View from India: Digital Transactions Taxonomy

The past decade has seen a substantial rise in digital transactions across the globe with a chunk of service providers based in developed nations like the US. The Indian policymakers have been on the forefront to ensure that domestic companies are at the level playing field when it comes to payment of taxes on digital transactions in India.

In 2016, India became one of the first countries to introduce the “Equalization Levy” at the rate of 6 percent on “online advertisement services”. The levy is not a constituent of the Income Tax Act, 1961, and rightly so as there is no attempt to tax the net income of offshore digital service providers. However, the industry players look at the levy as a tax in lieu of income tax due to the overall structure of the levy. The objective to keep the equalization levy outside the income tax statute led to other issues including availability of tax credits in other countries.

The scope of the equalization levy was enlarged in 2020 when a 2 percent equalization levy was introduced (also known as Digital Service Tax or DST) on a non-resident e-commerce operator. However, where goods and services sold on a foreign e-commerce platform are owned or provided by an Indian resident or Indian permanent establishment, they will not be subject to the two percent equalization levy. Further, the e-commerce levy does not apply to transactions covered by the original advertising levy which was liable to tax at 6 percent.

Apart from the equalization levy, in 2018 the Indian policymakers widened the term “Business Connection” to include a new concept of “Significant Economic Presence” (SEP) within the tax statute. The SEP related provisions were deferred from the original intended applicable year, i.e. 2018-19, due to ongoing international deliberations on the taxation of digital economy. On May 3, 2021 the tax authorities issued a notification prescribing relevant thresholds for non-residents to constitute SEP in India. The provisions will come into effect from April 1, 2022. Once the provisions are made effective, non-residents having SEP in India would be deemed to have a ‘business connection’ in India.

Therefore, any income attributable to the SEP would be taxable in India. The relaxation is provided in cases where the tax treaty is applicable. The threshold limit for SEP prescribed in India is in terms of revenue as well as user base:

  1. Revenue linked: For transactions in respect of any goods, services or property carried out by a non-resident with any
    person in India including provision of download of data or software in India, if the aggregate of payments arising from such transaction(s) exceeds INR 20 million
  2. User linked: Systematic and continuous soliciting of business activities or engaging in interaction with users in India exceeding 3 lakh users

The language of SEP provisions seems to go beyond the intended objective of taxing digital business. The policymakers are expected to provide adequate guidance on how to determine the thresholds for attribution of profits to SEP related activities in India.

From a broader perspective, the SEP provisions are unlikely to affect many non-resident businesses due to tax treaties
entered with many countries by India in recent past. Further, the tax statute has provided specific exemption to the income chargeable to equalization levy. Hence, the business activities liable to equalization levy will remain outside the purview of SEP provisions.

On a macro level, India is not the only country imposing taxes on digital sellers, which is termed as discriminatory. Countries such as France and ASEAN member countries have also imposed digital services tax in their local jurisdiction. The recent consensus at G-7 to overhaul the international tax rules and upcoming discussions at larger forums like G-20 and OECD can pave a smoother way and provide better clarity on the taxation for digital businesses.

Contributing Advisors