Introduction:
The digitalization of the economy has fundamentally reshaped global trade, business operations, and consumer interactions. It has allowed businesses to transcend physical boundaries, offering consumers unprecedented access to goods and services. For governments, digitalization presents an opportunity to increase fiscal revenues. However, the adoption of digital taxation systems remains uneven across the globe, leaving many developing countries struggling to adapt.
As digital commerce continues to transform the global economy, traditional tax frameworks, which were designed for brick-and-mortar models, have encountered significant challenges to tackle tax leakages arising from cross-border digital transactions. The rise of the digital economy has also transformed global value chains, enabling multinational enterprises to integrate operations across jurisdictions without a physical presence. This evolution has posed significant challenges to international taxation, leading to concerns over Base Erosion and Profit Shifting (‘BEPS’).
In response to these concerns, the Organization for Economic Co-operation and Development (‘OECD’), in collaboration with G20, introduced 15 BEPS Action Plans. Notably, Action Plan 1 focused on addressing the tax challenges arising from digitalization had identified three options to deal with BEPS challenges arising from digital transactions namely:
(i) a new nexus in the form of a significant economic presence,
(ii) a withholding tax on certain types of digital transactions, and
(iii) an equalisation levy
Recognizing these challenges, India had introduced the Equalization Levy (‘EL’ or ‘Levy’) in 2016 as a unilateral measure to tax the payments made to non-resident entities for online advertising services at the rate of 6%. In 2020, the scope of the levy was expanded to include e-commerce transactions at the rate of 2%, thereby extending its reach to a broader spectrum of digital activities conducted by foreign companies without a physical presence in India. Recently, the Indian Government has taken a bold step to abolish this Levy in India.
This report explores the implications of indirect taxation of e-commerce and digital trade in developing economies, identifies the main challenges, and highlights international experiences that could guide policy reforms.
The Global Landscape of Digital Taxation:
The OECD/G20 Two-Pillar Approach
In 2021, 137 of 141 countries within the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) reached a landmark agreement on a two-pillar solution, known as BEPS 2.0:
- Pillar One: Reallocates a portion of profits of the largest and most profitable multinational enterprises (MNEs) to market jurisdictions, even if they lack physical presence.
- Pillar Two: Introduces a Global Anti-Base Erosion (GLoBE) rule, ensuring MNEs with revenues above EUR 750 million pay a minimum 15% tax in each jurisdiction.
This framework addresses tax avoidance and modernizes international taxation by ensuring businesses are taxed where value is created. Yet, its implementation remains complex and delayed.
Rise of Digital Service Taxes (DSTs)
The digital economy has also given rise to Digital Service Taxes (DSTs), levied unilaterally by several countries to capture revenues from digital giants operating without physical presence. While DSTs serve as interim measures, they risk double taxation and trade disputes unless aligned with global frameworks.
How did EL address Taxation Gaps in the Digital Economy:
The introduction of EL in 2016 marked a pivotal shift in India’s approach on taxing the digital economy. The levy tried to address several key gaps in the taxation of cross-border digital transactions like:
- Bypassing the PE Requirement: One of the most significant challenges in taxing digital companies was the absence of a PE in India. EL bypassed the PE requirement by taxing gross payments made to non-resident digital service providers, ensuring that companies without PE in India still contribute to the Indian exchequer.
- Clarifying Tax Treatment of Digital Services: EL provided statutory guidance on scope of services covered under the levy, thereby reducing ambiguity and litigation.
- Reducing dependence on Treaty interpretations:EL is not a part of the domestic income-tax law and hence outside the ambit of the bilateral tax treaties. This allowed India to assert taxing rights unilaterally, without being constrained by treaty provisions.
Additionally, Section 10(50) of the Act was introduced to provide an exemption from income-tax in the hands of non-resident taxpayers for income chargeable to EL to prevent double taxation on transactions. However, with the abolition of the EL, the exemption under Section 10(50) will no longer be available.
Developing Countries: The Challenge of Indirect Taxation
E-Commerce and Indirect Taxation:
E-commerce poses unique challenges for tax administrations in developing countries:
No physical presence of companies operating across borders.
High tax evasion and difficulties in tracking digital transactions.
Unfair competition with local businesses bound by traditional tax rules.
Social security and labor classification issues in the collaborative economy.
For regions like Latin America and the Caribbean (LAC), tax evasion accounts for 6.3% of GDP, severely undermining fiscal capacity. Similar challenges exist across Africa and parts of Asia, where VAT collection on digital services remains underdeveloped.
India’s Digital Taxation Experience:
India has been a pioneer among developing countries in digital taxation:
Equalization Levy (2016): 6% levy on online advertising services, later extended in 2020 to include a 2% tax on foreign e-commerce operators.
Significant Economic Presence (SEP) Rules: Companies must comply if revenues exceed INR 20 million or 300,000 users in India.
Goods and Services Tax (GST): 18% tax applies to digital services provided by platforms like Netflix and Amazon.
While these measures broaden India’s tax base, they raise implementation challenges, including risks of double taxation, enforcement difficulties, and compliance burdens on non-resident companies.
Proposed a 3% tax on revenues of digital companies with global turnover above EUR 750 million. Progress in indirect taxation (VAT on digital services), but consensus on direct taxation remains elusive.
G20 and IMF:
G20 (2019) proposed a global digital tax based on significant economic presence, user base, and data volume. IMF highlighted risks of base erosion, urging coordinated efforts and better reporting standards.
International Cooperation:
Key themes from forums and communiqués: Strengthening BEPS compliance and tax certainty.Enhancing digitalization of tax administrations (use of AI, big data, analytics).Building capacity in developing countries through training and information-sharing.
Recommendations for Developing Countries Adopt:
Simplified VAT/GST Models for Digital Trade Require foreign suppliers of digital services to register and remit VAT.
Explore automated systems for e-invoicing and digital transaction monitoring.
Regional Cooperation:
Harmonize tax rules across regions (e.g., African Union, ASEAN) to reduce administrative complexity and tax avoidance.Gradual Implementation of OECD Frameworks Align national laws with BEPS 2.0 pillars. Avoid unilateral DSTs where possible to prevent trade disputes. Strengthen Domestic Capacity Invest in digital tax administration tools, including blockchain and data analytics. Enhance taxpayer education and compliance support.
Balance Revenue with Equity:
Ensure taxation of digital giants contributes to reducing inequality rather than overburdening smaller digital players.
Case laws:
Commissioner of Income-Tax (Intl. Taxation) v. Amazon Web Services, Inc. — Delhi High Court, 29 May 2025
Held that payments for standardised cloud-computing services (AWS) do not constitute “royalty” or “fees for technical services” (FTS) under the Income-tax Act / India–US DTAA — because customers only get access to services, not IP/transferable rights or a “making available” of technical know-how. This is a pivotal decision for cloud providers and cross-border.
Google AdWords / Google Ireland / Google India disputes — ITAT / High Court rulings (various years; key coordinate ITAT rulings 2017 → recent clarifications 2023–2024)
Tribunal and coordinating benches have repeatedly examined whether payments connected to the AdWords/online-ad reseller arrangements are “royalty/FTS” or ordinary business income. Recent coordinate ITAT rulings have tended to treat AdWords-type receipts as not royalty/FTS (i.e., not taxable in India in the absence of a PE), although factual variations have produced competing decisions. These Google/AdWords rulings are essential precedents when characterising online advertising / platform transactions.
Hyatt International Southwest Asia Ltd. v. ADIT — Supreme Court of India, 24 July 2025
The Supreme Court affirmed that sustained, substantive operational control exercised from abroad over Indian operations can give rise to a Permanent Establishment (PE) — i.e., PE tests may capture business models where control/oversight (even without a fixed physical office) amounts to a taxable presence. This has broad implications for platform/management/oversight models in the digital economy.
Italy — VAT claims on user data (Meta, X, LinkedIn) — ongoing; major litigation / appeals in 2025
Italian tax authorities have issued large VAT demands (combined ≈ €1bn+) on the view that allowing users free access in exchange for personal data is a “barter” / taxable supply. Meta, X and LinkedIn have appealed these assessments — the case is closely watched because a ruling for Italy would be transformational for VAT treatment of “free” digital platforms across the EU. (Italian authorities have sought an EU VAT Committee opinion; litigation is ongoing.)
Chamber of Commerce et al. v. Lierman (Maryland digital ad tax) — 4th U.S. Circuit Court of Appeals, Aug 15, 2025 (digital-ad tax litigation)
A federal appeals panel struck down (or limited) provisions of Maryland’s digital advertising tax — most notably the law’s ban on companies informing customers about tax-driven price increases — on First Amendment grounds. The case highlights U.S. constitutional constraints on state digital-tax designs and the political/legal pushback against unilateral digital-ad taxes.
Conclusion:
The digital economy is expanding rapidly, offering opportunities for innovation, growth, and fiscal revenues. However, without effective taxation, developing countries risk losing significant revenues and worsening inequality. The OECD/G20 two-pillar solution, India’s pioneering equalization levy, and EU initiatives illustrate the range of approaches under consideration.
For developing countries, the path forward lies in adapting indirect taxation frameworks, strengthening digital tax administration, and ensuring international cooperation. By doing so, they can safeguard their tax base, promote fair competition, and finance sustainable development in the digital era.
References:
1. https://www.ey.com/en_gl/taxation-digital-economy
2. https://www.ciat.org/tax-administrations-and-control-of-the-digital-economy/?lang=en
3. https://www.bdo.global/en-gb/services/tax/taxation-of-the-digital-economy
4. https://www.elibrary.imf.org/display/book/9781513511771/ch010.xml
5. https://www.irs.gov/tax
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Author: Anjali, Final Year Law Student | Lovely Professional University
