March 25, 2020
Amendments to the Finance Bill, 2020
The Finance Bill, 2020 (“Finance Bill”) was introduced at the time of presentation of the Union Budget for financial year (“FY”) 2020-21 by the Indian Finance Minister on February 01, 2020. Our hotline containing a detailed analysis of the Finance Bill can be found here. Subsequently, certain amendments were proposed to the provisions of the Finance Bill through a notice of amendments passed by the Lok Sabha on March 21, 2020 (“Amendment (s)”). On the digital taxation front, some of the crucial Amendments include extending Tax Deduction at Source (“TDS”) obligations imposed by the Finance Bill on e-commerce operators to all platform owners, expansion of the scope of equalization levy (“EL”) and extension of lower withholding rate (made applicable for ‘fees for technical services’ under Finance Bill) to royalty payments as well. Other changes proposed by the Amendments include addressing inconsistencies in respect of certain measures introduced by the Finance Bill such as abolition of Dividend Distribution Tax (“DDT”), tax exemption to sovereign wealth funds (“SWF”), introduction of new tax residency rules, tax collection at source (“TCS”) obligations on remittances under Liberalized Remittance Scheme (“LRS”) etc. The Amendments are discussed in detail below:
1. AMENDMENT TO SECTION 194-O: TDS OBLIGATIONS ON E-COMMERCE OPERATORS
Section 194-O was introduced with a view to “widen and deepen” the tax net by bringing transactions facilitated by e-commerce operators within the ambit of TDS provisions under the Income Tax Act, 1961 (“ITA”).
The draft provision originally proposed in the Finance Bill imposed an obligation on e-commerce providers to deduct tax at the rate of 1% of the gross amount paid to an e-commerce participant for the sale of goods or services through its platform by such seller. Importantly, a company had to be responsible for paying the sellers under such an arrangement for it to be considered an e-commerce operator (apart from either owning, managing or controlling an e-commerce platform or online or digital facility that enabled such sales by third party sellers). Additionally, the proviso to the main section set out the deeming fiction that even if the money paid to the sellers did not flow through the e-commerce operator, nevertheless, such operator was deemed to have paid the sellers such money and therefore obligated to withhold 1% on such sums as well.
What was a bad situation to start with, in terms of the obligation to comply with TDS being imposed on intermediaries (and arguably imposed on non-resident platform operators), has been unimaginably made worse. The original draft provision was worthy of criticism from a practical perspective since it is quite difficult for companies to comply with TDS obligations when the platform is not in control of the money or payments being made to the sellers who sell through its platform. In such a case, there is a serious cash flow issue for platform operators, not to mention that it becomes quite complicated to then do business while being a non-resident, as such an amount has to be recovered from the Indian resident sellers in one way or another. Only in cases where platforms operated cash on delivery models, was it possible for companies to be excluded from the definition of an e-commerce operator and therefore not be subjected to the draft provision. Further, the provisions are so widely worded that even if platforms bought goods or services for their own consumption through their platform (or other digital facility or proprietary software), potentially such transactions could also be covered, even though no third-party buyers were involved.
However, the Amendments have made it far worse by making all platform owners e-commerce operators, irrespective of whether they are responsible for making the payment or not. This change, read with the deeming fiction in the proviso to the section means that all platform operators appear to be covered and would be required to pay 1% of the gross value of all the sales through their platform, even though not a single rupee from such sales that are paid to the sellers passes through the platform or is under the control of the platform. In fact, while e-commerce platforms have had the choice of integrating payment aggregation as part of their platform (where the money flows through them to the sellers), instead of opting for the cash on delivery option, from 1st April, 2020, e-commerce platforms do not have that choice anymore. The Reserve Bank of India (“RBI”) has introduced “Guidelines on Regulation of Payment Aggregators and Payment Gateways dated 17th March, 2020, coming into effect from 1st April, 2020, wherein e-commerce platforms are not allowed to undertake such online payments without a licence. To comply with the regulations and obtain a license many companies may have to hive out the payment aggregation or online payment facility into a new entity and separate it from the e-commerce business. Even assuming that a license is obtained, the regulations make it clear that the money collected from the customers shall be kept in an escrow account and paid to the seller. No debits can be made from that account for the purpose of paying TDS as that is not a transaction that is permitted under the guidelines. Hence, there is no possibility of the e-commerce platform ever having control of the money for the purpose of paying TDS, to effectively pay tax on behalf of the sellers. Further, it is important to note that the guidelines, quite sensibly, also expressly exclude cash on delivery situations. Keeping this in mind, it is clear that the amended section 194-O has not been harmonized with the requirements of the RBI guidelines. This clearly appears to be a case of inconsistency between regulators which needs to be rectified immediately.
Laws requiring e-commerce operators, including foreign e-commerce operators, to abstain from collecting money from a regulatory side but nevertheless pay 1% as TDS under tax laws is a contradiction that will cause unnecessary complexity and is impractical on the face of it. The fact that such an issue arises at a time when online sales and supplies are the need of the hour in an unprecedented lockdown situation is unfortunate.
2. EXPANSION OF EQUALIZATION LEVY TO FOREIGN E-COMMERCE OPERATORS
The Equalization Levy (EL), introduced vide Finance Act, 2016 imposes a 6% tax on consideration in excess of INR 100,000 (approx. USD 1,500) for a ‘specified service’ received or receivable by non-residents from Indian residents or non-residents having a permanent establishment in India. At the time of its introduction, the EL was limited in its application to consideration received by a non-resident for provision of specified online advertising services. This was intended to ‘equalize’ or create an equal playing field for non-residents and residents. However, in practice the tax ended up being a burden on domestic businesses.
In addition to the changes to significant economic presence proposed by the Amendment, the Government has now sought to impose an additional equalisation levy on incomes earned from supply of digital goods and services which are provided directly by or facilitated by e-commerce platform owners.
With effect from April 1, 2020, the scope of the EL has been expanded to cover non-resident e-commerce operators making supplies in India or having a nexus with India by imposing a 2% EL on the amount of consideration received or receivable by an ‘e-commerce operator’ from ‘e-commerce supply or services’ made or provided or facilitated by or through it:
For this purpose, the term ‘e-commerce operator’ is defined to mean “a non-resident who owns, operates or manages digital or electronic facility for online sale of goods or online provision of services or both”.
The expression ‘e-commerce supply or services’ is defined to mean:
The expansive language used to define ‘e-commerce operator’ and ‘e-commerce supply or services’ could potentially cover all sorts of digital transactions into India, including transactions between non-resident entities that have at best a tenuous nexus with India. It is doubtful whether transactions between two non-residents would create nexus with India merely because advertisements target Indian customers. Even under Goods and Services Tax (“GST”) when mostly online services are provided to customers located in India, there are multiple criteria that needs to be satisfied as a matter of fact for nexus with India to be established. Such criteria is lacking in the new provisions except for the mention of IP addresses or that the customer is a resident in India. Mere accessibility of a website or advertisement is internationally still understood to be insufficient to create taxable nexus in a country and such a view is also supported by decisions of courts in India. Further, even the sale of data, relating to a person resident in India, between non-residents should not have any nexus with India. To that extent, the constitutional validity of parts of the above provision may come into question.
When applied, the provisions purport to tax sale of data between non-residents (and not other forms of use of data such as license or shared data), irrespective of when it was collected in the past and irrespective of its current location or ownership. Problems can also arise in determining the residency status of customers in India as a matter of fact and it is unclear what activities would constitute as ‘targeting’ a customer in India. It is further unclear whether mere accessibility of an advertisement is sufficient to trigger the provision or something more intentional is required. Even assuming a more intentional act is required the burden of proof should still lie on the tax department in such situations to prove that the intention of the advertisement was to target a person resident in India. While this may be clear in many cases, it is still possible to cause confusion in cases where the target market was for instance the USA, but such websites are accessible from India.
The expanded EL is also in furtherance of the Government’s attempt to tax non-residents on business profits derived from India that would otherwise remain non-taxable in India on account of physical presence-based permanent establishment (PE) tests. Once implemented, the expanded EL could impact several global digital players and a variety of business models.
The application of the expanded EL to non-resident e-commerce operators is subject to certain de minimis thresholds, including a turnover threshold of INR 2 crore (USD 0.2 million approx.), which is significantly higher than the INR 100,000 (USD 1318 approx.) threshold applicable under the existing rules. If the sales, turnover, or gross receipts of the e-commerce operator from the e-commerce supply or services made or provided or facilitated is less than INR 2 crore in a given financial year, the expanded EL shall not be charged. In addition to this threshold, the EL shall also not be charged in cases where: (a) the e-commerce operator making or providing or facilitating e-commerce supply or service has a PE in India and such e-commerce supply or service is effectively connected with such PE; or (b) the e-commerce supply or service is subject to a 6% EL under existing rules.
Income of e-commerce operators on which the expanded EL has been paid would continue to remain exempt from income-tax in the same manner as under the existing rules for EL on specified services.
A major point of departure between the expanded EL and the current rules relates to collection and recovery of EL. Whereas the EL on consideration for specified services in the nature of online advertising is to be deducted and paid to the Government by the Indian payer, no such obligation has been imposed on the person making payment to the e-commerce operator. Instead, the expanded EL shall be paid directly by the concerned e-commerce operator to the Government on a quarterly basis. Failure to pay the whole or any part of the EL renders the e-commerce operator liable to pay simple interest at 12% p.a. on the delayed payment and a penalty equal to the amount of EL that it failed to pay.
The proposed expansion in scope of the EL creates several ambiguities and challenges, including:
It should be noted that an expanded EL was not contemplated when the Union Budget was presented earlier this year but is likely intended to compensate for the expected shortfall in Government revenue on account of COVID-19 and the global economic slowdown.
Unlike the revised Significant Economic Presence rules, the expansion of EL will have an immediate impact on all foreign e-commerce operators irrespective of their state of residence or the availability of treaty benefits. Foreign e-commerce operators should therefore review their current operations in India or in relation to Indian customers or data and assess potential risks from the implementation of the expanded EL.
This also demonstrates the keenness on part of the Government to tax income derived from monetization of data collected from Indian residents since this expanded EL is in addition to other changes brought about to significant economic presence rules that also target similar income streams. In fact, while the Organization for Economic Co-operation and Development (“OECD”) is finalising the position on taxation of digital transactions, the end result of these Amendments is that foreign digital players shall be required to pay taxes one way or another, either as EL or as income connected with a permanent establishment. Despite earlier criticisms that the introduction of the EL was an intentional treaty override, India continues to pursue taxation of such income streams through all means possible.
3. EXTENSION OF LOWER WITHHOLDING TAX RATES TO ROYALTY PAYMENTS
Section 194J of the ITA imposes a TDS obligation of 10% on certain payments, including fees for technical services (“FTS”) and royalty, to be made to residents.
Taking note of the large number of pending cases on the characterisation of certain payments as FTS and the TDS rate to be consequently applied, the Finance Bill had proposed to amend section 194J to reduce the TDS rate in respect of FTS from 10% to 2%, while maintain a 10% TDS rate on all other payment specified in that section including ‘fees of professional services’ and ‘royalty’.
It is now proposed to extend the lower TDS rate of 2% to payment of any sum by way of royalty, where such royalty is in the nature of consideration for sale, distribution or exhibition of cinematographic films. In all other cases, the 10% TDS rate will continue to be applicable.
While this extension of the lower TDS rate to royalty is a welcome move, its applicability in the context of outright sale of cinematographic films is nuanced. This is because an outright sale of Intellectual Property (“IP”) is ordinarily characterised as transfer of a capital asset and any income arising therefrom is consequently taxed under the head ‘capital gains’. On the other hand, the term ‘royalty’ usually refers to payments for the use or right to use (but not for the transfer of) any copyright, patent, trademark or other IP assets. Even under Indian copyright law, the ownership of copyright in IP assets (including a cinematographic film) can be transferred only through a written assignment agreement, and the assignee will be treated as the owner (and not the licensor) of the copyright to the extent it is assigned. Even under tax laws, the definition of royalty excludes situations that result in capital gains. To this extent, the proposed amendment to section 194J should be understood in light of the above when it comes to sales of cinematographic films.1
4. AMENDMENTS TO TAXATION OF DIVIDENDS – AN INCOMPLETE RESPONSE TO INDUSTRY CONCERNS
In a landmark step, the Finance Bill had proposed the abolition of the DDT– a 15% additional income-tax payable by Indian companies on amounts declared, distributed or paid by them as dividends and instead move to the classical system of taxing the shareholders on the dividends received. Several amendments were proposed to the ITA to provide a mechanism for taxation of dividends going forward, and to enable a smooth transition out of the DDT regime.
Amendments proposed to the Finance Bill provisions pertaining to abolition of DDT, with a view to clarify certain inconsistencies, are as follows:
The move in Finance Bill to abolish the DDT was a long-awaited change, one that industry participants had been hoping for years, considering the anomalies the DDT regime was creating particularly in the cross-border context – such as availing of foreign tax credit of the DDT by a non-resident shareholder. While the change was welcome, some unintended aspects created significant side-effects in hurting investor morale – particularly the incongruity in taxation of distributions by REITs and InvITs. The changes proposed now through the Amendments are largely corrective, indicative of a responsive government. However, the amendments partially reinstating exemption for distributions received by unit holders are bitter-sweet at best, considering the requirement of the underlying SPVs (particularly existing ones) to forego a number of deductions and allowances it can otherwise avail under the ITA.
5. AMENDMENTS TO TAXATION OF SOVEREIGN WEALTH FUNDS – HALF BAKED MEASURES
The Finance Bill had proposed a new provision in respect of exemption to SWFs. The provision provides exemption to SWFs from income which is in the nature of dividend, interest or long-term capital gains which is earned by SWFs when investment by the SWF is made in the infrastructure sector, subject to fulfilment of specified conditions. This was done with a view to encourage long term stable capital participation from SWFs into India’s infrastructure space. Several suggestions were made to the Finance Ministry for amendments to the proposed exemption from the viewpoint of making it more effective.
Amendments proposed to the Finance Bill provisions pertaining to tax exemption granted to SWFs are as follows:
While the Government has taken steps to reduce the ambiguity pertaining to availment of the exemption, there still exists a lot of ambiguity in certain aspects. For example, there is no definition of SWFs or pension funds, and question therefore arises whether entities recognized as SWFs / pension funds in their countries of existence should suffice for the purposes of this exemption. Further, the scope of ‘infrastructure facility’ for the purposes of this exemption is restricted to its definition under section 80-IA (4)) and hence very narrow. The Government should have extended it to all sectors classified as ‘infrastructure’ under the harmonized master list of infrastructure sub-sectors notified by the Department of Economic Affairs, Ministry of Finance. Further, there is no clarity yet on whether SPVs of SWFs / pension funds – including the ones located in other jurisdictions – should be covered. Technically, wholly owned SPVs set up by SWFs should also be given the same treatment as that of an AIF. Other than that, investment into a private equity fund by an SWF which invests into an infrastructure facility in India should have also been given the exemption.
The Amendment also provides powers to the Central Board of Direct Taxes (“CBDT”) to issue guidelines for the purpose of removing difficulties that may arise and provides that such guidelines will be laid before each House of Parliament and shall be binding on the income-tax authority and the taxpayer. The Amendment further provides that if during the year the conditions provided to avail the exemption are not satisfied, the income shall become taxable and the exemption will not be available to the taxpayer in such circumstances.
6. AMENDMENTS TO RESIDENCY RULES UNDER THE ITA: FLIP FLOP ON RESIDENCY RULES FOR INDIVIDUALS
Finance Bill had introduced a slew of changes to expand the scope of Indian tax residency for individuals, primarily aimed at increasing the tax liability of Non-Resident Indians (“NRIs”), Person of Indian Origin (“PIOs”) who spend substantial time in India. To summarize, these changes were as follows:
The Stateless Person Test appeared to target individuals who do not spend considerable amount of time in any country so as to be treated as tax residents of such foreign countries. Specifically, this proposed amendment garnered a lot of criticism from the NRI community, especially from persons working bona fide in a foreign jurisdiction like UAE, where individuals are not subject to income taxes.
To allay such concerns, the CBDT issued a clarification stating that the Stateless Person Test should not affect bona fide workers in other countries such as the Middle East and that such individuals will only be liable to tax on India sourced income.
In furtherance of the above, few more changes have been proposed to these provisions through the Amendments, as discussed below:
The RNOR status granted to Indian citizens, PIOs abroad who do qualify for the Stateless Person Test or the New Visit Test is a well-intended move to protect the tax residency status of such individuals and ensure that the worldwide income of such persons is not taxed in India. However, the manner in which the new tests have been introduced and consequent granting of RNOR status is confusing, convoluted, and unnecessary as the proposed implications of being a resident by virtue of the New Visit Test and Stateless Person Test appear to be negated by the RNOR status introduced. The ultimate result of these amendments is to differentiate between PIOs and Indian citizens who meet the New Visit Test or Stateless Person test as the case maybe, and accordingly qualify as RNORs, as opposed to non-residents, which is the case when the Threshold is not met in each of the two tests. The difference between a ‘non-resident’ status and RNOR status is with respect to the taxation of income from a business or profession controlled from India in the hands of the RNOR. This is nothing but a theoretical distinction, and therefore in effect the Amendments make no change from the existing law. It is not clear what the intention was to do this flip flop, especially considering the issue raised in the Memorandum explaining the provisions to the Finance Bill regarding taxation of stateless persons who don’t pay taxes in any jurisdiction is not being addressed.
Lastly, given the COVID-19 pandemic and consequent travel restrictions and country-wide lockdowns being put in place, it is difficult for non-resident individuals travelling to India or on a visit to India to return back to their home jurisdiction. An exemption for such a situation to count towards the day count test would have been a welcome move. The presence of such non-residents in India owing to the pandemic could also trigger Indian tax residency for companies and other legal entities incorporated outside India, and an exemption in this regard would have offered some comfort to the affected persons.
7. AMENDMENTS TO PROVISIONS RELATED TO TCS ON LRS REMITTANCES – AMBIGUITY PREVAILS
Section 206C of the ITA imposes a tax collection at source (TCS) obligation on specified persons in respect of profits and gains from business of trading in specified goods. Finance Bill had proposed to expand the scope of section 206C by introducing TCS on sale of overseas tour packages, sale of goods in excess of INR 5 million (USD 0.7 million approx.) and overseas remittance by a ‘buyer’ under the Liberalized Remittance Scheme (LRS).
As per the Finance Bill, the obligation of TCS on remittances under LRS was to be imposed on authorized dealer banks at the rate of 5 % on the aggregate amount of remittance. Importantly, the term ‘buyer’ was not defined which led to questions such as whether remittances made by individuals for purchase of non-trading capital goods such as overseas shares under the LRS should also be covered. Even if so, there was no clarity on whether it would cover primary or secondary purchase of shares, or both considering that a primary is not a sale and therefore there can be no seller or buyer.
The Amendments proposed to the Finance Bill provisions pertaining to TCS on LRS remittances are as follows:
While these amendments have provided more clarity in respect of the newly introduced TCS obligation on LRS remittances, some important questions such as whether it is applicable on purchase of capital goods such as overseas shares (whether by way of primary or secondary transactions), particularly owing to the fact that the term ‘buyer’ for the purpose of TCS on LRS is still not defined, continue to remain.
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1 Please note that the language of the amended section as set out in the version of the Finance Bill, 2020 which is available on the Lok Sabha website appears to have a typographical error. The amended language may have been inserted at the incorrect place, resulting in the section referring to “professional royalty”. We believe this to be a mistake and that it shall be corrected shortly.
2 Section 115U, ITA