Digital tax dilemma: India's equalisation levy on online business of non-resident firms may hamper FTA talks with US

Finance Minister Nirmala Sitharaman in February’s budget introduced the digital tax. The equalisation levy (EQL) was operationalised from April 1 - the first instalment was due on July 7 - and applies only to non-resident companies selling goods and services online.

"The levy was introduced as a wild card entry in the Finance Act, 2020, without a proper consultation/ policy process that typically precedes a tax reform in India," Amit Singhania, partner, Shardul Amarchand Mangaldas & Co, said.

Earlier this month, the income-tax department introduced changes in a form that is required for paying the equalisation levy and included the option of paying the new 2 percent levy on digital transactions conducted in India by foreign e-commerce companies.

"E-commerce operators have argued that they were left with very limited time to understand and prepare for the impact of such a broad-based levy on their businesses or plan its compliance. Compliances required businesses to evaluate various aspects such as pricing and making changes to billing systems, renegotiating contracts, etc," Rohinton Sidhwa, Partner, Deloitte India, said.

In addition to the timing and lack of opportunity to prepare, the EQL provisions are unclear on various aspects, such as whether levy will be charged only on the service fee of commission income retained by the e-commerce company or the entire consideration from sale of goods as major e-commerce players work on a fee/commission model and do not own the goods themselves.

"In a scenario, where EQL is to be levied on the entire consideration of the sale of goods and the e-commerce operator does not have the ability (on a commercial basis) to pass on the levy to merchants, it might end up paying the levy out of its own pocket as the levy might be higher than its commission income," Sidhwa said.

Singhania said that the new 2 percent EQL is discriminatory in nature and has created structural issues for foreign companies operating in India. "The economic viability of many e-commerce companies may come into question depending on their operational structure in India. Further, benefit of tax treaties may not be available on the levy since it has been kept outside the ambit of the Income-tax Act, 1961," Singhania said.

In the absence of clarifications, the current EQL provisions might also cover the sale of goods or services that are contracted online but delivered or provided offline, such as online booking of hotel room, air ticketing and financial services such as banking and insurance.

Following India's levy, the US last month decided to start an investigation under Section 301 of the Trade Act, 1974, into the digital services taxes that have been adopted or were being considered by a number of countries, including India, to 'unfairly' target American tech companies.

"The US probe has come at the time when the two countries engage in negotiations to achieve a limited trade deal with ambitions for a free trade agreement (FTA) in the future," Sidhwa said.

A similar tax was announced by France on digital companies in 2019. In protest to the same, the US administration has announced on July 12, 2020, that it will impose a retaliatory 25 percent tariff on handbags and cosmetics imported from France within the next 180 days.

"The US may approach the India digital tax in a similar manner and may impose tariffs on India’s exports to the US unless both parties reach a satisfactory agreement. Such an action will also hinder the current negotiations on the FTA between India and the US. On the other hand, other South Asian nations may take advantage of this encounter," Sidhwa pointed out.