On June 2, 2020, Trump administration announced probe into digital services taxes that have been either adopted or are under consideration by its trading partners viz. Austria, Brazil, the Czech Republic, the European Union [EU], India, Indonesia, Italy, Spain, Turkey, and U.K. This is the so-called Section 301 investigation by the United States Trade Representative [USTR] to determine whether levies on electronic commerce [or ‘Google tax’ in short] discriminate against American tech giants like Apple, Google, Amazon etc. This could lead to the US imposing tariffs on exports from these countries.
Earlier, USTR had launched and completed section 301 probe into France’s digital services tax regime [France levies Google tax @ 3% on digital transactions of firms that have annual local turnover of > US$ 850 million – all US-based tech giants fall in this category] and was contemplating 100% import duty on its major exports such as champagne, cheese, cosmetics etc.
The US is hoping that negotiations on the broader issue of a ‘framework agreement’ – also referred to as base erosion profit shifting [BEPS] – on how to address taxation of multinational corporations [MNCs] – currently going on under the aegis of the Organization for Economic Cooperation and Development [OECD] – will lead to a global regime that is far less antagonistic to its tech giants than what countries planning to tax them would want it to be.
Looking at the unfolding scenario, it appears that conclusion of negotiations under OECD and completion of investigations under Section 301 by USTR will happen around the same time [sometime in 2021] and any concrete action will happen only thereafter. Meanwhile, it is necessary to look at the crucial points which are bone of contention between Trump administration and countries that have mooted the ‘Google tax’.
Do these countries have jurisdiction to tax income of MNCs? Are their actions ‘unilateral’ violating global consensus? Are they unfairly targeting and discriminating against US tech giants? What should be the criteria for taxing them? What is OECD stance? How does India deal with it?
The first question is most troublesome as MNCs, by nature, have operations in several countries and many of them have place of incorporation in jurisdictions [normally low/zero tax, say Netherlands or Singapore] different from countries where much of their economic activity happens. They do this with the sole purpose of minimizing their tax liability or fully escape paying tax in the country where they actually generate most of their income/revenue [also known in tax parlance as ‘source’ country].
The lack [or absence] of concrete mechanism in the source country to establish that MNCs are actually generating most of their revenue from the source country helps the latter get away with their practices thereby causing gargantuan loss of tax revenue to the former. For global tech giants such as Amazon/Face book/Twitter/Google whose transactions are digital and are under no compulsion to even have physical presence in the source country, it becomes all the more difficult for the department to get them pay tax.
Who has the jurisdiction to tax? This can be determined only by ascertaining the place where economic activity – to which the income relates – happens. The global tech giants deliver their services viz. e-commerce [Amazon], search engine [Google], social media [Face book] etc to Indian users within the territory of India. Hence, it is none other than the Government of India [GOI] which has the right to tax income accruing to them from these activities. This material fact won’t change even if these firms don’t have presence in India. This is also the sense one gets from the OECD parleys on BEPS framework which stresses on taxing income where it is generated.
As regards, the charge of countries acting in contravention of the rule based consensus approach, such moral policing by the US is completely out of sync with administration’s own unilateral actions viz. steep hike in import duty on steel and aluminium, dumping the Doha Development Agenda [DDA] under WTO, blocking appointment of members of the appellate authority of dispute settlement body [DSB] etc. Even so, all affected countries [except France] are trying to work out a consensus formula under the aegis of OECD. Lately, even France has joined negotiations under this forum.
The charge of unfairly targeting and discrimination against US tech giants too is without any basis. A case for imposing tax on a firm is based solely on the premise of the place where its revenue is generated and profits earned. It doesn’t discriminate against any company based on its nationality. Just because most of the global companies in the digital space come from a particular country [read: USA], and happen to come under the purview of Google tax, it can’t be surmised that they are unfairly targeted.
Coming to India’s approach and the criteria, the government had introduced Google Tax – also known as Equalization Levy – in 2016 vide notification no. 37/2016: F.NO. 370142/12/2016-TPL with an intent to tax the Business to Business (B2B), E – Commerce transactions/Digital transactions. The tax is levied @6% on the payment made by a resident firm to foreign e-commerce companies for the online advertisements on latter’s platform.
While, making payment, the resident firm is required to deduct the tax from the consideration payable to say, Google and deposit to the department. For instance, if the consideration is Rs 1000,000/- then the former has to withhold 6% or Rs. 60,000/– and pay the net amount of Rs. 9,40,000/- [the so called Equalization amount] to the latter. The Google tax of Rs. 60,000/– is paid to the legislature.
Through an amendment to the Finance Act 2020, The scope of equalization levy was extended to “all sales, gross receipts or turnover of non-resident not having permanent establishment [PE], who is providing the online sale of goods or provision of services or both to a person resident in India or a non-resident in specific circumstances such as the sale of advertisement targeted to Indian market or sale of data collected from India market”. This levy is @ 2% on the sum received or receivable by an e-commerce operator and is payable directly to the central government on a quarterly basis.
Whereas, the tax imposed in 2016 had limited coverage [revenue from online ads only], the 2% levy introduced this year covers almost every goods and service provided or facilitated by the internet giants. But, it has serious limitations. Apart from riddled with too much ‘ad hocism’ and ‘arbitrariness’, because of the very nature of these levies, it is none other than the Indian users of the goods and services who end up paying for them [as Google et al inflate their charges by an amount equal to the levy].
No wonder, the government may be contemplating to drop this very approach of taxing digital companies. Then, what is the way forward? How to get these foreign firms pay tax on their earnings from their India operations?
In this regard, a committee set up by the Central Board of Direct Taxes [CBDT] – the policy making body on direct taxes in the revenue department, ministry of finance [MoF] – has mooted the concept of ‘digital permanent establishment’ [DPE]. If, DPE is recognized as a legal entity then, even if a digital major does not have permanent establishment [PE refers to a fixed place of business normally located in the territory of the source country (in this case, India) from where a foreign enterprise conducts transactions – including sales made in India – and is defined in tax treaties], it should still be possible to tax their profits generated from Indian operations.
The Income-Tax [I-T] Act provides for levy of tax on the profit attributed to the Indian operations of such an enterprise in India [read: PE]. The committee has proposed tax @30% – 40% depending on the user base and revenues [only firms with a user base of over 200,000 would be considered]. This is in sync with the current practice of taxing large Indian companies @30% and subsidiaries of foreign companies in India @40%.
To determine how much of profits can be apportioned to India operations, the committee has recommended a formula-driven approach involving three key factors viz. sales, manpower and assets. However, instead of equal weight for each factor proposed by the committee, the weight assigned to each should vary depending on the nature of business. For instance, in asset-light sectors such as IT [information technology]/IT-enabled services, manpower and sales should account for greater weight. Besides, for digital giants, the ‘user base’ also needs to be included.
India should pursue this line of action at the OECD.