India's experience in taxing foreign digital platforms is a mixed bag

In 2016, India was one of the first countries globally to impose Equalisation Levy, a direct tax that is withheld at the time of payment by the service recipient. The idea was to bring foreign digital platforms, such as Google, Facebook and LinkedIn, into the tax net. The user base of these platforms in India is a sizable contributor to their revenues. The government has sought to have a fair share of the profits, in the form of taxes. Neeru Ahuja, partner, Deloitte India, explains the challenges in the exercise

Why do revenue authorities find it challenging to tax foreign digital enterprises?

Typically, a foreign enterprise is charged to tax in a country where it constitutes a permanent establishment (fixed place of business). In a digital world, the business can be conducted by foreign digital enterprises without having any physical presence in the country. The current Double Taxation Avoidance Agreements (DTAA) that India has entered into with other countries do not provide for a mechanism to tax such business profits of foreign enterprises in the absence of their permanent establishment. 

What steps have been taken by the tax authorities to tide over the absence of permanent establishment?

In order to tax foreign digital enterprises, an ‘Equalisation Levy’ was introduced through the Finance Act, 2016. The Equalisation Levy is a 6 per cent tax on payments made to a foreign enterprise for online advertising, digital advertising or other facility or services, for the purpose of online advertisements, if the payment exceeds Rs 100,000 in a financial year.

Also, the concept of ‘significant economic presence’ (SEP) has been introduced in the Income-tax Act, 1961, (I-T Act), through the Finance Act 2018. This concept expanded the scope and ambit of the term ‘business connection’ as defined in an inclusive manner in Section 9 of the I-T Act. An SEP means transactions in respect of any goods, services or property carried out by a non-resident in India (including the provision of data or software to be downloaded in India) if the aggregate payment arising from such transaction or transactions during the previous year exceeds the prescribed amount. Consequently, any income attributable to such SEP in India will be considered as taxable in India. However, the threshold for constituting an SEP in India is yet to be finalised.

An SEP does not unilaterally change the tax position for digital enterprises which operate from countries having DTAA with India. Apart from the introduction of the SEP concept, the definition of royalty was changed to include any consideration payable for any right, property or information, irrespective of the location of such right, property or information being outside India. However, this amendment is again a unilateral amendment in the IT Act which may not impact digital enterprises taking recourse to the provisions of DTAA. 

How successful have been such steps in garnering tax revenue?

Media reports have pegged the aggregate Equalisation Levy collections between Rs 10 billion to Rs 30 billion. While collections from this levy do not seem to be significant considering the overall direct tax collections, this levy does set the direction for taxing foreign digital enterprises. 

Furthermore, the judiciary has more often than not taken a view that the provisions of DTAA prevail over the provisions of the I-T Act. This is particularly highlighted in the matter of taxation of royalty income, which generally has a narrow definition in the DTAA, as compared to the definition in the I-T Act. 

However, in a recent significant ruling, the Bangalore Tax Tribunal held that the payments made by Google India to its overseas group company constitute royalty payment, and thus, liable to tax in India. This ruling is based on specific facts and may not be generalised. 

What is the key lesson from India’s experience of taxing foreign digital enterprises?

The government has made its intent clear that it is looking for a fair share of taxes from foreign digital enterprises. Various amendments have been brought into the statute with the aim to tax digital enterprises. However, there appears to be a limited success so far in garnering tax revenue. The road to tax digital enterprises may not be free from speed breakers as allocating revenue between jurisdictions is a complex exercise. This becomes all the more challenging with multiple jurisdictions staking claim to the same.