By Ashish Goel

On the sidelines of the G7 Finance Ministers and Central Bank Governors Meeting in May 2024, US Treasury Secretary Janet Yellen chided India for ‘stalling’ a historic, multilateral deal shepherded by the OECD to address the international tax challenges posed by the digital economy.

The tax deal aims to reallocate the taxable income of multinational firms to market or source jurisdictions. The current form of the OECD’s proposal has faced objections from developing nations, including India, who feel that their rights and interests are not sufficiently protected and that there are alternate ways to address the problem.

The current principles of international tax law were drafted in the 1920s and were designed by capital-rich nations to protect their taxing rights and economic interests. Today, they restrict India’s right to tax business profits of a foreign company unless the business is carried out through a ‘permanent establishment’. Tax treaties define ‘permanent establishment’ to include a physical presence, through offices or employees, or a representative presence. But this stipulation does not account for today’s highly digitalised economy that relies on hard-to-value intangible assets, data and automation.

When the OECD embarked upon an ambitious project to revamp international tax rules in 2013, the issue of digital economy taxation was high on its agenda. But the OECD failed to reach a consensus on tax rights in the digitised economy because ‘it would be difficult, if not impossible, to ring-fence the digital economy from the rest of the economy for tax purposes’.

India was left with three options in the absence of a multilateral solution. The first was to amend existing tax treaties to provide for a digital presence. But this was a hard sell for the United States and other treaty partners, especially when the OECD — the world’s de facto international tax organisation — was deliberating upon it.

India could also amend its domestic tax law to provide for a digital presence, which it did. But in the absence of corresponding changes to tax treaties, a change in domestic tax law is at best symbolic. Under international tax law, India is obliged to honour treaty obligations in good faith and domestic tax rules cannot override tax treaty provisions.

The third solution was to wait for a multilateral fix. India got the ball rolling in 2016 with a levy on advertisement-related receipts earned by foreign digital companies. The levy was expanded in 2020 to cover e-commerce transactions.

The OECD’s slow progress led several countries to adopt interim domestic measures. US regulators threatened countries adopting such measures with retaliatory sanctions, which could be counter-productive in many ways. Research suggests that the total impact of imposed and announced tariffs would reduce long-run GDP in the United States by 0.5 per cent, which means lower wages and fewer jobs.

Some of the world’s largest digital businesses are US-based and their profits are primarily taxed in the United States. Any reshuffling of taxing rights may mean less revenue for the US government. To allay concerns that tax measures discriminate against US firms and contravene international tax law, the OECD has worked to finalise a Multilateral Convention to Implement Amount A of Pillar One (MLC), setting out key rules to govern the issue.

The OECD initially committed to table the MLC for signature by the end of June 2024. That deadline has passed and the prospects of an OECD-led solution continue to hang in the balance. India is one of the largest market jurisdictions for US digital businesses and Washington will not sign the MLC if Delhi backs out.

International tax treaties require a two-thirds majority in the US Senate for ratification, but US President Joe Biden and the Democrats may struggle to reach that threshold. Ratification is necessary to meet the required minimum tax base under the MLC to bring it into effect.

There is no data-based assessment yet on whether India would be better off under the proposed MLC when compared to the digital levy that is already in force. One study finds that developed and high-income countries would gain more revenues under the proposal than developing and low-income countries. This is vital because, under the MLC, not only would India have to withdraw its levy, but it also could not introduce new levies in the future. This severely restricts India’s sovereign power to legislate on tax law and policy and runs against the canon of equity in tax matters.

While unilateral measures are antithetical to fairness and certainty in the international tax law framework, any solution must be consensus-based and reflect India’s rights and interests. 

The United Nations General Assembly is currently working on a new tax convention to improve governance over the digital economy. The United Nations is perceived as more equitable for non-developed nations and is better placed to lead the reform process, unlike the OECD’s club of developed, capital-exporting nations. Until that happens, India should dig in its heels against the United States.

• About the author: Ashish Goel studied law at NUJS, Kolkata and King’s College London and is an Indian Supreme Court lawyer. 
• Source: This article was published by East Asia Forum