The withdrawal of the 2% e-commerce equalization levy, effective Aug. 1, is one of the most far-reaching measures for the digital sector announced in the Indian Budget 2024 and proposed by Finance Bill 2024.
The withdrawal of the 2% levy is expected to benefit offshore digital services companies with Indian customers, particularly US-based digital services companies. A majority of in-scope companies subject to the levy were US-based, as noted by the Office of the United States Trade Representative, or USTR, in its 2021 report.
While the withdrawal of the 2% levy may be welcomed by multinational enterprises, the wider geopolitical and trade-related objectives from an Indian government perspective remain unclear, particularly considering that the June 30 deadline on the OECD’s Pillar One Amount A proposal has passed, and since prospects for Pillar One largely depend on US buy-in.
The withdrawal of the levy is partial because the original 6% equalization levy continues to apply. India introduced an equalization levy of 6% in 2016, applying to nonresidents providing online advertisement services or digital advertising space targeted at Indian customers.
In 2020, the scope of the levy was expanded to introduce a 2% e-commerce equalization levy applying to nonresidents providing “e-commerce supplies or services”—covering a wide range of digital services, including cloud services and online gaming services—to Indian customers.
These measures were targeted at offshore companies with no taxable presence in India. Under the existing tax treaties physical presence was required, and the government felt that companies with digital operations in India should also pay taxes in India.
Where the 2% levy applied, the nonresident was generally also required to meet various compliance requirements in India, including filing yearly statements.
The policy rationale for the withdrawal, according to the Memorandum to the Finance Bill, stems from stakeholder concerns regarding the ambiguous scope of the 2% levy and consequent compliance burden for nonresidents.
Such issues may be fixable with less drastic measures, such as clarifications or amendments following stakeholder consultations, something global industry bodies, including a coalition of tech and trade associations, have sought in the past.
However, according to the Finance Minister’s speech during the post-budget press conference, while the 2% equalization levy was aimed at taxing nonresidents, it might in practice eventually be passed on to Indian recipients, for instance through higher prices. This would render Indian recipients worse off compared to nonresident recipients located in jurisdictions that didn’t impose a similar digital services tax.
As negotiations at the global level on the Organization for Economic Cooperation and Development Pillar One and Pillar Two proposals are ongoing, the withdrawal may also be seen as a step in a positive direction toward achieving multilateral consensus on a solution.
Another possible policy reason may be to avoid trade tariffs and other retaliatory measures that may potentially be imposed by the US in response to India’s unilateral levy. The USTR concluded in its report that the 2% equalization levy is discriminatory and restrictive of US commerce, and the compromise agreement between India and the US on this issue expired on June 30.
The withdrawal departs from the approach adopted by other countries such as Canada, which has decided to implement a unilateral digital services tax owing to the expiry of the Pillar One Amount A deadline. At the EU level, there have been talks on implementing a potential EU-wide digital services tax.
In line with these global trends and the failure to achieve multilateral consensus on Pillar One by the June 30 deadline, expectations from the Indian Budget 2024 included a possible expansion of the scope of the 2% levy. The withdrawal of the 2% levy is indicative of a shift in India’s policy stance, which suggests that negotiations on Pillar One are still ongoing (despite the expiry of the deadline) and that India intends to wholeheartedly move toward achieving consensus on a multilateral solution.
The original 6% levy, which specifically targets online advertisement services, was structured as a withholding tax on Indian residents, as opposed to the 2% levy that was applied to nonresident companies. While the withdrawal of the 2% levy is welcome, it is still a partial withdrawal since the 6% levy remains, and such a move isn’t indicative of a stable or holistic tax policy promoting tax certainty. If the 2% levy is proposed to be removed, on the same grounds the 6% levy should also be removed along with it.
But the removal of the 6% levy seems unlikely to happen in the near future. It may be one of the last remaining cards India has to play in the ongoing negotiations under Pillar One.
If Pillar One doesn’t achieve global consensus, for which US buy-in is necessary and which looks increasingly unlikely, India has given up a taxing right for no potential gain other than possibly not being subject to retaliatory trade measures by the USTR.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Meyyappan Nagappan is partner at Trilegal. Shweta Mallya is an associate at Trilegal.
