Advancement in technology and digitization has enabled businesses to generate revenues from other countries/market jurisdictions without the need for any physical presence in such countries. This has been a cause of concern for market jurisdictions where the consumers/users are located. These jurisdictions are deprived of their share of the tax pie due to historical tax rules which were designed to cater to brick-and-mortar business models and focus on physical presence to allocate taxation rights. This has been a major area of debate in international tax for past several years. Globally, there have been several attempts to frame new rules of international taxation to keep pace with these new and emerging business models.
One such solution was offered by Organisation for Economic Co-operation and Development (OECD) under Base Erosion and Profit Shifting (BEPS) Action Plan 1. This Action Plan recommended three interim options to address the tax challenges arising from digital economy till a global consensus is reached to address this issue. These options were:
* Significant economic presence (SEP);
* Withholding tax on digital transactions; and
* Equalization levy
After these developments, several countries have taken unilateral steps and made necessary changes in their domestic laws to tax new-age businesses.
India: the early mover
India was one of the early movers in this direction. The Central Board of Direct taxes (CBDT), the apex tax administrative body in India set up a committee on taxation of e-commerce to evaluate the options available. The committee recommended equalization levy as a viable option for India, as it did not require alternation in the existing tax treaties, which would have been a tedious and time-consuming process. Thus, India became one of the first countries to levy equalization levy of 6% on online advertising and related services in 2016. The equalization levy provisions were substantially widened in 2020 by bringing in its ambit the online sale of goods and services.
The committee was also of the view that concept of SEP could be introduced within the concept of “business connection". Under Indian domestic tax law, a non-resident is taxed in India if it has a “business connection" in India. BEPS Action Plan 1 had recommended that a non-resident enterprise would create a taxable presence in a country if it has a SEP in that country on the basis of factors that have a purposeful and sustained interaction with the economy by the aid of technology and other automated tools.
Advent of SEP provisions
In this backdrop, the SEP provisions were initially introduced in 2018. It was felt that this change in the domestic law will enable India to negotiate for inclusion of this new nexus rule in the tax treaties. These provisions, however, remained inoperative as the thresholds were not prescribed.
The current SEP provisions are applicable from 2021-22. As per the current provisions, a non-resident having SEP in India shall be deemed to have a business connection in India. Accordingly, income attributable to the transactions or activities referred to in these provisions shall be deemed to accrue or arise in India and hence taxable in India.
SEP of a non-resident would be established if:
* the aggregate of payments arising from transactions in respect of any goods, services or property carried out by a non-resident with any person in India including provision of download of data or software in India, during the financial year exceeds `20 million (during a financial year); or
* Non-resident undertakes systematic and continuous soliciting of business activities or engages in interaction with 300,000 or more number of users in India.
SEP provisions would be applicable, irrespective of whether:
* Agreement for such transactions or activities is entered in India; or
* Non-resident has a residence or place of business in India; or
* Non-resident renders services in India.
It has also been clarified that income attributable to the operations carried out in India, shall include income from:
* advertisement which targets a customer who resides in India or a customer who accesses the advertisement through internet protocol address located in India;
* sale of data collected from a person who resides in India or from a person who uses internet protocol address located in India; and
* sale of goods or services using data collected from a person who resides in India or from a person who uses internet protocol address located in India.
It is important to note that the concept of SEP has been introduced in the Indian domestic tax law. As far as the tax treaties are concerned, they provide that business profits of a non-resident would be taxable in India only if the non-resident has a permanent establishment (PE) in India. Under the tax treaties, the PE provisions, in general, would get triggered basis some physical presence of an entity. For example, having an office or physical presence of employees exceeding specified number of days etc. Therefore, non-residents who are entitled to claim treaty benefit would prima facie not be impacted by the SEP provisions, considering that the scope of PE in tax treaties continues to be much narrower.
SEP provisions would, however, be relevant in cases where tax treaty benefit is not available. This could cover taxpayers based in jurisdictions with whom India does not have a tax treaty.
It would also include taxpayers from countries where India has a tax treaty in force, but the treaty benefit is not available. The reasons for non-availability of treaty benefit could be several. These could range from the taxpayer not qualifying as ‘person’ or a ‘resident’ under the treaty due to its entity type, or applicability of anti-avoidance provisions such as General Avoidance Rule (GAAR) under the domestic law or Principal Purpose Test (PPT) under the tax treaty.
Equalization levy vs SEP
Currently, the equalization levy provisions and SEP provisions co-exist in the Indian domestic laws. Hence, it is possible that there could be an overlap between the two. It has, however, been provided that if a transaction is subject to equalization levy, then there would be no further Indian income tax liability. Accordingly, non-residents would need to check if equalization levy provisions are applicable in the first instance. If these provisions are applicable, then the transaction should be outside the purview of SEP provisions. Broadly speaking, equalization levy provisions reign supreme.
Stakeholders have pointed out that the thresholds provided for SEP are quite low and should be reconsidered. It has also been highlighted that though the intent was to tax digital businesses, its provisions seem to be far more expansive. Further, meaning of key terms such as “systematic", “continuous", or “soliciting" has not been provided which may lead to litigation on scope of the provisions. There are concerns on how the number of users will be determined, considering they are not limited to residents.
On the practical side, taxpayers would need to monitor if the SEP provisions are triggered in case of non-resident payee, so that appropriate taxes are withheld.
Considering the recent G7, G20/OECD developments to arrive a consensus-based solution on new international tax principles, one would have to wait and watch to see the impact, if any on the domestic SEP and equalization levy provisions. This is considering that India would have to realign its domestic tax laws based on the global solution, to which it has prima facie extended its support. Indeed, it will be an interesting play to watch as things unfold in near future.
Richa Sawhney and Ankita Chowdhry contributed to this article