The globalized and intangible character of digital transactions creates a number of complex issues for India's digital economy's taxation. This makes it more difficult to attribute profits because digital company models mostly depend on intangible resources like algorithms and user data, making it challenging to precisely distribute profits among jurisdictions. Additionally, active tax planning techniques that weaken India's tax base include transfer pricing and IP moving to low-tax jurisdictions, which support base erosion and profit shifting (BEPS).

Many organizations and intergovernmental organizations have come together to try to develop a solution that will work with the different countries' systems and achieve tax neutrality because governments are now worried about the potential impact that electronic commerce may have on their tax revenues due to this shifting business pattern. Although India's Equalization Levy (EL) on specific digital services attempts to solve these issues, it has sparked worries about the costs of compliance and the compatibility with international tax standards. India should amend its tax laws to incorporate digital-specific clauses, like globally-standard significant economic presence (SEP) criteria, in order to successfully handle these difficulties. Digital taxes regulations can be harmonized globally through multilateral collaboration through organizations like the OECD, which will decrease tax disputes and improve compliance.

Introduction:
In the age of swift technology development, the digital economy has changed international trade, altering cross-border consumer interactions and corporate structures. The digital economy includes a broad range of activities, such as online shopping, services, cloud computing, and internet advertising made possible by digital platforms and technology. Digital transactions, in contrast to traditional economic activity, frequently cross-national borders, creating special taxing issues. The current deed levy was extended to a variety of digital services including e-commerce platforms in March 2020. There is now a two-levy cap on any payment made by non-residents to an Indian user.

There are several other nations besides India are considering or have already implemented taxes on online purchases, such as: Australia—A digital services tax, sometimes known as a turnover tax, is about to be implemented. It will be imposed on the profits of large multinational corporations that provide advertising, commerce platforms, and the sharing of user data. New Zealand: Books and online purchases will be subject to the Amazon tax. Uganda—Social media taxes that require users of Facebook, Twitter, and WhatsApp to pay a charge.

With 29 states, India's digital industry has the ability to contribute significantly to its economy. All of these pressing challenges impact India as well. India cannot afford to ignore taxes on the "Digital Economy" or "Digital India" emerging as a single digital market. A fair and neutral tax structure for "Digital Goods" and "Digital Services" is urgently needed to resolve issues.

1. Digital Good: The word "digital good" refers to any electronic delivery or transfer of software, sounds, pictures, data, or facts in digital format. The transaction's actual object should be the good itself, not the activity or service that produced it. The term "Digital Goods" implies that sales and purchases follow the same regulations as "Goods" outlined in the constitution and related statutes. Hence, just as goods are subject to "sales" under article 366(29A), so will be "Digital."
    
2. Digital Service: The word "digital service" refers to any electronic service, including remote access and usage of digital goods. According to section 65B (44) of the Finance Act, 2012, a "digital service" is a "service" that is not a "digital good".
    

Digital Taxation Around the World:

• In 2020, East and Southeast Asia accounted for 40% of the world's internet users, despite North America producing 40% of the value generated in the information sector. Policy discussions over the taxes that digital businesses pay and where they pay them have coincided with the expansion of the digital economy in recent decades.
• Many nations implemented unilateral tax measures aimed at digital enterprises, such as digital services taxes (DSTs), gross-based withholding taxes, and regulations governing digital permanent establishments, in the absence of a multilateral shift in taxation. As of right now, 18 nations have unilateral DSTs in place, and Canada will shortly follow suit.
• The United States, which is home to the majority of the companies affected by DSTs, intends to eradicate DSTs through trade threats and possible trade wars or by a global agreement.
• There are certain beneficiaries and losers in the multilateral solution of Amount A from Pillar One, and the United States has the power to ratify the treaty or not. However, the removal of all DSTs may not occur even if the treaty is signed. DSTs will keep spreading and cause ambiguity and double taxation if a multilateral solution is not found.
   

Digital Taxation in India:

• India has taken a number of efforts to guarantee taxation on digital transactions: Levy for Equalization (EL). When the Equalization Levy was first implemented in 2016, it was applied to internet ads that were supplied by non-resident organizations. It was extended to e-commerce companies in 2020 and levied a 2 percent tax on the gross sales of international digital companies from Indian consumers. The purpose of this charge is to guarantee that international digital businesses that generate revenue in India pay their fair share of taxes.
• The Finance Act of 2018 introduced Significant Economic Presence (SEP) to reinterpret the definition of "business connection" under the Income Tax Act of 1961. SEP increases the tax obligation of non-resident digital companies with a significant user base in India, even if they do not have a physical location. SEP requirements include: i) threshold for revenue from transactions involving Indian users; ii) number of Indian users interacting with the digital platform.
• India's Goods and Services Tax (GST) policy imposes an 18% GST levy on foreign digital service providers, including software-as-a-service (SaaS) companies, over-the-top (OTT) platforms, and e-commerce operators. The Reverse Charge Mechanism (RCM) requires taxes to be paid by Indian companies that employ these services from non-residents.
   

Need of Digital Tax in India:

• Current tax policies (both international and domestic) were developed decades ago using the brick-and-mortar industry as a guideline. It has become outdated with the rise of the digital economy. Profits from digital firms are increasing across nations, yet no laws exist to tax them effectively. The government's identification as a 'catalyst,' innovation, enabling organizations to take advantage of the loopholes that existed between various tax systems to reduce dutiable income or shift profits to a low-tax country.
• The digital tax is a solution to this problem since it increases revenue-based taxes on digital enterprises in local governments. Any income made by global digital enterprises in these countries must be subject to the Digital Service Fee or Google Tax, whichever term is applicable. There are several informal names for the tax levied on internet service income.
• As a result, all governments must amend and update their tax laws to reflect the digital economy's theft of tax money. However, in this sense, the term 'Digital Economy' differs from e-commerce. For example, the Indian government may take any company that has a physical presence in India. However, digital giants like Facebook and Amazon offer online services that are unavailable in India.
   

Implementation of Digital Tax in India:

• Some countries have taken unilateral actions to tax the digital economy, while the OECD attempts to reach an agreement on an inclusive framework to address tax challenges connected with digitization. In 2016, India enacted a new Equalization Levy on non-residents' revenue from online advertising and connected services. The concept of SEP was introduced into Indian tax legislation in 2019 through an amendment.
• Although the Finance Act 2020 was enacted, the Indian government has postponed its implementation, citing a lack of effective processes under the country's international tax agreements. Everyone was shocked by the addition of an Equalization Levy on multinational e-commerce operators' product and service sales in India, which was not initially included in the Union Budget 2020-21 guidelines. This tax went into effect on April 1, 2020, and it now covers a wide variety of costs.
   

Benefits of Digital Tax after Implementation:

• Digitalization levels the playing field for both domestic and international businesses, rather than providing foreign firms an unfair competitive advantage over MSMEs and start-ups in India. It changes the nature of innovation, product development, and revenue generation for both taxpayers and the government. Previously, corporations without a physical presence in India but with a digital presence were exempt from local tax laws.
• No corporation can escape tax rules or shift their headquarters to heavenly regions if they don't have a real presence in India and yet make money from Indian clientele.
• Taxpayer services are improving as data becomes more accessible and analytics develops. Tax administrations now have new options for making the tax system easier to grasp for individuals while still operating more effectively. The government also obtains revenue from taxes levied on non-resident e-commerce businesses via Digital tax.
• Since indirect taxes were implemented through digitization, fewer forms and returns are now filed physically and electronically online. To guarantee simple, precise, and quick tax compliance, they have embraced technology like the cloud.
• The e-way bills will make it possible to move products without having to deal with paperwork and lengthy lines. In addition to posting the invoices to the portal, the e-invoicing system offers a reporting tool. It will speed up the flow of data.
• E-assessment facilitates the rapid and effective delivery of information to tax authorities in the context of direct taxes. By keeping the documents orderly and lowering the cost of compliance, it has eliminated the possibility of file loss and damage. The corruption has decreased as a result.
   

Challenges of Digital Tax after Implementation:

• When a new tax system is established, it often affects both supply and demand in the business. The supply side of the digital economy includes internet search corporations (such as Yahoo) and social media companies (such as Facebook and YouTube), as well as digital marketing organizations (such as Web Chutney), whose networks underlie the whole digital network. In contrast, local enterprises dominate the demand side. According to a research, advertising expenditure "grew by 15.5% in 2016 to Rs.57,486 crore, with digital ads rising at the fastest rate of 47.5% to Rs. 7,300 crore and accounting for 12.7% of total ad spending."
• One may argue that the equalisation tax is an example of one-sided nation-state leadership. If governments elect to assess on a one-sided basis without any co-appointment or agreement with the partner state, the same money may be taxed several times, obstructing free trade. Nations must always evolve adopting a "consensus-based approach". A one-sided tax would be burdensome for enterprises, increasing administrative work and confusing the tax law. To put it another way, an equalisation levy will only complicate matters for businesses while providing few, if any, effective solutions.
• Start-ups that spend a lot of money promoting their products or services to reach a larger audience would be damaged by the equalisation burden since it would increase ad costs, putting a stop to fresh ideas and discoveries. The high advertising expenditures will impede customer base growth and the creation of new firms. According to this narrative, "At a time when India is riding on a start-up and digital wave, Government has opted to penalize those who try to embrace the new digital medium."
• Blockchain technology will become more widely used in the next years, leading to greater openness and decentralization of information. New models will challenge data storage and management, allowing internet-based enterprises to build new financial solutions. Products and services. The internet of things will generate vast amounts of data that may be combined with physical and digital data to enhance products and services, including biometric authentication. Quantum computing will enable real-time economies and empower mobile devices with computational capacity.

Court decisions:
Flipkart India Pvt Ltd (April 2018):
This decision was issued by the Income Tax appeal Tribunal (the second level appeal body) in Bangalore and applies to the taxpayer's income for fiscal year 2014-15. The issue under discussion was the deductibility of sales discounts for computing taxable company income. The taxpayer, an Indian corporation, was involved in wholesale trading. It offered big discounts to its clients (i.e., retail dealers) while incurring significant losses. The retail dealers then sold the products on flipkart.com, the online marketplace.

The taxpayer's rationale for deducting these discounts was that the e-commerce business was in its early stages in India and were provided to increase sales volume. The Indian tax official believed that selling the items at a loss was not usual business practice, and that this method was used to build consumer goodwill and brand value in the long term, reaping the advantages in coming years. The tax officer recognized that the taxpayer's profit foregone was really the expense made for the production of intangibles, which should be classified as capital expenditure. The tax officer also noted that two venture capitalists paid a premium for the taxpayer's shares during the relevant fiscal year.

The tax officer justified the taxpayer's high share premium by citing their intangible asset, brand value. However, the tax officer did not allow a deduction for the discount in computing income. The appellate authority ruled in favor of the taxpayer, stating that if a trader transfers goods to others at a lower price than competitors, the transaction is bona fide. The appellate authority further stated that a tax officer's task is to analyse the profit or loss reported in the taxpayer's books of account and that the taxpayer's book results cannot be ignored and the taxpayer's income estimated in a different manner.

MasterCard Asia Pacific Pte Ltd (June 2018):

• This verdict was issued by the Authority for Advance Rulings ("A.A.R.") in the instance of a Singapore-incorporated taxpayer.
• The taxpayer, MasterCard Asia Pacific Pte Ltd ("M.A.P.L."), provided transaction processing and payment services.
• M.A.P.L. has entered into agreements with customer banks and financial institutions in India to provide electronic authorization, clearing, and settlement services for card-based transactions.
• The transaction took place over the MasterCard Worldwide Network.
• To connect to this network, a MasterCard Interface Processor ("M.I.P.") is installed at the customer's location in India.
• These M.I.P.s are owned by the Indian subsidiary of M.A.P.L.
• The issue before the A.A.R. was whether a P.E. existed for M.A.P.L. in India.
• The A.A.R. ruled that the automatic equipment installed in the customers' premises are in the nature of a P.E. that causes M.A.P.L. to be taxed in India in connection with the revenue generated through the use of the equipment.
• The A.A.R. observed that in order to constitute a fixed place P.E. (permanent establishment), it is not necessary that the equipment be fixed to the ground; it is sufficient that the equipment remains on a particular site, in accordance with the O.E.C.D. Commentary.
• M.A.P.L. can produce a P.E. as long as it has a specific amount of space.
• Furthermore, the A.A.R. recognized that any payment processing actions carried out by people in India were neither preliminary nor auxiliary. They focused on the heart of the revenue-generating activity.

Google India Pvt Ltd (October 2017):
This decision was made by the second level appeal authority in Bangalore. Google India Pvt Ltd, an Indian corporation, was tax resident in India. Google India was awarded marketing and distribution rights to the Adwords program for Indian marketers. The main under the distribution arrangement was Google Ireland. Google India sent payments to Google Ireland under the Adwords arrangement without collecting withholding taxes.

According to Google India, the payments to Google Ireland were for the usage of advertising space. The tax officer determined that the payments were in the form of royalties and so subject to withholding tax.
The appellate authority noted that the arrangement between Google India and Google Ireland constituted more than just a contract for the selling of advertising space.

The payment represented compensation paid by Google India for the use of Google Ireland's proprietary algorithm to determine which advertisement would be shown to a specific user who made a search on the Google website. The licensed technology enabled Google India to run a targeted marketing campaign for Google's clients' products and services using technology. The search engine technology, related software, and other elements were considered intellectual property held by Google Ireland. As a result, Google India's payment for using these technologies to accept adverts was in the form of a royalty.

Recent Developments:

• The Equalization Levy has been expanded to cover digital services, guaranteeing that international digital enterprises' revenue is taxed in India.
• GST processes have been eased for small e-commerce sellers, including threshold exemptions and simpler return submission.
• India actively engages in worldwide initiatives, including those headed by the OECD, to solve tax difficulties associated with the digital economy. These projects try to establish consensus on international tax standards.
• The Indian government organized a task group to analyse and suggest optimal taxation on digital economy transactions.
• In the new income tax bill 2025, it includes the expansion of tax authorities' powers into virtual digital spaces, stemming from the increasing digitization of financial transactions and the rise of digital tax evasion methods.
• In the new income tax bill, it addresses Tax Evasion in Digital Spaces. Authorities often face challenges in detecting concealed income and undisclosed transactions occurring through online wallets, crypto assets, or offshore accounts. The new bill closes this loophole by ensuring that digital records can be investigated similarly to physical records.
• Many developed economies already have provisions that allow tax authorities to inspect digital transactions and encrypted financial accounts. The new income tax bill brings India's tax regime in line with global best practices.

Conclusion and Recommendations:
By bringing digital assets into the scope of tax investigations, the New Income Tax Bill, 2025, marks a major step toward modernizing India's tax system. The rule has sparked worries about privacy and compliance challenges even as it aims to reduce tax evasion and simplify direct taxes. Discussions about striking a balance between privacy rights and tax enforcement will be essential as the law advances in Parliament to guarantee its equitable and open implementation.

The taxation of the digital economy in the long run is The OECD released revised reports on its two-pillar plan to address the tax issues arising from the economy's digitization for public comment on October 12, 2020. While the Pillar 2 proposal also obliquely seeks a global minimum effective taxation, the Pillar One proposal concentrates on new nexus and profit allocation criteria. The investigation came to the conclusion that, in contrast to international tax laws, other elements of the modern legal system that are shaped by the revolutionary impacts of digitalization present both opportunities and difficulties.

Certain recommendations are:

1. The most effective and efficient method to tax the digital economy is to renegotiate treaties and implement a new nexus rule that will include digital business models in the taxation framework. However, negotiating with different countries to change treaty provisions appears to be a difficult and time-consuming procedure. The research advises that in the interim, treaties might be prioritized with nations whose nationals are heavily involved in digital transactions in India. Alternatively, a Multilateral Instrument might be developed; however, it is crucial to remember that not all countries may agree to sign such an instrument.
    
2. Assuming that treaties are signed, it is critical that the Indian government's unilateral action of imposing an equalisation levy be reconsidered, and potentially its existence re-evaluated. In addition to the new nexus regulation, procedures for allocating profit to the new nexus will be implemented.
    
3. Even if treaties are not signed, if data localization rules are implemented, many e-commerce enterprises may be subject to taxes. Companies can still legitimately evade taxation if their essential function is not done on a server in India. Thus, data localisation regulations compel any website to have servers solely in India. While the tax implications of such data localization rules appear to be favorable, their merits must be further studied.

References:

• https://ijcrt.org/papers/IJCRT22A6894.pdf
• https://taxfoundation.org/research/all/global/digital-taxation/
• https://icmai.in/TaxationPortal/upload/DT/Article/53_1_09_03_21.pdf
• https://ispirt.in/wp-content/uploads/2018/11/TAXATION-O-THE-DIGITAL-ECONOMY-V1.4-finalized-08122015.pdf
• https://files.taxfoundation.org/20200527192056/Digital-Taxation-Around-the-World.pdf
• https://taxguru.in/income-tax/indias-digital-service-taxation-issues-solutions.html

Written By: Shruti Nair, BALLB - Manav Rachna University