With rapid technological advancements, businesses have spread over their presence globally through digital means without having any physical presence. India is already among the top global economies in terms of digital consumer base of active internet users.
The traditional taxation system was formulated taking into consideration the traditional way of doing business, i.e., a brick-and-mortar model, which has become outdated now since the nature of business has evolved.
This has also given rise to several issues of base erosion and profit shifting (‘BEPS’) concerns in the taxation of digital economy. In line with the same, India was among the first to implement the Equalisation Levy (EL) for B2B transactions in 2016 on online advertisements related services and substantially expanded the scope of this levy in 2020 to cover e-commerce supply and services.
Interestingly, the term, Significant Economic Presence (‘SEP’) was introduced in the domestic act to cover B2C transactions in the year 2018. The resulting income of a non-resident attributable to SEP in India was considered to be taxable. However, this would not have an impact on non-residents coming from treaty countries due to the possibility of availing restrictive definition of Permanent Establishment under the tax treaties.
Owing to the delay in accomplishing a global consensus, which could have enabled amendment of tax treaties through a Multi-Lateral Instrument, SEP provisions were deferred and are now applicable from April 1, 2021 and Central Board of Direct Taxes has proceeded and notified the limits of its applicability on May 3, 2021.
The aggregate of payments arising from transactions carried out by a non-resident in India pertaining to any goods, services, property, provision of download of data or software in India is Rs 2 crores annually to trigger SEP. Another consideration to trigger SEP is the number of users with whom systematic and continuous business activities are solicited or who are engaged in interaction and limit prescribed for the same is Rs 3 lakhs.
The rules shall come into effect retrospectively i.e. from April 1, 2021.
It may be said that SEP would not just be limited to digital transactions and could also impact typical buy-sell or service transactions between non-resident and an Indian resident as the concept is of “significant economic presence” not “just digital presence”..
Therefore, typical import transaction could also be treated as SEP. However, as mentioned above, the impact of SEP would only be in cases where there is no treaty between India, or the non-resident is not able to substantiate treaty entitlement.
Implications for CFOs
In view of all this, CFOs would have to be extra diligent to review the withholding tax position as any shortfall could trigger expense disallowance, interest, and penal consequences.
Another concern for finance leaders would be of attribution as India currently has two provisions for attribution of profits. Rule 10 of the Income Tax Rules which essentially says that revenues from India divided by global revenues multiplied by global profits should be the taxable base in India. It would be impossible to apply this principle in a digital business. The second rule is the arm’s length principle under transfer pricing. This also can’t be the answer since the entire functions, contractual and legal risks are outside of India in the digital business context. Hence, it would be critical to see the attribution aspect in this scenario..
It is worth mentioning that there are several proposals coming from various sides to tax the digital economy. It needs to be analysed thoroughly wherein how several measures; including ones already in place like EL, SEP and classification of certain services as Fees for Technical Services etc. as well as those in the pipeline like proposal of introduction of Article 12B for taxation of Automated Digital Services (ADS) in the model convention by UN; would interact with each other.
These would certainly raise the complexities and the tax department should issue detailed FAQs from time to time so that the taxpayers, advisors and the IT officers are in sync with each other.
About the Author: Amit Maheshwari is Tax Partner, AKM Global.
DISCLAIMER: The views expressed are solely of the author and ETCFO.com does not necessarily subscribe to it. ETCFO.com shall not be responsible for any damage caused to any person/organisation directly or indirectly.