In 2016, India became the first country to impose a 6 percent equalization levy on digital advertising and related services, a provision later expanded in 2020 to include the sales of online goods and services. Simultaneously, provisions for Significant Economic Presence (SEP) were discussed and introduced in 2018 after amending domestic law, with the current SEP provisions effective from FY 2021-22. In this discussion, we explore SEP provisions, draw comparisons with the equalization levy, and discuss stakeholder concerns.
BEPS Action Plan 1 and Indian adoption of the 'significant economic presence' concept
India's digital market, currently valued at US$5,118 million, is expected to reach US$55,372 million by 2032. Concerned that existing international tax rules did not adequately cover non-brick-and-mortar business models, i.e., online commerce, the Indian government sought solutions from the Organisation for Economic Cooperation and Development (OECD) under the Base Erosion and Profit Shifting (BEPS) Action Plan 1. The OECD proposed three interim options: SEP, withholding tax on digital transactions, and equalization levy.Following this, India’s tax body, the Central Board of Direct Taxes (CBDT), established a committee on the taxation of e-commerce to evaluate these options. The committee recommended the equalization levy as the most viable option, avoiding modifications to existing tax treaties, and suggested the possibility of introducing SEP within the concept of "business connection." Subsequently, the SEP provisions were introduced in 2018 but remained inactive until the thresholds for implementation were prescribed. The current provisions, effective from fiscal years 2021-2023, deem non-residents with SEP in India to have a business connection, subjecting their income to Indian taxation.
Read: Equalization Levy Compliance Framework for Non-Resident E-Commerce Operators in India
Understanding the conditions for triggering a significant economic presence
According to BEPS norms, a non-resident enterprise establishes a taxable presence in a country through SEP if it has purposeful and sustained interactions with the economy aided by technology and other automated tools.The Indian tax administration, on May 3, 2021, issued a notification prescribing revenue and user thresholds for applying the new nexus rule. Conditions include aggregate payments exceeding INR 20 million (US$239,839) in a financial year or non-residents engaging systematically and continuously with 300,000 or more users (Indian users) (US$1=INR 83.39).
SEP provisions apply regardless of where agreements were entered or whether the non-resident has a residence or business place in India or renders services in India. These provisions explicitly include sources of income attributable to operations in India: (a) advertisements targeting customers residing in India or accessing advertisements through an Indian internet protocol (IP) address; (b) the sale of data collected from individuals in India or utilizing an IP address in India; and (c) the sale of goods or services utilizing data collected from individuals in India or using an IP address located in India.
These revenue and user thresholds became effective from April 1, 2021 – aligned with the implementation date of SEP provisions.
Equalization levy vs. SEP
Both equalization levy and SEP coexist in the Indian tax jurisdiction, leading to potential overlaps. A provision has been added to clarify that if a transaction is subject to equalization levy, no further Indian tax liability would be imposed. Non-residents are advised to check equalization levy applicability first, as it renders transactions outside the SEP purview.Domestic tax law vs. treaty protection
SEP has been introduced under Indian domestic tax law. Tax treaties, however, stipulate that the profitable income of non-residents is taxable only if they have a permanent establishment (PE) in India. Non-residents enabled by permanent establishment to claim treaty benefits need not concern themselves with SEP provisions.
SEP provisions are imposed on taxpayers based in jurisdictions without a tax treaty with India. They also apply in treaty cases where benefits are unavailable due to disqualification as a "resident" or a "person," or due to anti-avoidance provisions under domestic law or Principal Purpose Test under the treaty.
Concerns regarding SEP provision
A major concern is determining the number of users, considering they could be both residents and non-residents. The current SEP has a low threshold compared to the volume of transactions in India's large economy. Originally intended for digital businesses, the provisions have expanded to include non-digital transactions, causing ambiguity due to undefined terms like "continuous" or "systematic." Stakeholders are advised to monitor their digital transactions for SEP triggers and take proactive tax-related actions.Upon the activation of taxation in India, the payer must withhold the applicable tax, and the nonresident is mandated to file a tax return. Failure to comply with withholding obligations may result in disallowance of deductions and imposition of interest and penalties on the Indian payer. Additionally, there is a risk of the Indian payer being considered a representative assessee of the nonresident. In the absence of guidance on income attribution principles for SEP, the payer may need to coordinate with tax authorities to determine the accurate taxable amount for withholding compliance.
Until the OECD reaches a consensus on a new tax regime for the digital economy, India’s domestic tax laws may undergo periodic changes, requiring global stakeholders to adapt accordingly.
