I have paid for an extra 2TB of data storage on my iphone 12 but how does it work?

The storage you pay for is iCloud storage. It resides on Apple servers. It is used to store your iPhone's iCloud backups, synced Photos, contacts, iCloud email, and synced files in iCloud Drive.

It does not and has never been purported to increase the local capacity of our iPhone in any way.

Its like asking why you are paying for a U-Store storage warehouse and don't get any extra room in your actual house.

Local storage capacity of an iPhone can never be changed. If you are running low on local storage space you need to delete content from the iPhone to make room.

The 2TB is on Apple's servers and doesn't add to the iPhone's internal storage. Delete or offload content from it.

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