Advocates Nishant Thakkar, Hiten Chande and Jasmin Amalsadvala have made out a compelling case as to why the Equalisation Levy is constitutionally invalid. The learned authors have explained with the aid of practical examples that the levy has extra-territorial operation and fails the Nexus test and the Object test. They have also argued that the Equalisation levy is nothing but an alternate form to computing and collecting Income-tax and that the provisions of a DTAA must be available for application and due benefit
1. Introduction:
a. Equalisation Levy was introduced by the Finance Act of 2016 in the form of Chapter VIII therein.
b. The Levy has been introduced based on the recommendations of the Report of the Committee on Taxation of E-Commerce – February 2016.
c. Finance Act, 2016 restricted its applicability to online advertisements. Section165 r/w section 166 requires the consumer of online advertisement services to deduct 6% from the consideration paid.
d. Finance Act, 2020 has extensively amended the levy by expanding it to all goods and services transacted domestically and internationally, resulting in having far reaching effects. Section 165A requires every E-Commerce operator to pay 2% on the consideration for E-Commerce supply or services provided or facilitated by it.
2. Extra-Territoriality:
a. The SC has laid down “nexus test” and “object test” as the tests to check competence of the Parliament to enact a law under Article 245.
b. The SC holds that – (a) for the nexus test to be satisfied, the law must relate to aspects or causes which have some impact on or nexus with or to India (b) for the object test to be satisfied, such laws are intended to benefit India.
c. To the extent the levy is imposed on transactions, any part of which has situs in India, it may not be possible to challenge the imposition on the ground of extra-territoriality.
d. However, to the extent it seeks to impose levy on transactions which originate and conclude wholly outside India, it appears that the levy under sections 165A(1)(i) and 165A(1)(ii) read with section 165A(3)(i) would be beyond the powers under Article 245 of the Constitution of India.
e. Example A: A Resident Indian visiting United Kingdom(“UK”), purchases a Pizza online from a local UK restaurant for consumption while he is in UK and pays for it in pounds by cash on delivery. In this example the Act contemplates a levy under section 165A(1)(i).
i. Nexus Test:
1. The revenue would argue that the existence of a resident Indian in the equation would satisfy the nexus test.
2. However, if one examines the transaction from its facets it would be seen that the food is prepared in UK, ordered in UK, paid for in UK and consumed in UK.
3. In such a situation it may be possible to urge that there is no real nexus with India. The existence of a resident Indian is only by chance and not design. The nexus, if at all, is at the highest illusory and tenuous; and therefore, would not satisfy the nexus test.
ii. Object Test:
1. As per the Report of the Committee on Taxation of E-Commerce (February 2016), the objective of the Equalisation Levy is to create:
a. a tax neutral level playing field between a foreign to local E-Commerce operators and its competing domestic business operator, and
b. to provide clarity to the Non-Resident E-Commerce operators.
2. This also appears to be the objective of the Organisation for Economic Cooperation and Development (“OECD”) as is suggested in Para 302 of Action 1: 2015 Final Report (Addressing the Tax Challenges of Digital Economy).
3. Since there is no competing domestic business involved in this example and also that this foists an unclear burden on the non-resident business to know Indian domestic laws, it could be argued that this test is not satisfied.
f. Example B: A Resident Indian visiting UK, goes to an internet café and searches for Indian fairness creams sold by stores in UK. The web search engine throws up names of stores which sell Fair and Lovely, Emami Fair and Handsome etc. The web search engine charges the non-resident store for throwing up the advertisement. The revenue would
seek to impose a levy on the sale of the advertisement under section 165A(1)(ii) read with 165A(3)(i).
i. Nexus Test:
1. The revenue would once again argue that the existence of a resident Indian in the equation would satisfy the nexus test.
2. However, if one examines the transaction from its facets it would be seen that the store is located in UK, it is advertised in UK and the product is sold in UK.
3. In such a situation it may be possible to urge that there is no real nexus with India. The existence of a resident Indian is only by chance and not necessarily by design. The nexus, if at all, is at the highest illusory and tenuous; and therefore, would not satisfy the nexus test.
ii. Object Test: The same position as in Example A prevails.
g. Given that on the above ground, a constitutional challenge may be maintainable to the Levy only to a partial extent, it is more likely that the Courts would be inclined to read-down the sections to allow the Levy only to the extent the transaction has a more live nexus / object, rather than striking them down in the entirety.
3. Arbitrariness:
The Hon’ble Supreme Court has held “arbitrary” to mean: in an unreasonable manner, as fixed or done capriciously or at pleasure, without adequate determining principle, not founded in the nature of things, non-rational, not done or acting according to reason or judgment, depending on the will alone.
a. The entire scheme of assessment and appeal provided under Chapter VIII of the Finance Act is absurd and irrational:
i. A statement of deduction and/or payment of Levy is required under section 167 of the Act.
ii. Under section 168, the Assessing Officer (“AO”) is empowered to verify the statement only for arithmetical accuracy. The AO is not empowered to undertake a quasi-judicial process to determine the correctness (as opposed to accuracy) of the statement filed (unlike section 143(3) of the Income-tax Act, 1961).
iii. If subsequently, it is found by the AO that there has been a failure to pay Levy, the AO can straight away initiate Penalty proceedings under section 171.
iv. An order under section 171 is only an order imposing penalty. There is no provision in the Act which empowers the officer to pass an order fixing/ determining the Levy.
v. An appeal under section 174 has been provided only against the order imposing penalty under section 171.
vi. There is no appeal against the determination and/or imposition of the Levy and the interest thereon.
vii. An appeal before the Commissioner of Income Tax(Appeals) under section 174, and all other appeals provided thereafter, will proceed on the basis that there is a failure.
viii. Let us take any of the two examples above. In order for the E-commerce operator to decide whether or not to pay the levy, he will have to determine that the purchaser is an Indian Resident:
1. Firstly, that imposes an impossible burden on a Non-Resident to know Indian law of residence.
2. Secondly – assuming the Non-Resident E-Commerce operator knows this Indian law – There is no guidance on how the Non-Resident E-Commerce operator will satisfy himself with respect to the residential status of its customer under section 165A(1)(ii) read with 165A(3)(i). At the highest (although not prescribed) the E-Commerce operator may require a declaration from the customer whether or not he/she is a resident Indian.
3. Consider a situation where it turns out that the declaration given is false. What control does the Non-Resident E-Commerce operator have? Further, if the declaration is found to be false by the AO, the E-Commerce operator has no remedy in law.
ix. As stated earlier there is no provision to pass a separate order imposing/determining the Equalisation Levy.
Having said that it may be possible for the Revenue to contend that the determination and/or imposition is also decided in the order under section 171. But, it could be argued that this is not what the section contemplates and in any case is absurd:
1. Take for e.g. a situation where the e-commerce operator obtains a declaration from the service recipient that he/she is not a resident Indian and therefore does not pay the Levy on that transaction, that declaration is later found to be incorrect by the Assessing Officer.
2. The only recourse available to the Assessing Officer is to pass an order under section 171 and in that order seek to impose the Equalisation Levy, Interest and Penalty.
3. However, if in appeal, the E-Commerce operator is in a position to show that he had taken a proper declaration and therefore proceeded on a bona fide belief, the order under section 171 would require to be quashed in view of section 173(1).
4. In which case not only will the penalty, but also the Equalisation Levy will stand set-aside, as there is no independent order imposing the Equalisation Levy.
Conclusion: A revenue law without a proper assessment or appellate mechanism is incomplete and it may be possible to argue that on that count alone the law deserves to be struck down as:
1. It is violative of Article 14.
2. Will seriously tempt the revenue authorities to adopt an aggressive approach.
3. Vests arbitrary powers in an Assessing Officer.
4. Results in putting excessive pressure on constitutional courts.
5. When other direct and indirect tax laws provide for a proper assessment and appellate
mechanism, why should this law not provide for one?
6. For unintelligible reason an appeal is provided only against the order imposing penalty?
b. Effect of absence of adequate determining principle or the provisions being non-rational:
i. Chapter VIII imposes an irrational burden on a foreigner to know Indian law and ascertain the residential status of an Indian with respect to transactions which originate and conclude wholly outside India.
ii. There is no foundation known to tax laws justifying such a levy, to the extent it seeks to impose levy on transactions which originate and conclude wholly outside India.
However, since this argument only partially impinges upon the validity of the provisions, that the Courts, if they were to agree with this argument, would be more likely to read the provisions down to exclude transactions which originate and conclude wholly outside India.
4. Legislative Competence – Compatibility with International Law/Commitments:
a. Power to legislate under Article 245 must be read with Article 51 (obligation to adhere to International Law and Treaty) of the Constitution of India to mean that the powers of the legislature are circumscribed by its international commitments.
b. Whether violative of International Agreements, such as General Agreement on Tariff and Trade (GATT), General Agreement on Tariff and Services (GATS), etc? Just to further explain with example – under GATT and GATS the limitations accepted by India are:
i. Most Favoured Nation (“MFN”) Treatment – The aforementioned Agreements deal with non-discrimination between member nations. Prima facie, it appears that Chapter VIII does not discriminate between countries and hence the Levy may not be in breach of this commitment.
ii. National Treatment – Unlike the MFN treatment obligation, National Treatment need not be a general obligation but could also be a sector-specific commitment which every WTO Member undertakes. As the Equalisation Levy covers specified services rendered from outside India, its imposition will affect the supply of goods and services from outside India and work to the disfavour of the non-resident suppliers and alter the rules of the field as they existed. On fact-based analysis it could be considered whether the Levy breaches India’s commitment.
5. Certain Situations Specifically Confirmed by The Revenue as Exigible to the Levy:
a. Example C (Purchase of a Computer Online from India):
i. Mr. A, a Resident Indian, is desirous of owning and using a computer manufactured by UK company (say, “Moon”). He could have ordered the Moon Computer from an Indian E-Commerce Operator, but Mr. A chose to order Moon computer from Moon’s website hosted on UK servers. The contract is concluded online. The payment for the same has been made by Mr. A through his bank account in India. It is agreed that the property
i.e. Moon computer is transferred to Mr. A in UK when the computer is handed over to the carrier in UK.
ii. The Revenue Authorities have during oral discussions confirmed that the above transaction will be exigible to the Levy under section 165A(1)(i) read with S.164(cb)(i) and that the Levy will be on the entire transaction value, i.e. the price paid by Mr. A for the purchase of Moon Computer.
At the outset it may be possible to argue that this transaction is not exigible to the Levy, for the following reasons:
1. S.165A prescribes a Levy of 2% of “the amount of consideration received or receivable by an e-commerce operator from e-commerce supply … provided … by it”.
2. Insofar as is relevant, e-commerce supply has been defined in S.164(cb)(i) as “online sale of goods by e-commerce operator”.
3. The word "online" has been defined in S.164(f) to mean “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”.
4. In this case it could well be argued that there is no “online sale of goods”:
a. The word “sale” has not been defined under Chapter VIII. It must therefore be understood as per the Sale of Goods Act, 1930 – i.e. when the title in the goods passes [section 4(3)].
b. When title passes, is a question which would need to be answered based on the terms of the contract, viz. based on whether the contract is subjected to law of the country of the seller or Indian Laws. In this case, I proceed on the footing that the contract is governed by (English) Sale of Goods Act, 1979 (i.e. governed by the law of the country of the seller, which in all likelihood such online transactions would be)[“English Act”].
Section 17 of the English Act is similar to section 19 of the (Indian) Sale of Goods Act, 1930 and provides that property in ascertained goods passes when intended to pass. In the example, the parties have agreed that title to Moon Computer passes to Mr. A, only on delivery to the carrier.
Therefore, the title would pass on delivery and not “online”.
c. What occurs online in this case is only the execution of an Agreement to Sell.
5. It is further pertinent to note that, this very Finance Act, 2020 also makes an amendment to the Income-tax Act, 1961 (“ITA”) by inserting section 194-O. Section 194-O of the ITA, insofar as is relevant for the present discussion, requires an E-Commerce operator to deduct tax from the payment made by it to the E-Commerce participant w.r.t. sales facilitated through its platform. In drafting this section, the legislature has consciously chosen not to use the word “online” to describe the mode/manner of sale and instead provides – “194-O. (1) … where sale of goods … of an e-commerce participant is facilitated by an e-commerce operator through its digital or electronic facility or platform …”. This, it could be argued, further demonstrates that by use of the words “online sale of goods” in section 164(cb) there is a conscious distinction being drawn by the legislation when it comes to imposing of the Levy.
Without prejudice to the above, it may now be considered whether the aforementioned example in any manner supports a constitutional challenge to the provisions.
1. Extra-territoriality:
a. Nexus Test – Given that the order originates from India and transaction concludes in India with the delivery in India, it may be difficult to argue that there is no nexus with India.
b. Object Test – The object of creating a tax-neutral playing field for the domestic business selling computer could also be said to have been achieved inasmuch as the Non-Resident E-Commerce operator will now be taxed similar to a person having presence in India. It may therefore be difficult to challenge the validity on this ground.
2. Arbitrariness: The argument explained earlier goes to the root of the legality of the Levy and is not situation driven.
3. Compatibility with International Commitments: The argument explained earlier goes to the root of the legality of the legislation and is not situation driven.
b. Example D (Booking of a Foreign Hotel Room from India):
i. Mr. A, a Resident Indian, books a hotel room in an American Hotel (say, Hotel Orange), on Hotel Orange’s website hosted on American servers. The booking is concluded online. The payment for the same has been made by Mr. A through his bank account in India.
ii. The Revenue Authorities have during oral discussions confirmed that the above transaction will be exigible to the Levy under section 165A(1)(i) read with S.164(cb)(ii) and that the Levy will be on the entire transaction value, i.e. the price paid by Mr. A for booking a room in Hotel Orange.
At the outset it may be possible to argue that this transaction is not exigible to the Levy, for the following reasons:
1. S.165A prescribes a Levy of 2% of “the amount of consideration received or receivable by an e-commerce operator from e-commerce … services … provided … by it”.
2. Insofar as is relevant, e-commerce supply has been defied in S.164(cb)(ii) as “online provision of services provided by the e-commerce operator”.
3. The word "online" has been defined in S.164(f) to mean “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”.
4. In this case it could well be argued that there is no “online provision of services”:
a. The provision of services in this example is providing of hotel accommodation and hotel services, such provision is not online but in flesh.b. What happens online, in this case, is only the execution of a contract to make available a hotel room
5. It is further pertinent to note that this very Finance Act, 2020 also makes an amendment to ITA by inserting Section 194-O. Insofar as is relevant for the present discussion Section 194-O, requires an e-commerce operator to deduct tax from the payment made by it to the e-commerce participant w.r.t. provision of services facilitated through its platform. In drafting this section, the legislature has consciously chosen not to use the word “online” to describe the mode/manner of provision of services provides – “194-O. (1) … where … provision of services of an e-commerce participant is facilitated by an e-commerce operator through its digital or electronic facility or platform …”. This, it could be argued, further demonstrates that by use of the words “online … provision of services” in section 164(cb) there is a conscious distinction being drawn by the legislation when it comes to imposing of the Levy.
Without prejudice to the above, it may now be considered whether the aforementioned example in any manner supports a constitutional challenge to the provisions.
1. Extra-territoriality:
a. Nexus Test – Given that the booking originates in India and money is paid from India by a resident Indian, it may be difficult to argue that there is no nexus with India.
b. Object Test – In contrast to the position in Example C above, the object of creating a tax-neutral playing field for the domestic business could not be said to have been achieved inasmuch the domestic business operating a hotel in India has no competition from Non-Resident E-Commerce operator providing hotel accommodation in UK.
It may therefore be possible to impinge the Levy on the basis of extra-territoriality; however even if the Courts were to accept this argument, it is very likely that they would read the provisions down.
2. Arbitrariness: The argument explained earlier goes to the root of the legality of the Equalisation Levy and is not situation driven.
3. Compatibility with International Commitments: The argument explained earlier goes to the root of the legality of the legislation and is not situation driven.
6. Levy and The Double Tax Avoidance Agreements:
It may be possible to argue that the Levy falls under Clause 82 (taxing income) of List I of the Seventh Schedule of the Constitution of India owing to the following –
a. The ITA has expanded the definition of business connection in section 9 to tax income arising from the transactions covered by the levy.
b. Section 10(50) exempts income from transactions which have been subjected to Equalisation Levy.
c. Para 302 of Action 1: 2015 Final Report (Addressing the Tax Challenges of Digital Economy), OECD, Equalisation Levy could also be seen to support the afore.
d. Circular No.3 of 2017 dated January 20, 2017 at Para 32.5 also suggests that it is a substitution for Income-tax.
e. The fact that legislature, by virtue of S.40(a)(ib), has made the allowability of the whole expenditure on which the Levy is imposed, subject to deduction of the Levy therefrom, like other cases of TDS, also lends support to its equivalence to it being a tax on income.
f. The Report of the Committee on Taxation of E-Commerce – February 2016 [“E-Commerce Report”] (Para 10.3) however, denies that Equalisation Levy is tax on income or a substantially similar tax, and claims that Equalisation Levy is under Entry 92C and 97 (residuary clause) of List I of the Seventh Schedule of the Constitution of India.
g. Firstly, Entry 92C has been deleted by The Constitution (One Hundred and First Amendment) Act, 2016 and therefore what remains is Entry 97. Secondly, Article 246A deals with levy of tax on goods and services and as per the GST law enacted thereunder, tax is levied on goods and services imported into India.
h. Very broadly speaking, on a reading of the whole of Chapter VIII it appears that the limiting factor of the impost is the residential status of the person seller/ provider/ facilitator. In other words, so long as the seller/ provider/ facilitator is a non-resident the activity of sale/provision/facilitation is subjected to levy. To put it differently, the Levy
would be imposed whether or not the goods move into or inside India so long as the person (seller/ provider/ facilitator) is a non-resident, for e.g. if a non-resident sells goods to an Indian resident the transaction will be subjected to EL even if the goods do not come into India. Contrast this with GST, where the limiting factor is the activity, i.e. so long as there is an activity of the prescribed nature into or within India there is an impost. It therefore appears that the pith and substance of the Equalisation Levy is a tax on the person and hence must fall within Entry 82. That fact that that the avowed object of the Equalisation Levy is to provide a tax neutral level playing field between a foreign e-commerce operator and competing domestic business operator, owing the former’s physical absence in India, further lends support to the view that the tax is covered by Entry 82 as the tax (which immediately comes to mind) which the foreign e-commerce operator escapes due to its physical absence in India, is income-tax. The E-Commerce Report in Para 10.3 explains that the Equalisation Levy is not a tax on income because the impost is on the gross transaction value and hence it cannot be a tax on income. It could be argued that this observation of the Committee is mis-guided since the Indian Income-tax Act does contain provision whereunder income-tax is computed based on gross transaction values, for e.g. Sections 44B, 44BBA.
In view of the above, one must consider urging that the Equalisation levy is nothing but an alternate form to computing and collecting Income-tax and provisions of the Treaty must be available for application and due benefit.
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