US sets, then suspends tariffs over digital taxes

Context:

The United States government announced further suspension of punitive tariffs for six months on India, Austria, Italy, Spain, Turkey, and the United Kingdom while it continues to resolve the digital services taxes investigation amid the ongoing multilateral negotiations at the OECD and in the G20 process.

Relevance:

GS-III: Indian Economy (Growth and Development of Indian Economy, Taxation, International Trade), GS-II: International Relations

Dimensions of the Article:

1. What is Digital Services Tax (DST)?
2. How does India tax Digital Businesses?
3. Advantages of Imposing Digital Tax
4. Disadvantages of imposing Digital Tax
5. Issues with the Existing Taxation systems for taxing Digital Services
6. What are the Issues with India’s DST that is taken by the USTR?
7. About the recent US move regarding suspension of tarrifs

What is Digital Services Tax (DST)?

• Digital Services Tax (DST) is a tax levied on revenues that certain companies generate from providing certain digital services.
• The digital businesses include both the digital-only brands that focus on virtual commodities and services and the services traditional market players use for transforming their businesses with digital technologies.
• Virtual commodities include downloaded software, website applications and digital assets like eBooks, image files, audio clips/audio files, movies or digital files.
• Digital services include those provided by social media companies, collaborative platforms etc.

How does India tax Digital Businesses?

• India has been making use of an ‘equalisation levy’ to level the playing field for the domestic and the foreign players on the virtual platform.
• While the domestic businesses are subject to the Income Tax Act, their foreign counterparts are exempted from its provisions. Hence they enjoy an advantage over the domestic firms. This is what the levy seeks to equalize.
• Equalisation levy was first introduced in 2016 at the rate of 6%. However, this was only limited to advertisements online.
• It is noted that this is a transaction-based tax, as opposed to a tax on earnings. This is to ensure that India doesn’t violate its international obligations.
• It was introduced based on the recommendations of the Committee on Taxation of E-Commerce.
• In 2018, the Finance Act introduced the Significant Economic Presence concept to IT Act of 1961. It incorporates a digital nexus to tax the profits of foreign businesses, based on its revenues and local user-base. This is yet to come into force.
• Currently, India too is involved in the talks to bring in a revamped framework for taxing digital businesses as the international taxation principles being used in the present are outdated (formulated in the 1920s).

Advantages of Imposing Digital Tax

• Tech giants like Google, Facebook, Amazon etc., which have a huge consumer base in developing countries like India will not be able to avoid taxation by shifting their offices to low-tax regimes.
• If the law prevents profit shifts, the countries from which the cross-border digital companies’ profit will be able to stop losing corporate tax revenue.
• Digital tax will ensure a level playing field for both domestic and foreign players. In the absence of such a law, the goods and services provided by firms based in a foreign country would get taxed less and hence have a significant competitive advantage over the domestic firms.
• It seeks to create a clear international tax system with improved transparency and certainty for businesses and security for national tax revenues.

Disadvantages of imposing Digital Tax

• Taxing the gross revenues instead of the firm’s profits is problematic.
• The move to bring in digital tax would hurt trade ties with the US.
• It may harm start-ups– especially during their initial expansion stages.
• There is a risk of ‘double taxation’ when shifting from a ‘country-of-establishment’ principle to a ‘country-of-destination’ principle.
• These platforms and broker service providers would pass on the burden of tax to the end consumers or the sellers. This will affect their affordability and popularity.
• The government had opted for low taxation on digital businesses to promote innovation. Increasing taxes may impede global economic and technological advancement.
• Compliance with the transparency guidelines would bring in additional cost burdens on the businesses.

Issues with the Existing Taxation systems for taxing Digital Services

• The sine qua non for taxing any person in India is either he should be resident of India, or the income should accrue or arise in India or deemed to accrue or arise in India i.e., the source of income should be from India.
• Residence-based and source-based are the two criteria to tax a person. Residence-based is largely followed by the developed nations whereas the source-based principle is largely followed by the developing nations.
• India is following basically residence-based taxation; however, foreign companies are taxed in accordance with source taxation and domestic companies are taxed on residence principle.
• The rules of the Income-tax Act 1961 are very clear for taxation of domestic companies, but the rules to tax MNCs having only digital presence are not as clear as that of domestic companies.

Permanent Establishment (PE) determination issue

• To tax foreign or any entity, there needs to be two essential things: one is the jurisdiction over the entity to be taxed and the second is taxable income. Jurisdiction is established through the Permanent Establishment (PE) and taxable income is as per the tax slabs under the Income-tax act 1961.
• With the advent of digital markets/ digital economy the concept of PE has undergone drastic change.
• With the rise of digital economic activities, the conventional PE definition (brick & mortar definition) has blurred and now, the companies have significant economic presence without even having a single asset in the source state.
• Digital businesses have three unique characteristics which are not considered by the current Tax regimes:
  1. They offer services by having limited or no physical presence. Example: Facebook, Twitter etc.
  2. They are highly dependent on intellectual property assets that are typically located in or can be shifted to a low-tax jurisdiction
  3. They can increase the value to their goods and services through highly engaged ‘user participation’ from other countries.

What are the Issues with India’s DST that is taken by the USTR?

• The US is probing the 2% Digital Services Tax (DST) that India adopted in 2020.
• The tax applies only to non-resident companies with annual revenues over $267,000, and covers online sales of goods & services to persons in India.
• Further, equalisation levy at 6% has been in force since 2016 on payment exceeding Rs. 1 lakh a year to a non-resident service provider for online advertisements.
• This is applicable for e-commerce companies that are sourcing revenue from Indian customers without having significant presence in the particular country.
• It is argued that India’s equalisation levy is complex and ambiguous which includes the possibility of double taxation.
• Further, India continues to be on the ‘Priority Watch List’ of USTR for lack of adequate Intellectual Property (IP) rights protection and enforcement.
• In India’s case, the probe could potentially affect the outcome of a bilateral trade deal that India has been looking to forge with the US.

About the recent US move regarding suspension of tarrifs

• The US is focused on finding a multilateral solution to a range of key issues related to international taxation, including the US’s concerns with digital services taxes.
• The suspension came after the conclusion of a year-long investigation into taxes which the US has stated are against tech companies like Apple, Amazon, Google and Facebook.
• In January 2021, following investigations, the USTR determined that the digital services taxes adopted by Austria, India, Italy, Spain, Turkey, and the UK discriminated against US digital firms.
• The US announced 25 per cent tariffs on over $2-billion imports from these six countries, but then immediately suspended the duties to allow time for international negotiations.
• In case of India, USTR’s proposed course of action includes additional tariffs of up to 25 per cent ad valorem on an aggregate level of trade that would collect duties on goods of India in the range of the amount of DST that India is expected to collect from US firms.

-Source: The Hindu, Indian Express