Since the humble beginning of internet adoption in 1995, India has come a long way to become one of the largest and fastest growing digital consumer markets with more than half a billion internet subscribers today.
The country has the potential to create up to $1 trillion of economic value from the digital economy by 2025.
Amongst several advantages, the foremost is the capability of digital to do away with the need for businesses to establish local presence.
This has made physical presence-linked taxation tenets redundant. Like many other countries, India too has been concerned with the progressive erosion of its tax base due to the rapid expansion of digital business models.
While countries are pursuing a common consensus-based solution at the OECD/G20 level to address this issue of erosion of the tax base, owing to lack of worldwide consensus, several countries including India, have started adopting unilateral measures to tax digital businesses for revenues generated from the local customer base.
One of the measures India took early in 2016 was to introduce Equalisation Levy ('EL') at 6% of online sale of advertisements and related services from non-residents ('NR'), as a withholding tax on the payers.
In 2020, the government finally widened its scope ('EL 2020'), to apply at the rate of 2% on the consideration from online sale of goods or provision of services facilitated or provided by NR e-commerce operators.
Besides applying to transactions with Indian tax residents, EL-2020 also applies to select transactions between two NRs, such as for sale of advertisements targeting Indian customers or sale of data collected from Indian residents or with an IP address located in India.
EL-2020 was introduced in a rather hasty manner - it was brought in at the amendment stage of the Finance Bill without any stakeholder consultation and without any explanatory statement or memorandum.
The first installment was due by July 7, 2020 when the country and the world at large were grappling with rising COVID-19 cases.
The introduction has also drawn the attention of the United States Trade Representative (USTR), which has initiated an investigation against various countries including India, with the focus on discrimination against US companies.
EL vs GST - overlapping provisions
Before the EL-2020 was introduced, India had already collected GST of 18% on all digital goods and services, falling within the ambit of 'Online Information Database Access and Retrieval Services' ('OIDAR').
The overlapping burden of tax has manifold impact on digital businesses where margins are lean and businesses are operating under losses due to stiff competition. This has compelled some companies to consider passing the taxes on to consumers. This makes these levies regressive since digital today is very much the mainstream means for B2C commerce.
Global trends and uncertainty
There has been strong concern among international businesses on the increasing trend of digital service taxes (DSTs) - in different avatars in various countries.
While the objective of market countries getting their fair share of tax is understandable, these taxes apply on gross consideration and are not creditable in home countries.
This leads to a huge cash flow impact on such businesses. It also requires them to track data based on users in each jurisdiction. With differing scopes and thresholds for DSTs in each country, the compliance burden on e-commerce platforms, search engines and social media platforms has increased manifold.
Especially in the Indian context, owing to the hurried introduction, businesses have been uncertain about the application. The scope of EL-2020 is wider than DST introduced by European countries, and even applies to intercompany transactions.
For instance, DST covers only specified digital services such as online marketplaces, social media platforms, online advertising and excludes intra-group services, regulated financial services.
Traditional brick and mortar businesses that use some digital or electronic facilities, incidentally, are also exposed to EL-2020, bringing transactions worth several billions of dollars within the ambit of EL-2020 provisions.
In order to avoid double taxation, India has announced exemption from income tax for any income that is subject to EL-2020; though, somehow this exemption is not available in 2020-21.
Further, as EL is not an income tax, if businesses end up having a permanent establishment in India, there is no clarity on how credit will be given, as in such cases, their net income will be subject to income tax in India.
Several similar interpretational issues make EL-2020 a gateway to extensive future litigation, a consequence least desired by any party.
Compliance and administrative burden
Today, while businesses globally are reeling from the crippled business environment due to the pandemic, EL-2020 adds a layer of additional compliance, without any guidance.
International businesses may be organised in the form of several business entities, some or all of whom may be exposed to EL-2020, with the need to obtain tax registrations in India and make filings. Some European countries have provided for a group representative concept for DST compliances, making it easier for reporting.
International businesses are therefore now required to have proper infrastructure and systems in place to deal with technological challenges to determine whether the IP addresses of their customers are located in India or not.
Given some of the vexatious issues noted above, there is a dire need for calibration of EL 2020 which can only be undertaken with proper stakeholder discussion, since e commerce models vary from business to business and are ever evolving and dynamic.
Since the eventual scope of taxation has to be based on the global consensus at the OECD level, it is pertinent that EL 2020 is applied as an intermediate levy.
The Indian government should narrow down the scope of EL-2020 in the upcoming Budget 2021 in line with global trends such that businesses are able to take decisions more freely and with greater certainty.
The government should ensure that an interim measure of this sort does not chase away investor sentiment from the country.
(The author is Partner in Deloitte India)