Digital Companies Earn From India Without Fair Tax Liability

TAXING VALUE WITHOUT PRESENCE
Deficiencies in transfer pricing framework and tax rules allow digital companies to earn from India without paying a fair share…

Economic value is generated in India, but the tax incidents shift to foreign jurisdictions. The structure of tax systems based on the Income Tax Act 1961, on physical economies, is increasingly unable to capture value created in digital markets. This is no longer a technical limitation; it is a lacuna in the international taxation framework, then it allows multinational enterprises to minimize tax, despite deriving substantial economic value from user markets.

Globally, India is one of the largest digital markets. Multinational Companies such as Meta and Google generate significant revenue from Indian users through advertising, data monetisation and platform-based services. Yet, a framework dependent on physical presence and comparability fails to effectively tax this value. Transfer pricing refers to profit shifting from international transactions or specific domestic transactions between associated enterprises, and profits are shifted from high tax jurisdictions to low tax jurisdictions.

Globally, this challenge has prompted coordinated reform efforts led by the OECD/ G20 under the BEPS (Base Erosion and Profit Shifting) framework, which introduced 15 action plans to address tax avoidance and profit shifting by MNCs. In Global anti – based erosion (GloBE) rules under Pillar One seek to reallocate taxing rights to market jurisdictions where consumers and users are resident, even if MNCs do not have any physical presence there (ex. Meta & Google). Second is Pillar Two establish a global minimum corporate tax 15% to prevent and control profit shifting to low tax jurisdictions. If a company shifts its profit low tax jurisdiction, other countries can topup additional tax to ensure the minimum tax.

India’s transfer pricing regime, based on the Arm’s Length Principle (ALP), Income Tax Act 1961(s.92 to 92F) & 2025 Act (s. 161 to 177), assumes that international transactions between associated enterprises can be assessed by reference to multiple methods. One of these models is the CUP method (Comparable Uncontrolled transactions) seeks to direct comparison between the price charged in controlled transaction and that in a CUP with in independent enterprise this method enabling a precise determination of the ALP, this principle recognized in Serdia Pharmaceuticals India Pvt. Ltd. v. ACIT (2011) the court held that the CUP method is the most reliable method where close comparable are available, and that strict comparability standards must be satisfied for its valid application.

In comparison, the RPM method (Resale price method), the ALP by deducting an appropriate gross margin profit from the resale price at which goods are sold to an independent company, then compared by associated enterprises. In Bose Corporation India Pvt Ltd vs ACIT (2015, the RPM is the most appropriate method for testing the ALP nature of transactions of pure distributors operating without significant functional modifications. Similarly, the CPM (Cost plus method) determines the ALP by markup to the costs incurred in supplying goods or services to an associate enterprise, particularly in service or manufacturing arrangements. In Sony India Pvt Ltd vs DCIT (2008), the court held that a reasonable profit margin may be added to operating costs where the tested party performs routine functions with limited risks.

However, the PSM (Profit split method) allocates the combined profits arising from controlled transactions between associated enterprises based on their relative contribution to value creation, involving integrated operations and unique intangibles. In DIT vs Morgan Stanley & Co (2007), the Supreme Court held that profit attribution must reflect the economic contribution and functions performed within the jurisdiction.

In practice, the TNMM (Transactional Net Margin Method) net profit margin realised by an enterprise from a controlled transaction relative to an appropriate base compares with an independent company. In, CIT vs EKL appliances Ltd (2012), the court held that TNMM provides a practical and flexible approach for determining ALP outcomes, where exact comparables are not available. Also, the Income Tax Act of 2025 allows any other prescribed method. In digital business models, however, the framework was inherently inadequate. There exists an absence of reliable comparables for user-generated data, network effects or algorithmic value creation. The outcomes are inherently imprecise, resulting in erosion of the tax base.

Judicial pronouncements reflect this conflict between legal form and economic substance. In Vodafone International Holdings v Union of India (2012), the Supreme Court emphasised the importance of legal form, thereby restricting the power of tax authorities to disregard formal arrangements and individual steps. However, Tiger Global International III Holdings v. Authority for Advance Rulings (2026) reflects a gradual shift in tax jurisprudence from 2012 to 2026 towards the principle of substance over mere legal form.  To address these lacunae, India introduced unilateral measures such as the Equalisation levy and the SEP (Significant Economic Presence) concept to tax digital economic activities conducted without physical presence. In European Commission against Apple and Meta, in the European Commission proceeding against Apple and Meta imposed heavy penalties on these platforms under the Digital Markets Act 2025. This case reflects the “substance over form” approach towards taxing digital market power based on economic substance and digital presence rather than traditional physical establishment principles.

The persistence of form based taxation in a value driven digital economy exposes the gap between where value is created and where it is taxed. Judicial pronouncements have begun to acknowledge economic substance, the legislation framework has yet to fully adapt. Unless tax rules evolve to capture digital value creation effectively, the continued erosion of the tax base will undermine both fairness and fiscal sovereignty.

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P. Rajagopal -II year LL.B.(HONS) Vinayaka Mission’s Law school, Chennai. Interested in Tax law and international taxation.