Significant Economic Presence (SEP): Implications for Non-Residents in India

Understanding SEP in Tax Laws

This article sheds light on the concept of Significant Economic Presence (SEP) under Section 9 of the Indian Income Tax Act, 1961, and its implications for non-residents.

Defining SEP: SEP, as per the tax laws, covers transactions carried out by non-residents in India, such as goods, services, or property dealings, where the aggregate payments exceed INR 2 Crores during the financial year. It also encompasses systematic and continuous soliciting of business activities or engaging with 3 Lakh users in India.

SEP Implementation: SEP provisions, introduced in FY 2018, became operational from the financial year 2021-22. The delay in implementation was due to ongoing global discussions as part of the OECD BEPS project.

Unravelling SEP Components

First Limb: Transaction Inclusions

The first aspect of SEP broadens its scope by including transactions related to goods, services, or property conducted by non-residents in India.

Second Limb: Business Activities and User Interaction

The second facet of SEP focuses on systematic and continuous solicitation of business activities or interaction with users in India.

The Digital Business Objective

SEP, influenced by the OECD BEPS Action Plan 1, aims to tax income generated from new business models, especially digital transactions, without requiring physical presence.

Unintended Consequences of SEP

Low Thresholds Challenge

One major challenge with SEP is the low thresholds, potentially covering a large number of non-residents.

Wide-Ranging Definition

The broad definition implies that even if goods or services are sold from outside India, SEP may apply if revenue or user thresholds are exceeded. This brings transactions from outside India under the SEP ambit.

Impact Beyond Digital Transactions

SEP provisions extend beyond taxing digital business, aiming to cover all transactions non-residents may have with persons in India.

Questioning Other Income Streams

An open question arises on whether income streams like royalties, cost recharges, etc., could also result in SEP.

Disregarding Continuity and Regularity

The current drafting of SEP provisions disregards the continuity and regularity aspects typical in business connections. Stand-alone transactions could also constitute SEP if monetary thresholds are breached.

Interplay of SEP and Tax Treaty

Nullification Effect

SEP’s impact on nations with Double Taxation Avoidance Agreements (DTAA) with India is null, as treaties override domestic tax laws.

Negotiation Necessity

To enforce SEP taxation in nations with DTAA, India would need to negotiate deals with counterparts of 86 nations and mutually agree to SEP taxation.

Assessee’s Power to Choose

In DTAA, the assessee can choose to be governed by the treaty or domestic taxation laws, giving them the power to select the most convenient path for tax payment.

SEP and Tax Treaty Interaction

Favourable Tax Regime

SEP provisions don’t significantly impact the tax liability of non-residents with existing tax treaties, offering a favourable tax regime.

Onus on Non-Resident Entity

The responsibility to establish treaty residency lies with the non-resident entity claiming tax treaty benefits.

Override with Tax Treaty Provisions

For non-resident entities eligible for tax treaty benefits, SEP provisions are overridden by tax treaty provisions. These provisions specify that the income of non-residents is taxed in India when constituting a Permanent Establishment, following defined criteria in respective treaties.

Conclusion: Understanding Taxation under SEP

Transaction Category Remarks

• Where No DTAA Exists: The income of non-residents on account of SEP would be chargeable to tax in India as business profits at the effective rate of 43.68%.
• Where DTAA Exists: Non-residents can invoke the provisions of the tax treaty to the extent that it is beneficial. The narrower definition of permanent establishment in existing treaties provides an avenue for non-residents to navigate the challenges of SEP.

This article aims to decode the intricacies of SEP, offering a clearer understanding of its components, challenges, and the interplay with tax treaties for non-residents.