/ Significant Economic Presence – Understanding the Implications- Indian Tax Laws
The principles of “nexus” and “profit allocation” have long served as the foundational pillars of the global taxation landscape. However, the rapid digitalization of the world is continuously challenging the efficacy of these foundational pillars with businesses increasingly switching to efficient operational models that no longer require their physical presence in the target markets. This shift has facilitated tax avoidance as foreign companies have been seen shifting profits to low-tax jurisdictions, a key focus of the OECD’s Base Erosion and Profit Shifting (BEPS) project. To combat this, the BEPS Action Plan was introduced, consisting of 15 actions to address tax avoidance and ensure proper taxation of profits based on economic activities and value creation, regardless of physical presence.
Action Plan 1 specifically tackles the tax challenges posed by the digital economy, and India has been proactive in incorporating its proposals into its tax laws. The concept of “Significant Economic Presence” (SEP) from Action Plan 1 has been adopted by India through the Finance Act of 2018. It has broadened the concept of “Business Connection” present in its income tax law which happens to be a concept like “Permanent Establishment” (PE) enshrined in tax treaties albeit a wider one in its coverage.
The Concept of SEP
SEP is based on the principle that taxation should be based on significant involvement in the market and economy and not only on the physical presence based on the concept of PE. As per the current legislation, a non-resident (NR) will form SEP in India if:
it engages in any transaction involving goods, services, or property with any person in India, including the download of data or software, and the total payments arising from such transaction or transactions in the previous year exceed INR 20 million within the financial year. (Limb 1)
or
it engages in a systematic and continuous soliciting of business activities or engages in interaction with 0.3 million users within the financial year. (Limb 2)
The implications
The idea behind the SEP provision is to ensure that no one deriving gains out of a country evades taxation and that all market players are captured uniformly thus leading to a more equitable taxation framework. Though this evasion usually happens in the space of the digital economy, the current implementation of SEP appears to have a broad scope. It encompasses all transactions involving goods, services, or property carried out by non-residents with any person in India irrespective of how it is conducted (online or offline). SEP in its current form includes even the basic transaction such as the export of goods to India by an NR done all while being outside the country. Moreover, the existing framework also lacks consideration for the “regularity of activities”, meaning that even an isolated transaction surpassing the prescribed thresholds can trigger the application of the SEP provision. The challenges also lie regarding the interpretation of the phrase “systematic and continuous” to be found in the second limb (Limb 2).
With these issues apparent, non-residents are likely to fall under the current SEP provision due to the minimum thresholds in place. To exemplify, if an NR exporter of goods exports to India items having a transaction value of more than INR 20 million in a financial year he will form an SEP in India and will be subjected to compliance requirements. Once the provision is triggered, non-residents must maintain of books of accounts, undergo audits, pay taxes, and file returns in India all limited to their India operations. However, it is worth noting that the benefits available under tax treaties remain intact.
SEP and Tax Treaty
A respite from the attraction of SEP provisions comes to those NRs who are residents of countries with which India is having a tax treaty. SEP is a concept local to Indian tax laws. The local law also provides that for non-residents it is the most beneficial provisions of either the Indian tax law or the tax treaty that ultimately prevails. The tax treaties do not contain the concept of SEP and work with the concept of PE which is narrower in its scope. As long as NRs are able to demonstrate them not having any PE situated in India, they will continue to remain out of the ambit of SEP provisions. However, this will again be subject to NR furnishing the prescribed documentation which includes a tax residency certificate, no PE declaration and Form 10F in some cases.
However, the brunt of the SEP provisions will continue to be felt by those NRs who come from countries which are not having any tax treaty with India. Tax positions for such entities having India related transactions require careful consideration going ahead.
Conclusion
The concept of SEP marks a significant shift in the Indian taxation landscape as it tries to align it with the realities of the digital economy. By capturing the economic value generated by foreign businesses operating in India, SEP tries to ensure equitable taxation and lays a level playing field. However, it is the implementation of SEP that raises apprehensions due to its wide-ranging scope. The concerns intensify considering the ambiguities in interpretation and the absence of a global consensus regarding the SEP thresholds. A reconsideration of the existing SEP framework would always be welcome but for now, it is for the NRs to navigate the complexities surrounding the current regime and comply with the regulations.
Seeking an expert’s guidance regarding the assessment of tax position will always be of great help.
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