Section 2 - Digital Economy: Current status and Growth Prospects

2.1 Introduction

9. Rapid and progressively evolving changes in information and communication technology have led to cataclysmic changes in the manner businesses are conducted around the world. Technological advancements and cheaper innovations have ensured widening spread of these techniques to hitherto unexposed populations. Entrepreneurs across the world have been quick to evolve their businesses to take advantage of these changes. The digital means of doing business have perpetrated so fast that the Task Force on Digital Economy (TFDE) of the Committee on Fiscal Affairs of the OECD has commented in its report that the digital economy is fast becoming the economy itself. The digital economy2 has not only forced radical departures in ways of doing business it has also created entirely new businesses and opened up new markets and growth and new job opportunities. The growing prevalence of E-Commerce³ and new services like Cloud Computing⁴ indicate the rising significance of digital economy in international commerce.

10. Part of the reasons for the rapid expansion of the ICT sector is progressive fall in prices of ICT devices and services because of the tendency for greater standardization, commoditization and interoperability in this sector. Technological innovations in hardware and greater integration of hardware and software produced commodities with greater value for money and led to expansion of use. Coupled with improving telecom network infrastructure, open source codes leading to development of software applications and self-propagating user generated content have led to increasing penetration.

2.2 Forms of Prevalent Businesses in various segments of Digital Economy

11. There has been a consistent expansion of E-Commerce businesses over the last couple of decades. The BEPS Report on Action 1 (2015) lists some of the more prevalent forms of these in paragraphs 118 to 121, as under:

“4.2.1.1 Business-to-business models 118. The vast majority of e-commerce consists of transactions in which a business sells products or services to another business (so-called business-to-business (B2B)) (OECD, 2011). This can include online versions of traditional transactions in which a wholesaler purchases consignments of goods online, which it then sells to consumers from retail outlets. It can also include the provision of goods or services to support other businesses, including, among others: (i) logistics services such as transportation, warehousing, and distribution; (ii) application service providers offering deployment, hosting, and management of packaged software from a central facility; (iii) outsourcing of support functions for e-commerce, such as web-hosting, security, and customer care solutions; (iv) auction solutions services for the operation and maintenance of real-time auctions via the Internet; (v) content management services, for the facilitation of website content management and delivery; and (vi) web-based commerce enablers that provide automated online purchasing capabilities.

4.2.1.2 Business-to-consumer models 119. Business-to-consumer (B2C) models were among the earliest forms of e-commerce. A business following a B2C business model sells goods or services to individuals acting outside the scope of their profession. B2C models fall into several categories, including, for example, so-called “pureplay” online vendors with no physical stores or offline presence, “click-and-mortar” businesses that supplemented existing consumer-facing business with online sales, and manufacturers that use online business to allow customers to order and customise directly.

120. The goods or services sold by a B2C business can be tangible (such as a CD of music) or intangible (i.e. received by consumers in an electronic format). Through digitisation of information, including text, sound, and visual images, an increasing number of goods and services can be delivered digitally to customers increasingly remote from the location of the seller. B2C e-commerce can in many cases dramatically shorten supply chains by eliminating the need for many of the wholesalers, distributors, retailers, and other intermediaries that were traditionally used in businesses involving tangible goods. Partly because of this disintermediation, B2C businesses typically involve high investment in advertising and customer care, as well as in logistics. B2C reduces transaction costs (particularly search costs) by increasing consumer access to information. It also reduces market entry barriers, as the cost of maintaining a website is generally cheaper than installing a traditional brick-and-mortar retail shop.

4.2.1.3 Consumer-to-consumer models 121. Consumer-to-consumer (C2C) transactions are becoming more and more common. Businesses involved in C2C e-commerce play the role of intermediaries, helping individual consumers to sell or rent their assets (such as residential property, cars, motorcycles, etc.) by publishing their information on the website and facilitating transactions. These businesses may or may not charge the consumer for these services, depending on their revenue model. This type of e-commerce comes in several forms, including, but not limited to: (i) auctions facilitated at a portal that allows online bidding on the items being sold; (ii) peer-to-peer systems allowing sharing of files between users; and (iii) classified ads portals providing an interactive, online marketplace allowing negotiation between buyers and sellers.”

2.3 Extent of Digital Economy in World & Prospects of its Growth

12. A report by the Boston Consulting Group in 2012 had estimated that there would be 3 billion internet users in the world by 2016.The digital economy which contributed USD 2.3 trillion in G-20 countries in 2010 would expand to USD 4.2 trillion. The digital economy is growing at 10% a year, significantly faster than the global economy as a whole. With increasing penetration, the emerging economies are now becoming the drivers of innovation.⁵ The number of Internet-connected devices (12.5 billion) surpassed the number of human beings (7 billion) on the planet in 2011, and by 2020, Internet-connected devices are expected to number between 26 billion and 50 billion globally.⁶

13. The growth of internet and this so called ‘digital economy’ has been all encompassing around the globe. The volume and scope of its expansion is aptly summarized in the BEPS Report on Action 1 (2015) as under:

“123. For example, e-commerce in the Netherlands has increased as a share of total company revenue from 3.4% in 1999 to 14.1% in 2009. Similarly, between 2004 and 2011 this share increased from 2.7% to 18.5% in Norway and from 2.8% to 11% in Poland. Based on comparable data, as illustrated in the chart below, e-commerce is nearing 20% of total turnover in Finland, Hungary, and Sweden, and 25% in the Czech Republic (OECD, 2012).

"124. In 2014, B2C e-commerce sales were estimated to exceed USD 1.4 trillion, an increase of nearly 20% from 2013. B2C sales are estimated to reach USD 2.356 trillion by 2018, with the Asia-Pacific region expected to surpass North America as the top market for B2C e-commerce sales in 2015 (Emarketer, 2014). According to the research firm Frost and Sullivan the B2B online retail market is expected to reach double the size of the B2C market, generating total revenues of USD 6.7 trillion by 2020. Such B2B online sales will comprise almost 27% of total manufacturing trade, which is estimated to reach USD 25 trillion by 2020 (Frost and Sullivan, 2014).”

“139. Internet advertising is rapidly growing, both in terms of total revenues and in terms of share of the total advertising market. PwC estimates that Internet advertising reached USD 135.4 billion in 2014. The market for Internet advertising is projected to grow at a rate of 12.1% per year during the period from 2014 to 2019, reaching USD 239.8 billion in 2019. Internet advertising would by that point surpass television as the largest advertising medium. Within the online advertising market, search advertisement holds the greatest share. Paid search Internet advertising revenue is forecast to grow from USD $53.13 billion in 2014 to USD $85.41 billion in 2019, accounting for over 35% of total Internet advertising by then, although video and mobile advertising are experiencing rapid growth. While video Internet advertising only accounted for 4.7% of total Internet advertising revenue in 2014, it is expected to grow at over 19% a year, rising from USD $6.32 billion to USD $15.39 billion in 2019. Similarly, mobile Internet advertising grew from just 5% of total Internet advertising in 2010 to 16.7% of the global share in 2014 and is expected to increase as mobile devices continue to proliferate (PwC, 2015).”

14. More than two billion people globally are expected to use mobile devices to connect to the Internet in 2016, with countries like India, China and Indonesia leading the way. More than a billion people use the Internet to bank online, to stream music, and to find a job. More than two billion use email and read news online and more people than ever before are making purchases online, it added.⁷

15. The growth and development of digital economy is reported and analyzed in great detail in Chapters 3 and 4 of the BEPS Report on Action 1 (2015), in statistical terms as well as in terms of their reliance upon information and communication technology as the primary means of doing business, along with the various business models that have emerged in the process. Because of their extensive reliance upon telecommunication and exchange of data, arising primarily from the revolutionary breakthroughs in their costs, these businesses are characterized by features that make them stand apart from the traditional brick & mortar businesses in many ways. Paragraph 158 of this summarises them as under:

“158. In addition, technological advances increasingly make it possible for businesses to carry on economic activity with minimal need for personnel to be present. In many cases, businesses are able to increase substantially in size and reach with minimal increases in the number of personnel required to manage day-to-day operation of the businesses (so-called “scale without mass”). This has been particularly true in the case of Internet businesses, which have in many cases quickly amassed huge numbers of users while maintaining modest workforces. As a result, the average revenue per employee of top Internet firms, as shown in Figure 4.8, is substantially higher than in other types of businesses within the ICT sector.”

2.4 Digital Economy in India

16. The Indian story in this regard is similar. According to Internet and Mobile Association of India (IAMAI), India's internet user base grew over 17% in the first six months of 2015 to 354 million. It took 10 years for India to get her first 10 million users and another 10 years to clock the first 100 million. As the rate picked up, the next 100 million users came in three years and the third 100 million took only 18 months. Internet users crossed 300 million in December 2013. India was expected to reach 402 million internet users by December 2015, registering a growth of 49 per cent over 2014 and surpassing the number of users in the United States. About 306 million of these are expected to access Internet from their mobile devices. At around that time the number of mobile users crossed one billion. With greater penetration, improving speeds and cheaper devices hitting the market, the target to reach 500 million internet users is likely to be achieved by 2016.3

17. The Department of Electronics and Information Technology (DeiTY), Government of India, is of the opinion that with the advent of the Internet of Things (IoT), which is defined as the interplay of software, telecom and electronic hardware industry, the number of connected sensors will soon reach trillions, working with billions of intelligent systems involving numerous applications which will drive new consumer and business behaviour. The demand for increasingly intelligent industry solutions based on IoT will drive trillions of dollars in opportunity for IT industry and even more for the companies that take advantage of the IoT. The draft IoT policy of DeiTY has set an objective of creating an IoT industry in India of USD 15 billion by 2020 assuming that India would have a share of 5-6% of global IoT industry.⁸ The launch of the Digital India Campaign also points to the high priority the Government of India accords to changes in the broadband infrastructure and favourable regulatory policy.

18. A report by Cisco estimates that all Internet of Everything (IoE) pillars - Internet of things, Internet of people, Internet of data, and Internet of Process for India have a value at stake (VAS) of INR 31.880 trillion (about half a trillion U.S. dollars) for the next ten years.⁹

19. Within the larger universe of the digital economy, India's e-commerce market was estimated to be worth about $3.8 billion in 2009 which went up to $12.6 billion in 2013. In 2013, the e-retail segment was worth US$ 2.3 billion. A large part of India's e-commerce market was travel related, but that may be changing now. According to Google India, there were 35 million online shoppers in India in 2014 Q1 and is expected to cross 100 million mark by end of year 2016. Electronics and Apparel are the biggest categories in terms of sales. Overall the ecommerce market is expected to reach Rs 1,07,800 crores (US$24 billion) by the year 2015 with both online travel and e-tailing contributing equally.¹⁰

20. A research conducted by octane.in has revealed interesting insights regarding the state of online marketing in India. According to it, 85% of the Indian marketers are tracking revenues generated through e-marketing activities. 50% of respondents share that e-marketing activities are contributing to more than 10% share of their revenues. It also reports that social media updates was the top choice for achieving maximum customer engagement (46%) followed by email campaigns (28%). Social Media (66%) also topped the list of marketing activities planned for 2016. Email marketing was not far behind, with a 53% share of Indian marketers.¹¹

21. These figures clearly indicate that digital means of communication and social interaction are giving rise to new businesses that did not exist very long ago. Many of these businesses that have generated only in last two decades, occupy considerable share of market segments, and form a significant part of the economy and tax base. Their growth in India has also reached proportions that make them significant actors in Indian economy.

2.5 Committee’s observations

22. In view of the aforesaid details and observations, as well as the details provided in the BEPS Report on Action 1¹², this Committee is of the view that this rapidly expanding segment of business that extensively relies upon the new advances in information and communication technology, the telecommunication networks and the internet, has now become a significant segment of economy around the world, including India. The Committee notes that these developments have made it essential that its impact in terms of the applicability of existing tax laws and the challenges posed by it, is properly appreciated, understood and taken into account in the tax systems. The Committee is also of the view that these challenges need to be addressed at the earliest, and also monitored on a regular basis.

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2. Section 4.3 of the BEPS Report on Action 1 describes the characteristics of digital economy as under: “4.3 Key features of the digital economy

151. There are a number of features that are increasingly prominent in the digital economy and which are potentially relevant from a tax perspective. While these features may not all be present at the same time in any particular business, they increasingly characterise the modern economy. They include:

• Mobility, with respect to (i) the intangibles on which the digital economy relies heavily, (ii) users, and (iii) business functions as a consequence of the decreased need for local personnel to perform certain functions as well as the flexibility in many cases to choose the location of servers and other resources.

• Reliance on data, including in particular the use of so-called “big data”.
• Network effects, understood with reference to user participation, integration and synergies.
• Use of multi-sided business models in which the two sides of the market may be in different jurisdictions.

• Tendency toward monopoly or oligopoly in certain business models relying heavily on network effects.

• Volatility due to low barriers to entry and rapidly evolving technology.”

3. Paragraph 117 of the BEPS Report on Action 1 (2015) describes e-commerce or Electronic Commerce as under: “117. Electronic commerce, or e-commerce, has been defined broadly by the OECD Working Party on Indicators for the Information Society as “the sale or purchase of goods or services, conducted over computer networks1 by methods specifically designed for the purpose of receiving or placing of orders. The goods or services are ordered by those methods, but the payment and the ultimate delivery of the goods or service do not have to be conducted online. An e-commerce transaction can be between enterprises, households, individuals, governments, and other public or private organisations” (OECD, 2011). E-commerce can be used either to facilitate the ordering of goods or services that are then delivered through conventional channels (indirect or offline ecommerce) or to order and deliver goods or services completely electronically (direct or on-line ecommerce)….”

4. Notes to Chapter 4 of the BEPS Report on Action 1 (2015) describe Cloud Computing as under: “Cloud computing is defined in the report of the US National Institute of Standards and Technology (NIST) as ‘a model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources (e.g. networks, servers, storage, applications, and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction.’ According to NIST, the cloud model is composed of five essential characteristics:

• On-demand self-service: A user can unilaterally act without requiring human interaction with each service’s provider.

• Broad network access: Capabilities are available over the network and accessed through standard mechanisms that promote use by heterogeneous client platforms (e.g. mobile phones, laptops, and PDAs).

• Resource pooling: The provider’s computing resources (e.g. storage, processing, memory, network bandwidth, and virtual machines) are pooled to serve multiple users using a multi-tenant model.

• Rapid elasticity: Capabilities can be rapidly and elastically provisioned.

• Measured Service: resources use can be monitored, controlled, and reported providing transparency for both the provider and consumer of the utilised service.”

5. Boston Consultancy Group

6. Department of Electronics and Information Technology (DeiTY), Government of India
7. Economic Times articles dated 6th February, 2015, 3rd September, 2015 and 1st January, 2016; the Internet and Mobile Association of India (IAMAI)

8. The website of the Department of Electronics and Information Technology (DeiTY)

9Article “Opportunities for India in the Digital Economy” by Shri V C Gopalratnam, CIO, Cisco, published in CIO Review

10. Wikipedia

11. 2016 Annual Research Study on State of Online Marketing in India – Octane.in

12. Chapter 3 Information and communication technology and its impact on the economy & Chapter 4 The digital
economy, new business models and key features

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