[Ayushi Singh is a 5th year student at National Law University, Jodhpur]
Multilateral trade relations have suffered numerous blows from proponents of unilateral protectionism in the form of trade wars and economic warfare. The issue of digital taxation has the potential of becoming an additional blow. The United States Trade Representative [USTR] has announced the initiation of investigations under section 301 of the Trade Act of 1974 into digital services taxes [DSTs] promulgated by various countries, including India’s equalisation levy. Under the Finance Act, India mandates the collection of an equalisation levy of 6% and 2% for ‘digital advertising services’ and ‘e-commerce operators’ respectively. This is applicable exclusively on non-residents having no permanent establishment in India that earn consideration from residents in India. The levy is subject to revenue thresholds that are enumerated in the Act.
While we await the result of this particular USTR investigation, it could be insightful to refer to the observations and conclusions of a similar investigation completed against French DSTs. The French DSTs placed a 3% levy upon ‘digital interface services’ (akin to ‘e-commerce operators’) and ‘online advertising services’. In the conclusion of its report, the USTR declared the DSTs to be discriminatory and contrary to international tax principles, especially extraterritoriality, double taxation, and chargeability on revenue. It recommended the use of a range of tools in “retaliation”, including invocation of the World Trade Organization’s dispute settlement mechanism; or imposition of duties, fees, or other import restrictions. Given the Trump administration’s continued rejection of multilateral forums, the latter approach was taken wherein the French were threatened with the declaration of 100% retaliatory tariffs on wine, cheese, and handbags. This led to a subsequent roll back of the DSTs, marking a win for the aggressive unilateral posturing of the US.
A similar fate could be expected for India’s equalisation levy. India has already borne the brunt of American unilateral measures in the past, in the form of aluminium and steel tariffs and revocation of its GSP status. However, in the absence of any collective multilateral solution to the issues surrounding digital taxation, importers of digital services have no choice but to use domestic tax regulations. The objective of this two-part discussion is to highlight several academic issues that have to be collectively resolved and the path forward from prevailing WTO jurisprudence.
Traditionalistic Tax Regimes and Rise of Digital Services Trade
Trade liberalisation has allowed companies to access competitive markets and consumer bases in new jurisdictions including India. In this context, it is important to note that states have also been empowered to exercise their sovereign fiscal duty to charge taxes for income generated by non-residents in their territory. Section 9 of the Income Tax Act, 1961 deems non-resident income to have accrued or arisen in India subject to the establishment of a business connection or permanent establishment [PE]; and classification of the income as business income, royalty, or fee for technical services.
For income classified as business income, the non-resident would be taxed at a rate of 40% subject to the establishment of a business connection. Royalty and fee for technical services need not have any PE and are taxed at a rate of 10%. A PE is further subject to the comprehensive double taxation avoidance agreements [DTAAs] which countries enter into to counter the phenomenon of double taxation where non-residents are subject to taxes in both the chargeable state and their home state.
Article 5 of the USA-India DTAA defines PE as a fixed place of business where business activity is wholly or partly carried out. It also provides an inclusive illustrative list of such fixed places such as an office, a branch, a factory, etc., along with a list of exclusions. In article 5(2)(l), non-residents furnishing services in a contracting state (India) are required to have employees and personnel in that state in order to constitute a PE. Article 7 mandates the attribution of profits to the PE after its establishment in the contracting state.
Let us shift focus to the concerned non-residents involved in the present issue – the American ‘digital giants’ that provide a plethora of digital services to users based in India. The illustrative list in article 5 foresees a physical establishment in India or a presence in the form of employees. A digital service accessible through the Internet may never establish any such fixed place of business but continue to access the domestic user base. For example, India provides the highest user base for Facebook and WhatsApp. However, they do not have any fixed place of business in India and thus their business profits cannot be taxed. Storage facilities and maintenance of stock of goods, used by Amazon for stocking and dispatch of goods sold through its website, are not considered PEs under article 5. India and other digital services importers feel entitled to revenue from such enterprises which have access to the states’ user base despite not having a PE in them.
Base Erosion Profit Shifting [BEPS] and Significant Economic Presence [SEP]
Digital service companies have been accused to be tax evasive, incentivised by the need to maximise their profits. The corporate tax structures of these companies allow them to shift their income out of the jurisdiction of the user base into the jurisdiction of a tax haven that charges minimal to no corporate taxes. For example, the tax arrangement between Apple and Ireland, which was unsuccessfully challenged by the EU, provided for corporate tax rates of less than 2%. Google and Amazon allegedly report low profits by attributing sale from units in havens like Ireland, Luxemburg, or Bermuda. To counter this phenomenon, the OECD released the Report on Action Plan on BEPS to assist in framing tax policies for digital companies. It recommended three courses of action, namely – equalisation levy, withholding taxes, and the concept of significant economic presence.
The USTR considers this crop of DSTs to be a targeted attack on US digital giants – Google, Amazon, Apple, Facebook – and an unfair, discriminatory burden on US digital companies and their technologies. The structure of ‘digital interface services’, to which the French DST applied, is a platform that allows connection and interaction of users for trade in goods or services. This structure is similar to that of the US digital giants, who would also be included under the ambit of ‘e-commerce operators’ to whom the equalisation levy applies.
In this context, it would be relevant to note that article I of the General Agreement on Trade in Services [GATS] extends to those measures that affect the trade of services including specialised digitalised services. Trade of services may occur via four modes of supply: cross-border supply, consumption abroad, commercial presence, and movement of natural persons.
Article II of the GATS accords immediate and unconditional application of the most-favoured nation [MFN] treatment, which entails that countries supplying similar services should be treated equally. Article XVI of the GATS accords the national treatment protection i.e. foreign services and service suppliers should be treated equally with their domestic counterparts. However, national treatment protection is not provided uniformly to all states under the GATS and is subject to the specific commitments made by states for classified services in their respective schedules. For example, India has not made any specific commitments for advertising services or relevant computer related services and thus, is not obligated to provide national treatment protection for foreign services and service suppliers in its tax measures and domestic market regulations. Therefore, tax measures and regulations can treat Amazon unequally in comparison to Flipkart despite them being similar service-suppliers. However, USA could yet claim protection under the MFN principle for possible discrimination against American services and suppliers in comparison to other jurisdictions in the same market.
The author will discuss this possible MFN action and academic ambiguities surrounding digital service trade in the next post.
[to be continued]
– Ayushi Singh