Digital Services Tax in India & USTR Report

United States Trade Representative (USTR) investigation report found India’s Digital Services Tax (DST) to be discriminatory.  It said the tax is “inconsistent with prevailing principles of international taxation”, and burdens or restricts U.S. commerce.

In 2016, the Akhilesh Ranjan Committee Report had suggested that in order to create a level-playing field between online businesses and brick-and-mortar businesses, digital businesses which do not have a physical presence in India but are able to enjoy a sustainable economic presence should be paying a certain amount of tax. This was how the equalisation levy of 2016 was conceptualised. Now, the BEPS project is based on the fact that digital companies are able to enjoy sustained economic presence in other jurisdictions without being physically present.

In 2013, the Secretary-General of the Organisation for Economic Co-operation and Development (OECD) released an action plan on base erosion and profit sharing (BEPS). The BEPS action plan discussed the “spread of the digital economy” and its impact on digital taxation. Despite these long-running and ongoing negotiations, India has chosen to move forward with its own taxes on digital services. The first such effort began in 2016, with India’s implementation of a 6% tax on digital advertising.

India, in 2016, became the first country to implement the equalisation levy, on advertising services at 6%. This was basically on payments made to a non-resident by a resident advertising on the platform. India, originally in 2018, had introduced a test for significant economic presence in the Income Tax Act, according to which, if a company had users in India, it sort of defined its economic connection with India, and therefore gives India the right to tax.

One of the primary criticisms against India’s equalisation levy is that it is a tax on revenue as opposed to being a tax on profits. The U.K. allows companies to not pay any tax if their net operating margin is negative.

More specifically, the DST does not apply “where the e-commerce operator making or providing or facilitating e-commerce supply or services has a permanent establishment in India. The U.S. Model Tax Treaty and the U.S.-India Tax Treaty both contain similar provisions barring taxation absent a permanent establishment. Also, The UN Model Treaty similarly provides that the profits of an enterprise are taxable in a country only if “the enterprise carries on business in through a permanent establishment.

Further, the Indian DST does not contain a global revenue threshold. Such thresholds can serve as a mechanism for shielding domestic companies—which tend to have lower global revenues than U.S. companies—from tax liability.

The OECD has several times cautioned against this discriminatory ‘ring-fencing’ approach, whereby digital companies are taxed, but non-digital companies that provide the same or similar services are excluded. In 2014, the OECD proclaimed that “certainty” is one of the “fundamental principles of taxation.”66 India’s DST provides no such certainty to stakeholders, and thus, contravenes this
fundamental principle.

Findings of report (USTR)

An investigation of India’s 2020 Equalisation Levy (the DST) under Section 301 of the Trade Act of 1974, as amended (the Trade Act). India’s DST imposes a 2% tax on revenue generated from a broad range of digital services offered in India, including digital platform services, digital content sales, digital sales of a company’s own goods, data-related services, software-as-a-service, and several other categories of digital services. India’s DST explicitly exempts Indian companies—only “non-residents” must pay the tax.

India’s DST is discriminatory on its face. The law explicitly exempts Indian companies, while targeting non-Indian firms. The result is that U.S. “non-resident” providers of digital services are taxed, while Indian providers of the same digital services to the same customers are not.

The DST taxes companies with no permanent establishment in India, contravening the international tax principle that companies should not be subject to a country’s corporate tax regime absent a territorial connection to that country. The DST taxes companies’ revenue rather than their income. This is inconsistent with the international tax principle that income—not revenue—is the appropriate basis for corporate taxation. India’s DST unreasonably contravenes international tax principles.

The DST creates an additional tax burden for U.S. companies. USTR estimates that the aggregate tax bill for U.S. companies could exceed US$30 million per year. Several aspects of the DST exacerbate this tax burden, including the DST’s extraterritorial application, its taxation of revenue rather than income, and its low domestic revenue threshold (2 crores)(which allows India to tax U.S. firms that do relatively little business in India). The DST burdens U.S. companies by subjecting them to double taxation.

However, the U.S investigations are under the Section 301 of U.S Trade Act 1974 are unilateral in nature, because the USTR is essentially deciding whether a measure is violative of the U.S.’s rights. The criticism against Section 301 investigations is that after the WTO law and the dispute settlement mechanism came into picture and the scope of the General Agreement on Trade in Services were expanded to include services as well, countries have been of the view that an international body should be looking at such disputes.

India has denied these charges. It is yet to see how GOI considers the report findings.

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