Exports (Representative image)
In the early hours of May 11, the United States Trade Representative held a hearing on whether retaliatory tariffs should be imposed on India for its decision to levy a digital services tax on foreign technology majors.
The unprecedented move comes in the wake of the government standing firmly behind the digital tax, officially known as the 'equalization levy' which charges all non-resident entities up to 2 percent on their earnings through digital businesses based in or targeting the Indian market.
While a fight had been brewing over the issue between the two nations for long, the pace of the US action has surprised New Delhi which had hoped for more cordial trade relations after four years of a combative Donald Trump administration.
What is the digital tax ?
The Finance Act, 2020 enhanced the scope of India's digital tax levy known as the Equalization Levy (EL) to cover 'e-commerce supplies or services'. With effect from 1 April 2020, it is chargeable at the rate of 2 percent on consideration received or receivable by non-residents who operate digital businesses targeting, among others, the India market.
It exists as a separate levy alongside the Goods and Services Tax (GST) on cross-border transactions and hence it is an incremental cost of doing business. The levy covers a range of digital transactions including business-to-business (B2B) transactions, business-to-consumer (B2C) transactions, e-commerce marketplaces and digital services.
This covers all digital transactions done in India as well as those which use Indian data if the offshore digital economy firm’s revenue from India is Rs. 2 crore or more.
First brought into force in 2016, the levy had been popularly known as 'Google Tax' and had just targeted offshore firms hosting advertisements aimed at Indian consumers. But its expansion to almost every corner of the commercial domain of the internet has stoked US anger.
What does the US want ?
The US has repeatedly opposed any taxation on the internet and back in January this year called the move discriminatory because it exempts Indian companies and targets non-Indian firms. A USTR report also pointed out that a disproportionate number (86 out of a likely 119) of American companies would be liable to pay out the taxes given that majority of the players on the digital and technology fronts are American.
On May 1, the Special 301 report brought out by the USTR had pointed out for the first time in 2020 that the tax was 'actionable'. US Trade Representative Katherine Tai said the issue would be the subject of intense bilateral engagement during the coming year.
The report is annually released by the USTR to highlight the level of Intellectual Property protection and enforcement regimes of Washington DC’s trade partners, which pose as market entry barriers for American businesses. Similar to the past few years, the report has yet again put India under the Priority Watch List, alongside nations such as China, Russia, Saudi Arabia, Ukraine, and Venezuela.
What is at stake ?
The latest hearing by the USTR has immense significance as the US continues to be the largest destination of Indian goods. Exports to the US remain broad based and in the latest financial year constituted almost 18 percent of India's overall international exports.
India’s merchandise exports to the US rose for 5-years straight until 2020-21 when the Covid-19 pandemic reduced it to $ 45 billion in the first 11-months of the year. Exports had raked in $53 billion in FY20. On the other hand, in-bound shipments also fell to $ 24.9 billion in the first 11-months of FY21 from $35.8 billion in FY20.
Any retaliatory measure would also have a cascading effect on domestic production at a time when the global trading scenario remains fraught with volatility owing to the pandemic, fear officials.
What will happen now ?
The government feels the levy is a prompt way to deal with growing calls of taxing digital majors like Google and Facebook who earn from the Indian market despite not having a physical presence in India and not paying taxes here.
The United States until now had said it was open to reaching an international consensus through the OECD process on international tax issues. But with the tax kicking in now, it has exercised its domestic trade response.
The latest hearing is the result of the Biden administration taking recourse to powers given to it under Section 301 of its Trade Act. This authorizes the US government to withdraw trade benefits, impose duties and import curbs or deny federal permits to supply services in some sectors. Also, it can engage with a foreign government to phase out the policy covered under the probe and offer compensatory trade benefits.
In March 2021, the government clarified that offshore e-commerce firms that sell through an Indian arm will not have to pay the two percent equalization levy. In essence, foreign e-commerce platforms with an Indian permanent establishment or those already paying income tax in India will not be subject to the digital tax. Further discussions between the two nations are expected to begin from this point.