Updated: Nov 17, 2020
Sulagna Dutta 
The growing inclination towards digitalization has been a recognized trend among the general population in the recent past. Though it has helped in major innovations and introduction of time-saving technologies, it has brought with it some critical tax challenges in the Indian taxation regime.
The erosion of the domestic tax base is caused by the strategies of the Digital Multinational Companies who are to be accounted for a major portion of the revenue lost, as a result of digitalization. The issues and concerns haunting the domestic tax base of India often remain unaddressed considering the advantages and benefits that digitalization brings along with it.
The challenges aggravate during the unprecedented times like COVID-19. The downfall of revenue collected through tax liabilities, as a result of the technological shift has been a setback to the government. This has called for some immediate remedial measures like modified economic and tax reforms. The dependence on digital means of working and communication have captured a significant place in the life of students as well as professionals.
A drop in the collection of revenue through indirect taxes and increase of e-billing has brought about some novel challenges that have compelled the Government to innovate and search for intensive measures to fight the same. The absence of effective laws governing digital transactions has taken a further toll on the economy. The outcomes are not only restricted to unemployment and inequalities of income but also highlight regulatory and strategic shortfalls in tax administration.
Challenges Shackling The Indian Taxation System Amid Growing Digitalization
Recent Changes in Taxation Regime and Implications
Since the onset of the global pandemic, India has been experiencing an exponential growth in the digital sector. The growth has added to the already increasing inclination towards a tech-friendly industry, characterized by a spur in innovation, cheaper, and faster information transfer as a means to bolster business operations across various sectors of the Indian economy. The government’s push to promote digital economy as a scheme of national interest has certainly brought about a number of advantages to the lives of the general public, but the same does not come without miseries.
Being one of the largest consumers of mobile data, the Indian Economy has been subjected to some serious challenges like that of increased frauds and erosion of tax base, as far as indirect taxation is concerned. These challenges include problems like erosion of tax base and shifting of profits. Post the implementation of the Goods and Services Tax Act, 2017, the tax regime of the country has been modified, which is a composite taxation of all indirect taxes imposed by the state governments and the Central government.
This has brought about considerable changes in tax mobility and method of taxing profits, thus posing threats to the regular regime. The base erosion in the indirect tax regime and profit shifting have been clearly demarcated to be major causes that pushed in the appalling drop in SGST tax collection during the pandemic. A major chunk of the loss of revenue can be attributed to tax evasion by businesses operating on the online platform even before the onset of the pandemic.
Lack of Adequate Laws for Regulation of Digital Economic Transactions
Another major setback for the digital transactions taking place within the jurisdiction of Indian legal framework has been the lack of adequate laws and regulations for digital transactions and transfers.
Apart from the privacy and data protection concerns, the lack of digital laws is heavily felt in the administration of tax collection and recovery too. With the sprawling number of digital activities observed during pandemic, the Government bore the brunt of the same. The primary and paramount objective of legislation is to regulate the system through composite checks and balances which in this case proved to be an enormous challenge to the concerned authorities.
The government levied tax on online advertisements as a part of the Finance Act, 2016 and the same was recognized as a first of its kind taxation on the digital platform. However, there is no general law to dictate the effective administration of digital tax collection as can be seen from a general overview of the recent instances of online tax evasion and the like. This allows for creation of an asymmetric approach and legal lacunae in the mentioned transactions.
Furthermore, tax frauds have come to be recognized as one of the budding concerns of an increasingly digitally dependent system. The potential amount of revenue lost by the Government through tax evasion attempts, accounts for quite a large chunk of the loss incurred.
With the present legal system, it is almost impossible to address the lucrative fraudulent operations over the digital platform. Malicious messages leading to fraudulent websites and links duplicating tax authorities have become the new attraction to dupe the general public without getting noticed or traced.
It is interesting to note that many of the attempts at phishing are done in the name of the Income Tax Department. These challenges demand immediate improvisation in the existing system to counter the loss of tax to the government. Tax collection and recovery of the transactions carried out on the digital platform should be systematically recorded, and accordingly imposed to ensure minimal scope of evasion or fraud
The International Taxation Regime
The Organization for Economic Cooperation and Development (OECD) has come up with an action plan to address the issues of tax base erosion and profit shifting with a uniform application titled as the Base Erosion and Profit Sharing (BEPS) Action Plan. The paramount objective of initiating this instant Action Plan is to address the challenges posed by digitalization.
However, such an approach can be analyzed to have an adverse effect on the Multinational Companies like Google and Microsoft as in some instances, however, multinationals have been able to use and/or misapply those rules to separate income from the economic activities that produce that income and to shift it into low-tax environments. In this aspect the Nexus Rule would be applied to the profits earned by the non-resident companies which have permanent establishments in the country of jurisdiction to determine the stance of its activity. This has been done to ascertain a revenue threshold against the Companies which have a significant influence in the business operation within the concerned territory.
Further, to determine the quantum of profit to be taxed in the country of jurisdiction in case of actual physical presence, the Profit Allocation Rule has been brought up. The principles are being deliberated upon at a global level to bring a consensus among the countries considering the factor of Unified approach.
Suggestions to Improvise the Digital Taxation System
The immediate impact of pushing towards a digital economy can be regulated through several instruments designed for tax monitoring and tax collection. A regime should be formulated to effectively administer the concerns that have been revolving around digital taxation for quite some time now. Following are some suggestions to curb the asymmetrical and haphazard digital operations in the Taxation system.
1. Amendment in Indian Taxation Laws- There is an immediate need to amend the Indian Taxation laws, especially with respect to those applicable to digital platforms. Although the Government has made significant changes in e-commerce taxation vide the Finance Act, 2016 to include those companies which have a significant economic presence or major business operations through an agent or through the digital mode. This has been allowed autonomous to the consideration of being present physically. The same has been recognized by the GST Act as well. However, the same needs further improvisation from the viewpoint of the challenges of lost revenue and tax evasion on the digital platform. Tax collection and recovery of the transactions carried out on the digital platform should be systematically recorded, and accordingly imposed to ensure minimal scope of evasion or fraud.
2. Strengthening the Equalisation Levy – Equalization Levy was first introduced in India in the year of 2016 through the Finance Act with an attempt to tax digital transactions in which income accrues from India to foreign e-commerce companies. Although the same was amended in 2020 to introduce a new rate of tax, certain loopholes still remain unaddressed, like the nature of tax whether direct or indirect. Further, an interesting turn of views can be witnessed when we analyze the aim of the levy with efficiency. While the levy was aimed at erasing out the inequalities between domestic and foreign companies, it had a negative impact on small scale companies.
3. Making the Collection and Recovery of Taxes a more Automated Process to Prevent Frauds- The digital platform as discussed is a common platform for practices such as tax evasion and scams. To tackle the same, the Authorities need to come up with more automated provisions and means of tax collection in digital transactions. This will not only ensure timely filing of taxes but also help in reducing the collection-based costs of the government. It will further ensure better compliance from big corporations and prevent forceful imposition of non-digital tax laws, that were designed for the traditional system, to the advanced transactions.
Therefore, it is essential that with the exponential and emerging digitalization of the economy, the laws are also amended, so as to supplement the requirements and challenges arising out of the same. The challenges that have raised a plethora of concerns in the mind of an average Indian citizen is a potential setback to the Government funds generated through tax revenues. The issue has remained almost unaddressed in the Indian legal regime and the problem has taken an aggravated form in the meantime. However, there is always scope of incorporating measures aimed at acing the challenges and taking the Indian Economy forward in the technical forum, whereby digital transactions would not be viewed as a shortcoming to the administration, thus making it a worthwhile development.
 Sulagna Dutta is an undergraduate from Symbiosis Law School. For any discussion related to the article, she can be contacted via mail: firstname.lastname@example.org.
Preferred Citation – Sulagna Dutta, “Demystifying the challenges to the Indian taxation system with growing trends of digitalisation", Syin & Sern Law Review, Published on 16th November, 2020.