On June 2, 2020, the Trump administration had announced the “Section 301 investigation” under the US Trade Act, 1974 into digital services taxes (DST) that have been either adopted or were under consideration by its trading partners viz. Austria, Brazil, the Czech Republic, the European Union (EU), India, Indonesia, Italy, Spain, Turkey and the UK. Conducted by the United States Trade Representative (USTR), the objective of the probe was to determine whether levies on electronic commerce discriminate against US technological giants like Apple, Google, Amazon and so on.
On January 6, 2021, the USTR released its findings on the probe and concluded that India’s 2% DST is discriminatory and restricts US commerce. It has raised three aspects which it alleges, are inconsistent with global tax principles viz. (i) DST taxes company’s revenue, not its income; (ii) subjects US companies to double taxation and (iii) lets India tax US companies that has extra-territorial application
The above findings could lead to the US imposing duties, fees on Indian goods; restrictions on import of goods and services; restrictions/denial on issuance of service sector authorizations; asking India for compensatory trade benefits and taking binding commitments from India to phase out the equalization levy (EL).
The stance taken by the US administration is untenable and totally unjustified. At the outset, let us take a close look at the DST and the reason why India had to introduce it.
By nature, operations of MNCs are transnational with entities located in several countries involving a high-level of interdependence and cross-border flows of goods and services between them, as also direct supplies to retailers and consumers. For firms such as Google, Facebook and Amazon etc doing business in digital mode, physical boundaries get blurred. They structure their investment arms through a maze of subsidiaries held outside India in low-tax jurisdictions such as Singapore, Mauritius, Ireland and among others.
These technology giants invoice Indian customers via these offshore entities despite having significant revenue, users or paying customers in the country even as their Indian entity is crafted more like a service company or commission agent to the parent company located abroad. This helps them in booking an overwhelming share of revenues in the parent company (registered in a tax haven) while a very small portion of service/commission revenue and income is reported in the entity registered in India.
In short, these companies make money from their operations in India but don’t pay taxes to the Indian Government. On the other hand, India based e-commerce operators are subject to taxes in India for revenue generated from the Indian market.
To address this anomaly, in 2016, Modi – Government introduced an Equalization Levy (EL) with an intent to tax the Business to Business (B2B), e–commerce/digital transactions. This tax is levied at 6% on the payment made by a resident firm to foreign e-commerce companies for online advertisements run on the latter’s platform. While making a payment, the resident firm has to deduct tax from the consideration payable and deposit it to the department.
Through an amendment to the Finance Act, 2020, the scope of EL was extended to “all sales, gross receipts or turnover of non-residents not having a Permanent Establishment (PE is a fixed place of business normally located in the territory of the source country), who is providing the online sale of goods or provision of services or both to a person residing in India or a non-resident in specific circumstances, such as the sale of advertisement targeted to the Indian market or sale of data collected from the Indian market.” This levy is at 2% on the sum received or receivable by an e-commerce operator and is payable directly to the Central Government on a quarterly basis.
The USTR has objected to the 2% DST (even as it is silent on 6% EL on online ad revenue). All the aforementioned objections raised by it are untenable. At the outset, the levy does not discriminate against any US company as it applies equally to all non-resident e-commerce operators, irrespective of their country of residence. Merely because of the 119 companies likely to be liable to tax, 72% happen to be American does not mean that the latter alone have been targeted.
Second, the levy is applied only on sales occurring in the territory of India through digital means. Consequently, the charge that it has extra-territorial application is baseless. It is ironical that the digital giants first use a disingenuous architecture to show revenue generated from India operations as happening in foreign jurisdictions and then, claim that Indian Government has no right to tax their profits. But, they and the US administration (which champions their cause) can’t get away from the fact that they are making profit from their operations from the Indian soil; hence liable to tax here.
In the normal course, for a foreign firm having a PE from where it conducts transactions — including sales made in India — and maintains accounts viz. receipts, expenditure, profit and so on for local operations, the tax department has a smooth sail. But technological giants don’t have a PE on Indian soil. To overcome this hurdle, in 2018, a committee set up by the Central Board of Direct Taxes (CBDT) had mooted the concept of digital permanent establishment (DPE). The Income-Tax Act provides for levy of tax on the profit attributed to the Indian operations of such offshore enterprises in the country.
The committee proposed tax at the rate of 30-40%, depending on the user base and revenues (only firms with a user base over 2,00,000 would be considered). As a follow up, in the Finance Act 2018, the Government proposed that “such offshore firms should be taxed in India if they have a market presence above a threshold to be defined in terms of their customer base and revenue.” But this needs an amendment to India’s tax treaties with all its trade and investment partners.
Till that is done – a time consuming process – the Government thought it prudent to levy tax on the amount received or receivable by an e-commerce operator (done vide an amendment to the Finance Act, 2020). That brings us to the third charge leveled by USTR i.e. ‘DST taxes company’s revenue, not its income’. Ideally, the profits (or income) made by the foreign entity from its operations in India should be taxed.
However, in view of the digital giants not having PE here and the concept of DPE yet to get incorporated in tax treaties with India’s trade and investment partners or an agreement at the global level which is acceptable to all (efforts are being made under the aegis of the Organization for Economic Cooperation and Development (OECD) to arrive at a BEPS (base erosion profit shifting) framework agreement; the OECD had released a draft report on “taxing digital companies” on October 9, 2019, but progress got stalled due Covid-19 pandemics), a levy on revenue is the logical way forward. This is also recommended as one of the three options in the OECD BEPS Report on Action 1 in 2015.
As for US companies being subject to double taxation, countries where these are incorporated such as Mauritius, Ireland etc normally charge low/nil tax; hence, even when India levies tax, such a situation won’t arise. Even if the tech firm pays tax in the country of residence leading to double taxation, it can’t be a valid basis for denying tax to a jurisdiction where it is legitimately due (read: India). In such a scenario, a firm keen on avoiding double taxation, it should sort out the matter with the country of residence instead of expecting the country where it is generating revenue and making profits (read: India) not to levy tax.
India’s right to collect tax is also in sync with the stance taken by the OECD under the BEPS framework agreement. It states: “Profits of MNCs should be available for taxation in the country where their customers are, irrespective of any physical presence in that market, and that a formula should be evolved for such taxation.”
To conclude, all objections raised by USTR on the 2% DST levied by Indian Government on foreign tech companies are baseless and unsubstantiated. It must not yield to the pressure tactics of US administration by withdrawing the tax.
At the same time, India should work for early finalization of BEPS framework agreement at the OECD. It should evolve consensus on acceptance of DPE concept and also get ready with a criteria for treating a foreign company as DPE. The criteria should give appropriate weight to three crucial parameters viz. the number of users, paying customers or annual revenue. The tax rate on such companies – treated as DPE – should be at par with the rate applicable to domestic companies to ensure fair play and non-discrimination.