Even during the coronavirus outbreak, efforts to change the way digital business models are taxed continue. The OECD announced on March 17 that efforts connected to their team’s work on digital taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. ation are continuing at “full steam” even as they shift to telework. The scope of the OECD work is expansive and the challenges for an international agreement seem even greater with the need for negotiations to be virtual.
However, as many around the world are learning the skills of remote work and there is an increasing reliance on cloud-based technologies to support productivity, politicians are unlikely to abandon efforts to redesign the international tax system around digital business models.
India announced this week that its tax aimed at foreign digital companies, the “equalization levy,” will be expanded. The equalization levy has been in place since 2016 and was originally designed as a 6 percent tax on gross revenues from online advertising services. In fiscal year 2017-2018, the revenue from the equalization levy was INR 550 crore (US $73.4 million). Only nonresident businesses are subject to the tax.
The new expansion will apply a 2 percent rate on revenues of e-commerce operators and suppliers. The change will go into effect April 1 and essentially expands the equalization levy from online advertising to nearly all online commerce done in India by businesses that do not have taxable presence in India.
Just as with the original proposal, this expansion only applies to nonresident companies. All nonresident e-commerce companies that sell more than INR 2 crore ($267,000) of in-scope goods or services to Indian customers will be subject to the tax.
As a tax on revenue, the equalization levy is essentially a tariffTariffs are taxes imposed by one country on goods or services imported from another country. Tariffs are trade barriers that raise prices and reduce available quantities of goods and services for U.S. businesses and consumers. and is not based on ability to pay. Businesses with higher profit margins on their digital business with India will face a lower marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. than businesses with lower profitability. The 2 percent revenue tax equates to a 20 percent income tax if a business has a 10 percent profit margin in India. This compares to the statutory tax rate of 22 percent. The lower a business’ profit margin, though, the higher the marginal tax rate under a revenue-based tax.
The Indian equalization levy is significant because it is much broader than the digital services taxes being put in place in Europe, and it is yet another unilateral measure that is contrary to the efforts of the OECD.
India is a significant player in the digital tax negotiations and is already eyeing potential revenue from the OECD outcomes.
In addition to the equalization levy, India introduced a new nexus test in the 2018-2019 fiscal year. The test defines “significant economic presence” (SEP) for the purposes of corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. . Income of nonresident businesses can be attributable to India for digital transactions by nonresidents in India above a payment threshold or systematic and continuous business solicitation and user engagement in India using digital platforms.
The equalization levy paired with the significant economic presence test represents one of the more coordinated efforts to tax digital business models. The strategy closely follows the options discussed in the OECD’s BEPS Action 1 report from 2015. However, a former member of the Central Board of Direct Taxes, Akhilesh Ranjan, said in February 2019 he wanted the measures to be temporary.
The question remains, are these policies the right way to tax digital businesses? The equalization levy essentially operates as a tariff on foreign-provided digital goods and services, and the significant economic presence standard creates challenges in minimizing double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. . If every country chose its own way of defining nexus, there would likely be overlaps in taxation where two countries think they have the right to tax the same income.
Tax policy needs to be designed in a way that is neutral, and the equalization levy is clearly discriminatory. And the double taxation potential of the significant economic presence test can create friction in international commerce.
It is important for policymakers to think through ways that digital taxes might impact the business models of the companies that are providing significant value worldwide during the current outbreak.
The temptation to apply special taxes to digital firms right now when they may be more profitable than the rest of the global economy will be strong. Over the course of time, broad-based, neutral policies should be the tools of choice for taxation. A tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. that relies too heavily on a particular sector could be left standing in the cold when the economic winds shift.
Countries will certainly face revenue difficulties in the coming months, both due to significant fiscal expansion in the face of the crisis but also because of the economic slowdown. Though politicians may spend their efforts on narrow, distortive policies, what will be critical to an economic turnaround are policies that are designed to support growth and investment.
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