Is 'Google Tax' Making Start-Ups a Tax Scapegoat ? This directly pushes up their cost of acquiring customers and quite possibly hit their growth metrics.

Looking factually among the next breakout economies, India is the largest pie of the future bread and butter to several large digital ad networks – the Googles and Facebooks of the world – thanks to its more than 277 million Internet users, second only to China and ahead of the US. In fact, it already is to a large extent albeit without any credit given to it in the form of taxes. Google tax, the name given to the equalization levy, was introduced in last year's budget to therefore tax foreign ad networks earning revenues from digital advertisers in India, which unfortunately backfired with controversy of being ill-fated for start-ups.

Google tax brings under ambit all the companies which don't have a permanent base in India and offers online advertising services to Indian businesses (B2B transactions) and hence, avoid payment of taxes on income accrued via such services in the absence of any law for it. The government hence levied six per cent Google tax on payment of Rs 1 lakh or more by customers in a financial year but since these are foreign entities, the onus to deduct the tax amount and file to the government fell back on the customers, Indian businesses, of these large technology companies.

At Google/Facebook Mercy?

As presumed, the biggest impact will be on start-ups and small businesses that might have to deposit that amount from their own pocket and penalty too in case of delay or failure to pay, if service providers pull themselves back from paying this amount. For e.g., for every payment of Rs 100, start-ups will have to pay Rs 106 instead of Rs 94.

"This is a direct tax collected in an indirect manner. It is like I have to pay someone else's income tax. This makes businesses completely dependent on the benevolence of bigger companies like Google and Facebook," says Subho Ray, President, Internet and Mobile Association of India (IAMAI).

A typical online start-up in India spends upwards of 70 per cent of its marketing budget on digital means to acquire customers, on which depends their growth rate, volume, valuation, funding etc. This directly pushes up their cost of acquiring customers and quite possibly hit their growth metrics.

"When the equalization levy was introduced, the foreign companies refused to pay the six per cent and instead asked business to shell out the extra from their own pocket. This additional six per cent cash flow will be the burden for start-ups," says Rakesh Nangia, Managing Partner, Nangia & Co. – a premier tax advisory firm based in Noida.

This is amid reports of hike from six to eight per cent tax and a proposed imposition of it on related services like cloud computing, website designing and hosting, etc," as per the February 2016 report by committee formed under Central Board of Direct Taxes for taxation on e commerce. "Already there is lot of paperwork. For every payment made, particularly to Facebook outside India, there is a significant paperwork involved over and above the service tax that we have to take care off. So it is further difficult for us to work with any digital foreign firms," says Sujayath Ali, CEO and Co founder, Voonik – Bengaluru-based online fashion store for women.

No State of Panic

However, when it comes to paying that extra six per cent, passed on from their technology vendors, startups doesn't seem to be panicking. Among the few start-ups that raised funding in the drought since last year, Furlenco – a furniture rental platform had initial hiccups with Google tax, however, there hasn't been any visible impact. "There was some confusion initially when Facebook asked us why there was deficit in payment. So we explained them and filled a form that they asked for and that was it," says Ajith Mohan Karimpana, Founder, Furlenco. The start-up in October last year raised an impressive $30 million.

Ali too is confident of these service providers remaining unfazed with any impact on their margins. "They are running a very high gross margin business. For them, it is not an increase in raw material cost that will be passed on to their customers," adds Ali.

Akhil Gupta, who co-founded "broker-less' real estate platform, NoBroker, in 2014, however, had to pay initially the levy until they could convince the technology companies to accept payments at a discount as per the law. "Around 75 per cent of our marketing spend goes on digital medium and most of these companies are registered outside India. So we paid the equalization levy as well. However, we got into the agreement that we will deduct the levy on their behalf," says Gupta.

Google tax is also seen by many as a burden in addition to the new 15 per cent service tax. And, if Goods and Services tax become effective in April this year, then it can take the combined tax to either 25 or 38 per cent including the Google tax, as per IAMAI. "Here double tax law comes into the picture," says Gupta. IAMAI as the industry voice has even called the six per cent rate irrational drawing comparison with other countries. "Globally it is not more than two per cent. There is no objection in paying the tax even as companies have been appealing to make it rational," says Ray.

The other alternative to the levy can be a part of revenues to be offered by the foreign companies to the government which they have so far rejected to comply with. However it will be worth noting how start-ups and service providers behave once GST kicks in.

(This article was first published in the February issue of Entrepreneur Magazine. To subscribe, click here)