As you are aware, the genesis of Significant Economic Presence (SEP) was provided by the Organisation for Economic Co-operation and Development (OECD) in the Base Erosion and Profit Shifting Action (BEPS) Action 1: 2015 Final Report. In the Indian context, the scope of the term 'business connection' as provided in S. 9(1)(i) of IT Act was expanded vide Finance Act, 2018 to include the concept of SEP. The SEP provisions are effective from Financial Year (FY) 2021-22.
As per Explanation 2A to S.9(1)(i) of IT Act, SEP of a Non-Resident (NR) in India shall constitute "business connection" in India and "SEP" for this purpose, shall mean—
- transaction in respect of any goods, services or property carried out by NR with any person in India, including provision of download of data/ software in India, if aggregate of payments arising from such 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 in India, as may be prescribed.
Further, CBDT through Notification no. 41 dated May 3, 2021, introduced Rule 11UD of Income-tax rules, 1962 (IT Rules) to prescribe thresholds in relation to above transactions / activities for determining SEP.
Based on feedback received from the industry, we have made a submission to Ministry of Finance highlight the following issues which require clarification for smooth implementation of SEP provisions:
Introduction of rules for attribution of profits/ income in respect of SEP
As per Rule 11UD of IT rules, transactions in respect of any goods, services or property carried out by a NR with any person in India including provision of download of data or software in India shall constitute SEP if the aggregate of payments from such transactions during the previous year exceeds INR 2 crores.
Once the threshold for SEP is triggered, so much of income as is attributable to the transactions/activities referred to in Explanation 2A to S.9(1)(i) of IT Act will be taxable in India.
However, determining income attributable to SEP is a complex and highly subjective exercise and there is no clarity regarding the methodology to be followed for computation of profit attributable to business connection of NR in India on account of SEP. It is important to note that diverse methodologies have been followed by tax officers for determining income attributable to Permanent establishment (PE), thereby leading to uncertainty for the taxpayers.
With a view to bringing in clarity and certainty in relation to attribution of profit, the CBDT formed a committee to examine the existing scheme of profit attribution to PE and recommend changes in domestic tax laws. The Report of the Committee was released in April 2019 for public consultation which highlights different approaches to profit attribution. However, there has been no further development on this front yet. As a result, rules have not been finalised for attribution of income to transactions or activities specified in Explanation 2A to S.9(1)(i) of the IT Act, even though these provisions are applicable from FY 2021-22. This creates uncertainty for NR taxpayers to estimate income taxable in India. In the absence of specific guidance, it will be difficult to determine profits attributable to the transactions and activities referred to in Explanation 2A to S.9(1)(i), thereby resulting in increased litigation.
Suggestion – We have requested the Government to introduce rules for attribution of profits/ income in respect of SEP. This will provide certainty to NR taxpayers and help in avoiding litigation on interpretational issues, thereby providing ease of compliance for the industry.
Treatment under SEP, where payment qualifies as royalty or Fees for Technical Services under IT Act and also as business income on account of SEP
There may be instances where a payment qualifies both as:
- Royalty or Fee for Technical Services (FTS) under S. 9(1)(vi)/ 9(1)(vii) of IT Act; and
- Business income under S.9(1)(i) of IT Act due to business connection in India on account of SEP.
It is a well settled principle under law that specific provision overrides the general provision of law. Accordingly, since S.9(1)(i) (dealing with 'business connection') is generic in nature as against S. 9(1)(vi)/ 9(1)(vii) dealing with royalty/ FTS which are more specific in nature, payments which qualifies both as royalty/ FTS as well as business income on account of SEP should be taxed as royalty or FTS [i.e., under S. 9(1)(vi)/ 9(1)(vii)].
Further, there could be instances where a payment is categorised as royalty/ FTS, but is not taxable due to a specific exclusion under clause (b) of S. 9(1)(vi)/ 9(1)(vii) (i.e., where the resident payer utilises the services for the purpose of business carried on outside India/ making or earning any income from any source outside India) or by virtue of taxpayer claiming beneficial tax treatment under the double taxation avoidance agreement. Based on feedback from the Industry, there is lack of clarity that non- taxability of such payments under royalty/ FTS provisions by virtue of an exclusion will not result in taxability under SEP provisions. Specific clarification on this aspect will provide certainty to NR taxpayers.
Suggestion – We have requested the Government to:
- Exclude payments which qualify as royalty/ FTS under the IT Act, whether taxable or not due to an exemption in the IT Act or tax treaty benefit, from the ambit of SEP provisions. For example, if any payment is classified as royalty/ FTS, the same should be kept out of the ambit of SEP provisions.
- Clarify that such payments which qualify as royalty/ FTS under IT Act, whether taxable or not, should not be considered while computing the threshold limit for applicability of SEP provisions.
Treatment under SEP, where the transaction qualifies as an online sale which is liable for Equalisation Levy
Income arising from e-commerce supply of goods or services (other than royalty or FTS) which is chargeable to Equalisation Levy (EL), is exempt from tax under S.10(50) of IT Act. Accordingly, if EL is chargeable on online sale of goods/provision of services by NR to any person in India, such income is exempt under IT Act, even if such sales of goods/ provision of services results in creation of SEP for NR in India under clause (a) of Explanation 2A to S.9(1)(i) of IT Act read with Rule 11UD of IT Rules.
However, based on feedback from the Industry, there is a lack of clarity on whether such sale of goods/provision of services would be considered for computing the threshold limit of INR 2 crores for SEP as prescribed under Rule 11UD of IT Rules. This will result in litigation for the taxpayers.
Suggestion – Government should specifically clarify that payments which are liable to tax under EL provisions will not be considered while computing the threshold limit for applicability of SEP provisions.
Provide guidance on definition of the term ‘users’
As per Explanation 2A(b) to S.9(1)(i) of IT Act read with Rule 11UD of IT Rules, SEP would be constituted in India on account of systematic and continuous soliciting of business activities or engaging in interaction with three lakhs of more users. The term 'users' is not defined under IT Act or rules thereunder. On a plain reading, the said term can have a wide interpretation and could cover existing users, new users, active users, inactive/ dormant users, etc.).
Suggestion – Government should provide guidance to interpret the term ‘users’ in order to analyse the applicability of SEP provisions. The guidance could cover, inter alia, the following aspects:
- Clarity in case of repeated use by a single user, multiple accounts by single user, active and passive users, fake accounts etc.
- Tourists should be excluded while calculating the 3 lakhs threshold for “users in India”.
- Annual average of daily/monthly active users should be considered for calculating the 3 lakhs threshold
Amend S.195 to provide for TDS rate of 0.1% in cases where income is considered as business income of NR on account of SEP in India
Where NR seller resides in a country with which India does not have a tax treaty or where the NR seller is ineligible to claim benefit of tax treaty, the income from supply of goods which falls within the purview of SEP provisions is taxed @ 43.68%.5 The payer is required to undertake Tax Deduction at Source (TDS) on such transaction @ 43.68% under S.195.
In this regard, it is important to note that S.194Q of IT Act prescribes TDS rate of 0.1% in case payment is made to residents for purchase of goods. There is a huge difference in the TDS rate applicable on payment made to residents vs non-residents for supply of goods.
Suggestion – Government should amend provisions of S. 195 to provide for TDS rate of 0.1% where business income of NR from supply of goods is taxable in India on account of SEP. This will align TDS rate applicable to NRs with that of residents.
We hope you will find the update useful. We will keep you posted on further developments in this regard.
