Equalisation Levy: Digital Tax Discriminatory, U.S. Says. Should India Be Worried?

India’s equalisation levy is likely to impact 119 foreign digital service companies. Of these, 86 are from the U.S., seven from China and the U.K. each, six French and five Japanese. The levy is also wide in its scope compared to other countries- this discriminatory approach will have an outsized impact on U.S. digital firms, as per the investigation by the United States Trade Representative’s office.

Just because India’s levy is wider compared to other countries who have introduced a digital services tax, doesn’t make it discriminatory under section 301, Mukesh Butani, founding partner at BMR Legal told BloombergQuint. It applies to all non-resident digital service providers – so it’s clearly not targeted to U.S. businesses. ‘For these reasons, I find the USTR report weak on merits. U.S tax and trade policy has often been dictatorial,’ Butani opined.

The report is an outcome of a section 301 investigation by the USTR under the Trade Act of 1974. The investigation was initiated in June last year to ascertain whether India’s equalisation levy violates trade agreements, is unjustifiable, unreasonable, discriminatory or a burden on U.S. commerce.

Via the Finance Act, 2020, the government had imposed a 2% tax on sale of goods as well as services that take place through non-resident digital operators.

Broadly, it’s applicable to digital platform services, digital content sales, digital sales of a company’s own goods, data-related services, software-as-a-service, and several other categories of digital services. Companies that have a turnover or sales of more than Rs 2 crore, in the previous year, as a result of such supply, are subject to an equalisation levy.

Also Read: U.S. Section 301 Probe On India’s Equalisation Levy Is Ill-Conceived And Ill-Timed.

India’s Equalisation Levy Discriminates Against U.S. Companies, Says USTR

After several months of investigation, in its report, the USTR has made three key findings:

First, India’s equalisation levy is discriminatory since it exempts Indian companies while targeting non-Indian firms. The result is that U.S. “non-resident” providers of digital services are taxed, while Indian providers of the same digital services to the same customers are not.

“This is discrimination in its clearest form. Because U.S. companies are global leaders in the digital services sector, they face an inordinate share of tax burden. Indeed, of the 119 companies that USTR has identified as likely liable under the equalisation levy, 72% are U.S. companies.” - USTR Report

Second, the tax levy unreasonably contravenes international tax principles because:

Its text is unclear and ambiguous. For instance, India has failed to clarify the
applicability to intragroup transactions and re-seller/distributor arrangements;
the proper method of calculating a company’s tax base; applicability to the sale of
advertisements or data between non-residents etc.
It taxes companies with no business presence or permanent establishment in
India. This is contrary to the international tax principle that companies should not be subject to a country’s corporate tax regime absent a territorial connection.
It taxes companies’ revenue rather than their income.

“Failure to provide tax certainty, extraterritorial application, and application to revenue rather than income are inconsistent with international tax principles.” - USTR Report

Third, India’s equalisation levy burdens or restricts U.S. commerce. The aggregate tax bill for U.S. companies could exceed US$30 million per year. The unusually expansive scope of taxable digital services makes the tax particularly burdensome for U.S. companies. It forces U.S. companies to undertake costly measures to comply with the tax’s new payment and reporting requirements.

“This includes the reengineering of existing systems to collect and organize new and different types of information. USTR’s analysis indicates that compliance costs could run into the millions of dollars for each affected company.” - USTR Report

Should India Be Worried?

An adverse finding under Section 301 can result in suspension; withdrawal of trade concessions; duties, fees, import restrictions on goods and services; agreement to phase out the offending conduct etc. But the USTR report has stopped short of recommending any specific action against India.

The United States is witnessing a change in its administration and given India’s trade quantum, it’s unlikely they’ll take a flippant action, Ajay Rotti, partner at Dhruva Advisors said. That doesn’t mean, he added, that India should do nothing.

It’s an opportunity for us to relook at the scope of the equalisation levy. For instance, can the government limit the digital services to which this levy applies? Also, so far, India has been very dismissive of industry’s ask to clarify certain issues.

Ajay Rotti, Partner, Dhruva Advisors

Now, the government should consider issuing an FAQ to clarify some of the ambiguities which industry has pointed out, he said. ‘These two steps should blunt the findings of the USTR report that the levy is too wide and ambiguous and should be a good starting point for India to negotiate no adverse action,’ Rotti added.

Also Read: De-Escalating The Digital Tax Debate

As an immediate response, India has defended the levy saying:

Domestic e-commerce operators are already subject to taxes in India for revenue generated from Indian market.
It’s the non-resident e-commerce operators - not having any permanent establishment in India but significant economic presence - which are not required to pay tax on income from supply to Indian market.
The levy does not discriminate against any U.S. companies, as it applies equally to all non-resident e-commerce operators, irrespective of their country of residence.
It does not have extra territorial application as it applies only on the revenue generated from India.

“The Government of India will examine the determination / decision notified by the U.S. in this regard, and would take appropriate action keeping in view the overall interest of the nation.” - India’s Response

India can be proactive in clarifying nuanced aspects of its equalisation levy - a reasonable ask from U.S tech giants, Butani pointed out. That said, if the law is vague, the challenge lies at the domestic court level, he explained.

“I don’t know how it raises a discriminatory issue under section 301,’ Butani pointed out. It just so happens that a majority of the companies that are impacted are U.S. companies but the levy surely isn’t targeting just them alone, he said.