Assessing the expansion of Equalization Levy

The Finance Act, 2020, has widened the scope of equalization levy, which was introduced in the Finance Act, 2016, to include the consideration received by e-commerce operators from ‘e-commerce supply or services’. Viewed by the US as targeting its home-grown e-commerce companies such as Microsoft and Amazon, the Government of India is set to gain from the increasing digitalization of the economy. While the move comes in the backdrop of the US-China trade war, which was the result of China’s alleged discriminatory trade practices against American companies, it raises concerns of trade sanctions against India.  

Apart from the financial gains, the regulation of the e-commerce sector appears to be an adjunct objective. The Telecom Regulatory Authority of India had conducted a consultation process to address the lack of a regulatory and economic framework governing Over-the-Top (OTT) application services such as Amazon, Netflix, and Whatsapp, which use the bandwidth of highly regulated licensed telecom operators without requiring any kind of approval. In the absence of a straightforward solution to address the issue of parity with the telecom operators, owing to complications arising out of security concerns such as ensuring lawful interception by the OTT providers, the equalization levy on the e-commerce operators appears to offer a resolution for parity on the economic front. 

The Shift 

The equalization levy was first introduced in the Finance Act, 2016, on the services that are in the nature of online advertisement, or any provision for digital advertising space, or any other facility for online advertisement space provided by non-resident vendors to Indian resident customers at the rate of six percent of the consideration.  

In the Finance Act, 2020, a shift included the equalization levy of two percent being made applicable to payment received, or receivable, by a non-resident e-commerce operator for the online sale of goods or services or both, including situations where the e-commerce operator has facilitated the sale of goods or services to: (i) Indian residents, or (ii) to persons who buy goods or services using an internet protocol address located in India, or (iii) to non-residents for the sale of advertisement that targets a customer in India, or a customer who uses an internet protocol address located in India. Under this definition, even transactions for online hotel bookings on a website such as Booking.com are covered. 

The tax is exempted in three circumstances: (i) where the e-commerce operator has a permanent establishment in India, and the service is effectively connected with such permanent establishment; (ii) where the equalization levy of six percent is leviable; or (iii) the sale, turnover, or gross receipts of the e-commerce operator from e-commerce supply or services is less than Rs. 2 crore during the previous financial year.  

The requirement of a permanent establishment in India resonates with the government’s push for data localization. The Personal Data Protection Bill, 2019, imposes restrictions on the transfer of data outside India. The transfer of critical personal data is prohibited, and in the case of transfer of sensitive personal data, a copy must be retained in the country. The emerging idea is that data is the new oil; and, in view of the Cambridge Analytica scandal, e-commerce companies are likely to be pressured into having permanent establishments in India to comply with the legal requirements under laws that are being specifically designed for the digital sector, even though a permanent establishment will entail several other taxes. 

The Impact  

The Equalization Levy is considered a push to the ‘Make in India’ and self-reliant India policy. However, the wide ambit of the tax will arguably include many online transactions such as software purchases and hotel bookings, which will add to the burden of start-ups and small businesses as the tax may be passed on to them. While it was clarified by the government that the tax is not a protectionist measure, the widening scope of the equalization levy runs the risk of being viewed as invalidating these claims. The moot question is whether the tax, or the timing of it, will outweigh the risks. 

It cannot be overlooked that the US government has initiated an investigation under Section 301 of the Trade Act of 1974, which allows the US to unilaterally impose tariffs, or other trade restrictions, on foreign countries imposing a similar tax. It is also no coincidence that the American response comes in the election year where President Trump has set a tone of aggressive measures to protect American businesses and jobs. The economic uncertainty created by the Covid-19 crisis may restrict the success of any diplomatic relations in justifying the tax. Further, the Internet and Mobile Association of India has represented that it will require companies to change their internal systems and billing mechanisms during the Covid-19 pandemic. 

The recent news reports suggest that the government is reconsidering the equalization levy based on a cost-benefit analysis for the year. Given that the tax has been imposed when the Organisation for Economic Co-operation and Development is developing a consensus on taxation of digitalized businesses, it may be more prudent to suspend imposition of the tax till such time that the risk of retaliation is lower,  and await the implementation of legal measures such as the Personal Data Protection Bill, 2019, and a regulatory framework governing OTT services to meet the government’s objectives.