The India-US Digital Dosti Need Not Become Unduly Taxing

The last few months have been extremely adventurous and challenging for India. The COVID-19 pandemic has given digitalisation a push of the likes which ‘Digital India’ could never do. Recent border altercations in eastern Ladakh have more or less ensured that the Chinese do not henceforth partake in our digital story.

This has provided an opportunity to strengthen India-US dosti in the digital space. The intention to do so is mutual, as has been expressed by representatives of both nations. However, things are not as hunky dory as they seem. Ill-thought-through steps like the equalisation levy unfortunately run the risk of creating an unintended rift in the budding relationship.

The equalisation levy was imposed with the noble objective of levelling the playing field between domestic and foreign digital entities by imposing a tax on latter, given they are outside the purview income tax laws which the former need to comply with. So far so good. But it is beyond this point that things stop making sense.

The levy was introduced by the government in a rather stealthy manner. It did not find mention in the finance minister’s Budget speech or the Finance Bill which was originally presented in the Lok Sabha on February 1, but was introduced and ratified a day before lockdown was imposed, obviously without any debate or discussion within parliament or outside with key stakeholders. This is an obvious violation of the pre-legislative consultation policy of the government, at least in spirit. The levy was not even mentioned in the memorandum to the Finance Bill, resulting in stakeholders making wild guesses about the government’s intent and naturally becoming suspicious.

There is no clarity on the concept or scope of the levy, its coverage and timing, and even several expressions used are vague with the potential to have unintended far-reaching consequences. The levy introduces an IP address nexus as the basis of taxability, thereby extending the scope from only Indian residents to those who may be present in India and using Indian IP addresses or accessing Indian networks.

Also read: In New Lockdown Levy on ‘Non-Resident’ Digital Companies, a Novel Tax Adventure

It is likely that the levy will be passed on to domestic start-ups and digital SMEs, who already are required to bear a disproportionate burden of the regulatory state. This will increase the cost of doing business for Indian enterprises and make them worse off in comparison to their counterparts in other countries, as against the stated objective of achieving equalisation. It is not even clear if placing orders through internal online portals or emails attract the levy or not. Such ambiguities are disrupting daily business activities of digital enterprises.

Another question could be whether sharing research papers or findings online by foreign institutions or universities will fall under the ambit of this levy. Interestingly, obtaining tax registration in India by foreign firms has been mandated by way of requirement in the challan and not by governing law.

Given that gross consideration in digital transactions is taxed under the levy, it appears inconsistent with the Goods and Services Tax framework. Such unilateral action may also go against the ‘good faith principle’ under the Vienna Convention on Law of Treaties, and could be violative of tax treaty commitments, besides leading to double taxation for non-resident digital economy entities.

Making matters worse, the government is in no mood to entertain stakeholder concerns, by issuing clarifications in the form of FAQs for them to make sense of the levy by themselves. Bureaucrats in their ivory towers believe that the levy is sufficiently clear.

Not surprisingly, the US has been taken aback by India’s actions. It has initiated an investigation under Section 301 of the US Trade Act that empowers it to respond to a foreign country’s action considered unfair or discriminatory, and which negatively affects US trade. India has clarified that the levy is a non-discriminatory and cannot be said to have extra-territorial application, as foreign digital businesses have to have a taxable nexus in India.

Also read: What Progress on the US-India Trade Front Should Look Like

This may be correct to a certain extent. However, the manner in which the levy was imposed, its potential inconsistencies with other frameworks, and sheer disinterest of the government to engage with stakeholders does not inspire confidence on evolving regulatory framework for India’s digital economy.

While India was the first country to impose an equalisation levy in 2016, besides other two options – digital permanent establishment and withholding taxes, suggested by the OECD under the base erosion and profit shifting (BEPS) initiative – other jurisdictions have been steadily adopting digital taxes thereafter. If compared with digital service taxes (DST) regimes of other countries, the scope of expanded levy is significant wider than its overseas counterparts.

The UK DST law covers businesses that provide a social media platform, search engine and online marketplaces, while in jurisdictions like France and Italy it encompasses digital advertising services, transmission of user data and marketplace intermediary services only. DST regimes in some countries have specifically restricted the scope to business-to-business transactions and some have carved out payments for communication, banking and payment-related services.

The government should have made an attempt to turn the crisis into an opportunity by introducing more clarity and predictability in its taxation frameworks and institutionalising best practices, like a cost-benefit analysis to periodically examine impacts of regulatory frameworks on different stakeholders, and undertaking mid-course correction. Instead, it seems to be heading in the opposite direction, and wasting the opportunity offered by the crisis. There is a need to realise that such occasions are rare and need to be seized with full vigour. Also, such actions must be avoided in pursuit of accomplishing India’s ambitious target of a $5 trillion economy.

Jitin Asudani is a chartered accountant and Amol Kulkarni is a policy analyst, currently with CUTS International. 

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