Pitfalls in taxing the digital economy

N Venkataraman | Updated on January 20, 2018

Headaches galore On taxing e-commerce Rawpixel.com/shutterstock.com

A major grey area is the proposed equalisation levy — is it an income tax, service tax or something else?

Walking into a showroom, a shopping mall or a trade centre to buy goods is passé. Brick and mortar shopping platforms are slowly vanishing with the arrival of the digital era and the consequent electronic business platform popularly known as electronic or e-commerce.

However, this digital economy is throwing up tax challenges in all the jurisdictions. The Income Tax Act 1961 and the various Double Taxation Avoidance Agreements (DTAA) envisage cross-border taxation in India only if it is income earned in India or income earned through a permanent establishment in India. Now, a seller of goods or a service provider in Chennai or Delhi earning an income in India, or an overseas vendor setting up a sales outlet to deliver goods to Indian consumers, would pay tax on the income as a resident or as a permanent establishment. A service provider landing in India to offer advice and consultancy services will have to disclose income earned in India and pay tax. But digital e-commerce transactions through e-portals located outside India delivering the same set of activities in India go out of the tax ambit.

Digital pressure

The digital era is, therefore, exerting pressure on growing and consuming economies where activities and value get created but are not taxed.

When the OECD (Organisation for Economic Cooperation and Development) started to pay attention to Base Erosion and Profit Shifting (BEPS), it established various action points. Action Point 1 dealt with tax treatment for a digital business. It conceived of three options which had the approval of G20 nations to tackle the challenges. These are: significant economic presence, the application of a withholding tax on gross payments, or an equalisation levy. These options would enable consuming countries to tax digital transactions of a foreign enterprise deriving considerable sales without physical presence in the country concerned.

However, it recommended putting these options into place only through a multilateral instrument that would modify the existing bilateral treaties. This caution has been expressed evidently through para 383 of the Final Action Point 1 report.

Unfair advantage

In the Indian context, the report of the committee on taxation on e-commerce succinctly lays out the unfair advantage enjoyed by foreign enterprises over their Indian competitors — both digital as well as brick and mortar — in avoiding payment of tax on income earned in India. It has recommended equalisation levy as a viable option. It clarified that it should not be levied on imported goods merely because orders and payments are made through the internet.

The Government through its Finance Act 2016 (Chapter VIII) has introduced the equalisation levy with effect from June 1, 2016. Equalisation levy is defined as “the tax leviable on consideration received or receivable for any specified service under the provisions of this Chapter”. As on date, “specified service” is restricted to online advertising, digital advertising or other facility or service for the purpose of online advertisement, but it empowers the government to notify any other service. It has imposed a rate of 6 per cent on the amount of consideration where payment is made to a non-resident not having a permanent establishment in India.

The constitutional bench and other judgments of the Supreme Court have mandated identification of the nature and character of a tax as a sine qua non requirement for imposition of a levy. The question that needs to be addressed is: What is the true nature and character of this equalisation levy?

The definition says it is a levy on the consideration paid for the services received. Does it mean a service tax? It cannot be, since these transactions already suffer service tax at 15 per cent on a reverse-charge basis. It would be a double levy of service tax, which is not permissible. Incidentally, service tax is also levied under the Finance Act.

Is it then an income tax in the nature of withholding? The Government has clarified that the levy is not an income tax and does not form part of the Income Tax Act 1961. The government is bound by various bilateral DTAAs that exclude taxation of digital e-commerce transactions and allow taxation only when it is a business income earned in India, or that portion of the income earned in India through permanent establishment. When these factors are conspicuous by their absence, India cannot tax the transaction. It is for this reason that the OECD clarified that unless there is a modification of DTAAs through a multilateral arrangement, equalisation levy cannot be imposed under the domestic laws.

What is it?

Then what is the true nature of this levy? The Constitution permits a single transaction or activity to be taxed more than once provided there are multiple aspects available in that transaction for each one of them to be taxed. An architect rendering a professional service has to pay both service tax and income tax in view of the presence of two aspects, namely rendition of service liable to service tax and earning of income liable to income tax on the same consideration charged.

This equalisation levy is sought to be defended as one which is neither a service tax nor an income tax. One is unable to find a third distinct aspect other than these two available for Parliament to impose a levy under the residual powers of Entry 97 of List I of the Constitution. Globally, this levy is understood to be part of the income tax structure. The definition evidently makes it look like a service tax, for which levy at 15 per cent is already in force.

The Government has bypassed the caution alert put out by the OECD in bringing a harmony of the tax treaties to enable domestic laws impose equalisation levy. The equalisation levy may not have a smooth sail and the court may have to pronounce the last word.

The writer is a senior advocate in the Supreme Court of India

Published on June 22, 2016

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