It is hoped that Budget 2019 will lend better insight to dispel taxpayer’s worries
The concept of Significant Economic Presence (SEP) was introduced in India by the Finance Act 2018, as an extension of the concept of business connection (and hence a taxable presence) of a non-resident in India. The Honourable Finance Minister has strongly supported SEP as a solution to tax digital companies at the recent G20 summit held in Japan.
However, the present SEP provisions lack clarity. It has been more than a year since the SEP provisions were introduced and the notification of thresholds to operationalise SEP provisions have not been released. In April 2019, the CBDT released a draft Profit Attribution report for public comments, which inter alia covers the scenarios of profit attribution once nexus is created (including through SEP) seeking to introduce demand side factors and user based factors in addition to supply side factors for profit attribution.
It is hoped that the Budget 2019 will lend better insight to dispel the taxpayer’s worries on certain issues relating to SEP as discussed below:
1) An overarching issue lies in the conflict between the manner in which the SEP provision is broadly worded, i.e. covering any transaction with respect to goods, services or property carried out by a non-resident in India (which may even cover transactions in the brick and mortar economy), vis-à-vis the intent expressed in the Explanatory Memorandum to Finance Bill 2018, to tax only digital companies with economic presence in India. It goes without saying that it is desirable that a broad expression viz. ‘carried out by a non-resident in India’ may be elaborated to avoid ambiguity and litigation on the potential scenarios that may fall within the tax net.
2) The meaning to be assigned to expressions used in the second limb of activities that could constitute SEP viz. ‘systematic and continuous soliciting of business in India or engaging in interaction with users through digital means’ needs to be clarified. Doubts arise as to whether advertising amounts to solicitation or is it a more persuasive method of communication directed to a specific target. Do one-way communications in the form of e-mails, push notifications on the internet etc. amount to interaction with the user or is it a two way communication process that needs a user response?
3) A careful reading of the provision also reveals an internal contradiction - on one hand the provision seeks to tax a non-resident only on rendition of services in India and on the other, the proviso dispenses with this requirement.
4) Income from transfer of all or any rights relating to computer software has always been controversial. To compound miseries, now SEP covers download of software by a non-resident in India whereas the amended definition of royalties also covers income arising from transfer of all or any rights relating to computer software. This interplay between the provisions may lead to confusion.
5) It is sincerely hoped that the threshold to operationalise SEP provisions will not be a one-size-fits-all formula. Differing user thresholds may be considered taking into account different digital business models and level of engagement with users. It is hoped that the thresholds when notified would be sufficiently high so as not to unnecessarily impose compliance and tax burden on low value transactions and to be true to the name Significant Economic Presence. Drawing a clue from its origin, BEPS Action Plan 1, a user threshold with a weightage assigned to revenue earned from users would be a better measure for SEP than a plain user threshold.
It is interesting to note that the first set of transactions that are attempted to be covered under SEP, namely sale of goods, services, property carried out digitally by non-residents including download of data or software could be said to have a comparison to Online Information Database Access and Retrieval (OIDAR) services introduced under service tax law during late 2016.
Effective from December 1, 2016, by virtue of amendment in place of provision of OIDAR services, the non-resident OIDAR service providers were made liable to pay service tax either themselves or through intermediaries. This was a major shift in the taxation of digital supplies aligning the tax provisions to OECD guidelines (VAT on cross-border digital supplies) to curb tax evasions. In GST regime (implemented in July 2017), the provisions on taxability remained same.
Also the purview was extensive to cover a huge gamut of automated services that were delivered over the Internet, such as supply of software digitally, e-learning trainings, advertising over internet, digital data storage and online gaming.
The above has mandated the non-resident OIDAR service providers making B2C supplies to register in India and undertake compliances under GST.
Upon implementation of SEP, there would already be a record available with Indian indirect tax authorities that could be used for identification of the non-resident vendors to whom SEP could apply and also for screening their fulfillment of prescribed parameters as per SEP, which would otherwise be an impossible task with respect to entities located on the other side of the border. Thus there could be possible enabling provisions under both the laws for specific exchange of database and analytics.
The second limb of SEP includes transactions that establish business connection of a non-resident through soliciting of business or engaging in interactions with users through digital means. There appears no clarity whether such soliciting of business is on own account by the non-resident or on behalf of any other entity. There have been plethora of judicial precedents that have evolved recently in GST regime which deal with taxability of intermediary who facilitates supply of goods or services. SEP presently does not spell this thin line of distinction, which could also have far reaching implications in terms of how the businesses are viewed, as being taxable under GST. Hence businesses may have to evaluate overall implications under SEP as well as GST before entering into Indian markets.
Although digital businesses are cognizant of the impact of introduction of SEP, concerns on this account have not compounded owing to the fact that India’s tax treaties have not yet been amended to incorporate the concept of SEP. Thus, favourable treaty provisions continue to apply to eligible taxpayers. Further, as a recent development, India has deposited its instrument of ratification of MLI with OECD. Inability of a taxpayer to prove that the principal purpose is not to obtain a tax benefit may lead to loss of treaty benefit in which case SEP provisions become relevant. Surely, this will not be relevant say, in case of large US digital firms with a prominent Indian user base as US is not a signatory to MLI.
Clarifications in respect of SEP assume even more significance in light of the fact that even if SEP may not apply if a beneficial treaty provision is applicable, if the transaction is taxable as per SEP provisions in the domestic tax law, tax return may have to be filed failing which stringent penal and prosecution consequences may apply due to relatively recent changes in the law.
It remains to be seen when clarity will be provided - in the upcoming Budget or a separate Circular or under the new Direct Taxes Code?
If SEP is only an interim measure adopted by India and India proposes to align itself to the OECD approach, as a multilateral approach is always better than a fragmented one, the final contours of this new form of taxable presence i.e. SEP will be known once the final OECD Report is launched in 2020.
Tapati Ghose and Amit Sarker are Partners with Deloitte Haskins and Sells LLP