The Indian Tax Administration,1 on 3 May 2021, issued a notification2 prescribing revenue and user thresholds for the application of a new nexus rule for nonresidents in the form of “significant economic presence” (SEP) which was introduced under the Indian Tax Laws (ITL) in 2018.
The notification prescribes a revenue threshold of INR20 million (US$280,000) for sales to Indian persons or a user threshold of 300,000 (Indian users). If a nonresident exceeds either of these thresholds, the SEP rules will apply, resulting in taxation of the nonresident in India.
This Alert summarizes the development and implications for nonresident taxpayers.
The global technology revolution has changed the business landscape whereby entities can carry out businesses in any location without a physical presence. Recognizing the need to update the tax rules for the changes in the technology landscape, the taxation of the digital economy has become a key base erosion and profit shifting (BEPS) concern across the globe and a multilateral coherent solution is being discussed as part of the OECD’s3 and G20’s4 BEPS project.
Pursuant to BEPS discussions, India expanded the concept of “business connection” for taxability under the ITL to include a new nexus rule based on SEP in 2018.
Under the SEP provisions, a “business connection” will be created in India based on either of the following conditions:
SEP will be determined independent of whether:
Further, once the nonresident triggers SEP in India, only so much of the income attributable to the transactions or activities referred to in condition 1) or 2) above will be taxable in India. Additionally, income attributable to transactions and activities referred to in condition 1) or 2) above will also cover income from all of the following:
While the SEP provisions were originally intended to become applicable from tax year 2018-19 onwards, considering the ongoing international discussions regarding the taxation of the digital economy, the SEP provisions were deferred and subsequently made applicable from the tax year 2021-22 onwards.
The Indian Tax Administration has now issued a notification prescribing the revenue and user thresholds for the application of the SEP provisions as follows:
These thresholds are effective from 1 April 2022, i.e., tax year 2021-22 onwards which aligns with the effective date of the SEP provisions.
As a result of the notification of the revenue and user thresholds, the Indian Tax Administration has activated the SEP provisions. The language of the SEP provisions is broad and is likely to impact conventional transactions and activities even if they are not carried out in a digital form. In addition, a number of practical issues arise from the language of the threshold limits, for instance: (1) whether the INR20 million revenue threshold should be determined on gross or net of sales returns, discounts, etc.; 2) how the 300,000 users (resident in India or with an IP address situated in India) should be determined; and 3) whether any distinction can be made between active and passive users. Indian industry may need to engage with the Indian Tax Administration to receive additional guidance on various practical aspects.
While the expanded scope of ”business connection” does not override a tax treaty, which follows the traditional permanent establishment definition, this development will be of relevance to nonresident taxpayers who are resident in a jurisdiction which does not have a bilateral or multilateral tax treaty with India or the nonresident taxpayer is not eligible for tax treaty benefits.
Once taxation is triggered in India, the payer is required to withhold any tax due and the nonresident is obligated to file a tax return. Noncompliance with the withholding obligations can trigger disallowance of deductions and interest and penalties for the Indian payer. Furthermore, the Indian payer can also run the risk of being regarded as a representative assessee of the nonresident. In the absence of guidance on the SEP income attribution principles, the payer may need to liaise with the tax authorities to determine the appropriate sum which should be regarded as taxable in order to comply with the withholding provisions.
The interaction of the equalization levy with the SEP will also need to be considered by nonresident taxpayers.
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP (India)
Ernst & Young LLP (United States), Indian Tax Desk, New York
Ernst & Young LLP (United States), Indian Tax Desk, San Jose
Ernst & Young Solutions LLP, Indian Tax Desk, Singapore
Ernst & Young LLP (United Kingdom), Indian Tax Desk, London
Ernst & Young LLP (United States), Asia Pacific Business Group, New York