While the new equalisation levy comes with good intentions, it could have a negative impact on Indian small and medium businesses.
Silicon Valley, the harbinger of disruption, very rarely likes to talk about taxes. Who would, when some of your most prominent companies owe over hundreds of millions of dollars in back taxes to a great number of European and Asian countries?
On Monday though, India joined a list of other OECD and European countries that are looking to plug the tech tax avoidance loophole. A quiet paragraph in the Union Budget describes the contours of what is known in the UK and Spain as the ‘Google, Amazon and Facebook tax’ – a levy that is aimed at technology companies that primarily make money through online advertisements, the revenue of which is usually routed to a tax haven.
“In order to tap tax on income accruing to foreign e-commerce companies from India,” finance minister Arun Jaitley read out, “it is proposed that a person making a payment to a non-resident [technology company], who does not have a permanent establishment, exceeding in aggregate 1 lakh in a year, as consideration for online advertisement, will withhold tax at 6% of gross amount paid, as equalisation levy.”
The general problem in taxing online advertising companies such as Google or Facebook is that they charge customers in all markets that they operate in, but collect nearly all of their profits in tax-friendly countries such as Ireland or Luxembourg. For example, for the longest time, Indian customers of Google’s advertising service were not billed by Google’s India operations but were billed by Google Ireland.
All of the major Silicon Valley-based companies are locked in tax disputes in India over these and other similar issues. Their main counter-argument is perfectly encapsulated in a decision taken by the income-tax appellate tribunal in Kolkata which held that payments to companies such as Google and Yahoo were not liable to be taxed in India because “they could not be construed as permanent establishments or taxable presence of foreign enterprises owned and maintained in India”.
The new levy
So how are Modi and Jaitley getting around this issue? The equalisation levy, as an Ernst & Young note that was passed around to its clients yesterday says, looks at taxing “online advertisements, provision for digital advertising space or any other facility or service for the purpose of online advertisements”.
The levy looks at collecting taxes from online advertising companies in a very indirect, roundabout way that has the potential to backfire. Instead of taxing the technology companies directly, the levy has to be deducted by the party that pays for the advertisements: i.e., Indian merchants who advertise on Amazon, small and medium businesses that advertise on Facebook, and start-ups that compete for SEO space on Google.
“If you take for example, an Indian company that has to pay a foreign e-commerce company Rs. 10 lakhs for online advertisements. With the 6% levy, the Indian company will pay the foreign one, Rs, 9,40,000 instead. The other Rs. 60,000 will go to the government,” Hitesh Sawhney, Partner- Direct Tax, at PriceWaterhouseCoopers told The Wire, when explaining how the levy would work.
Who loses out here though? Do foreign online advertising companies simply accept lower margins and accept the equalisation levy? Or will they simply charge a higher advertising rate that takes into account the cost incurred by the levy?
The Wire spoke to a number of tax experts and executives from a few Silicon Valley-based companies, the latter of which did not want to be quoted. The consensus seems to be that most online advertising companies will simply “gross up”. Going back to our Sawhney example of an Indian advertiser and a foreign tech company, the Indian company will be forced to shell out Rs. 10,60,000 instead of the usual Rs. 10 lakh in order to compensate for the equalisation levy.
Let’s consider a couple of examples on how this levy could play out:
India’s digital media start-ups: Take for example an online start-up. If it is looking at shelling out money for Facebook advertising campaigns and its payments are more than Rs. 1 lakh over a year, it will be charged extra for this levy. Most new media publications simply don’t have the upper hand at the negotiation table to force Google or Facebook to accept lower margins. So while the government does get an extra inflow of tax revenue, Indian small business and medium businesses will be impacted negatively.
Amazon vs Snapdeal: This is perhaps one of the more interesting match-ups. Most e-commerce companies that operate in India make their money off advertising on the part of their merchants; commission fees for listing on their websites have slowly been phased out. Foreign e-commerce companies that don’t have a permanent establishment in India will be forced to take a hit, because of the equalisation levy, when compared to domestic competitors such as Snapdeal or Flipkart. Here, bargaining power will clearly lie on behalf of the Indian merchants and sellers who list on these websites simply because there are domestic alternatives. The levy will therefore certainly “equalise” the playing field between foreign and domestic e-commerce companies.
Requests for comment from companies such as Google and Amazon went unanswered by the time of publication of this article.
A global push
Is the equalisation levy a well-thought method of taxing the slippery technology companies, considering it has the potential to harm Indian small and medium businesses?
“While I can’t say whether this is the best way to tax foreign e-commerce companies, it follows in the footsteps of suggestions in the BEPS Action Plan 1 and U.K’s diverted profit tax,” said Sawhney. The BEPS (Base Erosion and Profit Shifting) project is an attempt by various G20 countries to globally increase tax compliance.
Certainly more clarification is necessary: it remains to be seen whether the government’s definition of “foreign e-commerce companies” will cover corporates such as Google and Facebook which are primarily global ad exchanges. Most tax experts, however, believe they will be affected.
Secondly, this equalisation levy may be rendered useless if technology companies are allowed to claim a tax credit in their home countries for the equalisation levy. This doesn’t seem very likely though.
“See, this equalisation levy is not part of the IT Act. It’s part of the Finance Bill. Introducing this levy separately, and not under the IT Act raises concerns about the applicability of double taxation avoidance agreements on these income,” said Sawhney.
While Modi’s Google tax is a decent, first attempt at trying to recoup lost tax revenues, it’s very indirectness means that a great number of Indian start-ups will be impacted. Direct naming-and-shaming, the way the UK has done to great effect, will go a long way in encouraging Silicon Valley to be more tax compliant. In this regard, the government’s close relationship with these technology companies shouldn’t matter. If TRAI was allowed to take on Facebook when it came to net neutrality, tax authorities should be allowed to do the same with Google and Amazon.