Government of India has levied a new tax called “Equalisation Levy” effective from June 1, 2016. It is levied on specified services which includes online advertisement services, provision for digital advertising space etc.
Equalisation Levy – Is it a beginning of a new saga?
Tax challenges faced by International Community
In the ever growing digital world it is possible to be heavily involved in the economic life of another country without having a fixed place of business therein which results in base erosion. Base erosion happens when a deductible payment is made for the purpose of business and claimed as business expense but the income arising from such payments is not taxable because of the limitations of existing international taxation rules. For example, deduction claimed by an Indian resident for incurring online advertisement expenses, however, income earned by the non-resident [not having a Permanent Establishment (‘PE’) in India] from rendering such online advertisement services not offered to tax in India in the absence of such non-resident’s PE in India.
In view of this base erosion, concerns were raised amongst international community regarding whether the existing definition of PE remains consistent with the underlying principles on which it was based. The said concern was reflected in BEPS Project endorsed by G-20 and OECD. India was an active participant in the BEPS Project.
In report on Action 1 of BEPS Project, following three options were suggested to address tax challenges of digital economy:-
|1.||New tax nexus rules based on significant economic presence|
|2.||Withholding tax on digital transactions|
In recent years, Indian judiciary in its various rulings favouring the assessee held that the revenue/profits from online advertisement services rendered by the non-resident are neither taxable as royalty/fees for technical services nor as business profits (in the absence of non-resident’s PE in India). The combination of inadequacy of physical presence based nexus rules in the existing tax treaties and the possibility of taxing such payments as royalty or fee for technical services creates a fertile ground for tax disputes, particularly in countries like India, where the taxpayer rights are fully protected by the appellate authorities, and imposition of tax under ambiguous laws are often not sustained.
Recognizing the significance of aforesaid issues and the need to have a simple way to resolve them and to bring greater clarity and predictability in the applicable tax regime, Government of India formed a Committee on Taxation of E-Commerce. The Committee in its report identified that the ability of MNCs to avoid paying taxes in India results in rising tax burden on Indian competitors and thereby such MNCs enjoy an unfair advantage over their Indian competitors which results in detrimental impact on growth of Indian digital enterprises. In view of this, the Committee suggested to adopt the option of levying an Equalisation Levy out of the three options suggested in Report on Action 1 of BEPS Project.
Following the Committee’s suggestion the Government of India vide Chapter VIII of Finance Act, 2016 (‘Finance Act’) levied Equalisation Levy on following services:-
|2.||any provision for digital advertising space; or|
|3.||any other facility or service for the purpose of online advertisement|
Nature of Equalisation Levy – Whether it is a tax on income
View 1 – It is NOT a tax on income
Not applicable to Jammu and Kashmir (‘J & K’)
Article 248 of the Constitution of India [or Entry No. 97 of Union List under Article 246 of the Constitution of India] grants power to Parliament to make laws (including the law which imposes the tax) in respect of matters not enumerated in Concurrent & State list (being the Residuary Power of Legislation). However, in view of Constitution (Application to J&K) Order 1954, under this residuary power law cannot be made for the state of J&K. Thus, tax imposed by parliament under Article 248 (or Entry No. 97 under Article 246) will not be applicable to J&K. As Equalisation Levy is not applicable to J&K, it seems to be levied under Article 248 (or Entry No. 97 under Article 246).
On the other hand, any tax levied under Entry No. 82 under Article 246 (e.g. Income tax) is applicable to whole of India (including J&K). In view above, equalisation levy does not seems to be a tax on income.
Applicable on gross receipts irrespective of any income
Equalisation Levy has not been introduced under the Income-tax Act, 1961 (‘the Act’) but under the Finance Act [like Service tax and STT were introduced earlier] and is applicable on gross receipts irrespective of whether any income arising from the transaction is taxable in India or not.
Comparison with Service tax
Section 163(3) of Chapter VIII of Finance Act, 2016 provides that Equalisation Levy shall apply to consideration received or receivable for specified services provided on or after the commencement of this Chapter.
On the other hand, section 64(3) of Chapter V of Finance Act, 1994 provides that Service Tax shall apply to taxable services provided on or after the commencement this Chapter.”
On a comparison, it is clear that both these taxesare on services and not on income and accordingly in the nature of indirect taxes.
Further, the Committee in its Report clarifies that “The Equalization Levy will be outside Income-tax Act. It is not a tax on income, as it is levied on payments“.
In view of above, it may be concluded that it is not a tax on income.
View 2 – Equalisation levy is income tax only though with a new nomenclature
“Tax” not defined in Chapter VIII of Finance Act, 2016
Section 164(d) of Chapter VIII defines “Equalisation Levy” to mean the tax leviable on consideration received or receivable for any specified service under the provisions of this Chapter. Further, section164(j) of the Finance Act provides that the words and expressions used but not defined in Chapter VIII and defined in the Act or the rules made thereunder, shall have the meanings respectively assigned to them in the Act.
The word “tax” has not been defined in Chapter VIII. However, section 2(43) of the Act defines “tax” to mean income tax, chargeable under the Act.
Linkage with income tax
Further, an exemption u/s 10(50) of the Act, disallowance u/s 40(a)(ib) of the Act and borrowing some of the provisions of the Act (as mentioned in section 178 of Chapter VIII) establishes linkage of Equalisation Levy with income-tax.
In view of above, one may conclude that equalisation levy is nothing but income tax though not introduced in the Act and levied indirectly vide Finance Act.
Note :- In view of the contrary views, the issue whether or not Equalisation Levy is in the nature of income tax may sooner or later face the heat of litigation.
Foreign tax credit available or not
Article 2 of India-USA tax treaty defines “taxes covered”. Paragraph 2 of the said Article 2 provides that
“The Convention shall apply also to any identical or substantially similar taxes which are imposed after the date of signature of the Convention in addition to, or in place of, the existing taxes. The competent authorities of the Contracting States shall notify each other of any significant changes which have been made in their respective taxation laws and of any official published material concerning the application of the Convention.“
Further, Paragraph 1 of Article 25 of India-USA tax treaty which deals with “Relief from Double Taxation” provides as under:-
“In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), the United States shall allow to a resident or citizen of the United States as a credit against the United States tax on income –
(a) the income-tax paid to India by or on behalf of such citizen or resident ; and
For the purposes of this paragraph, the taxes referred to in paragraphs 1(b) and 2 of Article 2 (Taxes Covered) shall be considered as income taxes.”
On a conjoint reading of Articles 2 and 25 of India-USA tax treaty it is clear that this tax treaty is also applicable to taxes which are identical or substantially similar to income tax. In view of this USA can grant its residents the credit of such taxes paid in India. Thus, even if Equalisation Levy is not a tax on income, yet it falls under the extended definition being identical or substantially similar to income tax. On this analogy, USA may provide to its residents the credit of “Equalisation Levy” paid in India.
The law laid down in above Articles forms part of many other tax treaties (might be in somewhat different form/language) signed by India and thus, the benefit of such credit may be availed by residents of many other countries as well.
The Committee in its Report stated that as it is not a tax on income, therefore it is NOT covered by tax treaties and accordingly, its tax credit would not be available under tax treaties. However, the same has not specifically been clarified in the Finance Act/Equalisation Levy Rules. As the said view of the Committee is not covered by Finance Act/ Equalisation Levy Rules, it may be seen as only a view expressed by the Committee and the credit may still be claimed in the light of above discussion on Article 2 and 25 of India-USA tax treaty.
The Committee further stated that, the country of which the taxpayer is residence may grant relief to the taxpayer, under its own domestic laws, to avoid double taxation. Further, in case such a country also imposes an Equalization Levy, there can even be the possibility of a reciprocal agreement between India and that country to provide relief from income-tax on account of such levy.
As discussed above, Equalisation Levy has been brought under Article 248 (or Entry No. 97 under Article 246) which provides it a constitutional validity.
Moreover, it is in accordance global consensus as it has been accepted by G-20 and OECD countries as a possible option which the countries can adopt in their domestic laws to address the tax challenges faced by digital economy.
In view of Vienna Convention for interpretation of tax treaties, it may be argued that levy of equalisation is a unilateral step on the part of India (though it is an outcome of BEPS project) without any amendment to tax treaties and thus, it tantamount to treaty override and a violation of international laws. However, India is not a signatory to Vienna Convention. So a question comes up that whether the principles laid down by Vienna Convention would be applicable to India.
Indian judiciary from time to time embraces the Vienna Convention on the Law of Treaties and recognized that the Vienna Convention codifies many principles of customary international law. So, though India is not a signatory to Vienna Convention yet the principles laid down therein may be applied for interpretation of tax treaties signed by India with several countries.
Further, Article 51(c) of the Constitution of India provides that India shall endeavour to foster respect for international law and treaty obligations and unlike some other countries India does not permit treaty overriding through its domestic law. Further, section 90(2) of the Act provides that the provisions of the Act will apply to a non-resident to the extent they are more beneficial vis-à-vis treaty provisions.
In view of above, one may argue that the imposition of Equalisation Levy is a case of treaty override as it takes away the benefit otherwise provided by tax treaties.
Future of Equalisation Levy
Even though the Committee in its report suggested Equalisation Levy on many services (like online advertising; digital advertising space; online news; download online music, movies, games etc.), as of now it is levied on a few services only (as discussed above). However, section 164(i) of Chapter VIII inter-alia provides that the specified services includes any other service as may be notified by the Central Government in this behalf. Though using this clause no other service has yet been notified, the scope of services and the rate of equalisation levy may be increased in future.
Here it is worth noting that service tax when introduced was levied only on three services with a rate of 5% and now we are living in the regime of negative list with a rate of 15%. So we will have to just wait and watch, what comes out of Finance Minister’s carry case in future. In view of above, what all can be said that imposition of Equalisation Levy might be a beginning of a new saga.