June 24, 2020 6:18:35 pm
By Shilpa Goel and Ashish Goel
On June 2, the office of the United States Trade Representative (USTR) announced that it is beginning investigations into digital services taxes that have been adopted, or are being considered, by several countries and the European Union. The investigations shall be conducted under section 301 of the US Trade Act, 1974, which vests the USTR with broad authority to respond to a foreign country’s action that is unfair or discriminatory and may negatively affect US commerce.
In the Indian context, the USTR is seeking to investigate the two per cent equalisation levy that applies to revenues of e-commerce suppliers and service providers from April 1. Pertinently, India was the first country in the world to introduce a 6 per cent equalisation levy in 2016, but the levy was restricted only to transactions involving online advertisements or provision of digital advertising space by foreign companies to Indian residents. The 2020 levy, however, is much broader in scope and involves all kinds of online transactions.
Unlike what the US government would have us believe, the Indian equalisation levy is informed purely by tax, and not some extraneous, considerations. In other words, the levy is inspired not by the idea of discriminating against US businesses as the US government seems to suggest, but it instead seeks to update the century-old principles of international tax law, which have largely outlived their utility in today’s digitalised era. Highly digitalised businesses that rely on hard-to-value intangible assets, data and automation can obviate a physical or representative presence in the market jurisdiction, which is a prerequisite for source-country taxation under the double taxation avoidance agreements.
Such is the salience of the issue that the Organisation for Economic Cooperation and Development (OECD) put digital economy taxation first on its agenda when it embarked upon an ambitious 15-point base erosion and profit shifting (BEPS) project in 2013 to revamp international tax rules. While the BEPS project did churn out key proposals pertaining to how multinational corporations should be or ought to be taxed, the OECD failed to reach consensus on how taxing rights should be better allocated in an increasingly digitised economy.
The absence of a multilateral solution to a rather complicated problem of allocation of taxing rights in a digitised economy led several countries in the EU (and elsewhere) to introduce digital services taxes. Unilateral action on the part of these countries, including India, to tax digital companies alarmed the US government, and for obvious reasons. Some of the world’s largest online companies are based out of the US and the profits that these businesses earned are primarily taxed, if at all, in the US. However, changes to rules on allocation of taxing rights between source and market jurisdictions mean that the US would get to enjoy a much smaller part of the tax pie.
But this is a change whose time has come. No matter what the US government says, there are strong reasons to support India’s right to tax digital businesses in the way it has sought to. The primary justification for the tax flows from the fact that digital businesses routinely interact with the users located in the Indian market to earn revenues and create value. Besides, the Indian government allows foreign digital businesses to use the country’s infrastructure, including a stable legal and economic system, and offers protection of intellectual property rights. And, in any event, the levy is not specific to large US digital companies (such as Facebook and Google) but extends to all non-resident digital service providers, given the low applicability threshold of Rs 20 million.
Pertinently, the implications of the USTR investigation for India could be onerous. Last year, a similar investigation was conducted by the USTR into the French digital services tax, leading to billions of dollars of tariffs on French goods. There is a strong possibility that the US government would respond to India’s equalisation levy with similar retaliatory tariffs. Should India decide to discontinue or reconsider its levy in view of the impending investigation, the Indian exchequer would undoubtedly suffer a severe a hit, especially at a time when the Indian economy is already reeling from the COVID-19 pandemic.
But India is not alone in this digital tax war that the US has sparked. The section 301 investigations cover nine countries and the European Union. Several countries in the European Union, including Italy, France, and the UK, have sent strong messages to the US government that an update of archaic international tax rules is much overdue to account for the digitised economy. All these nations should dig in their heels and not give the US government a free ground on the issue of digital economy taxation. Of course, a win-win situation for these governments would be to wait for the OECD Inclusive Framework, which involves 137 jurisdictions, to come up with a permanent multilateral solution to the underlying problems.
The writers practice law in the Supreme Court
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