Over the past four years 137 countries have engaged intensively with the OECD to find a solution to the tax challenges arising from digitalisation. Like any international agreement, finding a middle ground has been difficult and series of compromises were made. It was agreed intially the unique features of the digital economy- ability of a corporation to seamlessly operate across borders as well as the significant contribution of users and their data to profits- made it hard to tax. Yet, it was not clear the how profits were to be pinned down to any jurisdiction and thus became a political issue. Especially, since the largest techology companies are tax residents of developed countries and redefining digital presence as the basis of taxation would potentially allow large markets like India more right to tax.
The OECD’s work reflected the divergence in expectations among countries with regard to the ideal solution. Developing countries wanted that profits arising from digital operations should be fractionally apportioned to markets while developed countries believe that fraction of residual profit, mainly arising from marketing functions, should be taxed in markets. Such diveregence in thinking compelled countries to implement unilateral measures. India was the first country to implement a gross equalisation levy on turnover- in 2016. The unique feature of the tax is that it is not covered by tax treaties. So while the income tax act does not apply to the levy, credit is available for the tax paid by company in its home country. Similarly, several other countries including France, UK, Italy and Spain announced or implemented a digital services tax. In 2021, India further expanded the scope of equalisation levy from digital advertising to a range of e-commerce services. This pressured the US and the OECD to respond. The US intiated the US Trade Representative investigations asOECD paced its work. The investigations found DST to be discriminiatry and in response US announced retaliatory tariffs. While the tariffs were to be levied to less siginificant items of US-India trade, the DSTs encouraged the US to actively participate in finding a consensus based solution. As talks progressed, the OECD announced that the issue of allocation of taxing rights would be actively considered and two pillar approach was adopted. The first pillar was to define the rules for taxing digital companies. In 2021, after change in the administration, the US agreed to back the proposal. However, pillar one was to go beyond digital companies and apply to large companies with annual revenue over Euro 20 billion. The highly complex and administratively ardous solution now covers many multinationals from diverse sectors and countries. To ensure certainty to taxpayers, the solution will require excessive global coordination. For this an entirely different process of dispute resolution panel is being created. Whether this will undermine sovereignty, remains to be seen.
Therefore it is important to consider if the consensus approach is worth pursuing. The collections of equalisation levy have increased manifold since its implementation and are now close to INR 4000 crores. One way to assess the relative gain is to compare revenue from equalisation levy with the receipts under Pillar one. I estimate that India may gain only INR 1000 crore in the best case scenario or may otherwise end up losing revenues. In fact, the EL may apply to companies that are not be covered by OECD proposal, leaving one to wonder whether it will truly address the tax challenges from digitalisation.
In such a case, India’s stance on the OECD’s approach must be calibrated. Current tax collections indicate that the EL can level the playing field between digital and brick and mortar corporations, through behavioural change or higher taxes. Further, corporations that argue in favour of simplicity must also consider the potential benefits from an EL like tax, which sets aside the complications of attributing profits to complex functions.
The continued support for the OECD solution, depite the costs, is the criticality of US’ participation. As per the estimate of USTR, 72% of the companies covered by EL in India are US companies. Therefore, unless countries negotiate with the US, tax challenges will persist. In fact, there is no unanimous support for the Pillar One proposal in the US as well. A reason for this may be that the US could lose about 0.1% of its tax revenues.To compensate for that the global minimum tax is being proposed as a package deal. In effect, the OECD approach creates a fiction of reallocation, where the profits reallocated through Pillar one could in fact be compensated for by taxing back global profits taxed below 15%. As per Pillar One proposal, DSTs will be removed once the OECD approach is ratified in 2023. It is imperative therefore that countries assess the price of compromise.
Suranjali Tandon, is Assistant Professor, NIPFP, New Delhi.
The views expressed in the post are those of the authors only. No responsibility for them should be attributed to NIPFP.
This article was published in 'The Indian Express' on April 23, 2022.