Equalisation Levy: Effective Implementation of New Provisions

Background

In the world of digital transformation, digital presence is increasing where entities are supplying goods or services globally without having any physical presence. In India, digital market has expanded immensely over the years. The growth of digital market is getting strong impetus as a consequence of COVID-19 pandemic. In digital transactions, it becomes difficult for revenue authorities to clearly establish relationship between the source of income, and the geographical location on the one hand, and profit allocation for levy of income tax, on the other.

The Organization for Economic Co-operation and Development (OECD) proposed certain options in Base Erosion and Profit Shifting (BEPS) project under Action Plan 1 to resolve this challenge of levy of income tax.

OECD made proposals only for foreign trade providers, without a PE, making remote sale of digital goods or services to the in-country customers. The three tax proposals made by OECD were as under:

Subsequently, the CBDT introduced concept of Equalisation Levy (hereinafter referred as ‘EL’) in Chapter VIII of Finance Act, 2016. Equalisation Rules, 2016 were also notified in May 2020. Equalisation Levy is governed by Finance Act, 2016 and it is not a part of Income Tax Act, 1961.

Scope of Equalisation Levy (EL)

EL is applicable only to consideration received or receivable by NR. EL is not applicable to residents. When EL was introduced in 2016, it was charged on Specified Services provided by NR. Later, Finance Act, 2020 introduced charge of EL on E-commerce transactions undertaken by NR e-commerce operators. The amendment was not proposed in Finance Bill, 2020 presented on 01st February, 2020, but was directly introduced in Finance Act, 2020. So, this new provision came as a surprise for the taxpayers.

‘Specified Services’ covers online advertisement including provision of digital space, facility or service for online advertisement, or any other service as notified by Central Government. However, no service is yet notified for this purpose.

‘E-commerce transactions’ covers following types of e-commerce supply or services:

• (a) Online sale of goods or provision of services owned by e-commerce operator;
• (b) Facilitation by e-commerce operator for online sale of goods or services.

‘E-commerce operator’ means a NR who may own, operate or manage digital or electronic facility or platform for online supply of goods or services. If e-commerce operator hires and manages online platform instead of owning it, then also e-commerce transactions shall attract levy.

Applicability of EL: Comparative Analysis

The provisions for the applicability of EL in both types of transactions are as under:

In case of Specified Services, onus for collection and payment of levy is on service recipient. This provision has a drawback that NR are not willing to take burden of EL and recipient ultimately bears such EL which results in additional costs to service recipients.

In case of e-commerce transactions, onus of payment is on NR e-commerce operator only.

If EL is not charged on any transaction of specified service or e-commerce supply or services as per provisions of Finance Act, 2016, then provisions of Income Tax Act shall continue to apply.

Other Relevant Provisions of Equalisation Levy

Other relevant provisions of EL which are common for both transactions are:

Impact under Income Tax Act and DTAA

1. Income Exemption u/s 10(50)

In order to avoid double taxation, section 10(50) is introduced from 01-06-2016, to exempt the income arising from specified services on which EL is charged.

Finance Act, 2020 amended this provision to also exempt income arising from e-commerce transactions on or after 01st April, 2021. EL shall be charged on e-commerce transactions from FY 2020-21. However, exemption u/s 10(50) is provided from FY 2021-22. Therefore, e-commerce transactions shall be covered under EL and Income-tax both for FY 2020-21, which results in double taxation. It seems that there is an error in this provision and CBDT may come up with clarification soon.

Another issue is as income from such transactions is exempt in hands of NR, revenue authorities may take a view that related expenses shall not be allowed u/s 14A of the Act and determination of such expenses would be a challenging task.

2. Non-deduction of Expense u/s 40(a)(ib)

As per section 40(a)(ib), if EL is not deducted on specified services or deducted but not paid before due date of filing return of income, consideration shall not be allowed as deduction to assessee. However, such deduction shall be allowed in the year when EL is actually deducted and paid.

3. TDS u/s 194-O

Finance Act, 2020 introduced new TDS provision u/s 194-O. Although this TDS provision does not have direct nexus with Equalisation Levy, but as it is linked with e-commerce transactions, provisions are discussed herewith:

4. Significant Economic Presence (SEP) u/s 9

Finance Act, 2019 introduced Explanation 2A to section 9(1)(i). As per the provision, ‘significant economic presence’ of NR in India shall constitute ‘business connection’ in India. It also defined SEP for this purpose. Finance Act, 2020 amended the definition of SEP. The application of the provision is deferred till FY 2021-22.

5. Insertion of Explanation 3A to Section 9(1)(i)

Finance Act, 2020 inserted an Explanation 3A to section 9(1)(i) which shall be effective from FY 2020-21. The provision is reproduced herewith –

There seems to be an overlapping of provisions of Explanation 3A and EL. The charge of EL is an exclusive provision irrespective of its taxability under Income Tax Act. So, if any transaction gets covered under provisions of Equalisation Levy, it shall attract charge of EL and NR shall be able to take benefit of exemption u/s 10(50).

In case of specified services, EL is not applicable if recipient is NR and does not have PE in India. In such cases, if transactions gets covered under clause (i) of Explanation 3A, then it shall be governed by the provisions of Income Tax Act, 1961.

6. Double Taxation Avoidance Agreements (DTAA)

As Equalisation Levy is not a part of Income Tax Act, 1961 benefit of DTAA is not available for such EL in India. However, NR may receive Foreign Tax Credit of such EL in its resident country according to its domestic taxation law.

Manner of Charge and Payment in Case of Specified Services

Specified Services shall cover online advertising of products or services on portals like Google, Facebook, etc. As per section 165, 6% EL is charged on amount of consideration received or receivable by such NR. As per section 166 of the Act, the service recipient shall deduct EL from consideration paid or payable. This provision is similar to TDS in Income Tax. On failure to deduct EL, the service recipient shall have to pay EL from its own pocket. After deduction of EL, the payer shall pay net amount of consideration. NR-supplier shall not get any credit of such EL.

(i) Concept of Grossing Up

Usually Indian entities pay full amount of consideration to NR and EL is borne by them. The issue arises is whether the consideration paid shall be grossed up for charge of EL or not, i.e. it shall be deemed that consideration is paid after deduction of EL. In example 1, if ABC Ltd. pays entire consideration amount of INR 113,430 to Facebook, then as per concept of grossing up, it shall be assumed that consideration is paid after deduction of EL @ 6%. Accordingly grossed up consideration amount shall be INR 120,670 (113,430 / 94%). Therefore, EL shall be INR 7,240 (6% on INR 120,670).

There are two views for grossing up of consideration. One view is that as per section 166, EL is to be deducted and net consideration is to be paid. So, for any consideration paid or payable, it shall be construed to be paid after deduction of EL. Further as per section 165, EL is charged on consideration received or receivable. Therefore, grossing up is required to be done on consideration amount and EL is to be charged accordingly.

Another view is that EL is direct charge on consideration. The provisions of deduction of EL is merely a procedural mechanism developed for collection of EL. As per section 166(2) of Finance Act, 2016, if assessee fails to deduct EL, then he is liable to pay such EL from his own pocket. Further under Income Tax Act, 1961, while computing TDS in such cases, there is specific provision u/s 195A for grossing up. However, there is no such provision in Chapter VIII of Finance Act, 2016.

Prima facie, both views appear correct. However, the first view of grossing up of consideration seems to be more appropriate as section 166 clearly specifies to deduct EL from consideration paid or payable. However, any clarification from CBDT would be appreciated.

(ii) Impact of Foreign Exchange Fluctuation

EL is charged as soon as consideration is paid or becomes payable. In example 1, consideration becomes payable on 29-05-2020 which may become due depending upon the credit period. Once consideration becomes payable, EL is charged on consideration and it becomes payable by assessee. Such EL becomes due to be paid by 7th day of subsequent month. EL is to be computed by considering forex rate on the date of consideration becoming payable, i.e. 29-05-2020 in example 1. Some assesses compute EL by applying forex rate on the last day of month for aggregate of all transactions made during the month which is also, appears, an acceptable practice. Hence, forex rate on the date of actual payment is immaterial.

Manner of Charge and Payment in Case of E-Commerce Transactions

E-commerce transactions shall cover online sale of goods or provision of services by any NR through its portal. It also covers facilitation by NR for such transactions by any person. For example, Amazon, Alibaba, Netflix, Trivago, etc. shall be covered under this provision.

As per 165A, EL @ 2% is charged on consideration received or receivable by NR from online supply made or facilitated by it. As per section 166A, NR e-commerce operator shall be liable for deposit of EL. There is no liability for any payment or compliance on the buyer, recipient or consumer in this case. Consequently, question of grossing up shall not arise. EL shall be charged on consideration amount, i.e. before addition of indirect taxes. Further NR shall not collect EL from its recipient of goods or services. EL is a direct charge on consideration amount and has to borne by NR.

In example 2 and 3, NR e-commerce operator shall have to deposit EL by 07-07-2020 and provisions for date of charge of EL and forex fluctuations shall remain same as discussed in case of Specified Services above.

Challenges in Case of E-Commerce Transactions

There are various challenges in implementation of provision for charge of EL on ecommerce transactions:

In the case where goods are sold by NR e-commerce operator to any resident person, EL is charged. In such cases, resident person shall not be required to withhold tax u/s 195 as such income shall be exempt u/s 10(50). The issue is that by what means NR e-commerce operator shall be able to identify that the buyer is resident or non-resident. Similarly, resident person shall also be required to identify that e-commerce operator is NR and has paid EL. To overcome this situation, if resident person deducts tax u/s 195, then NR e-commerce operator may have to claim refund of such TDS. If any declaration is provided for residential status by e-commerce operator to buyer and vice versa, then the question arises is that whether such declaration would hold good in assessment proceedings or not.

Further EL is to be charged if recipient who buys goods or services is using IP address located in India. Hence, if any person, whether resident or non-resident uses IP address which is not located in India, then EL is not to be charged. In order to comply with such provision, NR e-commerce operator has to develop their systems in a way to track location of IP address through which transaction has taken place, keep a record of the same, bifurcate transactions on the basis of IP address and compute EL at the end of every quarter.

When e-commerce operator and recipient both are NR, EL is charged only for two specific circumstances as stated earlier. In such cases, also, both the above issues shall arise.

Concluding Remarks

The government is keen to tax the income of business running through digital platforms. Although the expansion of Equalisation Levy may result in increase of tax revenue, but its implementation has several challenges. Further the amendment in section 9 of Income Tax Act also has a larger impact. When the economies of world and India are already struggling over COVID-19 pandemic period, EL results in additional tax burden to NR. As huge revenues are earned by e-commerce operator in India, it would be interesting to see the figures of year-end revenue collection of Equalisation Levy.

With complexities revolving around new provisions of EL, reports also suggests that certain foreign e-commerce operators are evaluating to establish entities in India. It is expected that revenue authority may reconsider contentious aspects of Equalisation Levy and amendments to section 9 and issue necessary amendments or clarifications in this regard. ∎∎∎