Owing to the advent of digitalisation, India has been keen on taxing foreign digital businesses and adopted the concept of ‘Equalisation Levy’ and ‘Significant Economic Presence’ in its domestic law. SEP regulations were initially introduced in 2016 and the scope was widened in 2020. However, these provisions were deferred till April 2021.
At a concept level, SEP expanded the scope of income for a non-resident doing business with India. The provisions expanded the scope of ‘business connection’ (similar to Permanent Establishment) for non-resident, which may result in higher tax liability and compliances for non-residents. The tax rate applicable would be 40% (plus applicable surcharge and cess).
The SEP provision was deferred on grounds that a multilateral solution under the Organisation for Economic Co-operation and Development is being considered where all tax treaties will get amended automatically. Even though OECD and Group of 20 countries recognised the magnitude of digitalisation and devised the Base Erosion and Profit Shifting Action Plan 1 to address the tax challenges raised by digitalisation, it has not reached a global consensus to date.
Nevertheless, India has deemed it fit to operationalise the SEP provisions from April 1, 2021. This is done by notifying the ‘prescribed threshold’ vide notification dated May 3, 2021. As per this notification, a revenue threshold of Rs 2 crore and a user limit of 3 lakh users have been notified.
Implications For Non-Residents
Till now, foreign companies earning income from India on account of the sale of goods to India were not taxable under the Indian Income Tax Act if they do not have any business connection in India. This position was true irrespective of treaty availability.
Now, the concept of SEP provides that a non-resident would be deemed to have a business connection in India if it carries out specified activities or crosses the above thresholds which thus holds them liable to tax in India.
Given the low thresholds, it would affect a large number of non-resident/foreign companies doing business with India.
However, tax treaties with respective countries would come into the picture and protect these foreign companies doing business with India. Thus, non-residents / foreign companies that are from treaty countries would not be majorly affected except for the fact that they will have to have the documentation ready (like a Tax Residency Certificate) for claiming treaty benefits.
Non-treaty jurisdictions (though limited in number) may be hugely impacted as the thresholds are very low, and they would be governed by the domestic tax law only.
Indian Businesses May Also Have To Bear New Compliance Burden
While treaties would offer protection to many non-residents, this new concept of SEP may present a unique situation for Indian businesses that work with foreign vendors.
For companies in India, this would have a huge impact as now they would have to be more vigilant while applying withholding tax considering the SEP provisions for their foreign vendors even on transactions such as import of goods which till now was by and large not taxable and no documentation as such was required.
Indian companies may now have to insist foreign vendors provide a Tax Residency Certificate to get covered under tax treaty provisions even for a transaction such as import of goods to get away from SEP provisions. In absence of TRC, Indian companies making payments to non-residents would not be able to provide treaty protection.
In such a case, they would have to determine the revenue attributable to India to apply appropriate withholding tax rate or apply a straight 40% (plus applicable surcharge and cess) rate on the gross payments or ask the non-resident vendors to get a lower withholding tax order from the tax department.
Similarly, in the case where Indian companies are granting exemption under the Indian IT Act (even for treaty countries) would have to see the applicability of SEP.
The SEP provisions are wide enough to cover much more than digital transactions.
Given such low thresholds, any revenue generated from activities like the sale of goods/types of machinery, etc, may also be brought under the coverage of SEP.
Similarly, in cases where payments for services amount to royalty or fees for technical services under domestic laws one may have to adopt a position that specific provisions should override the general provisions of SEP since SEP also covers services.
These provisions of SEP have been made applicable from April 1, 2021, however, given that the thresholds were not prescribed the provisions were inoperative. Now, given that thresholds are prescribed, companies will have to quickly look at implications arising from this and check payments made during April 2021 to see if these provisions would have an impact.
Government Should Revisit Threshold Limits To Alleviate Burden
The SEP concept was deferred till April this year on grounds that a multilateral solution under the OECD is being considered where all tax treaties will get amended automatically. However, it comes as a surprise that in the absence of a consensus by the OECD countries on taxation of the digital economy, India has deemed it fit to operationalise the SEP provisions by notifying the ‘prescribed threshold’.
All in all, while it appears that companies in treaty countries enjoy the protection, they will have to furnish documentation to ensure that their treaty protection claim is entertained. This would place a huge compliance burden on the shoulders of both Indian companies making payments to foreign vendors as well as on foreign companies. Government should think through this and revisit the SEP limits or provide alternate guidance to alleviate such a burden.
Maulik Doshi is Partner - Direct Tax and Transfer Pricing Services, Nexdigm and Nishit Parikh is Partner - Direct Tax & Regulatory Services, Sudit K Parekh & Co. LLP.
The views expressed here are those of the authors and do not necessarily represent the views of BloombergQuint or its editorial team.
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