The journey of re-writing international tax principles to represent the world as it stands in the 21st century has posed significant questions regarding the role of multilateralism in the field of taxation. The only reason this debate has been this long drawn is because an equitable solution requires global consensus. However, stakeholders on this subject represent vastly different economies, with varying policy priorities, besides tax being a sovereign subject. Their tax policies and dispute resolution mechanisms also stand at varying degrees of maturity. These differences are further highlighted in matters such as the one at hand, that relates to the exercise of sovereign powers such as levy of tax.
The redistribution of taxing rights over business profits earned by digitised businesses has become a heated global debate. The issue is being actively discussed since it was identified as one of the focus areas of the Base Erosion and Profit Shifting (BEPS) Action Plan by the OECD in 2015. In 2018, international agreement on the market’s jurisdiction i.e. where consumers are located, contribution to value creation, and the consequent need to reassess existing international tax principles began to take shape. However, discussions over the nuts and bolts of this reform have sparked a global debate and have now brought us on the brink of an economic war.
Frustrated by the slow pace of the global discussions on the topic, and anxious to mobilise revenue in light of the ongoing Covid-19 pandemic, several countries have either taken unilateral measures to tax the digital economy or are seriously considering their introduction. Take India for example. The Finance Act, 2020, exponentially widened the scope of equalisation levy. In addition to online advertising services, the same is now also imposed on revenues of e-commerce operators from supply of goods or services in a wide variety of circumstances. Many European countries including France, the U.K., Italy, and Spain are actively pursuing ways to cast their tax net over these tech giants.
The U.S.—as the residence jurisdiction for many of these technology giants and one of the countries likely to lose tax revenue in the event of reallocation of taxing rights—has retaliated against such unilateral measures. The U.S. Trade Representative has initiated an investigation into such levies imposed by several countries, including India. Further, the U.S. has formally put a pause on international negotiations, with a communication to 10 nations. Lastly, the U.S. also threatened the imposition of retaliatory tariffs. This was followed by U.S. treasury secretary Steven Mnuchin rushing a communication to OECD secretary general Angel Gurría, expressing displeasure at the imposition of unilateral levies by various nations. The pace of developments in the pandemic months led OECD tax chief Pascal Saint-Amans last week to announce deferral of the global tax reforms process until the U.S. elections.
The failure of multilateral efforts
Up until early 2020, multilateral discussions on the issue were underway, albeit at a slow pace. Global consensus on the matter was last reiterated as recently as January in the G20 communique, with 137 countries reaffirming their commitment to bridge the remaining differences and reach an agreement-based consent by the end of 2020. Admittedly, these discussions were politically driven, however they displayed multilateralism at its best.
Things appeared to change once Covid-19 began to spread across the globe at an alarming pace. The pandemic ushered the world into an era of consistently rising revenue needs. Since successful multilateral negotiations on the digital tax issue would mean one country ceding tax revenue in favour of another, the 2020 timeline for global consensus has begun to appear increasingly ambitious considering developments in the pandemic months. It is in this climate that several countries decided to take matters into their own hands, exercise their sovereign rights, and unilaterally tax the digital economy. India’s 2020 equalisation levy is a case in point.
Not all hope is lost
The primary idea behind unilateral levies is to impose a tax that would equalise the tax burden on foreign and domestic suppliers. Despite their noble intentions, such levies suffer from multiple flaws. Besides undermining principles of multilateralism that form the basis for international taxation, unilateral levies lead to double taxation and create an unhealthy environment for businesses to operate in. Experts have expressed reservations if India’s expanded equalisation levy meets the touchstone of constitutional provisions, though it is likely to be tested by the courts.
It has been reported that after the U.S. retaliation, many European countries including the U.K., France, Italy, and Spain proposed to limit the scope of digital tax. In an attempt to “ease the task of achieving a consensus-based solution and reach a political agreement within reach this year” the finance chiefs from the four countries offered to proceed with a “phased approach” which would initially only include automated digital services companies, they said in a letter to the U.S. treasury secretary, it was reported.
Based on this trend, it is likely that multilateral discussions will play a part in pacifying and minimising the scope of unilateral levies. Given the adverse impact of such levies on businesses, they do not benefit either of the countries involved in the long term. However, they do satisfy temporary revenue deficits, particularly in these times of economic stress, which is bound to severely impact treasuries of most nations. It is therefore likely that once the pandemic is brought under control, global negotiations on the levy of digital taxation will resume, though only towards the middle of 2021, given the stand of the U.S. administration, a significant stakeholder.
The looming threat of unilateral measures followed by opposition from the U.S. has eventually brought in focus multilateral negotiations in the past. In January for instance, when France contemplated levying digital tax, the U.S. threatened to impose retaliatory tariffs and expressed its intent to pull out of global negotiations. It is then that a truce was brokered and all 137 countries that constitute the Inclusive Framework were brought back to reiterate their commitment towards devising a solution to levy tax on the digital economy.
The way forward
It is critical to recognise that owing to the inherent differences between the stakeholders, a complete unanimity is difficult to achieve. This difficulty has further been underscored by the ongoing health and economic crisis. The pandemic will shift the interests and preferences of governments in digital tax negotiations, as economic and political circumstances take shape.
That said, the absence of at least a broad consensus on a mechanism to tax the digital economy could lead to double taxation, reduce tax certainty, and undermine the relevance and sustainability of the international tax framework, making it imperative to continue negotiations.
The implementation of unilateral measures has assisted in propelling the debate to tax the digital economy and has also contributed towards initiating global consensus on the matter. Therefore, if there is no movement at the global level, there may be some merit in the continuation of these unilateral measures in the interim. However, it is imperative that the unilateral measures such as equalisation levy, in their current form, are revisited such that their legal infirmities are addressed. It is anticipated that the finance ministry’s Department of Revenue shall shortly be issuing detailed FAQs to address concerns of stakeholders.
Though the regulations in the present form have left the digital players dissatisfied, in the medium to long term, India can work in shaping its regulations in a manner that the levy is not discriminatory; it is implemented after adequate stakeholder consultation; imposed at a net operating profit level; the rate as well as the revenue thresholds are determined after conducting extensive cost-benefit analysis; and suitable foreign tax credits are available under the tax treaty framework.
At the global level, instead of targeting complete consensus, multilateral organisations such as the OECD may refocus their efforts towards devising an equitable framework that minimises unilateral measures, while still granting countries a certain degree of flexibility to address the tax challenges of digitalisation.
Views are personal. Butani is founder and managing partner at BMR Legal. Gupta leads the tax law vertical at the Vidhi Centre for Legal Policy.