For long, India has voraciously advocated for international tax rules that allocate taxing rights to market jurisdictions. Propelled by global momentum to tax digital businesses, India’s need to introduce new tax rules was heightened when courts ruled that the existing legal framework could not bring online advertisement revenues under the Indian tax net nor could a permanent establishments (“PE”) be found absent a physical nexus. Since 2016, there has been a host of legislative amendments aimed at taxing foreign digital businesses. These include a six percent equalization levy on online ad revenues generated from India, introduction of the significant economic presence test to trigger taxation of business profits and a draft policy paper advocating the unified approach to PE attribution. In fact, India has lapped up nearly all interim measures discussed by the OECD to tax the digital economy, pending global consensus.
In this article, we discuss India’s recent two per cent equalization levy (“EL”) on foreign e-commerce operators catering to the Indian market, which has come into effect from 1 April 2020. This new levy was a silent entrant in India’s Finance Act, 2020 and did not form a part of the policy debate that usually precedes the formal introduction of tax amendments in India. We also deliberate on the ambiguities surrounding this new levy and its impact on varied digital business models and argue for its deferral.
A foreign enterprise, which owns, operates or manages a digital facility for selling or facilitating sales of goods and services online (“E-commerce Operator”) is subject to an EL of two per cent on the consideration received from making or facilitating sale of goods or services to Indian resident customers and customers using an Indian IP address.
Such levy also applies to consideration received from non-residents on (a) sale of advertisement targeting Indian resident persons or persons using an Indian IP address; and (b) sale of data collected from Indian resident persons or persons using an Indian IP address.
There are three exceptions to such levy. First, if the Ecommerce Operator has a PE in India and the relevant sales are connected to such PE. Second, the taxable sales, turnover or gross receipts are less than INR 20 million in the relevant tax year. Third, such sales are already subject to the six percent EL on online advertisement revenue. E-commerce Operator (and not the Indian customer) is responsible to deposit such equalization levy with the Indian government and meet associated compliances.
- Tax base of the new EL:
The charging statute for the new EL states that EL will apply at 2 per cent of “the amount of consideration received or receivable by an e-commerce operator from e-commerce supply or services made or provided or facilitated by it…”
For an online marketplace, which monetizes its platform by way of retaining a commission from the total supply proceeds, a key question is whether the new EL applies to the gross merchandise value (GMV) or the commission retained.
On the one hand, it is arguable that GMV is subject to TDS. This is because if the merchant had made a direct sale to an Indian customer on his own website, the entire GMV would be subject to the EL. Incongruous results would arise if EL is restricted to the commission earned by the market place in case sales are routed through an online marketplace. This would incentivize a foreign merchant to makes sales through online intermediaries rather than direct sales into India.
On the other hand, the more reasoned view is that EL should only apply to the commission earned by the E-Commerce Operator. First, EL is a substitute for income taxes, pending global consensus on international tax rules for digital economy. This is apparent because a transaction that is subject to EL is exempt from income tax. Moreover, no EL applies where the E-Commerce Operator has a PE in India. As a corollary, it follows that EL should be restricted to the income of the E-Commerce Operator and not the GMV. Second, the E-Commerce Operator does not receive the GMV on his own account but in trust for the merchant. Accordingly, the consideration received by the E-Commerce Operator from facilitation of online sales is commission and not the GMV. Third, GMV would be subject to double taxation if an Indian resident merchant were to sell his goods on the marketplace. In such case, the Indian merchant would rather sell his goods on a Indian owned and operated online marketplace.
At present, there is a little clarity on the tax base for EL as far as online marketplaces are concerned.
- Scope of facilitation
As such, EL is applicable on e-commerce operators on the e-commerce supply or services facilitated by them. The law is unclear as regards what would qualify as facilitation of an e-commerce supply to trigger the new EL. Would an advertisement, listing of products or product catalogue, amount to facilitation even if the transaction is concluded offline, or outside of the digital facility trigger EL. As such, no EL should apply where the E-Commerce Operator receives no consideration for such facilitation and payment exchanges hands directly between the buyer and seller.
This issue arises in the more in the context of new withholding tax obligation cast on E-Commerce Operators who facilitate sale of goods by Indian merchants on their digital platforms. In such case, E-Commerce Operators are required to withhold tax at 1 per cent from the gross value of goods sold even if the actual payment is not routed through them.
While the more sound view is that facilitation means facilitation of the sale – purchase transaction rather than the broad sale process, there is no clarity on this issue.
- Business to business sales
As a market jurisdiction, India’s policy intent underlying the new EL appears to be taxation of business profits generated by foreign enterprises from continued digital interaction with Indian user base. However, what happens in cases where an Indian distributor places orders for goods with a foreign manufacturer on an online order portal designed by the manufacturer. It is unclear whether tax policy intends to tax such transactions too, given that the supply chain following the distributor is already subject to Indian income tax.
- Financial services
New EL’s application to digital facilities that provide financial or transaction processing services such as online loans, payment gateway services, payment aggregators, etc. is also not clear. Indian case law in the past has held that interest payments are the result of a financing transaction and not a service. Similarly, transaction-processing fee charged by banks are a banking service and not commission. However, in the absence of any policy statement by the Indian Government, the scope of new EL ambiguous.
- Miscellaneous issues
A bunch of other miscellaneous issues remains open. For instance, the income tax exemption applicable to transaction subject to EL is effective 1 April, 2021 where as EL has come into force from 1 April, 2020. The policy rationale for this time lag is unclear. The law also does not specify the foreign currency exchange rate to ascertain the taxable threshold of INR 20 million.
Conclusion - a case for deferral
Indeed, the first policy question is the need for a new EL pending the firming up of international tax rules for taxing the digital economy. Keeping that aside, certainty is key to any tax policy and currently there are gaping holes in the new EL that need clarity to ensure effective compliance. A consultative process before introducing the new EL would have allowed the Government to foresee and test EL rules against the several online business models that are prevalent. For many businesses where the profit margin is 2% or less, serving the Indian Market has become commercially unviable. Additionally, E-Commerce Operators were not given any heads up to set up internal systems to secure compliance for a new levy introduced in the midst the covid crisis. To our mind, a deferral of the new EL post consultation with all stakeholders will go a long way in boosting confidence in the Indian tax system. The Government should also consider introducing a mechanism by way of which an e-commerce operator can seek an advance determination of whether the new EL rules apply to it.