Indian Journal of Tax Law · vol.iii issue i 2016 indian journal of tax law non-discrimination: the...

VOL. III ISSUE I 2016

INDIAN JOURNAL OF TAX LAW

NON-DISCRIMINATION: THE INDIA STORY Abhay Sharma &

Oscar D’sa

MAURITIUS TAX TREATY AMENDMENT TAKES AWAY

WITH IT ‘TREATY SHOPPING’ WHILE DOING BUSINESS

WITH INDIA

Karthik Ranganthan

KALDOR TO CHAOS Justice T.N.C.

Rangarajan

EQUALIZATION LEVY: TAXING THE OVERSEAS DIGITAL

GIANTS Ayush Vijayvargiya

VOL. III ISSUE 1 INDIAN JOURNAL OF TAX LAW 2016

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ADVISORY BOARD

Abhay Sharma

Partner, Shardul Amarchand Mangaldas & Co.,

Mumbai

Narayan Prasad Jain

Advocate, Calcutta High Court,

Kolkata

Neha Pathakji

Assistant Professor of Law,

NALSAR University of Law,

Hyderabad

Karthik Ranganathan

Advocate, Karnataka High Court,

Bangalore

Dr. Sanjay Kumar Yadav

Associate Professor of Law,

National Law Institute University,

Bhopal

EDITORIAL BOARD

EDITOR-IN-CHIEF

Arka Saha

MANAGING EDITOR

Akash Srinivasan

EDITORS

Anmol Awasthi Namrata Shrivastava Nitin Jeswani

Pragalbh Bharadwaj Samyuktha Srinivasan Shikhar Sthapak

Shruthi Pillai Vinti Agarwal Aadhya

COPY EDITORS

Sourabh Sotwal Rashmi Shukla Shobhit Ahuja

PUBLIC RELATIONS AND MEDIA MANAGERS

Bhakti Acharya Shivani Mane

~ INDIAN JOURNAL OF TAX LAW ~


[ii]

~ IJTL ~

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Mode of Citation: 3 (1) IJTL (2016)

Copyright © 2016, Indian Journal of Tax Law. Any reproduction and publication of the

material contained within the text of this journal, without prior permission of the publisher is

punishable under the Copyright Law.

Disclaimer: The views expressed by the contributors are personal and do not in any way

represent opinions of the publisher or any other institution associated with it.


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TABLE OF CONTENTS

EDITORIAL ...................................................................................................................... iv

NON-DISCRIMINATION: THE INDIA STORY (ABHAY SHARMA & OSCAR D’SA) ..................... 1

MAURITIUS TAX TREATY AMENDMENT TAKES AWAY WITH IT ‘TREATY SHOPPING’ WHILE

DOING BUSINESS WITH INDIA (KARTHIK RANGANTHAN) ...................................................... 6

KALDOR TO CHAOS (JUSTICE T.N.C. RANGARAJAN) ......................................................... 13

EQUALIZATION LEVY: TAXING THE OVERSEAS DIGITAL GIANTS (AYUSH VIJAYVARGIYA) . 25

NOTE TO CONTRIBUTORS ........................................................................................... vi


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EDITORIAL

The Editorial Board is pleased to release Issue I of Volume III of the Indian Journal of Tax

Law, the first student edited tax law journal in the country, which aims at discussing and

scrutinizing contemporary developments in the area of taxation in India and in other

jurisdictions.

Edited by the students and alumni of National Law University Odisha, Cuttack,

independently from the University, the Journal promotes discussion and in-depth academic

research in the area of taxation by inviting students, law practitioners, academicians and

policy makers to share their insights on significant and controversial tax issues which impact

national and international stakeholders. We are overwhelmed by the number of articles we

received for this issue, and would like to extend sincere gratitude to all authors. We would

also like to extend our gratitude to our Advisory Board, for constantly encouraging and

supporting our efforts.

Given the wave of globalization which has touched almost every aspect of our lives and has

consequentially, invigorated investment climate in both physical and virtual platforms, law

makers across the globe have been posed with considerable challenges in attempting to

address tax issues emanating from national and cross-border transactions. In India, to address

the said challenges, the Finance Act of 2016 introduced the concept of equalization levy to

tax revenue earned by non-resident e-commerce companies from online advertising in the

country. It also introduced significant tax amendments to encourage investments in Real

Estate and Infrastructure Investment Trusts. Indeed, the Government’s goal to make India

investment-friendly, is evidenced by the capital gains tax exemptions and tax holidays

introduced to boost businesses of start-ups.

In the sphere of indirect taxation, the Government has taken a momentous step to replace

existing Central and State level indirect tax legislations by a comprehensive Goods and

Services Tax, which will uniformly tax goods and services on their manufacture, sale and

consumption. Pertinently, the introduction of the Goods and Services Tax will not only bring

India at par with global best practices, but also effectively address the issue of cascading

effect of taxation and facilitate an integrated national market. Another pertinent development

in the realm of taxation laws is the amendment to the India-Mauritius Double Taxation

Avoidance Agreement which came into force in 1983 and has consistently acted as a pivot to

major foreign investment transactions. The 33 year-old capital gains tax exemption on shares


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held in a company resident in India has been removed, with the amendments finally seeking

to address notorious issues concerning double-non taxation and treaty shopping. Indeed, a lot

has been happening in the dynamic world of tax laws, requiring urgent study and research.

And to that effect, the Editorial Board of the Indian Journal of Tax Law, proudly presents the

first issue of Volume III of the journal, which consists of articles and essays on contemporary

national and international developments in the area of taxation.

BOARD OF EDITORS

VOL. III ISSUE I INDIAN JOURNAL OF TAX LAW 2016

[1]

NON-DISCRIMINATION: THE INDIA STORY

- Abhay Sharma* & Oscar D’sa**

ABSTRACT

Despite concerted global efforts to increase the legal protection afforded to individuals

against tax discrimination, the scourge of discrimination seems to be anything but a memory

from the past. The non-discrimination article in Double Taxation Avoidance Agreements

(“DTAAs”) purports to treat a foreign taxpayer and a local tax payer in similar circumstances

at par and recognises the fundamental right of a person to seek recourse by claiming equality.

This article evaluates the application of non-discrimination clause in the double tax avoidance

agreement from an Indian tax law perspective.

INTRODUCTION: CONSTITUTIONAL VALIDITY AND CONFORMITY

Any law made to affect the territory of India must be in conformity with the Supreme law of

India, i.e. the Constitution of India. Article 14 of the Indian Constitution states as follows:

“The State shall not deny to any person equality before the law or the equal protection of the

laws within the territories of India Prohibition of discrimination on grounds of religion, race,

caste, sex or place of birth”

The non-discrimination article under the DTAA should ideally be in consonance with the

Constitution of India. The non-discrimination article normally comes into play when

domestic law places foreign persons in a disadvantageous position as compared to a domestic

person in similar circumstances. The non-discrimination article mandates similar treatment of

persons belonging to a tax jurisdiction other than that of the taxing country and locals of the

taxing country for tax relevant situations. The non-discrimination article does however permit

a legitimate distinction between foreign persons and domestic persons founded on intelligible

differentia.

MODEL TREATIES: AIM & SCOPE OF NON-DISCRIMINATION ARTICLE

DTAAs are based on three main Model Tax Treaties, namely the Organisation for Economic

Co-operation and Development (“OECD”) Model, the United Nations (“UN”) Model and the

* Partner, Shardul Amarchand Mangaldas & Co. (Mumbai)

** Principle Associate, Shardul Amarchand Mangaldas & Co. (Mumbai)

VOL. III ISSUE I NON-DISCRIMINATION: THE INDIA STORY 2016

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United States of America (“US”) Model.

In order to understand the scope of the non-discrimination provision under various models of

tax treaties, one must first understand the aim of the Non-Discrimination Article.

Aim of Non-discrimination Article

The Non-Discrimination Article seeks to eliminate discrimination based on the nationality of

a person and not the tax residency. The term ‘nationality’ is distinct from ‘tax residency’.

Nationality has reference to the jural relationship which may arise for consideration under

International law and tax residency has reference to the jural relationship which may arise for

consideration under a domestic tax law.

Scope of Non-discrimination Article

Non-discrimination provisions are set out in Article 24 of the Model Tax Treaties. The scope

of the Model Tax Treaties extends to the following persons:

Nationals: Individuals as well as legal persons including partnerships or associations that

derive their status from laws in force in a treaty partner jurisdiction. The non-

discrimination article ensures that a non-national of a contracting state working under the

same conditions and circumstances as a national of the contracting state should not be

subject to more burdensome tax treatment than the national of the contracting state.

Stateless persons: A Person who is a national of a country that does not have a tax treaty

with the contracting state. A stateless person should not to be subjected to more

burdensome tax situations than the national of the contracting state. It is noteworthy that

stateless persons are not covered under the US Model, as United States applies the

residence rule of taxation1.

Permanent Establishments: A national of the other contracting state possessing a

permanent place of business in the contracting state.

Enterprises/Companies: An enterprise of the contracting state owned or controlled

directly or indirectly by the residents of the other contracting state.

Thus, the aforementioned persons i.e. nationals, stateless persons, permanent establishments

and enterprises/companies must not be arbitrarily or irrationally be taxed less favourably or

subject to conditions for being taxed which are burdensome as compared to domestic persons.

1 Residence rule of taxation dictates that residents of a country are taxed on their worldwide income irrespective

of the source of the Income


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SELECT JUDICIAL PRECEDENTS

The jurisprudence with respect to non-discrimination in DTAAs is somewhat limited in the

Indian context. The courts have however reiterated time and again that in order to establish

discrimination, not only does the taxpayer have to demonstrate discriminatory tax treatment

but also prove that the ground of such discrimination between nationals and non-nationals is

unreasonable, arbitrary or irrelevant. Cited below are some judgments that enumerate the

situations where a taxpayer has been granted or denied treaty benefit under the Non-

discrimination Article in the DTAAs.

1. Universities Superannuation Scheme Ltd. In re2

The Authority for Advance Rulings (“AAR”) held that denial of indexation3 benefit,

available to a resident or a domestic company for calculation of capital gains, to a Foreign

Institutional Investors (“FII”) would not constitute discrimination under Article 26 of the

India-United Kingdom DTAA as the IT Act provides for a special tax regime4 for

taxation of a FII. The AAR also acknowledged that a FII is not working under the same

conditions as a domestic person, because the FII is governed by different regulations in

India and clarified that there is no discrimination on the basis of nationality.

2. Banca Sella S.p.A In re.5

The AAR held that the Indian branch office of a foreign company is a capital asset6 under

the IT Act and the transfer of the Indian branch office upon amalgamation with another

foreign company, results in extinguishment of rights of the amalgamating company in the

Indian branch office. Section 47(vi) of the IT Act exempts the amalgamating company

from payment of capital gains tax on transfer of a capital asset pursuant to a scheme of

amalgamation if the amalgamated company is an Indian company. However, a similar

exemption is not available for transfer of a branch in India on amalgamation of two

foreign companies. The AAR clarified that the same exemption will also be available if

the amalgamated company is an Italian company as the extant provision discriminates

between the companies based on their nationality.

2 Universities Superannuation Scheme Ltd. In re. [2005] 275 ITR 434 (AAR) 3 Indexation: Indexation is a technique to adjust income payments by means of an index with a view to maintain parity in cost of the long term asset after inflation 4 Income Tax Act 1961, Section 115AD 5 Banca Sella S.p.A In re [2016] 66 ITR 662

6 Income Tax Act 1961, Section 2(14)

VOL. III ISSUE I NON-DISCRIMINATION: THE INDIA STORY 2016

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It is interesting to note that there is an exemption from capital gains tax on transfer of

shares of an Indian company upon amalgamation of two foreign companies subject to

fulfilment of certain conditions. However, the aforesaid provisions were not referred to in

the judgement.

3. DaimlerChrysler India Pvt. Ltd. v. DCIT7

On account of a global restructuring Daimler Benz AG (“DBAG”) and Chrysler

Corporation, USA, merged into a new company DaimlerChrysler AG (“DCAG”). DCAG

is a company incorporated in Germany and listed on recognised stock exchange in

Germany. By virtue of this global restructuring, DCAG held 81.33% shares of the

assessee company, DaimlerChrysler India Pvt. Ltd, which it received from DBAG, thus

making DCAG the German holding company of an Indian company i.e. the assessee.

Pursuant to the change in shareholding of the assessee company the tax officer denied the

assessee brought forward unabsorbed tax losses. As per the IT Act, in case of change in

shareholding of a company in which public are not substantially interested by more than

49% during any financial year, the unabsorbed tax losses are not allowed to carry forward

and set off in the subsequent years. As defined in the IT Act, a company in which public

are substantially interested includes a Indian company, in which atleast 50% of the voting

powers are held by a company listed on a recognised stock exchange in India. In this case

tax officer disallowed the brought forward tax losses to the Assessee as the Holding

company, DCAG, was not listed on a recognised stock exchange in India. The Tribunal

invoking the non-discrimination clause held that the distinction was based solely on the

nationality of the German Holding Company, and that it was impossible to comply with

the said section as only a company incorporated under the Indian Companies Act could be

listed on a recognised stock exchange in India. Thus the tribunal held that subject to

DaimlerChrysler India Pvt. Ltd. proving that its Holding Company was listed on a

recognised stock exchange in Germany, it would be allowed to carry forward and set off

the unabsorbed tax losses.

4. Chohung Bank v DDIT8

In case of Chohung Bank v DDIT, the Indian branch of a foreign company sought to be

taxed at the rate of 30%, as applicable to domestic companies instead of 40% as

7 DaimlerChrysler India Pvt. Ltd. v. DCIT [2009] 120 TTJ 803 (Pune)

8 Chohung Bank v DDIT (2006) 6 SOT 114 (Mumbai)


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applicable to foreign companies by placing reliance on the non-discrimination article

under the India-Korea DTAA. The Tribunal held that since domestic banking companies

and foreign banking companies do not function under the same circumstances, i.e. foreign

banking companies are free to operate its profit making apparatus to the maximum

possible extent, the difference in rates could not be construed as discrimination and hence

the Article 25 to the India-Korea DTAA would not confer any relief on the assessee. Thus

in order to avail of the non-discrimination article, the non-national must be working in the

same circumstances and same conditions as the local national of another country.

CONCLUSION

The non-discrimination article is an important tool in fostering co-operation in international

taxation. The jurisprudence on the subject in the Indian context, albeit limited, lays down

some key markers. In the commercial context, as we move to a world without borders, one

suspects that the article is going to assume greater significance in the years to come, since tax

laws cannot operate in vacuum and must necessarily be just and equitable to all stakeholders.

[Disclaimer: This article only expresses personal views of the authors.]


[6]

MAURITIUS TAX TREATY AMENDMENT TAKES AWAY WITH IT ‘TREATY

SHOPPING’ WHILE DOING BUSINESS WITH INDIA

- Karthik Ranganathan

India’s tax treaty with Mauritius was amended on May 10, 2016. Hitherto, residence based

taxation on capital gains was followed as per the tax treaty. Much of the investments into

India came via Mauritius as it was the first tax treaty India entered into with a low tax

jurisdiction (LTJ), in 1983. Majority of foreign investors into India, be it portfolio investment

or direct investment, the Mauritius tax treaty to in India which is typically at 20%. The tax

treaty follows residence based taxation whereby the jurisdiction where the alienator of the

shares is resident will have the right to tax the capital gains. India generally has 20% capital

gains on long term investments (shares held more than a year) and 30% on short term

investments. Over the years, in order to create more favorable investment climate even from

non-Mauritius jurisdictions, specific provisions were introduced in the Income-tax Act, 1961

(the Act) to limit the capital gains tax on long term holding at 10% and short term at 30% for

listed securities. This benefit was initially available to Foreign Institutional Investors (FII)

alone but was later extended to Foreign Direct Investors (FDI) as the latter is the one which

actually makes long term investment much needed capital to the Indian companies. Under the

Act itself, sale of shares by any foreign investor through the stock exchange resulting in long

term capital gains was exempt in India with small fee to be paid to the stock exchanges called

the Securities Transaction Tax (STT). If it results in short term capital gains the same is taxed

at 15%. However, for FDIs which usually invest in unlisted securities, the above tax

exemption and lesser tax rate was not available. The India-Mauritius tax treaty was a big

relief for them as such capital gains were liable to tax only in Mauritius which does not

impose any capital gains tax thereby resulting in double non-taxation.

Since much of the investments were flowing into India through Mauritius, the Indian

Governments, over the time, did not take real steps to prevent this double non-taxation

situation. Instead, they fought only a shadow-fighting with the investors/ taxpayers in the

courts that though treaty was available the taxpayers were expected to ignore it and still pay

tax in India. However, the courts in India including the Supreme Court time and again

Advocate, Karnataka High Court, Bangalore

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MAURITIUS TAX TREATY AMENDMENT TAKES AWAY WITH

IT ‘TREATY SHOPPING’ WHILE DOING BUSINESS WITH INDIA

2016

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blessed the Mauritius route stating that there was nothing illegal in such treaty shopping.

Unlike the US tax treaties, India does not have Limitation of Benefit (LOB) Article in all its

tax treaties especially with the Mauritius treaty which was much needed to prevent treaty

shopping. This catch-22 situation of the Indian Tax Department (ITD) i.e. the choice between

the economic growth and tax base erosion was evident from its aggressive and going

overboard measures in denying tax treaty benefits to the investors in the name of substance

over form concept. Though not directly related to India-Mauritius tax treaty, ITD’s frustration

was visible in the (in)famous Vodafone indirect transfer transaction in which a Mauritian

entity was also involved. The rest are details with regard to the Vodafone transaction which

led to the retroactive amendment to the Act and the introduction of the draconian General

Anti Avoidance Rule (GAAR) in the Act which will come into force from April 01, 2017.

GAAR has provisions which will override tax treaties thereby disregarding tax treaty benefits

like that of Mauritius.

Under these circumstances, the breaking news that India’s tax treaty with Mauritius has been

amended whereby source based taxation will be followed post April 01, 2017 is certainly one

more weapon in the ITD’s artillery. This simply means the capital gains benefit in the India-

Mauritius tax treaty has been officially sealed off.

The key amendment to the tax treaty which took place through a Protocol is the source based

taxation of capital gains on shares. Consequent to the said protocol, India is vested with

taxation rights on capital gains arising from alienation of shares acquired on or after 1st April,

2017 in a company resident in India with effect from financial year 2017-18. However,

investments in shares acquired before 1st April, 2017 are excluded from the same. Further, in

respect of such capital gains arising during the transition period from 1st April, 2017 to 31st

March, 2019, the tax rate will be limited to 50% of the domestic tax rate of India, subject to

the fulfilment of the conditions in the Limitation of Benefits Article. Taxation in India at full

domestic tax rate will take place from financial year 2019-20 onwards.

The implication of the above is that the taxing right to India is only prospective and not

retroactive. In the sense, only those shares acquired on or after April 01, 2017 and transferred

thereafter will be liable to tax in India. Further, with regard to shares acquired after April 01,

2017 but transferred before March 31, 2019 will be taxed only at 50% of the applicable

capital gains tax subject to fulfilling the LOB requirements introduced in the protocol.


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The tax implication for FIIs on the transfer of shares acquired and transferred during this

interregnum (April 01, 2017 to March 31, 2019) is as follows:

1. Short term capital gains tax on sale of shares on-the-floor of the stock exchanges will be

only 7.5% (50% of current 15%). Long term capital gains are already exempt from tax.

2. Short term capital gains tax on sale of shares off-the-floor of the stock exchanges will be

only 15% (50% of current 30%). Long term capital gains will be taxed at 5% (50% of

current 10%).

3. FIIs (now FPIs) are not allowed to invest in the shares of the private limited companies

(unlisted) post introduction of the new SEBI Foreign Portfolio Investment Regulations,

2014.

The tax implication for FDIs on the transfer of shares acquired and transferred during this

interregnum (April 01, 2017 to March 31, 2019) is as follows:

1. Short term capital gains tax on sale of shares on-the-floor of the stock exchanges will be

only 7.5% (50% of current 15%). Long term capital gains are already exempt from tax.

2. Short term capital gains tax on sale of shares off-the-floor of the stock exchanges will be

only 15% (50% of current 30%). Long term capital gains will be taxed at 5% (50% of

current 10%).

3. Short term capital gains tax on sale of shares of unlisted companies (like private limited

companies) will be only 20% (50% of current 40%). Long term capital gains will be taxed

at 5% (50% of current 10%).

To summarize, the above part of the protocol lays down three situations:

1. Shares acquired prior to April 01, 2017 and transferred before or after April 01, 2017 will

not be subject to tax in India and will be governed by the law prevalent at the time of

investment i.e. only Mauritius will have a right to tax based on residence test.

2. Shares acquired after April 01, 2017 but transferred before March 31, 2019 will be taxed

at 50% of the applicable capital gains tax.

3. Shares acquired on or after April 01, 2017 but transferred after April 01, 2019 will be

taxed at full rate as per the Act.

This appears to be a very sensible way to introduce this sudden change in the Mauritius route.

This means that investors who have already made the investments need not worry about the

change in the treaty as they will continue to avail the benefit of capital gains exemption from

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both countries. With regard to investors making investments post April 01, 2017, it depends

on their nature of investment i.e. whether FII or FDI. FIIs usually tend to exit in few years’

time and if it is less than two years then they will be taxed only at 50% tax as explained

above. However, FDIs invest for a longer period to do business in India and may more likely

end up paying full capital gains tax (10% for LTCG and 40% for STCG). Further, it should

be noted that this year’s Indian Union Budget has set the holding period (tacking) of unlisted

securities at two years (instead of previous one year) to be treated as long term capital assets.1

Therefore, FDIs who invest in unlisted securities after April 01, 2017 will end up paying 50%

on short term capital gains of 40% (i.e. 20% tax) if they wish to exit before March 31, 2019.

Any transfer post April 01, 2019 will be treated as long term capital gains taxable at full rate

of 10%. However, on strict reading of the amendment, only shares are liable to capital gains

tax and other securities appear to be out of it.

To enjoy the 50% tax on capital gains tax, an LOB clause has been introduced which tries to

achieve some commercial substance for a Mauritian entity investing in India. This type of

LOB is similar to the one prevalent in the tax treaty between India and Singapore. The

Mauritius treaty LOB requires the Mauritian entity, in order not to be treated as shell/ conduit

company, has to incur operating expenses of Indian Rupees 2,700,000 or Mauritian Rupees

1,500,000 in Mauritius in the immediate preceding 12 months. In case of India-Singapore tax

treaty the amount is Indian Rupees 2,400,000 in the immediate preceding 24 months. This

appears to be kind of proxy LOB clause given the paltry sum that has to be incurred to create

commercial/ economic substance in Mauritius. In effect, the LOB clause is relevant only for

two financial years (FY) to enjoy the beneficial 50% tax on the capital gains tax.

IMPACT ON PARTICIPATORY NOTES (P NOTES) BY THE RECENT AMENDMENT

Post the OECD’s BEPS Action Plans, several countries are taking effective steps to

crackdown tax evasion. India is not a member of OCED but is a member of G20 countries

which is also part of the BEPS Action Plans. India has been a big victim of these P Notes. P

Notes have significantly contributed to money laundering in India to the tune of

approximately INR 3 Trillion (USD 45 Billion). P Notes are the derivatives issued by the FIIs

to its investors for the underlying securities invested by the FIIs on the Indian stock markets.

P Notes have several benefits including free from compliance of Indian regulations,

1

‘Analysis of the Union Budget 2016 Direct Tax’, February 29, 2016

www.karthikranganathan.com/sharing_read.php?_knowledge_id=NjQ


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converting unaccounted money into accounted money through round tripping. The real

beneficial owners of P Notes are usually untraceable thereby encouraging investments in the

FIIs. P Notes investors are referred to ghost investors due to their anonymity. Mauritius was

the most suitable jurisdiction to invest this unaccounted money through P Notes as several

FIIs were set up in Mauritius to avail India-Mauritius tax treaty benefits. The P Notes enjoyed

the same capital gains benefit as the FIIs enjoyed at the time of transfer of shares by the FIIs

on the Indian securities.

It appears that there were two compelling requirements for this recent tax treaty amendment.

One is the clarity in capital gains taxation as the ITD continued to deny tax treaty benefits

despite certain Supreme Court rulings. Second, the Indian Government wants to have a

crackdown on these P Notes investments. Since collating information about the P Note

holders could not be achieved, shutting this investment route may be a solution to prevent this

menace. However, Indian unaccounted money took a round trip i.e. went out of India and

came back through P Note investments. Now, there may be only half of round trip where the

unaccounted money may go out of the country and may never come back or the unaccounted

money may never come out.

RECENT AMENDMENT TO AFFECT INDIA-SINGAPORE TAX TREATY AS WELL

The most convenient jurisdiction for money laundering and enjoying capital gains tax

benefits since 1983 was the Mauritius. However, Singapore also acted as an alternative to

Mauritius due to its banking secrecy laws and limited Know Your Client (KYC) norms

followed by its Regulators. To add to this, similar amendment vide a Protocol was introduced

in the India-Singapore tax treaty in 2005 which shifted the capital gains taxing rights to

residence country which was hitherto with the source country i.e. typically India. However,

an interesting article was introduced in the Protocol that this residence based capital gains

benefit in the Singapore treaty will only be available as long as the Mauritius treaty with

India continued with similar benefits. Now that Mauritius treaty has been amended, the

Singapore treaty with India will also automatically lose its benefits. The relevant portion of

the Protocol read as “Articles 1, 2, 3 and 5 of this Protocol shall remain in force so long as

any Convention or Agreement for the Avoidance of Double Taxation between the

Government of the Republic of India and the Government of Mauritius provides that any

gains from the alienation of shares in any company which is a resident of a Contracting State

shall be taxable only in the Contracting State in which the alienator is a resident”.

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Since, post April 01, 2017, India will start to tax at 50% on the capital gains tax by which the

residence based taxation will be shifted to source based taxation, the benefit between India

and Singapore will also terminated.

DOES INDIA HAVE ANY OTHER TREATY WHICH CAN SUBSTITUTE MAURITIUS TREATY?

Mauritius was the only tax haven/ LTJ since 1983 which the foreign investors could use to

invest in India for capital gains tax benefit. Singapore turned out to be an alternative since

2005 with the introduction of the said Protocol. No other LTJ with which India has

comprehensive tax treaty has residence based taxation with similar benefits that of Mauritius

and Singapore. The other LTJs with which India had entered into comprehensive tax treaties

are Luxembourg, Netherlands, Malta, Cyprus, New Zealand and UAE. Cyprus which has

residence based taxation like Mauritius and Singapore has been blacklisted by the Indian

Government since 2011 for noncooperation in exchange of information. Barring Netherlands

all other countries mentioned above have source based taxation where India will have a right

to tax. Netherlands has tricky residence based taxation with Participation Exemption rules.

However, from a closer reading of this capital gains article it appears that FIIs can use this

route as upto 10% of the investment in India and disposal will be liable to tax only in

Netherlands. Interestingly, under foreign exchange laws in India (FEMA), an FII can invest

only upto 10% in a particular company. However, all FIIs together can invest upto 24% in a

company. So, individual FIIs may still stand to benefit through Netherlands route. It,

therefore, appears that the end of Mauritius tax treaty benefits puts an end to any treaty

shopping with India vis-à-vis capital gains benefit is concerned.

GAAR IMPACT POST THIS AMENDMENT

GAAR has treaty override provisions. GAAR is expected to come into force from April 01,

2017. GAAR emphasizes on substance over form theory. Therefore, in effect, even if the tax

treaty with Mauritius would not have been amended, GAAR would have taken care of it! In

fact, GAAR may disregard Mauritius tax treaty benefit even for shares acquired prior to April

01, 2017 thereby making the prospective amendment to the tax treaty ineffective.

The question whether the provisions of the Act can override the tax treaty has been held in

favor of the tax department by the Madras High Court in a recent case holding that the Act of

Parliament prevails over Executive action of entering into tax treaties applying dualistic

approach theory. Therefore GAAR, if challenged, may be held to be constitutionally valid.


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WHAT IS THE IMPACT OF THIS TREATY AMENDMENT?

It was feared that the Indian bourses will tank significantly due to this amendment. Rather the

stock market surged after this amendment at least for the time being. The reason appears to

be that this amendment has created much certainty in capital gains taxation while making

investments via Mauritius. Till now though the treaty gave Mauritius the right to tax, the ITD

was denying this benefit stating it was a tax driven structure. Now this uncertainty has been

put to rest though it may incur 20% tax cost to the investors which is worth incurring given

the fundamental economic stability in India. However, the investors from US and UK still

have to rely on Mauritius or Singapore tax treaty as Indian tax treaties with US and UK do

not give any capital benefit and leaves the right to tax on capital gains to both countries

thereby resulting in double taxation. Foreign tax credit (FTC) will not be available in both

jurisdictions as both India and US will treat the capital gains as their source income applying

their domestic laws and thereby, pushing the FTC ball into the other’s court. The amendment

to the treaty has also introduced source based taxation on fees for technical services (FTS)

and has introduced service permanent establishment (PE) which was hitherto not present in

the tax treaty.

Much thought has to go, hereafter, before investing or transacting with India keeping in mind

the treaty amendments and GAAR implications. With the recent amendment to the Mauritius

tax treaty, Benjamin Franklin’s old ‘taxing’ quote has been buttressed again! Death &

Taxes…..

VOL. III ISSUE I KALDOR TO CHAOS 2016

[13]

KALDOR TO CHAOS

- Justice T.N.C. Rangarajan*

The following is an excerpt from a lecture delivered by Retd. Justice Rangarajan, at the Ras

Behari Ray Memorial Lecture delivered at Cuttack on 28th June 2008. It has been reproduced

upon obtaining due permission from the justice.

INTRODUCTION

I am privileged to be invited to deliver the Ras Behari Memorial Law lecture. Sri Ras Behari

Ray was born just a year before my father. I recall the father figure whom I had met when I

first came to Cuttack in 1974. He was the Chairman of Tax Bar Associations of Orissa and he

welcomed Brother Rotho and myself when we were posted here. Besides being an expert in

tax law he could lace his conversations with spiritual wisdom. The best tribute I can pay to

that great personality is to present a lecture which I hope he would have approved.

Cuttack was my kindergarten for income tax. I learnt many things here. I got married when I

was here. So I took brother Rotho's advice and visited Puri and Konark and learned many

things from the sacred to the profane. I have made many friends here. Those who appeared

before me in the Tribunal have prospered and have become personalities to acknowledge. So

when the opportunity came to visit the field of my initiation, I thought I should have an

overview of what I had learnt.

SEEKING A PATTERN

It is human nature to seek a pattern in everything. I believe there is a big board in the

Smithsonian Institute at the front and the lights flash there at random and it is an experiment

to see how much an observer is frustrated when no pattern is discernible. When we were

hearing cases in the Tribunal here, we saw only the particular section that we were dealing

with and at best with the scheme as it applied to that assessment year. In fact my senior used

to say that judges are often behind times because they deal with the law applicable some

years back, as the cases take time to come for hearing and may not know the current law. I

thought this is now the chance to see the wood instead of the trees and try to see if there is

* Former Judge, High Court of Andhra Pradesh; Former Judicial Member and Vice-President, Income Tax

Appellate Tribunal (South Zone)


[14]

any method in the madness of the tax tangle.

ORIGINAL SCHEME

We may not recall that the 1961 Act was the kingpin of a system of taxation proposed by

Prof. Nicolas Kaldor. It was a tight system with income tax, expenditure tax, wealth tax, and

gift tax and estate duty. The tax chased you from womb to tomb. Earn and pay tax, spend and

pay tax, save and pay tax, gift and pay tax and die and pay tax. The objective was socialistic

distribution of excess wealth. When we look back we find that the entire system has slowly

changed to something else without anyone being aware of it or planning it. Let us see how

this incrementalism has happened. Estate duty was abolished in 1984, Gift tax was omitted

with effect from 1st October 1998, Wealth tax reduced to tax on non-performing assets from

1st April 1993

1, Expenditure Tax abolished within three years of its introduction in 1956 and

again revived in 1987 to tax expenditure in hotels. But we have other taxes such as Banking

Cash Transaction Tax, Fringe Benefit Tax, Securities Transaction Tax and Service Tax. But

they do not make any system as such.

INCOME

Income was advisedly left undefined. It is generally understood as a periodical monetary

return coming in with some sort of regularity from a definite source2 similar to the fruits of a

tree. But by an inclusive definition, receipts which may not be regarded as income have been

now included such as voluntary contributions to a trust, perquisites and special allowances,

capital gains, winnings from lotteries and races, and even gifts and loans.

PREVIOUS YEAR

The 1918 Act levied income tax on the income of the current year itself, by taking the

previous year's income as the basis and adjusting the current income at the end of the year as

well as aggregating the income from all sources for the first time. The 1922 Act created a

charge on the income of the previous year itself. Such accounting year was also at the option

of the assessee to end on a date of his choice. The 1961 Act began with that position and

slowly removed that option so that the previous year is only the accounting year ended 31st

March, the earlier fiscal year. It is as if the previous year is itself the assessment year though

named as the next year. Though it is meant to provide for uniformity, it has a couple of

1 Section 2 (ea), Definition of Assets, available at http://www.incometaxindia.gov.in/wealth%20tax%20act.asp

2 CIT v Shaw Wallace & Co., 1932 (6) ITC 138.


[15]

drawbacks. It requires the assessee to prepare accounts afresh up to the required date, though

it is kept on another preferred date for ascertaining the profits. It also does away with the

staggering of the due dates for filing returns resulting in overload at the uniform due dates.

COLLECTING DATA

In order to levy the tax we have to find the income and identify the assessee. The original

method was for the assessing officer to identify assessees by survey and send notices calling

for returns. This has been replaced by voluntary compliance by requiring the assessees

themselves to file the return, if they have taxable income. This was sought to be compelled by

the one by six scheme, requiring filing of returns if any one of six criteria is met. But nothing

came out of it and it was abandoned in 2005. The latest is the e-filing of the return without

any annexures to explain the items of income. Of course the powers of survey and search are

still there to ferret out the assessees in hiding. In addition, financial institutions are required

to file an Annual Information Return giving details of high value transactions.

HEADS OF INCOME

There were six head of income – salaries, interest on securities, income from property, profits

and gains of business, capital gains and income from other sources. The head of income

'interest on securities' has been omitted by Finance Act 1988.

SALARIES

The definition of salary has been slowly expanded to include every kind of perquisite and to

top it, all there is a Fringe Benefit Tax on the employer for the benefits supposedly enjoyed

by the employee. Even terminal benefits are sought to be taxed such as leave encashment,

which thanks to the Tribunal, has become tax free. Valuation of perquisite has been a handle

for increasing the tax by rules. Here again the treatment of the government servants and the

other employees is marked by a distinction without a difference.3

PROPERTY

Income from property was assessed on notional rent even if it was self-occupied on the

premise that what is saved is income. But now only rent from property is taxed at actuals. It

has also become subject to Service Tax as well as deduction of tax at source.

BUSINESS

3 Arun Kumar v Union of India, Appeal (Civil) No. 3270 of 2003.


[16]

Computation of the income from business has always been a contentious issue. While

assessees hope to reduce the taxable income by reporting less receipts and inflating the

allowable expenditure, it is the constant effort of the revenue to do the opposite. This has led

to several games of hide and seek. Revenue went to the extent of disallowing even

expenditure on offering tea or coffee for the customers. Incentives were another bane of the

assessees. There was a media hype that many a company has become zero tax company by

availing the tax holidays. Minimum Alternate Tax was introduced by Finance Act 1987.

METHOD OF ACCOUNTING

Originally, assessees were allowed to maintain their accounts according to the method of

their choice of cash system or mercantile system or a combination of both in a hybrid system.

In the case of professionals like advocates the hybrid system of accounting for receipts on

cash and expenditure on accrual was the most sensible because of the uncertainty of the

receipt of fees promised. That has now been abolished and the assessees have to choose only

between cash and accrual systems. In spite of that, in the accrual method of the assessee, the

revenue interferes by disallowing expenditure not paid within the previous year. So what is

bad for the assessee is good for the revenue and accounts can be willfully distorted for

increasing the liability.

OTHER SOURCES

Income not falling under any specific head is charged under the head income from other

sources. Dividends and interest income fall under this category.

CASUAL INCOME

Casual receipts are windfall and cannot be income at all. It was fully exempt initially but in

1972, winnings from lotteries were brought to tax and other casual receipts were exempt only

to the extent of Rs 1000. Though this limit was increased to 5000 in 1986, eventually the

exemption itself was removed altogether.

ASSESSMENT

Originally, there was a hearing and a reasoned assessment order after scrutiny of the

accounts. Then there was a stage of accepting the returns with prima facie corrections. Then

intimation of acceptance without scrutiny. Then the acknowledgment of the return itself is an

assessment.


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RATES OF TAX

The high rates of tax in early sixties were drastically brought down in 1997. Due to inflation

the threshold exemption limit has also gone up. There is also deferential higher exemption

limit for women and senior citizens now.

COLLECTION OF TAX

The main object of the levy of income tax is to collect it. The original idea was that the

income of the previous year would be computed after the end of that year and assessed to tax.

Slowly most of the income is subjected to deduction of tax at source. The rest is subject to

payment of advance tax to the extent of 100% even 15 days before the end of the previous

year. The situation has quietly gone to 1918 position without any clear declaration to that

effect. In addition to that, dividends, interest, and lottery income have been subject to full

deduction before receipt. They are also left out of the total income. The continuation of the

total income concept seems to have lost its rationale.

LITIGATION

The original pattern was an appeal to the Assistant Commissioner, a second appeal to the

Appellate Tribunal and then a reference on a question of law to the High Court and

eventually an appeal to the Supreme Court. The reference has now been replaced by another

appeal on a question of law. In addition, the High Court is sought to be replaced by a

National Tribunal. The composition of the National Tribunal with members drawn from the

department has attracted justified criticism and the matter is pending consideration at the

behest of the Supreme Court. In my opinion this is corrupting the Constitution, as the basic

feature of the constitution is that only the judiciary can adjudicate questions of law. At the

same time, the revenue has powers to revise the assessments for lapses as well to bring to tax

escaped income. The change brought about is the time available to reassess which has come

down to six years from the earlier ten years and the abolition of the need to record reasons.

CHANGING THE RULES

A peculiar feature of income tax law in India is that whenever the court rejects the meaning

attributed by the department to a provision of a statute, the law is amended retrospectively. It

is almost a childish assertion that it should never be taken as anything different from what the

department meant. To take a few examples:


[18]

Court says capital gains on sale of agricultural lands cannot be taxed4 – Explanation

added to Section 2(1A) with effect from 1.4.70 by Finance Act 1989 declaring it to be

assessable.

Court says only amounts validly due and payable can be disallowed5 – Explanation 2

added to Section 43B by Finance Act 1989 with effect from 1-4-1984 that “any sum

payable” includes any sum not payable within the year

Court says wealth tax is a deductible expense6 – Clause (iia) inserted in Section 40 (a) by

Amendment Act 1972 making it inadmissible with retrospective effect from 1-4-62

Court says coffee and tea expenses are not entertainment7 – Explanation 2 added to

Section 37 (2A) by Finance Act 1983 with retrospective effect from 1-4-1976 to say that

it is.

These amendments deprive the honest assessees of the benefit of the judgments of the courts,

which alone are empowered by the Constitution to give meaning to legislation. Surprisingly,

though the Supreme Court only declares the law and such declaration is ipso facto

retrospective, it preferred the concept of prospective overruling8 to avoid injustice to those

who might have followed the law as it was understood, before the Supreme Court gave a

different meaning to it. Yet, retrospective legislation, which may be acceptable in the case of

technical faults, have been left untouched even where it would make the earlier levy

unconstitutional. Such retrospective legislation requires the assessing officer to reopen many

concluded cases and make fresh demands because the CAG feels it would be a revenue

leakage. We are not unique in this respect as in UK; the finance minister announced that if

they find any tax avoidance schemes they would introduce legislation to make them illegal.

PATTERNS

There are three noticeable patterns in the process of changing tax law.

First the emphasis is on levy of more and more taxes, squeezing those already in the tax

net and fierce collection. Surcharges come and go and come back. Service tax expands

4 Manubhai Seth v. ITO, 128 ITR 87 BOM. 5 Srikakolu Subba Rao v. Union of India, 173 ITR 708 AP. 6 Indian Aluminium v. CIT, 84 ITR 735 SC. 7 CIT v. Patel Brothers and Co. Ltd., 106 ITR 424 GUJ.

8 Golak Nath v. State of Punjab, AIR 1967 SC 1643.


[19]

exponentially. Unconstitutional levies such as Fringe Benefit Tax, Cash Transaction Tax

and substitution of registration value for stated consideration in capital gains, abound.

The second is the outsourcing of the process as much as possible. Deduction of tax at

source is making the employers work for the department. The Planning Commission has

estimated that the cost incurred by companies for such gratuitous work is nearly 45% of

the tax collected at source9. Returns are prepared by the assessees but the annexures are to

be retained by them, meaning storage of the record is outsourced.

The third is controlling the litigation. Packing the adjudicating forums and retrospectively

amending the statutes to overrule adverse judgments are the methods.

CONCERNS

Taxation is essentially a tug of war between the state and the individual. Instead of the State

existing for the citizen and facilitating a good life, the department now expects the individual

to exist for the state and do all its work. Outsource everything and take a vacation can be the

motto of the department. The principles of taxation such as being simple, certain and

equitable are sacrificed at the alter of increasing revenue. There is also the angle of Human

Rights which include the right to life, the right to privacy and freedom from discrimination

and procedural fairness. Making an employer collect the tax without remuneration is but

slavery. Making a public profile with data inputs distorts the income of the assessee. Such

methods are appropriate in a society where all transactions are banked or done electronically.

Outsourcing the data entry is a breach of the right to privacy as contractors will not be

governed by the statutory controls. There is a grave danger of the financial information of

citizens being sold to unsocial elements. Lack of taxpayer friendly methods of resolving

differences can contribute to corruption at all levels.

EVIDENCE BASED POLICY

Modern government requires formulation of policies based on evidence. Of course the

Finance Minister must have been supplied with data based on which the policies of each

Finance Bill are made. However the citizen or even the Members of Parliament are unaware

of the basis. To understand the situation let us take the case of returns filed by individual tax

payers. We do not know how many tax payers are there in the initial band of 10% tax rate and

9 ‘The Income Tax Compliance Cost Of Indian Corporations’, National Institute of Public Finance and Policy,

December 2002, http://planningcommission.nic.in/reports/sereport/ser/stdy_cprtcost.pdf


[20]

how many of them are government servants and how many finally receive refunds due the tax

deducted at source being more than the tax payable on their total income. The Controller and

Auditor General of India in his report for 2005-2006 states that the government refunded Rs.

30,032 crores from gross collection of Rs. 1, 87,294 crores and paid interest amounting to Rs.

4,575 crores which worked out to 15 percent of the amount refunded. This information gives

an idea about how the exercise of annual filing of income tax returns is infructuous when

most of the tax is deducted at source. A more poignant situation is when tax is deducted,

though the person has no taxable income10

. Of course the person could have avoided it, if he

had filed a declaration to that effect and he can also ask for refund. But both the exercises

involve only compliance cost without any benefit either to the taxpayer or the department.

Similarly when an amendment is made retrospectively to overcome a judgment of the

Supreme Court we do not know how many assessees had benefited by that decision, how

many assessments will be revised and how much revenue will be generated by that exercise,

not taking into account the further work to be done by the taxpayer and the government

department concerned. Such data would show up the cases where the amendment is made

only to assert the view of the government and nothing else.

ELSEWHERE

In the USA there is a movement for a Flat Tax. There is also a debate about National Sales

Tax replacing income tax. Above all there is a National Research Program to collect data and

ensure taxpayer compliance with minimum burden. One general concept of such a system is

for IRS to generate tax returns for individuals who volunteered to be covered by the system

on the basis of (1) income reported on information returns and (2) information on filing status

and dependents provided by taxpayers on a new simpler tax form. IRS would then mail the

returns and refunds or tax bills to taxpayers, who would need to review their returns and

notify IRS whether they agreed with the return information. In Canada, General Sales Tax

had replaced income tax. Australia also has gone the GST way. There is no direct tax except

withholding tax on wages, so that no individual has to file any return at all. In UK, however,

the pattern is the same as here. But UK taxation is covered by the European Convention for

the Protection of Human Rights and Fundamental Freedoms, incorporated into UK law by the

Human Rights Act 1998. In summary, these principles require the court to consider not only

whether the relevant authority acted reasonably, carefully and in good faith but, in addition,

10

‘Tax Deducted at Source: Woes Of Senior Citizens’, The Hindu, June 23, 2008,

http://www.hindu.com/2008/06/23/stories/2008062355391500.htm


[21]

whether the authority’s action was proportionate to the aim pursued. Importantly,

incorporation of Convention rights by the HRA has “brought the concept of proportionality

directly into force in the law of the United Kingdom”, and that concept is now “at the heart of

the HRA case law.” What this actually means in practice is that, rather than questioning

whether a public authority reasonably believed that their decision was proportionate and not

therefore irrational, it has to be asked whether the decision was in fact proportionate.11

SUGGESTIONS

I believe that any criticism should be constructive. So here are a few of my suggestions, for

whatever they are worth, for being taken up by the profession.

The tax system should be established properly to achieve the objects of taxation.

The Finance Minister announced that at his request, the Empowered Committee of State

Finance Ministers has agreed to work with the Central Government to prepare a road-map

for introducing a national level Goods and Services Tax (GST) with effect from April 1,

201012

Since it would cover all expenditure by individuals and leave out basic necessities

and thereby not harsh on the poorer sections, it would be a good idea to abolish personal

income tax altogether.

Taxing the total income as a concept has become meaningless, as many items such as

dividends, mutual fund income, income from lotteries etc. are separately taxed. It is only

the aggregation of income which requires the filing of returns and processing them. If the

idea of total income is given up, lots of paper work can be saved leading to great savings

in government and private expenditure.

Taxing the salaries of government servants is a wasteful exercise. Government is taking

back what is given by government itself and is essentially an accounting entry which

unnecessarily involves tremendous paperwork and infructuous work by government

officers. Why not abolish tax on government servants' salaries and make it clear that

government service being a status and not a job, it would be paid less than the market rate

for such services, because it would give them tax free income as well as dearness

allowances. Besides, Government servants enjoy other perquisites such as

11 Lee, Natalie, The Effect of the Human Rights Act 1998 on Taxation Policy and Administration, [2004]

eJlTaxR 8; (2004) 2(2) eJournal of Tax Research 155, http://www.austlii.edu.au/au/journals/eJTR/2004/8.html 12

Ministry of Finance, Budget 2007-2008 Speech of P. Chidambaram, February 28, 2007,

http://indiabudget.nic.in/bspeech/bs200708.pdf


[22]

accommodation, health care etc. which the private sector cannot give in those terms.

Since the Government has to decide on pay revision this is the appropriate time to do it.

Taxing private salaries involves deduction of tax at source. Now that consumption tax has

the ascendancy it would be inequitable to tax the salary as well.

Deduction of tax at source is an imposition on the payer – an outsourcing of work without

remuneration. It can be replaced by a system of getting the tax from the payee instead.

Since there is a system of identifying the payee by PAN number it would be easy to link

his bank accounts and provide that if the taxpayer chooses, there will be no TDS by the

payer but 10% of the amount credited to his account will be frozen or directly credited to

Government account till the end of the year so that the tax is computed and deducted from

the bank account directly. This will save lot of work of the companies and will not

involve any great work for the bank as it would be purely an arithmetic exercise which

the computer can be programmed to do.

The public profile and comparison with the private profile of the individual taxpayer is a

system of voluntary participation in the USA. But it is being utilized to coerce the

taxpayer in India which is a harsh measure. In fact when the Supreme Court13

held that

banks cannot be compelled to give information, it led to the introduction of Annul

Information Returns. It means there is no trust on the taxpayer. Such an attitude does not

auger well and is ethically bad as it encourages people to avoid the banking habit.

Therefore it is better to give it up and instead, encourage the taxpayer to have transparent

transactions and pay tax based on bank accounts by himself. There can be some

incentives also by giving health insurance on such accounts. For instance Andhra Bank

has a scheme of insurance for its account holders and BSNL gives personal accident

insurance for all its subscribers.

Taxes on unearned income is taken by way of dividend distribution tax as well as

securities transaction tax. This can be fine-tuned by introducing personal investment

accounts with depositories which can maintain a consolidated account for all transactions

giving transparency. Since the accounts will always be available with the depository there

will be no need for the taxpayer to maintain the record. Cost of compliance will be

substantially reduced.

13 Collector v. Canara Bank, 2005(1) SCC 496.


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Since renting out property is taken as a service and assessed to service tax, it should be in

the fitness of things to give up income tax on property income. It would also relieve

people living on meager rents from tax burden.

Capital gains is taxed moderately and is not included in the total income. So why not tax

it separately through the registrar of assurances. It would reduce the need for filing

returns. Capitals gains from movable assets such as financial instruments can also be

collected directly from the financial institutions as in the case of NRI's.

Since we have the system of tax preparers, outsourcing the documents can be dispensed

with by requiring the tax preparers to see the original documents in support of the returns

and certify that the figures have been checked. After all the taxpayer is required to pay Rs

250 for each return and why not get some work from them on behalf of the department.

Policies should be evidence based and such evidence must be disclosed. Consultative

committees should be more active and should have such information to comment on.

Income of a company is taxed at a flat rate. The problem is only the computation of the

taxable income by making several adjustments. Why not accept the book profits and give

up such computations when there is already the minimum alternate tax, if the taxable

income is less than the book profits.

Charitable Trusts apply their income to the same public purposes which the Government

collects tax to perform. That is the justification for exempting charitable trusts from

income tax. But once in a while the department feels that the tax that could have been

paid by the trusts is lost and disallow the exemption either by amending the provisions or

misapplying the provisions. The recent amendment withdrawing exemption for trusts

carrying on business as part of the object of the trust is a case in point. It is arguable that

that withdrawal is unconstitutional and even if it is not accepted it is an irrational denial

of a human right.

Finally it is disappointing when the Supreme Court does not treat tax matters with the

priority it deserves. When High Courts admit writ petitions about the constitutionality of

levies such as Fringe Benefit Tax and even grant stay, immediate disposal of the cases

would be the appropriate course. The delay gives a chance to the revenue to plead that the

amounts cannot be returned as they have been spent for public purposes defeating the

judicial system itself.


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CONCLUSION

We can very well appreciate that processing the returns is a tremendous task. In 2005-6 there

were three crore returns of which assessees with less than 2 lakh income were 2.6 crores and

upto 5 lakhs were 20 lakhs and upto 10 lakhs were 20 lakhs. Since the present approach is

voluntary compliance, the revenue is left with the impression that either returns are not filed

by those who are taxable or the returns filed are deceptive. Since it is impossible to scrutinize

every one of those returns, attempts are made to randomly check them or to track escaped

income. Failing in those two areas, the department falls back on squeezing those already in

the net. There is a talk of replacing the Income Tax Act and then, I hope, that the chance will

be taken to device a better system where taxpayers will be happy to keep their transactions

transparent and painlessly contribute the tax. Thinking like a lawyer we are concerned with

the process and not with the object, which we know is to raise revenue and cannot be avoided

at all. Our main concern is only that the process of levying and collecting tax should be right

in every way.

Let me end with how nicely a judge dealt with a clever advisor. A wealthy man had an

advisor who told him to write a will and remember him in it. So the man wrote: “Let my

advisor give what he wants to my family and take the rest”. When he died and the will was

read, the advisor said I want to take all the wealth except ten thousand which I give to the

family. So naturally the family went to court. After hearing the case, the judge said the

adviser will take 10000 and the wealth will go to the family. The advisor said I don't

understand this conclusion. The judge said if we read the will correctly, it tells the advisor to

give “what he wants” to the family that means, what he desires must be given to the family

and he can take the rest. I hope the revenue will also give what they want to the people.

VOL. III

ISSUE I


GIANTS

2016

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EQUALIZATION LEVY: TAXING THE OVERSEAS DIGITAL GIANTS

A bona fide endeavor, beleaguered by haste

- Ayush Vijayvargiya*

ABSTRACT

The digital advertisement market in India is growing at a yearly rate of 28% and is pegged to

become the largest in the advertisement sector. Majority of the players in this domain being

non-resident entities, the Union government under the Finance Act, 2016 therefore, in a bid

to tap the hitherto untapped revenue source, proposed imposition of a 6% “Equalization

Levy” [‘EL’] on non-resident companies providing ‘online advertisement’ services in India

principally through their websites. This paper thus seeks to expound and critique the various

facets and nuances involved in its understanding.

Attempts have been made in the past to club this amount under ‘fees for technical services’,

alongside proposing obviation of ‘physical establishment’ requirement in scenarios

concerning digital interface. But this endeavor has always met the same fate, thereby making

way for EL, which was one of the three alternatives recommended under the Organisation for

Economic Co-operation and Development (‘OECD’) report on Base Erosion and Profit

Sharing (‘BEPS’). Analysis and feasibility of the other two alternatives, therefore, follows as

a logical corollary and finds a dedicated section in the paper.

In addition, the paper does not just strive to critically appraise the imposit ion, but also to

streamline the debate concerning nature of the levy, alongside highlighting a few lacunas in

the proposed scheme. As a parting point, it emphasizes the need for comprehensive

reassessment of EL on certain fronts and cautions the reader of the potential it has in terms of

diverting the government from more important issues like non-adversarial tax regime, hybrid

mismatch arrangements et al.

DECODING THE LEVY

Before the introduction of Finance Bill, 2016 [‘Bill’]1, it was a well-recognized position

under the Indian taxation jurisprudence that non-resident companies providing ‘online

* Student, 4th Year B.A. LL.B. (Hons.), NALSAR University of Law, Hyderabad. The author can be reached at

[email protected]. The author would also like to thank Kartikh Suresh and Harshitha Reddy Kasarla for

their valuable inputs.


[26]

advertisement’ services in India, and having Indian existence principally through their

websites2, will not be liable to pay tax on the revenues generated through offer of these

services.3 The rationale being that virtual presence, through which these services are offered,

does not qualify as Permanent Establishment [‘PE’] under Indian laws and should not be

taxed. This rationale gets further strengthened when the difficulties, between transactions and

tax jurisdictions, encountered by these service providers are taken into account.4

In an attempt to overcome these obscurities, the Union government proposed imposition of a

6% “Equalization Levy” [‘EL’] through the 2016 Bill.5 It finds mention in Chapter VIII of

the Bill and stands as a levy on the revenues generated by the non-resident online

advertisement service providers.6

The Bill was passed by the parliament with a few

amendments, not pertaining to EL, and it came to be termed as the Finance Act, 2016 [‘Act’]7

with the levy becoming effective from June 1, 2016.8 The scheme of this levy provides that

the revenue on which it can be imposed must be generated from the provision of certain listed

services like ‘Online advertisements’ and ‘digital marketing’, to the Indian residents.9 The

Union government, however, is entrusted with the authority to include other services also

within the ambit of this levy, as and when deemed necessary.10

The levy is not dependent on the nature of revenue. Since it is an independent levy, not in the

nature of income tax, even double taxation avoidance agreements are not applicable.

Furthermore, use of the prefix ‘equalization’ highlights the intention of legislators to bring

non-resident service providers and domestic ones to an equal pedestal.11

Presently, the

domestic service providers are covered under the Income Tax Act. 1961 [‘IT Act’]12

and pay

at the rate stipulated in it, while non-residents fall outside the IT Act’s ambit. Therefore, this

1 Finance Bill, No. 18 of 2016 (2016). 2 These service providers need not be confused with their Indian Subsidiary, as the latter has a separate entity for

taxation purposes. 3 Income Tax Officer v. Right Florists Pvt. Ltd, [2013] 143 ITD 445 (Kol). 4 Equalization Levy, 2016: Is it equitable?, DELLOITTE (June 2016), available at

https://www2.deloitte.com/content/dam/Deloitte/in/Documents/technology-media-telecommunications/in-tmt-

equalization-levy-2016-noexp.pdf (last accessed on 31st August, 2016). 5 Supra, n. 1. 6 CA Rashmin Sanghvi, How to tax e-commerce businesses? - Equalisation Levy is an answer, TAXMANN (29

February, 2016); available at https://www.taxmann.com/Budget-2016-17/budget/t162/how-to-tax-e-commerce-

businesses-equalisation-levy-is-an-answer.aspx (last accessed on 31st August, 2016). 7 Finance Act, No. 28 of 2016 (2016). 8 Reuters, Rajya Sabha passes Finance Bill, BUSINESS LINE, May 11, 2016. 9 Supra, n. 7, Section 164(i). 10 Ibid. 11Memorandum explaining the provisions in the Finance Bill, MINISTRY OF FINANCE (DEPARTMENT OF

REVENUE), p.5 (Feb. 29, 2016); available at http://indiabudget.nic.in/ub2016-17/memo/mem1.pdf (last accessed

on 31st August, 2016). 12 Income Tax Act, Act 43 of 1961, (1961).

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Act seeks to enforce some parity by imposing this levy merely on the foreign providers. The

levy is collected by way of withholding tax, whereby the burden of deducting and depositing

the said amount rests upon the Indian residents i.e., the remitter of payments.13

It is a measure

undertaken to ensure ease of compliance.

It is important to note that the EL is deducted even before remitting the payments to non-

resident service providers, and the receiver merely gets the post-deduction amount.14

The

amount deducted is then deposited with the tax authorities, in adherence with the prescribed

rules and regulations.15

In case of any default by the Indian residents, penalties will be

imposed or interest charged, or both.16

Additionally, failure to deduct the levy or deposit it

with the department will also result in the concerned amount being automatically disallowed

as expenditure in computation of the defaulting resident’s taxable profits.17

In simple words,

in case of any default, the assessee would not be allowed to claim such expenditure as against

his/her business income. This will raise the total taxable income by the amount of disallowed

expenditure, thereby increasing the tax payable. Such treatment becomes important from a

taxation perspective, as once the Indian resident fails to deduct equalization levy before

making the payment to a non-resident, the latter cannot be called upon to pay anytime

afterwards.18

In its current form, EL is supposed to be levied merely on the entities generating a

considerable amount of online advertisement revenue from India. In pursuance of this

scheme, an exception has been carved out in order to shrink the liability of small

entrepreneurs. As per this exception, if the cumulative sum received for the specified services

does not exceed rupees 1 Lakh in a given financial year, the entity stands exempted from the

levy.19

Furthermore, when the non-resident has a PE in India and services provided are

effectively connected with the PE, no such levy would be imposed.20

Moreover, two provisions, namely Section 10(50) and 40(a)(ib), were introduced in the

Income Tax Act in an attempt to bring it in line with the new imposition. Section 10(50) was

13 Supra n. 7, Section 166. 14 Supra n. 7, Section 165. 15 Equalization Levy Rules, Notification No. S(O) 1095(E), (27th May, 2016). 16 Supra n. 7, Section 170. 17 Supra n. 7, Section. 18 Ranjeet Mathani, Equalization Levy: A Step Into Uncharted Territories, BUSINESS WORLD, 29th March, 2016. 19

Supra n. 7, Section 166 (1). 20 Supra n. 7, Section 165 (1) (ii).


[28]

introduced in order to prevent the Foreign Service providers, from whom the levy is being

exacted, from getting doubly taxed in the Indian jurisdiction.21

The amendment to Section 10

acts as an assurance that the amount on which levy has already been deducted shall be

considered exempt from the tax imposition. Similarly Section 40(a)(ib) provides that any

amount already paid or still payable to the foreign service provider, wherein the equalization

levy is deductible but not deducted, the whole disbursement will be disallowed in the payer’s

books for taxation purposes.

Over the course of this paper, divided in eight parts, we would be delving into multiple facets

of this imposition. At the outset, an attempt would be made towards gauging the economic

significance of EL and the erstwhile position of Tribunals and Courts before coming into

effect of this levy. Following it, would be an assessment of the various alternatives available

to this levy, as proposed under the OECD report, and their practical feasibility. Lingering

uncertainty over the nature of this levy necessitates a detailed discussion of the arguments

advanced from various factions and hence a section would be dedicated for the same. The

subsequent segments would entail appraisal of pros and cons to this levy, and by design

would be followed by underscoring of lacunas in the entire scheme.

ECONOMIC SIGNIFICANCE OF THE IMPOSITION

A detailing of the mixed reactions to the levy, which will be elaborated in the latter part of

the paper, necessitates an inquiry into the characterization of ‘online advertisement’ and the

size of the relevant market. Online advertisement, although not legally defined anywhere, is

understood in normal parlance as a market strategy which uses the internet as an intermediary

for online traffic solicitation on the website, and ensures that marketing messages are

received by potential consumers.22

As of February 2016, the digital advertisement market in

India stood at $1,603.8 million and various reports in India have estimated it to grow to the

extent of $3372 million by 2020.23

This signifies a yearly growth of 28% for the next few

years, with the industry pegged to become the largest in the advertisement sector.

“Search and display” constitutes the largest chunk of the digital advertisement expenditure in

India. Search ads forms 38% of the overall spending on digital advertisements whereas

21 Supra n. 12, Section 10(50). 22 ROB STOKES, E-MARKETING; THE ESSENTIAL GUIDE TO MARKETING IN A DIGITAL WORLD, 294 (5th ed., 2014). 23

Digital advertisement in India (2016), STATISTA; available at

https://www.statista.com/outlook/216/119/digital-advertising/india#market-revenueYearIndustry

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display advertisements constitute 29%, followed by social media at 13%.24

Although the

concerned market does have a few domestic players, for the most part, foreign players

dominate it. Non-regulation of the transactions undertaken by these non-residents as a result

was causing enormous loss to the exchequer. Taking into account the size of the industry and

its touted growth rate, the proposed levy is expected to bring in a substantial sum of revenue.

POSITION OF INDIAN COURTS AND TRIBUNALS BEFORE THE FINANCE ACT, 2016

Before the Union Government came up with the proposal of imposing EL, taxability of these

online payments was posed as an issue before the Kolkata Tax Tribunal in the case of ITO v.

Right Florists Pvt. Ltd.25

The Income-Tax Appellate Tribunal (ITAT) held in this case that

the remittances to online advertisement websites like Google and Yahoo were not liable to be

taxed in India; reason being the absence of any PE or taxable presence in India. As all the

web servers are located outside the country and no link exists otherwise as well, no taxable

presence can be traced to India. The Tribunal opined that these service providers should

instead be taxed in the countries which host their tangible servers.26

Right Florists Pvt. Ltd. was an Indian company incorporated under Companies Act, 1956

and provided florist services in India. It entered into an agreement with Google Ireland Ltd.

and Overture Services Inc. (Yahoo)27

for availing advertisement services on their respective

search engines. After making the payments to these search engines, and during the filing of

Income Tax returns, Right Florists claimed deductions for the said payment but was

disallowed the same in spite of the payment being made pursuant to Section 40 (a)(i).28

It was

disallowed by the Assessing Officer on the ground that the assessee had failed to act as per

Section 195, and was unsuccessful in withholding the said amount.29

The issue posed before the tax Tribunal was whether it is mandatory to withhold tax before

remitting payments to a non-resident for the services rendered. In simple words, are the

payments made to search engines like Google and Yahoo for their advertisement services

taxable in India? Counsels for Right Florists argued that the amount received by the

24 Internet and Mobile Association of India, Digital Advertising in India (Nov. 17, 2015),

http://www.iamai.in/media/details/4486. 25 Supra, n. 3. 26 Supra, n. 3, ¶ 15. 27 Based in United States of America. 28

Supra, n. 12, Section 40(a)(i). 29 Supra, n. 12, Section 195.


[30]

concerned non-residents on provision of online services were in the nature of business profits

and thus cannot be taxed by Indian Income Tax department in absence of a PE. However, the

Income tax department denied the said claim by classifying the payment as Fees for

Technical Services [‘FTS’], taxable under Section 9 of the IT Act, thereby obviating the need

of a PE for taxation purposes.30

While adjudicating on the given issue, and in order to address all the concerns suitably, the

court extensively delved into the various aspects brought up during the proceedings which

inter alia include PE, Business Connection, Royalty and FTS.

With respect to permanent establishment, the Tribunal held the presence of Google in India

through its website as not amounting to PE in light of the basic rule of ‘physical presence’

laid down by them when read with Section 5(2) of the IT Act. In ITAT’s opinion, even

though the conventional PE test does not find high relevance in the virtual world, the

requirement of physical presence still stands as the basic test. The quantum of cross-border

activities undertaken by the concerned enterprises, without the mandatory physical presence,

does not seem to have any impact on the understanding of PE. Therefore, the Tribunal held

that websites cannot be said to have physical presence on the internet, and are supposed to

have it where the place of effective management and their tangible servers lie.31

Similarly, the Tribunal found no existence of business connection either. Given that one of

the essential requirements under Section 9(1)(i) is to establish a nexus between revenue

generation and an entity based in India, revenue generation has to essentially be supported,

serviced or connected by that domestic entity. Due to lack of any such nexus, the possibility

of business connection’s existence was denied by the court.32

Furthermore, after taking into account the arguments advanced by both the sides, the court

held that the payment made for online advertisement would not even qualify as royalty.33

To

reach this conclusion, the Tribunal placed reliance on the case of Pinstorm Technologies Pvt

Ltd v. ITO34

. It had a similar factual matrix whereby the appellant remitted consideration to

Google35

for provision of banner advertisements on its gateway, and the Mumbai tax Tribunal

held these remittances to be merely in the nature of business profits. It held that Google does

30 Supra, n.3, ¶ 27. 31 Supra, n.3, ¶ 13. 32 Supra, n.3, ¶ 21. 33 Supra, n.3, ¶ 9. 34

ITS 536 ITAT (2012) Mum. 35 Manages its operation from Ireland.

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not have any PE in India, making it impossible for the tax authorities to bring it within its

ambit. Hence no tax can be deducted from the payment made by Pinstorm in lieu of services

provided.

However, the most contentious issue was whether the remittance by Rights Florists would

amount to ‘fees for technical services’. There was constant unanimity over the fact that all the

advertising services under consideration, be it through sponsored results or web banner, were

highly technical in nature. But considerable uncertainty prevailed on what qualifies as

‘technical services’ under Section 9 (1) (vii) of IT Act, as this terminology has no specific

definition assigned to it.

The Tribunal disqualified the activity as not being in the nature of technical services, owing

to the non-fulfillment of requirements laid down in cases like Yahoo India Pvt. Ltd.36

, ISRO

Satellite Centre37

and Dell International Services (India) P. Ltd.38

One of the prime

prerequisites for qualifying as technical services is human intervention during the course of

service provision and this is not the case with the provision of online advertisement services

by forums like Google and Yahoo. Therefore, it was held that, in spite of the service being

technical in nature, the remittances would not qualify as FTS due to lack of any human touch

in the whole process.

Further the term ‘technical’ appears along with ‘managerial’ and ‘consultancy’ in the bare

text of the statute. It was held by the Mumbai Tribunal in the case of Kotal Securities Ltd v.

DCIT 39

, that ‘human intervention’ is the common denominator that runs across all the three

terms; and hence human intervention is quintessential to qualify as technical service under

this Act. Even the Delhi HC in the case of CIT v. Bharti Cellular Limited40

has held that if a

group of words share certain common characteristics, then such characteristics should act as a

limitation while determining of the scope of these new words. Therefore, in the absence of

any human touch involved in the entire process of advertising by Google, from provision of

services to receipt of online advertisements, it cannot be taxed as FTS.

Hence, with the Tribunal holding the remittances to online advertisement websites as

36 Yahoo India P. Ltd. v. DCIT, Range 7(3), [2011] 46 SOT 105 (Mum). 37 ISRO Satellite Centre (ISAC) Department of Space vs. Commissioner concerned DIT (Intl. Taxation), ( 2008 ) 220 CTR ( AAR ) 13. 38 Dell International Services India Pvt. Ltd. vs. CIT (International Taxation), ( 2008 ) 218 CTR ( AAR ) 209. 39

[2012] 50 SOT 158 (Mum). 40 [2008] 319 ITR 139 (Del).


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ineligible for taxation in India, some recourse needed to be taken by the government.41

Even

though in my opinion the ITAT should have diluted the test in order to suit the changed

business circumstances at least for the sectors where human involvement is kept minimal, the

stance taken by the Tribunal can be rationalized as an effort to steer clear of the negative

spillover effect it might have caused. Leniency shown in application of the established tests

of ‘permanent establishment’ and ‘fees for technical services’ could have led to a chain

reaction whereby likelihood of their extended application to highly unwarranted scenarios

would have increased. However, success of the government’s attempt to set a separate test

instead of diluting the existing one it is yet to be seen and would only be clear after passing of

a few years of its application at the ground level.

ALTERNATIVES AVAILABLE AND THEIR FEASIBILITY

In a larger scheme, equalization levy can simply be termed as a measure to overcome the

issue of base erosion and profit shifting (BEPS). With India being the pioneer of this

imposition, it may even be apt to call it India’s response to BEPS.42

Base erosion practice has

been present amongst all the major ‘global digital companies’ since the upsurge of 2008

financial crisis, but has caught the attention of the developed and emerging economies only

lately.43

It is in wake of this that the G-20 assigned OECD with the task of formulating a

report, with the objective of recommending appropriate measures for overcoming tax based

erosion and profit shifting by the large MNCs.44

This report gained more importance with

time as these digital giants are not only avoiding taxes in the revenue generating countries but

are also evading taxes in the source country by routing the operation through tax havens or

low tax countries.

In November 2015, the OECD released a 15 point action plan as part of its final

recommendations, which provided for multiple alternatives to tackle the various problems at

hand.45

India, along with associated developing countries, enthusiastically participated in the

OECD proceedings. Participation of the said developing countries can however be attributed

41 Supra, n.3, ¶ 30. 42 Other countries like UK and Australia have ‘Diverted Profit Tax’ and ‘Multinational Anti-Avoidance Law’

respectively. These are anti-avoidance principles, different from the equalization levy, and are used to tackle

physical location based PE problems. 43 Michael Plowgian, BEPS: The Shifting International Tax Landscape and What Companies Should Be Doing

Now, THE TAX EXECUTIVE; available at https://www.tei.org/Documents/TTE_ND13_Plowgian_BEPS.pdf (last

accessed on 31th August, 2016). 44 D P Sengupta, The Indian Equalisation levy, (23 March, 2016), TAX INDIA INTERNATIONAL, available at

http://www.taxindiainternational.com/columnDesc.php?qwer43fcxzt=MjQ1. 45

OECD, Action Plan on Base Erosion and Profit Shifting, ORGANISATION FOR ECONOMIC CO-OPERATION AND

DEVELOPMENT, (2013).

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to the recent acknowledgment by OECD that the traditional international tax infrastructure

put in place by the developed countries needs overhaul as business digitalization has lately

aggravated the BEPS concern in the regime.46

This system hitherto has worked in favour of

developed countries and most of these countries are therefore diametrically opposed to the

idea of changing fundamentals of the established structure.

The OECD also recognized that digital economy raises a range of other broader policy issues

related to taxation infrastructure, especially with respect to existence of nexus and

characterization. To redress and remedy these issues, multiple potential options were

discussed extensively and subsequently proposed in the report, namely:

Substantial economic presence as a new criterion for establishment of taxation nexus; or

Imposition of withholding tax; or

Equalization levy.

The report, however, does not recommend any of these options and merely suggests them as

alternatives that can be adopted by the countries. This approach of OECD can be rationalized

as an attempt to steer clear of any expectations that parties might associate from these

measures. Absence of such a precautionary measure might raise the possibility of

participating countries not only expecting it to mitigate the issues identified in digital

economy but also address broader tax challenges with it. Therefore the report tries to entrust

the countries with the choice to adopt any of the three stated options within their domestic

framework in the form of an additional safeguard, over and above the treaty obligations that

already exist.

The OECD, in its report, has not proposed the adoption of one of these options by the

participating countries, but has instead recommended continuous monitoring of the digital

economy till 2020.47

Deferring any concrete measure till a future date in 2020 can be ascribed

to the higher likelihood of a larger consensus amongst the concerned countries in this regard.

The OECD action plan does, however, provide three alternatives to countries, and it is critical

to examine the relative merits of each of these proposals.

1. The report proposes use of significant economic presence as a criterion for

establishing nexus, followed by consequent creation of taxable presence. Factors

46

Supra. n. 43. 47 Supra, n. 44.


[34]

evidencing such economic presence should be something that demonstrates a

purposeful and continuous interaction of an entity with the Indian economy, through

modes like technology and automated tools. These factors need not necessarily meet

some high threshold and even revenue based or digital factors like local domain

name, local payment option and digital platform will suffice.48

An alternative for

determining such presence is by relying on user-based data like digital content

generated/received and number of users active on a monthly/quarterly basis.

However, even if the strict requirement of PE is watered down to form this loose

provision of significant economic presence, it will nonetheless require additional

modifications to be made to the domestic law as well as the other related treaties.

Moreover, without any substantial change to the norms governing profit attribution,

the increase in revenue generation would only be meager owing to very little profit

allocation to such economic presence.49

2. Another proposal pertained to withholding tax on a certain form of payments made

to the non-residents, for activities like provision of goods and services online. This

impost was not supposed to be introduced as an independent levy, but instead

charged from within the existing taxation structure. However, there exists difficulty

in tax collection procedure and enforcement of similar such rules. Furthermore this

option would not be feasible without any considerable modification in the existing

treaties, more so in the Indian context where withholding tax amounts to definitive

chargeability of the concerned income.50

3. The last alternative recommended imposition of an equalization levy; which was

eventually adopted by the Indian authorities as a part of the proposal under Chapter

VIII of the Finance Act, 2016. As per the OECD, this final proposal saves the

country from difficulties related to modification of rules to suit the nexus

requirement of significant economic presence. This report also acknowledged the

usage of this approach by a few countries already, but in a dissimilar manner. It is

used by and large as a measure to remove disparity that exists between the domestic

and foreign suppliers and ensure equal treatment to both. Although in India it seems

48 Committee on Taxation of E-Commerce, Proposal For Equalization Levy On Specified Transactions, CBDT,

DEPARTMENT OF REVENUE, MINISTRY OF FINANCE, GOVERNMENT OF INDIA (February 2016), http://www.incometaxindia.gov.in/news/report-of-committee-on-taxation-of-e-commerce-feb-2016.pdf (last

accessed on 31th August, 2016). 49

Ibid. 50 Ibid.

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to be enacted with the dual motive of (a) overcoming BEPS practices, and (b)

removing disparity that exists on the basis of residential status.

Conclusively, the report also cautioned the member countries about the probable conflicts

that the proposed options may have with certain existing trade agreements, particularly the

ones involving European Union. The report does not explicitly provide for existence of any

conflict in the Indian context, but a cursory perusal of certain major trade agreements seem to

suggest a few minor discrepancies, which shall be discussed under the subsequent heading. It

is in this backdrop that the budget 2016 has taken up equalization levy as the best alternative.

The inclusion of EL in the domestic law can be rationalized by envisaging the difficulty that

its incorporation in all the tax treaties would have caused.

NATURE OF LEVY: CLEARING THE MIST

An important aspect which draws one’s attention is the introduction of EL not as an

amendment to the IT Act, but instead separately as a distinct chapter under the Finance Act.

It’s true that it is not the first levy to have been introduced this way, and impositions like

Service Tax and Securities transaction tax have been previously brought in vide Finance Acts

of the year 1994 and 2004 respectively. However in this case, unlike before, it is effectively

the income that is being taxed. One argument for not introducing it as a part of the Income

Tax Act can be it being an imposition on the income of non-residents and not Indian

residents.

Divergent views exist with respect to the nature of this imposition. On one hand, where a case

can very well be made out calling this impost an income tax; there exist equal amount of

evidence, on the other, to prove it as a levy distinct and independent from Income Tax. This

section aims to highlight all the major substantive arguments that can be advanced in support

of both the prevalent views. This lingering uncertainty and ambiguity with respect to the real

nature of this levy necessitates a clarification or amendment from the government in the near

future.

Levy as an Income Tax

Section 164(d) of the Finance Act defines ‘equalization levy’ as the “tax leviable on

consideration received or receivable for any specified service”. The definition uses the term


[36]

‘tax’ to characterize this levy, but Chapter VIII does not define the term ‘tax’;51

and Section

164 (j) provides that the terms or expression used under this chapter but not defined herewith

shall derive its meaning from the IT Act. Therefore, reliance should be placed on Clause 43

of Section 2, which defines Tax to mean “income-tax chargeable under the provisions of this

Act” amongst other meanings and interpretations. In simple words, for the purposes of IT

Act, Tax means income tax.52

Now with clause (j) providing that undefined terms in Chapter

VIII should derive its meaning from IT Act, ‘Tax’ here would also mean income tax. In light

of the imposition being unqualified, the levy cannot be restricted to mean something different

form income tax.

Had the legislature intended to give a different meaning to this levy, it would have defined it

so while framing the legislation. Legislature could have either defined the term itself

differently under Section 164, or could have made an addition to clause (j) along the lines of

“unless there is something in the subject or context inconsistent with such construction”.53

If

the latter alternative was to be adopted, one could have argued that in light of the context and

content of the charge the impost does not qualify as income tax. As there was nothing that

prevented the legislature from using such language, its absence could be construed to mean

an intended omission. Hence, as far as literal interpretation of this levy goes, it constitutes

income-tax. Furthermore, both these imposts i.e., equalization levy and income tax, function

in identical fields and are strongly intertwined. Assessment as well as the appellate authorities

is same for both the imposts and Section 178 of the Finance Act even list out various

provisions of IT Act which applies to equalization levy.

Reference made to double taxation under Section 10(50) of the IT Act54

further reinforces the

notion of this levy being Income tax. It is a widely settled fact that the concept of double

taxation creeps in only when the same income is charged twice, and that too under the same

statute. If the impost on the same income is flowing from two different statutes, then it will

not qualify as double taxation. The reason being, every legal framework has a different set of

reasons behind its promulgation and a different set of objects to be achieved. Reference made

to double taxation in the current context, therefore, indicates that income tax and equalization

51 Manish, Is equalization levy a tax?, TAXOF INDIA, (March 28, 2016); available at

https://taxofindia.wordpress.com/2016/03/28/is-equalisation-levy-a-tax/ (last accessed on 31th August, 2016). 52 Definitely including other kinds of taxes mentioned in the definition as well, but those taxes are irrelevant for

the current purposes. 53

Supra n. 51. 54 Inserted through Finance Act, 2016.

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levy are not capable of being imposed at the same time. This leads one into drawing the

inference that both the levies are one and the same.

Additionally, in lack of any other form of travaux préparatoires, one way to interpret the

legislative intent behind this levy would be to analyze the Finance Minister’s budget speech

with respect to the Equalization levy. The opening part of the 151st paragraph of the speech

makes it crystal clear that the intent of the legislature is to tap in on the e-commerce income

generated by non-resident units.55

The focus thus lies in taxing the ‘income’, and helps in

concluding that equalization levy in this sense is merely a variant of income tax.

Levy as an independent imposition

However, the aforementioned position cannot be the only conclusion drawn from the

analysis, and inferring an entirely contrary conclusion stands as an equally valid possibility.

This alternate conclusion points towards the equalization levy and income tax belonging to

different regimes altogether. Careful perusal of all the related provisions in Income tax Act

and the Finance Act helps one in framing certain arguments which further the said view,

namely:

Impost of this levy is via insertion of a separate chapter in the Finance Act. If both the

levy were indeed similar, the legislature would’ve covered it within the ambit of Income

Tax itself.

Chapter VIII of the Act seeks to create a new and independent code by itself. The said

chapter has everything including charging provision, collection related procedure and

penal measures that are triggered on failure to abide. The borrowing of some specific

provisions from income tax statute, enlisted under Section 178 of the Act, is merely a

device to strengthen this independent framework.

Liability with respect to the deduction and payment of equalization levy lies with the

Indian resident making remittances to the Non-resident service providers for the services

availed. The burden to timely deduct this tax and deposit it with the authorities lies also

with the residents making payment, and not the exchequer. Even the assessment and

penal measures are provided for against the payers, and payee merely acts as the stimuli.

55 Speech of Arun Jaitley, Minister of Finance, Notification No. : 2(9)/2016-B(D), MINISTRY OF FINANCE,

(February 29, 2016); available at

http://www.thehindu.com/multimedia/archive/02756/Budget_Speech_2756516a.pdf (last accessed on 31th

August, 2016).


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This non-resident payee owes no liability and stays unharmed by the tax collection and

compliance methods undertaken, in spite of being the income earner. This mode of

operation is unknown to Income Tax statutes, which never absolve the income earner

from tax liability. Similarly all the compliance measures are also enforced against the

income earners, unlike the case of equalization levy.

Although arguments advanced in favour of both the propositions sounds extremely plausible,

but in my personal opinion EL is more of an independent imposition, separate from Income

tax. Arguments made in favour of income tax largely place reliance on inferences drawn by

its conjoint reading with other statutes or giving undue emphasis to the omission made. On

the other hand, there are enough explicit evidences in favour of EL being an independent

imposition and there stands no need to draw any implication whatsoever. Therefore, there is a

need for pointed clarifications or amendments by the government that clears the lingering

ambiguity prevailing over this aspect of the levy. The present uncertainty over its nature only

opens the door to a plethora of other related and unanswered questions.

APPRAISAL OF THE LEVY

At this initial stage, EL is proposed to be imposed only on business-to-business transactions

[B2B] and not business-to-consumer transactions [B2C].56

Section 164 (h) of the Finance Act

defines these specific services as online advertisement, providing digital advertisement space

etc. However, this section also entrusts the government with power to expand its ambit by

notifying inclusion of other services.57

The government even holds the power to include

within the levy’s ambit e-commerce transactions like downloading of movies, albums and

books, software downloads, online news consumption and online sale of other goods and

services. There is a range of varied services which can easily be subject to this proposed levy,

whose implementation will not even require any infrastructural changes.

This excessive power entrusted with the government although might be well intentioned, but

there also exists high possibility of its negative consequences. In this light, certain similar

instances form the past are worth mentioning. As mentioned already, Service Tax was also

introduced in a similar fashion in India via Finance Bill, 1994.58

When introduced, it was

levied on merely three services at the rate of 5%. Contrast this with the current regime of a

56 Lakshit Desai, Equalization levy – a step towards taxing digital transactions, [2016] 71 taxmann.com 44,

(June 2016); available at https://www.taxmann.com/articles.aspx (last accessed on 31th August, 2016). 57

Supra, n. 7, Section 164. 58 Supra, n. 7, Chapter V.

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12.5% imposition and the presence of a negative list.59

It is not farfetched to imagine the

equalization levy also progressing in a similar fashion.

Additionally, owing to the uncertainty which looms over the reaction of the digital giants to

this levy, it is speculated that the brunt of the levy will be faced by the small and medium

sized businesses and the newly growing market of startups. These entities place high reliance

on forums like Google, Facebook and Amazon for the purpose of advertising their goods and

services.60

A key factor for which these forums are popular with small and medium

businesses is the ease with which the targeted audience can be reached through them,

eliminating the huge investment in advertisement. However, through the new levy, these non-

resident digital giants are highly likely to increase the price at which they offer services so as

to accommodate the imposition.61

This new proposal, therefore, seems to be harming some

businesses in more ways that it is benefitting a few.

For example let’s assume that before the imposition of this levy, a particular service was

provided by Google at Rs. 2,00,000. With the introduction of 6% equalization levy, Google

would only be receiving Rs. 1,88,000 as reimbursement its services. In order to make up for

these lost revenues, Google will start charging around Rs. 2,12,000 thereby leading to an

increase in cost for small resident businesses. This does not impact the revenue generation of

the non-resident companies. As a consequence, even though the intention behind imposition

of this levy was taxing the big online companies, in effect it is turning out to be a cost for the

small businesses which rely on these forums for advertisement purposes.

The legislators have carved out an exception whereby if the net proceeds remitted by an

Indian resident do not exceed Rupees 1 Lakh in a financial year, then levy would not be

imposed. 62

However, this provision does not seem to hold much practical relevance. As

exemplified above, the implementation of this levy is highly likely to lead to an increase in

the fees charged by these companies. Therefore, all the service subscribers across the board

59 Dinesh Agarwal & Ankit Shah, Service Tax Changes: Effective 1 April 2016, MONDAQ, (5 April 2016);

available at

http://www.mondaq.com/india/x/479844/sales+taxes+VAT+GST/Service+Tax+Changes+Effective+1+April+2

016 (last accessed on 31th August, 2016). 60 Dipak Mondal, Equalisation Levy: Google, Facebook unlikely to foot the bill, BUSINESS TODAY (June 1,

2016). 61 Karnik Gulati, Equalisation Levy: A toothless taxing tiger, (March 16, 2016), TAXNEWS; available at

http://www.tax-news.com/articles/Equalisation_Levy_A_toothless_taxing_tiger__573442.html (last accessed

on 31th August, 2016). 62 Supra, n. 7, Section 166.


[40]

will have to pay more and the cost of doing business in digital India will go up even for the

people paying less than Rupees 1 Lakh.63

This argument of price increase has to be understood with some amount of caution as it is

based on two assumptions. At the primary level it is being assumed that the non – resident

service providers would increase the price as an attempt to make up for the lost revenue.

Further, there is a second assumption that the price determination power lies with the service

providers themselves, and not with the market forces.

On the brighter side, there are some domestic players like the indigenous e-commerce

companies that this equalization levy would be helping. Earlier these E-commerce websites

used to charge commission fees for listing the products on their websites. But this fee has

slowly been phased out, and most of these e-commerce websites now generate revenues

merely off advertisements from their respective merchants. With the implementation of

Equalization levy, while the foreign services providers would be forced to either increase

their prices or take a hit in any other manner, these resident online websites like Flipkart and

Snapdeal will remain unaffected.64

The bargaining power, however, will still lie with the

Resident merchants who list on these websites. They should be encouraged to prefer domestic

websites over the other alternatives, both because they are cheaper as well as indigenous.

LACUNAE IN THE PROPOSED SCHEME

Foreign tax credit availability

A glance at the foreign trade credit clauses of the various bilateral tax treaties, to which India

is a signatory, sheds light on the ambiguity that exists in this regime. Substantial uncertainty

lingers over the issue of whether the non-residents, who have paid equalization levy in India,

can claim credit from their respective country of citizenship for the amount paid as the levy.65

This issue can be better understood through the example of the India-US tax treaty. Article 2

of the treaty defines “tax covered” and covers within its ambit “any identical or substantially

similar taxes”.66

Article 25 of the treaty titled ‘Relief from Double Taxation’, lays down that

“U.S. shall allow to a resident or citizen of the US, as a credit against the US tax, on income

63 Shrutika Verma, India’s Google tax may raise costs for Indian units of global firms, LIVE MINT, June 1, 2016. 64 Remy Nair, More digital transactions may come under equalization levy’s ambit, LIVE MINT, March 30,

2016. 65 Deepak Goel, Equalisation Levy – Is it a beginning of a new saga?, TAXMANN, [2016] 71 taxmann.com 195. 66 Convention Between The Government Of The United States Of America And The Government Of The

Republic Of India For The Avoidance Of Double Taxation And The Prevention Of Fiscal Evasion With Respect

To Taxes On Income, art. 3, 20th Dec, 1990, Notification No. GSR 990(E).

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tax paid to India”.67

It further provides that “the taxes referred to in paragraphs 1(b) and 2 of

Article 2 (Taxes Covered) shall be considered as income taxes”.

The simultaneous reading of these provisions i.e., Article 2 and 25 of the India-U.S. treaty,

brings to fore the possibility of other countries granting credit to its citizen for paying taxes

that are identical or substantially similar to income tax. Equalization levy, even if not a tax on

income, is substantially similar to income tax and the U.S. government might therefore give

credit to its citizen for the levy paid by him in India.68

Additionally, clauses like Article 2 and

25 are not merely limited to the India-U.S. tax treaty and are rather omnipresent; implying

that the same benefits can be reaped by the residents of other countries as well. No

clarification has been issued by either the finance ministry or CBDT in this regard and hence

the problem continues to persist.

Brand promotion activities

This is a critical area which might attract a lot of litigation in future. The current framework

provides no clarity on the imposition of this levy on brand promotion activities which the

parent company, not having a PE in India, might render to its Indian subsidiaries. One of the

biggest losers to this underlying uncertainty would be the big brands, which have worldwide

presence and promotional activity are centrally undertaken by the holding company, followed

by cost allocation to each such subsidiary.69

Similarly, even a significant chunk of the service

fee charged by online stores like Amazon and Flipkart might fall within the ambit of

equalization levy, as the fee charged by these digital marketplaces is already inclusive of

brand promotion charges.

For the purpose of resolving this problem, an easy way out for the government can be tagging

these services as advertisements and bringing them within the ambit of the levy, followed by

waiting for years of litigation to finish and courts finally reaching a conclusion. However, a

few fallouts to this approach would be loss of foreign taxpayers’ confidence and negative

impact on the ‘Digital India’ initiative. Therefore, the better option for the government is to

preempt this problem and define ‘services’ covered in a manner that is more inclusive, yet

67 Ibid, art. 25. 68 Supra, n. 65. 69 Neeraj Sharma, Whether Equalisation Levy is an Effective tool to tax enterprises with digital presence in

India?, [2016] 69 taxmann.com 89; available at https://www.taxmann.com/articles.aspx (last accessed on 31th

August, 2016).


[42]

flexible.70

Composite agreement covering multi-jurisdictional provision of advertisement services

Ambiguity persist with respect to valuation of the consideration paid in lieu of services

provided in India, when the said contract pertains to a composite agreement involving

provision of services in India (inclusive of J&K) as well as abroad. Equalization Levy Rules,

201671

failed to bring clarity in this regard and thus difficulty would arise in separating the

amount charged for services in India (exclusive of J&K) as against the amount for services in

other countries and J&K. Furthermore, there is lingering uncertainty even with regards

valuation of the amount on which levy is to be calculated if consideration paid is in non-

monetary form. As “measure of value” is considered as an essential component of a tax

alongside nature, rate and individual being taxed,72

clarity in this respect is vital.

In addition to other criticisms and controversies, certain fundamental jurisdictional issues also

plague the current proposal. It is widely accepted as a settled principle in taxation

jurisprudence that legal fiction cannot be accepted as a basis for determination of

international income tax jurisdiction.73

However, the government can be said to be resorting

to this legal fiction for invoking Indian jurisdiction when they are deeming the online

advertisement spending of Indian residents to mean an actual activity in India by the non-

resident recipients of the payment.

The issue as it stands today, is whether a mere change in phraseology can alter the nature of

this otherwise ultra vires levy into a rightful exercise of jurisdiction, under the general

principle of international taxation law. Furthermore, if similar levies are imposed by other

market jurisdictions as well, then the consequential aggregate over-taxation that is likely to

result would be extremely regressive. However the Report of the Committee on Taxation of

E-Commerce74

found no possible errors with this approach.

CONCLUSION

While EL is a commendable attempt towards recovering the revenue which otherwise gets

lost owing to limitations in the taxation infrastructure, it would not be erroneous to assert that

70 Ibid. 71 Supra, n. 15. 72 Govind Saran Ganga Saran v. Commissioner Of Sales Tax, 1985 AIR 1041. 73 This principle was clearly stated by the Indian Supreme Court in Vodafone International Holdings v. Union of

India, (2012) 6 SCC 613. 74 Supra, n. 48.

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its indirectness is highly likely to impact the small and medium level businesses and startups.

This levy, passed under the influence of OECD Action Plan, seems to have been introduced

in a rush and requires a comprehensive reassessment to achieve its desired objective.

Considering the significant economic dimension of this levy, as has been elucidated in the

second part, this source of revenue should not be left untapped; but in its current shape it will

only increase litigation and further burden the overburdened judiciary.

Memorandum attached to the Finance Bill makes its exceedingly clear that EL derived its

inspiration from the OECD Action plan, wherein it was proposed as one of the ways to tax

‘economic nexus’ which otherwise goes untaxed under the existing structure. In spite of the

introduction of EL in domestic taxation framework, the legislature has failed to clarify how

the said ‘economic nexus’ is justified by this imposition. In addition, low threshold of Rs. 1

Lakh makes its ambit rather wider and covers even those transactions whose economic nexus

to India is rather flimsy.

Furthermore, nothing in the budget speech, the Memorandum to the Finance bill or the

committee report justifies the adoption of EL, as opposed to other alternatives, as the most

suitable mode of taxing these overseas online transactions by the government. The raison

d'être behind this imposition therefore remains unclear. Moreover, clarification regarding the

nature of this levy becomes imperative in light of the multilayered ambiguity that exists,

especially with respect to the phraseology used by legislature. Even though Part V of the

paper attempts to collate equally plausible arguments advanced from both the factions, but

evidentiary balance tilts towards it being an independent imposition for the reasons already

discussed. However, till the issuance of an official clarification, these claims would qualify as

mere speculations.

In addition there are a few lacunas in the proposed scheme,75

with respect to the availability

of foreign tax credit, ‘measure of value’ and assessment of centrally undertaken brand

promotion activity, which require immediate attention to provide some semblance of

certainty. Because even after these fundamental challenges are overcome by the government,

a string of smaller issues would arise during the actual implementation of the levy, which can

only be redressed over the course of time.

75 As flagged off in part VII of the paper.


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Conclusively, this act of government is neither in line with tax competitive measures, which

is the need of the hour for any developing economy, nor does it help boost investor

confidence by providing a more stable taxation regime. Instead, it is likely to divert the focus

of government from more important issues such as non-adversarial tax regime and a few

other problems flagged under the OECD action plan; with no attempts being made to attract

the government’s attention back to these important issues. Aspects like ‘limitation of interest

deduction’, ‘disclosure of abusive arrangements’ and ‘hybrid mismatch arrangements’

requires adequate attention in the recent past nor can the inclusion of transfer pricing

regulation in the domestic framework be deferred for longer.

Therefore, this step towards equalization levy is being welcomed by the community with

further hope that the determination of the government towards reforming the extant structure

would not diminish in spite of pressure from different quarters, and the aforementioned much

needed follows in line.

VOL. III INDIAN JOURNAL OF TAX LAW 2016

[vi]

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