Budget 2023-24 Expectation: Need for clarity on equalisation levy; higher tax on virtual digital assets

Among the tax base broadening initiatives taken by the government in recent years in the digital sector, two key measures that have stood out are the equalisation levy and higher tax on virtual digital assets (VDAs). Both measures are aimed at bringing digital transactions into the tax fold. Given the ever-expanding technology footprint and the challenges it has posed for global tax systems, the intent is well-appreciated.  However, there is considerable uncertainty surrounding the equalisation levy and taxation of VDAs. The forthcoming Budget should provide greater clarity on these issues to bring greater tax certainty. Equalisation levy (EQL) was first introduced in 2016 as an interim measure to tackle the issue of non-taxation of profits generated by non-resident digital companies. It initially taxed only the online advertising revenues at 6 per cent. However, as the international consensus on the right mechanism for taxing the profits of digital companies was taking time, the scope of equalisation levy was extended to other revenue streams by Finance Act, 2020. A levy of 2 per cent was imposed on consideration received by non-resident e-commerce operators for e-commerce supplies or services. Finance Act 2021 further expanded the scope of ‘online sale of goods’ or ‘online provision of services’ to cover, among others, online acceptance of offers for sale or online placing/acceptance of purchase orders or online payment of consideration. Taxing digital economy Unlike the digital services tax applied by some other countries, the widened scope of EQL provisions in India covers even the traditional businesses in physical goods and services wherein technology plays only an incidental role such as for seeking information or confirming the booking, or simply streamlining the supply chain. The primary object of such businesses continues to be the purchase of physical goods or an availment of physical services. Similarly, non-resident payment gateways or aggregators may come under the EQL scope, even though they are only facilitating the payment leg of an offline transaction, or a transaction facilitated by another e-commerce operator. There is considerable ambiguity on multiple levels of taxation where a single transaction of online sale of goods or provision of services is made by one non-resident entity through another non-resident e-commerce operator and payment is facilitated through still another non-resident payment gateway. The government should clarify the correct scope of EQL and restrict EQL only to those cases wherein all or substantially all activities take place online. The government should also clarify that given the intent to tax e-commerce transactions, instances such as online ordering systems or ERP or internal corporate websites through which orders are received, etc. are outside the ambit of EQL. SEP provisions likely to impact conventional transactions India also introduced the new nexus rule based on Significant Economic Presence (SEP) in 2018, thus expanding the concept of ‘business connection’. The revenue and user thresholds for the application of the SEP provisions were also notified, effective from April 1, 2022.  SEP provisions, as currently worded, also have a broad scope and are likely to impact conventional transactions and activities even if not carried out in a digital form. While it is clarified that existing treaty rules are not modified pending multilateral agreement for such measure and hence, non-resident taxpayers eligible for tax treaty benefits are not impacted by SEP, the government should also clarify non-applicability of procedural compliances like obtaining PAN and filing returns for such entities. In the case of non-resident taxpayers not eligible for tax treaty benefits, clarity is still awaited on many application aspects such as the criteria for determination of revenue threshold and users, profit attribution rules, and the interaction of EQL and SEP. India and US had, in principle, mutually agreed that India will continue its interim 2 percent EQL on e-commerce transactions till the implementation of Pillar One or March 31, 2024, whichever is earlier. The terms of the agreement were to be finalised by 1 February, 2022, but there is no clarity on subsequent development on this front.  Considering this, the Budget may provide some clarity on the way forward. Aspects of VDA taxation need clarity With increased adoption of digital services and surging demand in new-age technologies like Artificial Intelligence (AI) and 5G services, business models in the digital domain have become even more complex, experimenting with newer digital assets. In view of the popularity of Virtual Digital Assets (VDAs), more popularly known as crypto-assets/currency, the government introduced in the last Budget a special regime of 30 percent tax on the transfer of VDAs and 1 percent TDS on the payment made to residents in this respect. No deduction of expenditure (except the cost of acquisition) or set-off of losses is permitted.  The definition of VDA includes non-fungible tokens (NFTs) attached to digital assets. Many aspects of VDA taxation need clarity, without which there is a risk of inadequate compliance or disputes. For instance, clarity is needed regarding the determination of the cost of acquisition where VDA is held as inventory. Similarly, for non-residents, the circumstances under which VDA can be considered as located in India to trigger taxation need to be clear. Further, NFTs should be provided a carve-out from the VDA tax regime since, unlike virtual currencies such as bitcoin, the NFT derives its value from a definite underlying asset such as photos, videos, audio files, and paintings. Before the VDA tax, NFTs representing both physical and digital assets were subject to normal tax treatment. However, the VDA tax discriminates against digital assets. Provide some indication of tax rules under Pillar Two Even as OECD is working towards finalising the framework for addressing the tax challenges of a digitised world, each jurisdiction including India is working towards its implementation plans. While Pillar One may take some more time to have a consensus, the deadline of 31 December, 2023, has already been set for implementing the global minimum tax rules across the world under Pillar Two. Taxpayers would like the Budget to provide some indication of India’s timelines and contours of the tax rules under Pillar Two, to help them prepare sufficiently in advance. The writer is the Director, Tax Economic & Policy Group, EY India (@EY_India). Akanksha Mittal, Senior Tax professional, EY India also contributed to the article. Views expressed are personal Read all the Latest News, Trending News, Cricket News, Bollywood News, India News and Entertainment News here. Follow us on Facebook, Twitter and Instagram.