DIGITAL TRANSACTIONS – A ‘TAXING’ MAZE of SEP, EQL and SPECIAL INCOME
Abut By Author
Shravan Suratwala
Chartered Accountant, B.Com., Dip. IFRS (ACCA UK)
Brief profile:Shravan has six plus years of post-qualification professional experience in advisory, litigation and compliance areas of Corporate and International taxation. He has also worked three plus years in the field of Internal and Process Audit during his internship. Shravan has worked with multinational and reputed firms like Deloitte, SKP and Kirtane&Pandit across levels and also was a part of Direct Tax Committee of The Institute of Chartered Accountants of India.
After 3 years of introducing the concept of ‘Significant Economic Presence’ (SEP) in the domestic tax laws, the Indian tax authorities have notified the thresholds for applicability of the SEP provisions.As per the notification 41/2021 dated 03 May 2021, the payment threshold in respect of any goods, services or property carried out by a non-resident in India, including the provision of download of data or software in India has been notified as INR 2 crores (USD 0.26 Mn). Further, for the activity of systematic and continuous soliciting of business activities or engaging in interaction, the threshold for number of users has been notified as 3 lakh users. At the outset, these thresholds seem to be low and therefore, many non-resident entities would fall within the ambit of SEP.
SEP provisions were introduced to expand the scope of ‘business connection’ under section 9(1)(i) of the Income Tax Act, 1961(ITA) for non-resident entities. The erstwhile scope of ‘business connection’ focused more on taxation based on physical presence of a business in India. However, with the advancement in information and technology, the tax authorities realized that foreign businesses were now operating remotely through digital medium and earning income from Indian customers/users. Therefore, the Indian tax authorities introduced the concept of SEP to tax such income of offshore non-resident entities which earn significant income from Indian customers/users. SEP provisions are triggered irrespective of the fact whether the agreement for transaction or activity has been entered in India or not, whether the non-resident has a place of business in India or not or whether the non-resident has rendered any services in India or not.
SEP provisions are applicable from 1 April 2022.However, it is important to note that the SEP provisions are unilateral amendments in the Indian domestic tax law (ITA). There have not been corresponding amendments under the tax treaties which provide for a narrower definition of business connection i.e. ‘Permanent Establishment’ (PE). Therefore, the position or benefit taken by non-resident entities considering the narrow definition in the tax treaties may not be impacted.
Equalization levy (EQL) provisions
Apart from SEP provisions, the Government of India had introduced EQL provisions in 2016 and 2020 in order to tax the income earned by non-resident entities via digital mode. In a summarized way, the provisions of EQL are applicable:
- On provision of services by a non-resident for online advertisement or services related to online advertisement[Levy Rate 6% ; threshold INR 1 lakh per financial year; EQL to be paid by Indian customers]
or
- To a non-resident, being an e-commerce operator, who owns, operates or manages digital or electronic facility or platform for online sale of goods or online provision of services or both.Here, online sale of goods or provision of services could include any service/sale of goods provided via internet or other form of digital communication if either the contract or the delivery is concluded online.[Levy rate 2% and threshold of INR 2 crores(USD 0.26 Mn) per financial year]
It is important to note that EQL is not a part of the ITA and therefore, benefit under tax treaties may not be available to the non-residents while determining tax implications under EQL provisions.
In case a transaction falls within the ambit of EQL, the same will be exempt from tax under the provisions of the ITA. Further, EQL shall not include consideration which is taxable as royalty or fees for technical services as per the ITA.Therefore, non-resident entities need to analyze the transactions under both, the ITA and EQL provisions, in order to determine final taxability under respective laws.
Taxability under other provisions of section 9(1) under ITA
SEP taxation falls within section 9(1)(i) of the ITA, which in essence, is taxation of income as ‘business income’chargeable to tax at the rate of 40% on net basis. Other limbs of Section 9(1) of the ITA deal with specific categories of incomes viz. fees for technical services, royalty, etc. (Special incomes). For these special incomes, the ITA and tax treaties usually provide for a special reduced tax rate on gross taxation basis.
There could be situation wherein certain services rendered by non-resident entities could fall within the ambit of SEP as well as other limbs of section 9(1) i.e. Fees for technical services, royalty, etc.Therefore, once SEP provisions come into effect, it will be pertinent to analyze that the services provided by the non-resident entities need to be taxed within which limb of section 9(1)i.e. under SEP provisions under section 9(1)(i) or under special income provisions.
For example, in a case where tax treaty is not available and a service is being taxed as fees for technical services until now, whether post 1 April 2022 the same will fall within the ambit of section 9(1)(i) and not section 9(1)(vii)? One may argue that specific provision should prevail over a general provision, however debate around this cannot be ruled out and each transaction may have to be evaluated on one to one basis.
Therefore, determining the specific section for taxability is crucial, as the mode and rate of taxation under these provisions differ.
Comments
There could be a transaction which falls within the provisions of SEP, EQL as well as other special incomes under section 9(1) of the ITA. All three provisions have different modes of taxation and therefore, determining the taxability in an optimum manner for digital transactions is going to be a taxing task for the non-resident entities as well as for the Indian customers for determining the withholding tax liability. In addition to this, once discussions by the OECD[1] members on ‘BEPS[2] Action Plan 1 – Addressing the Tax Challenges of the Digital Economy’are concluded and a consensus is reached, the tax treaties will have to be read with the corresponding multilateral instruments which could lead to further complicacy in determining the tax implications for a digital transaction in India.In the light of all this, detailed clarifications and FAQs from the Indian tax authorities under various scenarios are welcome which would assist the tax-payers in determining the correct liability under the India Tax laws.
[1] The Organization for Economic Co-operation and Development
[2] Base Erosion and Profit Shifting
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