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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.

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Equalisation Levy in Simple Words

 

 

III. Equalisation Levy in Simple Words
 

By
 

CA Rashmin Chandulal Sanghvi
 

III.1 What is Equalisation Levy?
 

Equalisation Levy is a direct tax imposed on-
 

Non-Resident service providers –
Who earn revenue from India in excess of the Threshold.
The rate of tax is 6%.
 

This law is a work-in-progress. It needs to be developed further.
The present form of the law does leave certain issues not addressed adequately.
The reasons for weaknesses in EL have been discussed at length in this paper. In short, the reason is that OECD is not able to change the Model Convention – which is out dated.
 

2. Listing of Sections:
 

Section 163 provides for the jurisdiction comparable to Section 1 of Indian Income-tax Act (ITA).
 

Section 164 provides for definitions.
 

Section 165 provides for the charge of tax (Section 4 of ITA), Scope of tax (Section 5 of ITA), and the assessee [Section 2 (7) of ITA].
 

Section 166 provides for TDS.
 

Section 167 provides for filing of annual return.
 

Section 168 provides for assessment.
 

Other sections are for interest, penalty, prosecution & appeals.
 

3. Scheme of the EL: Chapter VIII:
 

In a very small chapter all the provisions for charging of tax, scope of revenues liable to tax, collection machinery, assessment, penalty, prosecution and appeals – everything is provided. This chapter is an independent & complete chapter by itself.
 

4. Administration:
 

Equalisation Levy will be administered by the Income-tax department.
 

5. Only Non-Resident Earners:
 

Equalisation Levy is charged only on non-residents of India. Its very purpose is to protect Indian Residents. Hence Indian E-commerce companies like Flipkart, Snap Deal etc. are not liable to Equalisation Levy. If a company is non-resident today and it opens a subsidiary or a PE in India to provide E-commerce services in India, the Indian subsidiary / PE will be liable to normal Indian Income-tax and it will escape Equalisation Levy.
 

Also, all Indian residents are already liable to Indian Income tax on their global incomes. We cannot again tax them with EL. Only Non Residents who earn revenue from India; and escape Indian Income tax are sought to be covered by EL.
 

6. Only Services are Taxable:
 

Equalisation Levy is charged only for services. There is no such tax on goods sold through E-commerce. Simple reason is: Somehow, the rules of international taxation have distinguished goods and services. This weakness in the system continues at present. Government of India is not trying to remove a global weakness through the Finance Act. The impact is: If someone purchases goods on E-commerce platforms, he will not have to deduct EL at source.
 

7. Home Consumer is exempt for TDS:
 

Millions of home consumers and small business consumers utilise internet services like Google, Face Book, WhatsApp, Twitter etc. Most of us do not make any payment to the service provider. Hence we are not liable to deduct any tax at source. (No payment, No tax.)
 

Assuming some home consumer makes payment for any specialised services, he will still not be liable to deduct any tax. This is specifically provided in the charging section – 165 (1) (i). This means that millions of consumers are not at all affected by EL.
 

8. No Computation:
 

Tax is payable on gross amount. Hence no computation of taxable income, no deduction of expenses. Entire computation machinery Sections 14 to 89 not required. Since there is no computation of income, Transfer Pricing provisions (Section 92 to 94A) and GAAR provisions (Section 95 to 102) are not applicable and not relevant.
 

Reminder: This is my personal view. Some geniuses may find out a way of avoiding income-tax & paying EL. In appropriate circumstances – wherever income-tax is avoided, the department may invoke TP/GAAR. Prima facie in normal circumstances, an EL assessee does not have to comply with TP provisions.
 

9. No Characterisation / Categorisation:
 

EL is so designed that there is no characterization issue. One does not have to determine whether it is a business income, royalty, or FTS or any other category of income. Categorization of Income under OECD & UN model convention is another serious weakness of the model convention. It causes huge litigation. This has been discussed in some of my earlier papers on E-commerce. EL avoids this weakness.
 

10. No Permanent Establishment:
 

There is no need to determine Permanent Establishment or any other nexus to India. Simply because a non-resident earns revenue from India he is liable to Equalization Levy. Revenue is the source. When in excess of the threshold, it is the nexus adequate for India’s tax jurisdiction.
 

In fact, outdated PE definition under the OECD & UN Model Conventions is the core issue that has caused –
 

(I) Huge tax avoidance by many MNCs; (This is admitted in BEPS Action 1 report, in introduction.)
 

(ii) BEPS discussions under Action One; and
 

(iii) Introduction of EL by Government of India.
 

Hence substituting “PE (a threshold for COS jurisdiction)” by “revenue as a threshold” under EL is of course the prime necessity.
 

11. Independent of ITA: No DTA:
 

This is not Income-tax . Chapter VIII of Finance Act does not become part of the Income-tax law. Like STT, it will remain a separate tax. Hence Double Tax Avoidance Agreements are not applicable to EL.
 

12. Compliance by Indian Resident Payer:
 

12.1 Ideally, the responsibility to pay tax and file EL returns should be on the non-resident. However, enforcing these obligations on a non-resident requires a lot of ground work. Best method of ensuring compliance by Non-Residents who have no PE in India would be – to ask all banks, credit card companies and Payment Gateways to deduct EL before making the remittance abroad. However, at present, there is no mechanism under which EL can be deducted by credit card companies from payments made through credit cards. The E-Commerce Committee had a discussion with Reserve Bank of India. And RBI confirmed that at present, it will not be possible to impose EL TDS through credit cards. In the circumstances, the only mechanism available to the Government of India is to recover the tax from the Indian resident payer. This is the procedure adopted by most countries while taxing non-residents. TDS on royalty, FTS etc. are paid by Indian Resident Payer (IRP).
 

This will mean: the burden of tax may fall on the Indian resident payer. The non-resident service provider may refuse to bear the cost of EL. There can be different situations. Large consumer goods companies - that advertise on media & net - have strong bargaining power. They can refuse to bear the cost. And any online company hosting the advertisement may have to bear the cost of EL for advertisements received from such strong companies. Very small payers – paying less than Rs. one lakh will not be liable to deduct EL. Payers falling between the two categories, may have to suffer the burden of EL. Even these persons may have choices in some cases. If there is competition, they will go to an alternative where the payer does not have to suffer the EL. Hence the force of market competition may make the NR receiver to bear the cost of EL.
 

It may be noted that the present proposal is a work-in-progress. A lot of work needs to be done. Government in collaboration with Reserve Bank of India can work out a mechanism whereby any payment from an Indian resident to a non-resident can be separated if it is an E-commerce payment. Once this step is implemented, EL can be deducted by credit card companies, banks and all payment gateways. Until this is done, a compromise has to be accepted. This is what the Finance Act, 2016 has done. The burden of compliance is on Resident Payers. However, for further details, please see Para I.20 below.
 

Under the Finance Act Indian resident payers will deduct EL at source and pay to the Government of India. Whole mechanism for charging of tax, payment of tax, filing of returns and assessments – all can be completed on internet. The tax deductor may not have to meet Income-tax department.
 

12.2 Business:
 

Only persons carrying on business or profession and making payment for specified services to non-resident E-commerce companies are liable for deducting EL at source and paying to Government of India.
 

“Consider S.166(1) – An Indian resident carrying a business or profession shall deduct the equalisation levy …..”
 

Clear words of the law provide that if an Indian resident is carrying on business and he makes payment to a non-resident for specified services, then the IRP must deduct equalisation levy at source. It is possible that the IRP is a charitable trust carrying on business. The charitable trust may be an educational institution or a hospital. It may be getting tax exemption under sections 11 – 12 – 13 read with S. 2(15) of the ITA. Hence for the IRP, claiming of payment as an expenditure is not relevant.
 

Similarly, there may be an IRP who is incurring substantial losses. Hence it may not be interested in claiming expenses.
 

In both the above referred illustrations, the IRP has to still deduct the EL at source. Whether the payment is claimed as an expenditure or not is not relevant.
 

The payment mechanism is simple. From all the payments to a non-resident for specified services, tax should be deducted @ 6% throughout a month. It has to be paid to the Government of India on or before 7th day of next succeeding month - Section 166.
 

12.3 Thresholds:
 

The TDS is applicable only if the payment for specified services to non-resident service provider exceeds Rs. 1,00,000 during a financial year. Section 165 (2) (b). Thus assessees making small payments are exempted from TDS compliance. This system does leave some scope for leakages. For example, one Non-Resident may receive – say Rs. 99,000 from ten Indian assesses. Still, he will not suffer any EL. Similarly, one resident may pay Rs. 99,000 to ten non-residents. He will not be liable to deduct EL. It may be noted that the NR E-commerce MNCs earn from Rs. 100 crores to Rs. 5,000 crores from India. For these target companies, the thresholds of Rs. 1,00,000 are so small that any manipulation by increasing the number of companies won’t be worthwhile.
 

For clarification: there are two way thresholds:
 

(i) If the non-resident service provider receives less than Rs. 1 lakh from one Resident Payee, he is not liable to EL – section 165 (2) (b).
 

(ii) If the resident payer is paying less than Rs. 1 lakh, to each NR service provider, he is not liable to deduct EL at source – Section 166 (1).
 

12.4 The responsibility to deduct EL is cast upon – (i) Indian resident business entity; as well as (ii) a Non-resident’s permanent establishment in India – if it is carrying on business in India and makes payments for specified services.
 

A return of EL needs to be filed on or before the 30th June immediately following the financial year. (Refer Equalisation Levy Rules, 2016 dated 27.05.16.)
 

If the Indian resident assessee does not pay tax to the Government of India, he will be liable to tax, interest and penalty under Chapter VIII of the Finance Act. He will also be liable to disallowance of expenditure from his business income under Section 40 (a) (ib).
 

12.5 Non-resident – No compliance:
 

At present, the non-resident has no responsibility under the law. He does not have to file any tax return nor pay anything. If a resident payer does not deduct EL at source and does not pay to the Government of India, it does not mean that the non-resident receiver is then liable to pay the tax. This is a deficiency and needs to be reviewed.
 

EL under Finance Act, 2016 is only the first step. Next steps necessary to be taken are:
 

(i) Develop the law fully and cast the burden on the NR revenue earner.
 

(ii) Amend S.9 of ITA and cover this revenue within the scope of Total Income.
 

(iii) BEPS Action One Task Force should provide for modifying OECD Model Convention & PE definition.
 

Since this third step may not happen anytime soon; earlier two steps have no practical utility. Hence EL is incomplete today.
 

13. Its connections with Income-tax Act are as under:
 

(i) Words not defined in this chapter will take their meanings from Income-tax Act.
 

(ii) If the Indian Resident does not deduct EL, the expenditure will not be available as a deduction under ITA Section 40 (a) (ib).
 

(iii) Once a payment is chargeable to EL, it will be exempted from Income-tax. ITA Section 10(50).
 

(iv) Appeal (only partly) & similar other provisions of ITA will apply to EL also. EL Section 178.
 

Except for these issues, the Income-tax Act concepts are not applicable to El.
 

14. No Double Taxation within India:
 

Once a non-resident’s revenue is chargeable to tax under chapter VIII of The Finance Act, 2016, it is exempted from Indian Income-tax under Section 10 (50). Thus, there will be no double taxation of the same income within India. It may be better for the non-resident to be covered under EL rather than under ITA. At the same time, there is no option for the assessee. A non-resident paying 10% TDS on interest or royalty cannot say that he will pay 6% EL and then not pay 10% TDS. His services should be “Specified Services” to be covered under EL.
 

15. No Grossing up:
 

(i) Under Indian Income-tax Act, Section 195 etc. provide for deduction of Income-tax at source from payments made to non-residents. There are cases where the non-resident insists that the tax should be borne by Indian resident. In such a situation, the Indian resident has to gross up the tax and suffer more. Section 195 A. For illustration, if the TDS rate is 10%, in this situation, Indian resident payer will have to suffer 11% tax.
 

(ii) Section 166 of Chapter VIII provides for deduction and payment of EL. Section 166 (3) provides that even if Indian resident payer does not deduct EL, he has to make payment of EL to Government of India. Thus, consider that the Indian resident has made a payment of Rs. 100 to the non-resident, he has not deducted any tax at source. He will simply pay Rs. 6 to the Government of India and close the chapter.
 

(iii) I should mention here that – when S. 166(3) is read with S. 166(1), another interpretation is possible – viz – “EL should be grossed up.” My submission is: the view expressed in (ii) above is a better interpretation.
 

16. Tax Rate:
 

The rate of tax under EL is only 6%. This is much lower than the normal TDS rates of 10% to 15%. This is an attraction for the non-residents providing specified services. Instead of suffering a higher rate of tax under Income-tax, they can bear the EL and pay lower tax. Further, there will be no further controversy about characterisation of payment, determination of PE etc. The whole scheme will be simple in administration by the department and compliance by the assessee.
 

The lower rate compensates for the fact that most assessees may not be able to claim credit of EL under the Double Tax Avoidance Agreements. They can of course claim the EL as an expenditure suffered by them but may not get the relief of full tax adjustments.
 

17. Specified Service:
 

Section 164 (i) defines specified service as – online advertisement, provision of digital advertising space etc. and includes any other service as may be notified by the Government.
 

It may be noted that E-commerce is a constantly developing business. There are so many technologies which together make it possible to do global business without PE in COS. Some of them can be listed as: computers, internet, television, mobile phones, satellites, cables, telephones; and a convergence of all these technologies. Each technology in the field of science keeps developing. Convergence of developing technologies provides a huge constantly changing mechanism for developing new businesses. Today traditional businesses conduct their business with new technologies. And completely new businesses are developing.
 

In this situation, defining anything as E-commerce would be incorrect. Today’s definition in the law will require an amendment within a few years. Recognising this fact, OECD had earlier published its reports under the title – “E-commerce”. Present BEPS action reports are calling the same business as “Digital Commerce”. Sometime back E-commerce could be conducted only through computers. At that time, no one could imagine international business transacted through telephones. Today, international business through mobile phones has become a reality. It is eminently possible that in three years’ time, there will be another way of doing international business which is not considered today.
 

Recognising these facts of modern life, the Finance Act defines the services as “Specified Service”. This definition can always be expanded by the Government. Thus the law provides for flexibility in line with the kind of business proposed to be taxed.
 

18. Liability for EL TDS – Following assessees are liable to comply with deduction of EL at source: S.166(1):
 

An Indian resident carrying on business or profession; and a NR having a PE in India. In other words, if a NR’s Indian PE is making payment to any NR for specified services, the PE will be liable to deduct EL & pay to Government of India.
 

Thus the concept of PE has been treated in different manners under EL. Some of these issues are again discussed in this paper – just to abundantly clarify the concepts.
 

Consider an illustration: A non-resident provider of specified services has a collection agent in India. The collection agent is merely collecting consideration and remitting the same to the non-resident. Specified Services are provided by the non-resident. Can the Indian resident payer claim that: “Since he is making payment to an Indian resident (the collection agent) he need not deduct equalisation levy at source”?
 

My response: Under the Contract Act, the agent steps in the shoes of the principal. When the IRP pays to the collection agent, the legal effect is that he is paying to the non-resident. Hence the IRP is liable to deduct equalisation levy at source.
 

On the other hand, if the Indian agent were providing the specified services, then the agent would become a PE. Hence as discussed in paragraph (I.21.2) above he would constitute a PE. The PE will be liable to Indian Income-tax under ITA. Hence the PE would not be liable to equalisation levy. IRP may be liable to TDS under ITA but not liable for EL TDS.
 

19. Tax Priority: EL or ITA?
 

19.1 When an Indian Resident (IR) has to make payment to a NR, he has to determine – “whether he should deduct tax as per ITA or EL”.
 

The law provides reasonable clarity. As seen earlier in Paragraphs I.15 and I.21; whatever is taxable under EL is exempt from ITA (Section -10.50). And whatever is taxable under ITA is specifically excluded from EL – Section 165 (2)(a).
 

Hence the IR payer has to examine whether the services for which he is making payment are covered under the definition of “specified services” or not. S.164(i). If it is covered, EL will apply & ITA will not apply. If the nature of service is not covered as a specified service; then clearly EL does not apply. Subsequent taxation & categorisation of income will be determined under ITA. We won’t discuss ITA provisions here.
 

Where EL is applicable, it is not necessary to examine whether the payment constitutes Business Income, Royalty or FTS. This is an important destroyer of litigation.
 

19.2 Indian PE Payer:
 

Assume that a NR has an Indian PE. Such PE makes payment for specified services – to its own head office, or to any other NR. Such Indian PE has to deduct EL & pay to Government of India. Section 166(1).
 

19.3 Indian PE Receiver:
 

Assume that an NR has an Indian PE. The PE provides Specified Services and receives remuneration from other IRP. PE’s income will be taxable under ITA & no EL is to be deducted by IRP. S. 165 (2) (a). Where ITA is applicable, the IRP will have to examine whether it is Business Income or Royalty or FTS.
 

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