[i]Simran Sabharwal and Rakshit Sharma

Introduction

Digitalisation has changed the way a business operates in the 21st century. The use of technology has broken geographical barriers and enhanced digital trade. Despite a challenging year, the e-tail sector grew by 27.6% in 2020. The total revenue generated through the e-commerce sector amounted to $25.6 trillion in 2018. Primary reason for the same being the global outreach of the companies in this sector due to its digital interface. Many global companies were generating huge revenues without paying proportionate taxes to the countries in which they had a huge consumer base. To curb the menace, countries like United Kingdom, Italy, Spain and Israel adopted Digital Services Tax (“DST”). Taking a cue from this move, the Indian government decided to tax businesses that have a close nexus with the Indian market through their digital operations. Close nexus here means companies that are not based in India, but have substantial clientele which forms an Economic Presence. Major examples could be Amazon, Apple, Facebook, etc.

Revisiting the Background of Digital Services Tax

In 2016, the Government of India, on the recommendation of the Organisation for Economic Co-operation and Development [“OECD”] in Base Erosion and Profit-Sharing Project [“BEPS”] introduced Equalisation Levy under Section 165 of Finance Act, 2016, making India one of the few countries to initiate such form of taxation. It was charged at 6% solely on online advertising. Later, the government deferred the implementation of the 6% levy as it lacked an effective mechanism and inserted amendments under Part VI of the Finance Act, 2020 [“Act”]. Subsequently, Section 153 of the Act was introduced for taxing digital transactions at 2% and the subsequent income earned by foreign e-commerce companies in India. Such levy would not be charged on business income earned by a non-resident e-commerce company that has a permanent establishment in India. 

Out of the 119 foreign e-companies trading in India, 79 companies have their base country in the United States of America. As a result, this Indian legislation came under scrutiny. A report on India’s Digital Service Tax [“Report”] was published by United States Trade Representative under Section-301 of the Trade Act, 1974, challenging the implementation of DST by the Indian government. In essence, this act empowers the U.S. to take retaliatory actions against certain countries which harm American commerce. It is important to note that there exists no international organisation to determine the validity of the same. The report claims that the digital tax introduced by India contravenes international taxation principles on the following grounds –

  1. Inconsistent with international taxation principles.
  2. Discriminates against US digital services.
  3. Burdens or restricts US commerce.

The article will analyse the report and negate the grounds challenging India’s DST.

India’s DST is Consistent with International Tax Principles

One of the foremost grounds put forward by the USTR report states that India’s DST is inconsistent with international taxation principles. The report reasons that lack of certainty on the quantum of tax, solely extraterritorial application, and the revenue-oriented nature of DST, contravenes international principles of taxation. The report criticises the lack of legislative debate on DST, mentioning that it was hurriedly implemented with no discourse. However, a Committee on Taxation of E-Commerce was formed that published a report highlighting the importance of such a tax.

The same lack of legislative debate for which they accuse India can be seen in the U.S., as per the document of the Congressional Research Service (CRS) on Section-301, wherein legislative members have openly criticised the unilateral actions of the U.S. under Section-301 of Trade Act, 1974, along with demands for a new and a more consultative process. This lack of consistency between their actions and ideas was also showcased in South Dakota v. Wayfair, Inc. wherein the U.S. Supreme Court empowered the individual states to collect sales tax from retailers who do not have physical presence and function digitally. The judgment of 2018 allowed practising such form of taxation, which India started in 2020, and the U.S. is blatantly opposing it. Additionally, a 2015 report by France Stratégie  (autonomous institution of the Prime Minister of France) stipulated that the digital economy includes blurring of territorial frontiers making jurisdictions complex. For that, it might be better if only foreign digital services are taxed, which was also something that was vehemently opposed in the USTR report.

Further, Indian DST applies on revenue rather than income which is not a widely used practice in the world taxation regime as of now.  But there are countries, as mentioned at the beginning which have taken revenue as the reference point in their digital taxation policies. This income-revenue dilemma can be addressed by analysing the current tax-paying trends, which show that a lot of firms over-report true costs to minimise tax bills. Hence, the revenue orientation is a welcome step in the taxation principles. It can be seen that Indian DST does not violate any taxation principle.

India’s DST does not Discriminate against U.S. Digital Services Companies

The report criticises the DST for being ‘discriminative’ on two grounds, i.e., it does not apply to companies of Indian origin and does not extend to similar services provided by non-digital service providers. Both the arguments can be summed up in stating that the U.S. is infuriated as such form of taxation is not applicable to Indian companies, making us believe that the U.S. has totally misunderstood the idea behind the introduction of DST. The U.S. cites that a total of 119 foreign companies trade in India, out of which 72% of the companies subjected to the said tax belong to the United States, making it the most affected country in DST. The idea behind imposing this form of taxation was to create a level playing field between the brick-and-mortar stores that pay tax regularly and digital companies that easily avoided it by camouflaging themselves under geographical boundaries. For instance, one of the largest e-companies, Amazon, paid zero federal tax by exploiting the loopholes of the system. It was easier to do so because there was no prescribed taxation format for a company like Amazon, since it existed in the digital realm. Hence, this tax will work as an equaliser.

As Indian companies are already taxed by the rules of the land, DST cannot be applied. Further, domestic companies do not have the liberty to establish offices in tax haven countries (i.e. country with a low rate of taxation for foreign investors) because their end customers are specifically Indians. Such a practice can easily be adopted by a foreign company.  

India’s DST does not Burdens or Restricts U.S. Commerce

The Indian DST imposed on US companies neither pressurises nor restricts the e-commerce between the two nations. The purpose of imposing the Equalisation Levy was to ensure transparency, fairness, and reasonableness. The South Dakota judgement made it clear that the U.S. legal framework of taxation is similar to that of India.

The provisions of the Income Tax Act, 1961 [“IT Act”] by the means of Section 90(2) provide that in case of a clash between the Double Taxation Avoidance Agreement and the IT Act, it is upon the taxpayer to decide whichever provision comes to be more beneficial to him. This puts upon them, the least possible and legitimate burden. This shall also help India to receive its share of tax, as it serves to be one of the biggest customer pools for such companies. Even by following the principles of Virtual Equity (i.e., virtue of a taxpayer in better circumstances to bear the larger part of tax burden), which are recognised by the OECD, India is only getting its rightful share. Companies like Amazon, which boast of its two-day delivery system, nearly doubled its profits to $11.2 billion in 2018 from $5.6 billion the previous year, are prime examples of companies, who are defying the said principle, and must come in consonance with it.

The government imposed the tax on revenue rather than on income, making the taxation system unique. This raised global debates as it was not a generally followed international tax principle. However, location-specific taxation is more feasible as it involves lesser compliance costs. Moreover, the threshold of 2% is much lower than envisaged by EU countries. In no way does Indian DST burdens U.S. commerce.

Conclusion

Over 30 countries have adopted the new taxation mechanism. The aim of imposing a digital tax by the Indian government was to tax companies that have been operating in India digitally. It is no one’s fault if U.S. firms dominate the market share. Even if we call the Indian DST discriminatory, the retaliatory approach adopted by the U.S. of imposing tariffs on Indian goods can never be termed as a solution. The global market will get extremely affected if India adopts a similar approach.

The US government should understand that DST is an interim measure until a proper agenda is suggested by the OECD. Contrary to this, on March 30, 2021, the United States of America has requested comments and notice on public hearing, post which the department will take potential trade actions. The situation can lead to a digital taxation war.

[i] Third year and first year law student at the Rajiv Gandhi National University of Law, Punjab, respectively. The authors can be reached at simransabharwal@rgnul.ac.in and rakshitsharma20143@rgnul.ac.in.