1. Introduction

Does the OECD’s project for countering Base Erosion and Profit Shifting (BEPS) permit a party to a tax treaty (a Contracting State) indulge in ‘treaty override’ (i.e. violate its tax treaty obligations)? Does it permit, in a tax treaty situation, the Source State taxation of business profits even if they are not attributable to a permanent establishment in the Source State?

For analyzing the above-mentioned questions, we may consider the Indian version of equalisation levy as a ‘test case’. The Indian equalisation levy came into force with effect from 1 June 2016, and it is imposed by way of a deduction (withholding) from consideration for ‘specified services’ payable to non-resident service providers not having a permanent establishment (PE) in India.

The stated rationale behind the Indian equalisation levy is to provide an effective mechanism for securing a fair tax share in the targeted non-resident enterprises’ incomes from Indian customers. Probably, it may also appear as a potential solution for overcoming the limitations of the concept of ‘permanent establishment’, evolution of which has not kept pace with technological developments. But it is fraught with an engrained vexing question: is it compatible with India’s existing bilateral tax treaty obligations?

For the reasons explained in this article, in the author’s view, the Indian equalisation levy is incompatible with Art. 7 (Business profits) of India’s tax treaties. This view is based on a careful analysis of the Indian tax authorities’ attempt to tax income from digital businesses, the BEPS Action Item 1 final report, the inherent nature of the Indian equalisation levy and its comparison with its OECD counterpart (as discussed in the BEPS Action Item 1 Final Report), and its inapplicability in a situation where a permanent establishment exists. 

 

Further, while reaching the above-mentioned conclusion, it is also important to take into account certain judicial developments in Brazil. In those decisions, the Brazilian tax authorities’ attempt to circumvent Art. 7 (Business profits) of tax treaties – on the lines somewhat similar to the Indian equalisation levy – were held to be in conflict with Art. 7 and hence rejected.