The Karnataka government has erred in asking online retailer Amazon to pay value added tax (VAT) on products it does not own or sell.

The company is just a service provider, a service it calls 'fulfilment' on its marketplace platform for which it charges the merchant. The merchant, in turn, pays VAT collected from the customer to the state government.

Amazon, if at all, is liable only to pay service tax, and for this, the Centre should deem 'Fulfilment by Amazon' as a taxable service. The current tax row though is independent of the enforcement directorate's probe to find out if Amazon has violated India's foreign direct investment laws.

Online retail is expanding fast in India. The case to bring it into the tax net is compelling. It will help prevent tax-base erosion profit shifting. Not unexpectedly, the OECD, a club of rich countries, sees the digital economy as a revenue gold mine, and urges countries to impose VAT.

In the US, for example, online retailers already pay sales tax in many states that have adopted state online laws, also called Amazon tax laws. There is no reason why India should be an outlier.

True, state tax laws in India predated online retail and, therefore, e-commerce transactions do not find specific mention in these laws. That must change. It makes eminent sense to tax e-commerce deals because India wants to adopt a goods and services tax (GST). Without a tax on e-commerce sales, the GST chain would be broken.

A tax on their sales is the only way e-retailers can get credit for the taxes they pay on their inputs. Else, doing business in India will not be lucrative. The main job is for the government to create procedures that make tax compliance easy for e-commerce operators, and tax all value additions along the chain.