Taxing The Digital Financial system – Thresholds For Constituting Vital Financial Presence Notified – Tax

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The concept of ‘Significant Economic Presence’ (SEP) was
introduced in India’s domestic tax law in 2018, with the intent
of bringing income of non-residents operating in the online /
digital space (such as e-commerce, online streaming, etc.) within
the ambit of India-sourced income. However, the concept of SEP
remained inapplicable as the thresholds for constituting SEP had
not been prescribed. Through a notification dated 3 May 2021
(Notification), the Government of India (Government) has prescribed
the relevant thresholds for non-residents to constitute SEP in
India, which will come into force from 1 April 2022.

Non-residents having SEP in India would be deemed to have a
‘business connection’ in India, and income attributable to
the SEP would now be taxable in India (except in cases where a
tax-treaty is applicable). A non-resident will be considered to
have SEP in India in either of the following situations –

Transaction in respect of any goods, services or property are
carried out by a non-resident with any person in India (including
provision of download of data or software in India), if the
aggregate of payments arising from such transaction(s) exceed the
prescribed amount (given below); or
Systematic and continuous soliciting of business activities or
engaging in interaction with such number of users in India as may
be prescribed (given below).

Through the Notification, the Government has prescribed the
threshold as INR 20 million in case of (a) above,
and 300,000 users in case of (b) above.

Notably, the income-tax law was recently amended to provide that
income attributable to the SEP would include income from
–

Advertisement targeting an Indian resident customer or a
customer accessing the advertisement through an Indian IP
address;
Sale of data collected from Indian residents or from persons
who use an Indian IP address; and
Sale of goods or services using data collected from Indian
residents or from persons who use an Indian IP address.

Analysis of SEP and prescribed thresholds

The wide language of the SEP provision seems to go beyond the
stated objective of taxing digitized businesses and may bring
within its purview even non-digitized businesses. For instance, it
is unclear whether sale of physical goods outside India by a
non-resident to a resident would fall within the ambit of SEP.
Further, the phrase “systematic and continuous” is
ambiguous and its interpretation could be a magnet for tax
litigation. Further, the prescribed thresholds for constituting SEP
appear to be on the lower side, especially for the threshold on
payments being set at INR 20 million. Lastly, the income
attribution mechanism for non-residents constituting ‘business
connection’ (including by way of SEP) remains unclear, and it
is hoped that the Government would provide guidance on this matter
to provide certainty to foreign businesses.

Relevance of SEP

Even though the thresholds for constituting SEP have been
notified, it is important to note that SEP will not be
applicable for non-residents / foreign companies that are eligible
to avail benefits of a tax treaty entered with India. This
is because if a tax treaty is applicable, foreign companies’
income is taxable in India only if it has a ‘Permanent
Establishment’ (PE) in India and the income is attributable to
the PE.

Further, it is important to note that India has legislated a tax
on non-residents in the online space in the form of
‘equalisation levy’ (EL). EL is levied through the Finance
Act, 2016 and not the Income Tax Act, 1961 (IT Act), and as such,
it overrides the tax treaty provisions. Further, incomes chargeable
to EL are exempt from income-tax under the IT Act. Therefore, even
in case of non-resident businesses that are from non-treaty
jurisdictions and operating in online/digital space, SEP provisions
will not apply vis-à-vis incomes that are
chargeable to EL. Therefore, from a practical standpoint, SEP
provisions are unlikely to affect many non-resident businesses in
view of comprehensive tax-treaties entered by India with many
countries and the recently-introduced EL provisions.

That said, the relevance of SEP provisions should be seen in the
context of ongoing negotiations at the OECD-G20 Inclusive Framework
for arriving at a global consensus-based solution on taxing the
digital economy, which is expected to reach a conclusion around
mid-2021. When SEP provisions were introduced for the first time in
2018, the Government had stated that inclusion of SEP in
India’s domestic law would enable India to negotiate for
inclusion of SEP in its tax treaties. With EL provisions already in
place and SEP thresholds now notified, the Government may perhaps
be further equipped at the negotiation table for a consensus-based
solution to tax income from the digital economy.

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views/position of Khaitan & Co but remain solely those of the
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