Taxation of digital companies has been a key concern for G20 countries. The agenda to reform international tax law so that digital companies are taxed where economic activities are carried out was formally framed within the OECD’s base erosion and profit shifting programme. Seven years since its inception, it is still work in progress. Worried they might cede their right to tax incomes, many countries have either proposed or implemented a digital services tax. India is amongst the first to have implemented an equalisation levy in 2016 which sought to tax payments made for online advertising services to a non-resident business by residents. Subsequently in March 2020, it expanded the scope of the existing equalisation levy to a range of digital services that includes e-commerce platforms. Any payment made by non-residents in connection with an Indian user will now attract 2 per cent levy. Such an approach is often viewed contrary to the ethos of international agreements that are negotiated on commonly agreed principles. However, the proliferation of digital service taxes (DSTs) is a symptom of the changing international economic order. Countries such as India provide large markets for digital corporations that seek a greater right to tax incomes.
Apprehensive that DST’s could become the norm, in June 2020, the US initiated USTR investigations under section 301 of the Trade Act 1974 against 10 jurisdictions, including India. The intent of this inquiry is to find if DSTs are discriminatory against the US corporations. The report released in January 2021 confirmed that India’s equalisation levy is unreasonable for its sudden implementation and retrospective application, and is discriminatory since of the 119 companies to which it is likely applicable, 72 per cent are US based and burdens or restricts US commerce since this can result in double taxation. It cannot be dismissed that the tax can result in over taxation since the company will not be able to claim any credit for tax paid on Indian sales. Further, the clarifications have not been made available. However, it is predominantly applicable to US companies since the market for digital services is dominated by US based firms. The law itself in no way discriminates based on size of operations or nationality, and has no retrospective element. Any company that has a permanent residence in India is excluded since it is already subject to tax in India. For example, if there is a company A that has a local subsidiary or is registered entity no levy is payable. On the contrary, if firm B operates services in India, but its billing address is registered in Ireland then the levy will be charged on payments to this entity from India. It has also been suggested by experts that such taxes can be passed on to consumers as higher costs of services. While the Indian customer may not pay this as a tax, this could mean higher prices contrary to the claim that it taxes the company. The USTR investigations pose a threat of retaliatory tariffs. In a similar investigation for France’s DST, the US responded with the threat to levy tariffs on select French exports, implemented in January 2021. However, these were suspended in light of other ongoing investigations. As it seems trade is now a new collateral of tax negotiations.
The core problem that the international tax reform seeks to address is that digital corporations, unlike their brick and mortar counterpart, can operate in a market without physical presence. The current basis for taxing a business in a particular jurisdiction is based on a notion of fixed place of business. To overcome this challenge, countries suggested that a new basis to tax, say, number of users in a country, could address the challenge to some extent. The EU and India were among the advocates of this approach. In 2018, India introduced the test for significant economic presence in the Income Tax Act. However the proposal of a revised nexus was not supported widely. Moreover, to give effect to a new nexus would require bilateral renegotiation of tax treaties that supersede domestic tax laws. Meanwhile, the OECD continued to work to find commonalities among a range of solutions. In October 2020, it released the blueprint of the solution that it seeks to finalise by June 2021. But, consultations held with stakeholders this month do not inspire confidence. In its current form, the solution is too complex to administer and proposes to allocate residual profit — a term that has no economic definition, thus calling into question the gains. It would also require political consensus on multiple issues including sensitive matters such as setting up of an alternative dispute resolution process comparable to arbitration. This can strain the already short administrative capacity and increase burden of compliance. To add to this, the US has expressed its preference to apply this the measure on a safe harbour basis which can limit the companies to which it may be applicable.
As countries carefully calibrate their response to competing demands for sovereignty to tax, DST’s are an interim alternative outside the scope of tax treaties. It possesses the advantage of taxing incomes that currently escape tax and creates space to negotiate a final, overarching solution to this vexing conundrum.
Suranjali Tandon, is Assistant Professor, NIPFP
This article first appeared in the print edition of Indian Express on January 21, 2021, under the title “The Cyber Tax Conundrum”.
The views expressed in the post are those of the authors only. No responsibility for them should be attributed to NIPFP.