EQUALISATION LEVY IN THE CONTEMPORARY SCENARIO
This article has been authored by Saoumya Vashisht, a fifth-year student at Amity Law School, Delhi.
Multinational Corporations, popularly known as MNCs or MNEs, are the Catch-22 of the world economy. These colossal corporations with operations running in several countries surpass the GDP of a few developing nations. Worldwide globalization has made it non-viable to solely deal with domestically produced goods and services, especially when almost one-third of the global production can be attributed to MNEs. Notwithstanding the influx of Foreign Direct Investment within the country, MNEs play an important role in transfiguring the products ultimately supplied by Small & Medium Enterprises. Being the forerunner of cutting-edge technology and productivity in the market, they contribute towards the development of a nation and provide incentive for foreign tourism. It can be concurred that these conglomerates put the face of a nation on the world map.
Mutual concessions are an imperative part of every transaction and investment decision, withal, these corporations are driven by their self-sustaining models and profit motives. A nation, secondary to the host nation, provides these corporate entities with a legal status for functioning in their market. It opens its doors to a corporation through a legal backing and a market base, which significantly decreases the market portion for the domestic industries as an opportunity cost for investment. In consideration of this quid pro quo relationship between a host country and an MNE, the legal requirements of the nation purveying its market need to be followed.
The aforementioned situation paves the way for imposition of corporate taxes on Permanent Establishment (PE) of an MNE. All around the world, countries partake in mutual agreements such as the Double Taxation Agreement (DTA) to set the percentage along with the tone of the said taxation. Corporations utilizing the resources of a country to further their profit motive are taxed at a certain percentage based on the specifications of the DTA, ensuring that they are not unfairly taxed either. Subjecting these PEs to taxation is a common practice around the world, however, its unprecedented counterpart, canonically known as ‘Equalisation Levy’ was set in motion vide Chapter VIII of Finance Act, 2016 (hereinafter, the “Act”) in India.
Base Erosion and Profit Shifting- An Organisation for Economic Cooperation and Development Initiative
It would not be wise to jump the gun and proceed with the discussion on Equalisation Levy before understanding the need for its conception. MNEs are more often than not equipped with exemplary tax and legal experts who scout for tax cuts in the corporation’s countries of operation. Big-wheel companies manage to ricochet all their tax liabilities through tax inversion, the process of shifting the residence of the company from one country to another due to its lower tax rates or on account of that country being a tax haven.
Base Erosion and Profit Shifting (BEPS), thus, refers to tax planning strategies used by multinational enterprises that exploit gaps and mismatches in tax rules to avoid paying tax. Organisation for Economic Cooperation and Development (OECD) claims that a major chunk of developing countries’ tax collection consists of corporate tax which gets compromised with copious tax avoidance on the part of MNEs. International intervention in the prevailing tax structure seemed to be the ideal way to rectify the problem at hand. The first step out of 15 suggested by OECD was with regard to the “Tax Challenges Arising from Digitalisation”.
More than 50% of global transactions being digital in nature, with a growth rate of approximately 338% every year, render the ‘brick and mortar’ tax structures based on physical presence of a corporate entity to the market, redundant. The companies no longer have to invest in Branch Offices all around the globe to make their presence felt and expand their corporate empire. Technology and the convenient usage of it makes it possible for them to settle for Offshore Accounts without investing heavily into a country while reaping all the market benefits, furthering the enterprises’ ability to avoid tax. Equalisation levy is the first step in this direction, taken to account for their share of market through a robust levy.
Equalization Levy, 2016: The First Leg of Digital Taxation
In consonance with the OECD’s BEPS project, the Government of India introduced Equalisation Levy or Digital Services Tax (DST), informally known as the Google Tax owing to its Bermuda functioning, in the Finance Act of 2016. It is a form of direct taxation which the MNEs with no Permanent Establishment in the country are required to pay to the government for specified services. These provisions came into effect from 1st June 2016, with the percentage of deduction set at 6% for the non-resident companies. India being the first country to have conquered this feat, required an Expert Committee to be set up by Central Board of Direct Taxes, to go through all the growth prospects and implications of imposing the set percentage of tax (which initially ranged from 6-8%) on transactions.
Specified Service mentioned in Section 164(i) of the Act, restricted itself to the ambit of online advertisement or any such digital advertising space. This was to act as a bolster for any further impositions in the upcoming years. This levy only applies to transactions which transcend the threshold of Rupees 1 lakh. In the nascent stage of its imposition, the government observed that big corporations shifted their burden of taxation onto their clients by including the levy in the total mark up of services provided.
This garnered the need for a clarification stating that the equalization levy would be a Tax Deducted at Source (TDS), making it a withholding tax. Section 166 of the Act provides a softer curve into the legislation by rounding off the interest, consideration, penalty or any other quantifiable amount pertaining to the tax, to the nearest multiple of ten.
The amount of tax collected by the Income Tax Department by the end of previous Financial Years (FYs) economically and politically validated the imposition of this levy. Receipts from offshore digital firms with respect to online advertisements and its niche area of operation amounted to: Rs. 339 crore in FY 2017, Rs. 590 in 2018 and Rs. 939 in FY 2019, with a year on year growth rate of 59.2%. This unanticipated growth prompted the government to seek a new framework which could expand the scope of taxation in services.
Equalisation Levy, 2020: Broadening the Horizon through a Controversial Reform
In the wake of the pandemic, the Government of India came up with new reforms in the Equalisation Levy through the amendments made in in Financial Bill 2020, on 23rd March 2020. The government through this new piece of legislation has expanded the scope of taxation based on the nexus between non-resident corporations and Indian market. This move came as an interim measure before the final consensus on the OECD G20 Unified Approach, which is to appropriate the rights of countries with respect to taxation.
The new reform does not limit its application to only Business-to-Business (B2B) model of transactions, directly levying a 2% tax on receivables by non-resident companies through e-commerce portals on their gross revenues. The levy now applies on sale of products via online media and not just online advertisements. The new act specifies e-commerce supplies and services provided by an ‘e-commerce operator’, defined as “a non-resident who owns, operates or manages digital or electronic facility or platform for online sale of goods or online provision of services or both”, under Section 164 of the Act. Moreover, the Act’s bearing appended to a non-resident buying goods or services using the IP Address located within India. Earlier this provision only dealt with a transaction between residents and corporations. Hence, the sharp rise in number of commercial transactions online in lieu of COVID-19 is anticipated to collect substantial amount of taxes, through the hosts of a commercial transaction as well as the subject matter of it.
Although, the income arising from e-commerce supply or services subjected to Equalisation levy would automatically exempt that income from the application of income tax, this amendment, managed to cause a disarray of responses gathered from all the blue-chip companies considering their prevailing business models within the country.
This subtle legislative move prompted a group of Technology Giants namely, Google, Amazon, Microsoft and Facebook to approach the US Trade Representative through a joint letter, addressing the hindrances arising due to the current regime. Section 301 of the Trade Act 1974, allows the United States Government to investigate any foreign nation on the grounds of its unfair tariff or non-tariff barriers, however, any consequential action is yet to be performed by the US government on the accord of negotiations between the two countries.
Amidst all the perplexity revolving around the application of the Direct Services Tax, one of the major players in the Indian economy recently procured a green chit from the Delhi High Court with respect to being subjected to the new tax. In MasterCard Asia Pacific Pte. Ltd. v. Union of India, the question regarding taxability of fees in respect of services for the processing of card payment had already been settled by the Authority of Advance Ruling stating that the plaintiff has Permanent Establishment within the country according to the DTA between India and Singapore. The plaintiff sought a stay on the payment of equalization levy under Section 165A r/w Section 166A Finance Act, 2020. The Honorable Court held that the petitioner was not liable to pay the Equalisation levy.
There is a lot of ambiguity in the implementation of the new tax regime, especially with respect to parallel proceedings just on the grounds of Permanent Establishment itself. This creates a lot of burden for the courts along with a negative business attitude amongst the foreign investors. The extension of tax to online sales and technology enabler services has instilled an air of uncertainty among big corporations. With the current Indian taxation regime being Greek to everyone, there are little to no chances of positive outcomes. The government needs to come up with felicitous guidelines to address this issue and win the global business sentiment back on its side.