Issue of Digital Services Tax between India and US – Explained

Recently the U.S. determined India’s Digital Services Tax (DST) as discriminatory. It concluded that the DST is causing an adverse impact on American commerce and hence, an action needs to be taken under trade act. Meanwhile, The USTR also said, “DST by its structure and operation discriminates against U.S. digital companies”. But the USTR in its special 301 report missed few important aspects and also completely neglected the global need to tax digital services.

What is Digital Services Tax (DST)?

In 2016 India introduced a 6% equalisation levy. But the levy was restricted to online advertisement services (commonly known as “digital advertising taxes” or DATs). In simple terms, the levy applied on the payments made to a non-resident by the Indians for advertising on their platform.

The government in 2020 introduced an amendment to the equalisation levy in the Finance Bill 2020-21. The important amendments include,

• • A 2% Digital Service Tax (DST) was imposed on non-resident, digital service providers. With this amendment, the foreign digital service providers have to pay their fair share of tax on revenues generated in the Indian digital market.
  • The amendment widens the tax to include a range of digital services. These services include digital platform services,  software as a service, data-related services, and several other categories including e-commerce operations.
  • Companies with a turnover of more than Rs. 2 crores, will pay this tax. 

Why India introduced the Digital Service Tax?

First, the nature of digital service companies. These companies don’t have any physical presence in the markets. Instead, they use intangibles to provide services. For example, one can pay for the Amazon Prime membership in India. But the services of prime membership like watching movies, listening to songs are intangible.

Determining the value of these intangibles is tough. So the government introduced the Digital Service Tax of 2% on non-resident service provider’s revenue in India.

Second, the failure of international consensus.  In 2013, the OECD (Organisation for Economic Co-operation and Development) launched the Base Erosion and Profit Shifting (BEPS) programme. It was launched primarily to find a way to tax digital companies. But no consensus has been achieved yet.  So, in 2016 India became the first country to implement the equalisation levy as a temporary way of taxation. This is then followed by countries like France, UK, etc.

Third, India’s right to tax digital service providers. If a company has users in India and also has an economic connection with India then, India has the right to tax its economic operation. India being a developing country provides large markets for digital corporations. So taxing them is a matter of right.

Fourth, These DST create a level playing field between online and regular (brick and mortar businesses). In 2016, the Akhilesh Ranjan Committee Report had also suggested to tax the digital companies as they enjoy a sustainable economic presence.

What are the accusations mentioned by the US? What India said in reply?

The first accusation, DST is inconsistent with the principles of international taxation. International taxation laws apply to the revenue of companies (not on income), extraterritorial application of DST (Digital service companies present outside India), etc.

• • Indian reply: Several global tax measures like royalty, technical fees are not levied on revenue. Similarly, all US states have laws on remote sellers, and they tax non-US resident entities.

The second accusation, DST does not extend to identical services provided by non-digital service providers. This is a violation of trade practices.

• • Indian reply: When the company is non-digital (i.e., brick and mortar) then that company is subject to Indian income tax. Further, this DST has been introduced to provide a level-playing field.

The third accusation, DST is discriminatory because it targets US companies.

• • Indian reply: The DST is applicable to all digital service providers having an annual turnover of more than ₹2 crores in India-based digital services. As per USTR’s own analysis, only 119 companies in the world would likely be subject to the DST, of which 86 are U.S. companies. So the criteria do not target anyone. It is the result of the asymmetric digital power of US companies.

Concerns associated with DST:

First, the DST as a tax policy targets a single sector (digital services). Economic experts argue that framing a tax policy to target a particular sector is unfair and have disastrous consequences for the growth of that sector.

Second, digital service providers might pass on the tax to consumers. Ultimately, burdening consumers. Just like service tax passed on to consumers, DST can also pass on to consumers if the service provider wishes.

Third, not feasible to separate the digital economy and the global economy. The growing digitization has blurred the line between them. This is one of the prime reasons due to which OECD is unable to arrive at a consensus.

Fourth, the DST might attract Retaliatory Tariffs. The USTR investigations pose a threat of retaliatory tariffs and might trigger the trade war between India and the US. Even the slightest retaliatory tariff will affect the Indian ICT industry’s growth.

Suggestions:

First, India can follow the U.K. model of DST. The major advantages of the U.K. model are,

• The U.K. allows companies to not pay any tax if their net operating margin is negative. By including this, India can avoid criticisms like India’s equalization levy is on revenue and shift towards the profit of the company.
• India can consider taxing only 50% of the revenues from the transactions involving three jurisdictions. For example, an Australian user located in India receiving services from a U.S. company. This will make Indian DST more inclusive and also garners international support.

Second, India has to remain committed to the OECD process. Apart from that, India can mention the ways to tweak DST design or try to achieve consensus. This will make India move ahead and phase out DST and roll out the new agreed tax policy of OECD.

Third, the U.S. government has to realize the challenges in taxing digital service providers and also have to participate in these global talks. This will not be only beneficial for other countries but also a way to make these digital giants accountable.

More than 24 countries have either adopted or are considering adopting, a DST or a DAT after the concept got introduced in India. So the tax challenges posed by the digital economy is not a problem between India and the US. It is a global problem and the US has to accept this and act accordingly.