ASSESSING THE NECESSITY OF DIGITAL TAXES IN A GLOBALIZED ECONOMY

ABSTRACT

The rapid expansion of the digital economy has disrupted conventional tax systems, creating challenges in jurisdiction, enforcement, and revenue collection—particularly for developing countries. In response, India introduced the Equalisation Levy in 2016, initially taxing online advertising services at 6%, and later expanding in 2020 to a 2% levy on e-commerce goods and services provided by non-resident operators. [i]This policy sought to address revenue leakage caused by multinational enterprises shifting profits to low-tax jurisdictions. India’s digital taxation regime significantly boosted collections, with revenues rising from ₹1,136 crores in 2019–20 to ₹4,000 crores in 2021–22. However, global negotiations under the OECD–G20 Inclusive Framework, which advocate for a uniform two-pillar model including a 15% global minimum tax, have compelled India to align its framework and withdraw the Equalisation Levy from August 2024. This paper critically examines the evolution, impact, and challenges of India’s digital taxation policy, including jurisdictional disputes, risks of double taxation, and classification ambiguities under the Income Tax Act. It also explores tensions between national tax sovereignty and international consensus, concluding with policy recommendations for safeguarding India’s fiscal interests in a borderless digital economy.

INTRODUCTION

The rapid proliferation of digital technology has reshaped the global economy, enabling cross border transactions without there being a need of physical presence. This transformation although profitable it has posed a major challenge with regards to traditional taxation frameworks which require permanent establishment in order to tax. A key legal issue that arises out of such a challenge is how to tax Foreign Companies operating virtually in Indian borders which escape local taxes.

Online subscription-based services, online sales of goods/ services/ software, online gaming, hotel/ flight booking, Netflix, Amazon, Flipkart, Uber, Airbnb, MakeMyTrip etc are global or national brands which form a major part of the Indian Digital Economy. Majority of the countries have found taxation of these cross-border e-commerce transactions a significant challenge, including India, due to multiple different factors like: administrative challenges in tracking and collecting taxes and issues in asserting taxing jurisdiction, the location of the supplier, absence of any local country physical presence, difficulties in characterizing the nature of the transaction (e.g., as sale of goods or service). In furtherance of the same, the government in the year 2016 introduced Equalisation Levy or digital tax with the aim to recognise the digital transactions that occur between India and outside e-commerce platforms. [ii]It started off with a 6% tax on companies such as Google that made money off of Indian advertisers. In the year 2020, it followed it up with a 2% tax on foreign e-commerce companies.

The research has focused on the introduction of digital taxes in India, examining the role they have played in ensuring a fair share of tax revenue from the global digital economy.

WHY INDIA INTRODUCED DIGITAL TAXATION AND ITS ROLE IN SECURING REVEUE SHARE

The rise of the digital economy has relentlessly disrupted traditional tax systems, compelling them to undergo transformative reforms to address these challenges. As mentioned earlier, online subscription-based services, online sale of services, goods, software, hotel/flight bookings etc are all a part of the digital economy. The location of the supplier, the absence of a physical presence in the country, the administrative difficulties of tax monitoring and collection, the challenges of establishing taxing jurisdiction, and the taxing of these cross-border e-commerce transactions has proven difficult for many jurisdictions around the world, including India.

Many countries worldwide have faced digital taxation issues, especially developing countries. This is mainly due to the rise of Multinational Enterprises (MNEs) from developed countries which conducting digital businesses in developing economies. As a result, it has led to the revenue generated by MNE’s from developing countries untaxed or shifted to low-tax jurisdictions, thereby, causing these developing countries to lose a considerable amount of revenue. [iii]

To address this problem, India introduced an Equalization Levy in the year 2016, imposing a 6% tax on non-residents engaging in online advertisement and related activities with Indian customers (Finance Act 2016). However, since the provision applied only to online advertisements its scope was limited.  As a result, on April 1, 2020, India expanded the scope of the Equalisation Levy to include a 2% tax on e-commerce goods and services, based on the gross income generated by a non-resident e-commerce operator. [iv]

India has joined the Organisation for Economic Co-operation and Development. It is called as the OCED-G20 framework. This framework is known as the OCED-G20. More than 140 countries currently agree on the two-pillar model that the OCED recommended to guarantee that all nations have a consistent digital taxes rate. Since India is also a part of the same, the finance minister has suggested eliminating the country’s present digital tax rates to bring them into line with the OCED reform. [v]

Role, it has played-

India’s implementation of digital taxation measures, notably, the Equalization Levy has significantly contributed to its tax revenues. For instance, India collected ₹1,136 crores from digital taxes between 2019 and 2020. This increased to ₹2,057 crores between 2020-2021 and in 2021-2022 it further rose to ₹4,000 crore, marking a clear indication of the success of Equalization Levy. [vi]

CHALLENGES IN INDIA’S DIGITAL TAXATION FRAMEWORK

Current Digital Taxation Framework

Countries like Kenya imposed a tax of 1.5%. Countries in Europe levied taxes of up to 5% and USA did disapproved this provocation and instead threatened to impose retaliatory tariffs on these countries. In order to settle this, the Organisation for Economic Co-operation and Development (OECD) stepped up and proposed a solution to have a uniform rate of digital tax across the world with presently over 140 countries participating. They proposed two pillars-

• Pillar one: Multinational enterprises with global sales of over €20 billion and profitability of 10% will have to pay some taxes on where they conduct business irrespective of their home market.
• Pillar two: They agreed on a global minimum tax rate of 15% and made sure that every company had to pay at least 15% tax on income irrespective of where they set their home base. [vii]

India joined the OECD-G20 framework in the year 2021. An essential prerequisite for a country to have tax revenue under pillar one is the abolition of any kind of digital services tax measures that exist in the country, any other similar measures that exist as well as a commitment to not introduce any such measures in the future. The Union Budget 2024–25, presented on July 23 2024, proposed the withdrawal of the 2% equalisation levy, effective August 1 2024. [viii]It was highlighted by the finance minister Nirmala Sitharaman that such a move was pivotal for India to ensure alignment with OECD’s pillar one and two solutions which would allow India to integrate itself into the global tax framework without any hinderance caused by Equalisation Levy. [ix]

Challenges

Challenge 1: The current version of the OECD’s plan has received concerns from developing nations, particularly India, as they contend that their interests and rights are not effectively safeguarded and that there are other approaches to handle the matter. In order to protect their financial interests and taxation power, capital-rich nations developed the modern concepts of international tax law in the 1920s. These days, unless the business is conducted through a “permanent establishment,” they limit India’s ability to tax the profits of foreign companies. According to tax treaties, a “permanent establishment” is defined as having a physical presence, such as through offices or staff, or a representative presence. In the context of today’s increasingly digitalised economy, continuing with the traditional tax framework would place India at a significant disadvantage. When met with this challenge, could either implement domestic legislation, revise its bilateral tax treaties, or wait for a worldwide agreement. By implementing the Equalisation Levy at 6% in 2016 and then raising it to 2% in 2020, it took the third route. Since domestic legislation cannot supersede the terms of legally binding tax treaties, India must continue to respect its international tax responsibilities in good faith even as it asserts its fiscal sovereignty through these unilateral steps.

Challenge 2: “Addressing the Tax Challenges of the Digital Economy” (OECD BEPS Action 1 Report 2015) notes that exercising tax sovereignty may involve contradicting claims from two or more jurisdictions over the same taxable amount, which may lead to juridical double taxation, which is the imposition of comparable taxes in two (or more) states on the same taxpayer in respect of the same income. By widening the aspect of “business connection” by introducing the concept of SEP, undue hardship of double taxation will be caused for the tech company as its PE will be situated in one country and SEP in multiple countries, rendering it liable for double taxation. [x] This would defeat the objective of the double taxation avoidance agreement (DTAA) treaties signed between India and other countries in which the global tech companies are based.

Challenge 3: Under the Income Tax Act, 1961- Section 9 is applicable to non-residents and it has categorised income into three distinctive classes as business income, royalty and fee for technical services for technical services. [xi]It is pivotal to classify income primarily because it helps in the determination of tax as each income has different tax consequences based on the head under which the income lies. Different tax rates have been established by the Act for various categories. For example, income classified as business income is subject to a 10% tax rate and a 40% tax rate. However, in order to classify the revenue as business income, a permanent establishment (PE) must be established, which is a challenging undertaking in the context of a digital economy. Whether, earnings from the digital marketplace would be classified as income or fees for technical services is another issue that comes up.

CHALLENGES WHILE IMPOSING DIGITAL TAXES AND POTENTIAL SOLUTIONS

1. Outdated International frameworks

The majority of international tax treaties were created or formed in an era when the concept of a global digital economy was non-existent. These agreements were structured around the traditional notion of permanent establishment (PE), a principle that required businesses to maintain a physical presence within a jurisdiction to be subject to taxation there. Such frameworks were adequate for the industrial and service-based economies of the past. [xii]

However given the rise of technological advancement, this criterion has become less and less relevant. Through websites, e-commerce platforms, or the distribution of digital items, contemporary companies may now sell goods and services across borders without having a physical presence in the nation where the transactions take place. This is made possible by technological improvements. A sizable fraction of multinational firms are from rich countries, and they make a sizable amount of money by doing business in developing countries. These corporations often generate extensive profits from these jurisdictions without establishing permanent installations or physical presences that traditionally form the basis for taxation under existing frameworks. The, absence of such permanent establishments has been strategically exploited by many of these entities to avoid paying taxes in the very markets that contribute significantly to their profitability.

In the wake of strong global commitment to put an end to tax avoidance strategies predominantly built around mismatches in domestic tax rules, the Organization for Economic Co-operation and Development (OECD)/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) developed the Multilateral Instrument (MLI) in 2016. These solutions will enable governments globally to fix loopholes in international tax treaties by implementing certain minimum standards to counter treaty abuse and improve dispute resolution mechanisms. 

2. Friction between nations 

The digital economy is disadvantaged compared to the offline sector since DSTs often only apply to digital services. Lastly, rather from taxing domestic companies, DSTs frequently have specific revenue limits that essentially pick out big tech companies with headquarters in the US. The Office of the US Trade Representative applied retaliatory duties after concluding that the DSTs of many nations discriminate against US enterprises, which produced conflict. The EU member states that have DSTs often apply digital taxes.

The US Treasury Department announced reaching a compromise with five European countries after a dispute over taxes on American tech giants. [xiii]The digital services taxes have primarily affected large US corporations, such as Google and Facebook. Washington had called for abolishing those taxes, saying they were unfairly targeting US tech giants for tax practices that European companies also use. Tech companies have backed Washington’s stance. In exchange for the ability to tax a portion of their income under a new worldwide corporate tax system, they would prefer that nations remove the taxes on individual digital services. Following the introduction of levies on digital services, the United States threatened to impose punitive penalties on France, Austria, Italy, Spain, and Britain. As nations tried to come to an agreement first, the duties were never put into effect. [xiv]

The United States said it will not impose them as part of the accord announced Thursday. Once the global minimum corporate tax agreement is in place, the five nations will also stop taxing Big Tech firms under the joint accord. Any levies paid for the digital services tax will be applied to subsequent tax returns in the interim. “This compromise represents a pragmatic solution,” the nations released a joint statement.

3. The borderless character of digital financial transactions presents opportunities for tax evasion and base erosion, as businesses may take advantage of tax law loopholes to lower their tax obligations. There exists a significant risk of Base Erosion and Profit Shifting, a tactic whereby companies transfer profit to low-tax regions. On May 29, 2013, during the OECD Council Meeting at Ministerial Level, the Declaration on Base Erosion and Profit Shifting was adopted. During this meeting, ministers underscored the significance of re-establishing fairness and confidence in tax systems, including by combating tax fraud and evasion, and acknowledged recent work on Base Erosion and Profit Shifting (BEPS). The Declaration on BEPS encourages the OECD to produce a Comprehensive Action Plan to adjust international tax rules to hinder companies from inappropriately transferring profits to regions offering more preferable tax treatment.

CONCLUSION

India’s journey towards implementing digital taxation, particularly through the Equalisation Levy, reflects a strategic response to the unique challenges posed by the modern digital economy. By acting unilaterally in 2016 and later expanding its scope in 2020, India sought to safeguard its tax base and claim a fair share of revenues generated within its market, even in the absence of a physical business presence. The OECD–G20 Inclusive Framework offers a pathway towards global uniformity, but its terms—especially the requirement to abolish unilateral digital tax measures—pose policy dilemmas for developing nations concerned about retaining fiscal sovereignty. While India’s withdrawal of the 2% levy aligns it with the global tax consensus, it also reopens questions about whether the OECD’s “two-pillar” approach adequately protects developing economies’ revenue interests. Ultimately, the future of India’s digital tax policy will depend on its ability to balance global cooperation with the need to preserve domestic revenue rights, ensuring that the benefits of the digital economy are distributed equitably rather than concentrated in the jurisdictions of multinational tech giants.

REFERENCES

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[i] RSM US, ‘India Has Significantly Expanded Its Equalisation Levy’ (23 January 2023) https://rsmus.com accessed 7 August 2025.

[ii] Income Tax Department, ‘Equalisation Levy’ https://incometaxindia.gov.in/Pages/equalization-levy.aspx accessed 8 August 2025

[iii] India Business and Trade, ‘India’s Digital Service Tax Landscape and Its Implications’ (26 April 2021) https://www.indiabusinesstrade.in/blogs/indias-digital-service-tax-landscape-and-its-implications/ accessed 5 August 2025.

[iv] Indian Journal of Law and Legal Research, ‘Equalisation Levy: An Analysis of Digital Taxation’ https://www.ijllr.com/post/equalisation-levy-an-analysis-of-digital-taxation accessed 5 August 2025

[v] Organisation for Economic Co-operation and Development, Addressing the Tax Challenges of the Digital Economy https://www.oecd.org accessed 7 August 2025

[vi] Finshots, ‘An Explainer on India’s Digital Tax Revenues’ (18 May 2022) https://finshots.in/archive/indias-digital-tax/ accessed 6 August 2025

[vii] International Tax Review, ‘India and the Two-Pillar Solution: The Road Ahead’ (16 August 2024) https://www.internationaltaxreview.com/article/2dmy2lhwi8la8dmbp6gw0/sponsored/india-and-the-two-pillar-solution-the-road-ahead accessed 8 August 2025

[viii] Economic Times, ‘India Will Have to Scrap “Digital Permanent Establishment” Rules Post Global Tax Deal’ (12 October 2021) https://economictimes.indiatimes.com/news/economy/policy/india-will-have-to-scrap-digital-permanent-establishment-rules-post-global-tax-deal/articleshow/86956997.cms accessed 7 August 2025

[ix] Ministry of Finance, Government of India, ‘India Joins OECD/G20 Inclusive Framework Tax Deal’ (2 July 2021) https://pib.gov.in accessed 8 August 2025.

[x] Pallavi Prakash, ‘Digital Economy and Its Impact on Indian Taxation in 2024’ (Tax Management India, 16 September 2024).  https://www.taxmanagementindia.com/visitor/detail_article.asp?ArticleID=12929#:~:text=Key%20Challenges%20in%20Digital%20Taxation&text=However%2C%20digital%20companies%20like%20Netflix,they accessed 6 August 2025.

[xi] Ajay Sharma and Nikhil Gupta, ‘Digital Tax: The Changing Contours of Tax Structure in India’ (SCC Online, 22 October 2019) https://www.scconline.com/blog/post/2019/10/22/digital-tax-the-changing-contours-of-tax-structure-in-india/ accessed 9 August 2025

[xii] Economic Times, ‘India Will Have to Scrap “Digital Permanent Establishment” Rules Post Global Tax Deal’ (12 October 2021) https://economictimes.indiatimes.com/news/economy/policy/india-will-have-to-scrap-digital-permanent-establishment-rules-post-global-tax-deal/articleshow/86956997.cms accessed 7 August 2025

[xiii] Deutsche Welle, ‘US Reaches Agreement to End European Digital Services Taxes’ (22 October 2021) https://www.dw.com/en/us-reaches-agreement-to-end-european-digital-services-taxes/a-59584827 accessed 9 August 2025.

[xiv] Centre for European Reform, ‘The US Proposals on Digital Services Taxes and Minimum Tax Rates: How the EU Should Respond’ (15 April 2021) https://www.cer.eu accessed 9 August 2025