India’s Evolving Solution To Digital Taxation

Some people look at India’s equalization levy and don’t like what they see.

The aversion could stem from the details of the tax, or from Western discomfort with the fact that a prominent market economy has chosen not to sit on its hands while the OECD fiddles with a coordinated response to the challenges of the digital economy.

The better perspective is that an equalization levy is a sign of the times — a sign with which we should learn to get comfortable.

Critics will complain that the equalization levy is one of those unilateral measures we keep hearing so much about. So what if it is? Do me a favor: Every time you hear the words “unilateral taxation,” allow your brain to auto-correct the remark to “defensive countermeasure.” This simple task will make the next few years a lot more tolerable.

I’ve previously argued that India’s equalization levy is an appropriate response to the shortcomings of the modern corporate tax base. If other countries are seeking a suitable template for digital services taxes, they could do far worse than mimicking India’s approach.

When future historians write books about the evolution of DSTs over the course of the 21st century, I expect they’ll devote a full chapter to how Indian policymakers were at the forefront of this movement.

This was no accident, given India’s history of conflicts with firms like Google and Yahoo — and the related court decisions that left stakeholders confused as to whether digital service payments to nonresident companies were taxable as royalties.

Presented with messy case law and uncertainty about the viability of the significant economic presence standard as a basis for establishing a new nexus concept, it was only reasonable for India to seek a quick remedy outside the confines of the corporate income tax.

Another March Surprise?

Unlike last year’s March surprise, India’s Finance Bill 2021 does not include a formal expansion of the equalization levy. But it remains unclear whether the government has taken the more subtle — some would say passive-aggressive — route of informally extending the scope of the tax under the guise of interpretive clarification.

One concern is that the updated equalization levy may soon be applied to online communications platforms that facilitate commercial transactions without taking a commission. The conventional thinking is that these digital services should fall outside the scope of the equalization levy because the platforms often aren’t in a position to know whether a sale has occurred, who the buyer was, or what price was charged.

My hope is that what has occurred with the proposed Finance Bill 2021 is an innocent transposition of words that won’t carry the feared consequences. Nevertheless, this article summarizes the controversy and context. After what happened last year at this time, you can’t blame taxpayers for feeling a bit paranoid about the scope of the tax.

To review, the equalization levy is not a constituent part of India’s Income Tax Act, 1961. Codification of the tax is self-contained in a separate statute — Chapter VIII, sections 163 to 180 of the Finance Act 2016.

The placement is appropriate because the levy does not attempt to tax net income, although many people regard it as a measure that is imposed in lieu of an income tax. The structure of the tax promotes that perception.

It’s important to remember how modest the equalization levy was in its original form. It was (and remains) a 6% gross receipts tax on online advertising and related services. It applies only to the consideration for those services received by nonresident firms without a local permanent establishment.

There was no need to apply the levy to PEs or resident firms because they are subject to domestic income taxation. The thing being equalized is not the treatment of digital operators versus brick-and-mortar firms, but the treatment of nonresidents with PEs versus nonresidents without PEs.

The original levy applied only when the advertising services in question were provided for the benefit of resident persons conducting a business or profession, or nonresidents operating in India through a PE. This excluded business-to-consumer transactions.

To mitigate potential double taxation, any income subjected to the equalization levy was exempt from the ITA. As such, the digitally derived income of e-commerce operators would be subject to India’s income or the equalization levy, but not both.

It goes without saying that a gross receipts tax is not everyone’s cup of tea. Total receipts, or annual turnover as it is sometimes called, is not reflective of ability to pay.

Gross receipts taxes reach firms in a loss position. If that seems hard, bear in mind that nonresident e-commerce operators who feel aggrieved by the levy have a rather easy means to avoid it altogether — they can acquiesce to an Indian PE. That effectively makes the equalization levy an elective regime.

The choice is between keeping your non-PE status and suffering gross basis taxation or taking on a local PE to attain net basis taxation. That’s reminiscent of the U.K. diverted profits tax and how the avoidance of PE status can be twisted into a less favorable alternative. The sport of cricket isn’t the only thing India has borrowed from the Brits.

The sting of last year remains fresh in taxpayers’ minds. The version of Finance Bill 2020 that was tabled in Parliament included no references to the equalization levy, but days before the bill received presidential assent the scope was dramatically expanded without adequate opportunity for debate or discussion.

The resulting Finance Act 2020 added a 2% gross receipts tax on the consideration received for “e-commerce supply or services,” which goes well beyond online advertising and does not exempt business-to-consumer transactions.

These dual facets of the equalization levy differ so greatly that they deserve to be spoken of as two distinct taxes. Over the last year we’ve been in the habit of distinguishing between the original 6% “advertising” levy (which was never repealed) and the expanded 2% “e-commerce” levy.

To avoid overlap, the e-commerce levy does not apply to transactions covered by the original advertising levy. Again, the expanded levy does not apply when the nonresident e-commerce operator has an Indian PE as long as the supply of goods or services is effectively connected with that PE.

For the expanded levy, the term “e-commerce supply” was defined to mean:

• the sale of goods owned by the operator;
• the provision of services by the operator; or
• the sale of goods or provision of services facilitated by the operator.

At the time, I did not regard the phrasing of these bullet points as problematic. I still don’t. The language in the third point about sales being “facilitated” by operators would seem to cover online marketplaces in which the company operating the platform does not own the goods in question.

That’s in contrast to the first bullet point, which addresses marketplaces in which the operator does own the goods being sold. To my sensibility, that makes it clear that the e-commerce levy applies to both situations.

Not everyone agreed. A vocal group of businesses have complained that the language of Finance Act 2020 was sufficiently vague to cast doubt on whether the levy applies to online platforms (think eBay) that do not hold inventory — or at least don’t own their inventory.

I wonder if those grievances were genuine or just sour grapes over the hasty manner in which the 2020 expansion was pushed through. Either way, with Finance Bill 2021 the government has taken steps to clear away any doubt.

Unintended Consequences?

The Ministry of Finance previewed the country’s 2021-2022 Union Budget on February 1. Shortly after, it released Memorandum to the Finance Bill 2021.

Among other things, the memorandum sheds light on how the term “consideration received or receivable” should be interpreted for applying the equalization levy to online marketplaces. The phrase was not defined in Finance Act 2016, which created the levy, or in Finance Act 2020, which expanded it.

If enacted, Finance Bill 2021 would define the phrase to include:

• consideration paid for the sale of goods, regardless of whether the operator held title to the goods in question; and
• consideration paid for the provision of services, regardless of whether the operator provided or facilitated the service.

The upshot of the clarification is that India’s equalization levy now unambiguously pulls in online marketplaces that function solely as intermediaries between buyers and sellers in the manner described above. But this doesn’t mean people have stopped arguing about the scope of the levy or pleading for a delayed effective date.

A related issue is whether the base to which the levy applies is the total consideration paid by the buyer or the commission retained by the e-commerce operator. For example, let’s assume a person in Mumbai purchased a radio through an online marketplace for INR 3,000 (about $41), and the e-commerce operator retained a commission of INR 150, representing 5% of the sales price.

Should the 2% levy be applied to the full sales proceeds of INR 3,000, resulting in a tax of INR 60, or to the operator’s commission (INR 150), resulting in a tax of INR 3?

Considering that we’re dealing with a gross receipts tax, which decidedly makes no attempt to gauge a taxpayer’s net income, the correct answer seems to be that the levy is applied to the full proceeds.

Some commentators want to quibble with the reasoning above, citing the specific language of sections 163 and 165A. Their suggestion is that there’s a difference between consideration received or receivable for e-commerce supply (per section 163) and consideration received or receivable from an e-commerce supply (per the charging provision of section 165A).

In this view, it can reasonably be argued that the levy should be applied only to the operator’s commission, rather than the full sales proceeds. If that’s correct, the pain of the levy would be reduced by an order of magnitude.

This strikes me as wishful thinking premised on a net taxation model, which doesn’t square with an understanding of the levy as a gross receipts tax. The consideration “received or receivable” is surely broader than the operator’s commission.

To fixate on the preposition being used — “for” or “from” — seems like a distinction without a difference. I’m confident Tax Notes readers will respond accordingly if that’s not the case.

Separately, note how the levy — when applied to the full measure of consideration — can completely wipe out the operator’s profit margin if the commission rate is the same as (or higher than) the tax rate. If an e-commerce operator insisted on preserving its margin, it would need to increase the commission fee by an amount equivalent to the tax rate.

In our example, that would require increasing the commission charged to the seller from 5% to 7%. In turn, a higher commission could influence sellers to increase their asking prices to maintain their net receipt. This is how tax burdens are passed on to the next person in the stream of commerce.

Nobody can say for sure whether a particular e-commerce operator would be able to accomplish the fee adjustment without suffering a corresponding decline in consumer demand. The capacity of e-commerce traders to absorb someone else’s tax burden is not infinite.

The outcome depends largely on the competitive conditions in each market segment. Those fortunate e-commerce operators that enjoy quasi-monopolistic powers should be able to pass the tax burden on to others in this fashion. To the extent that this occurs, the economics of the levy seem closer to an excise tax than a tax on nonresident businesses.

I don’t think India’s government cares how the equalization levy is labeled for these purposes. It’s not the finance minister’s problem if e-commerce operators respond by increasing fees.

The optics of the tax are that it falls on nonresident firms that don’t pay local income taxes by dodging PE status. Every tax is inherently political, and India’s political class thinks they’ve stumbled on to a winner with the equalization levy. You call it unilateralism; they call it sovereignty.

I Saw It on Craigslist

There’s a problem with the clarifications proposed by Finance Bill 2021. If taken literally, they would implicate e-commerce platforms that primarily function as communication tools without extracting a commission. That seems like the wrong result. This is the Craigslist scenario.

Craigslist is available in 70 countries, including India. It’s an online marketplace for a seemingly endless variety of goods and services, most of which are sold by individuals rather than businesses. It has increasingly become the digital counterpart to old-fashioned classified ads in newspapers.

Sellers can post goods for sale, and the website provides interested buyers with a means of contacting them via third-party email services. The platform itself doesn’t perform the messaging function; it merely facilitates it by cloaking a user’s personal email account. This provides a degree of anonymity, should the counterparty you’re dealing with turn out to be a creep.

The platform also doesn’t track the sales transaction. All payments occur directly between the buyer and seller — often in cash or whatever terms the parties find mutually agreeable. No payments are processed through the platform itself.

The platform wouldn’t know, for instance, if any haggling had occurred to cause the actual price to deviate from the asking price. Nor does the platform concern itself with shipment or delivery details.

All of this means the e-commerce operator remains blissfully ignorant as to whether the proposed sale was concluded. It’s out of the loop, and purposefully so. So far as digital marketplaces go, Craigslist and Amazon couldn’t be more different.

It’s also fair to say that Craigslist isn’t your typical profit-seeking, capitalist endeavor. It doesn’t charge fees for listing goods or services, though it does charge employers to post online job listings, which generates enough revenue to pay the bills.

Generally speaking, the pursuit of profits seems to be a low priority for the company’s management. Forbes has described the outfit’s business model as reflecting socialist principles.

As you may have guessed, the company is not publicly traded. Online auctioneer eBay once held a minority stake in Craigslist but divested its shares in 2015 after some internal turmoil.

Putting these peculiarities aside, it’s unclear how this kind of e-commerce operator would be treated under the proposed revisions to the equalization levy. The platform facilitates communications, but it doesn’t do much else — and it steers clear of both payment processing and fulfillment obligations. 

Craigslist doesn’t own the goods being sold, but Finance Bill 2021 (if enacted) clarifies that this factor alone will not relieve an in-scope operator from the levy.

Moreover, the operator doesn’t receive any commission from sales activity. In fact, the operator possesses no way of knowing whether a sale has occurred. It knows only when a listing has been posted and removed, which doesn’t confirm anything.

If platforms like Craigslist were subject to the levy, what would be the appropriate tax base? The two options are the full sales proceeds or the operator’s commission.

The commission is zero, but the analysis above would dismiss that possibility as off the mark for a gross receipts tax. The statute points us in the direction of “consideration received or receivable,” but that doesn’t work either. Here, the operator has no clue about the actual consideration that changed hands.

Could it be that the wrong answer for commission-based operators is the correct answer for noncommission-based operators? My instinct tells me that can’t be what the India government had it mind when it drafted the Finance Bill 2021.

Then what, if anything, prevents a platform like Craigslist from being subject to the levy on the full consideration conveyed between buyer and seller?

The fundamental problem is that the design of the levy assumes that every e-commerce operator is in the business of processing payments, and that’s simply not the case. As a result, it can’t deal with situations in which a communication platform doesn’t charge a commission. Although the operator’s commission isn’t the relevant tax base, its existence is apparently necessary to make the levy workable.

On this issue, the government still has some important work to do. For that reason, a postponement in the effective date of any statutory changes seems appropriate.

As things stand, Finance Bill 2021 would be applied retroactively to April 1, 2020, the effective date of the changes ushered in with Finance Act 2020. Considering that the envisioned outcomes don’t seem correct, a retroactive application hardly seems fair.

Having begun this article by praising India’s boldness in how it tackles the digital economy, I conclude it by urging temperance. This underscores that all DSTs are a work in progress, and probably will be for some time.