Understanding America’s response to India’s equalisation levy

 With the COVID19 pandemic feeding nativist impulses which may further complicate American negotiators’ attempt to seek renewed trading arrangements with reduced market-access barriers from its partner nations, the US seems to be increasing pressure. Hence, in rationalising its decision to launch a Section 301 probe, the same was deemed to be targeting US companies (even though India’s levy is clearly origin-neutral). In a statement, Lighthizer said, “President Trump is concerned that many of our trading partners are adopting tax schemes designed to unfairly target our companies”.

With the US crying foul, the expectation remains that this will not be followed with a full Section 301 investigation into India, especially since nine other countries have also been identified by the US for either levying (or currently considering) digital taxes. Moreover, the US has also been at odds over this issue with some of its long-standing partners. For instance, its negotiations with the European Union broke down last month as the EU continued to push for a digital tax. French finance minister Bruno Le Maire termed the US withdrawal from negotiations as a “provocation” as the Trump administration threatened tariffs on French wine, handbags, and cookware at the risk of starting “another trade war”.

International examples

Source: KPMG report on Taxation of the Digitalised Economy July 2020

 An imperfect solution

The current 2% tax follows the equalisation levy which India had introduced in 2016. At the time, it was dubbed the “Google Tax” and largely pertained to levying digital advertising companies with a 6% tax -- with other online services left out of its ambit. The tax applied to digital advertising services which were procured from a non-resident without a permanent establishment in India and the services had to be in excess of Rs 100,000. There was fear that the equalisation levy would make services and products more expensive as they would pass on the tax to the end-customer. Nonetheless, the tax brought the government an income of Rs 560 crore from local advertisers in 2017-18.

The Indian government said that it introduced this tax as part of its obligations to the Organisation for Economic Cooperation and Development (OECD). In 2013, the OECD released a report on the phenomenon known as Base Erosion Profit Shifting (BEPS), a series of corporate tax planning strategies where large multi-national firms would shift the profit from higher tax jurisdictions to lower tax jurisdictions like Ireland and the Cayman Islands. These structures allowed companies like Google to pay merely $16 million in taxes from sales worth $18 billion from 2006 to 2011 in the UK.

The OECD’s 15-point action plan called for the implementation of BEPS project globally, the development of an inclusive framework by early 2016 and the involvement of non-G20 countries as well. In 2015, the OECD released a report identifying three options that countries could adopt:

• an equalisation levy
• a withholding tax on certain types of digital transactions
• defining significant economic presence by digital companies.

However, the report mentioned that implementing these options was not recommended as the measures developed in the BEPS project would have a considerable impact on the broader issues previously identified in the digital economy. But it advised countries to adopt such options in their domestic laws as additional surety against BEPS. India’s Finance Ministry acknowledges this observation from the OECD and states that the equalisation levy is an interim measure till tax treaties account for the changes in the digital economy. Finance minister Nirmala Sitharaman supported the fine tuning of defining a significant economic presence as a measure to counter BEPS, diverging from the EU’s approach of introducing more digital taxes.

Nonetheless, India wasn’t the only country to impose new taxation on the digital economy following the OECD and G20 report. The UK imposed the diverted profit tax which looked to plug loopholes related to permanent entities. Japan has an eight percent consumption tax for cross border digital services. Australia introduced a new law which would charge GST on imported services and digital products. It also introduced a Multinational Antiavoidance Law which would apply to foreign companies and their resident entities which supply digital goods and services.

The equalization levy is far from perfect right now and there are still many debates to consider - for example determining whether the levy is a direct or an indirect tax - and interpretations that need to be applied. With regard to the two percent levy on e-commerce transactions, there are still many definitions which need to be spelt out. The text of the finance bill mentions terms like “e-commerce operators”, “online sales”, “electronic facility”, “platforms” etc, but does not specify what they would mean in terms of income tax rules.

Conclusion

As e-commerce bleeds into the offline world with multiple business models, greater clarity is required for these definitions. For example, it is unclear if the e-commerce equalisation levy will apply to online sales of a service or good (say a purchase of an e-book) or whether it will apply to an online sales generation when the service is carried out offline (like in the online-to-offline aggregator models). There are still questions regarding the intent of the levy. Tax statutes need to be interpreted strictly as per the language used in the legislation, but literal interpretation may produce unjust and absurd results. A more consultative approach before introducing the tax would have clarified matters.

All things considered, the US response to the digital sales tax - initiating a Section 301 investigation - is disproportionate, considering that it is part of the OECD and G20 and had been abreast on the developments on the various taxation measures other countries were adopting. In the absence of a global governance architecture on regulating e-commerce spaces, the issue of American conservatism’s push for unilateralist solutions outweighs the imperfect solution of the equalisation levy.

• US Foreign Policy
• Media and Internet
• European Union
• India
• USA and Canada
• D-10
• Digital Taxation
• Equalisation Levy

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