Over the years, India has made significant changes to its domestic tax law to ensure that it receives its fair share of tax from the digital economy. Some of the changes include:
- the amendment of the definition of “royalty” in 2012;
- the introduction of the equalisation levy in 2016 (restricted only to online advertisement services and providing digital advertising space), which was expanded in 2020 to include non-resident e-commerce operators within its ambit;
- the amendment of the definition of “business connection” to include a “significant economic presence” in 2018; and
- the introduction of withholding tax on domestic e-commerce transactions in 2020.
As per the expanded provisions, with effect from April 1, 2020, consideration received by a non-resident e-commerce operator from an e-commerce supply or service (except for online advertisement services already covered under the equalisation levy introduced in 2016) will be liable to equalisation levy at the rate of 2%. An exemption from equalisation levy is currently provided in the following cases:
- non-resident e-commerce operators having a Permanent Establishment (PE) in India and where the e-commerce transaction is effectively connected to such PE in India; and
- cases where the aggregate value of the consideration for the specified transactions does not exceed INR20 million (~ US$266,000) in a year.
Additionally, transactions entered into on or after April 1, 2021, which are chargeable to equalisation levy, are exempt from income-tax.
The Delhi High Court’s interim ruling
In the case of Google Asia Pacific Private Limited, Singapore (the taxpayer), the Delhi High Court (DHC) has dealt with the issue of withholding tax at source on Google’s cloud service-related payments which were already subject to a 2% equalisation levy.
As an interim measure, without ruling on the merits of the case, the DHC has allowed the Singapore based taxpayer to receive the payment from an Indian entity post deduction of tax at the rate of 8% (without additional surcharge and health and education cess based on the decision in the Epcos Electronic case and the Frequently Asked Questions explanatory circular issued by the Central Board of Direct Taxes) instead of 10% as provided under the “Royalty and fees for technical services” article in the India-Singapore double taxation avoidance agreement because 2% equalisation levy was already paid on the transaction.
Equalisation levy has been introduced as a separate Chapter in the Finance Act and, hence, does not form part of the Income-tax Act, 1961 (IT Act). Therefore, given that equalisation levy does not partake the character of income tax, credit of equalisation levy in the home country of the non-resident is, generally, not possible. Whilst much will depend on the provisions of the domestic tax law of the country of the non-resident recipient, but assuming that equalisation levy is not creditable, it is likely to result as a sunk cost in the hands of the non-resident.
While the equalisation levy applies with effect from April 1, 2020, the corresponding exemption from income tax in the hands of non-resident recipient applies only from April 1, 2021. Given this, there can be potential double taxation in the financial Year 2020-21, where the same transaction is subjected to equalisation levy as well as royalty or fees for technical services. So, the interplay of taxability of services under the head of royalty or fees for technical services vis-à-vis the equalisation levy provisions needs to be assessed.
The Finance Act, 2021, clarifies that equalisation levy shall not apply if the consideration is taxable as royalty or fees for technical services under the IT Act read with the tax treaty provisions. In the instant case, although the taxpayer had already paid equalisation levy, the tax department wanted to tax the same transaction under the royalty or fees for technical services provision. The DHC, as an interim measure, directed that the taxpayer would be entitled to receive the cloud service-related payment after deduction of tax at the rate of 8%. It is not currently known if the income-tax department will prefer an appeal against this ruling or will refuse the 2% equalisation levy adjustment at the time of assessment proceedings a year down the line.
Interestingly, India is a party to the two-pillar solution introduced by the OECD and the G20 Inclusive Framework on Base Erosion and Profit Shifting. Pillar One requires all member countries to withdraw their existing digital services taxes. However, on November 24, 2021, the Indian government announced that a transitional approach of 2% equalisation levy on e-commerce supply or services has been agreed with the US and the applicable interim period will be from April 1, 2022 until the implementation of Pillar One or March 31, 2024, whichever is earlier. As we see it, unless the interplay between the equalisation levy and the applicability of the royalty or fees for technical services provisions is sorted out soon, tax litigation on this issue cannot be ruled out.
About the Author
Ravi S. Raghavan has more than 25 years of experience in corporate tax advisory work, business re-organizations, international taxation (investment and fund structuring, repatriation strategies, treaty analysis, advance rulings, exchange control regulations, FPI taxation), tax litigation services, and other tax issues (including withholding taxes, capital gains tax, permanent establishment concerns, employee taxation, and tax holiday schemes).
Ravi has spoken at different forums on various tax matters, including at the Annual India Tax Forum in New Delhi, and at the Annual Symposium on India’s Taxation Regime at the National Law School of India University, Bangalore.
Prerna Seerwani is an associate at Majmudar & Partners.