By Ritu Shaktawat, Partner & Sneh Shah, Principal Associate, Khaitan & Co, Mumbai, India
The Indian government on 3 May announced the revenue and user-linked thresholds for a non-resident to be considered as having a taxable presence in India under new “significant economic presence” rules that became effective on 1 April.
Under the significant economic presence rules, non-residents undertaking certain transactions or activities with persons in India, which fulfill the prescribed revenue or user-linked thresholds, will be deemed to have a taxable presence in India based on economic nexus.
The concept of significant economic presence was first introduced under Indian tax law in 2018. Given the pending global consensus on the taxation of the digital economy, India deferred the applicability of significant economic presence provisions to 1 April 2021, but the thresholds had not yet previously been defined. These thresholds have finally been set for the significant economic presence provisions to now become operational.
Concept and scope of significant economic presence
The income of a non-resident is taxable in India if it is considered India-sourced, and there are sourcing rules that apply in this regard. Under these rules, business income earned by a non-resident is deemed as India-sourced only if such income arises through or from any “business connection” in India (a concept akin to “permanent establishment” under tax treaties but without a precise definition and, hence, wider in scope).
Like “permanent establishment” based taxable nexus under tax treaties, the provisions relating to “business connection,” prior to the introduction of significant economic presence, deemed certain forms of physical presence in India as taxable presence or nexus. Therefore, these rules suited the traditional business models requiring physical presence in the source jurisdiction.
Regarding services provided by a non-resident not having a business connection or taxable presence in India, fees from technical, managerial, or consultancy services provided to an Indian resident (non-resident in certain cases) are deemed as India-sourced and brought to tax on a gross basis, and income from other services is not taxable if not attributable to a “business connection” in India.
Source rules widened by significant economic presence
The significant economic presence provisions seek to widen the ambit of the source rules by deeming transactions in goods and services having economic nexus with India as a “business connection” in India. Under these provisions, a non-resident may be considered to have a significant economic presence in India in two situations.
The first situation is where a non-resident carries out transactions in respect of any goods, services or property (including the provision of download of data or software in India), with any person in India, and the aggregate payments arising from such transactions exceeds the prescribed threshold. This threshold has now been defined as INR 20 million (approximately USD 273,000) in the relevant year.
The second situation is where a non-resident undertakes a systematic and continuous soliciting of business activities or engages in interaction with a prescribed number of users in India. This threshold has now been defined as 300,000 users in the relevant year.
Further, the provisions state that these transactions or activities shall constitute a significant economic presence in India irrespective of whether the transaction agreement is entered in India, the non-resident has a place of residence or business in India, or the services are rendered in India.
As regards the attribution of income to a significant economic presence in India, income from advertisements targeted at, the sale of data collected from, and the sale of goods or services using data collected from, an Indian resident or a person using an internet protocol address located in India shall be included.
Tax treaty versus domestic law
Indian tax law gives precedence to tax treaties and recognises that in the case of non-residents, the applicable tax treaty shall prevail where it is more beneficial than the domestic law. Therefore, in the case of non-residents from jurisdictions with which India has a tax treaty, the provisions relating to “business connection” shall be overridden by those of “permanent establishment” under the treaty – which are narrower in scope and do not consider economic presence as a taxable nexus.
Given that India has an extensive tax treaty network with over 85 countries, the significant economic presence provisions would primarily be relevant for those non-residents who are from non-treaty jurisdictions or where the non-resident is not eligible to claim the benefits of a tax treaty (such as in the case of certain tax transparent entities).
Impact assessment
The scope of the significant economic presence provisions is all encompassing in nature, and the prescribed thresholds are at the lower end and could be met by smaller businesses or those undertaking fewer transactions with Indian customers. Further, the term “systematic and continuous solicitation” lacks a precise definition and could lead to ambiguity and interpretational issues, not only with respect to what it could entail but also with respect to how much income could be considered as attributable thereto.
Income of a non-resident having a significant economic presence in India will be taxable in India at 40% for a company, 30% for others, plus applicable surcharge and cess, on the income or profits attributable to the transactions and activities which constitute a significant economic presence.
Also, Indian tax law requires persons making payments to non-residents to withhold applicable taxes and satisfy related compliance requirements. In the case of a shortfall or non-compliance, applicable taxes can be recovered from the payer along with interest and penalties. Therefore, to be able to confirm whether the non-resident has a significant economic presence in India and consequent withholding tax obligation for the payer, the persons transacting with the non-residents would need to collect enough information to be able to make a determination in this regard.
In conclusion
With the global consensus on the taxation of the digital economy long pending, India has been quick to introduce unilateral amendments to its domestic law, so as to ensure that the new-age virtual business models are within the Indian tax net.
The equalisation levy on online advertisements introduced in 2016 and the levy’s expansion to e-commerce transactions in 2020 are the other steps which India has taken in this direction. Notably, the equalisation levy provisions were introduced as a separate fiscal legislation, and not as part of the Indian income tax law. This essentially means that the precedence given to tax treaties in the income-tax law does not extend to domestic equalization levy provisions. Also, how the significant economic presence provisions interact and interplay with equalisation levy provisions needs to be examined on a case-to-case basis.
From a tax revenue perspective, with the rapid digitalization of the world economy and virtual expansion of new business models being further accelerated by the ongoing pandemic, the timing of introducing such measures may be ripe. However, from a taxpayer’s perspective, while the applicability of the significant economic presence provisions may currently be limited, it is necessary to analyse the position both from the perspective of the non-resident’s Indian tax obligations and payer’s withholding tax obligations. Generally, where non-residents are taxable under domestic law but rely on favourable tax treaty positions, they are required to file tax returns in India to claim the tax treaty benefits. Therefore, even if no tax is payable in India, the compliance burden may substantially increase.
It will be interesting to see how the global framework for the taxation of the digital economy shapes up and if and how Indian law further evolves in response.
The views of the author(s) in this article are personal and do not constitute legal / professional advice of Khaitan & Co. For any further queries or follow up please contact us at [email protected].
-
Ritu Shaktawat is a partner at Khaitan & Co, Mumbai, India.
-
Sneh Shah is a principal associate at Khaitan & Co, Mumbai, India.
Be the first to comment