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Equalisation levy: a case of juridical double taxation and treaty override
Lakshmikumaran & Sridharan, New Delhi
Lakshmikumaran & Sridharan, Mumbai
The digital age has provided phenomenal expansion to businesses that is beyond the political frontiers sketched on the landmass.The digital age has made it possible to carry out business in multiple territories without establishing any physical presence in any territory. However, the evolution of the virtual world has turned out to be a challenge for nations in exercising their taxing rights. Conventional taxation models never envisaged anything but a bricks-and-mortar world.
Taxation issues relating to the digital economy were recognised and analysed by the Organisation for Economic Cooperation and Development (OECD). Potential options through which the issues could be tackled were analysed. The options included: (1) identifying the 'nexus' based on significant economic presence; (2) a withholding tax on digital transactions; and (3) an equalisation levy. None of these options were recommended; however, it was concluded that countries can introduce the options in their domestic tax laws as an additional safeguard while respecting tax treaties.
The Indian equalisation levy
India was a frontrunner in adopting the interim measures, starting from the introduction of an 'equalisation levy' in 2016. The charge was made on consideration for provision of 'specified services' by a non-resident. The scope of the levy has been extended by the Finance Act, 2020, to include consideration received for 'e-commerce supply or services' by a 'non-resident e-commerce operator'. Further, to avoid the double taxation of revenue that has suffered the equalisation levy, the income of a non-resident from the provision of specified services, or e-commerce supply or services is exempt from income tax under the Income-tax Act,1961 (the 'IT Act').
Is it an alternative form of income tax?
The statutory provisions relating to the levy and collection of the equalisation levy do not form part of the IT Act. It has been introduced as a separate levy under the Finance Act, 2016. Therefore, the question that arises is as follows: Is the equalisation levy a separate tax and not in the nature of an income tax? It is a settled principle of law that the object and purpose of a statute will determine its character. The equalisation levy has been brought into force to tackle direct tax issues relating to digital businesses. This is also supported by the concept of 'horizontal equity'; that is, taxing digital services rendered by non-residents with the objective of equalising their tax burden with other Indian competitors who are subject to income tax in India. Further, the equalisation levy is chargeable where the non-resident does not have a fixed permanent establishment in India. If there is a permanent establishment in India, then the profits attributable will be subject to income tax in India. The difference in these two situations clearly suggests that what is not covered by the IT Act is now covered through the equalisation levy. Moreover, the income of a non-resident who has suffered the equalisation levy is exempt from income tax under the IT Act. Thus, the object and purpose of the levy suggests that it is an alternate form of income tax, though not introduced under the IT Act or per se as 'income tax'.
A case of juridical double taxation?
The purpose of entering into double taxation avoidance agreements (DTAAs or 'tax treaties') is to avoid the dual taxation of the same income in two different jurisdictions, with a view to encourage cross-border services and investment. The DTAAs entered into by India forbid the taxability of the profits of a non-resident in India in the absence of any permanent establishment. Additionally, the DTAAs provide for the taxation of non-residents in India to the extent of profits attributable to a permanent establishment in India.
The business profits of non-residents from rendering specified services, or e-commerce supply or services are chargeable to income tax in their home country. With the enactment of the equalisation levy, the revenue giving rise to such business profits would also be subject to tax in India. The levy is imposed when the non-resident does not have a permanent establishment in India. However, this unilateral action of the Indian Government to impose the equalisation levy doesn’t align to the double taxation avoidance mechanism, or to allowing the claim of foreign credit or exempting such profits from tax in the home country. Imposing the equalisation levy on non-residents who do not have a permanent establishment in India is leading to 'juridical double taxation'.
On the one hand, the profits earned by a non-resident are subject to income tax in their home state and on the other, the gross receipts of non-residents are taxable in India (host state) in the form of the 'equalisation levy'. This is leading to double taxation. This concern has also been recognised in the final report of Base Erosion and Profit Shifting (BEPS) Action Plan – 1.
Is it compliant with treaty obligations?
The equalisation levy contravenes the 'permanent establishment' principle because it is leviable without any permanent establishment in India. It is this principle alone through which India exercises its taxing rights over the business profits of non-residents. Further, the IT Act provides that where a taxpayer is covered by a DTAA, then the provisions of the IT Act will apply to the extent to which they are more beneficial to the assessee. However, this provision would not stand to benefit taxpayers as the equalisation levy isn’t a part of the IT Act, and there is no such provision available under the equalisation levy to provide the benefit of DTAAs.
Under the given circumstances, does the Indian Parliament have the power to act in derogation of tax treaties or to circumvent the provisions of tax treaties through unilateral domestic legislation? Neither the Constitution of India, nor the IT Act or Chapter VIII of the Finance Act, 2016 (relating to the equalisation levy) contains any provision to resolve this dilemma. A reference can be made to Article 51 of the Constitution of India dealing with Directive Principles of State Policy which, inter alia, provides that the state shall foster respect for international law and treaty obligations. Also, the customary international law relating to treaties is well enshrined in the Vienna Convention on the Law of Treaties (the 'Vienna Convention'). Article 26 of the Vienna Convention prescribes the principle of 'pacta sunt servanda' as per which every treaty in force is binding upon the parties to it and must be performed by them in good faith. This principle has been acknowledged by the Indian judiciary on several occasions. Further, Article 27 of the Vienna Convention provides that a party may not invoke the provisions of its internal law as justification for its failure to perform a treaty.
Further, when the proposal of this option was made in the BEPS Action Plan – 1, it was intended to be respectful of existing treaty obligations and bilateral tax treaties. But given the way in which the equalisation levy has been introduced under the domestic tax laws in India, the intention appears to have been defeated or ignored.
Is there a way out?
The DTAAs provide for a 'credit method' to eliminate juridical double taxation. Under this method, non-residents are allowed the credit of income taxes paid in a foreign state while discharging the income tax liability in their home state. As it appears today, tax treaties are not aligned to cover the equalisation levy. However, the DTAAs, inter alia, provide that they shall apply to taxes imposed under Indian laws if they are substantial or similar to income tax. Further, the two contracting states have to notify each other with respect to the changes made to the laws of their respective states relating to taxes to which the DTAAs apply. There appears to be a ray of hope if the two contracting states can agree to cover the equalisation levy similarly to income tax and therefore allow credit with respect to the equalisation levy in the home country where the income of the taxpayer is to be subject to income tax. This will bring much-needed relief to taxpayers. Otherwise the impact of such a levy may sooner rather than later start appearing in the way business is being carried out. The existing business structures or the manner of carrying out business will demand reconsideration, and needless to say, the ultimate consumers will have to bear the brunt of increased tax costs.
In the absence of the above, the non-resident may explore the mutual agreement route as provided under the respective DTAAs.
The objective of the equalisation levy was to tax non-residents who remained untaxed, mainly due to a lack of adequate provisions, either under the DTAAs or IT Act. But the imposition of a unilateral levy through the domestic tax laws of India appears to contradict bilateral treaty obligations. It is ironic that taxpayers who remained untapped for tax payments in the source country will now have to pay tax in two states without any immediate solution against such juridical double taxation. Also, while framing the law, the Indian Government has kept in view its own interest and completely ignored the taxpayer's perspective. The law as it stands today, especially with the expanded scope, certainly adds to the plight of business owners. Owners are now faced with the nightmarish prospect of the need to reconsider their business structures, re-examine pricing and upgrade accounting systems to cope up with the new levy – that too in the middle of the Covid-19 pandemic-induced economic slowdown.
It is worth mentioning that India isn't the only country that has taken this action. Other countries, such as the United Kingdom, France, Austria, Italy, Turkey, Greece and Indonesia, have also implemented measures, such as a digital service tax, withholding tax and so on to tackle digital taxation issues. Countries such as the Czech Republic, Spain, Israel and Brazil have also expressed their intention to introduce such a tax/levy. Thus, every state is taking unilateral measures to tax the untaxed digital economy.
For now, countries are adopting these measures as temporary or interim measures. They will prevail until any viable solution is suggested by the OECD and agreed among the states. However, how long this interim period will last is a big question. But it is certain that the unilateral measures that are being adopted in the interim will pave the way to litigation in the near future.
 Addressing the Tax Challenges of the Digital Economy, Action Plan 1 Report, 2015.
 C VIII of the Finance Act, 2016.
 (1) Online advertising; (2) any provision for the digital advertising space; or (3) any other facility or service for the purpose of online advertising and; (4) any other service as may be notified by the central government in this behalf.
 S 165A of c VIII of the Finance Act, 2016.
 (1) Online sale of goods owned by the e-commerce operator; (2) online sale of services provided by the e-commerce operator; (3) online sale of goods or provision of services or both, facilitated by the e-commerce operator; or (4) any combination of activities mentioned in (1)–(3).
 A person who owns, operates or manages a digital or electronic facility or platform for the online sale of goods, online provision of services or both.
 S 10(50) of the IT Act.
 Memorandum to the Finance Bill, 2016.
 The concept states that taxpayers in similar circumstances should bear a similar tax burden.
 Report of the Committee on Taxation of E-Commerce, para 10.1.
 OECD Model Tax Convention (Condensed Version, 2017), Introduction (para 15.2), p 13.
 See n 11 above: imposition of comparable taxes in two (or more) states on the same taxpayer in respect of the same subject matter for identical periods.
 See n 1 above at para 126.96.36.199.
 S 90(2) of the IT Act.
 Vienna Convention on the Law of Treaties, 1969.
 See n 15 above, Art 26.
 Art 2 of the DTAAs.
 Mutual Agreement Procedure under the DTAAs.