Digital Service Tax

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Context: On January 6, the office of the United States Trade Representative (USTR) published a report concluding that the 2% digital services tax (DST) introduced by the Indian government vide the 2020 Finance Act discriminates against US businesses, contravenes settled principles of international tax law, and restricts US commerce.

Relevance: Mains- GSIII

  • Indian Economy & issues relating to planning, mobilization of resources, growth, development & employment
  • Government budgeting
Introduction
  • Today, we are witnessing the rise of digital technology, where there is no need for physical presence to do business in a particular jurisdiction.
  • The rise of digital technology has also created a significant challenge for global compliance because of the rise of intangible assets that can easily be shifted from one jurisdiction to another, in the search for lower tax rates
  • In the traditional economy, moving manufacturing facilities from one place to another would have come with a significant cost and the benefit from lower tax rates would have been considerably diminished.
  • Today, intellectual property rights, patents, can be easily moved and the cost of doing this is marginal.
  • The debate around taxing the digital economy has now become even more relevant because Covid-19 has forced many companies to go digital, and because of the amount of money that governments around the world have had to spend to support local economies.
  • In this dynamic digital economic environment, the Organization for Economic Co-operation and Development (OECD) has calculated that by changing how the digital economy is taxed, taxes will increase by $100 billion, representing 4% of current corporate income tax revenues.
Equalization levy
  • Since the humble beginning of internet adoption in 1995, India has come a long way to become one of the largest and fastest-growing digital consumer markets with more than half a billion internet subscribers today.
  • The country has the potential to create up to $1 trillion of economic value from the digital economy by 2025.
  • Amongst several advantages, the foremost is the capability of digital to do away with the need for businesses to establish a local presence.
  • This has made physical presence-linked taxation tenets redundant.
  • Like many other countries, India too has been concerned with the progressive erosion of its tax base due to the rapid expansion of digital business models.
  • While countries are pursuing a common consensus-based solution at the OECD/G20 level to address this issue of erosion of the tax base, owing to lack of worldwide consensus, several countries including India, have started adopting measures to tax digital businesses for revenues generated from the local customer base.
  • One of the measures India took early in 2016 was to introduce Equalisation Levy ('EL') at 6% of online sales of advertisements and related services from non-residents ('NR'), as a withholding tax on the payers.

Digital services tax
  • In the Financial Act 2020, the government further widen the scope of the equalization levy by bringing in the amendment to the Finance Act 2016.
  • It has extended the scope of the equalization levy to almost all digital e-commerce transactions in India which will come into effect from April 1, 2020.
  • It imposes a 2% tax on revenue generated from a broad range of digital services offered in India, including digital platform services, digital content sales, digital sales of a company’s goods, data-related services, software-as-a-service, and several other categories of digital services.
  • India’s DST only applies to “non-resident” companies.
  • The threshold limit is kept at Rs. 2 crores, the levy will be applicable on the whole of the sales, turnover, or gross receipts of the non-resident e-commerce operator, for calculation of threshold transactions or business with Indian residents only need to be considered.
  • The equalization levy on e-commerce operators shall apply even in case of personal consumption without any business activity (b2C).
Concerns of the United States
  • The U.S. has determined that India’s Digital Services Tax is discriminatory and hurts American commerce and is actionable under the trade act.
  • In the report, the USTR describes DST as “an outlier” that burdens U.S. companies by subjecting them to double taxation.
  • The USTR in the federal register said that DST, by its structure and operation, discriminates against U.S. digital companies, including due to the selection of covered services and its applicability only to non-resident companies.
  • The USTR alleged that DST is unreasonable because it is inconsistent with principles of international taxation and failure to provide tax certainty.
  • USTR alleged that several aspects of the DST exacerbate this tax burden, including
    1. the DST’s extraterritorial application,
    2. its taxation of revenue rather than income, and
    3. A low domestic revenue threshold allows India to tax U.S. firms that do relatively little business in India.
  • USTR noted that sections 301(b) and 304(a)(1)(B) of the Trade Act provide that if the U.S. Trade Representative determines that an act, policy, or practice of a foreign country is unreasonable or discriminatory and burdens or restricts United States commerce, the U.S. Trade Representative shall determine what action, if any, to take under Section 301(b).
Response of India 
  • The commerce and industry ministry said there is no retrospective element as the levy was enacted before the first day of April 2020, which is the effective date of the levy.
  • It also does not have extra-territorial application as it applies only on the revenue generated from India

The rationale for Digital service tax

Prolonged International Tax Law Negotiation

  • The agenda to reform international tax law so that digital companies are taxed where economic activities are carried out was formally framed within the OECD’s base erosion and profit shifting program.
  • However, seven years since its inception, it is still a work in progress

Changing International Economic Order

  • The proliferation of digital service taxes (DSTs) is a symptom of the changing international economic order.
  • Countries such as India which provide large markets for digital corporations seek a greater right to tax incomes.

Asymmetrical Digital Power

  • There is a huge asymmetry in digital service providers and consumers.
  • Thus, countries claim that the exponential increase of the digital economy and the digitalization of the traditional economy require the adoption of new tax rules.
Issues associated with Digital services tax

Eventually Burdening Digital Consumers

  • Experts suggest that DST can be passed on to consumers.
  • While the Indian customer may not pay this as a tax, this could mean higher prices, contrary to the claim that it taxes the company.

Retaliatory Tariffs

  • The USTR investigations could pose a threat of retaliatory tariffs, as similar tariffs were imposed by the US on France.
  • Further, it could turn into a digital trade war-like scenario and could harm India’s Information and communication technology industry.

Double Taxation

  • This was severely criticized by many countries as a unilateral measure that would result in double taxation.
Conclusion
  • A welcome step is taken by the government of India to widen the tax base in the new and evolving field of digital taxation and to curb tax avoidance.
  • A lot of work still needs to be done, e.g., the precise definition of the term ‘e-commerce’ is yet to be defined, the absence of which creates confusion, in the minds of the assessee.
  • In today’s global world, unilateral measures in taxation are not appreciated much and economies are so interconnected that it is difficult to sustain unilateral measures on grounds of parity and neutrality
  • While the digital economy and its implications continue to evolve, the multilateral solution at the level of the OECD must be expedited.
  • Moreover, it would also require political consensus on multiple issues, including sensitive matters such as setting up an alternative dispute resolution process comparable to arbitration.



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