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Rashmin Sanghvi & Associates

Chartered Accountants

220, 2nd Floor, Arun Chambers,
Tardeo Road,
Mumbai - 400 034,
Maharashtra, India.

Tel. Nos.: (+91 22) 2351 1878, 2352 5694.

Fax : (+91 22) 2351 5275.

Email : [email protected]

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Tax Burden & other issues



V. Equalisation Levy – Tax Burden & other issues


CA Rashmin Chandulal Sanghvi

V.1 Logic for Equalisation Levy:

COR & COS distribution of tax on E-Commerce:

1.1 Equalisation Levy, the law is simple in understanding, compliance & administration. But the logic behind Equalisation Levy is a very involved and complex issue of international taxation. OECD has been discussing the same for last 20 years and still has not come to any conclusion. Government of India appointed High Powered Committee which gave its report in July, 2001. The committee clearly stated that “The existing rules of international taxation are inadequate to deal with E-Commerce taxation.” However, India alone cannot change OECD or UN model of Double Tax Avoidance Agreement (DTA). Hence further progress could not be made.

1.2 Britain, France, Germany, Australia etc. countries are also seriously concerned that E-commerce companies collect massive revenue from their territories and pay no tax. How is it that so many country tax departments are frustrated over certain tax issues? Explaining this issue can take a lot of time. I will be brief.

1.3 Indian Income-tax Act, as well as the Income-tax laws of several countries; and the OECD plus UN Models of Double Tax Avoidance Agreements (DTA) are based on a tax structure which is almost 100 years old. There are several systemic weaknesses in the structure. For the present, I am focusing only on one weakness: The Government of a country (let us take India as the illustration) cannot tax the business income of a non-resident of India unless the non-resident has a permanent establishment in India. Permanent Establishment (PE) concept is also a 100 years old concept. It was developed when it was impossible for anyone to do business in another country without setting up a branch, factory or sales office – a physical, fixed place of business. Hence the concept of PE has been defined as a fixed place of business. (There are several clauses in the definition of PE. However, I am focusing only on the relevant issues.)

Now with the convergence of multiple technologies of computer, mobile phone, television and internet; global business without having a PE is practical. This business is called E-Commerce. And E-commerce business is growing very fast. No Government can afford not taxing E-commerce business.

1.4 If a Government wants to tax a non-resident E-commerce company, it has to amend its own domestic tax law as a first step. However, unless and until the DTA model is changed, the domestic law amendment has no impact. This is because, the Double Tax Avoidance Agreement (DTA) will override domestic law. To make it simple, let us consider an illustration:

1.5 A company named MNC is a non-resident of India. It has set up its registered office in a tax haven. Its entire computer – hardware and software is installed in the tax haven. Its website operates from the tax haven. On its website, the MNC provides entertainment programmes like music, literature, art and other popular materials. Internet surfers from around the world visit the website. Hence advertisers from around the world publish their advertisements on the MNC’s website. Let us say, Indian advertisers and internet surfers together pay every year Rs. 100 crores to MNC. Under the current liberalised FEMA, these remittances will go through bank or credit cards without any hindrance.

If Indian Income-tax officer wanted to tax the MNC on its revenue of Rs. 100 crore, the MNC would challenge the demand stating that India has no jurisdiction to tax it under the Indian Income-tax Act. Even if Indian Parliament amends the Income-tax Act, the MNC will take protection under DTA. In short, unless and until, the DTA is amended, India would not succeed in taxing the MNC.

(Illustration completed.)

1.6 OECD did not accept this reality as late as in the year 2010.

When the American financial crisis erupted in the year 2008, suddenly Governments around the world realised that this kind of tax avoidance cannot be tolerated. Britain, Germany & France were strong critics of tax avoidance. USA of course took unilateral steps to curb avoidance & evasion of US taxes. To curb all kinds of tax evasions and tax avoidance, in the year 2013; “Group of 20 Countries” (G20) and OECD appointed several groups of experts under the broad name: “Base Erosion & Profit Shifting or BEPS”. This is when OECD accepted that “The existing rules of International Taxation are inadequate to deal with E-Commerce.”

One may appreciate that G20 and OECD considered the tax avoidance by E-commerce companies to be the most important priority. The BEPS Action 1 report was named: “Addressing the Tax Challenges of the Digital Economy”.

The term “E-Commerce” is a mercurial term. The technology and the ‘technology based business’ are so rapidly evolving that yesterday’s definition becomes outdated today. OECD used the term E-commerce from the years 1997 till 2013. However, since the mobile business challenged the old definition of E-commerce, they have adopted a broad term “Digital Commerce”. I am pretty sure that even this term will be outdated soon. I am continuing to use the term “E-commerce” only for the reason that it has become a popular term. It broadly indicates that – “A company resident in country COR is doing business with residents of other countries (COS) and the Company A does not need permanent establishment in COS.

1.7 Is it not surprising that while BEPS Group 2 to Group 15 have already published their recommendations, Group 1 – the most important group has not been able to give any recommendation?

If you consider it deeper, you will find the reason to be very simple. As on today, most of the E-commerce MNCs are residents of USA. Today these companies avoid taxes in the “Countries of Source”- from where they earn revenues. If other Governments start taxing these MNCs, USA Government’s share of tax will go down. Hence USA opposes any modification in the DTA models. And when USA opposes something, it is not surprising that nothing happens for 20 years or more.

1.8 The international taxation on E-Commerce position at present is that COR will get total tax revenue. COS has to just forget taxing the MNCs. This is Gross Injustice. Somehow the critics of EL ignore this injustice. They can’t come out of (i) Interpretation Box; and (ii) OECD parameters box. Equalisation Levy is India’s attempt to ensure that even COS gets a share in the tax on profits earned by E-Commerce MNCs.

Conclusion of the situation discussed so far is that the OECD and UN Models of DTA may not change any time soon. This means that India cannot levy Income-tax on the E-commerce MNCs. Hence we have to find a way outside the Income-tax Act. Hence Equalisation Levy is outside the Income-tax Act. Double Tax Avoidance Agreements are not applicable to Equalisation Levy. It would be better if The Parliament made a specific provision within Chapter VIII that DTAs won’t be applicable to EL.

Equalisation Levy has been designed in the circumstances where existing rules of international taxation are outdated; and the global vested interest lobbies do not allow the OECD to change the rules.

V.2 Tax Burden:

2.1 Main criticism of EL is that the tax burden and compliance burden are cast upon the Indian Resident. The foreign seller of goods and services actually does not suffer the tax.

It is possible to shift the Burden to the Non-Resident. At present there is inadequacy of logistics within India. Clear target should be:

(i) Payment:

Equalisation Levy (and even other taxes) should be paid by the targeted assessee; and not by Indian Resident Consumer. Who ultimately bears the tax will depend upon the bargaining power of the parties. But Government should provide for a legal and logistical mechanism so that the Non-Resident pays the tax.

(ii) Compliance with Return filing etc.:

All responsibilities for filing tax return, assessment etc. should be cast upon the targeted assessee. The payer is a facilitator in the process of Government collecting the tax. Payer should not be the target of primary responsibility.

India already taxes: import of goods – with customs duties; and import of services – with Service Tax on Reverse Charge Mechanism. In all the cases (EL, customs duty and service tax) it is the Indian consumer who has to suffer all the taxes.

The fact that - “other taxes (like TDS on Royalty & FTS etc.) are also suffered by the Indian consumer” - is not a good response to the question – why EL should be suffered by the Indian consumer. We have to find out a way of ensuring that the tax is actually suffered by the target assessee and not others.

How can we do it?

2.2 Income-tax TDS in case of Bank Payments:

For income-tax, the mechanism is in place. When Indian Resident pays royalty, interest, FTS, etc. he is supposed to deduct income-tax at source. The bank remitting the amount abroad will not remit unless and until the payer submits forms 15CA and 15CB and the payee has to submit TRC & PAN. (Tax consultants know that even in this matter, there has been a lot of confusion. CBDT has moved back and forth many times. If CBDT wants to develop a fool proof system, many unintended businessmen will suffer. And if CBDT tries to avoid public difficulties; there are tax leakages.)

If the Non-Resident supplier insists that he will not bear the tax; and the resident payer must bear the tax; then Indian resident will bear it. This is a matter of “Bargaining Power”. I will discuss it in more details separately in paragraph 20.8 below.

For the time being, let me say that “The Government of India (GOI) has provided legal and logistics support for facilitating payment by the Non-Resident assessee. If the Indian payer does not have bargaining power, he suffers.”

2.3 Credit Card Payments:

However, even in case of royalty, interest and FTS, assume that a party pays through the credit card. What happens? No tax is deducted. And the credit card company will process the payment. Ultimately Indian resident’s bank account will be debited. Government will not get TDS.

Then the Resident Payee is expected to make payment separately. If he does not pay the due TDS, he suffers – recovery of tax, interest, penalty, disallowance of expenditure and prosecution.

Government does not get the tax at the stage of payment to vendor itself. Later, it should get.

If Resident payer / importer does not pay the TDS and if the Assessing Officer does not discover, the tax is lost.

Conclusion: In case of payments through credit cards, GOI has not enforced logistics for TDS. Why?

2.4 Credit Cards: Inability for TDS

E-Commerce Committee member met RBI – Payments & Settlements Section to find out a mechanism to facilitate TDS through credit cards. The discussion was as under:

When an Indian Resident makes payment to a non-resident through credit card, what happens? He may swipe the credit card at a vendor’s place; or pay through computer or mobile phone. RBI has ensured that within two seconds he will get OTP (one time password) on his mobile phone. Within a few seconds, payer’s account will be debited and Credit Card Company will get the funds.

Then another process starts.

The credit card company converts Indian Rupees into the currency of the vendor and within agreed time; credits the account of the vendor. Before this credit, the credit card company will deduct its agreed commission. It may be 2% or 6% or any other rate as may be agreed between the credit card company and the vendor. This rate depends upon the bargaining power of the two parties. Further, the commission is shared between the credit card company and the banks involved. The bank’s share is automatically transferred to the bank before the payment is made to the vendor.

How is it possible to transfer the funds within two seconds?

When IRP swipes a credit card, there is a software at the vendor’s store. When IRP pays through computer/mobile phone; the credit card company’s software works. Depending upon - whether the transaction is domestic or international; respective softwares will work.

There are millions of credit cards transactions every day. There are millions of credit card holders, bank branches and vendors, several credit card companies, several international currencies and several countries’ regulators.

For completing the giant processing required; massive series of softwares and hardwares work. All softwares and hardwares are connected through global internet - networks. Some may be through landline cables, some through undersea cables and some through satellite channels. (They are synchronised).

Credit card companies give guarantee to the vendors. Once the payer has swiped his card; for no reason he can withhold or cancel the payment. He can only dispute the payment later in case of fraud, etc. Vendor will get the money within agreed period.

For all this to actually happen; entire process has to be computer driven. No human being will interfere the payment process. No one will exercise a judgement and decide - whether to permit the payment or not. Assume that the payment is in violation of FEMA. It will still happen.

Credit card mechanism is truly globalised. And the process is invisible – in the sense that no human being will interfere while the process is going on.

The Committee had been told by RBI that it is not practical to ask the credit card companies to deduct any tax at source. Indian payment system logistics are not equipped for TDS.

Now what can the Committee or GOI do?

2.5 Important Global Developments:

(i) Consider the fact that internationally Governments are exercising their jurisdiction in different manners. China has prohibited Google’s search engine in China (for reasons other than tax). They have developed their own search engine company – “Baidu” to provide similar service. It has become a big hit in China. They have no problems about WTO. Even if there is a problem, they will face the problem.

Moral of the story: Today there are technologies available with Governments. They can prohibit NRs from trading within their respective countries. Same technologies can be used to regulate NRs who want to do substantial business in COS.

(ii) In USA, there are several states. Each state has its own taxation regime. The E-commerce business has flourished in USA. One
E-commerce company may sell its goods and services all over USA. The State Governments insist on collection of tax at the time of sale transaction itself. Thus for example, if Mr. A purchases goods from an E-commerce company on computer or mobile phone, he can make payment to the vendor by using the credit card. The Governments have insisted and the vendors have developed necessary software, so that all the taxes are paid directly to the Government. The vendor gets payment net of its taxes.

Moral of the story: Business and Governments have already developed software & logistics to deduct tax at source from credit card companies.

2.6 India Can:

Government of India can pass the necessary law to provide the following:

Any person wanting to sell goods or services on the E-commerce platform and receiving payments from within India must make the following arrangements:

The vendor will develop appropriate software on its website. When a visitor to the website decides to buy any product or service; the website will clearly show separately the taxes which are applicable and the net as well as gross amounts payable. In case of indirect taxation, where prima facie the tax is to be borne by the customer, tax will be added to the price offered by the vendor. (This is already being done in USA.) In case of direct taxes like Income tax and Equalisation Levy which are to be borne by the vendor, the website will show the gross amount, the tax to be deducted and the net amount payable to the vendor.

In all these cases, the tax amount will directly be credited to the Government’s account. Only the net sale proceeds will be credited to the vendor’s accounts.

The credit card companies will have to make appropriate software and the Central Government of India as well as the State Governments should develop appropriate softwares. Since Reserve Bank of India acts as the treasurer for all the Governments in India; RBI also will have to develop appropriate software. All these softwares will be interconnected. It can be a giant task. It may take some time. It may be difficult but certainly practical.

When all the softwares are made operational, the burden of tax as well as compliance can be shifted to the vendor.

Similar arrangements already exist in USA. There is no reason why it cannot be implemented in India.

2.7 Shift the Burden to NR:

Once a complete software system has been installed, all responsibilities should shift from the Indian resident consumer to the Non-Resident vendor. Thereafter provisions can be made so that the vendor will file its own tax returns. Vendor will provide complete information regarding taxes due from the vendor, taxes recovered through the internet sale, taxes paid by the vendor directly; and balance dues if any. For the Indian resident consumer, there should be no further responsibility except complying with the instructions on the vendor’s software. Thus the complete burden of taxation as well as compliance with law will be shifted from consumer to the vendor.

2.8 Bargaining Power:

There is a repeated criticism that whenever any tax is imposed on the Non-resident, he does not accept the tax. He passes on the burden to the Indian resident. Ultimately Indian resident has to bear the tax by grossing up. Equalisation levy also, will be borne by the Indian resident payers.

This issue may be responded to in the following manners:

2.8.1 Considering the current times, most of the world is passing through recession or low growth periods. Indian economy has the highest growth rate. From American aeroplane manufacturer – Boeing to mobile phone manufacturers, everybody finds India to be an attractive market. In this situation, actually while the Indian buyer is having a stronger bargaining power; he does not recognise his power and does not use his power. For this inferiority complex, who is to be blamed?

There was a time when some of the white skinned people believed and claimed that they are superior to the coloured people. Now what can the coloured people do? It is for them to refuse the racist claims. Independence is not granted or donated. It has to be commanded. And if someone cannot be independent, government of India cannot help him.

2.8.2 Let us say, an Indian resident wants to buy a product or service. Will he not negotiate for the price? Will he not look out for the best offer available in the world? If the non-resident increases the price by 10% or even 2%; will not the Indian resident bargain? Today, in case of internet purchases specially, there are comparative charts available. Most internet savvy buyers make good comparisons & then buy. If an MNC wants to stand in the competition, it will have to offer the products at an all-inclusive competitive price.

2.8.3 I would agree that the logistics and the mechanism should be such that it is practical and easier for the Indian resident buyer to pass on the burden to the Non-resident seller. This part of the article is for that purpose.

2.8.4 Even the law should cast primary burden on the non-resident seller who is the targeted assessee. At present legally the burden is cast upon the Indian-resident payer while the non-resident has no burden of compliance. This law needs substantial change to cast the primary burden on the Non-resident. Let us say, the present law is a first step in the evolution of law. It is a work in progress. Not a finished product.

V.3 Permanent Establishment:

PE has been dealt with in EL in different manners.

3.1 Jurisdiction to levy EL – Establishing India’s jurisdiction to levy EL where it does not have jurisdiction to charge Income-tax under ITA. While taxing a NR E-commerce service provider, PE in the traditional sense is not required. NR’s earnings beyond the threshold means the NR has Significant Economic Presence in India – adequate enough to give India the jurisdiction to levy EL. S.165(1).

3.2 Exemption from EL: NR – Specified service provider may choose to set up a PE in India in the traditional sense. If the PE earns specified services revenue from India, to the extent of such revenue, it will be liable to tax in India under ITA & DTA. The revenue, which is chargeable to Income-tax is exempted from EL. S.165(2).

3.3 Under Income-tax Act, a PE’s revenue becomes liable to tax only if that revenue is “attributable” to the PE’s operations carried out within India. ITA uses the term “Business Connection” instead of “Permanent Establishment”. See Section 9(1)(i) read with Explanation 2 &
Explanation 3.

DTA uses the term income “attributable” to “Permanent Establishment”. See Article 7(1).

Conversely, the EL will be exempted u/s. 165(2)(a) of Chapter VIII only if the specified service is “effectively connected” with the Indian PE.

Note: ITA & DTA use the term “attributable”. EL uses the term “effectively connected”. Ideally, even under EL, the term should be “attributable”.

V.4 EL Tax Avoidance

It is possible that some Indian Resident Payers (IRP) can avoid EL TDS. Instead of the Indian Company making payment for the NR’s
E-Commerce services; its foreign subsidiary or sister concern will make the payment. Such payment will escape EL TDS.

This is fine.

What is the impact?

When a payment is made by a foreign entity, that payment will not be available as deductible expenditure for Indian Income tax purposes.

Consider Illustration:

Company IR utilises NR’s E-Commerce services in India. IR has to pay Rs. 10,00,000. This would attract EL TDS of Rs. 60,000.

When IR pays Rs. 10,00,000 and claims this as a deductible expenditure; IR’s Indian Tax liability goes down @ 34% or by Rs. 3,40,000.

If IR’s foreign sister company pays Rs. 10,00,000 to the NR; the Indian company won’t be able to claim the expenditure. The group as a whole will make a loss of Rs. 2,80,000 (3,40,000 – 60,000).

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