Digital commerce, which was in its infancy, accentuated during the Covid-19 pandemic.  The ability to provide goods and services from far-flung locations, as never-before, complicated and completely frustrated existing regulatory frameworks, designed to address traditional commerce.  The pressing priority undoubtedly involves an overhaul of the regulatory framework, while not impeding the trajectory of digital commerce.

In International taxation framework, digitalisation obviated nexus between income producing activity and location, consequently, rendering physical presence based rules of taxation obsolete.  Further, it made characterisation and consequent taxability of receipts of a non-resident technology company (“NRTC”) an onerous task.

In an effort to reign in and tap the income of NRTCs escaping Indian taxing net, India unilaterally introduced Equalisation Levy (“EL”) in 2016,^[1] to implement 6% tax on gross revenue received by NRTCs for digital advertising services rendered to residents.^[2]  The scope of EL was significantly expanded in 2020, by implementation of 2% tax on gross revenue received by NRTCs for any other service, rendered to residents digitally.^[3]  Thereafter, in 2021, by way of a retrograde amendment, EL was made inapplicable on passive incomes, being “Royalty” or “Fees for Technical Services” (“FTS”).^[4]  This completely undermined the objective of introducing EL, which was designed to avoid characterisation issues.

India follows a residency-based taxation system.  Residents are taxed on their domestic and worldwide income and non-residents are taxed on their source based income.  A non-resident’s chargeability to tax in India is subject to the provisions of applicable Double Taxation Avoidance Agreement (“DTAA”).^[5]  Since income of NRTCs was sought to be taxed in the guise of EL, EL was intentionally kept outside the purview of Indian income-tax law, thereby, rendering DTAA protection nugatory.  Owing to operation of EL, receipts of NRTCs run the risk of triple taxation.  First, the said receipts are already subjected to the charge of EL.  Second, owing to the 2021 amendment, the said receipts may also be taxed as passive incomes, being “Royalty” or FTS.^[6]  Third, the said receipts may be subjected to corporate income-tax in the country of a NRTC’s residence.  That apart, since EL has strategically been implemented outside Indian income-tax law, EL paid by a NRTC will not be available as a credit against the NRTC’s income-tax liability in its country of residence.

It would now be relevant to dwell into the concept of “Significant Economic Presence” (“SEP”), which already finds place in the text of the Indian income-tax law.^[7]  A NRTC having a SEP as per the threshold and criterion set out under the provisions of the ITA, is subject to tax to the extent of income attributable to its SEP in India.  Where, however, a DTAA applies, SEP is ineffective owing to supremacy of the DTAA.  To resolve the problem of characterisation, triple taxation and attribution, the Parliament should consider:

i.) To resolve the problem of characterisation and triple taxation:

• repealing EL from the statue book
• giving an overriding effect to SEP contained in the Indian income-tax law over other deeming provisions, such as those pertaining to passive incomes, being “Royalty” or FTS,^[8] and DTAAs^[9]. This will resolve the problem of triple taxation by overcoming characterisation issues as well as DTAA supremacy ^[10].

ii.) To resolve the problem of attribution: clarifying that in case of a NRTC having business connection in India on account of a SEP, a sum equal to 5% of the amount of consideration received or receivable by the NRTC through its SEP in India, shall be deemed to be profits and gains of the NRTC, chargeable to tax in India.^[11]

The strategy canvassed should be made applicable prospectively.  If this is done, tax paid by a NRTC would also be available as a credit against the NRTC’s income-tax liability in country of residence.

The conviction in the strategy stems from the agreement between United States Trade Representative and Government of India,^[12] which is indicative of the consensus that non-residents generate income in market jurisdictions through rendition of digital services therein and such income should be apportioned to and taxed by the said market jurisdiction to the extent of operations carried out there.

Sometimes an astonishingly simple solution may solve a rather complex problem.  While such easy solution is rather difficult to come by, it is important to remember that it is any day better than a complex solution.  The easy solution afore-advanced is likely to bring out the desired balance between fairly appropriating tax base and facilitating cross-border trade.

Footnotes:

[1]              The Memorandum to Finance Bill, 2016; Provisions Relating to Direct Tax; Additional Resource Mobalisation; Equalisation Levy; Available at: https://www.indiabudget.gov.in/budget2016-2017/ub2016-17/memo/mem1.pdf; Accessed on: 02 October, 2023.

[2]              The Finance Act, 2016; Chapter VIII pertaining to Equalisation Levy.

[3]              The Finance Act, 2020; Chapter VIII pertaining to Equalisation Levy.

[4]              The Finance Act, 2021; Chapter VIII pertaining to Equalisation Levy.

[5]              Section 90(2) of the Income-tax Act, 1961 (“ITA”).  Article 51(c) of the Constitution of India, 1949 is a Directive Principle of State Policy, which states that the State shall endeavor to “foster respect for international law and treaty obligations in dealings of organized people with one another; and encourage settlement of international disputes by arbitration”.  Although this is not enforceable, it is a fundamental principle of governance.  GVK Industries Ltd. vs. ITO, [2011] 332 ITR 130 (Supreme Court).

[6]              It is in Google Asia Pacific Pte Ltd. vs. CIT, W.P.(C) 12045/2022, C.M. No. 36000/2022, order dated 14 September, 2022 (Delhi High Court) and Google India Pvt. Ltd. vs CIT, W.P.(C) 23410/2022, order dated 02 December, 2022 (Karnataka High Court), where the issue of concurrent taxability as EL and Royalty or FTS came up for consideration and Courts were pleased to make an interim arrangement pending final adjudication.

[7]              Explanations 1(a) and 2A to section 9(1) of the ITA read with Rule 11UD of the Income-tax Rules, 1962.

[8]              Sections 9(1)(vi) and 9(1)(vii) of the ITA.

[9]              There is already existing precedent in this regard.  The Indian Parliament brought in force section 90(2A) of the ITA, to give domestic “General Anti-Avoidance Rule” an overriding effect over the corresponding anti-avoidance provisions contained in DTAAs.

[10]             Indian Parliament is supreme in the law-making domain [Gramophone Company of India vs. Birendra Bahadur Pandey, [1984] SCR (2) 664 (Supreme Court)].  DTAA supremacy is only owing to Parliamentary.  This is apparent from the unequivocal language contained in section 90(2) of the ITA [UOI vs. Azadi Bachao Andolan, [2003] 263 ITR 706 (Supreme Court)].  That said, the Parliament, in its wisdom, can legitimately provide for a rider to DTAA supremacy.

[11]             If 40% tax rate is applied on an amount of deemed profit equal to 5% of consideration received or receivable by a NRTC through its SEP in India, then, the resultant tax liability would be the same as 2% EL on consideration received or receivable by the NRTC through its SEP in India.  Therefore, from India’s standpoint, in mathematical terms, there would be no tax leakage.  Further, from the perspective of a NRTC, there would be no additional economic burden.

[12]             Executive Office of the President, the Office of the United States Trade Representative; “United States and India Sign Framework for Cooperation on Trade and Investment”; Available at: https://ustr.gov/about-us/policy-offices/press-office/blog/2010/march/united-states-and-india-sign-framework-cooperation-trade-and-i; Accessed on: 02 October, 2023.