India, with its vast consumer market and wide user base, has always been at the forefront regarding taxation of the digital economy. Drawing inspiration from BEPS Action 1, India introduced an equalisation levy (EL) and a significant economic presence (SEP) provision as unilateral measures.
With the pillar one solution of the OECD around the corner, all eyes have been on India to see how and when it will roll back the unilateral measures entirely to pave the way for pillar one.
To put to rest some of the speculation, in the Union Budget 2024, India proposed the abolition of the EL of 2% that is applicable to overseas e-commerce operators.
This article takes a deep dive into the potential impact on overseas entities.
Unilateral measures introduced by India
In 2016, India levied an EL of 6% on online advertisement services provided by overseas entities, colloquially referred to as the ‘Google tax’. As the levy was imposed and collected from service recipients in India, no tax treaty benefit could be claimed to neutralise the same. As a result, the levy increased the cost of online advertisement services offered by overseas entities.
In 2020, an EL of 2% was levied on non-resident e-commerce operators for e-commerce supply or services made, provided, or facilitated by the e-commerce operator.
India also introduced a new nexus rule in the form of SEP provision in 2018, the rules for which were notified in 2021. Under this rule, a non-resident is considered to have a taxable presence in India if the total receipts arising out of the supply of goods or services to Indian residents exceeds INR 20 million in a financial year, or the non-resident vendor systematically and continuously solicits business or interacts with at least 300,000 users in India.
Although the measures were introduced to target the digital economy, the language was wide enough to potentially apply to conventional bricks-and-mortar business models.
Changes proposed in the Union Budget 2024
In the annual budget speech in July 2024, the Indian finance minister, Nirmala Sitharaman, announced that the 2% EL will not be applicable on online transactions undertaken on or after August 1 2024 and necessary legislative changes have been proposed to this effect. The rationale given is that the levy is “ambiguous” and leads to a “compliance burden”.
The withdrawal of the 2% EL is a welcome measure for overseas entities undertaking business transactions involving India. The move is also a step forward by India towards its international commitment of implementing the pillar one solution proposed by the OECD.
However, India shall continue to apply an EL of 6% on online advertisement services. Also, the new nexus rule of SEP will remain in the domestic tax law.
Whom will the amendment benefit?
If the overseas person is eligible to claim a treaty benefit, the abolition of the 2% EL will provide a major relief because in such a scenario, the business profits earned by the overseas person will not be taxable in India in the absence of a permanent establishment (PE) in India.
An overseas person is eligible to claim tax treaty benefits only if it maintains relevant documentation, including a tax residency certificate issued by the country/jurisdiction with which India has entered into a double taxation avoidance agreement, a declaration confirming that the overseas person does not have a PE in India, and a Form 10-F filed electronically through the Indian income tax portal.
Impact on entities not eligible for a tax treaty benefit
Until now, if the EL of 2% was applicable, an exemption was provided from the applicability of other income tax provisions (including SEP). With the withdrawal of the 2% EL, the exemption from income tax will no longer be available. As a result, if the business operations of the overseas person constitute an SEP in India, the income attributable to the SEP can be subject to tax in India.
Though the scope of income attributable to an SEP and the manner of calculating the same may be subject to debate and interpretation, the law expressly provides that income attributable to the following is subject to taxation in India:
Operations carried out in India;
An advertisement that targets a customer who resides in India or a customer who accesses the advertisement through an internet protocol (IP) address located in India;
The sale of data collected from a person who resides in India or from a person who uses an IP address located in India; and
The sale of goods or services using data collected from a person who resides in India or from a person who uses an IP address located in India.
As a result, it may be a case of ‘out of the frying pan, into the fire’ for overseas persons not entitled to treaty benefits due to the non-existence of a tax treaty with India or the non-fulfilment of conditions.
Impact of the amendment on India–US ties
In response to India’s introduction of a 2% EL in 2020 and similar unilateral measures by certain European countries, the Office of the United States Trade Representative (USTR) initiated a probe and concluded that such unilateral measures were unreasonable and discriminatory, and restrict US businesses’ trade with India/Europe. Though the USTR recommended the imposition of retaliatory or punitive tariffs on certain imports from India and various European countries, they were suspended temporarily to provide for additional time for negotiations between countries.
On November 24 2021, taking its cue from the joint statement issued by the US and certain European countries on digital services tax, India announced an agreement reached with the US on a transitional approach to the 2% EL. The transitional approach suggested that India shall provide a credit of the excess EL it collected during the ‘interim period’ compared with the potential pillar one liability for the period. The credit shall be provided once pillar one becomes applicable. The interim period has been agreed to be April 1 2022 to March 31 2024 but has been extended to June 30 2024 in an announcement on June 28 2024.
India agreed to the transitional approach on the premise that the retaliatory tariffs proposed to be imposed by the US in response to India’s 2% EL shall be dropped and no further trade actions shall be initiated by the US until the end of the interim period.
The latest announcement by India to discontinue the 2% EL may spare Indian exports to the US from punitive tariffs. Also, for the interim period, the transitional approach as agreed between India and the US shall continue to be applicable.
The fate of India’s other unilateral measures
It will be interesting to see India’s approach with respect to other unilateral measures. As part of the international commitment to implement the pillar one solution, it is mandatory for India to abolish the 6% EL. This is, therefore, also quite likely.
With regard to SEP, India has not made any such commitment. Accordingly, SEP may continue to be part of the Indian domestic tax law even after the implementation of pillar one. The tax risks associated with SEP in the absence of tax treaty benefits may therefore continue to worry overseas entities.
