India’s 2 per cent digital services tax (DST) on e-commerce supply discriminates against US companies and is inconsistent with international tax principles, a US Trade Representative (USTR) investigation has said.

The finding paves the way for potential retaliatory tariffs but the USTR did not immediately specify actions to counter these taxes.

In its report on India’s digital services tax, the USTR said its investigation showed the levy discriminates against American companies, unreasonably contravenes international tax principles and burdens or restricts US commerce. The report says its investigation also indicates that India’s DST discriminates against US digital services companies.

However, India has defended the DST or Google Tax as it seeks to ensure a level playing field between local and foreign e-commerce companies. The tax does not discriminate against any US company and has no retrospective element as the levy was enacted before April 1, 2020 which is the effective date of the levy. It does not have extra territorial application as it applies only on the revenue generated from India.

Commerce ministry sources said the purpose of the ‘Equalisation Levy’ is to ensure greater competitiveness, fairness, reasonableness and exercise the ability of the governments to tax businesses that have a close nexus with the Indian market through their digital operations.

It is a recognition of the fact that in a digital world, a seller can engage in business transactions without any physical presence and governments have a legitimate right to tax such transactions.

The USTR report says there are three aspects of India’s digital service tax that are inconsistent with international tax practices.

The text of the tax is “unclear and ambiguous” and there is no official guidance to resolve these ambiguities. It provides no tax certainty to investing companies

The DST taxes companies with no permanent establishment in India, contravening international tax principle that companies should not be subject to a country’s corporate tax regime if they have no territorial connection to it.

The DST taxes companies’ revenues rather than income (profits), again flouting international tax practices. The tax covers players such as Google, Uber, Udemy, Zoom, Expedia, Spotify, and eBay.