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Digital Economy:

Equalisation Levy
Levelling economic presence with taxable
presence: How fair it is!!
In this era of technology intertwined lifestyle, e-commerce has become a way of
life. E-commerce seemingly facilitates every other aspect of our lives at a click of
a button, whether its procurement of daily household items or requisitioning of
any particular service. Today, accessibility to the digital world is not a privilege
but a necessity for most people, particularly in urban areas.
Over the past few decades, the burgeoning development of the Information and
communication technology (ICT), its accessibility and affordability has led to
this digital revolution around the world. ICT has also provided opportunity to
businesses to tap the world markets and bridge the requirement of physical
presence across the globe.
The model of doing business electronically has provided immense growth
opportunities. Digital economy across the world is reflecting a growth rate of
10%1 which is significantly higher than the growth numbers of the global
economy as a whole. Research and studies around the world have indicated that
investment in ICT positively affects the productivity and GDP growth of a country.
Developed countries in terms of ICT development have the highest GDP levels,
which indicates that implementation of ICT in a country improves its overall
economic health.
Despite the significance of ICT in overall development of an economy, ICT
quotient has remained low in India. Though, in past few years, India has
witnessed some successful start-ups in this field, development of the concerned
infrastructure is much needed to capitalise on the growth opportunities.
Foremost

India

has

to

bridge

the

urban-rural

hiatus

in

terms

of

the

communication infrastructure. With the NDA government vision of Digital India, it


1 Proposal for Equalisation Levy on Specified Transactions Report of the
Committee on Taxation of E-Commerce dated February 3, 2016, however made
public on March 21, 2016

is expected to embark a digital revolution in India and to achieve the desired


growth rates.
Albeit, this model of conducting business through the realms of cyberspace has
led the enterprises in procurement and selling of goods and services in different
jurisdictions without any physical presence in that country, the same has also led
to severe tax challenges direct as well as indirect. The economic presence in a
sovereign through the world of web has posed direct taxation concerns due to
absence of physical presence in that specific jurisdiction.
The development of the cyber economy has captured the attention of the
taxman

of

the

world

economies

to

test

their

fundamental

Permanent

Establishment rules developed for old brick and mortar economies, in the light
of the tax challenges caused by the new digital business models. The digital
market has revolutionized traditional ways of conducting business around the
globe, while tax rules have been slow to adapt to this new business environment
and could not come up with the possible solution.
It is widely felt that MNEs have treaded the path of aggressive tax planning
thriving upon the interaction of tax laws and treaty provisions between different
sovereigns and have relatively paid low amounts of tax or no tax by artificially
shifting profits away from the economy where they are earned, to a more
favourable tax jurisdiction. This has led to a divide between the economic
presence in a country vis-a-vis taxable presence in such jurisdiction.
G202 members have expressed their concern with regard to artificial shifting of
profits by the MNEs to the low or no tax jurisdictions and in response thereto
announced a coordinated drive with Organisation for Economic Cooperation and
Development (OECD) to modernise the current framework of tax treaties and
nationally set anti-tax avoidance laws. OECD at the request of G20 is leading the
initiative of development of a strategy to address such profit shifting, through its
Base Erosion and Profit Shifting project (BEPS). Since 2012, OECD is working
hard to achieve the goal to curb the unwarranted tax practices by MNEs and has
2 G20: The Group of Twenty (also known as the G-20 or G20) is a forum for the
governments and central bank governors from 20 major economies. The
members, , include 19 individual countries -Argentina, Australia, Brazil, Canada,
China, France, Germany, India, Indonesia, Italy, Japan, Republic of Korea, Mexico,
Russian Federation, Saudi Arabia, South Africa, Turkey, United Kingdom, United
States-and the European Union (EU).

introduced 15 Action Plans in mid 20133 highlighting the necessary areas of


concern, action points to address them and the expected outputs of those
actions.
OECD in its BEPS report Action Plan 1 4 on addressing the tax challenges of the
digital economy, has highlighted tax neutrality 5 as a major concern and
suggested several options to tackle the direct tax challenges which inter-alia
includes amendment in the Permanent Establishment rules, modifying the
definition a PE to address artificial arrangements through certain conclusion of
contracts arrangements, amendments in the OECDs transfer pricing guidelines
and designing of rules for Controlled Foreign Corporations (CFCS) Rule. Apart
from the aforesaid the Task Force also considered certain other options inter-alia,
a nexus test in the form of a significant economic presence requirement; a
withholding tax on certain types of digital transactions on the payments made by
the resident to the Non-Resident enterprises for the goods and services procured
digitally; charging of an Equalisation Levy to impose equal treatment of foreign
and domestic suppliers by taxing the foreign suppliers for their economic
presence in that country, but the same were not recommended by OECD in its
final report on tax challenges of the digital economy under Action Plan 1. 6
In the midst of this debate of challenges and the recommendations on taxation
of the digital economy and majority of the world economies still considering the
options recommended by OECD, India has taken a leap to address the challenges
3 OECD Report on Action Plan on Base Erosion Profit Shifting
4 Action Plan 1 addresses the tax challenges posed by the emerging business models in
the new digitalized world. The Action Plan inter-alia examines the ability of a company to
have a significant digital presence in the economy of another country without being
liable to taxation due to the lack of nexus under current international rules. The Action
Plan 1 further recommends some new rules and regulations to curb such a situation and
levy taxes on income where value is created, without insisting on physical presence of
businesses.

5 Tax Neutrality: The principle of tax neutrality provides that tax should seek to
be neutral and equitable between various forms of business activities. Where a
domestic enterprise may be taxed at marginal rates, a MNE may not be taxed in
the country of source due to presence over cyber space and no physical
presence.
6

in terms of taxation of MNEs having a digital economic presence in India without


any physical presence.Though, UK and Australia too have initiated steps to tap
the concerns of BEPS by introducing Diverted Profit Tax and Multinational Anti
Avoidance Law respectively.
The Indian tax proposals announced wide Union Budget 2016-17, suggests
introduction of a new Chapter VIII forming part of Finance Bill separate from the
Income Tax Act, 1961 comprising 17 Sections, an Equalisation Levy of 6% on the
amount of consideration for the digital advertising services provided by a nonresident not having a permanent establishment in India to a resident in India who
carries business or profession or to a non-resident having a permanent
establishment in India.
The proposed levy provides for a withholding of an Equalisation Levy by the
receiver of the services on the payments made to the Non-Resident service
providers. Further, in order to reduce burden on the small players in the digital
domain, it is proposed that no levy shall be made in case the receipt of
consideration by a non-resident enterprise not having a PE in India from a
resident or a non-resident having a PE in India is in aggregate does not exceed
Rs. One Lakhs7. Equalisation Levy to be levied only if the payment is made for
business and profession purposes any expenditure by an Indian resident is not
for the purposes of business is exempt from withholding of such levy.
Although, the ambit of the digital economy is expensive and inter-alia includes
purchase and sale of goods, cloud computing, digital advertising, procurement
and selling of softwares, applications, music, movies etc., equalisation levy for
the time being is only proposed to be charged on the services of online
advertising services provided to the businesses in India by certain giants such as
Google, Yahoo, Facebook, Twitter etc. The provision is worded as such, that in this
ever changing techno environment, other digital services may be brought into
this ambit.
Its an undisputed fact that fair share of taxes should be paid by the enterprises
for their economic presence in India, however, a cost and benefit analysis may
change the scenario. In a situation where the NDA government understands the
importance of the ICT sector in Indias growth story and has initiated a drive of
Digital India, such a levy on the other hand may usher a pause in the expected
7 Equivalent to US $1505 approximately

results and benefits. Where most of the developed and developing economies of
the world have shown resistance on the recommendations of OECD provided in
Action Plan 1, such a levy by Indian government is premature. India, being a
growing economy should also understand the importance of being tax
competitive, in a scenario where other developing nations are urging for foreign
investments through liberal and stable tax policies.
Prior to introduction of the instant levy, the taxman in India have taxed such
transactions of payments made for online advertisement on the search engines
of Google and Yahoo.

However the Honble Kolkata Bench of Income Tax

Appellate Tribunal8 while adjudicating on such aspect has held that since such
search engines have its presence through its website cannot be considered to
constitute a PE unless its web servers are also located in the same jurisdiction. It
was further held such payments shall not fall within the ambit of royalty and Fees
for Technical Services.
Now, equalisation levy has been introduced as a separate code in itself to bring
to tax net such transactions. The code has been designed in such a way that
there is no characterisation required. Equalisation tax shall be levied irrespective
of its nature of business income, royalty or fees for technical services.
Equalisation Levy is advocated to be different from Taxes on Income or
Corporation Tax and thus may not necessarily be subjected to limitation of tax
treaties9.
With the introduction of a new Chapter VIII in Finance Bill, 2016 independent of
Income Tax Act, 1961 concerns have been highlighted with regard to the non
availability of the tax credit of such equalisation levy withheld in India, in the
home country of the Non-Resident recipient; however, such intent is not flowing
from the proposed legislation. The recent report of the Committee on Taxation of
E-Commerce10 provides that since Equalisation levy is imposed on gross amount
8 In the case of ITO v. Right Florists (P) Ltd. (ITA No. 1336/Kol/2011)
9 BEPS Action Plan 1 report has also conceptualized Equalisation Levy as a tax
different from Corporation Tax. Furthermore UK has also imposed Diverted Profit
Tax which is independent of Corporation Tax or Taxes on Income.
10 Proposal for Equalisation Levy on Specified Transaction dated February 3,
2016, made public on March 21, 2016

of transaction, and not on the income arising from such transaction, it shall not
fall within the scope of income tax or tax on income or any identical or
substantially similar taxes as provided in Paragraph 4 of Article 2 11 of the OECD
Model Tax Convention and hence no tax credit shall be allowed to the NonResident enterprise in the home country.
However, just because such levy is imposed on gross amount rather than income
and BEPS report conceptualises such levy to be independent of corporation tax
whether the same flows out of the purview of Paragraph 4 of Article 2 of the
OECD Model Tax Convention shall have to stand the test of time.
In the framework where there is ambiguity about the availability of the tax credit
in the home country and where the digital advertising market is dominated by
few major players in India, it is most likely for the non-resident advertisers to
relay such excess cost of 6%, which may lead the start-ups and ecommerce
companies to bear the brunt of equalisation levy. However, on the other hand,
many big business houses in India, which are advertising intensively over the
online media, do have a strong bargaining power and may make the non-resident
advertising companies to bear the additional tax.
Such a levy has to be withheld even in those cases where the amount is paid for
any online advertisement which is uploaded outside the Indian digital domain.
Thus, whether the advertisement is reflected within India or not, such levy has to
be withheld. There is no differentiation on the basis of territorial nexus.
Contextually, the extra-territorial operations of the Income Tax Act, 1961
provisions has been a matter of intense debate over the last few years 12, such a
levy may open the debate. Although, in India, Article 245 of the Constitution of
India gives Parliament the authority to make laws which are extra-territorial in
application, however, such application is based on the existence of a clear nexus
with the country in question.

11 Paragraph 4 of Article 2 of the OECD Model Tax Convention on which the tax
treaties between the sovereigns are worded provide for applicability of the
conventions on an identical or substantially similar taxes which are imposed in a
contracting state after the date of the signature of the convention
12 The Apex Court in the case of GVK Industries [2015] 54 taxmann.com 347
(SC) has touched upon the principle of "extra-territorial application".

Where, the government has taken a back door entry to bring to tax such
transactions, the power of the government to levy an equalisation tax on
specified online advertisements ought not be overlooked. Article 265 of the
Constitution of India provides that no taxation shall be levied or collected except
by authority of law. A tax could only be imposed by a law which is in conformity
to the criteria laid down in the relevant Articles of the Constitution of India. These
are inter-alia (i) the law should be one within the legislative competence of the
legislature, being covered by the Legislative List assigned to it by the
Constitution- Article 246; (ii) the law should not be the one prohibited by any
other Article of the Constitution; (iii) the law or the relevant portion thereof
should not be void under Article 13 i.e in conflict with the Fundamental rights
incorporated in Part III of the Constitution. Albeit, the committee on taxation of ECommerce transactions in its recent report has advocated the constitutionality of
such levy to be in accordance with entries at serial number 92C 13 and 9714 of List
I of Schedule 7 to the Constitution of India, the same may have to undergo the
test of Court of Law. One should also be cautious of nature of such levy, whether
a service tax or any other independent levy.
The Modi led NDA Government, has emphasised the need of stable tax laws in
India. India has achieved some encouraging growth members in the last few
quarters, although there is still a fair distance to cover before India truly
becomes a bright spot of the Economy. Projects like Make in India, Start Ups,
Digital India can contribute immensely to the Indias growth story, however,
they need to be fuelled up with stable and competitive tax laws to achieve the
desired result!!

13 Entry 92C List I Schedule 7 of Constitution of India: Taxes on Services


14 Entry 97 List I Schedule 7 of Constitution of India: Any other matter not
enumerated in List II or List III including any tax not mentioned in either of those
lists.