Author: Suryansh Mishra, Symbiosis Law School
Introduction: The Mismatch of Tradition and Innovation
The principles upon which international taxation law was established have been seriously upended by the digital revolution. Because they are based on the idea of “permanent establishment,” or physical presence, traditional tax systems are becoming less and less capable of reflecting the economic realities of the digital economy. One of the most urgent issues facing tax authorities globally is this mismatch, especially in emerging countries like India where tax revenue optimization is still vital for economic growth despite the rapid pace of digital revolution.1
The fundamental issue is how digital businesses generate value. Despite having little to no physical presence in India, IT behemoths like Google, Facebook, and Amazon make significant income from Indian customers through data collection, advertising, and digital services. User-generated data, network effects, and intangible assets that transcend borders are all key components of their value generation approach.2
There have been two main reactions to this challenge worldwide. First, to collect money from digital activity within their boundaries, individual nations have enacted unilateral measures, most notably Digital Services Taxes (DSTs). Second, the Organization for Economic Co-operation and Development (OECD) has led a concerted effort to find multilateral solutions in order to create new international tax laws that more accurately reflect the reality of the digital economy.
Unilateral Responses: The Rise of Digital Services Taxes (DSTs)
The quickest solution to the problem of digital taxes is the implementation of digital services taxes. Regardless of whether the company has a physical presence in a certain jurisdiction, DSTs are normally imposed on the gross revenues that digital businesses get from offering specific digital
services to users in that jurisdiction. With a special emphasis on services that significantly rely on user engagement and data, these taxes aim to capture value where it is created.3
There are various strong arguments in favor of DSTs. They tackle the underlying injustice that local companies with physical stores pay corporate taxes while their online rivals do not, even though they share the same user base, legal framework, and market infrastructure. DSTs provide a workable way for nations like India to guarantee that the financial gains of digitization are matched by the right amount of revenue paid.
By leveling the playing field between conventional brick and mortar companies and digital operations, DSTs also help achieve larger economic policy goals by avoiding market distortions that might hurt regional businesses. Additionally, they give governments much-needed sources of income at a time when the demand for digital infrastructure is rising, and traditional tax bases are shrinking due to digital transformation.
DSTs do, however, have some serious disadvantages. The biggest worry is the possibility of double taxation, in which businesses would pay corporate income taxes in their home countries in addition to DSTs in market jurisdictions. This can skew foreign investment flows and add difficulty to compliance. Companies must deal with disparate tax rates, thresholds, and definitions across several jurisdictions, which is made worse by the absence of coordination between the DST regimes of various nations.
By imposing a 3% tax on specific digital services offered by businesses with worldwide revenues exceeding €750 million and French revenues exceeding €25 million, France led the way in adopting the contemporary DST method in 2019. Data transmission services, intermediation platforms, and advertising services are the targets of the French DST. But this caused a great deal of diplomatic strain with the US, which threatened to impose retaliation taxes on French products.4
In April 2020, the UK enacted its own DST, taxing social media, online markets, and search engines at a rate of 2%. The UK’s strategy, which includes particular carve-outs for online payment processing and financial services, illustrated how difficult it is to define the taxing scope of digital services.5
India has taken a particularly sophisticated stance, enacting an “equalization levy” that has changed over time. India first imposed a 6% charge on online advertising services in 2016. In 2020, the fee was raised to 2% to cover a wider range of digital services. With revenue thresholds intended to attract major digital businesses without placing an undue burden on smaller operators, India’s framework focuses particularly on e-commerce operators and digital advertising services.6
These unilateral actions have caused significant diplomatic conflict. Investigations under Section 301 of the US Trade Act and threats of retaliatory tariffs have resulted from the United States’ persistent claims that DSTs unfairly single out American technology businesses and amount to discriminatory trade practices.
The OECD’s Bid for a Global Solution: Pillar One
With its two-pillar strategy, the OECD has led efforts to provide a complete multilateral solution, acknowledging the unsustainable nature of expanding unilateral DSTs. Amount A or Pillar One, is the most ambitious attempt to update international tax laws for the digital era.
Redistributing taxing authority over the biggest multinational corporations to market jurisdictions where users and customers reside, irrespective of their physical presence, is the main goal of Pillar One. The century-old idea that the location of value creation through tangible economic activity should determine the taxation of rights is essentially called into question by this. Rather, Pillar One acknowledges that value generation in the digital economy increasingly happens through market specific activities, data usage, and user engagement.7
In particular, Amount A aims to distribute 25% of revenues over a 10% margin to market jurisdictions using a methodology that takes sales and possibly other variables like user engagement into account. This strategy seeks to give developing nations more taxing authority over the revenues of the digital economy while preserving enough cash for source nations to encourage further innovation.8
The Multilateral Convention (MLC), which would abolish current DSTs and create legally binding worldwide tax regulations, is essential to the achievement of Pillar One. The MLC is a complex legal tool intended to supersede current bilateral tax treaties and establish consistent taxation guidelines for the digital economy. Crucially, in order to resolve concerns regarding double taxation and the complexity of compliance, countries implementing Pillar One would have to eliminate their current DSTs.
However, there are a lot of implementation issues with Pillar One. Significant technical complexity necessitates the use of elaborate systems for formulaic allocation, profit computation, and dispute settlement. Concerns have been raised by developing nations that the €20 billion revenue requirement and 10% profit margin criterion may disqualify a large number of important digital businesses, so reducing the amount of additional revenue they could obtain.9
There are advantages and disadvantages to Pillar One from an Indian standpoint. Multinational digital corporations may generate significant additional tax revenue from India’s enormous digital market and user base. The framework’s emphasis on market jurisdictions is consistent with India’s view that value creation is increasingly taking place in the locations of consumers. However, Pillar One would require the dismantling of India’s current equalization levy scheme, necessitating a thorough examination of whether the new framework would produce comparable revenue outcomes.
Deeper conflicts between wealthy and developing nations over taxes in the digital economy are reflected in the ongoing discussions about the sufficiency of Pillar One. Many developing countries contend that the profit allocation formula undervalues the value generated by their sizable user bases and expanding digital markets, and that the framework’s scope is too limited.
The Frontier of Digital Assets: Cryptocurrencies and NFTs
Non-fungible tokens (NFTs) and cryptocurrency have opened up a whole new taxation landscape, upending established ideas about asset classification, transaction recognition, and reporting procedures. The combination of blockchain technology and conventional tax concepts creates special challenges as India struggles to regulate and tax these digital assets.10
Characterization is the main obstacle to bitcoin taxation. Are cryptocurrencies a brand-new asset class, commodities, currencies, or securities? The applicable tax treatment is determined by this classification; company inventories and capital assets are subject to separate regulations. In an effort to create clear regulations while preserving income generation, the Indian government recently imposed a 30% tax on virtual digital assets in addition to a 1% Tax Deducted at Source (TDS).11
It is necessary to carefully examine the taxpayer’s intention and trading frequency in order to distinguish between capital gains and business revenue in bitcoin transactions. While few transactions may be eligible for capital gains treatment, regular trading activity may qualify as business income subject to higher tax rates and different deduction restrictions. Decentralized finance (DeFi) operations and automated trading algorithms make this distinction especially difficult to understand.
In the bitcoin industry, taxable events go beyond straightforward buy-and-sell transactions. Under the laws of the majority of nations, including India, cryptocurrency-to-cryptocurrency exchanges that do not include conventional fiat money are nevertheless considered taxable events. Because taxpayers have to keep track of the fair market value of cryptocurrencies at the time of each trade, this poses serious compliance issues.
Other complications in DeFi protocols include staking, yield farming, and liquidity provision. Because of the volatility of cryptocurrencies and the intricacy of the DeFi process, it can be difficult to predict the timing and valuation of the consistent revenue streams generated by these
activities through protocol awards. Another layer of compliance is added by the tax treatment of protocol governance tokens that are obtained as rewards.
The timing of revenue recognition and suitable valuation techniques are called into question by airdrops, in which tokens are freely given to current cryptocurrency holders. Is it better to tax airdrops when they are received, when they can be traded, or only when they are actually disposed of? For taxpayers, the absence of clear guidelines in many jurisdictions, including India, causes uncertainty.
Tax authorities throughout the world, including in India, are creating new strategies to keep an eye on and enforce compliance. Some of these strategies include stricter reporting guidelines for cryptocurrency exchanges and a greater emphasis on blockchain research tools.
Conclusion: The Path Forward
A fundamental conflict between national sovereignty over taxation and the requirement for coordinated international responses to cross-border economic activity is represented by the taxation of the digital economy. DSTs and other unilateral actions offer quick fixes, but they run the risk of fragmenting and inefficiently changing the global tax system. Multilateral strategies, such as the OECD’s Pillar One, on the other hand, provide all-encompassing answers but encounter major political and implementation barriers.
This tension is especially noticeable from an Indian point of view. India, one of the biggest digital markets in the world with a fast-growing technology adoption rate, is entitled to tax income from its user base and digital infrastructure. However, India must take into account the wider effects of its tax policy decisions on competitiveness and economic development as a developing nation looking to draw in foreign investment and grow its own technological industry.
The OECD’s two-pillar proposal is unlikely to be the last word on taxation in the digital economy, even though it represents unprecedented international cooperation on tax policy. Existing frameworks will continue to be challenged by the speed at which technology is developing, necessitating constant modification. Given the difficulty of putting Pillar One into practice and the continuous political disputes over scope and profit distribution, it appears that the international tax environment will continue to change.
These difficulties take on a new dimension with the rise of digital assets. More advanced methods of classification, valuation, and reporting will be required by tax systems as cryptocurrencies, NFTs, and other blockchain-based assets gain traction.
Looking ahead, the way forward necessitates striking a balance between short-term revenue demands and long-term policy consistency. This requires India and other developing nations to carefully consider whether to stick to unilateral policies while taking part in multilateral frameworks or to completely commit to global solutions that might offer more stability in the long run.
Taxation in the digital economy will demand hitherto unheard-of levels of technological competence, international collaboration, and legislative flexibility. The core values of justice, efficiency, and certainty that support successful tax systems must be upheld while tax authorities build new capacities in data analysis, blockchain monitoring, and cross-border cooperation.
Citations:
1 Michael P. Devereux & John Vella, Debate: Implications of Digitalization for International Corporate Tax Reform, 46 INTERTAX 550 (2018)
2 Anil Kumar & Rajesh Singh, Digital Economy and Tax Challenges in Emerging Markets: The Indian Perspective, 48 INT’L TAX J. 45 (2022)
3 Arthur J. Cockfield & Calder C. MacArthur, Digital Services Taxes and Trade Law, 102 TAX NOTES INT’L 789 (2021)
4 French Ministry of Economy and Finance, DIGITAL SERVICES TAX: IMPLEMENTATION GUIDE (Government Publication 2019)
5 HM Revenue & Customs, DIGITAL SERVICES TAX: GUIDANCE (UK Government Publication 2020) 6 Priyanka Sharma & Ankur Jindal, India’s Equalization Levy: A Critical Analysis of Digital Taxation Framework, 69 CHARTERED ACCOUNTANT 52 (2021)
7 Yariv Brauner, BEPS Pillar One: A Change of Direction or More of the Same?, 75 BULL. INT’L TAX’N 178 (2021)
8 OECD, TAX CHALLENGES ARISING FROM DIGITALISATION – ECONOMIC IMPACT ASSESSMENT (OECD Publishing 2020)
9 Allison Christians, The Dubious Legal Pedigree of IGE (and Why It Matters for Pillar One), 98 TAX NOTES INT’L 525 (2020)
10 Danton Bryans, Bitcoin and Money Laundering: Mining for an Effective Solution, 89 IND. L.J. 441 (2014) 11 Sanjay Gupta & Ravi Mehta, Taxation of Virtual Digital Assets in India: A Comprehensive Analysis, 64 INT’L J.L. & MGMT. 445 (2022)
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