The Organisation for Economic Co-Operation and Development and G20 member countries are developing a standardised approach to taxing the digital economy. Their ongoing collective effort aims to ensure relevant jurisdictions can tax their fair share of profits based on current digital and economic realities. Related OECD/G20 recommendations are known as Pillar One and Pillar Two.
Pillar One addresses taxing-rights allocation, profit allocation and nexus rules. In particular, it examines how to tax large multinationals that generate profits where they don’t have a traditional tax presence.
Although the OECD has not yet agreed on the final approach to Pillar One , many countries have developed and implemented their own regulations for taxing cross-border digital services. Most of these country-specific taxes only affect very large multinational groups, typically those that have country-by-country reporting obligations.
Some countries, including India, have introduced digital services taxes (DSTs) with much lower thresholds. Given the size of the Indian economy, its tax is likely to affect more multinational businesses than any other low-threshold DST.
Background: India’s 2016 equalisation levy
In 2016, India introduced an equalisation levy targeting payments for “specified services” made by Indian businesses to non-Indian businesses. These specified services included online advertising, the provision of space for online advertising and associated electronically delivered advertising activity.
The 2016 equalisation levy was effective from 1 June 2016 and applied at a rate of 6 percent. The levy amount was to be withheld by all Indian businesses making payments for online advertising services and remitted to the Indian tax authority.
India’s expanded equalisation levy
In early 2020, a proposal was made to expand the equalisation levy to include all digital services, though at a lower rate of 2 percent. This expanded definition of the equalisation levy — sometimes referred to as equalisation levy 2 — was adopted and took effect from 1 April 2020.
In contrast to India’s original equalisation levy on online advertising services, the expanded equalisation levy covers substantially all revenue-generating online services and requires the non-Indian business providing the services to report and remit the levy.
The new equalisation levy will apply to all businesses with India-source revenue exceeding 2 crore rupees (approximately US$265,000), unless that income relates to a permanent establishment in India or is subject to the original equalisation levy on advertising services.
For the purpose of the new equalisation levy, India-source revenue is revenue arising from either:
- Sales to both business and non-business customers resident in India, or customers that are accessing the service from an India IP address; or
- The sale of data relating to either an individual or business resident in India or one that uses an Indian IP address.
India’s equalisation levy, then, has significant extra-territorial scope, as it applies to users that are resident in India but not physically present there. It also applies to sales of data relating to India residents by non-India resident businesses.
Businesses that are subject to the new equalisation levy are required to report and remit the relevant equalization levy on a quarterly basis. The first quarter end is 30 June 2020, with the other quarter ends being 30 September, 31 December and 31 March. The equalisation levy amount for a quarter must be remitted a week after the end of the reporting quarter.
Practical operation of India’s expanded equalisation levy
The design of India’s equalisation levy has caused concern among a number of tech companies. While it is relatively simple for businesses to measure service usage by IP address, it is almost impossible to identify which users are Indian resident — rather than located in India — when selling services or anonymised datasets. This is before the measurement of user location is further complicated by the growing use of VPN services by internet users.
The penalty for failing to collect and remit the equalisation levy is high, with penalties of up to 100 percent of the amount not collected, plus interest on late remittances of 12 percent APR. Despite these stiff penalties, little guidance has been published regarding the reporting process for the expanded equalisation levy.
India has enacted the equalisation levy outside of its Income Tax Act to take it outside the ambit of its double taxation treaties. India’s position here, though, is controversial. Many tax treaties contain clauses to bring into their scope any charges substantially similar to taxes but enacted as something other than a tax, as would appear to be the case here.
The United States government, for one, is reviewing whether India’s equalisation levy constitutes a tariff on trade between the two nations and whether the U.S. needs to take formal action in response.
The difficulty in accurately determining the revenue subject to equalisation levy, combined with the fact that the compliance burden is imposed on non-resident companies whose activities the Indian government is unlikely to be able to measure effectively, means that there are a number of compliance and enforcement challenges to consider. These challenges will affect both the companies subject to the equalisation levy and the Indian government.
These difficulties are no doubt contributing to reports that the expanded equalisation levy may be suspended (or even abolished) before the first reporting quarter ends. Given the high stakes, multinationals are sure to watch the developing situation with interest.
Tom Blessington, Manager, International Tax Advisory, contributed to this article.
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