India is a significant player in the digital tax negotiations. Even during the coronavirus outbreak, India has been putting efforts to change the way digital business models are taxed in India.
What is “Equalization Levy”
The equalization levy was introduced in 2016. It was originally designed as a 6% on gross revenues from online advertising services. In the financial year 2017-2018, the revenue from the equalization levy was INR 550 Cr (USD 73.4 million). Only nonresident businesses are subject to the tax.
India announced on March 23 that its tax aimed at foreign digital companies, the “equalization levy,” will be expanded. The new expansion will apply a 2% on revenues of e-commerce operators and suppliers. This change is applicable from April 1. This change expands the equalization levy from online advertising to nearly all online commerce done in India. The change is for businesses that do not have taxable presence in India.
Who will it be applicable to
This will impact those companies that don’t have a base in India, but sell their goods here. Any overseas platform that streams, advertises, or sells goods to an Indian IP address will be taxable. The levy would be imposed on those companies that have a turnover or sales of over INR 2 Cr (USD 267,000) in the previous year. Facebook, Google Amazon, eBay and many more will be affected by the tax.
Not a part of Income Tax
The equalization levy is essentially a tariff and is not based on ability to pay. Businesses with higher profit margins on their digital business with India will face a lower marginal tax rate than businesses with lower profitability. The 2% revenue tax equates to a 20% income tax if a business has a 10% profit margin in India. This compares to the statutory tax rate of 22%. The lower a business’ profit margin, the higher the marginal tax rate. Equalization levy may also add to the cost of operations for foreign companies. They may not get credit for the equalization levy in their residence country or avail any favorable treaty benefits.
What is SEP
Significant Economic Presence is a nexus test introduced in the financial year 2018-2019. Income of nonresident businesses can be attributable to India for digital transactions by nonresidents in India above a payment threshold. The test defines the significant economic presence for the purposes of corporate income tax. The equalization levy paired with the significant economic presence test represents one of the more coordinated efforts to tax digital business models.
The temptation to tax the more profitable business sectors
The extent of possible compliance disruptions caused by the tax is not not immediately clear. Neither is it clear how much India could garner from the tax. The timing of the introduction of the levy appears to be an attempt to increase revenue collections during the pandemic. The temptation to apply special taxes to digital firms right now when they may be more profitable than the rest of the global economy may be strong. But broad-based, neutral policies should be the tools of choice for taxation. A tax base that relies too heavily on a particular business sector could be left standing in the cold when the economic winds shift.
An element of surprise
India’s internet users are increasing at a fast pace. The country’s e-commerce and digital ad markets are also expanding, making it extremely attractive for Amazon and other players. However, the amount of revenue that can be generated by the new tax remains unclear. The technology giants seem to have been taken by surprise by the tax. India’s finance minister did not make any mention of the levy during her budget speech in February. The levy was reportedly included in the Finance Bill on March 23.
Push-back from major tech heavyweights & the six-month deferment
Facebook and Google are seeking to delay paying India’s 2% digital tax. Given the ongoing circumstances surrounding the COVID-19 pandemic, Google and Facebook have asked the tax to be deferred by at least six months. India, on the other hand, is looking to boost its tax reserves, which will also provide the country with additional resources to fight the coronavirus.
The equalization levy essentially operates as a tariff on foreign-provided digital goods and services The significant economic presence (SEP) test can create challenges in minimizing double taxation. This might lead to international friction. If every country chose its own way of defining nexus, there would be an overlap in taxation where two countries think they have the right to tax the same income.