From UPSC perspective, the following things are important :
Prelims level : Equalisation levy
Mains level : Paper 3- Digital Service Tax as an interim solution to the challenge of taxing digital companies doing business internationally
Business models of digital companies challenge the conventional basis of taxation in which the fixed place of business formed the basis. Digital Service Tax could provide a basis to deal with the challenge. The article deals with this issue.
Equalisation levy and issues with it
- Equalisation levy seeks to tax payments made for online advertising services to a non-resident business by residents in India.
- India is amongst the first to have implemented such levy.
- It is predominantly applicable to US companies since the market for digital services is dominated by US-based firms.
- Any company that has a permanent residence in India is excluded since it is already subject to tax in India.
- In March 2020, India expanded the scope of the existing equalisation levy to a range of digital services that includes e-commerce platforms.
- Such levy can result in over-taxation since the company will not be able to claim any credit for tax paid on Indian sales.
- Such an approach is often viewed as contrary to the ethos of international agreements.
Issue of taxation of digital companies
- The agenda to reform international tax law so that digital companies are taxed where economic activities are carried out was formally framed within the OECD’s base erosion and profit shifting programme.
- Worried they might cede their right to tax incomes, many countries have either proposed or implemented a digital services tax (DST).
- However, the proliferation of digital service taxes (DSTs) is a symptom of the changing international economic order.
- Countries such as India which provide large markets for digital corporations seek a greater right to tax incomes.
- 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.
- The current basis for taxing in a particular jurisdiction is a notion of fixed place of business.
- To overcome the challenge, countries suggested that a new basis to tax, say, the number of users in a country.
- The EU and India were among the advocates of this approach.
- In 2018, India introduced the test for significant economic presence in the Income Tax Act.
- However, the proposal of a revised nexus was not supported widely.
- Moreover, to give effect to a new system would require bilateral renegotiation of tax treaties that supersede domestic tax laws.
- Meanwhile, the OECD continued to work to find commonalities among a range of solutions.
- In its current form, the solution is too complex to administer and proposes to allocate residual profit — a term that has no economic definition.
- It would also require political consensus on multiple issues, including sensitive matters such as setting up of an alternative dispute resolution process comparable to arbitration.
- This can increase the compliance burden.
- The US has expressed its preference to apply this measure on a safe harbour basis, which can limit the companies to which it may be applicable.
Consider the question “Digital corporations can operate in a market without a physical presence. The current basis for taxing in a particular jurisdiction is a notion of fixed place of business. In light of this, examine the challenges in taxing the digital companies and how India is dealing with such a challenge?”
As countries calibrate their response to competing demands for sovereignty to tax, DST is an interim alternative outside tax treaties. It possesses the advantage of taxing incomes that currently escape tax and creates space to negotiate a final, overarching solution to this conundrum.