The early 2010s witnessed a drastic upswing in the number of e-commerce websites in India. From the American MNC, Amazon, launching its e-commerce operations in India in 2013 to the homegrown Nykaa in 2012, the number of e-commerce marketplaces has only increased with every passing year (The digital economy is said to be increasing at 10% every year!)
Because of this almost exponential expansion in digital services, there is an evolution in the types of business models too. With new models, there are new challenges on the taxation front. India provides these businesses with a large consumer base. Hence, source country taxation becomes important for India to get its fair share of taxes from digital transactions.
Various factors enter the picture like a physical presence, characterization, valuation of data, etc. But since businesses are now able to carry on their business in the digital market without having a Permanent Establishment (PE), allocating tax rights has become challenging and the government considers this an erosion in the tax base.
One of the measures taken by the government is the Equalization Levy introduced in the Union Budget in 2016.
What is the Equalization levy and how did it start?
The equalization levy was introduced with the intention of taxing non-resident companies that were earning income from digital transactions in India, primarily business-to-business transactions. It basically sets out to “equalize” the tax between a resident e-commerce company and a non-resident e-commerce company.
So, according to Sec165 of Finance Act 2016, a person resident in India or a non-resident having a permanent establishment in India shall deduct EL at 6% on the consideration paid to the non-resident towards specified services.
The services/ transactions that come under the purview of this tax are online advertisements and any provision for digital advertising space for the purpose of online advertisement.
It is a direct tax that is to be withheld at the time of payment to the non-resident service provider by the service recipient i.e. if you are seeking to place an online advertisement for your business on Facebook, you are the service recipient who will withhold the tax, and Facebook is the non-resident service provider who is providing you with the ad-space.
The two conditions that need to be satisfied are:
- The service provider should be a non-resident company
- Annual payment to such provider exceeds Rs. 1,00,000 in one financial year.
Also, the equalization levy is applicable for business or professional purposes only and not for personal purposes.
The onus of depositing the EL to the government treasury is on the person who is making the payment to the service provider.
For the service providers (e-commerce companies) on the other hand, the income on which such EL has already been deducted is considered tax-exempt in India.
Equalization Levy 2.0
The government introduced EL 2.0 in the Finance Act 2020, thus, widening the scope of the Equalization Levy.
It extends the applicability to non-resident e-commerce operators on the online sale of goods or online provision of services or a combination of both.
In this case, the threshold limit to attracting EL 2.0 is Rs. 2 crores and is charged at the rate of 2% on the amount received by the non-resident operator.
As opposed to EL1.0, here the onus of depositing the tax to the government and complying with the rules is on the non-resident e-commerce operator.
Further clarification was issued in the Finance Act 2021 which expanded the scope of the EL and brought under its purview more online activities, like:
- Acceptance of offer for sale
- Placing of purchase order
- Acceptance of purchase order
- Payment of consideration
- Supply of goods or provision of services partially or wholly
Impacts and Issues of Equalization levy
A wide range of businesses and business models, conventional and unconventional, are now under the ambit of the Equalization levy.
Because of the wider interpretation brought on by EL 2.0, even an online payment made by a resident Indian to a non-resident e-commerce operator for an order that was placed offline/physical mode could possibly attract the levy. So, traditionally brick and mortar businesses that simply use a website for their payments might also be subject to this levy.
The compliance burden of EL 2.0 is entirely on the non-resident e-commerce operator. They have to collect and deposit the EL before the respective due dates for each quarter. Failure to do so will attract interest and penal consequences.
The EL does not form a part of the Income-tax Act 1961, so a tax credit may not be allowed under the tax treaty for the EL paid in the source country. Double Taxation Avoidance Agreements (DTAA) between India and foreign countries are usually specifically defined and do not include the EL. This results in additional costs to the operators that they will ultimately recover from customers.
If a country does not have a DTAA with India, then the non-residence e-commerce operator may be able to claim the foreign tax credit in its home country jurisdiction. If that is not possible, then again it is a sunk cost.
The operators need to file an Annual statement by June 30 for all such transactions in the preceding financial year running from April to March.
The practical challenges faced by these operators have only been made more acute because of a lack of proper guidance and clarifications. Here are a few more such challenges:
- What constitutes a digital/electronic facility is open to interpretation. The government can argue that advice over e-mail can also constitute an electronic facility that is used for providing services online, and hence comes under the ambit of the EL
- No guidance on the applicability and procedural aspects of the EL. The constitutional validity and extraterritorial jurisdiction are also debatable.
- The wordings of the provision are also unclear as to whether the levy is on the gross amount or just on the commission received by the operator. A misinterpretation could lead to a huge loss of income for the operator.
- There are no exemptions for inter-company transactions.
- A service booked online, but enjoyed offline like airline or hotel bookings, could also be dragged under the EL by revenue officials. So clarity should be provided on whether EL is applied to digitized products only, or it is applied to services where e-commerce is just a facilitator for communications and bookings as well.
- A non-resident tourist could be purchasing goods online through an Indian IP address that are to be delivered to his overseas residence, even this transaction could be under EL merely because he uses an Indian IP address. So, such one-off transactions may also fall under the EL. Keeping track of such transactions could be a daunting task for operators.
What is happening now and what might happen in the future
As of now, India gets about Rs. 4,000 crores in EL which will have to be withdrawn as a part of a global tax deal by the OECD that will come into effect by 2023-24 after some details are finalized.
The new framework has two pillars-
- Pillar 1 proposes that multinational enterprises having global sales above Rs 20 billion and profitability over 10%, will have to allot 25% of their profit above the 10% threshold to markets they derive the revenue from.
- Pillar 2 introduces a global minimum corporate tax rate set at 15%. The new minimum tax rate will apply to companies with revenue above Rs 750 million and it’s estimated that this will generate around $150 billion in additional global tax revenues annually.
On November 24, 2021, the Ministry of Finance had announced that a transitional approach of a 2% Indian Equalization Levy (IEL) in e-commerce supply or services has been agreed upon with the US. This agreement follows the findings that showed that the IEL was inconsistent with principles of international taxation and discriminatory against US companies. This will be in effect until new rules and profit allocation rules come into effect in 2023-24.
Despite India being an attractive venue for business for players in all fields, the issue of taxation is holding many of them back. It is necessary to assess the ramifications of the wide EL 2.0 and gauge whether it is pushing out businesses or not since it would increase the operator’s cost of doing business in India. Not being able to claim credit is rubbing salt into their metaphorical wound.
It will take careful deliberation of the Finance acts, the EL in particular, to understand what taxes to pay if you run a non-resident e-commerce business in India. You may also need to understand the Foreign Tax Credit to see if you are eligible for any credit. It is advisable to take the help of a CFO consultancy service to do so.