India has significantly expanded its equalization levy

Effective April 1, 2020, an equalization levy (EL) of 2% is applicable in India on amounts received/receivable by a nonresident e-commerce operator from e-commerce supply or services. This new tax covers a wide range of e-commerce activities. This new tax is outside the scope of the U.S.-India income tax treaty and likely not creditable for US tax purposes; however, taxpayers may be able to claim a deduction for tax paid.

Global digital taxation

Globally, the digital economy is growing exponentially. This includes online subscription-based services, online sales of goods/ services/ software, online gaming, hotel/ flight booking, etc. such as Netflix, Amazon, Flipkart, Uber, Airbnb, MakeMyTrip, and Nintendo. Taxation of these cross-border e-commerce transactions have been a challenge for many jurisdictions worldwide, including India, due to the location of the supplier, absence of any local country physical presence, difficulties in characterizing the nature of the transaction (e.g., as sale of goods or service), administrative challenges in tracking and collecting taxes and issues in asserting taxing jurisdiction.

Nevertheless, certain countries such as France, the UK, Austria, Italy, India, etc. have taken unilateral actions by imposing digital services taxes even as many countries coalesce around the OECD’s recent proposals (Pillar 1) on the taxation of certain aspects of the digital economy.

Digital tax in India

Despite the OECD initiative, India unilaterally introduced an equalization levy (EL) in 2016, of 6% on nonresidents engaged in online advertisement and related activities with Indian customers (Finance Act 2016). This levy was on certain specified services such as online advertisement services, the provision of digital advertising space or facilities for online advertisement and thus was limited in scope.

However, India expanded the scope of the EL effective April 1, 2020 (Finance Act 2020). The EL was expanded in scope to introduce a levy on e-commerce supply or services equal to 2% of gross income facilitated by a nonresident e-commerce operator, as described below. It is the expanded scope of the EL that is the subject of this article.

In contrast to India's original EL which applied to a limited scope of services as mentioned above, the expanded EL covers substantially all revenue generated through specified e-commerce online services.

The expanded EL levy of 2% will apply to all businesses with India source revenue exceeding 20M Indian Rupees (approximately $250,000 U.S. Dollars) unless that e-commerce supply or service effectively relates either to a permanent establishment in India or is subject to the original EL of 6% on advertising services.

Applicability of expanded equalization levy

The EL imposes a tax of 2% on consideration received or receivable by an e-commerce operator from e-commerce supply or services made or provided or facilitated by it to the following persons:

• An Indian resident.
• Any nonresident in case of sale of advertisement, which targets a customer, who is resident in India or a customer who accesses the advertisement through internet protocol address located in India
• Any nonresident in case of sale of data, collected from a person who is resident in India, who uses internet protocol address located in India
• Any person who buys such goods or services or both using the IP address located in India

By definition, the expanded EL is broad in its application and may be extra-territorial in scope, as it applies to users that are resident in India but not physically present there. It also applies to sales of data collected from India residents by non-India resident businesses.

Equalization levy compliance

The EL is self-assessed by the e-commerce operator. Therefore, businesses that are subject to the expanded EL are required to report and remit the relevant levy on a quarterly basis. The amount of EL for a quarter must be remitted within a week after the end of the reporting quarter (i.e., the 7th day of the month following the end of the quarter). However, the time limit to remit the amount for the last quarter (January through March) is curtailed to the end of the quarter itself which would be March 31.

The penalty for failing to collect and remit the EL is high, with penalties of up to 100% of the amount not collected, plus interest on late remittances of 1% of such levy for every month or part thereof (12% APR). Further, the payer of the EL must submit an annual statement mentioning the details of the EL deducted and paid during the financial year (the financial year in India begins on April 1 and end on March 31 of the following year.). The due date of furnishing the annual EL statement is on or before June 30 immediately following the financial year end. Failure to submit the annual statement could result in a fine of 100 Indian Rupees per day for each day the non-compliance continues.

Nonresident e-commerce operators who fall within the scope of the EL will be under an obligation to:

• Obtain required tax registrations in India
• Identify all such transactions which are subject to the levy
• Submit an annual statement on or before June 30 of the following year
• Compute the amount of Levy and deposit the same in the prescribed form before the due dates

Despite these stiff penalties, very little guidance has been provided regarding the reporting process for the expanded levy.

Practical considerations and impact of the equalization levy

Given the expansive definition of activities that are subject to the expanded EL and the low registration threshold, the levy will be applicable to a broad range of transactions across industries that are not normally associated with digital transactions. For example, transactions within the travel and lodging business along with the professional services and media industries could now be subject to the expanded EL if the transactions involve provision of services to an Indian resident utilizing a digital platform.

It is very difficult if not impossible to identify which users are Indian resident – rather than located in India – when selling services or anonymized datasets. (Anonymized data is a type of information sanitization in which data anonymization tools encrypt or remove personally identifiable information from datasets for the purpose of preserving a data subject’s privacy). The growing use of VPN services by internet users makes identifying residents even more difficult.

The difficulty in accurately determining the revenue subject to the expanded EL, combined with the fact that the compliance burden is imposed on nonresident companies whose activities the Indian government is unlikely to be able to measure effectively, means that there are several compliance and enforcement challenges to consider. These challenges will affect both the companies subject to the expanded EL and the Indian government.

Income tax treaty relief

The EL is enacted outside of the Income Tax Act (1961), the primary statute that regulates income taxes in India. As a result, the EL would generally fall outside the ambit of double taxation treaties, as it would not be deemed an income tax.

However, many tax treaties contain provisions to bring into their scope any charges substantially similar to Income taxes but enacted as something other than an income tax. Such relevant tax treaty provisions should be reviewed to determine if the EL can be treated as income tax making tax treaty benefits potentially available.  

Availability of foreign tax credits

On Jan. 4, 2022, the United States Treasury department published its third set of final regulations (T.D. 9959, the Final Regulations) on foreign tax credits since the enactment of the Tax Cuts and Jobs Act (TCJA). One of the most significant changes in the final regulations is a new "attribution requirement" (known as the "jurisdictional nexus requirement" under the proposed regulations), which a foreign income tax must satisfy to be creditable under section 901. The attribution requirement responds to novel extraterritorial taxes, which depart from traditional international tax norms by asserting taxing jurisdiction based on factors such as destination, customers, and market access. This includes several digital services taxes that have been introduced in European and emerging-market jurisdictions including India. The attribution requirement has far-reaching effects and will impact the creditability of a wide range of foreign taxes.

The attribution requirement does not generally consider foreign taxes creditable unless the foreign law requires a sufficient connection between the foreign country and the taxpayer's activities or investments. As the guidance in the Final Regulations alludes to the laws of the foreign jurisdiction, a careful review of the foreign jurisdiction’s laws will likely be required to properly evaluate whether sufficient nexus levels have been met. The final regulations provide that in determining sufficient nexus in a country, relevant considerations could include having operations, employees, factors of production, or management in that foreign country. A tax imposed by a foreign country on a company lacking such nexus in their country will not be considered an income tax from the U.S. tax perspective and thus would not be eligible for an FTC. Under these criteria, the EL may not qualify as a creditable tax. However, in that event taxpayers may possibly claim a tax deduction for the EL tax paid.

ASC 740

Accounting Standards Codification (ASC) 740 is applicable to ‘taxes based on income.’ A tax based on income, reduced by some expenses, would be covered by this Standard. Thus, the expanded EL may not qualify as an ‘income tax’. However, there is no specific guidance in this area.

The way forward

Businesses based offshore and engaged in online supply of goods or services into India should evaluate the impact of the expanded EL provisions, including reassessing their business model, and evaluating if the creation of a business presence in India is a better alternative. Pricing of India-centric products and services should also be reviewed.

Businesses should also take necessary action to reconfigure their compliance/reporting systems and processes to ensure compliance, considering that among other things, the EL applies when goods or services are bought online using IP address located in India. Where necessary, businesses should also engage in policy dialogue with the government.