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Taxes without borders: Govt revises tax on digital transactions, but ambiguities remain

The expanded levy could address the drop in government revenues due to Covid, but the govt must clarify its applicability and enforcement mechanisms.

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The Narendra Modi government in March this year passed the Finance Act, 2020, which included a change to the equalisation levy, a charge on specified digital transactions. First introduced in 2016, the rate of this levy was six per cent, but was limited to online advertisements. But according to the latest amendment, a levy of two per cent will now be charged on gross payment “received or receivable by an e-commerce operator from e-commerce supply or services made or provided or facilitated” by such an operator.

This expanded levy surprised the tech industry as it wasn’t part of Finance Minister Nirmala Sitharaman’s annual Budget 2020 speech in February. While the revised levy appears to be a creative response to the sharp drop in government revenues due to the Covid-19 pandemic, the intent is long-standing and deliberate.

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History of the levy

The levy was first introduced to ‘equalise’ the tax burden between domestic businesses that are subject to the Income Tax Act, and their foreign counterparts that are not. The levy was classified as a transaction-based tax and not a tax on income, to ensure that India’s international obligations were not violated. Similar transaction-based levies also include the Security Transaction Tax (STT) and Service Tax.

International taxation principles were first formulated in the 1920s, but are now outdated in the digital-first world. It is in this context that more than 135 countries, including India, agreed to define new principles under the aegis of the Organisation for Economic Cooperation and Development (OECD). However, despite these efforts, a global consensus remains elusive. Countries like France, Spain and the United Kingdom have introduced unilateral measures that are primarily aimed at taxing global tech giants. India’s response has been no different.

In 2016, the Modi government first introduced an equalisation levy of six per cent on online advertising revenues, based on recommendations made by the Committee on Taxation on E-Commerce. Subsequently, the Finance Act, 2018 introduced the concept of Significant Economic Presence (SEP) to the Indian Income Tax Act, 1961. SEP incorporates a new digital nexus to tax business profits of foreign businesses, based on revenue and local user-based thresholds. This new digital nexus rule is yet to come into effect.

Such unilateral measures to tax digital players are perceived as instruments to target American companies. France’s decision to introduce a digital service tax (DST) sparked off trade tensions with the US. In retaliation, President Donald Trump threatened to impose tariffs on French wine. India’s equalisation levy does not appear to be targeted at a particular jurisdiction, but it still leaves several questions unanswered.

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Broad application

A primary concern with the expanded equalisation levy is its wide scope. According to the Finance Act, the e-commerce supply and services on which the levy is applicable includes (a) online sale of goods owned by the e-commerce operator; or (b) online provision of services provided by the e-commerce operator; (c) online sale of goods or provision of services or both, facilitated by the e-commerce operator.

The term e-commerce operator has been defined as a non-resident “who owns, operates or manages a digital or electronic facility or platform”.

This wide-ranging and imprecise definition has caused a lot of confusion. For example, will transactions between two residents, facilitated by an e-commerce operator, be subject to this levy? Or will transactions between two non-residents, say a foreign traveller paying her home cable bill when on holiday in India, using an Indian IP address, be similarly taxed? Such concerns are valid and require clarification.

However, the presumed intent of the expanded levy is to ensure that a consideration paid by an Indian resident, either directly or indirectly, to a non-resident e-commerce platform is subject to this levy. Additionally, a consideration earned by a non-resident e-commerce platform for facilitating an economic transaction between residents, as in the case of e-commerce marketplaces, is also subject to this levy. The Modi government would do well to spell out its intent clearly by using specific language. This would remove the scope for confusion and subjectivity, and potential overreach by tax officers.

In fact, the Committee on Taxation of e-Commerce had emphasised that equalisation levy should be limited to payments made for listed intangible services. It recommended that the levy be imposed on 13 specified categories of payments, including online advertising and web hosting services. The Committee acknowledged the importance of a taxable nexus in India. In other words, such services are either received, utilised, provided or performed in the country. Such clarity is absent in the Finance Act, 2020.

A broad application of a tax on digital players is in contrast to similar measures enacted in other countries. The UK DST only covers activities of online advertising services, search engine services, and online marketplaces. France’s DST covers provisions of digital interfaces that enable users to interact with intermediary services, online advertising services — particularly activities consisting of targeted advertising, and transfer of users’ data for advertising purposes.

Undue Tax Burden

Critics have pointed out that the 2016 equalisation levy has placed an undue burden on Indian start-ups and MSMEs, because of how closely it resembles an indirect tax. A critical distinction between direct tax and indirect tax is that the former is levied on an individual’s income, while the latter is imposed on the transacted, taxable value, and passed on to the end consumer (such as the GST).

Since the equalisation levy is akin to an indirect tax, it is easier for a non-resident to pass on the burden to Indian consumers. This problem is likely to persist even under the expanded levy, and will lead to an unequal tax burden on domestic consumers and businesses — the opposite of its presumed intention.

Compliance and reporting requirements

Under the 2016 equalisation levy on online advertising, the resident payer is responsible for deducting the levy from the amount paid or due to the non-resident, because of enforcement limitations. A non-resident entity may not fall within the ambit of Indian laws and procedure. Consequently, such an entity can evade the charge without liability.

The expanded levy, in contrast, imposes compliance and reporting obligations on a non-resident e-commerce operator. However, it is unclear how such mechanisms will be put in place. The deduction of levy at the payment gateway. is an option that was proposed by the Committee on Taxation of e-Commerce. In other words, payment gateways like Billdesk, Paypal and others will be obliged to deduct expanded levy on specified transactions. However, due to technological constraints, this option has not been formally recommended.

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Towards effective implementation of expanded levy

The Modi government is facing a revenue shortfall as it battles the Covid-19 crisis. It is natural that it will explore all possible means to widen its tax base and prevent avoidance. That said, the government must make concerted efforts to remove uncertainties that arise from the expanded levy.

The Ministry of Finance may defer the expanded levy’s implementation until September, according to media reports. This would provide the government enough time to clarify the expanded levy’s applicability and enforcement mechanisms, as well as engage with industry experts to formulate operationalisation rules. This would result in an unambiguous and compliance-friendly framework, which will allow the Modi government to achieve its policy objectives.

Most importantly, it will strengthen the government’s ability to constructively participate in the global effort to tax the digital economy via a universally applicable framework.

The authors work at Koan Advisory Group, a technology policy consulting firm. Views are personal.

This article is part of ThePrint-Koan Advisory series that analyses emerging policies, laws and regulations in India’s technology sector. Read all the articles here

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