The equalization levy was established in India’s Budget 2016. Moreover, Budget 2020 has significantly expanded the scope of the equalization levy with the purpose of taxing digital transactions that are income accruing to international e-commerce enterprises from India (primarily income accruing to foreign companies in the form of advertisements). Its primary goal is to tax business-to-business interactions.
The Need and Birth of the Equalization Levy Scheme in India
The Information Technology sector has grown at an exponential rate in India and throughout the world throughout the 2010s. This has resulted in a rise in the supply and demand for digital services.
As a result, several new business models have emerged, with a high emphasis on digital and communication networks. Consequently, new business models have brought with them a new set of tax difficulties in terms of nexus, classification, and valuation of data, as well as user contribution.
The insufficiency of physical presence-based nexus requirements in current tax treaties along with the prospect of taxing such payments as royalties or fees for technical services presents a ripe field for tax disputes.
To tackle this issue, the Central Government of India enacted the equalization levy idea. It was enacted in India in 2016 with the goal of taxing transactions online, i.e., money flowing to international e-commerce businesses operating in India. Its goal was to tax business-to-business interactions.
It also called into question the constitutionality of the constitution and compliance with international duties. Despite its flaws, the levy as it existed before 2020 generated cash and may have played a part in catalyzing worldwide talks on the subject. However, the 2020 change caused the levy’s reach to be strangely broad and unclear. Investor sentiments were influenced by the fact that the modifications were never included in the Government’s Budget presentation and were presented without consultation.
What Is the Equalization Levy?
It refers to the tax imposed on the compensation received or receivable for any specified service. The equalization levy (EL) is a tax levied on non-residents’ compensation for specific services. The term “specified service” refers to online advertising or the supply of digital space for online advertising and any service for the purpose of online advertising.
According to Section 165 of the Finance Act 2016, a person resident in India or a non-resident with a permanent establishment in India is required to deduct EL at a rate of 6% on the consideration paid to a non-resident for specified services.
The Finance Act of 2020 broadened the scope of the EL to encompass all non-resident e-commerce businesses who provide “e-commerce supplies or services”. According to the enlarged requirements, a non-resident e-commerce operator is required to pay an equalization levy of 2% on the consideration received/receivable from e-commerce supply or services beginning on April 1, 2020.
Treaty benefits would not be available to non-resident e-commerce businesses under EL 2.0 as they were in EL 1.0. They could, though, determine if any tax deductions are possible under their own country’s domestic tax legislation.
EL 2.0 must be submitted on a quarterly basis.
Applicability of the Equalization Levy
When it was originally implemented, the equalization levy resulted in double taxation and further complicated the taxation structure. It is a direct tax that is withheld by the service receiver at the moment of payment. The way EL 2.0 regulations are now stated, there is ambiguity regarding its reach, and there are several interpretational concerns leading to practical challenges in compliance. The following two requirements must be satisfied in order to be subject to the equalization levy:
- The payment must be paid to a non-resident service provider.
- The yearly payment to one service provider exceeds Rs. 1,00,000 in a single fiscal year.
Services Included Under the Equalization Levy
At the moment, not all services are covered by the equalization levy. The following services are included:
- Advertisements on the internet
- Any provisions for a digital advertising space or facilities/services for internet advertising
- Any other services that are informed will be included with the aforementioned services
What Is Tax Rate Under the Equalization Levy?
At present, the appropriate tax rate is 6% of the gross amount to be paid.
Equalization Levy on E-commerce Service Provision
According to Section 165A of the Income Tax Act of 1961, an equalization levy of 2% shall be charged on the amount of consideration received or receivable by an e-commerce operator from an e-commerce supply or service facilitated by:
- A person resident in India
- A non-resident in the specified
- A person who purchases such products or services or both using an internet protocol address located in India.
The charges shown above shall not be levied on the following:
- Where the e-commerce operator providing or facilitating e-commerce supplies or services has a permanent establishment in India, and as such, the e-commerce supply or service is effectively connected with such permanent establishment;
- Where the equalization levy is levied under section 165
- The e-commerce operator’s sales, turnover, or gross earnings from e-commerce supplies or services made, delivered, or facilitated over the previous year are less than Rs. 2 crores.
Penalties for Delayed Payments
In the event of a payment delay, interest is assessed at 1% of the outstanding levy for each month or the portion of the month that the payment is delayed.
In the event that the service receiver fails to comply, the service receiver is responsible for the equalization levy compliance procedure.
1. Penalty for late payment
- Equalization levy was not deducted: A penalty equivalent to the levy amount was not deducted (along with interest and depositing of the principal levy outstanding).
- Equalization levy was deducted but not deposited: Failure to deduct a penalty of INR 1,000 per day up to the maximum of the levy resulted in a penalty of INR 1,000 per day (along with interest and depositing of the principal levy outstanding).
- In the hands of the payer, such expenditure is disallowed (unless the defect is rectified).
2. Penalty for failing to file a compliance statement
- INR 100 per day for each day of non-compliance.
- If a fraudulent statement is filed, the individual may face jail for up to three years as well as a fine.
The Downsides of the Equalization Levy
The equalization charge was conceived as a stopgap mechanism to collect income while driving global negotiations. It was always recognized as an unsustainable fee that added complexity to the tax environment. Initially, policymakers saw this difficulty as an acceptable trade-off for short-term income benefits.
The maintenance of a basic, focused regime with limited distortions and low administration and compliance costs, on the other hand, was a critical component in this cost-benefit analysis. The levy as it now exists lacks all of these critical elements. Furthermore, global discussions have progressed with the recent shift in the US Government. In light of this, there is no need to continue imposing an onerous, imperfect, unequal, and probably unlawful equalization levy.
Thus, the scheme offers an effective approach to tax internet transactions between businesses, but its implementation can be challenging due to its ambiguous language and numerous loose ends.
Written by: Samiksha