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Digital Service Tax issue between India and US

Digital Service Tax issue between India and US

Relevance

  • GS 3 || Economy || External Sector || International Tax Issues

Why in news?

  • The United States recently announced 25% tariffs on over $2 billion worth of imports from six nations over their digital services taxes,but immediately suspended the duties to allow time for international tax negotiations to continue.

Background

  • After a “Section 301″inquiry established that their digital taxes discriminated against US business, the US Trade Representative’s office approved the threatened tariffs on imports from the UK, Italy, Spain, Turkey, India, and Austria.
  • The proposed tariffs aim to equalise the amount of digital taxes collected from US businesses.

Digital Tax

  • The “digital services tax” (DST) is a levy on the overall revenues earned by the supplier of specific digital services.
  • Digital companies are not adequately taxed because they don’t have a physical location in the markets where they operate.
  • Aim
    • DST aims to ensure that non-resident, digital service providers pay their fair share of tax on revenues generated in the Indian digital market.
    • The idea is to tax the profits of those online and offline businesses that don’t have a physical presence in India but derive significant economic value from the country.
  • Not to be confused with Netflix tax
    • The DST should not be confused with the so-called “Netflix tax,” which one may find in some western countries.
    • The Netflix tax is essentially a “value-added tax” on digital services where the consumer bears the entire tax burden on the value of the final product.

Evolution of DST in India

  • AkhileshRanjan Committee
    • Proposed in 2016 that internet and brick-and-mortar enterprises compete on a level playing field.
    • Because digital firms have no physical presence but do have a long-term economic presence, they must be taxed.
  • 2018
    • India was the first country to impose a 6 percent equalization charge on advertising services in 2016.
    • The term “substantial economic presence” was first used in India’s Income Tax Act in 2018.
    • According to this theory, if a corporation has consumers in India, it has defined its economic relationship with the country and thus grants India the right to tax.
  • 2020
    • The new equalization levy was expanded to include e-commerce in 2020.

The purpose/rationale behindDigital Service Tax

  • Prolonged International Tax Law Negotiation
    • The OECD’s base erosion and profit shifting initiative formally established the goal for reforming international tax law so that digital enterprises are taxed where economic activities are carried out.
    • Even though it has been seven years since its beginning, it is still a work in progress.
    • As a result, countries are concerned that they may lose their ability to tax revenue.
    • Digital services tax has been suggested or implemented in several nations.
  • Changing International Economic Order
    • The proliferation of digital service taxes (DSTs) is a symptom of a changing international economic order.
    • Countries that supply big markets for digital firms, such as India, are seeking a wider power to tax revenues.
  • Asymmetrical Digital Power
    • Because there is such a large asymmetry between digital service providers and users, taxing the digitalized economy has proven to be a controversial problem.
    • Furthermore, for countries like India and the United States, a redistribution of taxing rights might have enormous financial ramifications.
    • This makes achieving a consensus-based approach more difficult.
    • As a result, countries argue that the exponential growth of the digital economy, as well as the digitization of older economies, necessitate the implementation of new tax rules.

Concerns Raised by USTR & Counterclaim

  • United States Trade Representative (USTR) conducted an inquiry under Section 301 of the US Trade Act of 1974, which allows it to respond appropriately to a foreign country’s discriminatory behaviour that hurts US commerce.
  • USTR has concluded the digital taxes imposed by France, India, Italy, and Turkey discriminate against big U.S. tech firms, such as Google, Facebook, Apple, and Amazon.
  • The DST was judged to be discriminatory on two grounds by the USTR investigation
    • First, it states that the DST discriminates against US digital businesses because it specifically excludes from its ambit domestic (Indian) digital businesses.
    • USTR also says the DST is discriminatory because it does not extend to identical services provided by non-digital service providers.

India’s response

  • India has described the equalization levy as a fair, reasonable, and non-discriminatory taxaimed at all offshore digital economy firms accessing the local market and has denied it targets US companies
  • For India, it created enormous uncertainty, since the country has always been at the forefront of adopting the concept of taxing foreign digital companies.
  • It is now subject to a probe initiated by the US called the ‘Section 301’ investigations into digital taxes.

Is India’s Digital services tax discriminatory?

  • According to USTR reports, India’s DST is discriminatory because the tax incident is designed to focus on the levy of non-resident companies.
  • However, because the market is controlled by American companies, it appears discriminating, but this is not the case.
  • Equalization levy is lower than set by other nations
    • Furthermore, the equalization levy threshold set by India is far lower than that set by the EU.
    • The levy also tries to level the playing field by requiring ordinary enterprises to have a physical presence and pay monthly taxes.
  • Discriminatory claims are false
    • International communities are now moving toward a situation in which such transactions must be taxed.
    • As a result, claiming that the levy violates international tax rules is incorrect.

Digital tax in other countries

  • France-A 3% tax on internet services is imposed in France.
  • Singapore, Indonesia, and Malaysia all have a digital service tax, with Thailand declaring plans to tax international digital service providers soon.
  • OECD nations– Given the rapid rise of online economies, the Organisation for Economic Cooperation and Development (OECD) is currently negotiating with 140 nations to revise international tax standards.

Way forward

  • Develop a tax model/design suited for everyone
    • The core problem that the international tax reform seeks to address is that digital corporations, unlike their brick-and-mortar counterparts, can operate in a market without a physical presence.
    • Therefore, taxing in a particular jurisdiction may not augur well with the growth of the digital economy.
    • To overcome this challenge, countries suggested that a new basis to tax, say, the number of users in a country, could address the challenge to some extent.
    • India is committed to the OECD process, and there are methods to tweak the design.
    • The design can be developed while keeping the interests of emerging countries in mind.
  • Automated DST by UN
    • The United Nations is taking a lead role in this by developing its solution, which is an automated DST.
    • It signifies that a provision of withholding payments from markets to jurisdictions is suggested within the existing treaty framework.
  • Expediting MultilateralNegotiations
    • The DST will be implemented initially, after which countries will be free to negotiate bilaterally with their respective partner countries about how to credit this tax.
  • 2% DST
    • Lastly, India rushes to become a digital behemoth, the 2% DST should be negotiated to minimize any delays in implementation.
    • Furthermore, worldwide agreement on taxation in the digital economy is required.

Conclusion

  • A global consensus at the OECD or even the UN level may take several more months, countries including India are likely to continue with their unilateral DSTs.
  • At this juncture, when economies are reeling under the illeffects of the pandemic, no country would want to give up its share of revenue and wait for a global consensus to emerge.

Mains model question

  • What is Digital tax? Which countries have imposed it? Discuss its significance.

References