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Rashmin Sanghvi & Associates

Chartered Accountants

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

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Queries & Criticisms

 

 

VII Equalisation Levy - Queries & Criticisms
 

By
 

CA Rashmin Chandulal Sanghvi
 

VII.1 Query: Why was it needed?
 

Response:
 

Modern technologies have developed to a great distance from the technologies used for traditional commerce. Several technologies (telephones, computers, internet, satellite transmission, mobile phones) have all converged making things practical – which were not even imagined just thirty-years back. Modern business makes best use of available technology. Hence a business entity can provide many services (and goods) to customers in different countries without requiring permanent establishment in those countries. Thus they escape COS taxation.
 

These companies can easily set up facilities in tax havens & avoid COR tax also.
 

Existing systems of International Taxation are inadequate to deal with:
 

(i) COS tax loss; and
 

(ii) the double non-taxation.
 

Hence this system has to change .
 

COS needs a tax system to collect tax on such Non-Resident service providers. Some countries are protesting against any change in this respect.
 

COR needs to strengthen CFC & TP rules. BEPS Action Reports recommend changes to cure these weaknesses in the system.
 

USA has even proposed unilateral change with retrospective effect in its CFC legislation. (See U.S. Budget for the year 2016.)
 

BEPS Action Reports collectively exhibit a situation where –
 

If COR suffers; change the law.
 

If COS suffers; let them suffer.
 

This situation called for a unique method of bringing justice for COS nations.
 

India has tried with Equalisation Levy.
 

VII.2 Query: BEPS Action 1 Report observes that:
 

Other BEPS actions proposed will take care of many deficiencies of E-Commerce taxation. Then why impose EL?
 

Response:
 

Strengthening of CFC & TP provisions etc. will ensure that COR tax loss will be curbed. However, these steps will not curb COS tax loss. My main submission is that COS suffers a loss and it has to be taken care off.
 

VII.3 Alternative Laws:
 

3.1 Significant Economic Presence (SEP):
 

World is not prepared to wait until the COR lobby permits Task Force to recommend specific changes in OECD Model Convention. Several countries are working on unilateral steps to avoid this tax loss. See Para I.3.2 above. European Union is developing the concept of Significant Economic Presence (SEP). Once a NR has SEP in a country, the NR will be liable to income-tax in that country. PE in the traditional sense is nothing but a threshold that says: “The NR’s economic presence is significant enough to attract tax liability”. But PE definition requires fixed base. So a new concept of SEP will now define “what is adequate presence within a COS to attract tax liability”.
 

3.2 Formulary Apportionment:
 

Once an assessee has SEP in more than one country, its income will be apportioned to each country under a “Formulary Approach”. In other words, the income would be apportioned based on the assessee’s (i) sales (ii) wages and (iii) assets in each country.
 

Point is: World wide, Governments will work to get their due taxes. India has adopted one method. Other countries may adopt other methods. In the jungle of several different laws, avoidance of double taxation will be difficult. There can be chaos. Responsibility will squarely lie with the COR lobby which does not permit modifications in OECD model convention.
 

VII.4 Query: Why isn’t it called E-Commerce Tax?
 

Response: The term E-commerce Tax is already discarded by its promoter OECD. Now OECD uses the term Digital Commerce. This also may become redundant in a few years. For details, see Answer II.8 and Paragraph I.18.
 

We need a term which does not require changes in name – with changes in technology. Because technologies will keep changing at faster & faster rate.
 

“Equalisation Levy” is a term used by the BEPS Action 1 report. It also indicates one aspect of desire to improve, tTo endeavour level playing field between Resident & Non-resident service providers. See Paragraph – I.2.3.
 

VII.5 Query: Why the world experts including OECD cannot come out with proper E-Commerce tax after 20 years of study? Why do they want five more years?
 

Response:
 

In the year 2013 all OECD / G20 members realized that “The Exiting rules for international taxation are inadequate to deal with E-Commerce”. Hence they decided to come out with a recommendation to change the rules within a year.
 

As they proceeded, probably someone realised that one country might suffer with any change. So task force members representing that country probably protested.
 

And nothing moved. Almost.
 

When vested interest lobby protests, nothing may move for 25 years.
 

VII.6 Query: It is a tax on services.
 

1. Why only specific services are covered? Why other services are not covered?
 

2. Why only Non-Resident service providers are covered & Resident service providers are exempted?
 

Responses:
 

6.1 Equalisation Levy is a new tax. A lot of logistics are yet to be built. See Paragraph I.20 above. A new and unfinished tax law may cause unwanted hurt & injury to some tax payers.
 

Hence the idea is:
 

Start with a small section of businessmen.
 

Target the largest revenue businesses.
 

Build the system, the logistics,
 

When the system is refined, expand the tax base.
 

6.2 Indian residents are in any case liable to Indian Income-tax. Why cover them again?
 

VII.7 Query: TDS Compliance:
 

Why only business consumers of services are covered and home consumers are exempted from TDS compliance?
 

7.1 Response: Try to see from another angle also.
 

Any levy of tax or exemption from tax – is finally a tax on or an exemption for the non-resident service provider.
 

If & when India develops a taxing system where the tax burden is truly borne by the targeted tax payer – the Non-Resident; all the revenues flowing to the service provider – should be taxed. Whether it is paid by a businessman or by a home consumer.
 

“Until a good system is developed, cause no hurt to small payers” – is the theme.
 

7.2 What is the problem in the logistics? Please see Part V paragraph V.2.4.
 

VII.8 Comment: Burden:
 

The tax may be ostensibly charged on Non-Resident. However, the law does not cast any burden at all on the Non-Resident. Procedural compliance is also cast upon Indian Residents. Actual tax burden also may be generally borne by Indian Resident payers.
 

Why such an unfair law?
 

Response: Present law does not cast any compliance responsibility on the Non-Resident. Fact is accepted.
 

Indian Resident business entity making payment to the Non-Resident Service Provider has to deduct tax @ 6% on gross; pay to Indian Income-tax department. Resident Payer has to also comply with all the procedures & face consequences in case of Non-Compliance. There is no adverse consequence on the Non-Resident in case of ANY default.
 

This injustice needs to be cured. IT can be cured. Please see Part V.
 

VII.9 Query:
 

Equalisation Levy is supposed to be an E-Commerce tax. And it does not apply to Flip Kart, Amazon.in & Snap Deal. Something wrong somewhere? What is wrong?
 

Response: Many things are wrong with the OECD Model Convention. These weaknesses & OECD’s lack of will to remove the weaknesses has caused serious problems. Some of them –
 

  1. Nomenclature: “E-Commerce Taxation.”
     

  2. Existing Rules of International Taxation are outdated.
     

Weaknesses (i) & (ii) are discussed in Part I above.
 

  1. COS TDS is based on Categorisation.
     

  2. Inequality between “Goods” & “Services”.
     

Weaknesses (iii) & (iv) have been discussed in my earlier papers. Not discussed here.
 

  1. Determination of “Nexus” by permanent establishment. The definition of Permanent Establishment is dependent upon geographical base. And geography is largely irrelevant for
    E-commerce. This has been discussed in Para I.3.
     

Another view is given below in para II.8.1:
 

Equalisation Levy is the result of OECD’s reluctance to modify the outdated treaty model.
 

Elaboration of the 5 th weakness – PE as nexus:
 

9.1 “E-commerce Taxation” by its OECD definition refers to taxation of commerce carried on by electronic instruments. Tax rules can never be determined by the instrument of communication.
 

Real issue is finding out whether the COS has a nexus to tax a NR carrying on business from outside COS geographical boundaries.
 

If the definition of the problem (inability to tax certain revenue) does not help in indicating a direction to the solution; that definition will soon be redundant.
 

And actually OECD’s definition became less than relevant when Mobile Commerce became common.
 

OECD knew that the term E-commerce is outdated. Hence in BEPS Action 1 report, the Task Force used the term “Digital Commerce”.
 

Core issue is: Digital Commerce still refers to a method of communicating, and method of transacting business.
 

In 1998 when E-commerce was defined, no one imagined Mobile Commerce. Today world considers “digital” as widely prevalent. It is quite likely that very soon another method of communicating & transacting business will emerge – which is not envisaged today.
 

If the laws & treaties are drafted (i) using terms & factors which are liable to be soon outdated; and (ii) necessary amendments to treaties are going to take twenty-five years; we would be building a system that is doomed at design stage. (Answer to Question 3.)
 

Chapter VIII of Finance Act 2016; does not use the terms – “E-commerce” / “Digital Commerce” / “Mobile Commerce”.
 

The term Equalisation Levy refers to “equalising” or creating a level playing field between Resident & Non-Resident service providers. The structure of the Equalisation Levy has built in flexibility to cover any changing ways of future commerce without disturbing the taxation rules.
 

9.2 Flip Kart , Amazon.In, Snap Deal etc. are popularly called
E-commerce companies. However, we are not concerned with E-commerce. We are concerned with taxing the Non-Residents who earn revenue from India and do not pay tax under existing rules of International Taxation as drafted by OECD.
 

Flip Kart etc. are Indian residents liable to Indian tax on their global incomes. There is NO issue of international taxation. Why should their taxation be disturbed?
 

VII.10 Query: Constitutional Validity.
 

Is this tax valid under the Indian Constitution? (Independent of OECD & BEPS.)
 

Response:
 

I have solicitor’s opinion that this law is valid. In case, the law is challenged constitutionally, CBDT is capable of handling the litigation.
 

Very briefly:
 

Constitution, Article 246, Seventh Schedule, Union List Entry 97 provides authority to the parliament to pass a tax law on “Any other matters not enumerated in List II or List III.”
 

VII.11 Query: Discrimination.
 

Under Article 24 (OECD Model) this can be considered as a discrimination against non-residents. This tax is not imposed on Indian residents. Why only NRs are singled out?
 

Responses:
 

11.1 Level Playing field.
 

We may look at the issue from a different angle. Indian residents who provide specified services in India are fully liable to tax in India. Non-residents who provide specified services in India are at present escaping Indian Income-tax on their revenue. Hence Equalisation levy is actually trying to reduce injustice / discrimination against Indian residents. It is not a discrimination against non-residents. In fact, depending upon the net profit ratio, non-residents may be paying lower tax than what they would otherwise be liable to pay under ITA.
 

11.2 Tax haven entities.
 

Some of the non-residents provide services from a tax haven. They do not pay any tax in their COR. These NRs do not have any reason to complain. Largest avoidances of Indian income-tax have been by tax haven entities. All these people have NO grounds to complain.
 

11.3 Some NRs may be providing services from the COR where they pay normal taxes. These NRs may say that they are paying full taxes in COR; and then suffering a tax in India which is not available as credit in COR. This situation may be truly called a suffering for the concerned NRs.
 

(i) This is some what similar to Dividend Distribution Tax (DDT). (Section 115 O of the ITA.) Technically, for DDT paid in India, the COR of the share holder can refuse to give credit. However, some countries are giving credit. Similarly, if a COR wants, it can give credit for EL paid in India.
 

(ii) It is necessary to consider the macro picture. There are some vested interest lobbies which are not allowing the OECD Model Convention to be changed. Hence the issue of credit in COR remains pending. As seen earlier, current treaty model is outdated, inadequate to deal with E-commerce and needs to be changed. If it is changed properly, then the non-resident service provider will get credit in his COR. Then he will have no reason to complain.
 

(iii) India is trying to see to it that the treaty model is changed appropriately, and then there will be no injustice. Hence whatever injustice exists today is caused by vested interest lobbies who are not allowing to change the treaty. The injustice is not caused by India.
 

11.4 As far as India is concerned, the position remains that if somebody earns revenue from India beyond a threshold, he is considered to have adequate presence within India. He is liable to pay Equalisation levy within India. India is not doing anything unfair. The non-resident should represent to get the COR law amended to get credit of EL against domestic tax.
 

India may be prepared to sign a Double Tax Avoidance Agreement covering Equalisation levy wherever the countries so demand.
 

Note: This is an issue that may be taken up as the law on Equalisation Levy evolves.
 

VII.12 Query: DTA.
 

A non-resident’s advertisement revenue received from India is not taxable under ITA as well as DTA. How can we impose a tax under a separate chapter without amending the law?
 

Responses:
 

12.1 Some services are not taxable under existing ITA. In my personal submission, it would be better to amend the ITA – either Section 5 or Section 9 and bring such items under the Scope of Total Income. This has to be done in the near future.
 

How can India bring E-Commerce business revenue of a NR within the Scope of Total Income?
 

Frankly, this is the core issue for the whole discussion in this paper. Right course of action would be: bring in the concept of Significant Economic Presence (SEP) as a threshold for invoking COS jurisdiction to tax NR’s income arising out of revenue earned from COS. PE may continue for traditional commerce. All non-traditional & other businesses escaping PE may be covered under SEP. Tax these revenues under domestic law. Simultaneously amend the Multilateral Treaty – BEPS Action 15 and bring in the concept of SEP as an alternative to PE. Tax the income in COS. Give credit in COR. Then a separate chapter for EL will not be necessary. At present there are no signs of DTA model convention being amended any time soon. Hence EL in India.
 

12.2 There are some items included in the list of specified services given in the Committee Report. Some of those items are also taxable under ITA – as either royalty or FTS.
 

Committee’s idea was:
 

If any kind of income is taxable under the EL as well as ITA; then it should be taxed under EL & exempted from ITA. EL is simple to comply with (by assessee) and to administer (by the department). And EL is probably the lowest rate compared to TDS applicable to Royalty & FTS. Those who want to comply with the law may prefer EL over ITA. Items taxed under EL are exempted from ITA u/s. 10(50).
 

These services(royalty & FTS) are not included in chapter VIII of Finance Act 2016. Hence at present the issue of Double Taxation does not arise. When the list of services is expanded, and those services are taxable under ITA and EL, exemption from ITA will be available u/s. 10(50).
 

12.3 My Personal View:
 

The broad idea seems to be that if the concept of Equalisation Levy as a tax on e-commerce revenue is accepted by several countries around the world, then eventually the OECD convention can be modified suitably. Then the Equalisation chapter may be shifted and become part of the ITA itself. This will avoid certain anomalies as on today. To make the law fully streamlined, it is necessary to include it within the income-tax Act itself. Since the Task Force for BEPS Action 1 on E-commerce continues to discuss, probably India can push for the necessary modifications in the OECD Model Convention.
 

VII.13 Query: Direct Tax or Indirect Tax:
 

Is Equalisation Levy a Direct Tax or Indirect Tax?
 

13.1 If we say that it is an Indirect Tax, then some of the services are liable to tax under service tax as well as Equalisation levy. Same transaction gets doubly taxed. This may be challenged constitutionally.
 

13.2 If it is considered a direct tax, then it is similar to Income-tax. Hence covered under article 2 of the model convention. The consequences can be as under:
 

(i) In the COS, the assessee can claim that the Equalisation levy is covered under double tax avoidance agreement (DTA). The DTA will override Equalisation levy. Advertisement charges are covered under article 7 of the treaty. Since the NR has no PE in India, he is not liable to pay any tax in India.
 

(ii) The assessee may claim in COR that the Equalisation levy suffered in India is a tax available as credit against domestic tax under article 23.
 

Response:
 

EL is a direct tax . A specific provision in Chapter VIII of The Finance Act, 2016 similar to S.90(2A) – that DTA won’t apply to EL would help.
 

VII.14 Query: Why the levy rate of 6-8%in Committee Report?
 

Responses:
 

There are several permutations and combinations that may be considered.
 

14.1 When a non-resident company earns interest, royalty or FTS etc. from India, it generally suffers TDS @ 10% or 15% depending upon the applicable DTA. For this tax paid in India, it gets a credit against the tax payable in the country of its residence. For Equalisation Levy it will not get the credit. Hence it was considered fit to levy the tax at a lower rate. Now, what should be the rate is a matter of debate. It was thought that at the beginning, the rate should be low. Hence we recommended a range of 6% to 8%. Government of India chose 6%.
 

14.2 If a non-resident has a permanent establishment in India and earns business profits from India, it suffers Income-tax @ 40%. Equalisation Levy (EL) is on the turnover and not on the net profit. Now what should be the rate? If we assume the profit ratio of 20%, EL should be 8%. If we assume the net profits to be 25%, EL should be @ 10%. While taxing a non-resident, worldwide system is to presume an estimated rate. Levy a flat rate of tax on the gross revenue. Some companies earning more than the estimated rate of profit will benefit. The companies earning less than the estimated rate of profit will suffer. However, all the companies will benefit in the sense that they do not have to prepare books of accounts, they don’t have to get the accounts audited; and entire process of compliance with the law, assessment etc. becomes practical and simple.
 

In conclusion, TDS at flat rate on gross revenue is a globally accepted system for taxing non-residents. Since EL is not available as a credit in the country of residence, we recommended a lower rate.
 

VII.15 Query: Is the idea to encourage foreign e-commerce ventures to have a permanent establishment in India to bring them under domestic tax net?
 

Response:
 

The idea is not to encourage either one system or the other. Now there are two systems available to the multinational corporations supplying E-commerce services in India. Whichever is more beneficial to the MNC, may be selected by the MNC – in the sense that if the MNC opens up a PE or subsidiary in India; and supplies the services from India; it will escape Equalisation Levy. Indian assessee will then be liable to normal tax.
 

I personally believe the Equalisation Levy avoids considerable litigation and simplifies the matters for the assessee as well as Government of India.
 

VII.16 Query: Do you foresee any legal challenges to this levy, given that it has to stand the test of international tax laws, and bilateral investment treaties?
 

Response:
 

In a democratic set up, challenging any law is possible. In India, we are a litigious society. So, it is possible that someone may challenge. I believe, Income-tax department is competent to deal with all the challenges. And if I may tell you a secret: “Some of the Income-tax commissioners are great wizards on international taxation. They do not appear in the media. However, their knowledge is no less than several popular tax consultants.”
 

VII.17 Query: Why has the Committee suggested changes in Income-Tax Act, when the levy stands outside of I-T Act?
 

Responses: There are several reasons.
 

17.1 We wanted to avoid any double taxation within India. If one MNC pays Equalisation Levy in India, the same company should not be levied Income-tax on the same revenue. To eliminate the chances of litigation in this matter, a specific exemption is given under Section 10 (50).
 

17.2 Present system of tax collection is inadequate. (I am not referring to the law. I am referring to only the tax collection procedures.) In India, in USA, in UK & most other countries, a non-resident’s tax is collected by the TDS procedure. In other words, the Indian resident payer deducts the money from the payment to be made to the non-resident. And then pays to the tax department. Now, if the resident payer does not comply with TDS procedure, then the common preventive steps are: the tax is recovered from the resident payer; he is charged interest & penalty; and the expenditure is disallowed in his hands. This is the process adopted even under Equalisation Levy for enforcing the compliance by the resident payer. The disallowance of expenses if EL is not deducted by the Payer requires amendments in Income-tax Act. Hence insertion of Section 40 (ib).
 

17.3 This tax is to be administered by the Indian Income-tax department. In a democracy any tax should have the appellate mechanism also. Hence all the machinery & appellate provisions of Income-tax Act have been made applicable to Equalisation Levy.
 

VII.18 Query: "How do you assess the impact of the levy on Indian start-up community that are the primary consumers of such e-marketing services?"
 

Responses:
 

(i) Probably, the biggest advertiser in India is Hindustan Unilever Ltd. Is it a start up?
 

(ii) Let us rephrase the query: “For startups, internet advertising is more affordable. When internet advertising is taxed, startups will be affected”.
 

Well, Indian internet media advertisements are not subject to Equalisation Levy. Is it necessary for a startup to go to foreign media for advertisement?
 

It is a fashion to oppose any tax in the name of the weakest section of the society. These persons ignore the fact that MNCs earning billions in revenue from India are escaping without paying any tax in India. The tax that the MNCs don’t pay is ultimately suffered by rest of the tax payers. Which includes You & me and your & my typist & clerk. Not taxing the MNC is like subsidizing the MNC at the cost of the middle class of India.
 

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