In this week's FinMail we take a look at the Equalisation Levy (a.k.a the Google Tax) which India agreed to phase out with an agreement with US. We will also look at why it was introduced in the first place and what led India to cut it off.
On 24th November 2021, India and US signed an agreement to phase out the Equalisation Levy that India has been levying on the digital companies based out of India. This agreement comes after India and 135 other countries agreed to implement a minimum corporate tax of 15% in October this year. The agreement requires the countries to implement a similar kind of taxation system in order to tax MNCs for carrying out their businesses in different countries, and thus all the countries including India will now have to remove all the digital service tax or other such levies. And thus the phase-out of Equalisation Levy.
But wait... what exactly is this equalisation levy? Why it was introduced? And why the government is pulling a reverse move on it. All of it coming right up in this FinMail, so let's just start right away.
Equalisation Levy: The Need
The world is ever-changing and so are our primary needs. Ask someone what's your basic needs a decade ago and they would have replied, "Roti, Kapda, Makaan" but try asking someone now and they'd add Mobile or Internet to it. Internet is now an inseparable part of our lives because of the fact about how highly dependent we are on the Internet.
And this is also because through the years our dependency has only increased and the industry that has erupted out of it is only getting larger day by day. Just imagine your daily life without Google or Facebook; it will only get chaotic. And these are not just normal companies that manufacture or sell a product, these are the companies that feed on the internet. It is like the Internet is their factory or their workspace. Let me be more clear - these are the digital companies that only exist on the Internet. Remove Internet out of the equation and they'd be gone, as quick as a snap (Thanos pun).
They are the 'Internet-based Companies' and as long as the Internet stays, so do they. Being internet-based companies allow them to conduct their business, to provide their platforms in any part of the world no matter where they are located. Doesn't matter if Google is a US company, it still can earn money from India. Doesn't matter if Netflix is a company based in US but someone in Capetown or Sydney can still use their streaming services. All it needs is the presence of the internet which is quite literally everywhere. And this is their biggest strength which allows them to get really competitive with other companies present domestically. In most cases, there are no competitors and if they are, most of them get eliminated from the business because they can't compete with the deep-pocketed MNCs. So local businesses first of all are at risk which explains the very first need of this levy.
Secondly, such companies operate internationally but only pay taxes in the countries that they are headquartered in. Let's take an example here - if you promote/run an ad campaign on Instagram you pay to Facebook for the same which is headquartered in US. But you are based in India and you run an ad here on Instagram India but still, the promotion cost that you pay goes to Facebook because of the fact that it is the parent company of Instagram.
And in most cases, subsidiary companies transfer their revenues to their parent organisation through an offshore company based in a country where there are little to no taxes; the tax heavens and they end up paying lesser taxes than they should be otherwise. According to one report published in Fortune, big tech companies have saved more than $100 billion in taxes using legal loopholes. The report only points out the tax savings through legal loopholes, well, numbers could be much higher when we put 'tax avoidance through tax heaven' on the table.
So, there was a different need here as well. To tax the companies for the actual profits that they earn and not the profit that they show.
Equalisation Levy: The Meaning
With an objective to bring all the digital companies into the tax bracket, an Equalisation Levy of 6% was introduced in 2016 on internet-based companies, aimed to tax the revenue generated by companies based outside of India by allowing other businesses/person based in India to advertise on their platforms. And as in 2016, the major company earning through ad revenues in India was Google, the equalisation levy was also termed as the 'Google Tax'. Let's take an example to understand the equalisation levy better. Let's take an example:
Shweta is the owner of a clothing business, which is based in Pune. She often promotes her products on Instagram to increase the sales of her store which costs her let's say ₹1.5 lakhs a year. For her, it is an advertising cost but for Instagram, it is ad revenue. In absence of an Equalisation Levy, this income (for Instagram) would go directly to Facebook (now Meta) in US, and that too with a possibility that it would be transferred through tax heaven.
But after the introduction of the Equalisation Levy, the calculation would go like this. Shweta would pay ₹1.5 lakh to Instagram and a 6% equalisation levy would now be added to this cost. Instagram would now bill her ₹1,59,000 (₹1,50,000 + 6%). She would pay ₹1.5 lakh as usual to Instagram but she would now have to pay ₹9000 to the government. Instagram will generate the invoice for ₹1.59 lakh but she will deduct the 6% levy (₹9000) and pay the rest. The ₹9000 that she deducted will have to be paid to the government while filing the taxes.
It is the responsibility of Shweta to pay the levy on time, and failing to do so would attract legal and financial penalties. But the levy is only applicable to the businesses that spend more than ₹1,00,000 on digital advertisements on a particular platform for a single year. So if Shweta spends ₹80k on Instagram and ₹70k on Google annually, she wouldn't have to pay the levy.
Now it is just as complicated as it sounds. The responsibility of paying the levy is on the service user and if they miss it, there are consequences as well.
While it was troublesome for the digital companies and the service user, the government was surely successful in widening the tax base as reports suggest that the government has collected over ₹4000 Crore in Equalisation Levy since its introduction in 2016 till FY 2019-20 with the collection being ₹1000-1100 Crore in 2019-20 alone.
Equalisation Levy 2.0
Equalisation Levy was introduced in 2016 which targetted the digital companies who earned by allowing businesses to advertise on their platforms. But as the years passed on the definition of digital companies became wider but the tax definition remained the same. And hence the equalisation levy 1.0 was not enough for the government and thus came the equalisation levy 2.0. With EL 2.0 the government decided to extend the tax base and include the foreign E-Commerce companies as well.
In the finance budget of FY 2020-21, the government introduced a 2% levy on revenues earned by foreign e-commerce businesses that generate income by selling goods and services in India. And hence the likes of Amazon or Alibaba came into the tax bracket here in India. But like the Equalisation Levy of 6% didn't invite much criticism, the 2% EL 2.0 did.
Some called it a desperate move to obtain more revenue from taxes as the pandemic had closed many sources to earn revenues. The government of US called the imposition 'discriminatory' against US companies as the majority of foreign companies in India are based in US. The opposition did not stop there as the US government went on to impose punitive tariffs on at least 40 Indian products that were imported into US.
And after a lot of drama and bilateral talks, India and US have finally agreed to phase out the equalisation levy and the termination of the punitive tariffs as well. Let's take a quick look at the deal as well.
On 8th October 2021, 136 countries including India signed an agreement at OECD to impose a global minimum tax rate of 15% on corporates to allow a similar tax system across the world for companies that operate in various countries. These 136 countries represent nearly 90% of global GDP. The agreement further requisites that the countries remove all kinds of other digital taxes or levy that they have imposed to ensure the smooth implementation of the Tax. And hence following the same agreement, on the 25th of November officials of India and US met to sign a deal to phase out the equalisation levy imposed by India and to end the punitive tariffs imposed by US as a result of the levy.
The deal made by both countries suggests that the equalisation levy would be phased out from 1 April 2022 which is the date of the implementation of the OECD meet agreement or March 31, 2024, whichever is earlier. The final terms of the deal are to be finalised by February 1, 2022. So, it seems that we will just have to wait and watch till we get the final updates... Till then,
That is it for this week's FinMail, keep learning, keep growing & we will see you in the next week.
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