In a 41-page report released on January 6, the United States Trade Representative Robert Lighthizer criticised India’s decision to impose an Equalisation Levy of 2% on digital services. “India’s [Equalisation Levy] is discriminatory on its face. The law explicitly 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,” the USTR’s report said.
No enforcement action was announced, and the US Trade Representative’s office said that they would be evaluating all options.
The Indian government had introduced the Equalisation Levy in 2020. American companies have argued that the levy is overbroad in its scope; the OECD is negotiating a cross-border solution, but in the meantime warned that such unilateral levies can cause a global trade war that shaves off 1% of global GDP. The Indian government defended itself from the USTR’s investigation, arguing that the levy was not discriminatory.
Violation of “international tax principles”
The USTR said that the Equalisation Levy is a violation of international tax principles. First, the taxes are ambiguously defined without guidance to clarify applicability, and so the principle of certainty is violated. Second, the levy imposes a corporate tax on companies that don’t have a physical presence in India, which the report says is something tax principles recommend against. The third violation, USTR said, was taxing revenue. “This is inconsistent with the international tax principle that income—not revenue—is the appropriate basis for corporate taxation,” the report said.
- Discriminates against US companies: The tax discriminates against US companies, USTR said, as it only targets non-Indian companies. Of 119 companies whom USTR identified as likely to be liable for the tax, 72% are American.
“Ringfencing” digital companies
When similar services are provided digitally and non-digitally, the USTR said, there should be no tax discrimination. The Equalisation Levy engages in that behaviour, the report says.
Under the DST, if a company were to sell a movie to an Indian consumer, and deliver that content digitally, the proceeds of the sale would be taxable. If a second company were to sell that very same movie to the very same Indian consumer, but do so in a store on a DVD, that sale would not be taxable under the DST. This differential treatment of like transactions is a textbook example of discrimination. — USTR Report
It should be business models, and not the digital economy, the USTR argued, that should be taxed.
Restricting US commerce
The USTR said that the levy unduly burdens US businesses due to the following reasons:
- US businesses could, per USTR estimates, face an additional tax burden of up to US$30 million per year.
- Many digital companies are low-margin businesses, so taxing revenue instead of income is burdensome.
- The tax liability threshold is low, exposing many smaller companies and startups to liability.
- As shown in the below diagram, the levy impacts a broader range of businesses than other countries’ taxation systems, increasing the number of companies likely liable.
- Compliance costs could be in the millions of dollars, and sometimes getting a PAN in time for compliance may not be possible.
- The levy leads to double taxation.