Introduction
Significant Economic Presence (‘SEP’) was introduced in the Income Tax Act, 1961 from April 1, 2018. It expands the scope of Income of a non-resident which accrues and arises in India that results in a ‘business connection’ in India for that non-resident. The resulting income, attributable to the SEP, is taxable in India.
According to Explanation 2A of Section 9 of the Income Tax Act, 1961,
a.) Transaction in respect of any goods, services or property carried out by a non-resident in India, including the 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 such amount as may be prescribed.
b.) Systematic and continuous soliciting of business activities engaging in interaction with such number of users as may be prescribed.
Finance Act 2018 expanded the scope under domestic law of the term – ‘Business Connection’ to enable taxation on non-residents having s SEP in India.
Applicability of Significant Economic Presence:
According to Rule 11UD,
1.) Threshold in respect of payments is INR 20 million during the financial year; or
2.) Threshold in respect of number of users is 0.30 million users during the year in India through digital means.
Understand the Significance Economic Presence:
Significant Economic Presence Transactions or activities that create SEP irrespective of whether or not the non-resident has a residence or a place of business in India or renders services in India. However, only Income attributable to operations in India or transactions in India would be taxable.
The first part of SEP seeks to include within its purview, transaction in respect of any goods, services or property carried on by non-residents. The explanation is an expansive definition and seeks to cover all transactions which relate to goods, services and property.
The second part of SEP deals with systematic and continuous soliciting of business activities or engaging in interactions with users, in India. Two activities are sought to be covered, one is soliciting of Business activities and other is engaging in interaction with users.
Impact of Significant Economic Presence:
Following categories of non-residents carrying on specified activities beyond thresholds would be impacted due to the SEP provisions under the Act:
a.) Non-residents from countries that do not have tax treaties with India;
b.) Non-residents from countries that have entered into tax treaty with India but the non-resident fails to provide the Tax residency certificate from resident country.
Transactions covered:
a.) Sale or purchase of goods, services or property through digital means.
b.) Any transaction involving download of data or software in India (like in-app purchases)
c.) Provision of online training/ gaming services.
d.) Provision of services of streaming of e-content (audio/ video)
e.) Interaction with customers such as trouble shooting, etc
f.) Websites, online database, cloud storage and computing services with significant user base data in India.
Unintended Consequences of the SEP provisions:
The first and foremost challenge is the low thresholds, owing to which a large number of non-residents could get covered under the SEP.
Secondly, as also explained above, the definition is widely worded. This would imply that even if goods are sold or services are rendered from outside India, the same may result in SEP in India if the revenue or user threshold are exceeded. The provisions as they stand today, are much wider and go beyond taxing digital business and transactions and seek to cover all and any transactions that non-residents may have with persons in India.
The concept of continuity and regularity which are attributes of a business connection are disregarded in the manner in which the provisions are currently drafted. Stand-alone, stray and isolated transaction could also be held to constitute SEP, if the monetary thresholds are breached.
Where a SEP is constituted, non-residents would be subject to tax in India on the basis of income attributable to operations/transactions in India. In case of income attributable in India, non-residents would need to comply with requirements of books of accounts, conduct of audit and other compliances in India. However, this would be subject to tax treaty interplay, as explained below.
Interplay of SEP and Tax Treaty:
The SEP provisions do not seem to impact tax liability of non-residents, with which India has in place tax treaties, providing for a favourable tax regime.
For non-resident entities, who are able to claim tax treaty benefits based on their residential status, tax residency certificate (‘TRC’), beneficial ownership of income, etc.; SEP provisions will be overridden by the tax treaty provisions which provide that income of non-residents would be taxed in India, when they constitute a Permanent Establishment (‘PE’), which has some defined criteria in respective treaties. Gross basis taxation of certain types of income such as dividends, royalties, fees for technical services, etc. would continue to apply as earlier, even if there is no PE.
Issues of non-residents with no tax treaty protection:
The SEP provisions impact non-residents from jurisdictions with which India does not have a tax treaty in place. For such entities, applicability of the SEP provisions need to be evaluated.
New reporting requirements:
Having said that, non-resident still need to analyse, if the SEP provisions are applicable to them. This is because, non-residents who are obliged to file Income Tax Returns have to now declare in the return if they have a SEP in India from FY 2021-22 onwards (i.e. AY 2022-23). Accordingly, this imposes a difficult task on non-residents of compiling the necessary information and analysing transactions which need to be reported in the Return of Income as per the new requirement of disclosure regarding SEP.
In addition, payments made to non-residents may be subject to withholding tax in respect of certain income (interest, dividend, royalty, fees for technical services etc). Remitters of such income demand the non-residents to confirm if they constitute a SEP in India, in addition to requiring them to furnish certain documentation like Tax Residency Certificate (‘TRC’), No PE declarations etc.
SEP – Some recent developments around the world:
1.) Israel’s step towards SEP: Israel Tax Authority have prescribed various illustrative ‘digital factors’ to constitute SEP for foreign e-commerce and online services companies that operate in Israel.
2.) European Union (EU)’s proposal for taxation of Significance Digital Presence (SDP): EU proposes to establish a taxable nexus of a digital business based on revenue, number of users/ contracts for digital services.
Conclusion:
Introduction of SEP provisions is an indication of how India seeks to tax profits of non-residents doing businesses in India. Given the complexities involved, proper impact analysis of the new SEP provisions is required in respect of cross border business carried with Indian entities, whether through digital or conventional means.
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Authors:
Karan Vakharia | Partner
Nitesh Jha | Manager
Palash Jain | Associate Consultant
(Authors can be contacted at [email protected] or at +91 98709 25375 )
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