The End of Equalisation Levy 2.0: A New Beginning or Just the Tip of the Iceberg?

As the Union Budget 2024 ushers in a slew of changes, one of the most talked-about developments is the abolishment of the Equalisation Levy 2.0—a 2% tax that had been levied on foreign companies conducting digital business in India. This move, while lauded by many as a step towards a more business-friendly environment, leaves behind a landscape that still demands careful navigation, particularly around the concept of Significant Economic Presence (SEP).

Equalisation Levy 2.0: A Brief Recap

Introduced in 2020, the Equalisation Levy 2.0 was India's attempt to tax the digital economy, ensuring that foreign companies benefiting from the Indian market also contributed to the exchequer. The 2% levy applied to non-resident e-commerce operators, impacting major global players who offered services or products to Indian customers without having a physical presence in the country.

The levy was controversial from the outset. On one hand, it was seen as a necessary measure to ensure fair taxation in the digital age. On the other, it was criticized for its unilateral nature, creating tensions with countries where these foreign companies were based. The global discourse around digital taxation, coupled with ongoing negotiations at the OECD, made the Equalisation Levy a hot topic of discussion in international tax circles.

The End of an Era, But What Lies Ahead?

With the Union Budget 2024, the Indian government has decided to discontinue the Equalisation Levy 2.0, effective from August 1, 2024. This move is likely a nod to the evolving global consensus on digital taxation, particularly the two-pillar solution being developed under the OECD framework.

However, while the Equalisation Levy may be gone, the principles that underpinned it have not disappeared. The concept of Significant Economic Presence (SEP), introduced in the Indian tax laws in 2018, remains very much alive. SEP is a broader concept aimed at capturing income from digital transactions where a foreign entity has a significant economic footprint in India, even without a physical presence.

SEP and the Risk of Permanent Establishment (PE)

The abolition of the Equalisation Levy does not mean that foreign companies can now relax. SEP provisions continue to hold ground, meaning that if a foreign company has a significant economic presence in India, it could still be deemed to have a Permanent Establishment (PE) in the country. This would bring its profits attributable to India under the purview of Indian taxation.

For businesses, this raises an important consideration: How to structure transactions to avoid triggering SEP and, consequently, PE in India?

Navigating the New Landscape

While the Equalisation Levy 2.0 might be off the table, SEP rules are here to stay. Organizations must now be more vigilant than ever in arranging their transactions. Here are some key steps that businesses should consider:

1. Review Digital Business Models: Companies should carefully examine their digital operations and business models to assess whether they fall under the SEP criteria.
2. Transaction Structuring: Transactions should be structured in a way that minimizes the risk of crossing the SEP threshold. This may involve rethinking contractual arrangements, pricing strategies, and customer interactions.
3. Documentation and Compliance: Robust documentation and compliance practices will be essential to demonstrate that a business does not have SEP in India, thereby avoiding the risk of being classified as a PE.
4. Stay Updated with Global Developments: The landscape of digital taxation is rapidly evolving, with global initiatives like the OECD’s two-pillar solution coming into play. Companies should stay informed and adapt their strategies accordingly.

Conclusion

The discontinuation of the Equalisation Levy 2.0 marks a significant shift in India’s approach to taxing the digital economy. However, the principles underlying the levy, particularly the concept of SEP, continue to pose challenges for foreign businesses. As India aligns more closely with global tax standards, organizations must remain proactive in navigating this complex landscape to avoid unintended tax liabilities.

The abolishment of the levy might seem like the end of a challenging chapter, but in reality, it is just the beginning of a new phase in international taxation. Businesses that take the time to understand and adapt to these changes will be better positioned to thrive in this evolving environment.