Taxation of Digital Economy and E-Commerce in India

India's digital economy has seen remarkable growth in recent years, driven by widespread internet access, mobile technology, and a thriving startup ecosystem. With consumers and businesses increasingly shifting online, the traditional methods of taxation have faced significant challenges in keeping pace.

E-commerce platforms, digital advertising services, cloud computing, and online content providers have created new streams of revenue many of which cross borders without a physical presence. This has raised critical questions around how and where such income should be taxed. India, like many other nations, has responded with a series of policy and legislative changes aimed at securing a fair share of taxes from the digital economy.

1.Laws Governing Digital Taxation in India

To deal with the challenges of taxing digital businesses, India has introduced specific rules under both income tax and GST laws. Since many digital companies operate without a physical presence in India, these rules focus on taxing income based on economic activity and user base.

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Under income tax, one key step was the introduction of the Equalisation Levy, aimed at taxing online advertising and e-commerce services provided by foreign companies. India also added the concept of Significant Economic Presence (SEP), which allows it to tax non-residents based on sales or user engagement from India, even if they don’t have an office here. Another provision, Section 194-O, requires e-commerce platforms to deduct tax before paying sellers who use their platforms.

In the GST system, India taxes digital services provided by foreign companies, especially those offering Online Information and Database Access or Retrieval (OIDAR) services like online streaming or cloud software. These companies must register under GST and pay tax on their services. Indian e-commerce operators also face specific compliance rules, including collecting tax at source and filing monthly returns.

2. Equalization Levy

The Equalization Levy was introduced in India in 2016 to tax foreign digital companies that provide services like online advertising, but don’t have a physical presence in the country. The aim was to create a level playing field for Indian businesses competing with these global giants. Initially, the levy was set at 6% on payments made for online ads.

In 2020, the levy was expanded to include a 2% tax on e-commerce companies earning revenue from Indian users, even if the transactions happen outside India. This tax is separate from income tax, and companies that pay it cannot claim deductions or use tax treaties.

While the levy has generated growing revenue, it still only covers part of the digital economy. However, it helps India tax big digital companies like Amazon, Netflix, and Facebook that have large user bases in the country.

3. Significant Economic Presence (SEP)

In 2018, India proposed the introduction of Significant Economic Presence (SEP) under Section 9(1)(i) of the Income Tax Act to tax non-resident businesses based on their economic activity in India, rather than requiring a physical presence. SEP aims to expand the definition of ‘business connection’ to include non-resident companies that conduct substantial business online with Indian users.

The SEP concept covers various digital activities, including the provision of goods, services, or downloadable content like software. It also applies when the total payments from such transactions exceed a certain threshold. Additionally, if a company regularly engages with a significant number of Indian users or conducts business through digital means, this would also count as SEP.

However, implementing SEP requires amendments to India’s tax treaties, which can be a lengthy and complex process. Despite this challenge, SEP is a key part of India’s efforts to ensure that foreign digital businesses contribute fairly to the country’s tax system.

4. GST and the Digital Economy

India’s Goods and Services Tax (GST) system has specific rules to bring digital transactions under the tax net, especially those involving foreign service providers.

One key area is Online Information and Database Access or Retrieval (OIDAR) services. These include services like online streaming, cloud storage, e-books, and software downloads. If a foreign company provides such services to customers in India, it must register under GST and pay tax on those services.

Domestic e-commerce platforms like Amazon, Flipkart, and Zomato also have GST obligations. They are required to collect Tax Collected at Source (TCS) on sales made through their platforms and file monthly returns. Certain services, like ride-sharing or food delivery, may require the platform itself to pay GST instead of the individual service providers.

Overall, GST rules aim to ensure that both foreign and Indian digital businesses are taxed fairly, and the system captures the value of digital transactions taking place in India.

5. TDS on E-Commerce Transactions (Section 194-O)

To improve tax compliance in the digital space, Section 194-O was introduced in 2020. It requires e-commerce platforms like Amazon, Flipkart, and others to deduct 1% TDS on payments made to sellers for goods or services sold through their platform.

This provision applies to the platform operators, not the buyers or sellers directly. However, small sellers—specifically individuals or Hindu Undivided Families (HUFs)—are exempt if their annual sales through the platform do not exceed ₹5 lakh and they have provided their PAN or Aadhaar. The TDS deducted is shown in the seller’s tax records and can be adjusted while filing income tax returns.

Still, small sellers often face difficulties in tracking these deductions and matching them with their actual income. For the platforms, handling TDS across a large number of sellers comes with operational challenges, such as ensuring correct PAN details and avoiding mismatches in reporting.

6.OECD Two-Pillar Solution

In 2021, 137 countries agreed to a global tax reform under the OECD’s (Organisation for Economic Co-operation and Development) Two-Pillar Solution. Pillar One allows countries to tax large digital companies based on where their users are, not just where the company is located. Pillar Two sets a 15% global minimum tax to stop profit shifting to low-tax countries.

While the plan aims to make global taxation fairer, developing countries feel left out, as the benefits mostly go to richer nations. Some countries like Kenya, Nigeria, and Pakistan didn’t sign the deal, citing concerns over fairness and lack of transparency.

7.Case Laws that Shaped Digital Taxation

Payment by Google India to Google Ireland for Purchase of Online Advertisement Space for Onward Resale to Indian Advertisers not “Royalty”: ITAT

M/s. Google India Pvt. Ltd. vs The JDIT CITATION:   2023 TAXSCAN (ITAT) 215

The Bangalore bench of the Income Tax Appellate Tribunal (ITAT) held that payment by Google India to Google Ireland for the purchase of online advertisement space for onward resale to Indian advertisers does not amount to Royalty as per Article 12(3)(a) of India-Ireland Double Taxation Avoidance Agreement (DTAA).

However, the claim that the payment by Google India to Google Ireland for the purchase of online advertisement space for onward resale to Indian advertisers does not amount to Royalty, was allowed and the appeal was resultantly allowed and the counter appeals by the revenue were dismissed, in favour of Google India Private Limited.

Fee Received by MasterCard from Indian Customers Taxable as ‘Royalty’ not FTS as per Indo-Singapore DTAA: AAR

In Re: M/s MasterCard Asia Pacific Pte. Ltd. CITATION:   2018 TAXSCAN (AAR) 101

The Authority of Advance Rulings, New Delhi in the application filed by the applicant Mastercard Asia Pacific Pte. Ltd. constituting of Mr. R.S. Shukla as the Chairman and Mr. Ashutosh Chandra as the Member held that fees received by the services of MasterCard from Indian customers are taxable as “Royalty” and not “Fees from Technical Services”.

Hence, the Authority ruled against the applicant’s contention that the license was incidental to the major activity of transaction processing. The payment was hence held to be ‘royalty’ and would get taxed with the PE under Article 7 and not under Article 12. As already adjudged, that the fees arising out of PE and hence, will be taxed as business income through the PE.

Karnataka HC allows CCI’s Probe against Flipkart, Amazon for alleged involvement in Anti-competitive Agreements

AMAZON SELLER SERVICES PRIVATE LIMITED vs COMPETITION COMMISSION OF INIDA CITATION:   2021 TAXSCAN (HC) 344

In the major setback to the E-Commerce Giants, Flipkart and Amazon, the Karnataka High Court allowed the Competition Commission of India to investigate against Flipkart and Amazon for alleged involvement in Anti-competitive Agreements.

The division bench of Justice P.S.Dinesh Kumar upheld the Competition Commission of India’s decision to conduct an investigation through its Director General into whether they had entered into anti-competitive agreements in violation of the provisions of the Competition Act 2002.

8.Conclusion

India has taken significant steps to bring the digital economy within the tax net through measures like the Equalisation Levy, SEP, GST on digital services, and TDS on e-commerce. These efforts reflect a shift from taxing physical presence to taxing digital activity and user base. While these policies have improved tax coverage and compliance, challenges remain particularly in aligning domestic rules with international standards, avoiding double taxation, and addressing compliance burdens for businesses. As global tax reforms like the OECD’s Two-Pillar Solution continue to evolve, India will need to balance its revenue interests with international cooperation to ensure a fair, stable, and future-ready digital tax framework.

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