For the past six months, the United States Trade Representative (USTR) has been threatening to retaliate against the Equalisation Levy (EL) that government of India had imposed on e-commerce companies which do not have permanent establishment (PE) in the country.
The USTR’s threat of retaliation followed an investigation that it had conducted under Section 301 of the United States (US) Trade Act of 1974. Section 301 of the US Trade Act gives the USTR powers to unilaterally investigate and initiate action against foreign countries which it suspects are violating trade agreements, or have adopted acts, policies or practices that are unjustifiable, unreasonable, or discriminatory and burden or restrict US Commerce.
The concept of an EL owes its origin to the discussions taking place in the Organisation for Economic Cooperation and Development (OECD) on the broader tax challenges posed by the digital economy. EL seeks to address the disparity in tax treatment between foreign and domestic businesses in a jurisdiction, in which foreign business have a large economic presence. OECD’s Task Force on the Digital Economy proposed EL as one of the options that could be exercised meet the tax challenges in the digital age.
In India, EL was introduced through an amendment of the Finance Bill of 2020. It was fixed at 2% of the sales turnover or gross receipts of the companies that were operating from foreign jurisdictions. The levy is not imposed on two sets of e-commerce operators: (i) those that have PEs in India, and their e-commerce services or supplies are effectively connected with such PEs; and (ii) total revenue of e-commerce operators is less than ₹2 crore during the assessment year.
After investigating India’s EL, the USTR ruled in January 2021 that this tax violated US economic interests and was hence actionable under Section 301 and 304 of the US Trade Act. Thus, the decision was taken to impose additional import tariffs of up to 25% on 40 products imported from India. The additional tariffs were expected to generate $55 million annually, which, in USTR’s assessment, was equivalent to revenue that the EL would contribute to Indian government’s exchequer.
However, two months after the announcement of retaliation against India, the decision was put on hold for 180 days. Alongside India, similar retaliatory actions were also postponed for several other countries that had imposed similar taxes, and these include, the United Kingdom and Spain. In January, the USTR had indefinitely postponed retaliatory action against France, the first country to tax the digital companies.
The USTR’s proposed retaliatory action against India and its subsequent postponement raises two sets of questions. First, can USTR’s proposed unilateral trade retaliation against policies of foreign countries be justified, given that as a member of the World Trade Organisation (WTO) the US is required to desist from unilaterally acting against another member? Second, what are the possible factors responsible for USTR’s postponement of retaliatory action against India’s EL?
What is USTR’s Rationale for Unilateral Action and Can it be Justified?
USTR’s case against India’s EL used two strands of arguments. The first is that the tax is discriminatory, and that it imposed heavy burden on US-based companies since they are disproportionately impacted. The second is that India’s EL is in contravention of international tax principles.
The USTR argued that India imposed the tax on “non-resident” companies, while exempting Indian firms, which is unique among all jurisdictions that have introduced EL. In other jurisdictions, domestic companies are exempt using high revenue thresholds, but India exempted all domestic companies from the purview of EL. India’s discrimination would have a larger impact on American companies, since of the 119 companies on whom EL was likely to be levied, 86 are US-based. The USTR estimated that the aggregate tax liability on the US-based companies could exceed $30 million annually.
In making its second set of arguments against India’s EL, the USTR maintained that India was in contravention of the international tax principles since EL is levied on the revenues of the companies, rather than their income, or profits. According to the USTR, income and not revenue is the appropriate basis for corporate taxation. Let us understand the veracity of these arguments.
The USTR’s first argument regarding discriminatory nature of India’s EL should be assessed by referring to the relevant WTO rules provided in the General Agreement on Trade in Services (GATS). At the outset, it should be pointed out that GATS allows WTO members to impose taxes on service providers, provided they conform to the two touchstones of non-discrimination, namely, Most Favoured Nation and National Treatment. Therefore, in its application, India’s EL must treat service providers from all WTO member states equally and that the tax must be imposed in a manner so as to treat an Indian and a foreign service provider equally.
As stated above, India’s EL targets e-commerce operators who do not have a PE in the country but have revenue accruals of more than Rs 2 crore. In other words, a clear distinction has been made between e-commerce operators having a PE in India, i.e., those that are covered by the direct tax regime, and those without a PE, which were not taxed until EL was introduced.
Thus, EL addressed a case reverse discrimination against the companies having a PE in India. Moreover, EL is being imposed on e-commerce operators from all countries, thus fulfilling the MFN requirements. The threshold of Rs 2 crore can be considered as the de minimis level for the applying the tax, of which there is sufficient evidence in various WTO covered agreements, such as the subsidy disciplines.
Finally, the USTR’s suggestion that by introducing EL, India has violated international tax principles, is not supported by evidence. As mentioned earlier, EL is one of the options that the OECD has suggested that countries could use in order to meet the challenge of tax avoidance in a digital economy, “provided they respect existing treaty obligations”, including “their bilateral tax treaties”. None of the two provisos hold true for India.
But, while EL is compliant with India’s treaty obligations, the USTR’s proposal to initiate unilateral action against India for introducing EL cannot be justified under WTO rules for two reasons. First, WTO rules prohibit unilateral action by members, and two, WTO’s Dispute Settlement Body had given a ruling in the year 2000 that the US cannot retaliatory action using Section 301 and the related provisions.
As regards the WTO rules, Article 23 of the Understanding on Rules and Procedures Governing the Settlement of Disputes prohibits use of unilateral measures while resolving disputes between member states and provides a multilateral basis of resolution of disputes. Several dispute settlement panels have also pointed out that this Article underscores the primacy of the multilateral system and rejects unilateralism.
The US’ use of Section 301 and the related provisions was the subject matter of a dispute initiated by the European Union, with 16 other members joining as third parties. The main contention of the complainants was that the US had maintained on its statute book, Section 301, and the related provisions, including Section 304, which had empowered the USTR to undertake unilateral trade retaliation, even after the WTO was established. The panel had ruled that Section 304, which makes a determination of action against trade partners, was a violation of the US’ commitments under the dispute settlement understanding.
Reasons for US’ Postponement of Retaliation Against India
The major reason for the US to take a step back from retaliating against India’s EL is the expedited discussions among the major economies to introduce a common framework to ensure that companies in the digital sector pay their fair share of taxes in jurisdictions in which they have activities, and they earn their profits from.
In the aftermath of the Great Recession of 2008, the G-20 countries together with the OECD had initiated a project to address the problem of base erosion and profit shifting (BEPS), which describes the tendency of transnational corporations (TNCs) to shift their profits to low or no tax jurisdictions. Currently, 139 countries and jurisdictions are collaborating to put an end to the corporations’ tax avoidance tendencies.
Responding to the tax challenges arising from digitalisation, the OECD/G-20 Inclusive Framework has been developing a Two-Pillar approach since 2019. Pillar One seeks to establish new rules on where tax should be paid and to establish a fundamentally new way of sharing taxing rights between countries. The aim is to ensure that “digitally-intensive or consumer-facing” TNCs pay their taxes where they “conduct sustained and significant business, even when they do not have a physical presence”.
Pillar Two seeks to operationalise the objectives of Pillar One by introducing a global minimum tax that would help countries to address the remaining issues linked to BEPS of the TNCs, on which a consensus seems to be emerging among the major economic powers.
The changing dynamics of US participation in the BEPS project seems to have set the stage for its postponement of trade retaliation against countries, which, like India, had imposed taxes on digital giants. The pro-business Donald Trump Administration had refused to support the BEPS project, but with the coming of the Biden-Harris Administration, the US has become an active participant. It seems that the US Administration is willing to assess the outcome of the process of taxing the digital sector before weighing-in on the next steps to take on the disputes with its partner countries.
The writer is Professor, Centre for Economic Studies and Planning, School of Social Sciences, Jawaharlal Nehru University. The views are personal.