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.

The content of this document do not necessarily reflect the

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

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