THE Digital Economy

Digital economy is the product of economic activities associated with digital connectivity. The main feature of digital economy is hyperconnectivity, where there is a growing interconnectedness of people, organizations, and machines. The growth of digital economy is changing the structure of conventional businesses and the manner in which consumers obtain services. ¹

The digital economy is characterized by unparalleled reliance on intangible assets, massive use of data and the difficulty in determining jurisdiction. ² The challenging structure of digital economy has raised fundamental questions regarding the manner in which entities will earn profits and determine source and residence for purposes of levy of income tax. ³ With the growth of digitization, it was noticed that instances of non-taxation were on rise, mostly double non-taxation. The instances of double non-taxation led to the emergence of the Base Erosion and Profit Shifting (BEPS), an initiative led by Organization of Economic Cooperation and Development (OECD) to plug the gaps in the existing international taxation framework, owing to the rapid development in the digital economy.

BEPS Action Plan 1, which was released in October 2015, proposed three interim measures to tackle the challenges in the digital economy. ⁴ This included determination of significant economic presence, withholding tax for digital transaction and imposition of equalization levy. ⁵ Countries had the choice of adopting any of these options till a global framework was finalized. Along with countries like UK, Russia, France and Italy, India too took the decision of adopting one of the options. Consequently, India introduced the concept of equalization levy through the Finance Bill, 2016.

Historical Trajectory of Equalization Levy

India has grappled with the issue of taxing digital entities under the Income Tax Act, 1961 for a substantial period of time. Prior to the introduction of equalization levy, courts have dealt with matters concerning taxing of digital economies. Owing to the absence of any statutory provisions, it was The Courts time and again have been unable to tax digital entities, owing to the absence of any provision in the statute.

In 2001, High Powered Committee was set up by Central Board of Direct Tax (CBDT) to contemplate on the issues in the e-commerce sector. While India was an early starter, the Committee concluded that the legal framework was sufficient to tax e-commerce transactions. However, challenges were faced with the growing digital market, which was evident from the disputes that were filed before different tribunals and courts.

In Yahoo India (P) Ltd vs DCIT ⁶, the issue before the Mumbai Tribunal was regarding the taxability of payment made by the assessee to Yahoo Holdings Hong Kong Ltd (YHHL) under the Income Tax Act, 1961. ⁷ It was held by the Tribunal that YHHL did not have any permanent establishment in India, and hence the payment was not taxable. ⁸ A similar ruling was pronounced in ITO vs Pubmatic India (P) Ltd ⁹ , wherein it was held that the remittance amount sent to USA for purchase of advertisement space was not chargeable under the Income Tax Act, 1961 in as much as there was no permanent establishment in India.

In ITO vs. Right Florists ¹⁰, the issue before the Kolkata Tribunal was to determine whether the payment made by the assessee to Google Ireland Ltd and Yahoo USA for online advertising was taxable or not. ¹¹ The assessee, a florist, was using the platforms of Google and Yahoo for online advertisements for his products. ¹² The Assessing Officer held that the assessee ought to have deducted TDS. If such a deduction was not carried out, the expenditure was not allowable under section 40(a)(i) of the Income Tax Act, 1961. ¹³ The Commissioner of Income Tax, Appeals held that income can be taxed only if it accrues or arises in India. A website is not a permanent establishment and the activity carried out does not have a business connection under section 9 of the Income Tax Act, 1961. Hence, in absence of a permanent establishment, such payments cannot be taxed in India.

In order to plug these gaps in the international taxation framework, BEPS introduced Action Plan 1. In light of the global development, India too took certain steps towards finding solutions to the challenges posed by the digital economy. CBDT constituted the Committee for Taxation of E-commerce Transactions to provide for recommendations on ways to tax e-commerce entities. In light of the BEPS Action Plan 1, the Committee recommended the introduction of equalization levy. Soon, in response to the Committee's recommendations, equalization levy was introduced in the Finance Act, 2016 with effect from 1 st June, 2016.

Equalization Levy 1.0

Equalization levy is a direct tax which is leviable on consideration received or receivable for any specified service or e-commerce supply or services. ¹⁴ Specified services have been defined as services pertaining to online advertisement; or any provision for digital advertising space; or any other facility or service for the purpose of online advertisement; or any other services as may be notified by the Central Government. ¹⁵ Thus, it can be understood that the levy was purely for online advertisement or related services.

Any person resident in India carrying on business or profession in India or a non-resident having a permanent establishment in India will be liable to pay equalization levy under section 165 of the Income Tax Act, 1961 for the specified services. ¹⁶ However, this is not required to be paid if the receipt amount is not more than Rs. 1,00,000. The equalization levy will be 6% on the amount paid to the non-resident. Also, the income subject to equalization levy will not be subjected to the total income of the assessee under section 10(50) of the Income Tax Act, 1961.

The payer has to furnish the statement of specified services to the jurisdictional assessing officer or any other authority authorized by the CBDT. In case of any delay in furnishing of the returns, the payer can file the returns before the expiry of two years from the end of financial year in which the service was provided. ¹⁷

In cases of non-compliance, an interest of 1% will be levied every month. In addition to the imposition of interest, there will be an imposition of penalty for failure to deduct equalization levy. For continuing failure, a penalty Rs.1000 will be levied everyday which will be either equal to the amount of equalization levy or lower. In addition, if a payer fails to furnish statements, a penalty of Rs.100 will be imposed for each day till the failure continues.

In order to provide a grievance redressal mechanism to the payer, an appeal can be filed before Commissioner of Income Tax (Appeals) for an order related to penalty within 30 days of the receipt of the order. If the assessee is aggrieved by the decision of the Commissioner of Income Tax (Appeals), then an appeal can be filed before to the Income Tax Tribunal within 60 days from the receipt of the order.

In 2017, with the introduction of Goods and Service Tax (GST), the definition of ‘business connection' was expanded to include ‘significant economic presence' within it. ¹⁸ In 2020, withholding tax was introduced on domestic e-commerce transactions.

Equalization Levy 2.0

In 2020, the concept of equalization levy witnessed a significant change. The scope of equalization levy has been expanded with effect from April 1, 2020. As per the extended scope, consideration received by a non-resident e-commerce operator from an e-commerce supply or service is leviable to equalization levy at the rate of 2%. ¹⁹ As per this recent change, an e-commerce operator who is not resident in India has to pay equalization levy on the receipt of following services- online sale of goods owned by the e-commerce operator; or online provision of services provided by the e-commerce; or online sale of goods or provision of services or both, facilitated by the e-commerce operator; or any combination of the above-mentioned activities. ²⁰

A levy of 2% will be applicable on an overseas e-commerce operator if it receives the above services from- a person resident in India or a non-resident person. In case of a non-resident person, the levy will be applicable on the e-commerce operator, if the former engages in the following activities- i. sale of advertising, where the sale is targeted towards a customer who is resident in India, or a customer who accesses the advertising though an IP address located in India; and ii. sale of data where it is collected from a person who is resident in India or from a person who uses an IP address located in India; and iii. a person who buys goods or services, or both, uses an IP address located in India. ²¹

The new levy has certain exceptions. The levy will not be applicable in cases where the equalization levy is charged under section 165 of the Income Tax Act, 1961. ²² Also, it will not be applicable where the e-commerce operator has a permanent establishment in India and the supply concerned is directly related to such permanent establishment. ²³ In addition, the levy will not be applicable in cases where the revenue or sales figures of an e-commerce operator in the previous year is less than Rs. 2crore. ²⁴

Unlike the earlier equalization levy where the amount was required to be deducted by the service recipient, the new provisions under the Finance Act 2020 places responsibility on the e-commerce operator. The e-commerce operator has to make the payment to the Government's treasury on a quarterly basis. Any default in payment will lead to imposition of penalty on the e-commerce operator and the same shall be equal to the amount of equalization levy.

Thus, it can be understood that the new levy seeks to charge two non-resident entities. The new levy has led to the giants expressing their concerns. The time period for compliance and need to keep track of IP address for purposes of levy are certain concerns expressed by overseas entities, stating that the same might overburden entities.

Analysis of Equalization Levy 2.0

Under the Finance Act, 2020 the definition of e-commerce operator has been widened and it means a person who owns, operates or manages digital or electronic facility or platform for electronic commerce. ²⁵ The term electronic commerce has been defined as the supply of goods or services or both, including digital products, over digital or electronic network. ²⁶ Along with the definition of electronic commerce operator, the definition of supply of services by an e-commerce covers almost everything. The two definitions and its broad definitions brings under its ambit almost all entities, and goes beyond the normally understood connotations of intermediaries and aggregators. ²⁷

Due to its wide definition, equalization levy will cover even those entities which are operating under brick-and-mortar model with a fair degree of digitization. For example, an educational institution which provides majority of the courses through an offline model along with specific online courses will fall under the definition of e-commerce operator. Taking into consideration the definition of e-commerce under the Finance Act, 2020, even online exams conducted by educational institutions will fall under the ambit of equalization levy, even though the dominant structure of such entities is brick-and-mortar. ²⁸ Similarly, the hotel and flights bookings through digital platforms will attract equalization levy. ²⁹ In such cases, while the bookings take place online, the actual supply of services take place offline. Similar levy can be imposed on the media and entertainment industry, where digital mode is used for streaming of content and for online subscription of print media. ³⁰ Another instance where there might be a possibility of levy is when an overseas citizen buys goods through Indian IP address and gets it delivered in the overseas address of residence. While this should not attract equalization levy, the present provisions might allow sufficient leeway for imposition of levy on such transactions.

Therefore, the first challenge in the new levy provisions is the application of such an expansive definition. Every entity with fair degree of digitization will attract the provisions of equalization levy under the Finance Act, 2020. At this juncture, it becomes important for the Government to clarify the entities which will be classified as e-commerce operators. In absence of such clarity, this might lead to several disputes before the Courts. Also, this will have significant impact on the market in as much as it will deter overseas e-commerce entity from doing business in India.

The second challenge is the lack of clarity on the amount on which the equalization levy will be charged. The Government has not cited whether the levy will be on the entire gross amount of the consideration received by the e-commerce operator or on the service fee/commission fee retained by the operators. ³¹

Another significant challenge would be in terms of availability of credit to the ecommerce operator in their home country. The new levy is provided for under the Finance Act, 2020 and has not been incorporated into the Income Tax Act, 1961. This implies that the new equalization levy is excluded from the purview of the Income Tax Act. Therefore, in such a case, it will be difficult for the e-commerce operator to take credit of the tax paid. If we assume that the new provisions do not allow credit on the tax paid, then such payment will be a cost to the company. ³²

If we look at the manner in which the structure of equalization levy is structured, it seems to work more like an indirect tax. It is to be noted that India already has statutory provisions for levying indirect taxes on overseas entities for supply of goods and services under the Customs Act, 1962 and GST through reverse charge mechanism.

Also, the new provisions mandates that the overseas entity has to deposit the amount in the exchequer of the Government, for which it has to obtain a Permanent Account Number (PAN). ³³ Such a provision places unnecessary burden on the non-resident entity, especially when there is no statutory requirement under Indian laws for obtaining a PAN. ³⁴

While the grievance redressal mechanism under Income Tax, 1961 pertaining to equalization levy is clear, the new provisions does not provide any clarity. It does not provide for any recourse to the tax authorities to recover the equalization levy in case of a default. Under such circumstances, it becomes important to shed clarity on the recovery mechanism in case of a default.

Under section 174 of the Finance At, 2016, which has been incorporated into the Income Tax Act, 1961, a person who has been aggrieved by order of an assessing officer, can file an appeal before Commissioner of Income Tax (Appeals). Further, in cases where the person is not satisfied with the order of the Commissioner of Income Tax (Appeals) can file an appeal before the Income Tax Tribunal. However, these grievance redressal mechanisms are not provided for under the new equalization provisions. Under such instances, the only option left for a tax payer to address his grievance by filing a writ in the high court.

Concluding Remarks

Equalization levy was introduced as an interim measure in India, owing to the absence of global consensus on a framework for plugging the gaps in the international taxation framework. In pursuance of BEPS Action Plan 1, India introduced equalization levy vide Finance Act, 2016 which was subsequently incorporated into our Income Tax Act, 1961. While these provisions did not lead to emergence of concerning issues, the introduction of equalization levy vide the Finance Act, 2020 did generate sufficient debate.

As discussed above, there are numerous issues that needs to be addressed under the new provisions pertaining to equalization levy. It is important to provide clarity on the ambiguous provisions, as it might impact businesses and deter them from entering the Indian market. Therefore, it is important to streamline the structure in order to balance the competing interests in the market.

It will be interesting to see how countries harmonize their individual rules and regulations on taxation of digital economy after a consensus is built by OECD. Also, with rapid digitization, businesses have to develop equally and adopt to the changing global legal landscape.

(Shradhanjali Sarma has completed Daksha Fellowship, Chennai, with Technology Law and Policy as her dedicated pathway. She graduated from National Law University and Judicial Academy, Assam in 2017. Prior to Daksha Fellowship, she worked in a boutique law firm in Mumbai, dealing with indirect tax litigation and advisory. )

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¹ Deloitte. What is Digital Economy. https://www2.deloitte.com/mt/en/pages/technology/articles/mt-what-is-digital-economy.html

² OECD (2013), Action Plan on Base Erosion and Profit Shifting, OECD Publishing. http://dx.doi.org/10.1787/9789264202719-en

³Ibid

⁴ Vikas Vasal. (6 August, 2020). Equalization Levy: A New Tax Regime That Has Its Own Set of Challenges. (Livemint). https://www.livemint.com/money/personal-finance/equalization-levy-a-new-tax-regime-that-has-its-own-set-of-challenges-11596709767633.html

⁵Ibid

⁶140 TTJ 195 - 2011-TII-94-ITAT-MUM-INTL

⁷ Shaily Gupta. (11 July, 2017). India: Equalisation Levy – Genesis, Provisions and Interpretation Issues. ( Mondaq ). https://www.mondaq.com/india/social-media/602428/equalisation-levy-genesis-provisions-and-interpretation-issues

⁸Ibid

⁹ 60 SOT 54 - 2013-TII-148-ITAT-MUM-INTL

¹⁰ 154 TTJ 142 - 2013-TII-61-ITAT-KOL-INTL

¹¹Shaily Gupta. (11 July, 2017). India: Equalisation Levy – Genesis, Provisions and Interpretation Issues. ( Mondaq ). https://www.mondaq.com/india/social-media/602428/equalisation-levy-genesis-provisions-and-interpretation-issues

¹²Ibid

¹³Ibid

¹⁴Ibid

¹⁵Section 164 of the Finance Act, 2016; Shaily Gupta. (11 July, 2017). India: Equalisation Levy – Genesis, Provisions and Interpretation Issues. ( Mondaq ). https://www.mondaq.com/india/social-media/602428/equalisation-levy-genesis-provisions-and-interpretation-issues

¹⁶ Section 165 of the Finance Act, 2016

¹⁷ Section 172 of the Finance Act, 2016

¹⁸ Dhruva Advisors. (November, 2020). Equalisation Levy Taxing Cross-Border E-Commerce Transactions. https://dhruvaadvisors.com/insights/files/Dhruva-Equalisation-Levy-2020.pdf

¹⁹ Jiger Saiya and Jagat Mehta. Taxing The Digital Economy: Indian Equalisation Levy 2.0. ( BDO Global). https://www.bdo.global/en-gb/microsites/tax-newsletters/corporate-tax-news/issue-55-june-2020/india-taxing-the-digital-economy-indian-equalisation-levy-2-0

²⁰ Ibid

²¹ Section 165A(1) of Finance Act, 2020

²² Section 165A(2) of Finance Act, 2020

²³Ibid

²⁴Ibid

²⁵ Section 194-0 (6)(1) of Finance Act, 2020

²⁶ Section 194-0 (6)(2) of Finance Act 2020

²⁷ Jiger Saiya and Jagat Mehta. Taxing The Digital Economy: Indian Equalisation Levy 2.0. (BDO Global). https://www.bdo.global/en-gb/microsites/tax-newsletters/corporate-tax-news/issue-55-june-2020/india-taxing-the-digital-economy-indian-equalisation-levy-2-0

²⁸ Dhruva Advisors. (November, 2020). Equalisation Levy Taxing Cross-Border E-Commerce Transactions. https://dhruvaadvisors.com/insights/files/Dhruva-Equalisation-Levy-2020.pdf

²⁹Ibid

³⁰ Dhruva Advisors. (November, 2020). Equalisation Levy Taxing Cross-Border E-Commerce Transactions. https://dhruvaadvisors.com/insights/files/Dhruva-Equalisation-Levy-2020.pdf

³¹Ibid

³²Ibid

³³Ibid

³⁴Ibid