All objections raised by the USTR on the DST levied by India on foreign tech firms are baseless. The Govt must not yield to the pressure tactics of the US administration by withdrawing the tax
In its findings on the Section 301 probe conducted under the US Trade Act, 1974, the US Trade Representative (USTR) has inter alia concluded that India’s digital services taxes (DST) or the so-called equalisation levy (EL) at the rate of two per cent, unfairly targets US companies. The USTR raised three aspects that, it alleges, are inconsistent with global tax principles: First, the levy on US companies has extra-territorial application; second, DST is a tax on the firm’s revenue, not its income; and third, it subjects US companies to double taxation.
The above findings could lead to the US imposing duties on Indian goods; restrictions on import of goods and services; restrictions/denial on issuance of service sector authorisations; asking India for compensatory trade benefits and taking binding commitments from New Delhi to phase out the levy.
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.
The operations of multinational corporations (MNCs) are transnational, with entities located in several countries involving a high-level of interdependence and cross-border flow of goods and services between them, as also direct supplies to retailers and consumers. For firms such as Google, Facebook and Amazon, who do 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 and Ireland among others.
These technology giants invoice Indian customers through 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 firms make money from their operations in India but don’t pay taxes to the Government. On the other hand, India-based e-commerce operators are subject to taxes in the country for revenue generated from the Indian market.
To address this anomaly, in 2016, the Narendra Modi Government introduced EL with an intent to tax Business to Business (B2B) and e-commerce/digital transactions. This tax is levied at six per cent 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 it. This levy is at two per cent on the sum received or receivable by an e-commerce operator and is payable directly to the Central Government on a quarterly basis.
Though the USTR has objected to the two per cent DST, it is silent on the six per cent EL on online advertising 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. Just because out of the 119 companies likely to be taxed, 72 per cent happen to be American, does not mean that the latter alone have been targeted.
Second, contrary to what is claimed by the USTR, 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 Indian operations as happening in foreign jurisdictions and then, claim that the Indian Government has no right to tax their profits. But, they and the US administration can’t get away from the fact that they are making profit from their operations on Indian soil. Hence, they are 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, 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 per cent, 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 has levied tax on the amount received or receivable by an e-commerce operator.
This brings us to the third charge leveled by the USTR: “The DST taxes a 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 a PE here and the concept of DPE yet to get incorporated in tax treaties with India’s trade and investment partners or till such time an agreement at the international level which is acceptable to all is reached, a levy on the revenue is the only logical way forward. However, efforts are already being made under the aegis of the Organisation for Economic Cooperation and Development (OECD) to arrive at a so-called base erosion profit shifting (BEPS) framework agreement. The OECD had released a draft report on “taxing digital companies” on October 9, 2019, however, progress got stalled due to the Covid-19 pandemic.
As for the accusation of US companies being subject to double taxation, it is for them to sort out with the country where it is incorporated (or country of residence). Merely because they pay tax in the country of residence resulting in double taxation, it can’t be a valid basis for denying tax to a jurisdiction where it is legitimately due (India). Even so, several countries of residence happen to be low or nil tax jurisdictions or they provide set-off for taxes paid by MNCs in the country of operation, effectively ensuring nil 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 the USTR on the two per cent DST levied by the Indian Government on foreign technology companies are baseless and unsubstantiated. India must not yield to the pressure tactics of the US administration by withdrawing the tax.
At the same time, India should work for early finalisation of the BEPS framework agreement at the OECD. It should evolve a consensus on acceptance of the DPE concept and also get ready with a criteria for treating a foreign company as a DPE. The criteria should give appropriate weight to three crucial parameters i.e. the number of users, paying customers or annual revenue. The tax rate on such companies — treated as DPE — should be equal to the rate applicable to domestic companies to ensure fair play and non-discrimination.
(The writer is a New Delhi-based policy analyst. The views expressed are personal.)
