E-Commerce Committee Report proposing Equalization Levy

Section 10 - Characteristics of the Proposed ‘Equalization Levy’

124. Among the three options which were considered under Action 1 of BEPS Project, and which can be implemented by various countries under their domestic laws, the only option that appears to be feasible and can be resorted to, without violating the obligations under a Double Taxation Avoidance Agreement, is ‘Equalization Levy’. The BEPS Report on Action 1 does not provide any detailed design of such Equalization Levy but makes a suggestion that it can be designed as tax on the gross payments for digital goods and services, which is different from corporate income tax, but similar in design to the withholding tax.

10.1 Objective of Equalization Levy

125. Equalization Levy is intended to be a tax imposed in accordance with the conclusions of the BEPS Report on Action 1 that has been endorsed by G-20 and OECD, on payments made for digital services to foreign beneficial owner63, who enjoy an unfair advantage over their Indian competitors providing similar services by digital or more traditional means, with the objective for equalizing their tax burden with other businesses that are subjected to income-tax in India, without disturbing the existing tax treaties. Another objective of Equalization Levy is to provide greater clarity, certainty and predictability in respect of characterization of payments for digital services and consequent tax liabilities, to all stakeholders, so as to minimize costs of compliance and administration and minimize tax disputes in these matters. The target transactions would be those conducted primarily through digital or telecommunication networks, heavily relying upon latest telecommunication technology, and thereby avoiding the need of a physical presence in India, i.e. transactions which lead to profits that are not appropriately taxed in India because of the limitations of the existing international taxation rules. As stated in the BEPS Report, it is intended to be an interim measure that may not be required once the international taxation rules are modified to address the broad tax challenges that are imposed by the limitations of the existing international taxation rules in terms of nexus, characterization and valuation of user data and contributions.⁶⁴

10.2 Differences from Withholding Tax

126. Conceptually, such a tax may have features that are also shared by the withholding tax that is often levied on payments that give rise to income. However, the significant difference, between an ‘Equalization Levy’ that is proposed to be imposed on gross amount of payments, and the withholding tax under the Income-tax Act, 1961 would be that under the latter, withholding tax is only a mechanism of collecting tax, whereas an ‘Equalization Levy’ on gross payments would be a final tax. In case of withholding tax under the Indian Income Tax Act, 1961, the tax liability of a taxpayer is determined with reference to its total income as determined under the provisions of the Act, and the tax rate that may be applicable on it. If the tax collected by withholding mechanism is more than the tax determined under the Income-tax Act, the taxpayer becomes entitled to a refund, while, if the tax liability is more than the amount withheld, the difference needs to be paid by the tax payer. On the contrary, an Equalization Levy would be determined with reference to the gross amount of the payment and the rate of Equalization Levy applicable on it, which would be a full and final tax.⁶⁵

10.3 Tax on Amount of Payment for Specified Services & Not on Income: Hence Tax Treaties not Applicable

127. As the Equalization Levy is imposed on the gross amount of transaction, and not on the income arising from such transaction, it is applicable irrespective of whether any income arising from the transaction is taxable in India or not. As the Equalization Levy is not imposed on income, it does not fall within the scope of “income-tax” or “tax on income” or “any identical or substantially similar taxes”, which typically define the scope of taxes covered within the tax treaties.66 Thus, the inherent concept of ‘Equalization Levy’ as suggested in the BEPS Report on Action 1 keeps it outside the purview of the limitations imposed by tax treaties, a feature, which makes it the only option that can be adopted without violating or in any other way affecting the treaty obligations of the Contracting States in a tax treaty.

10.4 Advantages of adopting Equalization Levy in Domestic Laws instead of tax treaties

128. As every country including India has several bilateral tax treaties, and since there could be lack of uniformity on the preferred design of an equalization levy among different countries, including the Equalization Levy in the tax treaties may, apart from being a prolonged, uncertain and a time consuming process, also result in a number of variations in the design of the equalization levy imposed that could make the implementation of such a levy very difficult, uncertain and costly for all stakeholders including the Government of India. Thus, compared to the option of including equalization levy in a tax treaty, the option of imposing the same under the domestic law appears to have significant advantages in terms of providing simplicity, uniformity and consistency as well as minimize the cost of administration and compliance, and is therefore, a preferred option. Such a levy cannot, however, be imposed on income and would need to be imposed on the transacted amount or payment itself.

10.5 Placement in domestic laws: Outside the Income-tax Act, 1961

129. If the equalization levy is to be imposed under the domestic laws of India, if it is not to be imposed on income, and if it is not to be covered by the treaty obligations imposed by the tax treaties, then it will need to be separated from the laws determining the tax imposed on income in India. As the Equalization Levy on a transaction is, in any case, inherently different from a tax on income, it need not be included within the laws governing tax on income. Accordingly, it would be necessary to impose the Equalization Levy through statutory provisions outside the Income Tax Act, 1961. Instead, the provisions for Equalization Levy can be included in the Finance Act. Past precedence exist for imposition of similar taxes on transactions, like the Security Transaction Tax (STT)67 and the Service Tax68. In view of these precedents, and the need to keep the ‘Equalization Levy’ separate from the taxes on income, this Committee is of the view that the ‘Equalization Levy’ on payments for digital goods and services should be imposed through statutory provisions in the Finance Act.

10.6 Constitutional Validity of Equalization Levy imposed by the Union

130. In view of the constitutional division of taxing rights between the Union and the States69, it will need to be ensured that the Equalization Levy is consistent with the constitutional provisions. Equalization levy on gross amounts of transactions or payments made for digital services appears to be in accordance with the entries at Serial Number 92C70 and 9771 of the First List in the Seventh Schedule of the Constitution of India. The existing precedent in the form of the Service Tax appears to remove any ambiguities and doubts in this regard. Thus this committee is of the view that Equalization Levy as a tax on gross amounts of transactions, imposed by the Union through a statute made by the Parliament, would satisfy the test of constitutional validity.

10.7 Defining the Tax Base: Scope of Digital Services/transactions on which Equalization Levy can be imposed

131. The Equalization Levy should be limited to the payments made for intangible services, including payments for use or right to use any intangible, access a digital, telecommunication or similar network, or avail any service or other benefit received from a foreign company or a person resident outside India, provided the services are either received, utilized, provided or performed in India, and thus have a nexus with India, irrespective of whether the payment is made by a resident or a non-resident person. Thus, the payment made by the permanent establishment of a foreign company in India to its headquarters outside India would be covered if it otherwise falls within the scope of Equalization Levy.

132. The BEPS Report, while analyzing the option of ‘Equalization Levy’ suggests striking a balance between specifying the services (that will make it simpler, predictable and certain) and having a broader, more flexible description of services that would be covered (to take care of further technological advances and to avoid the need for frequent additions).72 The Committee considers that both aspects are important, but in view of the fact that it will be a new tax, is of the view that the need to achieve simplicity, predictability and certainty and minimizing disputes on characterization will be of greater importance. Thus, the Committee is of the view that to the extent possible, the categories of payments that would be subjected to Equalization Levy should be listed clearly. In view of the Committee, it may not be advisable to include broad categories as that may introduce an element of greater uncertainty and lead to disputes on characterization, avoiding which is one of the objectives of imposing Equalization Levy.

133. As the objective of the levy is to tax only those entities that enjoy an unfair tax advantage, payments that are made to the permanent establishment in India of a foreign company or a non-resident person, would be exempt from the Equalization Levy, if that payment forms a business receipt of that permanent establishment, and the income arriving from it is attributable to that permanent establishment in India and hence subject to tax under the provisions of the Income-tax Act, 1961. A verified declaration of the beneficial owner to this effect, in the prescribed form mentioning its Permanent Account Number (PAN) in India or its Tax Identification Number in its country of residence should be treated as sufficient for such exemption.

134. After detailed analysis, the Committee suggests that the following categories of payments may be subjected to ‘Equalization Levy’ at this stage:⁷³

135. Any sum paid or payable or credited as a consideration for any of the following:
(i) online advertising or any services, rights or use of software for online advertising, including advertising on radio & television;
(ii) digital advertising space;
(iii) designing, creating, hosting or maintenance of website;
(iv) digital space for website, advertising, e-mails, online computing, blogs, online content, online data or any other online facility;
(v) any provision, facility or service for uploading, storing or distribution of digital content;
(vi) online collection or processing of data related to online users in India;
(vii) any facility or service for online sale of goods or services or collecting online payments;
(viii) development or maintenance of participative online networks;
(ix) use or right to use or download online music, online movies, online games, online books or online software, without a right to make and distribute any copies thereof;
(x) online news, online search, online maps or global positioning system applications;
(xi) online software applications accessed or downloaded through internet or telecommunication networks;
(xii) online software computing facility of any kind for any purpose; and
(xiii) reimbursement of expenses of a nature that are included in any of the above;

Explanation – For the purposes of above, ‘online’ means a facility or service or right or benefit or access that is obtained through the internet or any other form of digital or telecommunication network.

136. The Committee acknowledges that in view of the rapid changes in technology and the way business models are continuing to evolve, this list may be need to be reviewed and modified from time to time. The Committee also notes that some of these payments could be taxable currently as royalty or fee for technical services, and by bringing them under the purview of Equalization Levy combined with exemption from income-tax, the effective rate of taxation on them will be reduced from 10%74 to 6 to 8%75. The Committee also notes that in respect of some of these payments, there could also be issues relating to characterization and potential for tax disputes. The Committee also took into account this possible overlap with taxation as royalty or fee for technical services, as well as the prolonged litigations that keep arising in respect of their taxability under the Income-tax Act, 1961. Having considered these issues, it is the considered view of the Committee that bringing such payments under the purview of Equalization Levy, as included in the list above, and the consequent exemption of income under the Income-tax Act, will bring about more certainty, predictability and stability to the tax regime, reduce costs of compliance as well as administration, and could significantly contribute to reducing tax litigation. Thus, the Committee recommends the aforementioned list of services for Equalization Levy.

137. Keeping in view the possibility that such transactions may be given a label by the parties that is not included in this list, it would be essential that it may be specified that these services would be subject to Equalization Levy, irrespective of whatever they may be called by the parties. Similarly, to prevent the possibility of avoiding the Equalization Levy by having the payment made by a third party outside India, which is subsequently reimbursed by the actual user, with a claim that no Equalization Levy is payable on reimbursements, it may need to be clarified that the Equalization Levy will be also payable on any payments made by a payer in India for reimbursements of expenses incurred by a third party outside India in respect of services covered under this levy. Lastly, it would need to be clarified that the Equalization Levy will become applicable once a payment is credited or paid – whoever is earlier, to the beneficial owner in the books of accounts, irrespective of when and how the actual payment is made.

10.8 Restricting application on B2B transactions & Having a Revenue Threshold

138. The Committee considers that from a policy perspective, it would be preferable to avoid placing the burden of compliance and administration related to Equalization Levy in cases, where the revenue collected would not be commensurate with cost of compliance and administration. For this purpose, it would be preferable to limit the application of Equalization Levy only to business-to business (B2B) transactions, and not apply it to the business-toconsumer (B2C) transactions, which are more frequent, but of smaller amounts, at this stage, or till that point of time when a mechanism becomes available, by which Equalization Levy can be seamlessly collected in B2C transactions, without burdening the consumer.⁷⁶

139. The purpose of restricting the burden of deducting the Equalisation Levy by the Payers – to ‘B2B’ transactions will be achieved by fixing the revenue thresholds significantly high. ‘B2C’ & ‘C2C’ transactions may not be specifically exempted under the law, simply because, for the assessee – the beneficial owner of revenue, it is not practical to find out whether a receipt is on B2B, B2C or C2C account. The revenue thresholds suggested here are unlikely to apply to home consumers.

140. The Report on Action 1 also advocates having a revenue threshold in the possible options that are included therein to address tax challenges of digital economy. The committee is of the view that having a revenue threshold for taxing such transactions will prevent the hardship that may be faced by small taxpayers, and avoid the compliance burden as well.

141. The Committee considers that both these measures will optimize the compliance and administration burden related to this new tax, and thereby minimize its negative impact on the digital economy. The Committee also considers that both these objectives can be largely achieved by having a single criteria of a reasonable revenue threshold of Rupees one lakh per annum, where the equalization levy is to be deducted by the payer or the authorized foreign exchange dealers. The applicable threshold in case of Equalization Levy being collected by the payment gateways could be different and with reference to the payments made by that gateway to that taxpayer during the year.

10.9 Rate of Equalization Levy

142. The basic objective of the Equalization Levy is to bring the tax burden on businesses that are able to avoid paying any taxes in India, at par with the tax burden likely to be faced by competing Indian businesses. Thus, the Committee was of the view that the rate of Equalization Levy needs to be fixed in a way that will lead to a tax incidence that is as close as possible, to the tax incidence that it might have faced had its income been taxable under the existing tax treaty rules. In a way this would make the Equalization Levy closer to the “deemed profit” taxation, except that unlike in a case of deemed profit taxation, there cannot be any rebuttal available, and the tax would be imposed irrespective of what the profits of the subject enterprise may actually have been. The Committee also notes that there is no single margin of profit that can be presumed universally in all businesses. Thus, the rate would need to be kept at a level where it does not lead to a tax burden that is prohibitively higher than that faced by its Indian competitors.

143. The Committee notes that Income-tax Act, 1961 imposes a tax rate of 10% for taxing royalty. The concessional rate of taxation for royalty and fee for technical services in the tax treaties entered into by India with other countries, which are also imposed on the gross payments, are also around 10-15% in most cases. However, the Committee also took note of the fact that unlike royalty, the marginal cost in many of the payments proposed to be subjected to Equalization Levy may not be close to zero, and unlike the tax treaties, there would not be any tax credits available to the taxpayer in its country of residence for the Equalization Levy paid in India.

144. Keeping these considerations in view, along with the fact that digital economy is in an evolving stage, and its growth has positive externalities for the Indian economy, the Committee is of the view that the rate of Equalization Levy may be set between 6% to 8%77 of the gross payment. Since, this is the first time such a levy is imposed, and the businesses may take time to fully adjust to it, a lower rate may be preferable at this stage. In any case, the Committee is of the view that the impact of Equalization Levy would need to be reviewed, and its rate can be revised upwards or downwards at a later stage, after reviewing and analyzing its likely impact on enterprises and economy.

10.10 Need to prevent double economic taxation

145. As the Equalization Levy is aimed at achieving greater tax neutrality by targeting those payments which lead to income that does not become taxable under the existing international taxation rules, it is important to ensure that Equalization Levy is not levied to transactions, where the resulting income is also taxed separately under the Income-tax Act, 1961. The Committee considered three possible options of achieving this objective.

146. The first option could be exempting income arising from specified transaction on which Equalization Levy has been paid.78 This provides ones of the simplest ways of avoiding double economic taxation, and also offers the advantage of providing a simple, certain and predictable solution to the challenge of characterization of income arising from digital transactions, which is often a matter of tax disputes. In this option, as the income becomes completely exempt, and if the rate of Equalization Levy is lower than 10%, there would be an inherent incentive for the taxpayer to pay Equalization Levy and avoid all consequences arising from taxation of income from that transaction. As the income from such a transaction would become exempt on payment of Equalization Levy, the compliance burden associated with income-tax obligations is also significantly obviated with this option.

147. The other two options that the Committee considered were providing a deduction from the total income, of an amount of income that has arisen from the payment on which Equalization Levy has been paid, and providing a tax rebate from the total tax liability of the taxpayer. However, both these options leaves the possibility of having a dispute between the taxpayer and the tax authorities, on what is the exact amount of income arising from the transaction covered, and thereby does not achieve the simplicity, certainty and predictability provided by the first option.

148. In view of these considerations, the Committee considers that the first option of exempting the income arising from a payment on which Equalization Levy has been paid, from income-tax under Section 10 of the Income-tax Act, 1961. This would be the most preferable way of avoiding double economic taxation on transactions subjected to Equalization Levy.

10.11 Payment and Reporting Obligations of the Beneficial Owner

149. The beneficial owner of the payment should be responsible for paying the Equalization Levy to the Government, and reporting the details of such transactions in a prescribed return annually. However, since the beneficial owner may be outside India, and not always within the ambit of enforcement by Indian laws and procedure, an appropriate mechanism of collection to ensure that the beneficial owner is not able to escape the Equalization Levy would need to be put in place. A similar mechanism in respect of income-tax exists in the form of tax deduction at source by the payer.

10.12 Compliance and Collection Mechanism

150. The BEPS Report on Action 1 (2015), while analyzing the various option for addressing broader challenges of digital economy considered two possible ways in which such taxes can be collected. The first is deduction of equalization levy by the payer making the payment, where the obligations of the payer would be largely similar to those of the person required to withhold income-tax. The other possible option could be to get the tax deducted by the payment gateways, such as banks, credit or debit cards, digital wallets etc. through which payments are made by consumer in India to an enterprise abroad.

A. Deduction by Payer

151. The option of getting the Equalization Levy deducted by the person making the payment for the specified transaction, has the advantage of simplicity, is workable and can be implemented straightway, without requiring any major changes in the regulations governing payments abroad. The negative side of this option is that it can place compliance burden on payers in India, and in some cases where the beneficial owner insists for receiving full payment irrespective of taxes, the payer may have to bear the tax burden as well.

152. The compliance burden on the payers in India can be significantly minimized by restricting the Equalization Levy to B2B transactions with a reasonable revenue threshold, as then the cases covered under Equalization Levy would be very restricted. There would be no compliance burden at all on consumers in India, and the revenue threshold will further ensure that there is no compliance burden on businesses in respect of occasional payments of smaller denominations. Another advantage of restricting the compliance burden to business payments is that the allowability of a business payment as deduction can be linked with the deduction of Equalization Levy by the payer, thereby creating a simple and reliable mechanism of compliance. As this mechanism of ensuring allowability of deduction is already in place in respect of withholding tax, and all businesses are fully well versed with it, it can be easily implemented and relied upon for ensuring compliance, without any major constraints.

153. In view of the above, the Committee is of the view that the obligation to deduct the Equalization Levy may be limited to businesses, by exempting payers who do not wish to claim the payment as either revenue expense or capitalized expense in a business the profits of which are taxable in India. The Committee is also of the view that linking the allowability of such payments as deduction for computing taxable profits under the Income-tax Act, 1961 can serve as a reliable mechanism for its compliance.

154. The Committee recognizes that one way in which the payer and the beneficial owner, particularly if they are associated enterprises, can avoid the payment of Equalization Levy, could be by giving a label to their payment that is somewhat different from the description of the payments covered under Equalization Levy, and claiming that the payment does not fall within the scope of payments on which Equalization Levy is imposed. It is also important to note that in the light of the decisions of the Hon’ble Supreme Court of India in the case of Transmission Corporation79 and GE Capital80, it is not necessary for the payer to always seek a certificate for non-deduction of taxes. The ambiguity arising from nomenclature of payments can thus become a valid excuse for non-compliance by the payer. Thus, to plug this potential loophole that may facilitate non-compliance, and also lead to litigation, it would also be advisable to put in place a mechanism that ensures credible deterrence against it. Such a mechanism can be put in place by making use of the existing mechanisms that already exist in the Income-tax Act, 1961, in the form of Section 195 (7) of the Act that states as under:

“(7) Notwithstanding anything contained in sub-section (1) and sub-section (2), the Board may, by notification in the Official Gazette, specify a class of persons or cases, where the person responsible for paying to a non-resident, not being a company, or to a foreign company, any sum, whether or not chargeable under the provisions of this Act, shall make an application to the Assessing Officer to determine, by general or special order, the appropriate proportion of sum chargeable, and upon such determination, tax shall be deducted under sub-section (1) on that proportion of the sum which is so chargeable.”

155. The Committee suggests that the payments subjected to Equalization Levy may also be notified under this provision, along with an exemption provided in the notification itself to those cases where Equalization Levy is paid. This, in effect, means that cases on which Equalization Levy was payable but has not been paid, would be mandatorily required to seek a certificate under section 197, irrespective of whether they include any income that may be taxable in India. Thus, in effect, such notification would cast an additional obligation on those who have failed to comply with payment of Equalization Levy, to seek a certificate under section 197, thereby providing an inherent mechanism for getting such non-compliance reported to the tax authorities. In such cases, the proceedings for issue of a certificate under section 197 would be independent of the obligation of deducting Equalization Levy, but would open the possibility of such defaults coming to the notice by the Assessing Officer, and thereby strengthen the deterrence required for its compliance.

156. The Committee recognizes that there is considerable uncertainty in respect of taxability of payments made for digital services and facilities, with differences of opinions between the taxpayers and the tax authorities leading to disputes in some instances. Such disputes, that also have their origin, to some extent, in the differences of positions taken by India and OECD countries in respect of scope of royalty and fee for technical services taxable in the source jurisdiction under the tax treaties, can escalate further and adversely affect all stakeholders, including the Government of India and large digital enterprises earning profits from India. This also creates uncertainties for Indian payers, who need to deduct income-tax on income of the beneficial owner that is chargeable in India. Although the obligation to deduct Equalization Levy may not be welcomed by those having to bear it, but the greater simplicity, certainty and predictability of Equalization Levy, along with a possible advantage of lower tax rate81 should more than offset this negative impact.

157. The Committee also recognizes that a likely criticism could be that due to asymmetrical bargaining powers between a small Indian consumer and a large multinational enterprise to which the payment is being made, the burden of tax may have to be borne by the Indian payer in many cases. The committee took into an account this argument and noted that this issue has already been dealt in sufficient detail by the Task Force on Digital Economy during the work on Action 1. Annexure E of the BEPS Report on Action 1 (2015) provides a comparative analysis of the economic incidence that is likely to result from the three possible options included in the Report, wherein, after detailed analysis, it was concluded that the economic burden of all the three options would be completely similar. In other words, the economic burden on Indian consumers or payers is likely to be the same, irrespective of whether the additional tax is to address broader tax challenges of digital economy is imposed in the form of tax on income by expanding the definition of Permanent Establishment, by means of a withhold tax on digital transactions or an Equalization Levy. In view of the fact that this analysis and these consequences have been uniformly accepted by the OECD and G20 Countries including India and also conform to the basic principles of economics, the committee is of the view that burden of Equalization Levy is unlikely to be different from other ways of imposing additional tax on hitherto non-taxable income of multinational digital enterprises in India.82 The Committee also observed that in a completely asymmetrical bargaining, even the burden of income-tax or any other tax may be shifted by a foreign supplier on the Indian payers, and in that way, the Equalization Levy is no different from any other tax. The Committee also noted that given the size and growth of Indian consumer market, it is highly unlikely that any major digital business would be in a position to ignore it, and a more likely outcome is that it would make necessary adjustments to maximize its participation in Indian markets.

B. Deduction of Equalization Levy by the payment gateway

158. The Committee considered this option, which also finds mention in the BEPS Report on Action 1 (2015), for ensuring compliance with Equalization Levy. A very large volume of payments made for digital transactions are made through certain specific payment gateways, like Banks, Credit/ Debit cards, Digital/Electronic Wallets and new gateways like Paypal. These payments gateways that enable parties in India to make payments to parties outside India are covered by Foreign Exchange Management Act (FEMA), as well as the applicable rules and regulations of Reserve Bank of India. The Committee was of the view that it may be possible to amend such regulations and the relevant laws for imposing a liability on these payment gateways to deduct Equalization Levy on specified transactions made by Indian payers to entities oversees and deposit such tax with the Government. This mechanism of collection of the equalization levy, if feasible, can have a very significant advantage of low costs of compliance, particularly if and when the equalization levy is extended to business–to–consumer (B2C) transactions, which take place in very large volumes involving smaller denominators. Another major advantage with this mechanism of collection could be that it will obviate the compliance burden placed on Indian deductors. The automated collection can also reduce the other problems associated with the deduction of Equalization Levy by payers.

159. In view of these possible advantages, the Committee examined the feasibility of resorting to this mechanism, and also held discussions with authorities in the Reserve Bank of India. However, after examining the existing mechanisms, it has become apparent to the Committee that the existing systems, processes, laws, rules and regulations governing these payment gateways would need to be substantially modified for collecting Equalization Levy through this mechanism.83 The Committee also came to realize that since the payments that are likely to be the subject of Equalization Levy can also be made by way of credits in the books or adjusted in a manner that obviates the need for an actual payment, particularly in a B2B transaction. This suggests that while the collection through payment gateways may be a more preferable mechanism for collecting Equalization Levy in case of B2C transactions (as and when that becomes applicable), this mechanism would not be feasible for the B2B transactions that are intended to be covered at this stage.

C. Deduction of Equalization Levy by the Authorized Foreign Exchange Dealer

160. The Committee also considered the possibility of getting the Equalization Levy deducted by the Authorized Foreign Exchange dealer, as many of the B2B transactions are likely to be routed through the Authorized Foreign Exchange Dealer. The Committee recognized that this is an important option that can obviate the obligations placed on the payers, but also noted that it will also require modifications in rule and regulations governing these dealers, and putting into place a mechanism for ensuring compliance by them. Further, such a mechanism would not work in case of credit of payments made by parties in their books of accounts without actual transactions. The Committee also noted that the existing mechanism for verification of nature of payments and in particular characterization of payments is not sufficiently robust for such a mechanism to operate, and necessary changes to ensure that Authorized foreign exchange dealers are able to deduct Equalization Levy in all cases will need to be put in place. The Committee considers that there is a need to explore this option and if found feasible, it may replace or supplement the obligation of the payer after putting the necessary mechanism for its implementation in place.

161. Keeping in view the limitation of the other options, the Committee prefers the compliance by placing the obligation of deducting the Equalization Levy on the payer, in a manner similar to the obligation that exists in case of withholding tax under Income-tax Act, 1961, with the following modifications:

- The obligation to deduct Equalization Levy may be limited to businesses, by exempting payers who do not wish to claim the payment as either revenue expense or capitalized expense in a business the profits of which are taxable in India.
- The allowability of the payment as an expense for determining the taxable profits under the Income-tax Act, 1961 may be linked with the payment of Equalization Levy, similar to the allowability under Section 40 of that Act.
- Payments subjected to Equalization Levy may also be notified under Section 195 (7) of the Income-tax Act, 1961, along with an exemption provided in the notification itself to those cases where Equalization Levy is paid, so as to strengthen the deterrent against non-compliance.

162. However, the Committee also recognizes the potential of collecting Equalization Levy through the payment gateways and authorized foreign exchange dealers. The Committee considers that deduction of Equalization Levy by them with proper systems in place can reduce the compliance costs and thereby improve compliance. The Committee is of the view that with increasing scope of digital services that may be covered by Equalization Levy in future, a three pronged approach for compliance, consisting of deduction by authorized foreign exchange dealers in B2B payments, deduction by payment gateways in B2C payments, and deduction by payers in other cases, like payment by credit in books of accounts could provide a way forward for seamless compliance with minimum costs of compliance and administration. Thus, the Committee strongly recommends that work on developing the necessary rules and regulations as well as the systematic requirements for implementation of a mechanism that will enable collection of Equalization Levy through payment gateways and authorized foreign exchange dealers may also be initiated at the earliest.

10.13 Reporting and Auditing Mechanism for Deductors of Equalization Levy payments

163. The Committee recognizes the need to put in place a mechanism for auditing and reporting such compliance. The Committee is of the view that a certificate of the Auditor that Equalization Levy has been deducted and paid on all payments as per law would go a long way in ensuring proper compliance. The mechanism for reporting compliance is required to be put in place, but should be simple and consist of an online form which can be filled and submitted online. However, the Committee also recognizes the need to ensure that smaller businesses are not burdened with costs that may create a hardship for them. Accordingly, the Committee is of the view that a person who is not required to maintain books of accounts under any law in India, should be exempted from the obligation of filing a return on deduction of Equalization Levy. Similarly, a person, who is not required to get its accounts audited under any law in India, should be exempted from the obligation of obtaining a certificate of the Auditor. The Committee is also of the view that harmonizing the reporting obligations in respect of Equalization Levy with the existing obligations in respect of withholding tax could be a possible way for avoiding duplication, and can be considered as a means for further reducing the costs of compliance. After takin into account the existing forms for Auditor’s Certification, the Committee is of the view that modification of Form 3CD can be a convenient option for obtaining Auditor’s Report on deduction of Equalization Levy.84 Alternatively a form can be prescribed for this purpose.

10.14 Efficient Risk Assessment Tools to obviate Random Scrutiny

164. The Committee noted that in order to minimize the compliance and administration costs, there would be a need for efficient risk assessment tools. As the scope of Equalization Levy is proposed to be restricted to B2B transactions at this stage, and many of payment made may also be subject to Service Tax as well as likely to be claimed as Reverse Charge therein, the reconciliation of Equalization Levy database and Reverse Charge claims in Service Tax may provide a useful risk assessment tool for this purpose. The Committee strongly recommends the use of similar non-intrusive tools that would provide highly efficient risk assessment and obviate the need for scrutiny in the administration of Equalization Levy.

10.15 Monitoring of Impact and Possible Expansion in Future

165. The Committee is of the view that there would be a need to monitor the impact of Equalization Levy on a regular basis, particularly as the digital services that can be provided and availed without physical presence continue to evolve and expand in India. There could be a need to modify the list of services covered under it, and find better ways of compliance that will enable a seamless collection of Equalization Levy, reduce the compliance burden on payers. With better mechanisms of collection, it may be possible in future to collect this levy on B2C payments too, without burdening the consumers with its collection and compliance.

10.16 Possible Grounds of Criticism of Equalization Levy & Explanations of the Committee

166. The Committee notes that following criticisms may arise in respect of this proposal, and attempts to provide explanation in respect of them.

· The greatest disadvantage and source of criticism of Equalization Levy is that it is an additional tax over and above all other taxes that are already in place, and that such additional tax burden may further affect ease of doing business in India.

The Equalization Levy is an additional tax only on foreign enterprises escaping tax in India due to the existing limitations in the existing international taxation rules, and does not affect other Indian or foreign enterprises that are already having a permanent establishment in India and getting taxed on their business profits in India. Further, the aim and objective of Equalization Levy is to ensure that unfair tax advantage to multinational enterprises is minimized, thereby improving the competitiveness of businesses in India (including foreign businesses having a taxable presence in India). The lower rate of 6% Equalization Levy and corresponding exemption from income-tax for payments that are very often a source of tax dispute and tax litigation, actually amounts to lowering the tax rate on such payments. Lastly, by bringing greater clarity in tax obligations in respect of digital businesses, particularly in respect of characterization disputes and consequent taxability of income (e.g. disputes related to characterization of payments as royalty/FTS), the Equalization Levy will stabilize the tax environment in India, and facilitate businesses in India.

· The tax burden of Equalization Levy is likely to fall on the Indian businesses having to deduct it, and would therefore only be detrimental to them
This burden is not different from the burden of withholding tax under the Income-tax Act, 1961 and relevant tax treaties, and by having a rate lower than that applicable for withholding tax on royalty & fee for technical services, it actually reduces the burden both in terms of actual tax payable, as well as in terms of greater certainty and predictability. The burden is likely to be restricted in India due to the revenue threshold and since deduction is not required to be made in respect of a payment either to an Indian entity, or to a foreign entity having a permanent establishment in India, or if the payment being made is not part of business expenses. The incidence is intended to fall primarily on the payment being made by the Indian subsidiaries to their associated enterprises outside India, and payments made by Indian businesses to an entity outside India of an amount more than the threshold that are claimed as deductible business expenditure in India, without leading to any corresponding taxable income in India in the hands of the beneficial owner. By having a clear and undisputable tax liability, the payer in India would be in a better situation to assess the tax impact and negotiate with the foreign beneficial owner. Lastly, even in cases where the economic burden of tax deducted falls on the Indian payer, the lower rate of 6 to 8% in respect of those payments that are potentially taxable as royalty or fee for technical services, would provide significant relief to them, and therefore should be seen as a relief and not additional burden.

· The imposition of such a levy may be a violation of international tax practices
The Equalization Levy is identified by the G-20 and OECD as a possible option that countries can adopt in their domestic laws. The Conclusions of the BEPS Report on Action 1 clearly state that. Thus the imposition of Equalization Levy under domestic laws is completely in accordance with the consensus view accepted by the G-20 and OECD.

· Why should India impose such a levy when it is not imposed by any other country
India is not the only country to have imposed a tax to address the concerns arising from the ability of digital multi-national enterprises to avoid paying taxes in the jurisdiction from where they are earning their income. UK has imposed a “Diverted Profit Tax” from 1.4.2015 to address these concerns. Australia has imposed a “Multinational Anti Avoidance Law” from 1.1.2016, Italy is reported to be considering a new “Digital Tax” consisting of 25% withholding tax on payments. Some countries, like Brazil already impose withholding tax on such payments. These instances, along with the fact that the G-20 and OECD countries now agree on the rights of every country to impose any of the actions identified in the BEPS Report on Action 1, is a clear indication that countries across the World are thinking about it. Compared to the taxes being imposed in other countries, the Equalization Levy proposed by the Committee is completely in accordance with the international consensus and suggestions

· There will be no foreign tax credit available to the taxpayer in lieu of Equalization Levy, which would amount to double taxation of their income. If it is to imposed, it should be under the tax treaties so that there is no double taxation
This is acceptably an inherent limitation of Equalization Levy or any other option that may be imposed under domestic laws, not covered by the tax treaties. However, it must be noted that there is nothing to prevent the country of which the taxpayer is residence from granting relief to the taxpayer, under its own domestic laws, to avoid such double taxation. In case such a country also imposes an Equalization Levy, there can even be the possibility of a reciprocal agreement between India and that country to provide relief from income-tax on account of such levy. Further, it is always open for a taxpayer being subjected to have a permanent establishment in India, and thereby get exemption from Equalization Levy completely. Thus, the Equalization Levy serves to create incentives for digital multinational enterprises to establish permanent establishment in India and get taxed only on its net income attributable in India, while creating disincentives against artificial arrangements to avoid paying taxes on income arising from India by exploiting the systemic weaknesses in the existing international taxation rules. The double taxation arising from Equalization Levy should be viewed from this perspective. Lastly, even for a taxpayer that has to bear such double taxation, partial relief may still be available in the form of deduction of the Equalization Levy from its taxable income as a business expense.

· The Equalization Levy may adversely affect the competitiveness of Indian digital enterprises
As it is levied only on foreign enterprises not having a taxable presence in India, the Equalization Levy improves the competitiveness of digital enterprises in India, including foreign enterprises having a permanent establishment in India, by reducing the tax disadvantage that they currently face in comparison with their foreign competitors. The existing tax advantage enjoyed by foreign enterprises over their Indian counterparts creates strong incentives for Indian enterprises to locate outside India, and thereby poses a strong challenge for the growth and expansion of Indian digital industry. The Equalization Levy aims at neutralizing this disincentive, and facilitating an environment, where Indian digital enterprises can compete with their foreign competitors without having to locate outside India.

63. The Committee notes that the phrase “Beneficial Owner” may need to be defined appropriately in accordance with the international standards.

64. In view of the Committee, the modification of existing international taxation rules may take a few years, or even more, given the differences in the preferences of different countries and the likely resistance from the countries that benefit from the limitations of the existing rules.

65. In the proposed Equalization Levy, the nexus between Indian jurisdiction and the taxpayer is proposed to be broadly similar to the nexus existing for royalty and fee for technical services, and would consist of payment arising from India or the utilization of services of rights in India.

66. Article 2 of the Model Tax Convention and most of the tax treaties (Double Taxation Avoidance Agreements) defines the taxes that are covered by it. The provisions of the treaty are limited to these taxes and do not apply on other taxes, nor in any way affect the sovereign rights of either Contracting States to apply any other tax.
67. The Securities Transaction Tax was imposed by the Chapter VII of the Finance No. 2 Act of 2004
68. The Service Tax was imposed by Finance Act 1994

69. Article 246 of the Constitution of India divides the powers to makes laws between the Union and the States. List I in the Seventh Schedule lists the items on which the Parliament has the exclusive powers of legislation.
70. 92C. Taxes on services.

71. 97. Any other matter not enumerated in List II or List III including any tax not mentioned in either of those Lists.
72. Paragraphs 145-146 of the BEPS Report on Action 1 states as under:

“7.6.3.1 Scope of transactions covered 145. The scope of transactions covered by the tax must be clearly defined, so that taxpayers and withholding agents will know when the tax applies, and to ensure that tax administrations will be able to ensure compliance. The scope should also be defined as simply as possible in order to avoid unnecessary complexity and classification disputes. The need for clarity and simplicity, however, must be balanced against a need to ensure that similar types of transactions will be taxed similarly, in order to avoid creating incentives for or against particular ways of structuring them.

146. For this purpose, although listing specific types of transactions covered would provide a degree of clarity, it would also likely result in disputes over the character of transactions, particularly as technology continues to advance. Such an approach also could lead to differences in treatment for tax purposes between economically equivalent transactions depending on their form. For this reason, a more general definition of covered transactions appears more appropriate. The tax could be applied, for example, to transactions for goods or services ordered online (i.e. digital sales transactions), or to all sales operations concluded remotely with nonresidents. The latter would have the advantage of flexibility, and would ensure tax neutrality between similar ways of doing business, and may reduce disputes over characterisation. In addition, if withholding is used as a tool to support net-basis taxation, a broad scope covering all distance selling would be more consistent with the sales threshold discussed above in the context of a nexus based on significant economic presence.”

73. The Committee also considered the possibility of levying the Equalization Levy on tangible goods like electronic goods sold to Indian customers by online transactions, but concluded that tax issues related to such remote transactions involving sale of tangible goods are different than the issues involving online services. The Committee arrived at a view that the tax issues related to remote transactions of tangible goods can be examined separately.

74. Existing tax rate on royalty payments

75. Proposed rate of Equalization Levy

76. Such a mechanism can be in the form of an obligation of the beneficial owner to pay the Equalization Levy, or the collection of Equalization Levy by the payment gateway through which the payment is made.

77. In view of the Committee, it may be a preferable option to restrict the rate of Equalization Levy at 6% at the time of its introduction, and then review it in subsequent years, to evaluate the desirability of raising it.

78. A precedence of exempting income in this manner exists in the form of Section 10(38) of the Income-tax Act, 1961, which exempts long term capital gains from transactions on which Securities Transaction Tax has been paid.
79. Transmission Corporation of A.P. Ltd. and Ors. v. CIT [1999] 239 ITR 587 (SC)

80. GE India Technology Cen. P. Ltd vs CIT & Anr. on 9 September, 2010, in Civil Appeal Nos.7541-7542 of 2010

81. Presuming the rate of Equalization Levy is less than 10%, it would be lower than existing tax rate that may be applicable on such transactions under the Income-tax Act, 1961 and relevant tax treaties.

82. As per the Economic Theory, the economic burden of taxes is different from the legal burden, and primarily dependent upon the elasticities of demand and supply. In the General Equilibrium Model, the taxes get partly shifted forward to the consumers, or backwards, to the factors of production like capital, labor and technology, and the final tax burden gets spread on the economy as a whole. Detailed analysis is available in Annexure E of the BEPS Report on Action 1 (2015). In case of a Monopoly, the prices are set to maximize revenue, and higher the surplus of the monopoly, the lesser is the likely economic burden of taxes on the consumers.

83. There may also be a need for developing proper monitoring mechanism to ensure compliance of laws related to equalization levy by the payment gateways. In view of these requirements that would need significant time to develop and evolve, at substantial costs, this mechanism of collection will take its own time to develop.

84. Suggested modifications to Form 3CD are annexed in Appendix-3 of this report.

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E-Commerce Committee Report proposing Equalization Levy