Digital Services Tax

The United States Trade Representative (USTR) published a report concluding that the 2 per cent digital services tax (DST) introduced by the Indian government vide the 2020 Finance Act discriminates against US businesses, contravenes settled principles of international tax law, and restricts US commerce.

The report was published following an investigation conducted by USTR under section 301 of the US Trade Act, 1974, which authorises it to appropriately respond to a foreign country’s action that is discriminatory and negatively affects US commerce.

India ’s response:

  • India’s 2 per cent DST is levied on revenues generated from digital services offered in India, including digital platform services, digital content sales, and data-related services.
  • Pertinently, India was one of the first countries in the world to introduce a 6 per cent equalisation levy in 2016, but the levy was restricted to online advertisement services (commonly known as “digital advertising taxes” or “DATs”).
  • The 2020 DST, however, is broader in scope and extends to all kinds of digital transactions.
  • The DST is aimed at ensuring that non-resident, digital service providers pay their fair share of tax on revenues generated in the Indian digital market.
  • Currently, Indian double taxation avoidance agreements (tax treaties) with foreign jurisdictions do not permit the source-based taxation of business profits of non-resident companies in India in the absence of what is called a “permanent establishment” (PE).
  • By definition, a PE is a fixed place of business through which the business activities of a non-resident company are carried on in India.
  • Importantly, while non-resident, non-digital service providers pay Indian corporate tax on income attributed to a PE in India, business models employed by non-resident digital service providers obviate the need for a physical presence in India and profits attributed to the Indian market could easily escape the Indian income tax net.
  • sections 301(b) and 304(a)(1)(B) of the Trade Act provide that if the U.S. Trade Representative determines that an act, policy, or practice of a foreign country is unreasonable or discriminatory and burdens or restricts United States commerce, the U.S. Trade Representative shall determine what action, if any, to take under Section 301(b).

USTR Report Findings:

  • The USTR report finds the DST to be discriminatory on two counts. First, it states that the DST discriminates against US digital businesses because it specifically excludes from its ambit domestic (Indian) digital businesses.
  • And second, according to the report, the DST does not extend to identical services provided by non-digital service providers.
  • While both these findings may seem justified at first glance, they are wholly misplaced and disregard the background and context in which the DST was introduced.

Several aspects of the DST exacerbate this tax burden, including the DST’s extraterritorial application, its taxation of revenue rather than income, and its low domestic revenue threshold which allows India to tax U.S. firms that do relatively little business in India.

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