International Tax on Digital Services: An Overview of the Global and Indian Perspective

Ritika Chauhan, Symbiosis Law School, Pune

The Indian economy has been in a constant state of digital transformation ever since 1991 when the country’s economy underwent liberal reformation.[1] Since then, the policymakers have faced with various tax challenges in regards to defining taxable entities, place of taxation, and valuation among others.[2]

One of the primary challenges before the policymakers has been to build a framework of regulations that discourages corporate entities from paying negligible taxes in the country despite generating massive revenues from the same.

Taxation of digital services: The Issue?

Tech giants such as Facebook, Google, and Apple, have become notorious for their aggressive tax planning strategies over the last few years. They are known to indulge in such practices that help them avoid a substantial portion of the tax they would ideally be required to pay. While this is done in a manner within the ambits of international and domestic law, many people argue that the same is highly unethical and against the principles of social justice.[3]

One the many tax planning strategy employed by these companies is parking their profits in a jurisdiction which imposes low or negligible taxes irrespective of where the profits are generated from.

Suppose there are two countries X and Y. X has a tax rate of 30%, and Y has a tax rate of 12%. There exists a company A that generates a significant chunk of its income from country X. Ideally, company A should be paying taxes in country X to give back to their community for supporting their business. But company A decides to have its registered base in country Y even though it conducts negligible business activity in that country. The government of country X finds it unfair that the business they are helping grow and earn millions of profits is taking it all to another country and paying taxes somewhere else.

The Global Perspective

While a unanimous consensus has been difficult to arrive at globally, many countries have decided to introduce taxes on digital services unilaterally.  In January 2020, Italy decided to come up with an international tax on revenue generated from certain digital services when the users of such services are located within their country.[4] The French government has already endorsed a 3 percent tax on revenue from digital services earned by companies.[5] This tax only applies to those countries that have a revenue of more than 250 million Euros from France and 750 million Euros worldwide.

Several other countries have also announced their intention of levying such a tax. These include Spain, Austria, the United Kingdom, and Canada. Members of the G20 had also expressed their intention to work towards these tax loopholes in 2020.[6] G7 countries have agreed there needs to be a minimum level of taxation to prevent low tax jurisdictions and tax havens from taking advantage of this loophole.[7]

 The U.S. – E.U. dispute

This issue of international taxation has led to the emergence of a trade dispute between the United States and several European nations such as France and Italy. The United States has realised the most of the targeted tech giants, such as Netflix and Google, are from its own country, and this form of taxation is likely to hit its traditional companies the hardest.[8]

The United States has threatened to declare tariffs up to 100 percent on its imports from countries such as France.[9] The targeted products include cheese, champagne, and handbags among others.

Jurisdictions with lower taxes, such as Ireland, have also expressed concern about this approach because if the same is translated to a unified step, it will result in lesser foreign direct investment for them.[10]

Other potential global disputes

There is a risk of double taxation if another jurisdiction imposes a tax on digital services on the same revenues due to inconsistencies between the U.K. national rules and those of the other DST jurisdiction regarding user location and taxing rights.[11] Therefore, countries should come up with a system of reimbursement or refunds for any overlap.

Another issue that is likely to surface is the difference in the approach for identifying users of the taxable digital services.[12] While some countries may consider the location of the users to be indicative of where the revenue is generated, other countries may assume it to be based on the user’s place of residence. Further, differences in data sources may provide conflicting evidence and, therefore, conflicting conclusions.

The use of personal data of users such as their location to determine where the revenue is generated is likely to raise personal data protection issues in various jurisdictions.[13]

The OECD Action Plan

In order to address the issues surrounding taxation of digital services at a global scale, the Organization for Economic Co-operation and Development (“OECD”) has been hosting several rounds of discussions and negotiations with more than 130 countries.[14] The organization strives to help the countries adapt their economics to a digital transformation. An agreement is expected to be signed in 2020. [15]

The Indian perspective

The foundation of our country’s tax policy was established around brick and mortar businesses or businesses having a physical presence in India. According to this, the profits of a multinational must be attributable to some physical activity for the same to be taxed by the authorities. Unlike traditional businesses, the multinational digital businesses can easily find a way around this because of their three main feature:

  • No physical presence required in the source market.
  • Higher reliance on intangible assets rather than tangible assets (e.g., Intellectual property)
  • Ability to generate very high revenues only by user participation from the source market

For a long time, India’s taxation policy did not accommodate for taxing the profits generated by such businesses.[16]

Before Finance Act 2020 (“the Act”), India had two policies in place to regulate payments made by digital multinationals to non-residents. Firstly, since 2016 the country imposed an Equalization Levy at 6 percent on such payments.[17] Secondly, it recognized the presence of such virtual transactions for the purpose of determining its taxing rights and consequently introduced the concept of Significant Economic Presence (SEP) in 2018. However, this remained an incomplete reform.[18]

Amendment vide Finance Act, 2020

With the increase in the scope of e-commerce practices in the country, the policymakers have seen to increase the scope of equalisation levy introduced in 2016 accordingly. Following are some of the significant changes introduced by the policymakers vide Finance Act 2020:

Before the amendment, the equalization levy was imposed on digital transactions involving advertising only. However, with effect from April 2020, an equalization levy at the rate of 2 percent is payable e-commerce operators on consideration received in lieu of supply or services made, provided or facilitated by it to any of the following: [19]

  • The term ‘e-commerce operator’ includes non-residents “who own, operate or manage digital or electronic facilities or platforms for the sale of goods or services or both online”.[20]
  • The term ‘e-commerce supply’ includes the following activities:
  • Sale of goods by the e-commerce operator online.
  • Sale of services by the e-commerce operator online.
  • Facilitation of sale of goods or services or both by the e-commerce operators.
  • Any combination of the above.” [21]

No equalization levy may be imposed in the following cases[22]:

  1. The gross turnover of the e-commerce operator is less than INR 20 million during the financial year.
  2. The e-commerce operator constitutes a ‘permanent establishment’ in India and the supply of service is in relation to such establishment.

The equalization levy, as conceptualized in Finance Act 2020, is required to be paid directly by the non-resident e-commerce operator instead of the residential customers in the form of withholding.[23]

In cases of late payment of the levy, simple interest at the rate of 1 percent per month or part month may be imposed. In case of failure to pay the levy, a penalty equal to the amount of the levy may be imposed.[24]

Conclusion

While many believe that with the Equalization Levy’ as introduced in Finance Act 2020, the Indian government has provided a fair taxation regime to regulate the digital economy of the country, there are some practical challenges to the application of such a levy.

Firstly, since the equalization levy is required to be paid by the non-resident e-commerce operators directly, there is a significant increase in the compliances required to be adhered to by foreign companies. This is likely to influence the decision of potentially interest digital giants before entering the country’s economy.

Secondly, there exists a possibility that double taxation might occur. Certain payments that may be covered under equalization levy are also covered under other provisions of income tax such as royalty, etc. Even though the Act introduces a provision that payments covered under equalization levy will be exempted from Income Tax, the same is enforceable only after April 1, 2021. There is no clarity as to how the same will be dealt with by the authorities for the period between April 1, 2020, and April 1, 2021.

Lastly, many law activists believe that the levy of 2 percent on the gross revenue of e-commerce operators does not take into account the profits or income of the operator and is inequitable in that regard.


Ritika Chauhan is a student at Symbiosis Law School, Pune. 

Photo Credits: INDRANIL MUKHERJEE/AFP

Note:

[1]Hitesh Garjaria, ‘India: Digital taxation, enlarging the scope of “equalization levy’, (KPMG, March 2020) https://home.kpmg/us/en/home/insights/2020/03/tnf-india-digital-taxation-enlarging-the-scope-of-equalisation-levy.html, Accessed on 14th June, 2020.

[2] Ibid.

[3] Ana Utumi, ‘The challenge of taxing digital goods and services’, (International Tax Review, March 2020) < https://www.internationaltaxreview.com/article/b1ky678ck9px6q/the-challenge-of-taxing-digital-goods-and-services> Accessed on March 2020.

[4] Richard Lough, ‘Explainer: Macron’s quest for an international tax on digital services’, Reuters (Paris, December 2019).

[5] Ibid.

[6] Supra 3.

[7] Supra 3.

[8] Supra 4.

[9] Supra 4.

[10] Supra 4.

[11] Wei Chui, ‘Who is afraid of Digital Services Tax?’, Bloomberg Tax (Canada, December 2019).

[12] Ibid.

[13] Ibid.

[14] Elke Asen, ‘Digital Services Taxes in Europe’, (Tax Foundation, March 2020) < https://taxfoundation.org/digital-tax-europe-2020/> Accessed on 20th May, 2020.

[15] Ibid.

[16] Sandeep Bhalla, ‘India: Amending the tax framework to move towards a digital economy’, (International Tax Review, April 2020) < https://www.internationaltaxreview.com/article/b1l2slw8nq6wzh/india-amending-the-tax-framework-to-move-towards-a-digital-economy> Accessed on 30th May 2020.

[17] Ibid.

[18] Ibid.

[19] Finance Act, 2020. S. 165A.

[20] Finance Act, 2020. S. 164 (ca).

[21] Finance Act, 2020. S. 164 (cb).

[22] Supra 19.

[23] Finance Act, 2020. S. 166.

[24] Finance Act, 2020. S. 170,171.

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