If not the entire levy, the government could consider a rollback of the expanded scope of 2020 and 2021 vintage
Rapid digitalisation is not a surprise to anyone. Digitalisation in the commercial world is also growing at a scorching pace. Old commercial and legal concepts such as place of conclusion of contracts or the passage of title have given way to online contracting, digital delivery and new payment norms. Globally, tax authorities are debating and observing the shifting base of the economic activities taking place in their respective jurisdictions, and the impact it has on the base available for levying taxes. This has led to a long-standing debate between taxing rights of the place where businesses are established and the place where the goods or services are sold or consumed.
This month’s agreement between 136 countries (including India) is an important milestone when it comes to addressing tax challenges brought about by digitalisation of the global economy. There is now a global consensus on the design and implementation of new rules (under Pillar 1) that will allocate more taxing rights to market jurisdictions like India. This development, in many ways, vindicates India’s longstanding position of advocating increased taxation of MNCs in countries where they earn their revenues.
The journey leading up to this consensus has been neither easy nor quick. With a view to protect our local tax base in the interim, and perhaps to strengthen our hand in these long-drawn out negotiations, India introduced ‘Equalisation Levy’ (‘EL’) to cover online advertisements at the rate of 6%. The scope of EL was significantly widened in 2020 to cover a broad range of online sales, services and facilitation by non-residents which were subjected to a 2% levy. In the world of indirect taxes, this journey started in 2001 with the introduction of service tax on Online Information Database Access and Retrieval (‘OIDAR’) services, which continues under GST. The expanded EL has proven extremely complex and poses several challenges to taxpayers. For instance, there are doubts over the nature of the levy (direct tax vs indirect tax), its overlap with OIDAR-services taxation under GST as well as constitutional questions around territorial nexus and legislative competence. There are also practical challenges with respect to the scope and applicability of EL on various types of transactions, the need for taxpayers to develop and install robust internal systems to track and report covered transactions and the absence of advance rulings or normal appellate remedies. At the macro level, it reignited the domestic debate on overall taxing rights. It also created disputes with jurisdictions where MNCs originated from. The debate even extended to the very concept of what should be covered under digital supply and what activities should be liable for EL.
It has been generally recognised that the EL would be a temporary levy, pending finalisation of the global consensus. This is now reinforced in the statement agreed to by India and other Inclusive Framework members earlier this month, which notes that countries will be required to remove all existing digital taxes and similar measures on all companies by December 31, 2023 or the rollout of a multilateral agreement to give effect to the Pillar 1 proposals, whichever is earlier.
While this may give India more than a year, the government should carefully consider the pros and cons of an early removal of the entire levy or at least of the expanded scope introduced in 2020 and 2021. There are several factors that could be considered in this regard.
First, with a global consensus on increasing the allocation of taxing rights to market countries like India, one of the main objectives of the EL, i.e., to strengthen our negotiating position at the OECD, stands achieved. There has been some debate as to how much India will benefit under the Pillar 1 proposals, but with the government signing on to the final statement and undertaking to withdraw EL, this issue is perhaps moot.
Second, the beneficial impact of an immediate withdrawal should be weighed against the incremental revenue that India could potentially generate from EL over the next year or so. Media reports suggest that EL collections for H1FY22 add up to around Rs 1,600 crore. While this represents a significant growth over last year, this is still quite small compared to say GST or income tax, where gross collections crossed Rs 600,000 crore each during the same period. Additionally, given the continued uncertainty over the scope of EL, there could be a large number of disputes and other legal/constitutional challenges even if EL remains in force only for a few years. These disputes could take several years to be resolved.
An early withdrawal, on the other hand, will significantly boost investor confidence. For businesses, this will provide much needed relief from the complex task of assessing EL liability based on transactions as well as the need to put in place expensive, time-consuming internal systems that may be needed to track and gather information to ensure compliance. Consumers and Indian businesses too, will benefit since the burden of EL would be, in many cases, passed on to them.
A withdrawal will send a strong positive message to the global community about India’s commitment to the multilateral tax reform and would be a big step towards ease of doing business. This may also help resolve trade disputes between India and the US owing to introduction of EL. The government should take a long-term pragmatic view while deciding on the date of removal of EL, especially considering the many benefits that could arise from an early removal.
Co-authored with Naveen Aggarwal, partner and North India tax head, KPMG in India