The concept of "Significant Economic Presence" (SEP) was introduced into Indian Tax Law in 2018 to increase the income of foreigners engaged in online / digital space (e.g. e-commerce, online streaming, etc.) . ) as part of the income from India. However, the concept of the SEP remained inapplicable as the threshold values for the formation of the SEP were not prescribed. In a notice dated May 3, 2021 (Notice), the Government of India (Government) set the appropriate thresholds for non-residents to form a SEP in India, which will come into effect on April 1, 2022.
Non-residents with SEP in India would be considered a "business relationship" in India and the income attributable to the SEP would now be taxable in India (except where a tax treaty is applicable). A non-resident is considered to have a SEP in India in any of the following situations:
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Transactions in relation to goods, services or property are carried out by a non-resident with a person in India (including the provision of downloading data or software in India) when the sum of the payments resulting from such transactions exceeds the prescribed amount ( given below); or |
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Systematic and continuous promotion of business activity or interaction with such number of users in India as required (see below). |
Through the notice, the government set the threshold at INR 20 million in the case of (a) above and 300,000 users in the case of (b) above.
In particular, the Income Tax Act has recently been amended to provide that the income attributable to the SEP is income from –
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Advertising to an India based customer or a customer accessing the advertisements through an Indian IP address; |
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Selling data collected from individuals resident in India or from individuals using an Indian IP address; and |
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Selling goods or services using data collected from individuals resident in India or from individuals using an Indian IP address. |
Analysis of the SEP and the prescribed thresholds
The broad language of the SEP provision seems to go beyond the stated goal of taxing digitized companies and can also bring non-digitized companies into their area of responsibility. For example, it is unclear whether the sale of physical goods outside of India by a non-resident to a resident would fall within the scope of SEP. In addition, the term "systematic and continuous" is ambiguous and its interpretation could be a magnet for tax disputes. Furthermore, the mandatory thresholds for the formation of SEPs appear to be on the lower side, especially for the threshold for payments, which is set at INR 20 million. Finally, the mechanism of income allocation for non-residents who constitute a “business relationship” (including through SEP) remains unclear and it is hoped that the government will provide guidance on this in order to provide security for foreign companies.
Relevance of SEP
Although the thresholds for the formation of SEPs have been communicated, it should be noted that SEPs do not apply to non-resident / foreign companies that are eligible for the benefits of a tax treaty with India. This is because if a tax treaty is applied, the income of foreign companies in India is only taxable if it has a “permanent establishment” (PE) in India and the income is attributable to the PE.
It should also be noted that India has imposed a tax on non-residents in the online area in the form of a "countervailing charge" (EL). EL is imposed by the Finance Act of 2016 rather than the Income Tax Act of 1961 (IT Act) and as such overrides the provisions of the Tax Agreement. In addition, income billed to EL is exempt from income tax under the IT Act. Therefore, the SEP provisions also apply to non-resident businesses that are from non-contractual jurisdictions and operate in the online / digital space, not for income billed to EL. So from a practical point of view, SEP regulations are unlikely to affect many non-resident companies given the inconsistent tax treaties India has with many countries and the recently introduced EL regulations.
However, the relevance of the SEP provisions should be seen in the context of the ongoing negotiations on the OECD-G20 inclusive framework in order to arrive at a global consensus-based solution for taxing the digital economy, which is expected to be concluded in mid-2021. When the SEP regulations were first introduced in 2018, the government had stated that the inclusion of SEP in Indian domestic law would allow India to negotiate the inclusion of SEP in its tax treaties. With EL regulations already in place and SEP thresholds now communicated, the government at the negotiating table could possibly be further equipped for a consensus-based solution for tax revenues from the digital economy.
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