vol iii equalization levy taxing the overseas digital...mar 04, 2018 · within the ambit of this...

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ISSUE I

EQUALIZATION LEVY: TAXING THE OVERSEAS DIGITAL

GIANTS

2016

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EQUALIZATION LEVY: TAXING THE OVERSEAS DIGITAL GIANTS

A bona fide endeavor, beleaguered by haste

- Ayush Vijayvargiya*

ABSTRACT

The digital advertisement market in India is growing at a yearly rate of 28% and is pegged to

become the largest in the advertisement sector. Majority of the players in this domain being

non-resident entities, the Union government under the Finance Act, 2016 therefore, in a bid

to tap the hitherto untapped revenue source, proposed imposition of a 6% “Equalization

Levy” [‘EL’] on non-resident companies providing ‘online advertisement’ services in India

principally through their websites. This paper thus seeks to expound and critique the various

facets and nuances involved in its understanding.

Attempts have been made in the past to club this amount under ‘fees for technical services’,

alongside proposing obviation of ‘physical establishment’ requirement in scenarios

concerning digital interface. But this endeavor has always met the same fate, thereby making

way for EL, which was one of the three alternatives recommended under the Organisation for

Economic Co-operation and Development (‘OECD’) report on Base Erosion and Profit

Sharing (‘BEPS’). Analysis and feasibility of the other two alternatives, therefore, follows as

a logical corollary and finds a dedicated section in the paper.

In addition, the paper does not just strive to critically appraise the imposit ion, but also to

streamline the debate concerning nature of the levy, alongside highlighting a few lacunas in

the proposed scheme. As a parting point, it emphasizes the need for comprehensive

reassessment of EL on certain fronts and cautions the reader of the potential it has in terms of

diverting the government from more important issues like non-adversarial tax regime, hybrid

mismatch arrangements et al.

DECODING THE LEVY

Before the introduction of Finance Bill, 2016 [‘Bill’]1, it was a well-recognized position

under the Indian taxation jurisprudence that non-resident companies providing ‘online

* Student, 4th Year B.A. LL.B. (Hons.), NALSAR University of Law, Hyderabad. The author can be reached at

[email protected]. The author would also like to thank Kartikh Suresh and Harshitha Reddy Kasarla for

their valuable inputs.

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advertisement’ services in India, and having Indian existence principally through their

websites2, will not be liable to pay tax on the revenues generated through offer of these

services.3 The rationale being that virtual presence, through which these services are offered,

does not qualify as Permanent Establishment [‘PE’] under Indian laws and should not be

taxed. This rationale gets further strengthened when the difficulties, between transactions and

tax jurisdictions, encountered by these service providers are taken into account.4

In an attempt to overcome these obscurities, the Union government proposed imposition of a

6% “Equalization Levy” [‘EL’] through the 2016 Bill.5 It finds mention in Chapter VIII of

the Bill and stands as a levy on the revenues generated by the non-resident online

advertisement service providers.6

The Bill was passed by the parliament with a few

amendments, not pertaining to EL, and it came to be termed as the Finance Act, 2016 [‘Act’]7

with the levy becoming effective from June 1, 2016.8 The scheme of this levy provides that

the revenue on which it can be imposed must be generated from the provision of certain listed

services like ‘Online advertisements’ and ‘digital marketing’, to the Indian residents.9 The

Union government, however, is entrusted with the authority to include other services also

within the ambit of this levy, as and when deemed necessary.10

The levy is not dependent on the nature of revenue. Since it is an independent levy, not in the

nature of income tax, even double taxation avoidance agreements are not applicable.

Furthermore, use of the prefix ‘equalization’ highlights the intention of legislators to bring

non-resident service providers and domestic ones to an equal pedestal.11

Presently, the

domestic service providers are covered under the Income Tax Act. 1961 [‘IT Act’]12

and pay

at the rate stipulated in it, while non-residents fall outside the IT Act’s ambit. Therefore, this

1 Finance Bill, No. 18 of 2016 (2016). 2 These service providers need not be confused with their Indian Subsidiary, as the latter has a separate entity for

taxation purposes. 3 Income Tax Officer v. Right Florists Pvt. Ltd, [2013] 143 ITD 445 (Kol). 4 Equalization Levy, 2016: Is it equitable?, DELLOITTE (June 2016), available at

https://www2.deloitte.com/content/dam/Deloitte/in/Documents/technology-media-telecommunications/in-tmt-

equalization-levy-2016-noexp.pdf (last accessed on 31st August, 2016). 5 Supra, n. 1. 6 CA Rashmin Sanghvi, How to tax e-commerce businesses? - Equalisation Levy is an answer, TAXMANN (29

February, 2016); available at https://www.taxmann.com/Budget-2016-17/budget/t162/how-to-tax-e-commerce-

businesses-equalisation-levy-is-an-answer.aspx (last accessed on 31st August, 2016). 7 Finance Act, No. 28 of 2016 (2016). 8 Reuters, Rajya Sabha passes Finance Bill, BUSINESS LINE, May 11, 2016. 9 Supra, n. 7, Section 164(i). 10 Ibid. 11Memorandum explaining the provisions in the Finance Bill, MINISTRY OF FINANCE (DEPARTMENT OF

REVENUE), p.5 (Feb. 29, 2016); available at http://indiabudget.nic.in/ub2016-17/memo/mem1.pdf (last accessed

on 31st August, 2016). 12 Income Tax Act, Act 43 of 1961, (1961).

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Act seeks to enforce some parity by imposing this levy merely on the foreign providers. The

levy is collected by way of withholding tax, whereby the burden of deducting and depositing

the said amount rests upon the Indian residents i.e., the remitter of payments.13

It is a measure

undertaken to ensure ease of compliance.

It is important to note that the EL is deducted even before remitting the payments to non-

resident service providers, and the receiver merely gets the post-deduction amount.14

The

amount deducted is then deposited with the tax authorities, in adherence with the prescribed

rules and regulations.15

In case of any default by the Indian residents, penalties will be

imposed or interest charged, or both.16

Additionally, failure to deduct the levy or deposit it

with the department will also result in the concerned amount being automatically disallowed

as expenditure in computation of the defaulting resident’s taxable profits.17

In simple words,

in case of any default, the assessee would not be allowed to claim such expenditure as against

his/her business income. This will raise the total taxable income by the amount of disallowed

expenditure, thereby increasing the tax payable. Such treatment becomes important from a

taxation perspective, as once the Indian resident fails to deduct equalization levy before

making the payment to a non-resident, the latter cannot be called upon to pay anytime

afterwards.18

In its current form, EL is supposed to be levied merely on the entities generating a

considerable amount of online advertisement revenue from India. In pursuance of this

scheme, an exception has been carved out in order to shrink the liability of small

entrepreneurs. As per this exception, if the cumulative sum received for the specified services

does not exceed rupees 1 Lakh in a given financial year, the entity stands exempted from the

levy.19

Furthermore, when the non-resident has a PE in India and services provided are

effectively connected with the PE, no such levy would be imposed.20

Moreover, two provisions, namely Section 10(50) and 40(a)(ib), were introduced in the

Income Tax Act in an attempt to bring it in line with the new imposition. Section 10(50) was

13 Supra n. 7, Section 166. 14 Supra n. 7, Section 165. 15 Equalization Levy Rules, Notification No. S(O) 1095(E), (27th May, 2016). 16 Supra n. 7, Section 170. 17 Supra n. 7, Section. 18 Ranjeet Mathani, Equalization Levy: A Step Into Uncharted Territories, BUSINESS WORLD, 29th March, 2016. 19

Supra n. 7, Section 166 (1). 20 Supra n. 7, Section 165 (1) (ii).


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introduced in order to prevent the Foreign Service providers, from whom the levy is being

exacted, from getting doubly taxed in the Indian jurisdiction.21

The amendment to Section 10

acts as an assurance that the amount on which levy has already been deducted shall be

considered exempt from the tax imposition. Similarly Section 40(a)(ib) provides that any

amount already paid or still payable to the foreign service provider, wherein the equalization

levy is deductible but not deducted, the whole disbursement will be disallowed in the payer’s

books for taxation purposes.

Over the course of this paper, divided in eight parts, we would be delving into multiple facets

of this imposition. At the outset, an attempt would be made towards gauging the economic

significance of EL and the erstwhile position of Tribunals and Courts before coming into

effect of this levy. Following it, would be an assessment of the various alternatives available

to this levy, as proposed under the OECD report, and their practical feasibility. Lingering

uncertainty over the nature of this levy necessitates a detailed discussion of the arguments

advanced from various factions and hence a section would be dedicated for the same. The

subsequent segments would entail appraisal of pros and cons to this levy, and by design

would be followed by underscoring of lacunas in the entire scheme.

ECONOMIC SIGNIFICANCE OF THE IMPOSITION

A detailing of the mixed reactions to the levy, which will be elaborated in the latter part of

the paper, necessitates an inquiry into the characterization of ‘online advertisement’ and the

size of the relevant market. Online advertisement, although not legally defined anywhere, is

understood in normal parlance as a market strategy which uses the internet as an intermediary

for online traffic solicitation on the website, and ensures that marketing messages are

received by potential consumers.22

As of February 2016, the digital advertisement market in

India stood at $1,603.8 million and various reports in India have estimated it to grow to the

extent of $3372 million by 2020.23

This signifies a yearly growth of 28% for the next few

years, with the industry pegged to become the largest in the advertisement sector.

“Search and display” constitutes the largest chunk of the digital advertisement expenditure in

India. Search ads forms 38% of the overall spending on digital advertisements whereas

21 Supra n. 12, Section 10(50). 22 ROB STOKES, E-MARKETING; THE ESSENTIAL GUIDE TO MARKETING IN A DIGITAL WORLD, 294 (5th ed., 2014). 23

Digital advertisement in India (2016), STATISTA; available at

https://www.statista.com/outlook/216/119/digital-advertising/india#market-revenueYearIndustry

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display advertisements constitute 29%, followed by social media at 13%.24

Although the

concerned market does have a few domestic players, for the most part, foreign players

dominate it. Non-regulation of the transactions undertaken by these non-residents as a result

was causing enormous loss to the exchequer. Taking into account the size of the industry and

its touted growth rate, the proposed levy is expected to bring in a substantial sum of revenue.

POSITION OF INDIAN COURTS AND TRIBUNALS BEFORE THE FINANCE ACT, 2016

Before the Union Government came up with the proposal of imposing EL, taxability of these

online payments was posed as an issue before the Kolkata Tax Tribunal in the case of ITO v.

Right Florists Pvt. Ltd.25

The Income-Tax Appellate Tribunal (ITAT) held in this case that

the remittances to online advertisement websites like Google and Yahoo were not liable to be

taxed in India; reason being the absence of any PE or taxable presence in India. As all the

web servers are located outside the country and no link exists otherwise as well, no taxable

presence can be traced to India. The Tribunal opined that these service providers should

instead be taxed in the countries which host their tangible servers.26

Right Florists Pvt. Ltd. was an Indian company incorporated under Companies Act, 1956

and provided florist services in India. It entered into an agreement with Google Ireland Ltd.

and Overture Services Inc. (Yahoo)27

for availing advertisement services on their respective

search engines. After making the payments to these search engines, and during the filing of

Income Tax returns, Right Florists claimed deductions for the said payment but was

disallowed the same in spite of the payment being made pursuant to Section 40 (a)(i).28

It was

disallowed by the Assessing Officer on the ground that the assessee had failed to act as per

Section 195, and was unsuccessful in withholding the said amount.29

The issue posed before the tax Tribunal was whether it is mandatory to withhold tax before

remitting payments to a non-resident for the services rendered. In simple words, are the

payments made to search engines like Google and Yahoo for their advertisement services

taxable in India? Counsels for Right Florists argued that the amount received by the

24 Internet and Mobile Association of India, Digital Advertising in India (Nov. 17, 2015),

http://www.iamai.in/media/details/4486. 25 Supra, n. 3. 26 Supra, n. 3, ¶ 15. 27 Based in United States of America. 28

Supra, n. 12, Section 40(a)(i). 29 Supra, n. 12, Section 195.


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concerned non-residents on provision of online services were in the nature of business profits

and thus cannot be taxed by Indian Income Tax department in absence of a PE. However, the

Income tax department denied the said claim by classifying the payment as Fees for

Technical Services [‘FTS’], taxable under Section 9 of the IT Act, thereby obviating the need

of a PE for taxation purposes.30

While adjudicating on the given issue, and in order to address all the concerns suitably, the

court extensively delved into the various aspects brought up during the proceedings which

inter alia include PE, Business Connection, Royalty and FTS.

With respect to permanent establishment, the Tribunal held the presence of Google in India

through its website as not amounting to PE in light of the basic rule of ‘physical presence’

laid down by them when read with Section 5(2) of the IT Act. In ITAT’s opinion, even

though the conventional PE test does not find high relevance in the virtual world, the

requirement of physical presence still stands as the basic test. The quantum of cross-border

activities undertaken by the concerned enterprises, without the mandatory physical presence,

does not seem to have any impact on the understanding of PE. Therefore, the Tribunal held

that websites cannot be said to have physical presence on the internet, and are supposed to

have it where the place of effective management and their tangible servers lie.31

Similarly, the Tribunal found no existence of business connection either. Given that one of

the essential requirements under Section 9(1)(i) is to establish a nexus between revenue

generation and an entity based in India, revenue generation has to essentially be supported,

serviced or connected by that domestic entity. Due to lack of any such nexus, the possibility

of business connection’s existence was denied by the court.32

Furthermore, after taking into account the arguments advanced by both the sides, the court

held that the payment made for online advertisement would not even qualify as royalty.33

To

reach this conclusion, the Tribunal placed reliance on the case of Pinstorm Technologies Pvt

Ltd v. ITO34

. It had a similar factual matrix whereby the appellant remitted consideration to

Google35

for provision of banner advertisements on its gateway, and the Mumbai tax Tribunal

held these remittances to be merely in the nature of business profits. It held that Google does

30 Supra, n.3, ¶ 27. 31 Supra, n.3, ¶ 13. 32 Supra, n.3, ¶ 21. 33 Supra, n.3, ¶ 9. 34

ITS 536 ITAT (2012) Mum. 35 Manages its operation from Ireland.

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not have any PE in India, making it impossible for the tax authorities to bring it within its

ambit. Hence no tax can be deducted from the payment made by Pinstorm in lieu of services

provided.

However, the most contentious issue was whether the remittance by Rights Florists would

amount to ‘fees for technical services’. There was constant unanimity over the fact that all the

advertising services under consideration, be it through sponsored results or web banner, were

highly technical in nature. But considerable uncertainty prevailed on what qualifies as

‘technical services’ under Section 9 (1) (vii) of IT Act, as this terminology has no specific

definition assigned to it.

The Tribunal disqualified the activity as not being in the nature of technical services, owing

to the non-fulfillment of requirements laid down in cases like Yahoo India Pvt. Ltd.36

, ISRO

Satellite Centre37

and Dell International Services (India) P. Ltd.38

One of the prime

prerequisites for qualifying as technical services is human intervention during the course of

service provision and this is not the case with the provision of online advertisement services

by forums like Google and Yahoo. Therefore, it was held that, in spite of the service being

technical in nature, the remittances would not qualify as FTS due to lack of any human touch

in the whole process.

Further the term ‘technical’ appears along with ‘managerial’ and ‘consultancy’ in the bare

text of the statute. It was held by the Mumbai Tribunal in the case of Kotal Securities Ltd v.

DCIT 39

, that ‘human intervention’ is the common denominator that runs across all the three

terms; and hence human intervention is quintessential to qualify as technical service under

this Act. Even the Delhi HC in the case of CIT v. Bharti Cellular Limited40

has held that if a

group of words share certain common characteristics, then such characteristics should act as a

limitation while determining of the scope of these new words. Therefore, in the absence of

any human touch involved in the entire process of advertising by Google, from provision of

services to receipt of online advertisements, it cannot be taxed as FTS.

Hence, with the Tribunal holding the remittances to online advertisement websites as

36 Yahoo India P. Ltd. v. DCIT, Range 7(3), [2011] 46 SOT 105 (Mum). 37 ISRO Satellite Centre (ISAC) Department of Space vs. Commissioner concerned DIT (Intl. Taxation), ( 2008 ) 220 CTR ( AAR ) 13. 38 Dell International Services India Pvt. Ltd. vs. CIT (International Taxation), ( 2008 ) 218 CTR ( AAR ) 209. 39

[2012] 50 SOT 158 (Mum). 40 [2008] 319 ITR 139 (Del).


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ineligible for taxation in India, some recourse needed to be taken by the government.41

Even

though in my opinion the ITAT should have diluted the test in order to suit the changed

business circumstances at least for the sectors where human involvement is kept minimal, the

stance taken by the Tribunal can be rationalized as an effort to steer clear of the negative

spillover effect it might have caused. Leniency shown in application of the established tests

of ‘permanent establishment’ and ‘fees for technical services’ could have led to a chain

reaction whereby likelihood of their extended application to highly unwarranted scenarios

would have increased. However, success of the government’s attempt to set a separate test

instead of diluting the existing one it is yet to be seen and would only be clear after passing of

a few years of its application at the ground level.

ALTERNATIVES AVAILABLE AND THEIR FEASIBILITY

In a larger scheme, equalization levy can simply be termed as a measure to overcome the

issue of base erosion and profit shifting (BEPS). With India being the pioneer of this

imposition, it may even be apt to call it India’s response to BEPS.42

Base erosion practice has

been present amongst all the major ‘global digital companies’ since the upsurge of 2008

financial crisis, but has caught the attention of the developed and emerging economies only

lately.43

It is in wake of this that the G-20 assigned OECD with the task of formulating a

report, with the objective of recommending appropriate measures for overcoming tax based

erosion and profit shifting by the large MNCs.44

This report gained more importance with

time as these digital giants are not only avoiding taxes in the revenue generating countries but

are also evading taxes in the source country by routing the operation through tax havens or

low tax countries.

In November 2015, the OECD released a 15 point action plan as part of its final

recommendations, which provided for multiple alternatives to tackle the various problems at

hand.45

India, along with associated developing countries, enthusiastically participated in the

OECD proceedings. Participation of the said developing countries can however be attributed

41 Supra, n.3, ¶ 30. 42 Other countries like UK and Australia have ‘Diverted Profit Tax’ and ‘Multinational Anti-Avoidance Law’

respectively. These are anti-avoidance principles, different from the equalization levy, and are used to tackle

physical location based PE problems. 43 Michael Plowgian, BEPS: The Shifting International Tax Landscape and What Companies Should Be Doing

Now, THE TAX EXECUTIVE; available at https://www.tei.org/Documents/TTE_ND13_Plowgian_BEPS.pdf (last

accessed on 31th August, 2016). 44 D P Sengupta, The Indian Equalisation levy, (23 March, 2016), TAX INDIA INTERNATIONAL, available at

http://www.taxindiainternational.com/columnDesc.php?qwer43fcxzt=MjQ1. 45

OECD, Action Plan on Base Erosion and Profit Shifting, ORGANISATION FOR ECONOMIC CO-OPERATION AND

DEVELOPMENT, (2013).

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to the recent acknowledgment by OECD that the traditional international tax infrastructure

put in place by the developed countries needs overhaul as business digitalization has lately

aggravated the BEPS concern in the regime.46

This system hitherto has worked in favour of

developed countries and most of these countries are therefore diametrically opposed to the

idea of changing fundamentals of the established structure.

The OECD also recognized that digital economy raises a range of other broader policy issues

related to taxation infrastructure, especially with respect to existence of nexus and

characterization. To redress and remedy these issues, multiple potential options were

discussed extensively and subsequently proposed in the report, namely:

Substantial economic presence as a new criterion for establishment of taxation nexus; or

Imposition of withholding tax; or

Equalization levy.

The report, however, does not recommend any of these options and merely suggests them as

alternatives that can be adopted by the countries. This approach of OECD can be rationalized

as an attempt to steer clear of any expectations that parties might associate from these

measures. Absence of such a precautionary measure might raise the possibility of

participating countries not only expecting it to mitigate the issues identified in digital

economy but also address broader tax challenges with it. Therefore the report tries to entrust

the countries with the choice to adopt any of the three stated options within their domestic

framework in the form of an additional safeguard, over and above the treaty obligations that

already exist.

The OECD, in its report, has not proposed the adoption of one of these options by the

participating countries, but has instead recommended continuous monitoring of the digital

economy till 2020.47

Deferring any concrete measure till a future date in 2020 can be ascribed

to the higher likelihood of a larger consensus amongst the concerned countries in this regard.

The OECD action plan does, however, provide three alternatives to countries, and it is critical

to examine the relative merits of each of these proposals.

1. The report proposes use of significant economic presence as a criterion for

establishing nexus, followed by consequent creation of taxable presence. Factors

46

Supra. n. 43. 47 Supra, n. 44.


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evidencing such economic presence should be something that demonstrates a

purposeful and continuous interaction of an entity with the Indian economy, through

modes like technology and automated tools. These factors need not necessarily meet

some high threshold and even revenue based or digital factors like local domain

name, local payment option and digital platform will suffice.48

An alternative for

determining such presence is by relying on user-based data like digital content

generated/received and number of users active on a monthly/quarterly basis.

However, even if the strict requirement of PE is watered down to form this loose

provision of significant economic presence, it will nonetheless require additional

modifications to be made to the domestic law as well as the other related treaties.

Moreover, without any substantial change to the norms governing profit attribution,

the increase in revenue generation would only be meager owing to very little profit

allocation to such economic presence.49

2. Another proposal pertained to withholding tax on a certain form of payments made

to the non-residents, for activities like provision of goods and services online. This

impost was not supposed to be introduced as an independent levy, but instead

charged from within the existing taxation structure. However, there exists difficulty

in tax collection procedure and enforcement of similar such rules. Furthermore this

option would not be feasible without any considerable modification in the existing

treaties, more so in the Indian context where withholding tax amounts to definitive

chargeability of the concerned income.50

3. The last alternative recommended imposition of an equalization levy; which was

eventually adopted by the Indian authorities as a part of the proposal under Chapter

VIII of the Finance Act, 2016. As per the OECD, this final proposal saves the

country from difficulties related to modification of rules to suit the nexus

requirement of significant economic presence. This report also acknowledged the

usage of this approach by a few countries already, but in a dissimilar manner. It is

used by and large as a measure to remove disparity that exists between the domestic

and foreign suppliers and ensure equal treatment to both. Although in India it seems

48 Committee on Taxation of E-Commerce, Proposal For Equalization Levy On Specified Transactions, CBDT,

DEPARTMENT OF REVENUE, MINISTRY OF FINANCE, GOVERNMENT OF INDIA (February 2016), http://www.incometaxindia.gov.in/news/report-of-committee-on-taxation-of-e-commerce-feb-2016.pdf (last

accessed on 31th August, 2016). 49

Ibid. 50 Ibid.

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to be enacted with the dual motive of (a) overcoming BEPS practices, and (b)

removing disparity that exists on the basis of residential status.

Conclusively, the report also cautioned the member countries about the probable conflicts

that the proposed options may have with certain existing trade agreements, particularly the

ones involving European Union. The report does not explicitly provide for existence of any

conflict in the Indian context, but a cursory perusal of certain major trade agreements seem to

suggest a few minor discrepancies, which shall be discussed under the subsequent heading. It

is in this backdrop that the budget 2016 has taken up equalization levy as the best alternative.

The inclusion of EL in the domestic law can be rationalized by envisaging the difficulty that

its incorporation in all the tax treaties would have caused.

NATURE OF LEVY: CLEARING THE MIST

An important aspect which draws one’s attention is the introduction of EL not as an

amendment to the IT Act, but instead separately as a distinct chapter under the Finance Act.

It’s true that it is not the first levy to have been introduced this way, and impositions like

Service Tax and Securities transaction tax have been previously brought in vide Finance Acts

of the year 1994 and 2004 respectively. However in this case, unlike before, it is effectively

the income that is being taxed. One argument for not introducing it as a part of the Income

Tax Act can be it being an imposition on the income of non-residents and not Indian

residents.

Divergent views exist with respect to the nature of this imposition. On one hand, where a case

can very well be made out calling this impost an income tax; there exist equal amount of

evidence, on the other, to prove it as a levy distinct and independent from Income Tax. This

section aims to highlight all the major substantive arguments that can be advanced in support

of both the prevalent views. This lingering uncertainty and ambiguity with respect to the real

nature of this levy necessitates a clarification or amendment from the government in the near

future.

Levy as an Income Tax

Section 164(d) of the Finance Act defines ‘equalization levy’ as the “tax leviable on

consideration received or receivable for any specified service”. The definition uses the term


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‘tax’ to characterize this levy, but Chapter VIII does not define the term ‘tax’;51

and Section

164 (j) provides that the terms or expression used under this chapter but not defined herewith

shall derive its meaning from the IT Act. Therefore, reliance should be placed on Clause 43

of Section 2, which defines Tax to mean “income-tax chargeable under the provisions of this

Act” amongst other meanings and interpretations. In simple words, for the purposes of IT

Act, Tax means income tax.52

Now with clause (j) providing that undefined terms in Chapter

VIII should derive its meaning from IT Act, ‘Tax’ here would also mean income tax. In light

of the imposition being unqualified, the levy cannot be restricted to mean something different

form income tax.

Had the legislature intended to give a different meaning to this levy, it would have defined it

so while framing the legislation. Legislature could have either defined the term itself

differently under Section 164, or could have made an addition to clause (j) along the lines of

“unless there is something in the subject or context inconsistent with such construction”.53

If

the latter alternative was to be adopted, one could have argued that in light of the context and

content of the charge the impost does not qualify as income tax. As there was nothing that

prevented the legislature from using such language, its absence could be construed to mean

an intended omission. Hence, as far as literal interpretation of this levy goes, it constitutes

income-tax. Furthermore, both these imposts i.e., equalization levy and income tax, function

in identical fields and are strongly intertwined. Assessment as well as the appellate authorities

is same for both the imposts and Section 178 of the Finance Act even list out various

provisions of IT Act which applies to equalization levy.

Reference made to double taxation under Section 10(50) of the IT Act54

further reinforces the

notion of this levy being Income tax. It is a widely settled fact that the concept of double

taxation creeps in only when the same income is charged twice, and that too under the same

statute. If the impost on the same income is flowing from two different statutes, then it will

not qualify as double taxation. The reason being, every legal framework has a different set of

reasons behind its promulgation and a different set of objects to be achieved. Reference made

to double taxation in the current context, therefore, indicates that income tax and equalization

51 Manish, Is equalization levy a tax?, TAXOF INDIA, (March 28, 2016); available at

https://taxofindia.wordpress.com/2016/03/28/is-equalisation-levy-a-tax/ (last accessed on 31th August, 2016). 52 Definitely including other kinds of taxes mentioned in the definition as well, but those taxes are irrelevant for

the current purposes. 53

Supra n. 51. 54 Inserted through Finance Act, 2016.

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levy are not capable of being imposed at the same time. This leads one into drawing the

inference that both the levies are one and the same.

Additionally, in lack of any other form of travaux préparatoires, one way to interpret the

legislative intent behind this levy would be to analyze the Finance Minister’s budget speech

with respect to the Equalization levy. The opening part of the 151st paragraph of the speech

makes it crystal clear that the intent of the legislature is to tap in on the e-commerce income

generated by non-resident units.55

The focus thus lies in taxing the ‘income’, and helps in

concluding that equalization levy in this sense is merely a variant of income tax.

Levy as an independent imposition

However, the aforementioned position cannot be the only conclusion drawn from the

analysis, and inferring an entirely contrary conclusion stands as an equally valid possibility.

This alternate conclusion points towards the equalization levy and income tax belonging to

different regimes altogether. Careful perusal of all the related provisions in Income tax Act

and the Finance Act helps one in framing certain arguments which further the said view,

namely:

Impost of this levy is via insertion of a separate chapter in the Finance Act. If both the

levy were indeed similar, the legislature would’ve covered it within the ambit of Income

Tax itself.

Chapter VIII of the Act seeks to create a new and independent code by itself. The said

chapter has everything including charging provision, collection related procedure and

penal measures that are triggered on failure to abide. The borrowing of some specific

provisions from income tax statute, enlisted under Section 178 of the Act, is merely a

device to strengthen this independent framework.

Liability with respect to the deduction and payment of equalization levy lies with the

Indian resident making remittances to the Non-resident service providers for the services

availed. The burden to timely deduct this tax and deposit it with the authorities lies also

with the residents making payment, and not the exchequer. Even the assessment and

penal measures are provided for against the payers, and payee merely acts as the stimuli.

55 Speech of Arun Jaitley, Minister of Finance, Notification No. : 2(9)/2016-B(D), MINISTRY OF FINANCE,

(February 29, 2016); available at

http://www.thehindu.com/multimedia/archive/02756/Budget_Speech_2756516a.pdf (last accessed on 31th

August, 2016).


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This non-resident payee owes no liability and stays unharmed by the tax collection and

compliance methods undertaken, in spite of being the income earner. This mode of

operation is unknown to Income Tax statutes, which never absolve the income earner

from tax liability. Similarly all the compliance measures are also enforced against the

income earners, unlike the case of equalization levy.

Although arguments advanced in favour of both the propositions sounds extremely plausible,

but in my personal opinion EL is more of an independent imposition, separate from Income

tax. Arguments made in favour of income tax largely place reliance on inferences drawn by

its conjoint reading with other statutes or giving undue emphasis to the omission made. On

the other hand, there are enough explicit evidences in favour of EL being an independent

imposition and there stands no need to draw any implication whatsoever. Therefore, there is a

need for pointed clarifications or amendments by the government that clears the lingering

ambiguity prevailing over this aspect of the levy. The present uncertainty over its nature only

opens the door to a plethora of other related and unanswered questions.

APPRAISAL OF THE LEVY

At this initial stage, EL is proposed to be imposed only on business-to-business transactions

[B2B] and not business-to-consumer transactions [B2C].56

Section 164 (h) of the Finance Act

defines these specific services as online advertisement, providing digital advertisement space

etc. However, this section also entrusts the government with power to expand its ambit by

notifying inclusion of other services.57

The government even holds the power to include

within the levy’s ambit e-commerce transactions like downloading of movies, albums and

books, software downloads, online news consumption and online sale of other goods and

services. There is a range of varied services which can easily be subject to this proposed levy,

whose implementation will not even require any infrastructural changes.

This excessive power entrusted with the government although might be well intentioned, but

there also exists high possibility of its negative consequences. In this light, certain similar

instances form the past are worth mentioning. As mentioned already, Service Tax was also

introduced in a similar fashion in India via Finance Bill, 1994.58

When introduced, it was

levied on merely three services at the rate of 5%. Contrast this with the current regime of a

56 Lakshit Desai, Equalization levy – a step towards taxing digital transactions, [2016] 71 taxmann.com 44,

(June 2016); available at https://www.taxmann.com/articles.aspx (last accessed on 31th August, 2016). 57

Supra, n. 7, Section 164. 58 Supra, n. 7, Chapter V.

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12.5% imposition and the presence of a negative list.59

It is not farfetched to imagine the

equalization levy also progressing in a similar fashion.

Additionally, owing to the uncertainty which looms over the reaction of the digital giants to

this levy, it is speculated that the brunt of the levy will be faced by the small and medium

sized businesses and the newly growing market of startups. These entities place high reliance

on forums like Google, Facebook and Amazon for the purpose of advertising their goods and

services.60

A key factor for which these forums are popular with small and medium

businesses is the ease with which the targeted audience can be reached through them,

eliminating the huge investment in advertisement. However, through the new levy, these non-

resident digital giants are highly likely to increase the price at which they offer services so as

to accommodate the imposition.61

This new proposal, therefore, seems to be harming some

businesses in more ways that it is benefitting a few.

For example let’s assume that before the imposition of this levy, a particular service was

provided by Google at Rs. 2,00,000. With the introduction of 6% equalization levy, Google

would only be receiving Rs. 1,88,000 as reimbursement its services. In order to make up for

these lost revenues, Google will start charging around Rs. 2,12,000 thereby leading to an

increase in cost for small resident businesses. This does not impact the revenue generation of

the non-resident companies. As a consequence, even though the intention behind imposition

of this levy was taxing the big online companies, in effect it is turning out to be a cost for the

small businesses which rely on these forums for advertisement purposes.

The legislators have carved out an exception whereby if the net proceeds remitted by an

Indian resident do not exceed Rupees 1 Lakh in a financial year, then levy would not be

imposed. 62

However, this provision does not seem to hold much practical relevance. As

exemplified above, the implementation of this levy is highly likely to lead to an increase in

the fees charged by these companies. Therefore, all the service subscribers across the board

59 Dinesh Agarwal & Ankit Shah, Service Tax Changes: Effective 1 April 2016, MONDAQ, (5 April 2016);

available at

http://www.mondaq.com/india/x/479844/sales+taxes+VAT+GST/Service+Tax+Changes+Effective+1+April+2

016 (last accessed on 31th August, 2016). 60 Dipak Mondal, Equalisation Levy: Google, Facebook unlikely to foot the bill, BUSINESS TODAY (June 1,

2016). 61 Karnik Gulati, Equalisation Levy: A toothless taxing tiger, (March 16, 2016), TAXNEWS; available at

http://www.tax-news.com/articles/Equalisation_Levy_A_toothless_taxing_tiger__573442.html (last accessed

on 31th August, 2016). 62 Supra, n. 7, Section 166.


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will have to pay more and the cost of doing business in digital India will go up even for the

people paying less than Rupees 1 Lakh.63

This argument of price increase has to be understood with some amount of caution as it is

based on two assumptions. At the primary level it is being assumed that the non – resident

service providers would increase the price as an attempt to make up for the lost revenue.

Further, there is a second assumption that the price determination power lies with the service

providers themselves, and not with the market forces.

On the brighter side, there are some domestic players like the indigenous e-commerce

companies that this equalization levy would be helping. Earlier these E-commerce websites

used to charge commission fees for listing the products on their websites. But this fee has

slowly been phased out, and most of these e-commerce websites now generate revenues

merely off advertisements from their respective merchants. With the implementation of

Equalization levy, while the foreign services providers would be forced to either increase

their prices or take a hit in any other manner, these resident online websites like Flipkart and

Snapdeal will remain unaffected.64

The bargaining power, however, will still lie with the

Resident merchants who list on these websites. They should be encouraged to prefer domestic

websites over the other alternatives, both because they are cheaper as well as indigenous.

LACUNAE IN THE PROPOSED SCHEME

Foreign tax credit availability

A glance at the foreign trade credit clauses of the various bilateral tax treaties, to which India

is a signatory, sheds light on the ambiguity that exists in this regime. Substantial uncertainty

lingers over the issue of whether the non-residents, who have paid equalization levy in India,

can claim credit from their respective country of citizenship for the amount paid as the levy.65

This issue can be better understood through the example of the India-US tax treaty. Article 2

of the treaty defines “tax covered” and covers within its ambit “any identical or substantially

similar taxes”.66

Article 25 of the treaty titled ‘Relief from Double Taxation’, lays down that

“U.S. shall allow to a resident or citizen of the US, as a credit against the US tax, on income

63 Shrutika Verma, India’s Google tax may raise costs for Indian units of global firms, LIVE MINT, June 1, 2016. 64 Remy Nair, More digital transactions may come under equalization levy’s ambit, LIVE MINT, March 30,

2016. 65 Deepak Goel, Equalisation Levy – Is it a beginning of a new saga?, TAXMANN, [2016] 71 taxmann.com 195. 66 Convention Between The Government Of The United States Of America And The Government Of The

Republic Of India For The Avoidance Of Double Taxation And The Prevention Of Fiscal Evasion With Respect

To Taxes On Income, art. 3, 20th Dec, 1990, Notification No. GSR 990(E).

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tax paid to India”.67

It further provides that “the taxes referred to in paragraphs 1(b) and 2 of

Article 2 (Taxes Covered) shall be considered as income taxes”.

The simultaneous reading of these provisions i.e., Article 2 and 25 of the India-U.S. treaty,

brings to fore the possibility of other countries granting credit to its citizen for paying taxes

that are identical or substantially similar to income tax. Equalization levy, even if not a tax on

income, is substantially similar to income tax and the U.S. government might therefore give

credit to its citizen for the levy paid by him in India.68

Additionally, clauses like Article 2 and

25 are not merely limited to the India-U.S. tax treaty and are rather omnipresent; implying

that the same benefits can be reaped by the residents of other countries as well. No

clarification has been issued by either the finance ministry or CBDT in this regard and hence

the problem continues to persist.

Brand promotion activities

This is a critical area which might attract a lot of litigation in future. The current framework

provides no clarity on the imposition of this levy on brand promotion activities which the

parent company, not having a PE in India, might render to its Indian subsidiaries. One of the

biggest losers to this underlying uncertainty would be the big brands, which have worldwide

presence and promotional activity are centrally undertaken by the holding company, followed

by cost allocation to each such subsidiary.69

Similarly, even a significant chunk of the service

fee charged by online stores like Amazon and Flipkart might fall within the ambit of

equalization levy, as the fee charged by these digital marketplaces is already inclusive of

brand promotion charges.

For the purpose of resolving this problem, an easy way out for the government can be tagging

these services as advertisements and bringing them within the ambit of the levy, followed by

waiting for years of litigation to finish and courts finally reaching a conclusion. However, a

few fallouts to this approach would be loss of foreign taxpayers’ confidence and negative

impact on the ‘Digital India’ initiative. Therefore, the better option for the government is to

preempt this problem and define ‘services’ covered in a manner that is more inclusive, yet

67 Ibid, art. 25. 68 Supra, n. 65. 69 Neeraj Sharma, Whether Equalisation Levy is an Effective tool to tax enterprises with digital presence in

India?, [2016] 69 taxmann.com 89; available at https://www.taxmann.com/articles.aspx (last accessed on 31th

August, 2016).


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flexible.70

Composite agreement covering multi-jurisdictional provision of advertisement services

Ambiguity persist with respect to valuation of the consideration paid in lieu of services

provided in India, when the said contract pertains to a composite agreement involving

provision of services in India (inclusive of J&K) as well as abroad. Equalization Levy Rules,

201671

failed to bring clarity in this regard and thus difficulty would arise in separating the

amount charged for services in India (exclusive of J&K) as against the amount for services in

other countries and J&K. Furthermore, there is lingering uncertainty even with regards

valuation of the amount on which levy is to be calculated if consideration paid is in non-

monetary form. As “measure of value” is considered as an essential component of a tax

alongside nature, rate and individual being taxed,72

clarity in this respect is vital.

In addition to other criticisms and controversies, certain fundamental jurisdictional issues also

plague the current proposal. It is widely accepted as a settled principle in taxation

jurisprudence that legal fiction cannot be accepted as a basis for determination of

international income tax jurisdiction.73

However, the government can be said to be resorting

to this legal fiction for invoking Indian jurisdiction when they are deeming the online

advertisement spending of Indian residents to mean an actual activity in India by the non-

resident recipients of the payment.

The issue as it stands today, is whether a mere change in phraseology can alter the nature of

this otherwise ultra vires levy into a rightful exercise of jurisdiction, under the general

principle of international taxation law. Furthermore, if similar levies are imposed by other

market jurisdictions as well, then the consequential aggregate over-taxation that is likely to

result would be extremely regressive. However the Report of the Committee on Taxation of

E-Commerce74

found no possible errors with this approach.

CONCLUSION

While EL is a commendable attempt towards recovering the revenue which otherwise gets

lost owing to limitations in the taxation infrastructure, it would not be erroneous to assert that

70 Ibid. 71 Supra, n. 15. 72 Govind Saran Ganga Saran v. Commissioner Of Sales Tax, 1985 AIR 1041. 73 This principle was clearly stated by the Indian Supreme Court in Vodafone International Holdings v. Union of

India, (2012) 6 SCC 613. 74 Supra, n. 48.

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its indirectness is highly likely to impact the small and medium level businesses and startups.

This levy, passed under the influence of OECD Action Plan, seems to have been introduced

in a rush and requires a comprehensive reassessment to achieve its desired objective.

Considering the significant economic dimension of this levy, as has been elucidated in the

second part, this source of revenue should not be left untapped; but in its current shape it will

only increase litigation and further burden the overburdened judiciary.

Memorandum attached to the Finance Bill makes its exceedingly clear that EL derived its

inspiration from the OECD Action plan, wherein it was proposed as one of the ways to tax

‘economic nexus’ which otherwise goes untaxed under the existing structure. In spite of the

introduction of EL in domestic taxation framework, the legislature has failed to clarify how

the said ‘economic nexus’ is justified by this imposition. In addition, low threshold of Rs. 1

Lakh makes its ambit rather wider and covers even those transactions whose economic nexus

to India is rather flimsy.

Furthermore, nothing in the budget speech, the Memorandum to the Finance bill or the

committee report justifies the adoption of EL, as opposed to other alternatives, as the most

suitable mode of taxing these overseas online transactions by the government. The raison

d'être behind this imposition therefore remains unclear. Moreover, clarification regarding the

nature of this levy becomes imperative in light of the multilayered ambiguity that exists,

especially with respect to the phraseology used by legislature. Even though Part V of the

paper attempts to collate equally plausible arguments advanced from both the factions, but

evidentiary balance tilts towards it being an independent imposition for the reasons already

discussed. However, till the issuance of an official clarification, these claims would qualify as

mere speculations.

In addition there are a few lacunas in the proposed scheme,75

with respect to the availability

of foreign tax credit, ‘measure of value’ and assessment of centrally undertaken brand

promotion activity, which require immediate attention to provide some semblance of

certainty. Because even after these fundamental challenges are overcome by the government,

a string of smaller issues would arise during the actual implementation of the levy, which can

only be redressed over the course of time.

75 As flagged off in part VII of the paper.


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Conclusively, this act of government is neither in line with tax competitive measures, which

is the need of the hour for any developing economy, nor does it help boost investor

confidence by providing a more stable taxation regime. Instead, it is likely to divert the focus

of government from more important issues such as non-adversarial tax regime and a few

other problems flagged under the OECD action plan; with no attempts being made to attract

the government’s attention back to these important issues. Aspects like ‘limitation of interest

deduction’, ‘disclosure of abusive arrangements’ and ‘hybrid mismatch arrangements’

requires adequate attention in the recent past nor can the inclusion of transfer pricing

regulation in the domestic framework be deferred for longer.

Therefore, this step towards equalization levy is being welcomed by the community with

further hope that the determination of the government towards reforming the extant structure

would not diminish in spite of pressure from different quarters, and the aforementioned much

needed follows in line.