India’s Digital services tax discriminates against U.S. Companies: USTR

 

The US has recently held that India’s 2 per cent digital tax on e-commerce supply of services discriminates against US companies and is inconsistent with prevailing principles of international taxation, and restricts US commerce. These were part of the findings of the US Trade Representative’s investigations of India’a Digital Service Taxes (DST) under Section 301 of the US Trade Act, released on January 6.

Section 301 of the US Trade Act empowers the USTR to investigate a trading partner’s policy action that may be deemed unfair or discriminatory and negatively affects US companies and take appropriate action, which could be tariff-based and non-tariff-based retaliation.

Brief overview of India’s DST: 

Through an amendment in the Finance Bill 2020-21 India had imposed a 2 per cent digital services tax on trade and services by non-resident e-commerce operators having a turnover of over Rs 2 crore, thereby expanding the scope of equalisation levy. This new levy came into effect from April 1 where e-commerce operators are obligated to pay such tax at the end of each quarter.

Results of USTR Investigations:

The USTR mainly looked into 3 issues in relation to India’s DST, which are as follows:

1.     whether the DST is discriminatory against U.S. companies, 

2.     whether the DST is unreasonable as tax policy, and 

3.     whether the DST restricts or burdens U.S. commerce

After analysing the above three issues it was held that the India’s DST discriminates against U.S. companies, contravenes unreasonably international tax principles, and burdens or restricts U.S. commerce.

A. India’s DST is discriminatory against U.S. Digital Services Companies

The USTR held that the India’s DST discriminates against US Companies due to following reasons:

1, The DST only applies to non-Indian digital services providers

India’s DST is discriminatory as it is applicable to “non-resident” companies, as against Indian firms. This approach of overtly targeting only foreign companies is a clear example of discrimination. Overall the impact of this discrimination falls disproportionately on U.S. companies as 72% of the DST affected companies are U.S. companies.

2. The DST only targets digital services, as against similar services provided non-digitally

The DST discriminatorily targets only a select group of digital service providers but does not tax companies that provide the same or very similar services in non-digital format. This comes under the OECD’s discriminatory ‘ring-fencing’ approach, whereby only digital companies are taxed and non digital companies providing same or similar services are excluded. 

Again this specifically targets US Companies as they are the global leaders in the digital services sector. 

B. India’s DST contravenes the exisiting international tax principles, and is therefore unreasonable

USTR’s analysis indicated three aspects of India’s DST that are inconsistent with international tax principles, and hence, unreasonable under Section 301. It can be attributed to the following reasons:

1. The DST’s failure to provide tax certainty to stakeholders

Stakeholders have found the DST text to be ambiguous and unclear. This has the potential to create uncertainty for companies regarding key aspects of the DST, including the scope of taxable services and the scope of firms liable to pay the tax. Also there is no official guidance by the Indian government to resolve such uncertainties. This amounts to a failure to provide tax certainty, which contravenes a core principle of international taxation.

2. The extraterritorial approach of the DST 

The USTR has held that the DST’s extraterritorial application—i.e., its targeting of revenues unconnected to a physical presence in India—contravenes prevailing international tax principles.

Also the DST applies not only to companies having permanent establishments (PEs) in India but also to companies without any PEs. This is inconsistent with international tax principles.

3. The revenue over income application approach of the DST

The DST applies to gross revenues from covered digital services as against taxes on income. 

However, the international tax principles recognises income-not gross revenue- as an appropriate basis of taxation. For instances, there is no reference to taxes on gross revenue under the U.S.-India Tax Treaty. Also Chapter 2 of the OECD publication Addressing the Tax Challenges of the Digital Economy, which is entitled “Fundamental Principles of Taxation,” lists only two bases for corporate taxation: income and consumption. Nowhere taxation of gross revenue has been recognized.

C. India’s DST creates restriction or burdens the US Commerce

USTR’s investigation revealed that India’s DST burdens or restricts U.S. commerce due to following reasons:

1.     An additional tax burden on U.S. companies under the DST

As stated before, the DST creates an additional tax burden by discriminatorily targeting non-Indian digital services companies. 

Secondly, the taxation of revenue rather than profit not only disregards the international tax principles but creates additional burden on low margin US businesses.

Thirdly, the DST targets small and medium sized companies due to low revenue threshold of approximately US$267,000.

Hence, this will result in substantial tax burden for many U.S. companies, especially smaller businesses and low-margin businesses.”

2. U.S. companies could be easily taxed under a broad range of digital services under the DST

India’s DST has a very broad scope, which increases the increases the tax burden on U.S. companies. 

Digital services taxes of any country typically cover: (1) digital advertising, (2) platform services, and (3) data-related services, 

However India’s DST covers the above 3 categories as well as additional services under the DST and India’s 2016 digital advertising tax. Those services include financial services, cloud services, software-as-a-service, education services, and digital sales of a company’s own goods.

The very broad scope of DST can expand the list of US companies subject to such tax, thereby creating additional tax burden on them.

3. U.S. companies face huge compliance costs in connection with the DST

4. U.S. companies face risk of multiple taxation under the DST

There is a risk of double or even triple taxation under the DST. U.S. companies will still be subject to US Corporate income tax, in addition to the India’s DST. For instance, Company A earned US$100 million from India-connected services, and incurred US$95 million in India-related costs. Company A must pay US$2 million (2% of Indian revenue) to India pursuant to the DST, leaving it with just US$3 million in remaining profit. Company A must then also pay U.S. corporate income tax on its residual US$3 million.

Furthermore, in some circumstances, companies subject to the DST could face triple taxation. Consider, for example, a French digital advertising company that directs advertising to Indian users. That company may be liable to pay the French digital services tax, the Indian DST, and French income tax on the revenue from that single advertising placement. Although the United States has no digital services tax, U.S. companies could nonetheless face triple taxation risk if they own subsidiaries in countries with national digital services taxes.

Thus, There exist “risks of multiple taxation intrinsic to an extraterritorial tax on revenue.

Conclusion:

USTR’s investigation concluded that:

1. India’s DST discriminates against U.S. companies;

2. India’s DST is inconsistent with international tax principles, and is hence unreasonable; and

3. India’s DST burdens or restricts U.S. commerce.

Due to the above three reasons , the Indian DST is actionable under Scetion 301. 

As per the Indian officials, The Government of India is examining the decision notified by the U.S. for appropriate action in view the overall interest of the nation. It will be interesting to analyse what measures the governments take to resolve the issue bilaterally.