Decoding equalisation levy for e-commerce sector: E-retailers may pass cost burden to sellers, consumers

The equalisation levy is levied on gross receipts from e-commerce supply, whereas taxes are levied on income, after reducing relevant expenses and deductions.

• By SR Patnaik & Sanjana Rao

Equalisation Levy (EL) was introduced in India in 2016. However, it became more intensive in scope and reach, and was slipped surreptitiously into the Finance Act, 2020 just before passage of the Budget, without any debate and discussions. The new EL was to come into effect from April 1, 2020, giving foreign companies operating in the digital space less than 10 days’ notice. The scope and reach of the revised EL came as a bolt from the blue for all stakeholders, as the broadest digital tax currently levied or proposed across the globe. In its present form, the EL proposes to levy 2 per cent tax on all non-residents engaged or facilitating the online sale of goods or services subject to certain conditions, in addition to the existing levy of 6 per cent on online advertisements. The EL is required to be paid directly by the non-resident, implying that no grossing up is possible.

Why Digital Tax?

The moot question is whether the complex profit-shifting arrangements choreographed by digital multinational enterprises to avoid tax liability in jurisdictions in which they operate digitally or market products, but do not have a permanent establishment, deserve to be taxed in such market states even in the absence of a permanent establishment. As territory-agnostic digital technologies evolved and the globe shrunk into a virtual space at the turn of the century, tax administrations realized that the extant laws were insufficient to bring such virtual entities under the tax net. Moreover, considering how COVID-19 has made digital technology a game-changer, countries are looking to leverage the current momentum. It must be noted that the Organisation for Economic Co-operation and Development (OECD) recognized the need to tax digital players, and considered equalization levy as one of the possibilities in its 2015 Action 1 Report, along with a disclaimer regarding the possible conflict with treaty obligations.

The controversial Equalisation Levy

The Indian EL has been rife with controversy since its introduction. It was argued that the EL did not conform to many of the rudimentary and internationally accepted attributes of taxes imposed by nation-states. It had extraterritorial reach, that is, a right to tax non-residents with no physical nexus to India. It is worth mentioning that in a recent response to the United States Trade Representative (USTR) investigations against the EL, the Government of India rubbished this argument, citing the US Supreme Court’s own judgment which had held that online sales were sufficient for the levy of taxes, and physical presence was not necessary. The judgment was rendered in relation to sales taxes levied on US-resident remote sellers by the State of South Dakota. The authors believe that the principles of international taxation are entirely different from local arrangements within the territories of a country. Since the EL could potentially infringe the residence country’s right to tax the non-resident e-commerce operator, it will become a hot topic to ascertain India’s jurisdiction.

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The EL is levied on gross receipts from e-commerce supply, whereas taxes are levied on income, after reducing relevant expenses and deductions. Further, the EL is outside the ambit of income tax as it was introduced through Finance Act, 2016, and is therefore not covered by double taxation avoidance agreements (DTAAs). Consequently, non-residents subjected to EL cannot claim relief under DTAAs and will not be entitled to credit for EL paid in India in their country of residence.

International negotiations and Pillar 1 approach

The 2015 OECD Action 1 Report has developed over time into an exhaustive digital taxation proposal, referred to as the “Pillar 1” approach, currently being negotiated at the OECD. A unilateral measure like the EL, in the wake of full steam multilateral negotiations, has the effect of undermining the international efforts towards achieving uniformity in digital taxes. Incidentally, the recent expansion of EL coincided with slight delays in negotiations on digital taxation at the OECD on account of COVID-19.

The government is aware of its responsibility to await a global consensus-based solution to taxation in the digital economy but ominously ignored it, conceivably due to disagreement with the OECD approach and the urgent requirement of revenue amid the pandemic. A unilateral EL not having the backing of international consensus will have a domino effect on Indian consumers. E-commerce operators will inevitably look to pass the additional costs of the new tax to sellers or consumers, as Amazon has announced to its sellers in the UK, where a similar levy will be operationalised soon.

The USTR has begun investigations into the EL, deeming it to be an unfair trade practice. If a positive finding is made through the investigations, the US will proceed to raise tariffs against Indian goods and services, which may culminate in a global trade war, more so if tariff barriers are thrown against France and UK as well. Irrespective of the USTR investigations, the challenges to EL will soon come home to roost in Indian courts, and the EL will have to be judicially tested on the touchstones of jurisdiction, constitutionality, and non-discrimination.

SR Patnaik is the Partner & Head – Taxation and Sanjana Rao is the Associate at Cyril Amarchand Mangaldas. Views expressed are the authors’ own.