India in a Quagmire Over Digital Taxation

 On the 1st of July 2021, the OECD nations adopted a High-Level statement containing an outline of the possible solution to address the tax challenges arising from the digitization of the economies.  India, which is also a signatory to the statement, has been consistent in its stand to equitably tax the digital economy. 

With the advent of the NDA Government in 2014, India’s pitch for accelerated digitization was evenly matched with its quest to tax the growing digital economy, primarily driven by the fact that despite being one of the largest markets, most of the technology giants did not pay income tax in India. 

India’s first move: 

While a consensus eluded the major nations on the appropriate manner of taxation of the digital economy, India, introduced a new concept called the Equalisation Levy (EL) in the 2016 Budget. India and Israel were among the earliest countries to unilaterally levy a digital tax on the foreign companies. India levied a 6% of digital tax on the B2B online advertisement revenues of the foreign e-commerce companies. 

On the indirect tax front, the Government started levying Service Tax (and later GST) on various cloud and electronic services rendered by these foreign companies in India. 

Equalisation Levy 2.0: 

With a view to monetize the growing digital transactions further, via Budget 2020, India proactively (and unilaterally) expanded the scope of Equalisation Levy to levy a 2% tax on e-commerce transactions carried out by foreign companies in India. EL 2.0 taxed various forms of online sales and digital services including digital platform services, software-as-a-service etc. 

The official stand of the Government is that EL is not income tax but a tax on the digital transactions and creates a level playing field between foreign and Indian companies. This was deliberately done to disable non-ecommerce operators from avoiding paying any tax by claiming Tax Treaty Benefits, which is available for Income Tax. 

US cries foul: 

Meanwhile, USA initiated investigation against India for imposition of Digital Tax, under Section 301 of the Trade Act of 1974. Their 2021 Report finds India’s levy of Digital Tax “discriminatory”, “unreasonable” and burdens or restricts US commerce. USA now threatens to impose retaliatory tariffs against India. 

This is not the first time USA has raised concerns over India’s Taxation policy. In 2019, Trump had famously called India “the king of Tariffs” over its levy of high customs duties on imports. The tariff war that followed greatly impacted India’s steel & aluminum exports. At WTO, USA had challenged various export subsidies (such as Merchandise Exports from India Scheme (MEIS) etc.) which were granted by India to Indian exporters. Even though India has challenged the WTO’s negative order before the Appellate Body, it has withdrawn the MEIS Scheme.

If USA goes ahead with its plan of imposing retaliatory tariffs, India could be on the backfoot again.  

Many countries like France and Italy have followed India’s example to go ahead and unilaterally levy digital tax, with a view to raise revenue from the increasing digital transactions. 

Majority of jurisdictions claiming new source taxing rights are market countries of USA based digital multinationals. USA is trying hard to protect its own tax base, as data rich, high consumption economies like India strive to increase their tax base. There was therefore felt a need for consensus based decision on the subject. 

As per the recent high level statement, the OECD has agreed on two key elements to address the tax challenges arising from the digitization - (a) ensuring multinational companies pay a minimum tax of 15% and (b) reallocation of additional share of profits qua the tech companies to the market jurisdictions. This is to ensure that digital companies operating in multiple countries pay taxes in all countries where they provide services. The profit allocation rules, which is a key element of the deal, is yet to be finalized.  

If the plan is finalized, all countries will have to abolish Digital Services Taxes. This would mean that India would also have to abolish the existing Equalisation Levy. 

The road ahead: 

Although India is in a quagmire over digital taxation, it has for the time being issued a cautious statement which says– it is in favor of consensus solution, at the same time, the solution should result in allocation of meaningful and sustainable revenue to the developing and emerging economies. 

India and other developing countries will only agree to abolish the existing Digital Tax, if they feel that the new solution is beneficial to them.  A broad-based and neutral Tax Policy is the need of the hour. 

Economic Laws Practice is a leading tax law firm in India.

Kumar Visalaksh is a Partner at the Economic Laws Practice (ELP), one of the leading full service law firms of the Country. He can be reached at kumarvisalaksh@elp-in.com.  Arihant Tater is a Senior Associate at ELP. The views expressed are personal.