By Meyyappan Nagappan & Anandapadmanabhan Unnikrishnan, Nishith Desai Associates
The Indian government on 13 July invited public feedback to aid in the development of its newly adopted “significant economic presence” test, a nexus rule designed to expand India’s taxation rights of over business profits of both digital and non-digital multinational firms.
India has been at the forefront of recent dialogue on taxation of the digital economy, both through its participation in the OECD/G20 base erosion profit shifting (BEPS) plan project, as well as through unilateral amendments to its domestic law.
It was among the first countries to introduce an equalization levy on cross-border digital advertising and followed that up by imposing GST on a plethora of cross-border online services imported into India.
Significant economic presence test
Subsequently, through the 2018 Union Budget, the government amended the domestic permanent establishment threshold, called “business connection” in India, to clarify that the significant economic presence of a non-resident in India would constitute a business connection in India.
While business profits will continue to be taxed in India in accordance with existing tax treaties until a significant economic presence test is introduced in treaties, the introduction of this test through domestic law is the first step toward making changes to India’s tax treaty framework. For now, businesses operating from non-treaty jurisdictions would be the ones likely to be affected by this new test for nexus.
Significant economic presence under the 2018 Union Budget changes means a:
- transaction in respect of any goods, services or property carried out by a non-resident in India including provision of download of data or software in India, if the aggregate of payments arising from such transaction or transactions during the previous year exceeds such amount as may be prescribed; or
- systematic and continuous soliciting of business activities or engaging in interaction with such number of users as may be prescribed, in India through digital means.
At the time of its introduction, the government had clarified that thresholds for the specified value and number of users would be determined in consultation with the stakeholders and not unilaterally, which is a welcome move considering the equalization levy was introduced directly in the Finance Act, 2016 without much discussion.
In furtherance of this intention, it its latest announcement, the government has invited suggestions and comments from stakeholders and the public on the appropriate revenue thresholds.
Specifically, the government asks what the thresholds should be for transactions in respect of physical goods or services carried out by a non-resident in India and for digital goods or services or property, including the provision of download of data or software carried out by a non-resident in India.
Moreover, the government asks for feedback on the threshold for number of ‘users’ with whom a non-resident engages in interaction or carries out systematic and continuous soliciting of business activities in India through digital means.
Broad scope
While the original intent for introducing a new nexus rule was to target digital services and the provision of digital goods, this intention seems to have gone missing in its implementation.
This is because, internationally, significant economic presence has been consistently distinguished from “significant digital presence,” namely, the latter deals only with fully digitalized services while the former is considered to be wide enough to include both digital and non-digital supplies of goods and services.
In adopting the significant economic presence approach, no clarification has been made to exclude activities falling within the significant economic presence test from the traditional PE tests under India’s tax treaties, which would be required for consistency and clarity and in the absence of which multiple thresholds for the creation of economic nexus for the same activity would exist and lead to litigation.
Moreover, neither the original 2018 Budget proposal nor the 13 July notification makes any reference to a time-period over which continuous and systematic engagement is to carry on with users in India, which is considered a significant criterion internationally for the creation of a significant economic presence.
For instance, international experts and academics are still debating whether it should be a monthly or yearly threshold for business activity to constitute systematic engagement.
Future notifications as to who would constitute a “user” would also be relevant, as the significant economic presence test could be limited to paid consumers or also encompass free users or residents in India (including those travelling or domiciled in India at the point in time the service was used), which is also a crucial criterion for creating a significant economic presence.
India’s tax treaty framework
While the government has fairly conceded that business profits will continue to be taxed in accordance with existing treaty rules until corresponding nexus rules are introduced in treaties, it is clear that the introduction of the significant economic presence test through domestic law is the first step towards making changes in India’s treaty framework.
While the government may have been confident of significant economic presence being incorporated through a multilateral instrument, global headwinds appear to have changed since, with the European Union increasingly calling for unilateral measures such as its own equalisation levy or even considering its own version of the global intangible low-taxed income as a possible alternative.
Should the EU proceed with such a unilateral move, the likelihood of implementing significant economic presence in India would become highly questionable as the prospect of the test being globally adopted would diminish.
In fact, it is likely that countries will expand unilateral measures such as the equalisation levy and formalize it as a proper regime for taxing digital income.
Attribution rules
More generally, without a change in attribution rules globally, the creation of a significant economic presence should not necessarily result in the attribution of significant income to India.
Keeping the above in mind, it is advisable that the government postpones the implementation of the significant economic presence thresholds till such time clarity is attained for otherwise, non-digital businesses operating from non-treaty jurisdictions would be the ones likely to be affected by the significant economic presence.
It also remains to be seen whether the government will introduce specific rules for assessment and attribution of income from transactions or activities resulting in the creation of a significant economic presence.
–-Anandapadmanabhan Unnikrishnan, Member, International Tax Practice, Nishith Desai Associates.
–Meyyappan Nagappan, Leader, Taxation of the Digital Economy, Nishith Desai Associates.
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