India Regulatory Brief: Digital Equalization Levy of 6 Percent and New Tax Proposed on Startups with Falling Valuation

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Digital Equalization Levy of Six Percent from June 1, 2016

The Finance Act 2016 has introduced a digital equalization levy, or ‘Google tax’, of six percent, with effect from June 1. It is applicable only in the case of business to business transactions. When a person makes the payment to a non-resident (without permanent establishment) that exceeds an aggregate of US$ 1493 (Rs 1 lakh) a year, a withholding tax – at six percent of the gross amount paid – is imposed as equalization levy.

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Compliance will require companies to file an online form stating the specified services provided by June 30, 2017. There are other online forms available in case of disputes, better enabling the assesse to appeal against the order of the assessing officer. Specified services that are covered by the levy include online advertising, provision for digital advertising space, rights or use of software for online advertising, including advertising on radio and television, designing, hosting or maintenance of websites, digital space for website, e-mails, blogs, facility for online sale of goods or services or collecting online payments.

The move is aimed at taxing digital portals and foreign e-commerce companies that get significant online advertisement revenues from India, like Alphabet Inc., Facebook Inc., and Twitter Inc. etc. Moreover, the new rules are in keeping with the Base Erosion and Profit Sharing (BEPS) action plan proposed by the Organization for Economic Co-operation and Development (OECD). They are also said to have incorporated the recommendations of a panel set up by the Central Board of Direct Taxes (CBDT), which included industry representatives.

Startups with Marked Down Valuations May Face New Tax

The income tax department is proposing a controversial levy on firms whose valuations have been marked down. The rationale is that since their valuations have fallen, the first premium exceeded the startup’s fair value. Such excess consideration is taxable in the hands of the startup, as an income, as mentioned in Section 56 (2) (vii) (b) of the Income Tax Act, 1961.

Tax officials have requested that several startups provide their detailed valuation reports for each round of investment. Also, the income tax department has defended the tax move stating that their objective is to track the flow of black money – whereby unaccounted cash is invested in a startup at a premium to get converted into legal money.

Though a formal notification of the new tax levy is yet to come, it is a double whammy for startups in India. Many of them (including a few unicorn firms like Flipkart) are already facing downward valuations and declining funding prospects due to fears of lack of profitability, unrealistic growth plans, and intense competition. Nevertheless, the new tax could only impact those investments made by angel investors and funds not registered with Securities and Exchange Board of India (SEBI); those who are funded by registered venture capital funds may be safe.

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RBI Asks Commercial Banks to Implement Cyber-Security Policy Immediately

The Reserve Bank of India (RBI) has advised all scheduled commercial banks in the country to immediately implement a cyber-security policy. The directive towards cyber-security preparedness comes in the light of the increasing vulnerability of financial institutions to online attacks.

In its notification released on June 2, the RBI said “Banks should immediately put in place a cyber-security policy elucidating the strategy containing an appropriate approach to combat cyber threats given the level of complexity of business and acceptable levels of risk.” Commercial banks are now required to identify potential risks as “low, moderate, high, and very high” and report all “unusual cyber-security” to the RBI. The cyber-security policy should also be distinct from the bank’s broader IT policy.

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