♣ Introduction of Significant Economic Presence (SEP):-

Section 9 (1) (i) of the Income-tax Act, 1961 (‘the Income-tax Act’) was amended to bring in the concept of “Significant Economic Presence” for establishing “business connection” in the case of non-resident in India.

Accordingly, significant economic presence shall mean–

i. Any transaction in respect of any goods, services or property carried out by a non-resident in India including provision of download of data or software in India if the aggregate of payments arising from such transaction or transactions during the previous year exceeds the amount as may be prescribed; or

ii. Systematic and continuous soliciting of its business activities or engaging in interaction with such number of users as may be prescribed, in India through digital means.

Provided that the transactions or activities shall constitute significant economic presence in India, whether or not,—

  • the agreement for such transactions or activities is entered in India; or
  • the non-resident has a residence or place of business in India; or
  • the non-resident renders services in India:

In order to prescribe the thresholds as mentioned above, suggestions/comments of stakeholders and the general public have been invited in order to prescribe the thresholds to establish significant economic presence of a non-resident in India. The comments and suggestions so received are under consideration.

If digital businesses operated by non-residents are structured to artificially avoid establishment of a “business connection” or “permanent establishment” in India, including by way of claiming the activities carried out in India to be preparatory or auxiliary in nature, the GAAR provisions under the Income-tax Act may become applicable to the income of such digital businesses in India. Signing of the Multilateral Instrument is unlikely to address the broader tax challenges of digitalization of economy owing to the redundancy of physical presence-based nexus.

♣ SEP and Permanent Establishment (PE):-

Article 7 of the DTA provides that the non-resident assesse is not liable to tax in the country of sales unless he has a PE in the Country of sales. Primarily, a PE requires a fixed place of business within the geographical boundaries of the country of sales.

Modern technology has made it possible for many companies to do business in several countries without PE. Phrases like “Borderless world” and “Modern technology defies Geography” have become reality for E-Commerce. But governments do want to collect income tax based on geography. They need a concept of a PE without fixed place of business. An SEP would be a PE not requiring the fixed place of business.

Indian Government has asserted its right to tax when income is associated with services consumed by Indian Resident Consumer irrespective of whether the services are rendered by the service provider in India or not.

Section 9 (1) (v) (VI) & (vii) read with explanation at the end of Section 9. Consumption of a service should be by an Indian resident. The non-resident service provider may provide services within India or outside India. The place of provision of service is not relevant.

Equalization Levy (EQL) & Significant Economic Presence (SEP):

Equalization Levy has been imposed as an E-commerce tax by Chapter VIII, Sections 163 to 180 of The Finance Act, 2016. No change has been proposed under Finance Bill, 2018 on Equalization Levy.

With introduction of Significant Economic Presence (SEP) in ITA & continuation of EQL under Finance Act, 2016; there will be an overlap. If a NR earns advertising revenue from India, he will be liable to which tax?

(i) Any income which is chargeable to EQL is exempt from Indian Income-tax u/s. 10 (50). Hence there will be no double tax.

Q1.Can such an assesse choose to be taxed under ITA instead of EQL?

 No. Finance Act, 2016 chapter VIII does not give any option to the assesse. If he is liable to tax under EQL, he has to pay tax as EQL & get exemption under ITA)

(ii) Many revenues will be covered under the definition of SEP & are not covered under EQL. Such revenues will not get exemption u/s. 10 (50).

Q2.What will be their tax exposure?

There can be two possibilities. Such assesse is entitled to DTA relief because he is resident of a country with which India has DTA; and the assesse produces Tax Residency Certificate (TRC). In such a case, under the present DTA, the NR businessman can claim that he does not have a PE in India. Hence his income will not be taxable in India)

(iii) There are NR assesses who are not entitled to DTA relief. Hence they do not get protection of PE. Their incomes will be – after 1st April, 2018 – covered under SEP & hence Business Connection. They will be liable to Indian Income-tax u/s. 9 (1) (i) Explanation (2A). Indian payers will be liable to deduct tax at source u/s. 195.

SEP and Income Tax Act (ITA) and Double Taxation Agreement (DTA):-

DTA did not provide for E-commerce taxation. Hence bringing such a tax under ITA was of no use. Since the Indian E-commerce tax is outside ITA, the DTA set off is not available to the assesse. When the non-resident assesse does not get a set off in his COR, he has a reason to insist that the tax should be paid by grossing up by the Indian payer.

Finance Bill, 2018 takes the first important step in breaking the dead lock. I will explain detailed process required to break the dead lock – in the paragraphs below. The dead lock can be broken by bringing E-Commerce tax within ITA. For this purpose, the definition of Permanent Establishment (PE) needs to be expanded by including a concept of Significant Economic Presence (SEP).India could have chosen any other means- for example, EQL under ITA itself. GOI chose SEP under ITA & kept EQL outside ITA.

Online information Database access and Retrieval Services (OIDRS) under GST & SEP:-

The IGST Act defines OIDAR to mean services whose delivery is mediated by information technology over the internet or an electronic network and the nature of which renders their supply essentially automated and involving minimal human intervention and impossible to ensure in the absence of information technology and includes electronic services such as, ––

  • Advertising on the internet;
  • Providing cloud services;
  • Provision of e-books, movie, music, software and other intangibles through telecommunication networks or internet;
  • Providing data or information, retrievable or otherwise, to any person in electronic form through
  • A computer network;
  • Online supplies of digital content (movies, television shows, music and the like);
  • Digital data storage; and
  • Online gaming;

For any supply to be taxable under GST, the place of supply in respect of the subject supply should be in India. In case, both the supplier of OIDAR Service and the recipient of such service is in India, the place of supply would be the location of the recipient of service i.e. it would be governed by the default place of supply rules.

(What happens in cases where the supplier of service is located outside India and the recipient is located in India?

In such cases also the place of supply would be India and the transaction would be amenable to tax). 

Indirect tax provisions under GST Act charges 18% on OIDRS. 

Illustrative list of transactions covered under SEP:-

  • Sale or purchase of goods, services or property through digital means.
  • Any transaction involving downloads of data or software in India (like in-app purchases).
  • Provision of online training / gaming services.
  • Provision of services of streaming of e-content (audio / video).
  • Interaction with customers such as for trouble shooting, etc.
  • Websites, online database, cloud storage and computing services, with significant user base in India.

Who is impacted?

  • Non-resident carrying on specified activities beyond thresholds may be prescribed,
  • Non-residents who do not have tax treaty benefits are directly impacted,
  • Non-residents who have tax treaty benefits need to consider consequential obligation, if any

Safeguards:-

  • India’s existing treaties contain the conventional concept of permanent establishment (PE) for taxing business profits of a non-resident and the inclusion of SEP in the ITA will not be read into the tax treaties unless they are amended.
  • Revenues and users not exceeding thresholds as may be prescribed, to remain outside of SEP.

Attribution of Profits to SEP:-

Once an SEP is treated as a BC and the non-resident is liable to tax in India under the deeming provision of Section 9(1) (i), it is not that the whole of its net profit is taxable in India. Only that portion of its net profit which is attributed to the Indian SEP will be taxable in India.

Thus, the system of SEP will be normal system of taxation of a foreign assesses branch /PE in India. It will not be like Equalization Levy where a flat rate of tax is levied on gross revenue.

Challenges in implementing SEP:-

Once the concept of SEP is brought within the concept of Business Connection, Government of India will have a nexus / connection under ITA to tax a non-resident’s business income in India. Thereafter Government of India has to amend the DTA to include E-commerce taxation; or in technical words, to add the concept of SEP to article5of the DTA which defines PE. India has signed around 85 DTAs with 85 different countries / jurisdictions. Hence Indian Government will have to try and negotiate the treaty with each country separately. Only when the other country accepts to add the concept of SEP, it will be added in the bilateral treaty. When it is added in the treaty, Government of India will be able to levy E-commerce taxation.

OECD – G20 Multilateral Instrument (MLI) does not have specific article for E-commerce taxation. If the MLI had a specific article on E-commerce taxation, India would not require fresh negotiations with all the 85 countries.

In any case, out of 85 countries, many countries would not have assesses providing E-commerce goods or services to IRs. Hence signing a treaty with them is not of any financial significance.

Yet, this is an important step in international treaty negotiations. India has taken a leadership in E-commerce taxation. It needs to maintain the leadership in BEPS negotiations to ensure that ultimately Action 1 Report makes a provision for E-commerce taxation.

Concluding Remarks:-

“Physical situs is one thing; origin or economic location is quite another thing: they do not necessarily coincide. Physical situs is of importance in economic allegiance only to the extent that it reinforces economic location”.

References/ Relevant-

Taxation of Digital Businesses

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