PUTTING THE INDIAN EQUALISATION LEVY IN TAX-TREATY
CONTEXT
Adv LLM thesis
submitted by
Abhishek Padwalkar
in fulfilment of the requirements of the
'Advanced Master of Laws in International Tax Law'
degree at the University of Amsterdam
supervised by
PERSONAL STATEMENT
Regarding the Adv LLM Thesis submitted to satisfy the requirements of the 'Advanced Master of Laws in International Tax Law' degree:
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Table of Contents
Table of Contents………..III
List of abbreviations used………..IV
Executive Summary………..V
Main Findings……….VI
1.
INTRODUCTION ... 1
1.1 Background – ... 1 1.2 Objective – ... 2 1.3 Research questions – ... 21.4 Brief introduction to chapters – ... 2
2.
TAXATION OF DIGITAL BUSINESSES IN INDIA – A TREND ... 3
3.
EQUALISATION LEVY – AN EVOLUTION ... 6
3.1 Tax challenges of digital businesses ... 6
3.2 BEPS Action Plan 1 ... 7
4.
INDIAN EQUALISATION LEVY ... 8
4.1 Report of the Committee on taxation of E-Commerce ... 8
4.2 Indian Equalisation Levy – form and structure ... 10
4.2.1 Charge of Equalisation Levy ... 10
4.2.2 Exemption ... 11
4.2.3 Collection and recovery ... 11
4.2.4 Computation & Characterisation ... 11
4.2.5 Nexus ... 11
5.
EQUALISATION LEVY & TAX TREATIES ... 12
5.1 Equalisation levy – whether a direct or indirect tax? ... 12
5.2 Article 2 of tax treaties –... 13
5.2.1 Paragraph 1 - ... 13
5.2.2 Paragraph 2 - ... 13
5.2.3 Paragraph 3 - ... 14
5.2.4 Paragraph 4 - ... 14
5.2.5 Conclusion - ... 16
5.3 Equalisation Levy whether a tax on income? – ... 17
5.3.1 Equalisation Levy whether a presumptive income tax?... 20
5.4 Relevant distributive rule – ... 20
5.4.1 Royalties – ... 21
5.4.2 Fees for Technical Service (FTS) ... 22
5.4.3 Business Income... 23
5.5 Compatibility with bilateral tax treaties ... 24
6.
CONCLUSION ... 26
Bibliography ... 28
List of case laws ... 30
List of abbreviations used
Art. Article
BEPS Base Erosion and Profit Shifting CBDT Central Board of Direct Taxes DTAA Double Tax Avoidance Agreement ECJ European Court of Justice
EU European Union
FTS Fees for Technical Service GST Goods and Services Tax ITAT Income Tax Appellate Tribunal
OECD Organisation for Economic Co-operation and Development para. paragraph
PE Permanent Establishment
pp. page
SEP Significant Economic Presence TAG Technical Advisory Group
TFDE The Task Force on the Digital Economy UN United Nations
UNCTAD United Nations Conference on Trade and Development VAT Value Added Tax
VCLT Vienna Convention on the Law of Treaties WP Working Party
Executive Summary
Rapid digitalisation has led to businesses moving towards virtual space. The brick-and-mortar economy is swiftly heading towards digital economy. The use of modern technology, ease of connecting with clients and non-requirement of physical space has made this model very popular in the last couple of decades. Though a massive hit in the business community, this business model is giving a hard time to tax authorities and policy makers looking to tax the income of such businesses. The current tax systems around the world still mainly focuses on the requirement of having a physical presence to tax business income. Digital businesses having no physical presence end up paying little or no taxes even in jurisdictions they earn revenue because of traditional tax systems.
To tackle this issue, many States have introduced digital taxes. These taxes however have been in controversy. India, in 2016 introduced its Equalisation Levy to tax digital business. The Indian Equalisation Levy has been a controversial topic in tax circles. Its form, reasons for implementation, guidance provided by the government, separation from Income tax Act, etc. has been a matter of debate. There are also questions about its nature – whether direct or indirect tax, applicability to tax treaties, non-discrimination provisions under Art. 24, availability of tax credit in home State, etc. This research
particularly focuses on whether the levy would be a “tax covered” under the provisions of Art. 2 and the analysis of the relevant distributive rules.
According to the author, Art. 2 of tax treaties is one of the most important but often ignored provisions. It is important in the sense that it lays down which taxes are covered by a particular tax treaty. Whenever a new tax is introduced, the same has to be tested on the anvil of the provisions of Art. 2. Once we determine the applicability of a new tax with respect to Art. 2, then can decide to proceed further to the relevant distributive rules to see which contracting State has the right to tax.
In this research, the author conducts a detailed analysis of the levy, the intention behind its introduction and its purpose. A meticulous study of Art. 2 has also been conducted with the help of various
commentaries, case laws and research articles to test the Equalisation Levy vis-à-vis Art. 2. As a consequence, analysis of the possible distributive rules is also provided. This would prove whether India does have the right to levy such a tax in its current form and whether the Equalisation Levy is in defiance of India’s treaty obligations and consecutively an attempt to override the tax treaties or a way to indirectly dodge treaty provisions.
Main Findings
The author has thoroughly analysed the provisions of Art. 2 of tax treaties with reference to various case laws, OECD Commentary, views of noted academicians, etc. For the purpose of this research, it was also important to study the structure of the Indian Equalisation Levy, the intention of the government and the reasoning provided for its current form. The result of both these studies were tested against each other to find out whether the levy does in fact has elements for it to equalify as a “tax on income”.
After meticulous study of the above, it was concluded that the Indian Equalisation Levy does in fact have the elements of “tax on income”. It definfitely does fall under “substantially similar taxes” as provided in Art. 2(4) of tax treaties. As a logical consequence, relevenat distributive rules were also analysed to see which contracting State can tax that income. For this purpose it was necessary to examine the provisions of Arts. 7(business profits), 12/12A (royalty/FTS). From a thorough review, it was concluded that the payment made to the non-resident for ‘specified services’ does fall under Art. 7 as the business income of the non-resident. It is clear that in the absense of a PE, India has no right to tax that income.
As a final consequence, it was also concluded that this unilateral action by India could possibly be termed as a treaty override or an attempt to dodge the provisions of tax treaties and hence a violation of
1. INTRODUCTION
1.1 Background –
Taxes are levied by governments to raise revenue. The government uses these revenues for
infrastructural projects, redistribution of wealth, functioning of the government, welfare activities of the state and other economic and social purposes. The term “tax” is understood by public in general, however it is not easy to define it. The Dictionary of Modern economics defines tax as – “Compulsory
levies on private individuals and organisations made by government to raise revenue to finance expenses on public goods and services and to control the volume private expenditure in the
economy”.1 In OECD classification, the term “taxes” is confined to compulsory, unrequited payments to general government.2
Tax systems have been in place even before the times of ancient Greek and Roman civilisations. There is evidence to show that the first known taxation took place in Ancient Egypt around 3000–2800 BC3. Since then, many different kinds of taxes have been added by States and tax systems have become more refined and suited for the changing times. Throughout the evolution of tax systems around the world, what has fairly remained the same is the nature of doing business. Though businesses have modernised over the years, the basic concept of having physical presence at the places of business has been constant. Tax laws, especially direct taxes, have been designed to suit these business models prevalent till late 20th century. Even the bilateral tax treaties and the OECD and UN Models on which they are usually based taken into consideration the physical presence of an enterprise. Arts. 5 and 7 of the OECD/UN Model are examples of the same.
However, since the beginning of the 21st century, especially after the boom of internet and the ‘world wide web’, more and more business models are moving towards the virtual space. The benefit of this is that it is cost efficient and doesn’t require the enterprises to have a physical presence in the
jurisdictions they want to do business in. That is the reason that companies such as Google, Amazon, Facebook etc. based on digital models are much more profitable than the ones following traditional business practices. The tax systems however haven’t been able to cope up with this rapid and swift change. Present tax laws and the bilateral tax treaties still revolve around the physical presence to tax business income.
Over the last few years, in order to address the growing problem of non-taxation of digital businesses, many States have modified their domestic tax laws to include various kinds of digital taxes. These taxes vary in their form and structure. Some of the examples of these digital taxes are –
Israel - In April 2016, Israel published guidelines on changes to income tax and VAT which expanded the concept of the PE to include non-resident online businesses, which sell or provide services through internet to Israeli residents.
Austria - Austria extended the scope of its national tax to include online advertising.
Hungary – In 2014 Hungary introduced Advertisement Tax Act targeted at advertisement turnover of companies, which were subject to progressive tax rates ranging from 0% to 50%.
Italy – In 2020, Italy finally introduced its much-anticipated Digital Services Tax. It is a 3% tax
1 Pearce D, The Dictionary of Modern Economics, 4th edition, pp. 421
2 ‘Definition of Taxes’ (1996), OECD Negotiating Group on the Multilateral Agreement on Investment, pp. 3 3 https://en.wikipedia.org/wiki/Tax
applicable to Internet services distinguished by minimum human intervention and use of technology, provided both by Italian resident and non-resident entities to local business recipients.
India – In 2016, India introduced the ‘Equalisation Levy’. It is a 6% charge on payments made to non-residents for specified online services.
There are many more examples of States bringing unilateral provisions in their domestic tax laws to tax digital businesses. Even global organisations like OECD, G20, European Union are making efforts to bring about a concrete solution to tax digital businesses. Many major steps have been taken by these organisations but as these businesses are active all around the globe, it is important to have a universal and long-lasting solution to the problem. The focus of this research is however, the India Equalisation Levy and its interaction with bilateral tax treaties.
1.2 Objective –
To tackle the tax challenges posed by digital businesses, India introduced the Equalisation Levy through Finance Act 2016. The intention of the government was to tax the revenue earned by e-commerce operators through India which escaped assessment. The Indian government has contended that as the levy is a separate code in itself and hence not covered within the scope of bilateral tax treaties entered into by India. There have been many questions raised by lawyers, economists and academicians questioning the nature of the levy. This thesis studies the structure of the Equalisation Levy as it existed till March 2020. The scope was expanded in Finance Act 2020 but the basic structure and implementation of the levy remains the same. The objective of this thesis is to analyse whether the Equalisation Levy is a tax on income falling within the scope of Art. 2 of tax treaties. As a corollary, the research also tries to identify whether the relevant distributive rules allow India to tax such kind of income. The research also touches upon the impact it would have on the tax treaties currently in force with a likelihood that the introduction of such a levy could lead to a possible treaty override or treaty dodging by India.
1.3 Research questions –
To attain the above objective of the research, it is important to analyse the form and structure of the Equalisation Levy in force. The evaluations of the levy alongwith the relevant provisions of tax treaties would help us answer the following main questions which form the core of this research –
1) Whether the Indian Equalisation Levy falls within the scope of Art. 2 of tax treaties entered into by India?
2) In case the above question is answered in affirmative, whether the relevant distributive rules allow India to tax the income?
3) What is the impact on the existing bilateral treaties?
1.4 Brief introduction to chapters –
Chapter 2 – This chapter gives a glimpse of how Indian tax authorities characterised the income earned by non-resident digital businesses. It also briefly discusses a few Indian case laws to understand how the payments made to these businesses were characterised by the tax authorities and how courts interpreted them.
Chapters 3 – The chapter succinctly points out the major challenges of digital economy on tax systems. It also briefly talks about the BEPS Action Place 1 Final Report which discussed three
possible options to tackle the problem.
Chapter 4 – This chapter discuses in a nutshell the reasoning provided by the Committee Report on Taxation of e-commerce for preferring to implement the Equalisation Levy over the other two options provided by the BEPS Report. This chapter also lays down in the detail the relevant provisions of the Equalisation Levy and its functioning.
Chapter 5 – This chapter forms the core of the research. It tries to answer the questions relevant to the research. It discusses the scope of Art. 2 of tax treaties, what taxes are covered under the provisions of Art. 2 and whether the Equalisation Levy falls within its ambit. It also discusses the application of relevant distributive rules and whether India has the right to tax that income. It also touches upon the levy being a step to dodge treaty provisions and the violation of international obligations under the VCLT.
Chapter 6 – This final chapter is by way of conclusion.
2. TAXATION OF DIGITAL BUSINESSES IN INDIA – A TREND
Over the last couple of decades, Indian tax authorities have struggled to bring digital businesses within its taxing jurisdiction. The Indian Parliament has expanded the definition of royalty and fees for
technical service to cover digital businesses. However, the scope of such expansion is limited in an international sphere. Sovereign right of a nation to tax cannot infringe upon its international
obligations.
The Indian Income tax Act covers within its royalty’s definition to include the following payments – - the transfer of all or any of the rights to use computer software, including the granting of a
licence, irrespective of the medium through which the right is transferred; and
- the transmission of data or signals by satellite, including uplinking, amplication and conversion for downlinking of any signal, cable, optic fibre or any other similar technology.4
With respect to software transfers, there is a difference between the domestic and treaty law. The Indian Income tax Act treats income arising from the transfer of all rights, including the granting of a licence, as royalties. On the other hand, royalties defined in tax treaties include only the consideration received for granting the right to use any copyright of scientific work, including software, secret formulas or processes, or for information concerning industrial, commercial or scientific experience. Thus, Indian royalty definition is wide enough to include sale, service and granting of licence to distribute software via CD or internet. However, when a tax treaty is in place only the granting of copyright in respect of software would falls within the definition of the royalties.
The Mumbai ITAT in the case of Dun & Bradstreet Information Services v ADIT5 clearly distinguished
between the sale of copyright material and the granting of copyright. In this case a US resident
company providing credit information in the form of “business information reports” (“BIRs”) stored them on a server situated in the US. The BIRs were sold worldwide through subsidiaries set up in the relevant region including Singapore which was the distributor for the Asia Pacific region. Neither the US nor the Singapore entity had a PE in India. The Indian tax authorities argued that the payments made by a resident for the BIRs should be characterised as royalty and therefore subject to tax in India. The Mumbai ITAT rejected this argument and held that the BIRs were akin to books and that their sale involved the sale of a copyrighted product rather than the underlying copyright. It was held 4 Section 9, Indian Income tax Act 1961
that the income of Dun & Bradstreet from these sales would be business income, which would not be taxable in India in the absence of a PE in India.6
Even with respect to the transmission of data and/or signals by satellite and cable, it can be said that the Indian law is wider than the tax treaties. The Indian law is based on the use of signals or data in India by the end-user for the purpose of its business or for deriving the source of income in India irrespective whether the control or possession is with the end-user in India. The royalty definition in tax treaties which includes the right to use industrial or scientific equipment, the end-user cannot be said to have the right to use the equipment. Even the OECD Commentary in Art. 12 clarified this issue –
“Satellite operators and their customers (including broadcasting and telecommunication enterprises) frequently enter into “transponder leasing” agreements under which the satellite operator allows the customer to utilise the capacity of a satellite transponder to transmit over large geographical areas. Payments made by customers under typical “transponder leasing” agreements are made for the use of the transponder transmitting capacity and will not constitute royalties under the definition of paragraph 2: these payments are not made in consideration for the use of, or right to use, property, or for information, that is referred to in the definition (they cannot be viewed, for instance, as payments for information or for the use of, or right to use, a secret process since the satellite technology is not transferred to the customer). As regards treaties that include the leasing of industrial, commercial or scientific (ICS) equipment in the definition of royalties, the characterisation of the payment will depend to a large extent on the relevant contractual arrangements. Whilst the relevant contracts often refer to the “lease” of a transponder, in most cases the customer does not acquire the physical possession of the transponder but simply its transmission capacity: the satellite is operated by the lessor and the lessee has no access to the transponder that has been assigned to it. In such cases, the payments made by the customers would therefore be in the nature of payments for services, to which Article 7 applies, rather than payments for the use, or right to use, ICS equipment.”
The definition of fees for technical service was also amended to include payment made by a person who uses software or data and/or signals for business purposes in India or for earning any income in India. That person must withhold tax while making payments to a non-resident taxpayer who is the transferor of the software or the operator and/or the owner of the satellite or the cable.
The scope of these amendments is pretty narrow. It is difficult to encompass majority of e-commerce business which are prevalent in India but who do not end up paying any taxes because of archaic taxing rules. Moreover, with a tax treaty in place, the expanded definitions of royalty and fees for technical services won’t be applicable in all cases. However, the Indian tax authorities have been innovative in their approach and interpretation to bring these businesses within their taxing net. Though, the courts on many occasions struck down these ingenious attempts by the tax authorities. It is important to discuss a few landmark cases which would help us understand the extent to which the tax authorities went to bring these businesses under its taxing net.
Yahoo India Pvt. Ltd7. –
In this case, the assessee i.e. Yahoo India was engaged in the business of providing consumer services, such as a search engine, content and information on a wide spectrum of topics, e-mail, chat, etc. It also paid fees to Yahoo Hong Kong in respect of the its web banner advertising services. The
6 Mumbai ITAT mainly based its ruling given by the decision of Indian Supreme Court in a sales tax case - Tata Consultancy Services v State of A.P., (2005) 1 SCC 308
tax authorities argued that the payments made by Yahoo India to Yahoo Hong Kong were payments in respect of the right to use industrial, scientific or commercial equipment.
The Mumbai ITAT held that the payments made to Yahoo Hong Kong for the services rendered for uploading and display of web banner advertisement was not in the nature of royalty. The Tribunal held the consideration received by Yahoo Hong Kong to be in the nature of business profit and in the absence of any PE of Yahoo Hong Kong in India, it was held to be not chargeable to tax in India. Right Florists8 –
In this case the assessee, a florist carrying out business in India made payments to Google Ireland and Yahoo USA for utilizing their online advertisement services. The main issue for consideration in this case was whether income tax was required to be withheld in respect of payments made to non-residents for rendering advertising services. The assesee argued that the payments made formed part of business profits of Google and Yahoo respectively, and in the absence of a PE, India has no right to tax the same. The tax authorities sought to tax the same under royalty/FTS.
Relying on the order passed by Mumbai ITAT in the case of Yahoo India (supra), Kolkata ITAT held that the payments made for online advertisement were not in the nature of royalty either under the Income tax Act nor under the relevant tax treaties. It was held that the services of online
advertisement did not involve the use or the right to use any industrial, commercial or scientific equipment by the Indian entity. With respect to the issue of a digital PE, the tribunal relied on the OECD Commentary to hold that while a website by itself could not be considered to be a PE due to the absence of a fixed place, the server from where the website functions could be a fixed place of business and could hence be considered to be a PE. Thus, it was held that when Google provides online advertising services in India, it does not necessarily carry on business through a PE in India and therefore its business income should not be taxable in India.
Some of the other important decisions by include the decision in Pubmatic India Pvt. Ltd9 where the
Mumbai ITAT held remittance made to a US company towards purchase of advertisement space fell under Art. 7 of India-USA DTAA and in absence of a PE of such company in India, income was not taxable in India. Also, in the case of eBay International Ag10, it was held that even when an
e-commerce website carried on substantial activities in India and supported by collection agents situated in India would not constitute a PE. The revenues earned by a foreign company through its dependent agents who were assisting eBay in operating websites in India was in nature of business profits as per Art. 7 of India-Switzerland DTAA but could not taxed as assessee had no PE in India.
Thus, the Indian tax authorities have tried to bring in the payments made for online advertisements and profits earned by e-commerce businesses within its taxing ambit. As seen above, the same was done either by expanding the definition of royalty/FTS to tax the payments made or by inferring that those businesses have a digital presence in Indian and hence a PE in India. These attempts by the authorities were thwarted by the courts on many occasions.
8 ITO v. Right Florist Pvt. Ltd, I.T.A. No. 1336/Kol./2011
9 ITO vs Pubmatic India (P) Ltd: 60 SOT 54
3. EQUALISATION LEVY – AN EVOLUTION
3.1 Tax challenges of digital businesses
In the last couple of decades, traditional business space has been occupied by digital businesses. The good and services which consumers and businesses could avail physically can now be opted for or purchased from a distant vendor digitally. The digital business model has made its inroads in various sectors viz. agriculture, retail, education, services, etc. The dominance of this model of business has led to imbalance in traditional tax system.
According to the IMF, “digital economy is sometimes defined narrowly as online platforms, and
activities that owe their existence to such platforms, yet, in a broad sense, all activities that use digitised data are part of the digital economy: in modern economies, the entire economy”.11 The UNCTAD defines digital economy as “the application of internet based technologies to the production
and trade of goods and services”.12 Digitalization of businesses raises new challenges to governments and policymakers around the world. The traditional tax systems find it difficult to bring these
businesses within its ambit. Also, some the income earned by these businesses is not always easy to characterize. This could lead to double taxation or non-taxation.
The Task Force on Digital Economy in its draft report of March 2014 emphasised the following four tax challenges posed by the digital economy—nexus, data collection, characterisation of its business, and collection of VAT.
According to tax treaties based on OECD and UN Model, a non-resident can be taxed only when it has a presence in that state. That presence can take the form of a subsidiary, permanent
establishment or a dependent agent concluding contracts on behalf of the non-resident. It can be said that a State can tax a non-resident only when there is a strong nexus with that State. The current definition of “fixed place” in tax treaties lay emphasis on physical presence. However, in today’s world, an entity can have a virtual presence in a particular jurisdiction. Having a virtual presence won’t fulfil the criteria of a fixed place and the profits earned by these businesses are not taxed even though substantial business activity is carried thereof. Thus, the main tax challenge in taxing digital businesses include the lack of nexus or taxable presence in a jurisdiction.
Another important issue is that of intangibles used by these businesses. The use of intangibles makes it easy for companies to structure their businesses so as to pay minimum taxes. On the other hand, for the tax authorities, it is difficult to identify these intangibles, value them and allocate them within a multinational group. Also, intangibles are highly mobile and this makes it easy for companies to set up a business far away from their consumers, where the actual economic activity takes place.
E-commerce companies also use a lot of user data. This raises an important question as to whether any value is generated by the data provided by the users. The answer to this could be in the positive. Though no product is directly generated by this data. Thus, data in itself wouldn’t create value unless processed. Profit is made by these companies by selling the data to online advertisers. It could be said that user data is a key driver of new business models. It can be said that “customers become virtual
volunteer workers for the companies providing the services that they use. The data from the users’ with their “free labour” are collected, stored and processed to be integrated into the production chain in real time, blurring the dividing line between production and consumption”.13 Whether all user data is 11 ‘MEASURING THE DIGITAL ECONOMY’ (2018) International Monetary Fund Staff Report, pp. 7
12 Casella B and Formenti L, ‘FDI in the Digital Economy: A Shift to Asset-Light International Footprints’ (2018),
UNCTAD Insights, pp. 102
13 Collin P and Colin N (2013): “Task Force on Taxation of the Digital Economy,” (France, January 2013) pp. 2,
relevant and hold same value has to be assessed. The traditional tax systems do not deal with this issue.
There is also an issue of characterization of income earned by the e-commerce businesses. Whether a particular kind of income earned by some of these companies would constitute a business income subject to corporate tax on net income or royalties/technical services subject to withholding tax on gross income. For eg. are payments for cloud computing payment for royalties or rentals, for technical services or business profits?14 Also, innovative business models such as 3D printing may raise unprecedented characterization questions.
Thus, challenges posed by digital economy can be broadly grouped into three categories15 – i. the difficulty of collecting VAT/GST in the destination country where goods, services and
intangibles are acquired by private consumers from suppliers based overseas which may not have any direct or indirect physical presence in the consumer’s jurisdiction;
ii. the ability of some businesses to earn income from sales from a country with a less significant physical presence in the past, thereby calling into question the relevance of existing rules that look at physical presence when determining tax liabilities;
iii. the ability of some businesses to utilise the contribution of users in their value chain for digital products and services, including through collection and monitoring of data, which raises the issue of how to attribute and value that contribution.
3.2 BEPS Action Plan 1
OECD with the patronage of G-20 launched BEPS project in 2013, wherein 15 action plans were published. In October 2015, the OECD released its final Report on Action Plan 1 – ‘Addressing the Tax Challenges of the Digital Economy’ dealing specifically with the taxation of digital economy. The Report acknowledges that current rules of international taxation are inadequate and that the digital economy raises more systemic and broader challenges, summarised as characterisation, nexus and data, for tax policy makers to deal with e-commerce businesses.
The Report identifies the following areas of base erosion with respect to digital businesses – i. avoiding of PE status in the market country;
ii. avoiding of withholding taxes;
iii. eliminating tax in the intermediate country or in the country of residence.
The Report discusses in detail the above issues and other challenges posed. However, it only gives indications of what could be the possible steps to tackle digital economy. It is not conclusive and still requires consensus and further work. The three options mentioned in the Report as recommended by TFDE are –
i. a new nexus test in the form of a significant economic presence requirement; ii. a withholding tax on certain types of digital transactions; and
iii. an equalisation levy.
The Report states that “countries could, however, introduce any of these three options in their
domestic laws as additional safeguards against BEPS, provided they respect existing treaty
14 Lahiri AK, Ray G and Sengupta DP, ‘Equalisation Levy’, Brookings India Working Paper, pp. 11 15 OECD Observer: Tax challenges, disruption and the digital economy: www.oecdobserver.org
obligations, or in their bilateral tax treaties. Adoption as domestic law measures would require further calibration of the options in order to provide additional clarity about the details, as well as some adaptation to ensure consistency with existing international legal commitments”.16 Thus, the Report only makes recommendations and does not give a clear indication as which is the most valid and favourable option. It gives the countries options to implement any of these options, but states that countries may introduce any of these three provided they respect existing treaty obligations. Prior to the publication of the OECD’s Action 1 Final Report, no serious study had been carried out into the changes brought about by the digital economy from a tax point of view.17 Even the Final Report didn’t go far enough in tackling the problem. The recommendations provided are indicators of possible solutions and not binding in nature. Since digital businesses have presence all around the globe, unilateral action by States cannot have far reaching effects. There is a need for a more inclusive and consistent approach.
4. INDIAN EQUALISATION LEVY
4.1 Report of the Committee on taxation of E-Commerce
To recognise the issues and difficulties in taxing e-commerce businesses and to come up with a simple solution on those issues, the Central Board of Direct Taxes (CBDT), Department of Revenue, Ministry of Finance constituted a Committee on Taxation of E-Commerce (the Committee). The term of reference of the Committee included detailing the business models for e-commerce, the direct tax issues in regard to e-commerce transactions and a suggested approach to deal with these issues under different business models.18 The Committee submitted its report on February 2016. The report examined the tax issues arising out of new business models and also took cognisance of and assessed the following three options provided by BEPS Final Report on Action 1 –
- New nexus based on significance economic presence; - Withholding tax on digital transactions; and
- Equalisation levy.
The report provided with its own analysis of the options indicated by the BEPS Final Report on Action 1 and also recommended as to which would be the best option which could be adopted by Indian at the present stage. Following is the brief summary of the three options analysed by the Committee – Option 1 –
The report acknowledged the difficulties in the application of existing physical based nexus rules that constitutes the definition of permanent establishment and supported the concept of “significance economic presence” (SEP) as an adequate fulfilment of nexus between the taxable enterprise and the taxing jurisdiction. The report laid down the nuances of how the SEP concept would work in practice. The introduction of SEP would require necessary changes in the domestic law as well as
re-negotiation of tax treaties entered into by India.
The report however arrived at a view that the issue of attribution of profit arising out of a nexus based on significance economic presence needs to be analysed in greater detail to ensure simplicity,
16 OECD/G20 Base Erosion and Profit Shifting Project: Addressing the Tax Challenges of the Digital Economy,
Action 1 2015 Final Report; pp. 13
17 Brauner Y, BEPS: An Interim Evaluation [2014], World Tax Journal, pp. 20
18 Report of the Committee on Taxation of E-Commerce, ‘Proposal for Equalization Levy on Specified
predictability and certainty in tax regime. The Committee also noted that the lack of clarity and uniformity of views in respect of attribution of profits can be a significant constraint in including this option in the bilateral tax treaties.19 The report further mentioned that adopting the concept of SEP in domestic law would be beneficial in non-treaty situations.
Options 2 –
The second option was identified as substantially similar to withholding tax in respect of payments made as interest, dividend, royalty and fees for technical services. Such withholding tax at
concessional rate would be applicable on gross amount. The report proposed that this option would be simple, predictable and pragmatic and much easier to implement as compared to the first option. The report however, pointed out that such withholding tax on B2B transactions can be implemented only if it is included in tax treaties.20
Option 3 –
Given the limitations of the first two options, the report proposed the introduction of an equalisation levy. According to the report, the word “equalisation” represents the objective of ensuring tax neutrality between different businesses conducted through differing business models or residing within or outside the taxing jurisdiction.21 The BEPS Action Plan 1 Report proposed the equalisation levy to be a levy imposed on the gross value of the goods or services provided to in-country customers and users, paid by in-country customers and users, and collected by the foreign enterprise via a simplified registration regime or by a local intermediary.22
The report reasoned how this option differs from the option of withholding tax. It provided that a withholding tax is a mechanism of tax collection whereas equalisation levy would be a final tax. Thus, the levy would be determined with reference to the gross amount of the payment and the rate of Equalization Levy applicable on it, which would be a full and final tax. The report provided that the levy would be outside the Income tax Act and would form a separate code in itself. The report also vaguely tried to argue that as the levy is charged on gross amount, that makes it different from an “income tax” or a “tax on income” or “any identical or substantially similar taxes” as provided in tax treaties. It also reasoned that since re-negotiating tax treaties is a time consuming, prolonged and uncertain process, bringing such a levy in domestic law would be beneficial in terms of simplicity, uniformity, consistency and the same would also lead to ease of administration and compliance.
As a result of the above benefits, the report advocated the introduction of an Equalisation Levy on payments made for digital services to a enterprise with the objective of equalizing the tax burden for other Indian businesses that are subject to income tax in India which provide similar services by digital or more traditional means without disturbing existing tax treaties. The Committee suggested the following categories of payments that may be subjected to Equalisation Levy –
i) online advertising or any services, rights or use of software for online advertising, including advertising on radio & television;
ii) digital advertising space;
iii) designing, creating, hosting or maintenance of website;
iv) digital space for website, advertising, e-mails, online computing, blogs, online content, online data or any other online facility;
19 ibid, para. 104, pp. 72
20 A closer look at the current form of the levy would tell us that it is infact a withholding tax. The same is discussed in chapters below.
21 ibid, para. 109, pp. 75
22 It is to be noted that the Indian version of Equalisation Levy differs substantially than that provided in the BEPS Report
v) any provision, facility or service for uploading, storing or distribution of digital content; vi) online collection or processing of data related to online users in India;
vii) any facility or service for online sale of goods or services or collecting online payments;
viii) development or maintenance of participative online networks;
ix) use or right to use or download online music, online movies, online games, online books or online software, without a right to make and distribute any copies thereof; x) online news, online search, online maps or global positioning system applications; xi) online software applications accessed or downloaded through internet or
telecommunication networks;
xii) online software computing facility of any kind for any purpose; and
xiii) reimbursement of expenses of a nature that are included in any of the above.
For the above purposes ‘online’ means a facility or service or right or benefit or access that is obtained through the internet or any other form of digital or telecommunication network.
The Indian government did not take into consideration all the recommendations by the Committee while enacting the law. Further details about the structure of the levy are discussed in the section below.
4.2 Indian Equalisation Levy – form and structure
Taking into consideration the recommendations of the BEPS Action Plan 1,India introduced the Equalisation Levy through Chapter VIII of Finance Act of 2016 which forms a separate code in itself. It is in nature of a separate levy and does not form part of the Indian Income Tax Act. The idea behind the levy was to tackle the challenges posed by taxation of digital businesses in India. Current form of the levy23 is only applicable to a limited number of services rather than all of the categories as recommended by the Committee.
Some of the salient features of the levy important for this research are as follows – 4.2.1 Charge of Equalisation Levy
Sec. 165 of the Finance Act 2016 deals with the provisions related to the charge of equalisation levy. It provides that equalisation levy shall be charged @ 6% of the amount of consideration payable, for any specified service received or receivable from a non-resident, by
i. A person resident in India carrying on any business or profession; or ii. A non-resident having permanent establishment in India.
For this purpose, it is clarified that “specified service” means online advertisement, any provision for digital advertising space or any other facility or service for the purpose of online advertisement, or includes any other service as may be notified by the central government in this behalf.
23 The scope of the levy was expanded to a few other services by Finance Act 2020. Those changes are not part
4.2.2 Exemption
There are certain instances where the levy won’t be chargeable. Equalisation levy shall not be charged in the following cases: –
i. The non-resident providing specified service has a permanent establishment in India and the specified service is connected with such permanent establishment; or
ii. The specified service is not for the purpose of carrying out business or profession (i.e. for personal purpose); or
iii. The aggregate amount of consideration payable for the specified service received or receivable does not exceed Rs. 1 Lakh (Rs. 100,000).
4.2.3 Collection and recovery
Sec. 166 provides for collection and recovery of the levy. It provides that a resident carrying on business or profession or a non-resident having a PE in India shall deduct the equalisation levy from the amount payable to non-resident in respect of specified services mentioned above and deposit the same to the credit of central government with in a period of 7 days from the end of the month.
Thus, the equalisation levy of 6% is aimed at taxing business-to-business transactions in the digital advertising space - that is, the income accruing to foreign ecommerce companies from within India. It’s a tax which is withheld at the time of payment by the recipient of the services.
Thus, it is levied on non-resident digital advertising companies, but it doesn’t cover all services. This means that Indian e-commerce businesses won’t be covered within the ambit of the levy. This is because these companies are already taxed on their worldwide income and charging an extra levy would lead to double taxation.
4.2.4 Computation & Characterisation
The tax is payable on gross basis. Thus, any expenses or deductions won’t be taken into
consideration when the payment is made. The distributive rules under the heads of income in the Indian Income Tax Act would be irrelevant for the purposes of the levy. Moreover, there won’t be any issue with the characterisation of the payment made. It should not matter whether the payment made takes the form of royalty, business income, fees for technical service, etc. The only thing which matters is that the payment falls within the scope of the levy and doesn’t fall into the “exemptions” as provided above.
So, if a company resident in India takes out advertising on, say, Facebook on a regular basis and the cost of advertising on one platform exceeds Rs. 100,000 in a single year, then the resident company must withhold the equalisation levy and pay it to the government.
4.2.5 Nexus
While imposing a tax, it is very important for a State to have nexus. Nexus in relation to a taxing statue can take form of economic or territorial nexus. Only in presence of a sufficient nexus, the exercise of imposing and collecting tax can be lawful. This fundamental principle has also been reiterated by Vogel thus: ‘Current international law permits taxation of foreign economic transactions when a
sufficient connection exists between the taxpayer and the taxing State”24
For Equalisation Levy, the payment is made by Indian resident or PE. The payment originates from India, there is a nexus with India to grant it the taxing power for the payment made. However, it has to be seen whether this would constitute a “sufficient nexus”. The Supreme Court of India in the case of
Ishikawajima Harima Heavy Industries (2007)25 while interpreting the Indian source rules in respect of fees for technical services, held that, with regard to the territorial nexus of a non-resident taxpayer’s income with India, the technical services must be both “rendered” in India and “utilized” in India. Consequently, the source rules in respect of fees for technical services were held to be inapplicable where the services were provided by a non-resident taxpayer from abroad, as such services did not have a source in India. Based on this reasoning by the Supreme Court, there is a possibility that the levy could fail the nexus doctrine.
5. EQUALISATION LEVY & TAX TREATIES
5.1 Equalisation levy – whether a direct or indirect tax?
Many economists and academicians have tried to distinguish between direct and indirect taxes but sometimes the distinction is not so clear. Taxes on income, profits, capital, inheritance are usually considered to be direct taxes. From the analysis of various bilateral tax treaties, it can be seen that they usually apply to direct taxes. The OECD Commentary however refuses to use the words “direct taxes” as it thinks that the term is “far too imprecise”. Whether a tax is technically termed as direct or indirect tax makes no difference for treaty application as long as it fulfils the elements provided in Art. 2. However, if it can be reasonably concluded that it is in the nature of direct tax, chances of it falling within the scope of Art. 2 are higher. As the tax treaties concluded by India apply to tax on the income of a person, similar direct taxes would fall within the scope of the term “identical or substantially similar taxes” under tax treaties.
It is clear from the reasoning provided by the government that the Equalisation Levy is a solution to the challenges posed by digital businesses to direct tax issues. The Memorandum to Finance Bill 2016 mentions that upon introduction of the levy, Section 10(50) would be inserted in Indian Income tax Act to provide an exemption for any income arising from providing specified services on which
equalisation levy is chargeable in order to avoid double taxation. This exemption in the Income tax Act which is a direct tax code and the reasoning given by the government provides hint that it is in the nature of a direct tax. It indicates that it is an alternate mode of collecting a direct tax. As seen above, the resident is liable to “deduct” the levy from consideration payable to the non-resident. Thus, Equalisation Levy is a deduction from the consideration receivable to the non-resident which makes it in the nature of withholding taxes which are direct taxes in nature.
The only tax on income that applies to resident businesses within India and not the non-residents without PEs is the Indian income tax. The Committee Report behind the equalisation levy
unambiguously stated that “The word ‘equalization’ represents the objective of ensuring tax neutrality
between different businesses conducted through differing business models or residing within or outside the taxing jurisdiction.”26 There can always be some residual uncertainty about legislative intention, but this intention behind the equalisation levy appears to be that of a ‘direct tax’, namely income tax. Though it is intended to have the effect of a direct tax, it is collected as an indirect tax with
24 Vogel K, Klaus Vogel on Double Taxation Conventions (Kluwer Law International 1997), 3rd edition 25 Ishikawajima Harima Heavy Industries v. DIT, 288 ITR 408
26 Report of the Committee on Taxation of E-Commerce, ‘Proposal for Equalization Levy on Specified
the hope that the burden is shifted by the buyers of the specified services from whom it is collected to the sellers.27
5.2 Article 2 of tax treaties –
Art. 2 of the OECD and UN Model tax treaties are identical. They provide for “taxes covered” under a tax treaty. This Article is of utmost importance because it determines as to which taxes would be covered by the tax treaty. If a given tax falls within any of the paragraphs of Art. 2, the distributive rules as provided by Arts. 6 to 22 would be applicable to determine which State could tax that income. If it could be reasonably concluded that the Equalisation Levy falls within the scope of Art. 2, the
distributive rules would give right to tax to one of the Contracting States as provided therein. Art. 2 of the OCED Model provides the following –
“1. This Convention shall apply to taxes on income and on capital imposed on behalf of a Contracting State or of its political subdivisions or local authorities, irrespective of the manner in which they are levied.
2. There shall be regarded as taxes on income and on capital all taxes imposed on total income, on total capital, or on elements of income or of capital, including taxes on gains from the alienation of movable or immovable property, taxes on the total amounts of wages or salaries paid by enterprises, as well as taxes on capital appreciation.
3. The existing taxes to which the Convention shall apply are in particular: a) (in State A): ...
b) (in State B): ...
4. The Convention shall apply also to any identical or substantially similar taxes that are imposed after the date of signature of the Convention in addition to, or in place of, the existing taxes. The competent authorities of the Contracting States shall notify each other of any significant changes that have been made in their taxation laws.”
5.2.1 Paragraph 1 -
Paragraph 1 of the Model states that the convention is applicable to taxes on income and capital. However, it nowhere defines what is meant by “tax”, or “income” or “capital”. The paragraph also provides that “…irrespective of the manner in which they are levied”. The commentary makes it clear
that method of levying taxes is irrelevant. The same can be by way of direct assessment, withholding, surcharges, additional taxes, presumptive taxes, etc. As long as it can be concluded that a particular tax is a tax on income or capital, the provisions of this paragraph are attracted regardless of the manner in which the tax is recovered from the assessee.
5.2.2 Paragraph 2 -
Paragraph 2 attempts to define what is meant by “taxes on income and capital”. This paragraph which elaborates and supplements paragraph 1 is not of much help either. It vaguely defines what would be covered by “taxes on income and capital”. The Report of WP No. 30 itself mentions that “the general
descriptions given in paragraphs 1 and 2 are not too precise and might probably be called to be rather
vague.” According to this paragraph, a tax on income would cover a tax on elements on income. It can
be said that taxes on elements on income would cover taxes on dividends, interest and royalties.28 These taxes aren’t levied on total income but only elements of income. What is a “tax on income or elements of income” is very litigative. If it can be concluded that a particular kind of payment can be qualified as income in the hands of a person or entity, a tax levied on such payment/income could be a tax on (elements of) income.
5.2.3 Paragraph 3 -
Paragraph 3 of the Model provides a list of taxes to which the convention would apply. It covers the taxes provided under the domestic laws of both the contracting States. Both the States could negotiate and add a list of taxes already in existence which they wish to specifically cover in their treaty. This list by no means is exhaustive in nature. The phrase “in particular” make that abundantly clear. The list serves to illustrate Arts. 2(1) and 2(2). This does not mean that the taxes not included in paragraph 3 would automatically fall outside the scope of the treaty. If the Contracting States wish to exclude a particular kind of tax which could possibly qualify as a tax on income, the same has to be explicitly mentioned in the treaty. This view is supported by WP No. 30 thus,
“The list of taxes will also give in principle a complete picture of all taxes imposed in each State at the time of signature and covered by the Convention. However, taxes not enumerated in paragraph 3 but qualifying for a test under paragraphs 1 and 2 are – under the present O.E.C.D. concept – nevertheless within the scope of the Convention.”
If the Contracting States incorporate broad general descriptions in the sense of Art. 2(1) and (2), coupled with a merely illustrative list of taxes covered, the objective intent can be seen to be of the character to “broaden as much as possible the scope of the Convention.”29 Thus, a tax not forming part of the illustrative list of paragraph 3 does not automatically fall outside the scope of the treaty unless it can be proved that such tax was explicitly omitted. The illustrative listing of Art. 2(3) will nevertheless be covered if it comes under the general descriptions of Art. 2(1) and (2). This approach best serves the purpose of Art. 2 to clarify the scope of the Convention: Exclusions of a tax from the intended broad scope should be explicitly made cognizable by the contracting parties.30
The Equalisation Levy being a new tax would definitely not be part of the treaties entered into by India. Moreover, as seen earlier, the Indian government denies that the levy is a tax on income and not part of the Income tax Act. If the levy is explicitly mentioned in paragraph 3 at all, then as analysed below, the specific distributive rules would make it difficult for India to tax that income. Thus, it is highly unlikely that Equalisation Levy would ever form part of any of the future tax treaties entered by India. However, as seen in the previous paragraphs, omission of a tax from paragraph 3 would be of no effect if it still falls under the general description of Art. 2(1) and 2(2) or substantially similar as provided in Art. 2(4).
5.2.4 Paragraph 4 -
Paragraph 4 is a residuary paragraph which provides that substantially similar taxes as provided in the preceding paragraphs would form part of this Article to which the convention would apply. This
paragraph extends the scope of the treaty to taxes introduced beyond the time of its signature. It covers taxes which are “identical or substantially similar” to existing taxes. Taxes levied at the time the
28 Cyril Eugene Pereira, In re (1999) 239 ITR 260 (AAR)
29 Brandsetter P, The Substantive Scope of Double Tax Treaties - a Study of Article 2 of the OECD Model
Conventions, doctoral thesis, pp. 31
treaty was signed serves as a benchmark. Thus, Art. 2(4) supplements Art. 2(3) and prevents a treaty from becoming inoperative if one of the Contracting States modifies it tax laws.31
That does not mean that all the subsequent taxes have to be similar to the ones listed in Art. 2(3) only. In this regard Lang argues that “Art. 2(4) of the OECD Model seems to refer to the taxes listed in the
provision equivalent to Art. 2(3) and not to include the general definition in Art. 2(2) as a benchmark. This does not mean, however, that a newly introduced tax may fall under the treaty only if a similar tax was already levied at the time the bilateral treaty was signed. On the contrary, the equivalent to Arts. 2(1) and (2) applies in addition. The scope of Arts. 2(1) and (2) is not limited to the taxes levied at the time of the treaty was signed. Thus, new taxes covered by the general definitions may fall within the scope of the treaty even if they are not similar to the taxes listed in the equivalent to Art. 2(3).”32 Thus, even if the new tax is not similar to the ones listed in paragraph 3, if it can be regarded similar to a “tax on income” or “elements on income” it would still fall within the scope of the tax treaty.
With respect to Art. 2(4) Vogel points out that “…What is necessary is the comprehensive comparison
of the tax laws’ constituent elements. In such a comparison, the new tax under review, rather than being compared merely with a solitary older one (to which it will be similar in some respects and different in others), should be considered with reference to all types of taxes historically developed within the state in question – and of the states with related legal systems – in order to determine which of such traditional tax comes closest to the new tax. Whether the tax is substantially similar to another can, consequently, not be decided otherwise than against the background of the entire tax system.”33
By this observation it can be said that if the constituent elements of a new tax are similar to taxes already in existence then it would be covered within the scope of Art. 2. It points out to the intention of a new tax having constituent elements or substance similar to an existing tax. A new tax which
functions in a way as to being within its ambit an item of income which it could not otherwise tax under the general tax laws already covered by the treaty, could be said to have the elements of the existing tax.
It can be said that paragraph 4 expands the scope of treaty application. Art. 2(1) and (2) applies to taxes on income or elements of income. Paragraph 4 on the other hand, covers taxes which are identical or have substantial similarity to the taxes already covered by the treaty and not strictly applicable to “income taxes”. Austrian Supreme Administrative Court held that substantial similarity to one element of a former tax is sufficient to draw a subsequently imposed tax within treaty scope.34 Thus, if a new tax has a substantial similarity to an important element of a tax previously covered or a tax already covered by the treaty, provisions of paragraph 4 would be applicable.
Before the introduction of capital taxes in treaties, many courts held that these taxes are “substantially similar” to taxes on income by taking refuge of Art, 2(4). The concept of income in tax treaties read with provisions of Art. 2(4) which gives it an expansive scope was considered enough to cover these taxes under the scope of Art. 2. With respect to capital taxes in tax treaties, Vogel observes that
“Taxation of capital gains is normally dealt with in income tax laws, though in some instances separate legislation is devoted to that subject. Consequently, any new capital gains tax will for Treaty purposes normally have to be considered as being at least similar to income taxes.”35
31 LJ Downing vs. Secretary for Indian Revenue; (1972) IBFD case no. 6737
32 The Concept of Tax, 2005 EATLP Congress, Naples (Caserta); chapter by Michael Lang: “Taxes covered” –
what is a “tax” according to Article 2 of the OECD Model?
33 Vogel K, Klaus Vogel on Double Taxation Conventions (Kluwer Law International 1997), 3rd edition.,
Commentary on Article 2(4), pp. 157
34 Austrian Supreme Administrative Court, Case No. 99/15/0265, decision of 3 August 2000
35 Vogel K, Klaus Vogel on Double Taxation Conventions (Kluwer Law International 1997), 3rd edition.,
Paragraph 4 is important in the sense that it prevents the treaty from becoming inoperative in the case there is a modification in the tax laws of one of the Contracting States. Many countries have frequent amendments in their Income tax Acts. India for example modifies its Income tax Act every year through Finance Bill/Act. In the absence of paragraph 4 in the treaty, any modification or insertion of a new tax similarly covered by the treaty would render the treaty kaput. In a way it can be said that paragraph 4 keeps the functioning of the treaty alive.
It is clear from the origins of Art. 2(4) and insinuated in the very wording “substantially similar” that the substance of the tax is of the essence. Though taxes covered by tax treaties are in the nature of income taxes, it can be said that any tax which does not necessarily fall within the domestic income tax statue but has elements close to a tax on income or in substance functions as a tax on income would be covered by the overarching meaning as provided in Art. 2(4). As rightly pointed out by Brandsetter, the denomination and formal arrangement of the tax cannot be more than a starting point in the determination of its substantial similarity; otherwise, a state could circumvent the test of
substantial similarity simply by inserting a newly created tax into the corpus of a tax that is expressly listed in paragraph 3.36
5.2.5 Conclusion -
Thus, the intent of Art. 2 is, inter alia, to:
- Clarify the terminology and nomenclature concerning the taxes to be covered by the convention;
- Widen the field of application of the Convention as much as possible;
- Avoid the necessity of negotiating a new treaty whenever domestic tax law is modified. Therefore, an expansive rather than a restrictive interpretation of Art. 2 is justified.37
It is interesting to note that the OECD Commentary in paragraph 2 mentions that the term “direct taxes” has not been used in the Article as the term is “far too imprecise”. This is true because the terms “direct” and “indirect” taxes aren’t conclusive and the elements of the two could overlap at times. However, the taxes covered by the Convention usually in the nature of direct taxes. It also mentions that the method of levying the tax is immaterial for the purpose of the Convention. This could be provided to clarify the levy in the nature of withholding taxes, which are sometimes difficult to distinguish from indirect taxes.
Unlike Art. 2(3), Art. 2(1) and (2) have to be interpreted without reference to domestic law. These provisions describe the scope of the OECD Model in a more general way and define the term “taxes
on income and on capital”. Since Art. 2(3) refers to domestic law, Arts. 2(1) and (2) make sense only if
they are seen as having an “autonomous” meaning independent of the domestic laws of the
contracting states. Otherwise, there would have been no need at all for provisions such as Arts. 2(1) and (2).38
Thus, a newly introduced tax has to be tested specifically against all the elements provided in Art. 2, unless it already forms part of the list as provided under paragraph 3. If it can be reasonably
concluded that a tax is a “tax on income” or “elements of income” or “substantially similar” to any 36 Brandsetter P, The Substantive Scope of Double Tax Treaties - a Study of Article 2 of the OECD Model
Conventions, doctoral thesis, pp. 37
37 Kinsella vs. Revenue Commissioner (2007) IEHC 250 (Irish High Court: Commercial Division) 38 Lang M, Bulletin for International Fiscal Documentation (Vol. 59, No. 6, June, 2005)
existing tax covered by the treaty, substantive scope of Art. 2 should automatically be attracted. Just because a tax falls outside a particular statue should be no reason to unquestionably exclude it from treaty application. If that were the case, States would have easily dodged the provisions of the treaty by introducing taxes falling outside the ones particularly mentioned in the treaty but having the essence and flavour of a tax on income or capital.
5.3 Equalisation Levy whether a tax on income? –
The word “income” has a very wide meaning and cover within its ambit all types income earned by an individual or entity. The term is not restricted to net receipts. Royalty, fees for technical service, interest etc are all charged on gross basis and still fall under the category of “income”. The term “income” can be broadly interpreted: “gross receipts can also constitute income. Even any other less
sophisticated yardstick qualifies as income for the purposes of Article 2(2) OECD and UN MC as long as the aim is to cover income (in the sense of money value of the net accretion of one’s economic power during a certain period of time) or essential elements thereof”.39
Equalisation Levy is charged on “consideration received” by the non-resident. This consideration forms part of the business income of the non-resident. It can be said that equalisation levy is a tax on “income” of the non-resident. Section 2(24) of the Indian Income tax Act defines income. It provides a list which is inclusive in nature of what would be included within the definition. If any payment is made by a resident to a resident enterprise for ‘specified services’, such payment made to the enterprise would fall within the definition as provided in Section 2(24). Needless to say, tax laws of other
countries would also qualify such definition as income of the enterprise. Bringing it outside the Income tax Act would still make it business income in the hands of the non-resident enterprise. One of the arguments provided by the Indian government is that the levy is on gross basis and it cannot be considered as a “income tax” or “tax on income” or “any identical or substantially similar taxes”.40 There is little weight in this argument. The commentary to Art. 2 makes it clear that a tax levied on a certain gross revenue and not on a net basis does not alter the fact that it qualifies as a tax on income as referred to in Art. 2 of the OECD Model. Many of the taxes imposed within a treaty are on a gross basis. Interest, royalty, FTS are taxed on a gross basis and generally collected from the person making the payment (in case source State has a right to tax). Even in the case of Cyril Eugene (supra) the court has held that taxes in the nature of royalty and FTS can be said to have “elements of
income” and hence covered under Art. 2. The current Equalisation Levy is substantially similar to a withholding tax on royalty or FTS. This mechanism used doesn’t alter the fact that the tax imposed on these payments is a tax on income. The levy makes the Indian resident liable to deduct 6% of the amount paid or payable to the non-resident as consideration for specified services. Failure to deduct the levy attracts penalty as provided in the Income tax Act. Thus, the consideration received by the non-resident can be termed as its income for provision of specified services.
In the case of Ministério Público and Fazenda Pública v. Epson Europe BV,41 Epson Europe BV, a company resident in the Netherlands, held more than 25% of the shares in its subsidiary in Portugal, Epson Portugal SA. Art. 5(1) of the EU Parent-Subsidiary Directive prescribes that no withholding tax may be levied in case of a shareholding of at least 25%. Art. 5(4) however permitted Portugal to postpone the full implementation of the Directive until 2000. The EU Parent-Subsidiary Directive provided that under a transitional arrangement withholding tax on dividends distributed by Portuguese
39 Riemer E & Rust A, Klaus Vogel on Double Taxation Conventions – Fourth Edition, Article 2. Taxes
Covered, pp. 159
40 Report of the Committee on Taxation of E-Commerce, ‘Proposal for Equalization Levy on Specified
Transactions’, 2016, pp. 127
