economy-policy/digital-taxation-how-a-consensus-based-approach-may-benefit-indian-economy-121072900155_1.html> accessed 31 October 2021.

[7] Suranjali Tandon, ‘Challenges of Levying Taxes on Digital Services’ (The Indian Express, 2020) <https://www.nipfp.org.in/media/medialibrary/2020/06/Challenges_of_levying_taxes_on_digital_services___The_Indian_Express.pdf> accessed 31 October 2021.

[8] Sarvamangala, Supra note 3.

[9] Siddhant Thakar, ‘Impact of Equalisation Levy on Digital Markets’ (TaxGuru, 2021) <https://taxguru.in/income-tax/impact-equalisation-levy-digital-markets.html> accessed 31 October 2021.

[10] Shubham Phophalia, ‘Equalisation Levy under Income Tax – A Brief Analysis’ (TaxGuru, 2021) <https://taxguru.in/income-tax/equalisation-levy-income-tax-analysis.html> accessed 31 October 2021.

[11] ‘Tax Challenges Arising From Digitalisation – Report on Pillar One Blueprint: Inclusive Framework on BEPS | En | OECD’ (Oecd.org, 2021) <https://www.oecd.org/tax/beps/tax-challenges-arising-from-digitalisation-report-on-pillar-one-blueprint-beba0634-en.htm> accessed 31 October 2021.

[12] R Mohan, ‘Two Pillar Solution to Tax Challenges for Digital Economy- Part 1’ (TaxGuru, 2021) <https://taxguru.in/income-tax/pillar-solution-tax-challenges-digital-economy.html> accessed 31 October 2021.

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