Equalisation levy - after eight months

The levy corrects the unfair advantage enjoyed by some non-resident companies over domestic players

The equalisation levy, introduced under Chapter VIII of the Finance Act, 2016, is completing its first eight months of existence. From June 1, 2016, the levy of six per cent became applicable “… to consideration received or receivable for specified services provided on or after the commencement of this Chapter” in business-to-business (B2B) transactions for more than Rs 1 lakh supplied by non-residents not having permanent establishments (PE) in India.

The levy has to be deducted by a recipient, who resides in India or has a PE in India, “from the amount paid or payable to a non-resident in respect of the specified service” and paid to the central government. Currently, “specified service” means online advertisement and any provision for digital advertising space or any other facility or service for online advertisement.

There are apprehensions that the levy will not only be passed on but also through grossing up create “huge problems” for start-ups and kill innovation. Start-ups rely heavily on online advertisement companies as windows to the outside world. As the levy is kept outside the Income Tax Act, foreign companies in their home countries may not get credit for the levy and decide to pass the same on to Indian consumers. With cost going up, Indian start-ups may have to cut down on their advertising budgets, thereby affecting their customer acquisition and growth. 

In the future, apart from online advertisement, such specified services can include any other service as may be notified by the central government. Close to Budget 2017-18, there are apprehensions that the list of specified services may be enlarged to cover “online marketing…, cloud computing, website designing, hosting and maintenance, digital space, digital platforms for sale of goods and services and online use or download of software and applications”, as recommended by the February 3, 2016 report of the Committee on Taxation of E-Commerce set up by the Central Board of Direct Taxes.

With the levy in existence for almost eight months now, a Brookings working paper entitled Equalisation Levy examines the pros and cons of the levy so far. It argues that the levy is a presumptive tax on some specified services provided by non-residents in the “hard to tax” digital sector. After examining the issue that the equalisation levy and service tax are both on the same base and payable through reverse charge, the paper, however, concludes that these common characteristics do not detract from the legislative competence to impose the levy.

 

In a market dominated by a few big players, because of the network effect and cost characteristics, the equalisation levy corrects the obviously unfair advantage that some non-resident companies without PEs enjoy over domestic players, tempting even some resident digital companies to become non-residents.

The study finds that, with the monopolistic competitive market in the specified digital service, the impact of the levy on cum tax price is far from clear. In sharp contrast to apprehensions and reports of foreign suppliers of such services passing on the full burden to buyers, there are also reports of some non-resident companies deciding to absorb the tax and not pass it on to their Indian customers. The burden on buyers and sellers, therefore, needs to be studied to calibrate the rate. Given the limited government revenues from the levy, estimated at Rs 146.5 crore in the first half year of its application, the beneficial effect of government expenditure financed by these additional revenues may be ignored and the argument for reducing the rate becomes stronger the higher the pass-through to resident buyers.

Apart from the triple advantages of clarity, certainty and predictability, the equalisation levy corrects the clear inequity in resident providers of “specified services” bearing the burden of corporate income tax, while some non-residents providing the same services not paying any such tax in their relevant tax jurisdiction, for example, in tax havens. But the problem arises when a foreign company, not having a PE and supplying such services, is subject to the levy in India and is also subject to corporate income tax in its relevant tax jurisdiction. Since the levy is kept out of income tax, the non-resident may not be able to claim credit for the tax paid, resulting in double taxation. The paper argues that the government should examine whether the levy can be made into a rebuttable presumptive one to avoid such a possibility. 

The equalisation levy follows the work of the Organisation for Economic Co-operation and Development (OECD) with regard to the problem of Base Erosion and Profit Shifting (BEPS) in the context of the digital economy.  Here, the paper argues that the problem of BEPS is different in developed and developing countries. For developing countries the main issue is the right to tax in the “source” country, while developed countries face the problem of profits and income being parked in intermediary tax havens away from “home” or “origin” countries. “Origin” or “home” provides the capital and produces the goods or service; “source” countries provide the raw materials and market. Tax treaties and the definition of PE have changed over time to tilt the division of tax jurisdiction in favour of “home” countries relative to “source” countries. This tilt has been accentuated by the digital economy. “Source” countries not only provide hard physical infrastructure such as roads and telecommunication but also soft infrastructure such as law and order. Moreover, the consumers in their territory work for free in expanding the network and adding value to the digital service provider.

Because “other measures” developed for addressing BEPS would “mitigate some aspects of the broader tax challenges”, the OECD only noted the equalisation levy as a possible solution, but did not endorse it. The paper argues that the equalisation levy even though a second-best policy, may nevertheless play an important role in exerting pressure on “home” countries for a more equitable distribution of tax jurisdictions, which is the ultimate goal. 

Ashok Lahiri is a former economic advisor; Gautam Ray is a former chief commissioner of Customs and excise; D P Sengupta is a former chief commissioner of income tax