Equalisation Levy Without Royalty Under DTAA: Delineating Emerging Ambiguities
Introduction
Information technology has developed at an exponential rate in India and around the world over the last decade. This has contributed to a rise in the cross-border delivery and purchase of digital content without needing a physical presence in the host country. The erstwhile direct tax provisions in India provided a threshold of ‘permanent establishment’ for taxation of business profits. However, the position of International e-commerce operators was anomalous. They did have a market presence in India but avoided their tax liability by not having a ‘permanent establishment’.[i]
To bring such e-commerce operators within the direct tax net, the Indian government under the Finance Act 2016, introduced an equalization levy at the rate of 6% on the consideration payable or paid to a non-resident person, not having a permanent establishment in India, for services related to online advertisement and provision of digital space.[ii] With an amendment made by the Finance Act, 2020, all non-resident e-commerce platforms are now subject to a new 2% equalization tax on sales of goods or services made by them in India.[iii]
Vide Finance Act, 2021, the Government has recently clarified that the 2% equalization levy extends to digital sales of goods and services by introducing the terms ‘online sale of goods’ and ‘online provision of services’.[iv] The amendment further mentions that equalization levy will not be applicable on the consideration received or receivable for specified services or for e-commerce supply, including sale of goods, which are subject to tax as ‘royalty income’ in India.[v] In this article, the author analyses the application of 2% equalization levy on such transactions which are not subjected to withholding royalty tax under Double Taxation Avoidance Agreements (DTAA) in light of recent Supreme Court judgment of Engineering Analysis Centre of Excellence Private Limited v. CIT & Anr[vi](Engineering Analysis).
No Royalty: A New Chapter for Equalization Levy
The Supreme Court recently, while relying on the case of Tata Consultancy Services v. the State of Andhra Pradesh[vii] held that ‘selling of computer software’ from non-resident supplier to Indian end user should be considered as sale of a physical object. Therefore, such transactions would be treated as ‘sale of goods’ and not fall under the definition of ‘royalties’ under DTAA tax treaties.[viii]
As a result of the Supreme Court judgment in Engineering Analysis case, there is no need for the Indian buyer to withhold 10% royalty tax on the payments on ‘selling of computer software’. Instead, the non-resident recipient of such software payments may have to remit 2% of the gross transaction value as equalization levy from a retrospective date i.e. starting from 01 April 2020. However, the equalization levy would not apply to such non-residents, who have a permanent establishment or facilitate through permanent establishment in India.[ix]
Ambiguities Surrounding New Developments in Equalization Levy
Articles 12(1) and (2) of the UN Model[x] are incorporated in India’s tax treaties, with the object and goal of granting reciprocal taxation rights to the source state. In this regard, India has chosen to tax royalties at the source, and as a result, the word “royalties” has been interpreted broadly. Under the DTAA tax treaties, ‘Royalty’ is defined to include “payments made for the use or right to use any copyright”.[xi] The Supreme Court in Engineering Analysis case ruled that by selling ‘computer software’, the developer of software only granted the end-user a non-exclusive and non-transferable right to use the computer program and a right to resell the computer software without changing its content, with an express stipulation that no ‘copyright’ is being transferred to it and only ‘copyright material’ is transferred.
Alternatively, where the definition of ‘royalties’ under a DTAA tax treaty explicitly includes ‘software programme’ like, in the case of Russia, Morocco, Kazakhstan, Tobago and Trinidad. The aforesaid Supreme Court decision will not apply to such transactions with these countries, and 10% withholding royalty tax will still be levied on e-commerce suppliers instead of 2% equalization levy. This would raise a question as to whether these countries can challenge the levy of ‘royalty tax’ on such transactions on the ground of discriminatory treatment under DTAA tax treaties?
As discussed, ‘royalty’ as defined under DTAA does not include ‘computer software’; conversely, under the Income Tax Act, ‘royalty’ has been defined as the consideration for the transfer of all or any rights (including the granting of a license) which includes ‘right to use a computer software’.[xii] However, if there are inconsistencies between the Income Tax Act and the DTAA, the provisions of DTAA prevail.[xiii] But, the Supreme Court judgment only applies to countries with whom the Indian Government has DTAA treaties and in absence of a DTAA tax treaty with a country, the definition of ‘royalty’ under the Income Tax Act would be effective. Thus, an ambiguity would arise as to whether non-resident software suppliers from countries with which India does not have a DTAA tax treaty will be subject to tax on the supply of software as ‘royalty income’ or will ‘equalization levy’ apply on them?
Further, there is an inherent ambiguity in the equalization levy. It is not a tax under the income tax act, but rather a levy imposed under a special clause of the statute. Thus, a non-resident taxpayer will not be entitled to claim credit for the levy paid in India against his tax liabilities in his residence country. This will cause double taxation to such non-residents, as they will be taxed both in India and in their residence country on the same transaction. Consequently, this will increase the cost of doing business for e-commerce operators.
Conclusion
To conclude, in general, the Supreme Court case only deals with the shrink-wrapped software products. However, the applicability of aforesaid analyses can be extended to other cross-border supply of goods or services on which tax under ‘royalty’ or ‘fees for technical services’ is not levied. Further, a provision on the ‘availment of credit’ for equalization levy under DTAA is much needed to resolve the issue of double taxation. The equalization levy addresses the crucial problem of taxing digital payments made for goods/services to international e-commerce operators. Additionally, to some extent, it has equalized the tax burden of domestic enterprises with their international e-commerce competitors without disturbing the existing tax treaties. Despite that, it suffers from certain ambiguities, both in terms of policy drafting and practical aspects as a result of new developments. Thus, clarifications and explanations are much needed for the equalization levy’s practical and successful implementation.
[i] Report of the Committee on Taxation of E-Commerce, ‘Proposal for Equalization Levy on Specified Transactions’, <https://incometaxindia.gov.in/News/Report-of-Committee-on-Taxation-of-e-Commerce-Feb-2016.pdf> accessed 18 May 2021.
[ii] Finance Act, 2016, s 165.
[iii] Finance Act, 2016, s 165A.
[iv] Finance Act, 2016, s 164(cb) (inserted by Finance Act, 2021).
[v] Income Tax Act, 1961, s 10(50); Finance Act, 2016, proviso to s 163(3) (inserted by Finance Act, 2021).
[vi] Engineering Analysis Centre of Excellence Private Limited v. CIT & Anr 2021 SCC OnLine SC 159.
[vii] Tata Consultancy Services v. State of Andhra Pradesh (2004) 271 ITR 401 (SC).
[viii] Engineering Analysis Centre of Excellence Private Limited v. CIT & Anr 2021 SCC OnLine SC 159.
[ix] Finance Act, 2016, s 165A(3)(b)(i) (inserted by Finance Act, 2021).
[x] Department of Economic & Social Affairs, ‘United Nations Model Double Taxation Convention between Developed and Developing Countries 2017’, Art 12(1) & Art 12(2), <https://www.un.org/esa/ffd/wp-content/uploads/2018/05/MDT_2017.pdf> accessed 18 May 2021.
[xi] Income Tax Department, ‘Definition of ‘Royalties’ under Double Taxation Avoidance Agreements’, <https://www.incometaxindia.gov.in/pages/international-taxation/dtaa.aspx> accessed 18 May 2021.
[xii] Income Tax Act, 1961, explanation 2 to s 9(1)(vi).
[xiii] Income Tax Act, 1961, s 90(2).