Addressing the digital tax challenge

Context: Over the past four years, 137 countries have been engaged with the OECD. It is related to the ongoing discussion and proposal to find a solution to the tax challenges arising from digitalisation.

What are the tax challenges in the age of digitization?

In a digital economy, the firms operate seamlessly across borders. Therefore, the manner of taxing profits in the digital economy becomes difficult in any economy.

It has also become a political issue. The largest technology firms are tax residents of developed countries

There is divergence in expectations among developed vs developing countries about the ideal solution. Developing countries want the profits from digital operations to be fractionally apportioned to markets while developed countries believe that a fraction of residual profit, mainly arising from marketing functions, should be taxed in markets.

The divergence has compelled countries to implement unilateral measures. For example, India implemented a gross equalisation levy on turnover. Similarly, several other countries have announced a digital services tax (DST).

In 2021, India expanded the scope of the equalisation levy. Thereafter, the US declared India’s DST discriminatory. The US also announced retaliatory tariffs.

What are the steps that can be taken?

The solution requires a consensus approach and excessive global coordination. For this, a process of dispute resolution panels should be created.

Redefining the digital presence of the large technology firms for the purpose of taxation would give India more right to tax.

The OECD has been considering the issue of allocation of taxing rights. It has adopted a two-pillar approach.

The first pillar involves defining the rules for taxing digital companies. It is supposed to go beyond digital companies. It will apply to large companies with annual revenue over € 20 billion.

India’s stance on OECD’s approach must be calibrated. Current tax collections indicate that the EL can level the playing field between digital and brick and mortar firms through behavioural change or higher taxes.

Corporations that argue in favour of simplicity must also consider the potential benefits from an EL like tax that sets aside the complications of attributing profits to complex functions.

As per an estimate of the US Treasury, 72% of the companies covered by EL in India are US companies. Therefore, India needs to negotiate with the US.

The OECD has proposed a global minimum tax as a package deal. It allows the profits reallocated through Pillar One to be compensated for. It allows taxing back global profits taxed below 155.

As per Pillar One proposal, once the OECD approach is ratified in 2023, it will lead to removal of DSTs.

Source: The post is based on an article “Addressing the digital tax challenge” published in the Indian Express on 23^rd April 2022.