 "Equalisation levy warrants public debate")
The traditional concept of cross-border business activities of a multinational enterprise is based on physical presence, called 'permanent establishment', or PE. If an enterprise carries on business in another country through a PE, the profits attributable to the PE are taxed in that country. There has been enough controversy over what constitutes a PE. That said, there is a consensus that unless there is a presence in a country, a foreign enterprise cannot be taxed there. The generally accepted concept is that what is taxable is trading in a country, and not trading with a country.
In the digital age, it is possible to do business in a country through electronic means without establishing a physical presence there. E-commerce is a classic example of this. The loss of revenues to the government as a result of non-taxation of profits of these firms which are able to trade in a country without a PE has been a matter of considerable debate. Also, whether the traditional concept of PE has relevance in the digital age is a point of global discussion.
When the Organisation for Economic Co-operation and Development (OECD) looked at the concept of base erosion and profit shifting, the first issue it considered was taxation of digital transactions. Without doubt, generating profits in a country and not paying taxes there on the premise that there is no PE would lead to base erosion and profit shifting.
How does a country deal with this issue? Three approaches were examined by the OECD: i) a new nexus in the form of a significant economic presence; ii) a withholding tax on certain digital transactions; and, iii) equalisation levy.
For a variety of reasons, none of the approaches was recommended. Countries were free to go ahead with any of the options they felt appropriate "provided they respect existing treaty obligations". India has chosen to be a torchbearer in this regard and proposes under the Finance Bill 2016 to impose an equalisation levy of six per cent on payments made to non-residents for online advertising and digital advertising services.
The rationale behind the levy is understandable given that India has always followed source-based taxation and likes to tax any amount that leaves its shores. Ordinarily, the levy would have been regarded as a financial cost of advertising online. However, the manner in which India has decided to impose the levy makes it interesting and challenging.
First, the charge of tax is not under the Income-tax Act. It is under Chapter VIII of the Finance Bill 2016. As a result, while the consequences to the payer flow from the Income-tax Act, the levy itself is not income-tax. Therefore, the recipient cannot get credit of the taxes withheld in the home country. Naturally, the recipient would likely insist on net of tax receipt, the tax being borne by the advertiser, grossed up. Also, such payments are subjected to a reverse service tax charge.
Consider, further, that OECD categorically provided that a country may choose to levy tax on any of the three basis set out above 'having regard to treaty obligations'. If the attempt is to bypass the treaty obligations, how is India complying with the OECD mandate?
Other pertinent questions are whether this is an indirect tax levied under the garb of direct tax. Is such a levy consistent with India's obligations on the World Trade Organization front? Does this amount to a tax on advertisements, which (other than for radio and television) is a state subject?
The world is looking at India as one of the first countries seeking to levy digital tax. It has a significant cost potential, disturbs the tax treaty framework, and could also lead to litigation. Perhaps a longer public debate on such complex issues is warranted before enactment.
The author is chief executive officer, Dhruva Advisors LLP
