The Finance Bill, 2018 attempts to advance the effort, in India and in other jurisdictions, to find ways to tax the digital economy, particularly when companies operate across borders without a ‘permanent establishment’ in the markets where their end-consumers are. The Centre, which had in Budget 2016 slipped in an ‘equalisation levy’ (making it the first mover in taxing the digital economy), has now introduced an enabling clause under Section 9 of the Income Tax Act to empower it to tax entities based on the concept of “significant economic presence”. Although that characterisation has not been defined — the rules that will be framed will hopefully throw light on the scope of the endeavour — the provision itself is in line with the OECD’s Action Plan 1 Report, under the Base Erosion and Profit Shifting(BEPS) package. That larger initiative seeks to plug the loopholes that allow cross-border profits to be taxed favourably in low-tax jurisdictions in violation of the spirit of tax fairness. To that extent, the Centre’s tax proposal is synchronous with the emerging international tax framework.

For sure, there are no winners from an arrangement where multinational corporations undermine the integrity of the international tax system. National governments, which see taxation through the prism of sovereignty, feel cheated of tax revenue, and are compelled to ensure compliance even at a high cost. In developing economies, including in India, this revenue loss translates into under-funding of investments needed to enhance human capital and promote economic growth. Businesses that exploit tax loopholes run the risk of reputational damage if the perception of them as tax-dodgers gains wider resonance. And an unjust tax system cramps fair competition and penalises companies that operate only in domestic markets.

Even so, the proposal to tax the digital economy, which has transformed the global business landscape and enhanced productivity levels, poses challenges. More than brick-and-mortar businesses, companies in the digital space rely disproportionately on intangible assets; often, the precise geographies in which discernible value creation occurs is difficult to fathom. In fact, there is a case to be made that the traditional template for assessing businesses does not apply in the digital world; even the notion of how the digital economy relates to the concepts of ‘residence’ and the characterisation of income for tax purposes is open to a re-examination. Also, the reporting requirement that the broader BEPS package imposes on multinationals, under which companies must declare their revenues, profits and taxes paid in each country they operate in, will translate into higher accounting costs for companies, and, worse, open them up to intrusive ‘fishing expedition’ scrutiny from tax authorities. In drawing up the details of ways to tax the digital economy, authorities must walk the fine line between ensuring tax fairness and wielding an exceedingly punitive stick that inhibits investment flows.