Last month, the office of the United States Trade Representative (USTR) said that India’s levy of 2 per cent digital services tax (DST) discriminates against US businesses, contravenes settled principles of international tax law, and restricts US commerce.
The levy is on revenues generated from digital services offered in India, including digital platform services, digital content sales, and data-related services. India was the one of the first countries to introduce a 6 per cent equalisation levy in 2016, but the levy was restricted to online advertisement services (commonly known as “digital advertising taxes” or “DATs”). The 2020 DST, however, is broader in scope and extends to all kinds of digital transactions.
The USTR report finds the DST to be discriminatory on two counts. Firstly, it states that the DST discriminates against US digital businesses because it specifically excludes from its ambit domestic (Indian) digital businesses. And secondly, it says the DST is discriminatory because it does not extend to identical services provided by non-digital service providers. Both these findings are wholly misplaced and disregard the background and context in which the DST was introduced.
The tax’s rationale
The DST is aimed at ensuring that non-resident, digital service providers pay their fair share of tax on revenues generated in the Indian digital market. Currently, Indian double taxation avoidance agreements (tax treaties) with foreign jurisdictions do not permit source-based taxation of business profits of non-resident companies in India in the absence of what is called a “permanent establishment” (PE), a fixed place of business for a non-resident company in India.
While non-resident, non-digital service providers pay Indian corporate tax on income attributed to a PE in India, business models employed by non-resident digital service providers obviate the need for a physical presence in India and profits earned here could easily escape the Indian income tax net.
It is true that the government amended the Income Tax Act to provide for a “significant economic presence” (to supplement physical presence) as a nexus to tax business profits of a non-resident company.
However, an amendment of this nature in the domestic tax law is ineffective for all practical purposes in the absence of a corresponding change to tax treaties. Tax treaties usually override provisions of the domestic tax law and negotiating the inclusion of such a change is next to impossible. No wonder then that the DST is a tax not on income, but on revenue, and has been carefully devised to fall outside the scope of tax treaties.
At best, the US government can term the DST as inconvenient to US digital businesses because, in the present scheme of things, most large technology companies are US-based.
It is true that Indian digital service providers will not pay the DST because of the explicit exemption in the law (of course, they are subject to Indian income tax), but even if the law did not provide for an exemption, only a handful of them would pay the DST in view of the revenue threshold (₹20 million in annual India-based digital services revenue).
US firms dominate
According to USTR, only 119 companies in the world would likely be subject to the DST, of which 86 are US companies. Of course, there may be a meaningful discussion to be had when an Indian company gets as big in size and sales as Google in the future and yet falls outside the scope of the DST.
Even if the DST is ex facie discriminatory, US retaliation through imposition of tariffs on Indian goods is not the solution. There are legal ways and mechanisms to settle this kind of a trade or a tax dispute and unilateral imposition of tariffs must be avoided.
Also if the India responds by imposing counter-retaliatory tariffs on US goods, it will impact all US companies not just digital ones, hitting growth and jobs in the long run.
The US government must realise that the DST has been adopted as an interim measure to cope with the challenges posed by the digital economy, while a multilateral solution at the level of the OECD is underway.
A prudent solution, therefore, is not for the US government to flex its muscles but to participate in these global talks and protect the interests of US businesses by entering into dialogues with hundreds of countries who are trying hard to reach global consensus on the issue of digital economy taxation.
What the US government should be worried about is that the threat of retaliatory tariffs seems to not have worked so far because over two dozen countries have either adopted or are considering adopting, a DST or a DAT.
The tax challenges posed by the digital economy is not an India versus US problem, it is a global problem. The sooner Washington realises this, the better.
The writers practice law in the Supreme Court