Taxation forms the bedrock of a nation's economic framework worldwide. With the rapid expansion of technology and e-commerce, digital services taxation (DST) has undergone a significant evolution, becoming a part of the direct tax regime since 1976. Overtime, with the expansion of cross-border digital transactions and increasing dominance of Multinational Corporations (MNCs) in the global economy, DST has extended into the indirect tax regime as well.

This article explores India's digital tax framework, challenges faced at both domestic and global levels, with particular focus on the multinational tax burdens. It also probes into the proposed global reforms and technology-driven innovative solutions that can contribute to the creation of a more efficient and equitable taxation system for the digital economy.

Evolution of India's digital services tax framework:

Foundation for the Digital Services Tax (DST) was laid by the concept of 'fee for technical services' (FTS)[1]. But FTS is of a limited scope as it covers only technical, managerial and consultancy services, but not digital services. With the wake of technological advancements and surge in offshore supply of digital services, proposals were made for a new exclusive law to tax the revenue from offshore digital services.[2]

In the year 2016, the Central Board of Direct Taxes (CBDT)[3] formed the 'Committee on Taxation of E-Commerce' under the chairmanship of Shri Akhilesh Ranjan. This committee gave a proposal for equalisation levy (EQL) and examined the issues of taxation in digital economy, specifically taking into account the OECD's Report on BEPS Action 1.[4] Based on this proposal, equalisation levy was incorporated in the Indian legal system through the Finance Act of 2016.

Equalisation levy is a tax leviable on the consideration received or receivable by a non-resident for any specified services,[5] from a resident in India or a non-resident with a permanent establishment (PE) in India at the rate of 6%, provided the consideration exceeds INR 1 lakh.[6] Equalisation levy was expanded in the year 2020 as 2016's EQL was limited to only digital advertisements.

So, a new charging provision Section 165A was incorporated through an amendment to Finance Act, 2016.[7] This levy is charged on the e-commerce operators for the amount of consideration received or receivable by an e-commerce operator from e-commerce services or e-commerce supply provided or made or facilitated by it to a resident of India or to a person who buys such goods and services using their internet protocol (IP) address located in India or a non-resident in 'specific circumstances'[8] at the rate of 2%, provided the amount of consideration is to be in excess of INR 2 Crore.[9]

Soon after the 2020 equalisation levy was enforced, the concept of significant economic presence (SEP) came into force (from the financial year 2021-22), through the 2018 Finance Act. The current threshold limit for SEP in India is that- the amount of aggregate payments from transactions with respect to goods or services carried out by non-resident is to be two crore rupees and the number of users with whom continuous business interactions are engaged with, shall be three lakhs (i.e.,0.30 million users).[10] This concept deems that the income of non-residents with a SEP in India is subject to Indian taxation regime.

As an extension of taxation in digital economy, a different yet related aspect was introduced albeit the Finance Act of 2022. A new provision of tax was added in the direct tax regime, where income tax is levied on the income from transfer of "Virtual Digital Assets (VDA)".[11]

This provision is applicable for both residents and non-residents and brings within its scope all crypto assets (including cryptocurrency, non-fungible tokens, and other notified digital assets).[12]At present gains from VDAs may be taxed at flat rate of 30% (plus surcharge and cess).[13] Though crypto is something distinct from the digital services category, it is definitely a significant milestone in the expansion of taxation within the digital economy in Indian taxation system.

In this technological era, the indirect tax, i.e., Goods and Services Tax (GST) is charged on the Online Information Database Access and Retrieval (OIDAR) services. These are the services provided online albeit internet without any physical interface between the recipient and supplier of service like e-commerce, cloud storage services, etc. With the "Digital India" campaign launched in the year 2015, these services surged in India.

As these services are of online nature, an overseas service provider with no physical presence in India escapes the Indian tax system, while a local service provider will be taxed for providing the same service. In order to create a level field for both local and overseas players and to enable the Indian government to ensure tax compliance, OIDAR services were included in the GST tax regime from the year 2017.[14]

OIDAR services are defined under Section 2(17) of the IGST Act, 2017 where services provided by information technology over internet is included, but this definition limited the scope of OIDAR services to those with minimal human intervention.

To transcend this limitation, an amendment was made albeit the Finance Act of 2023, where few words from the original definition under Section 2(17) of the IGST Act, 2017 were omitted,  in order to bring all the services delivered over internet or electronic network within the ambit of OIDAR Service. Through this amendment the definition of 'non-taxable online recipient' was also changed as any unregistered person receiving OIDAR services located in taxable territory. [15]

Roadblocks and Resolutions:

With the digital economy growing so fast governments have attempted to tax the income it generates, but this doesn't come without any hurdles. Double taxation, Base erosion and profit shifting (BEPS), consumer price rise and cross border payment issues have been few among the many. With the digital services tax being levied, the price of these services tends to rise whose burden the businesses often pass onto the consumers. Cross border payments which sit at the heart of the international trade are faced with four main issues- low speed, limited access, insufficient transparency and high costs.[16] The other two major drawbacks are addressed in the following discussion.

1. Double taxation and DTAA:
   As digital services are provided mainly by Multinational Enterprises (MNEs), which work from beyond the territorial borders, in remote locations with no permanent establishment (PE) in India, they were not taxed under the direct tax regime (income tax). In order to evade this income tax, MNEs in India misused this loophole, and migrated to other countries.
   
   To overcome this, equalisation levy was introduced, which taxed the non-resident digital services providers, with no physical presence in India. This gives way to double taxation risks, as those who have permanent establishment (PE) in India, will be subject to the traditional direct tax provisions (Income Tax Act, 1961) and also to the 2% EQL.
   
   So to prevent this potential double taxation risk, an exemption is made under the Income Tax Act, where income of a non-resident digital service provider, on which equalisation levy is levied is exempt from paying income tax.[17] In the pending case of Mastercard Asia Pacific Pte. Ltd v. Union of India before Delhi High Court, the above issue is what is under discussion and the order of Authority of Advanced Ruling(AAR) which is impugned is the other way around, holding that the petitioner has multiple PEs in India and thus are subject to income tax in India and not for EQL.[18]
   
   Apart from the risk of double taxation at the national level, DST also creates a multinational tax burden, where the revenue earned by the MNEs may be subject to Indian tax laws as well as to the corporate tax laws of their home (source) country, leading to the same income being taxed in multiple jurisdictions. To mitigate this we have treaties like Double Taxation Avoidance Agreements (DTAA).
   
   DTAAs are bilateral contracts that prevent  the same income from being taxed in two countries. For instance, 'A' , an American resident invests in a company in India (listed in Bombay stock exchange or National stock exchange). The dividend or capital gains that 'A' earns from these stocks could be taxable in both India and United States. However, if India and the United States have a DTAA in place, the income earned will be taxed only in any one of these countries based on the terms of the agreement.[19]
    
2. BEPS & the Two-Pillar Approach:
   A critical challenge in international taxation is the corporate tax planning strategy of Base erosion and profit shifting (BEPS)-where the Multinational Enterprises (MNEs) shift their profits to tax havens (i.e., low or no-tax locations), where they have a little or no economic activity or they will 'erode the tax bases' by making huge tax deductible payments like interest or royalties, to lower their taxable income in high tax countries (as in many cases, these expenses fall under the Tax Deducted at Source [TDS] system i.e., tax is levied on this income only after deducting these expenses).
   
   So, BEPS practices allow the MNEs to gain a competitive advantage over the ones with only a domestic level operation. Also, in a wider context this undermines voluntary compliance by all taxpayers as they see the large corporations evading tax. BEPS gravely affects the developing countries that heavily rely in corporate income tax for revenue.[20]

So to tackle this issue of tax avoidance by MNEs, OECD and G20 together launched the 'BEPS Project' in the year 2013. This project was a 15-point Action Plan to address the international tax loopholes. To bring these action plans into force, the 'OECD/G20 Inclusive Framework on BEPS' (BEPS 1.0) was established in the year 2016. Albeit, only the 'mitigation of general tax avoidance by MNEs' was the aim of BEPS 1.0, the very first action plan (Action 1) was in particular, to address the tax challenges in digital economy. But as this project did not sufficiently address these challenges the OECD introduced BEPS 2.0 – the 'Two Pillar approach' in 2019, which was released in the year 2021 and was accompanied by Model Global Anti-Base Erosion (GloBE) rules (model rules).

'Pillar One' provides for the new nexus and profit allocation rules i.e., to reallocate taxing rights to the market jurisdictions (countries where customers of MNEs are located), even if an MNE has no physical presence there. This was to address the same old problem that India faced, which was addressed by equalisation levy (EQL).

'Pillar Two' provides for a new global minimum corporate tax rate.[21] This is to ensure that large MNEs pay a minimum level of tax on their income from each jurisdiction. The effective tax rate (ETR) is 15% on income in all countries to prevent them from shifting their profits to tax havens.[22]

An Innovative Way Forward:
In the present thriving digital landscape, there is a need for harmonization of digital tax rules across jurisdictions.[23]OECD and G20 play a crucial role in facilitating multilateral dialogues on digital taxation through frameworks like BEPS Multilateral Instrument (MLI) to close loopholes and implement standards, to counter treaty abuse.[24]

Despite significant efforts being taken, there is no global consensus as many of these policies require voluntary compliance due to lack of a global enforcement mechanism, thus allowing dissent or assent at the choice of the countries. This has led to a delayed implementation of these policies.

Also major economies like the United states and European Union have not fully adopted the policy, making it ineffective. Pillar Two still has loopholes as MNEs can still use deductions and exemptions to erode their tax base. A real time instance for the failing policies is the case of Amazon paying $0 corporate income taxes on its $5.6 billion US income in the year 2018.[25]

So instead of relying on the global solutions, countries can use an alternative approach for tax administration like using artificial intelligence, machine learning algorithms, natural language processing technologies and blockchain technology for monitoring tax compliance and preventing tax evasion.

1. AI-driven tax compliance
   In this digital era, with cross border transactions and multinational operations, manual tax reporting systems are prone to errors and ensuring compliance across various regions can be overwhelming. Thus, instead of solely relying on voluntary compliance, AI technologies can be used for the automation and optimisation of tax compliance and for addressing the efficiency, accuracy, and timeliness challenges of digital services tax.
   
   Natural language processing (NLP), though is commonly associated with text analysis, plays a significant role in automating the interpretation of tax regulations and legal documents and can automatically adjust to new regulations. This is invaluable for the MNEs that must comply with varying tax laws across countries.[26]
    
2. Smart contracts and blockchain technology:
   Taxation being the fundamental revenue source for most governments, ensuring tax compliance remains a persistent challenge. With a blockchain-based automated tax regime, all wallets become visible to the tax authorities and money flow can be monitored. In this mechanism, every transaction will be recorded on a blockchain ledger, which is tamper proof, so once recorded, the transaction cannot be altered or deleted[27].
   
   Smart contracts are digital contracts stored in blockchain that automatically get executed when predetermined terms and conditions are met.[28] This allows automatic calculation and deduction of digital services tax when digital transaction occurs (as this can be set as one of the terms and conditions).Since these smart contracts operate on a blockchain ledger, the transactions are immutable and transparent,[29] allowing the tax authorities to track and verify digital services tax payment, mitigating tax evasion and fraud.

Conclusion:
In the rapidly evolving digital economy, India has been proactive in adapting its taxation policies, transitioning from the traditional 'fees for technical services' framework to the recent Significant Economic Presence (SEP) policy. Despite these efforts, enforcement and compliance remain to be major hurdles as the above mechanisms are primarily unilateral.

To foster a global cooperation; multilateral policies have been formed by OECD and G20 such as the BEPS Multilateral Instrument (MLI) and the Two-Pillar approach. Nevertheless, these frameworks are susceptible to loopholes and are slow in implementation due to lack of global consensus and has even led to trade tensions like the U.S. – Canada digital tax clash.[30]Thus, only a balanced approach combining multilateral tax agreements with advanced technology-based enforcement will be effective in creating a fair international tax system in this digital era.

End Notes:

1. Income Tax Act, 1961, S. 9(1)(vii).
2. Proposal for Equalisation Levy on Specified Transactions, Report of Committee on Taxation of E-Commerce, (February 2016).
3. CBDT is a statutory body under the Department of Revenue, Ministry of Finance, Government of India.
4. Base erosion and profit shifting (BEPS), OECD (Mar.16,2025,8:00 PM), https://www.oecd.org/en/topics/policy-issues/base-erosion-and-profit-shifting-beps.html.
5. Finance Act, 2016, S.164(i).
6. Finance Act, 2016, S.165.
7. Finance Act, 2016, S.165A.
8. Finance Act, 2016, S.165A(3).
9. Taxation on E-commerce,135 Tax Bulletin, ICAI, May 2023, at 7, 8.
10. Income tax Rules,1962, Rule 11UD.
11. Income Tax Act, 1961, S. 115-BBH.
12. Income Tax Act, 1961, S. 2(47-A).
13. Income Tax Act, 1961, S. 115-BBH.
14. Naina Himatsinghka, OIDAR in India: 2023 and Beyond, FONOA (Mar. 18, 2025,10:00 AM), https://www.fonoa.com/blog/oidar-in-india-2023-and-beyond.
15. Finance Act, 2023, S.160.
16. Cross-border Payment, FSB (Mar. 20, 2025, 8:50 PM), https://www.fsb.org/work-of-the-fsb/financial-innovation-and-structural-change/cross-border-payments/
17. Income Tax Act, 1961, S.10(50).
18. Mastercard Asia Pacific Pte. Ltd v. Union of India, W.P. (C) 10944/2018.
19. Ektha Surana, What is double taxation avoidance agreement? How NRIs can claim benefits under DTAA, CLEARTAX (Mar. 18, 2025,2:00 PM), https://cleartax.in/s/how-nris-can-claim-benefits-under-dtaa.
20. Base erosion and profit shifting (BEPS), OECD (Mar. 19,2025,8:00 PM), https://www.oecd.org/en/topics/policy-issues/base-erosion-and-profit-shifting-beps.html.
21. OECD BEPS 2.0-Pillar One and Pillar Two, AICPA&CIMA (Mar. 19,2025,8:05 PM), https://www.aicpa-cima.com/resources/landing/oecd-beps-2-0-pillar-one-and-pillar-two.
22. Global Minimum Tax, OECD (Mar. 19, 2025, 8:10 PM), https://www.oecd.org/en/topics/sub-issues/global-minimum-tax.html.
23. Joseph Kuba Nembe & Courage Idemudia, Designing effective policies to address the challenges of global digital tax reforms, WJARR, May-June 2024, at 1176.
24. BEPS Multilateral Instrument, OECD (Mar. 20, 2025,7:41 AM), https://www.oecd.org/en/topics/sub-issues/beps-multilateral-instrument.html.
25. Matthew Gardner, Amazon in Its Prime: Doubles Profits, Pays $0 in Federal Income Taxes, ITEP (Mar. 20, 2025, 6:58 AM), https://itep.org/amazon-in-its-prime-doubles-profits-pays-0-in-federal-income-taxes/
26. Oritsematosan Faith Dudu et al, Conceptual framework for AI-driven tax compliance in fintech ecosystems, IJFETR, September 2024, at 2.
27. Derya Yayman, Blockchain in Taxation, 21(4), JAF, 2021, at 141,146.
28. What are smart contracts on blockchain?, IBM (Mar. 20, 2025, 1:45 PM), https://www.ibm.com/think/topics/smart-contracts.
29. What is a Smart Contract in Blockchain?, ULTIMACO (Mar. 20, 2025, 7:13 PM), https://utimaco.com/service/knowledge-base/blockchain/what-smart-contract-blockchain.
30. Damon V. Pike, The Trade And Tax Issues Behind U.S.-Canada Digital Tax Clash, BDO (Mar. 20, 2025), https://www.bdo.com/insights/tax/the-trade-and-tax-issues-behind-us-canada-digital-tax-clash.