By Mit Gaglani – Sr. Manager – TransPrice
The CBDT vide notification number 41 /2021/ F. No. 370142/11/2018-TPL issued on 3rd May, 2021 has announced the thresholds for the purposes of Significant Economic Presence (“SEP”) by inserting Rule 11UD in the Income-tax Rules, 1962. The revenue threshold is INR 2 crore and the user threshold is 3 lacs.
“The oak is the strongest tree in the forest, but the willow bends and adapts. When the fires and storms hit, it is the willow that survives.” ― Kara Barbieri
The above quote captures the importance of adaptation amazingly well. Businesses have evolved from their conventional location-based set-ups to highly digitized and tech-driven remote set ups. This has made the international tax legislators realise the need to fortify the international tax legislative framework to accommodate such newer business models owing to the fact that the conventional legislation still focusses on taxation based on physical presence (permanent establishment).
In late 2015, BEPS AP-1 was launched which addressed the tax challenges arising out of a digital economy for the first time. The plan suggested alternatives like SEP, Equalization Levy (“EL”) and Withholding Tax on digital transactions which could be adopted by countries without however violating their existing international obligations and commitments.
In line with the suggestions recommended by AP-1, India introduced the following measures in its domestic legislation:
- EL in 2016 covering online advertising transactions – Introduced in the Finance Act.
- SEP in 2018 widening the existing definition of business connection subject to thresholds – Introduced in the Income-tax Act (“the Act”).
- EL 2.0 in 2020 widening the scope of EL 1.0.
Although, SEP was introduced in 2018, the said provision remained non-operational in the absence of thresholds which have now been introduced vide the above captioned circular by the CBDT.
Further, since SEP has been introduced in the Act, a shelter to non-residents (“NRs”) having residency of countries with whom India has signed DTAAs would anyway be available as these DTAAs are still not renegotiated to cover SEP and as a general rule, DTAA overrides the provisions of the Act (subject to other provisions of Principle Purpose Test and Limitation of Benefit Test) to the extent beneficial to the taxpayer i.e. NRs in this case. Therefore, with respect to transactions with such NRs, the thresholds introduced shall have no relevance. These thresholds have relevance for transactions with NRs to whom treaty benefits are not available.
Further, even if a SEP gets triggered in India, only profits attributable to the SEP can be brought to tax in India and currently there is no mechanism prescribed for the same which can lead to ad-hoc profit attribution by the revenue department thereby giving rise to litigation.
Concluding remarks on Digital Tax (EL + SEP)
The importance of digital tax in today’s times cannot be undermined especially in a growing digital market like India. This was evidenced in FY 2017-18 and FY 2018-19 i.e., the FYs immediately following the introduction of EL when India collected approximately INR 590 crore and INR 939 crore in FY 2017-18 and FY 2018-19 respectively by way of EL. This makes one think about the humongous tax revenue which India was losing before the said levy was introduced in the legislation.
Further, interestingly, while SEP has been introduced in the Income-tax Act thereby providing a treaty set-off to NRs, EL has been introduced in the Finance Act for which no such treaty set off is available. Also, no foreign tax credit shall be allowed to NRs in their home jurisdiction for EL paid in India. Further, there could be an overlap between EL and the existing Indirect tax regime in India thereby leading to double taxation. For instance, while EL covers online facilitation of a purchase-sale transaction on a gross basis, on the same transaction customs duty is also applicable if the goods are imported in India. Another instance of double taxation could be with respect to Online Information Access and Database Retrieval services covered under the GST regime as well as under the ambit of EL. Lastly, the scope of EL (which currently is very wide) due to the way in which the term “E-Commerce operator” has been currently defined is in itself the most ambiguous.
As far as SEP is concerned, for now the thresholds have limited significance as discussed above, however, one can argue that the thresholds set are very low and thereby, even small players can be covered within the purview of SEP thereby causing an unnecessary compliance burden on them.
With so many questions and uncertainties revolving around EL and SEP and considering the fact that the OECD Pillar One Project is yet to achieve any consensus, it will be interesting to see how the digital tax regime progresses in India.