Decoding India's stand on digital tax

Context: Failure of international tax principles in covering overseas uses of technology for market expansion and recent unilateral domestic amendments to tax digital presence requires a global consensus.

Base Erosion and Profit Shifting (BEPS) Action 1 Report 2015: The report for the first-time acknowledged issue. Recommendations include

• New nexus-based concept of “significant economic presence” (SEP).
• The imposition of a withholding tax.
• Introduction of equalization levy. 

Tax challenges of digitalization

• Traditional understanding of physical presence (brick and mortar models):  It fails to account for developments in technology that allow businesses to cater to market jurisdictions remotely.
• The concept of Permanent Establishment in the Double Taxation Avoidance Agreements doesn’t correlate with SEP.
• Tax Avoidance has perplexed tax administrations: Many businesses book massive gains by digitally servicing large markets without contributing tax revenue in the market jurisdiction.
• In friction with the international trade law and Centre-state power: 
• The U.S Trade Representative has initiated an investigation about equalization levy imposed by several countries.
• The US has backed out of international negotiations at the OECD.
• “Choose and Opt” interim measures: allowed under BEPS (given that tax is a sovereign matter) has failed to provide conclusive solutions.

Legislative Measures in India:

• Introduce the concept of SEP: through amendments to the Income Tax Act, 1961 in 2018.

• • • Widened scope of “business connections” to include SEP, which was in turn defined to cover two activities:

• Transactions in respect to goods, services or property carried out by non-residents in India.
• Widened scope of equalization levy: through Finance Act, 2020
• Inclusion of “systematic and continuous” soliciting of business activities or engaging in interaction with a prescribed number of users, regardless of receipts.

Justification of India’s Equalization Levy

• Huge Size and market penetration: Many businesses in the digitized economy see a huge untapped potential. This would put at the forefront of global debate.
• Need for resources amidst pandemic: The crisis period has turned out to be a “boom period” for digital businesses which justifies their taxation.

Way Forward:

• Devise and fair and equitable tax regime:  by involving all the stakeholders in achieving a global consensus; should be backed by legislation.
• Limit the scope: of taxation by ensuring reasonable, certain, and non-discriminatory parameters.
• What is lost on merchandise trade could be gained through services; as long as the balance is neutralized by capital inflows, no need to complain.