[2023] Bennett Journal of Legal Studies [Vol. 4.

1]

Bennett Journal of Legal Studies

Vol.04(01), Feb 2023, pp. 120 - 130

TAXING THE DIGITAL ECONOMY: A WAY FORWARD

Raunak Sood*

Abstract

In the recent budget session for the financial year 2022-2023 there
was a 30% tax imposed on virtual digital assets by the Parliament.
On the international front the UK and France announced taxes
where the big-tech companies were liable to pay taxes to the
respective sovereign governments. The current research paper
seeks to demonstrate the conventional international treaties on
taxation which need to be updated on an urgent basis, then for
applying a digital tax the international taxation norm that are
being physically present in a country, shifting the tax burden to
low tax jurisdictions for avoiding taxes and low tax rates on
digital services in some countries such norms need to be changed
for implementing digital taxation. In this research paper the
avenues related to taxation of the “digital economy” have been
illustrated by explaining what the digital economy is and how
domestic Indian law is lacking in keeping up with the emerging
trends. There are some principles which need to be agreed to
between the nations for establishing a technical and substantive
piece of legislation for bringing changes and uniformity in all
jurisdictions hence a draft comprehensive tax action plan has

*
The author is a Fifth Year, BBA LLB (Hons.) student at School of Law, Bennett University,
Greater Noida

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been discussed by the author in bits and pieces by using secondary

sources to conduct the research. The focus of this research paper
shall be to discuss the legal issues in arising from taxing
technology and will make recommendations for the formulation of
policies for using tax as a tool for incentivising parallel digital
economy to be merged into the mainstream economy and lastly,
the authors will give some solutions and way forwards which they
think is fit thereafter helping in tackling the issue of tax on digital
technology and economy.

Keywords - Taxation, Digital Economy, Income, Permanent

Establishment, Equalization Levy, Significant Economic
Presence

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 INTRODUCTION

The current regime for international taxation of digital economy has failed
miserably as there was a failure to adapt to the commercial practices of the market
therefore there has been a lack of legal update when it comes to taxing the goods
and services which are being offered digitally. The digital economy mainly
consists of the big-tech and multinational firms which offer goods and services
over the internet and as per European policy such big tech as classified as
“FAANG”- Facebook, Apple, Amazon, Netflix, and Google which upon
receiving liberal construction refers to the potentially increasing tax-base which
has ripened for taxation for the purposes of this Part.1 It is simply the digital
companies which make up the digital economy.2 These E-Commerce Platforms
or Digital Companies as the case maybe seek to deliver services or goods without
having any physical registered office or presence using huge amount of data to
process the operations thereby such companies (digital companies) are rendered
outside regulatory control of the Indian Government. Digital companies mainly
rely upon dataflows to generate their revenues and since there is no clear
definition in this existing law hence these digital companies have been able to
avoid taxation altogether. It is important to note that laws of international taxation
are applicable to only Non-Resident Indians (“NRI”). In this research paper there
shall be a discussion on the aforesaid issues with regard to the scope, extent and
solutions and a way forward shall be given at the end of this research paper.

1
Silvia Amaro & Karen Tso, US Tech Firms like Apple and Amazon Are Posing a ‘Huge’ Tax
Challenge for France, CNBC, https://www. cnbc.com/2017/10/06/apple-amazon-tech-
firmsare-a-tax-challenge-for-france.html (quoting Bruno Le Maire, the French finance
minister, referring to GAFAs), last seen 02/04/22.
2
Fair Taxation of the Digital Economy, EUROPEAN COMMISSION, https://
ec.europa.eu/taxation_customs/business/company-tax/fair-taxation-digital-economy-en, Last
visited Oct. 12, 2019.
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CHARACTERIZATION OF INCOME

Under Section 9 of the Income Tax Act, 1961 (hereinafter referred to as “IT Act,
1961/ IT Act”) bearing the short title “Income deemed to accrue or arise in India”
herein under this section there are three broad headings which are applicable to
NRI that are “Business Income”3, “Royalty”4, and “Fee for Technical Services”5.
This issue of characterization of income is really important to be redressed
because it makes a huge difference that whether the income from giving digital
services is classified as royalty or business income then there is a tax at 10%, if
NRI does not have “business connection” or PE in India, whereas if income
earned from digital sources is considered as business income then the tax rate at
40% is leviable provided that the said NRI has PE in India.

The presence of digital companies earning vide dataflows constitutes digital

economy and for taxing the digital economy the main challenge is that under
which head of income will the digital economy fall into. So, it is very important
to know that whether the commission which are received by e-service providers
are covered under which head of income:

1. The first problem faced is that whether commissions/ user fees and
received by website operators are to be treated as business income or fees
for technical services therefore in eBay International AG v. Deputy
Director of Income Tax6 the Income Tax Appellate Tribunal ruling against
the Respondent held that any user fees charged by eBay does not come
under the head “fees for provision of managerial services” under Section 9
of IT Act because eBay is a platform where merely buyers-and-sellers
interact. Since eBay does not play any role whatsoever in successful sales
thereof the contention of revenue authorities that commissions/ user fee

3
S. 9(i), Income Tax Act, 1961.
4
Explanation 2 in S. 9(1)(vi), Income Tax Act, 1961.
5
Explanation 2 in S. 9(1)(vii), Income Tax Act, 1961.
6
eBay International AG v. Deputy Director of Income Tax (IT), ITA No.6784/M/2010.

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received by eBay is taxable was rejected because only managerial services

were provided by eBay platform for managing customer orders.

2. The second problem faced while taxing digital economy might be that
whether income generated by digital companies in the form of subscription
fees is to be treated as business income or royalty. There are lot of
conflicting case laws on this aspect-
a. In Re: Dun and Bradstreet Espana, S.A.7- The Tribunal held that merely
giving access rights to reports which are already public documents and
giving service access to such reports compiled thereafter shall not
constitute as royalty payment because such services were available to
the public at large hence subscription fees cannot be held to be
constituted as royalty.
b. CIT v. Wipro Limited 8- The Hon’ble High Court of Karnataka held that
the payment received by authority having control over the database
shall constitute a royalty payment even though the database consists of
publicly disclosed documents, furthermore the license to use database
is again falling within the head of royalty and not business income.
c. In Re Cargo Community 9- The Appellate Authority held that the
quantum of money paid under the grab of subscription fee for the usage
of Cargo Community Network with regard to the provision of access
and usage of web portal whose server was at that point in time located
at Singapore would come under the head of “Royalty Payment”.

Therefore, it can be seen from the aforementioned case laws that there are
contradictory rulings of the judicial and quasi-judicial authorities/ tribunals when
it comes to classifying user fees or subscription fee under business income or as

7
In Re: Dun and Bradstreet Espana, S.A., (2005) 193 CTR (AAR) 9.
8
CIT v. Wipro Limited, [2013] 355 ITR 284 (KAR).
9
In Re Cargo Community, (2007)208 CTR (AAR) 184.

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license fee thereby being characterized as royalty, hence in conclusion there is a

basic lack of legislative clarity as to the classification into heads of income for
transactions generating revenue over the digital e-commerce.

ESTABLISHMENT OF PERMANENT ESTABLISHMENT(PE) IN

INDIA

The second most important thing after characterizing income as business income
is to check that whether there exists a “business connection” in India for the
particular income which is taxable in India. There are several business models
within the digital economy which place reliance on patents, copyrights,
trademarks, network effects or economies of scale which give digital companies
or digital firms a huge amount of leeway when it comes to choosing the location
of their central functions. Digital Companies or firms which earn revenue via
offering of their goods and services on their respective digital platforms to avoid
taxes set up their offices in those territories where neither the parent company is
a resident, nor the customers of that company reside. The online business model
structures seen in Uber India Services 10 where Uber India when questioned on its
tax liability stated that Uber India is merely a platform which gives support
services and a mere agent who collects revenue from India and disburses funds
as directed by Uber BV (parent company of Uber which has been established in
Netherlands) which enjoys a lot of tax benefits for the newly incorporated
companies within the territory of Netherlands. 11

The economy operating on digital platform has made it easy for the access to
service and goods on digital platforms across the globe where there is no necessity
to take into account the amount of time and finances to set up physical presence
(or registered office in the country) in the host country so far as the relevant
jurisdiction is concerned. The best example which can be given is of Meta which

10
Uber India Services Limited v. JCIT, 10039/JCIT(TDS)(OSD)-2(3)/2018-19.
11
Radhakrishnan Rawal, The Taxation of PEs: An International Perspective, (2nd ed., 2006).

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earns humongous amounts of financial revenue in its “subscription” fees account

by not needing an office in India which is engaged in service of Indian customers.
Even the servers of such companies like FAANG do not even have their servers
in India the said server is located somewhere abroad thereby the taxation laws of
India which have limited extraterritorial reach cannot such ripe high revenue
generating digital companies.12 Hence if there is a lack of business connection
then the taxation of such companies might fail.

ATTRIBUTION OF PROFIT TO PERMANENT ESTABLISHMENT

If the NRI possess the PE in connection to India, then the main task of assigning
profit to the account of that NRI and is a major issue which has not been settled
with regards to the operation of the digital economy. Article 7 of the OECD
(Organization for Economic Co-operation and Development) model convention
provides that for attributing profits to a particular PE the said PE should be
completely separate and stand on independent footing for comparison with third
parties to set up the whole transaction fees (price). In e-commerce transactions,
for example buying a shirt at Amazon.in therein we do not know that where the
server of Amazon is location because in this scenario we are assuming that the
PE is allocated to the server of Amazon.in hereof giving attribution to server of
Amazon.in is not a viable option since the server can be present at any jurisdiction
and there might not be enough manpower connected to the server performing the
day-to-day activities on that server therefore a technical problem arises for
calculation of the functions performed and the risks which were taken by the

12
Lina Spinosa & Vikram Chand, A Long-Term Solution for Taxing Digital Business Models:
Should the Permanent Establishment Definition be Modified to Resolve the Issue or Should the
Focus be on a Shared Taxing Rights Mechanism? 46 Intertax 476,494 (2018),
https://www.kluwerlawonline.com/abstract.php?area=Journals&id=TAXI2018052, last seen
on 14/09/2019.

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server. Hence currently there is a need to look at the alternative options which
have to be taken into account to attribute profits to digital PE.13

Rule 10 of the Income Tax Rules assigns the given profit rate which is applicable
to the quantum of financial revenue-based-turnover generated in India of a
company based abroad hereafter seeking the identification of assignable profits
(those profits which are assigned to operations of the foreign company) due to
operational activities carried out in India. Furthermore, the Apex Court in DIT v.
Morgan Stanley & Co., 14 held that principle of transfer pricing is to be applied
when assigning profit to that particular PE hence there are several judicial
decisions stating that in an ad hoc manner the profits have to be attributed to the
PE.

To further illustrate the principle of transfer pricing firstly its means that the
transaction price agreed thereto between the parties shall be equivalent to the
price of comparable transactions. It is also called as the arms-length principle.
For example, when a son buys house from his father the father will of course sell
the house to the son at a discount but if the father sells the same house to a stranger
then the sale price of the house will be different hence principle of transfer pricing
states that here the father (seller) will have to pay the price at the same price on
the gains made by him as if he was selling it to some stranger. The principle of
transfer pricing is used in international sales where one or more subsidiary
company of the parent buyout each other, hence the principle of transfer pricing
enables tax authorities to get a fair price for collecting the due revenue. 15
Therefore, following from the above examples and principle slaid down there is

13
Asaf Harpaz, Taxation of the Digital Economy: Adapting a Twentieth-Century Tax System
to a Twenty-First-Century Economy, 46 Yale Journal of International Law 57 (2021)
http://hdl.handle.net/20.500.13051/6747.
14
DIT v. Morgan Stanley & Co, (2007) 292 ITR 416 (SC).
15
Andres Baez Moreno & Yariv Brauner, Taxing the Digital Economy Post BEPS…Seriously,
58 Social Science Research Network 19,16 (2019) https://dx.doi.org/10.2139/ssrn.3347503
last seen on 11/04/2019.

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a lack of legislative clarity over the attribution of income to permanent

establishment when it comes to income being generated over the digital economy.

UNILATERAL MEASURES TAKEN BY INDIA

There are several measures which were taken by India as per the changes
suggested by the Akhilesh Ranjan Committee (i.e., the committee on taxation of
e-commerce) and some of these measures got outdated but later on the principles
suggested by this committee was valid to date and hence constitute the unilateral
measures taken by India and is explained as follows:

A. Equalization Levy- It is imposed in cases where tax is imposed on

payments which are being made to foreigners to put the domestic
competitors and foreign competitors on the same pedestal in connection
with the goods and services provided in the digital economy. This levy is
imposed on the income arising or incidental thereto the consideration
received by the NRI, thereby equalization levy is an indirect tax levied on
consideration arising out of trade in goods and services in the digital
economy. This equalization levy tax was bought into force before the GST
regime came into picture i.e., before 2016. Equalization Levy was inserted
vide Finance Act, 2016 to provide for an equalization levy of 6% on the
consideration received by the NRI. As per the provisions of the Finance
Act services like online advertising, facility service for online platforms
and their advertising were made taxable by the Government, herein the
term “online” was defined as a right or benefit which was derived through
internet mediums or any form of telecommunication. The scope of levy
was restricted to online advertisement services only. Equalization levy was
not charged any NRI who was having a PE in India and while making
payments to NRI’s the EL (in short for Equalization Levy) was to be
deducted before making the payment to any NRI who was not having a PE
in India. Therefore, only selective services of the digital economy were

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taxed altogether here Indian Government failed to recognize the essence of

the Digital Economy. 16
B. Significant Economic Presence (“SEP”) - This concept was introduced
vide Finance Act 2018 where SEP under the Income Tax Act. 1961 was
defined to be transaction where the NRI carries on transactions of goods
and services with any Indian Resident if the total payment is more than Rs.
20 million. For calculating SEP, the total value of all the considerations
received is taken into account. Furthermore, a wide definition in the stating
that a systematic and continuous business activities or interacting with a
lot of users here the activity must exceed the central government prescribed
number of users. As for the transactions who agreement for said activities
were signed and executed in India; NRI was business connections with
India; BRI renders service in India. As far as the digital economy is
concerned the law has failed to keep up because the term “user” was not
defined in the Act because a user can be a viewer, clicker, or subscriber
hence the government failed to identify the tax base altogether. For
example, on Facebook, YouTube, and Instagram the click-based user
generates data which is then targeted with advertisement thereof the money
is accumulated in a valorised quantum from the advertisement itself.17

THE WAY FORWARD

The way forward is to make sure that the countries are making sure that there
should be some negotiations which should be carried forth between various

16
Report of Ad Hoc Group of Experts on International Cooperation in Tax Matters: Eighth
Meeting, United Nations, Official Record, (Department of Economic and Social Affairs)
ST/ESA/258 (New York, 1998) 4 [18] available at
http://www.un.org/esa/ffd/tax/overview.htm last seen on 04/05/2022.
17
Committee of Experts on International Cooperation in Tax Matters, 30 October 30, 2006 - 3
November 3, 2006, United Nations, Official Report, Report of the Second Session 7 [26]
available at
http://www.un.org/ga/search/view_doc.asp?symbol=E/C.18/2006/10(SUPP)&Lang=E
accessed 04/03/2022.

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sovereign nations of this world for the purpose of uniformly deciding the very
definition of equalization levy where a unilateral measure of each and every
country of this world should be rethought thereby expanding the scope and
existence along with the renegotiating the chances that the same might lead to
double taxation.

The provision of SEP should be amended to make it clearer and objective wherein
the definition of “user” is expanded upon, and different in-depth models should
be used as an example for drafting the clarificatory words of the prospective
amending statue. The IT authorities should draft the rules for characterization of
income and attribution of profits to different heads of income. Taxability of
servers located abroad should also be taken into account while introducing new
policy on taxing the digital economy.

The authors further make the following recommendations:

1. The Government of India cannot always use legislative power to enact tax
laws for the regulation of digital economy therefore it is suggested that
nodal autonomous bodies on the lines of SEBI, CCI etc. something similar
can be born out of legislative enactment incorporated to solely aid and
advise the Government on aspects of digital economy and have some minor
regulatory powers to frame rules and regulations for the digital economy.
2. It is in benefit of Government to set up research centres which research on
aspects of digital economy and the way to streamline it within the main
economy thereby taxing this ripened tax base.

In conclusion, even though India took some unilateral measures to regulate the
income generated via the digital economy and technology but still the way digital
economy is moving faster than the law can keep up hence there exists a regulatory
gap altogether which needs to be addressed immediately.

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