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Significant Economic Presence (SEP) rules in India and its tax impact

Overview of the SEP rules for India

INSIGHT ARTICLE  | 

RSM India has published an overview of important international tax developments resulting from implementation of the Significant Economic Presence (SEP) rules by India that are important for multinational companies to consider when conducting business in or with Indian customers.

The Finance Act of 2018 introduced the concept of Significant Economic Presence into Indian taxation in order to address the proliferation of digital transactions that could not be easily taxed under the existing taxation framework.

Under the new rules, the Indian government expands the scope of the income tax for nonresidents and deems those nonresidents with SEP to have a ‘business connection’ in India. Thus, income attributable to the SEP is now taxable in India, except in cases where a taxpayer is eligible for tax-treaty benefits as outlined below.

On May 3, 2021, after a period of consultation with stakeholders and the public regarding the framing of Income tax rules related to the applicability of SEP, the Government of India announced that the SEP provisions would come into effect starting on April 1, 2022. Multinational companies conducting business in or with customers in India should consider this important international tax development for potential impact.

SEP is defined as:

  • A transaction in respect to any goods, services or property carried out by a nonresident in India. This includes the download of data or software in India, subject to a payment threshold to be determined.
  • Systematic and continuous solicitation of business activities or engaging/ interacting with a certain number of users (yet to be determined) in India through digital means.

Additionally, the SEP rules can be triggered whether or not the following items take place:

  1. The agreement for transaction or activity has been entered in India
  2. The nonresident has a residence or place of business in India
  3. The nonresident renders services in India.

*Note that only income attributable to operations in India or transactions in India would be taxable.

The threshold limits for applicability of the SEP rules are as follows:

Threshold criteria

Threshold limits

Revenue

Any nonresident deriving a revenue exceeding the threshold limit of INR 2 crores (approximately $274,000 U.S. dollars) in a particular financial year in respect to any transaction of goods, services or property carried out by such nonresident with any person in India. Such transaction would also include transactions involving downloaded data or software in India.

Number of users

Any nonresident entity, which is engaged in the systematic and continuous solicitation of business activities or engagement or interaction with 300,000 or more users in India.

 

If the threshold limit for either the revenue or number of users is met, then the SEP rules will be applicable.

The SEP rules will affect the following types of transactions:

  • Providing or delivering online training, trouble-shooting and/or gaming services
  • Transactions involving download of data or software in India (such as, in-app purchases)
  • Providing services such as streaming of e-content (audio / video)
  • Sale or purchase of goods, services or property through digital medium
  • Providing or delivering cloud storage, online database and computing services to significant users in India

Many nonresident businesses will likely be subject to the SEP provisions and thus their income could be subject to tax in India given the low thresholds and expansive definition of included activities. However, the SEP provisions will have a limited impact on nonresident businesses who are able to claim treaty benefits and apply the provisions of permanent establishment (PE), which has a much higher threshold before recognizing a taxing jurisdiction right to tax a transaction of a nonresident business.

The above-mentioned rules could have a significant impact on businesses from non-treaty countries, wherein their profits attributable to India because of the SEP rules would be subject to tax at a rate of 40%.

Additionally, the following few are specific challenges in regards to the application of the SEP rules, which should be given appropriate consideration:

  • The scope and extent of the SEP rules is quite expansive and can potentially cover any transaction carried out by a nonresident in India, irrespective of whether it is through digital means or otherwise. It may also cover transactions such as physical import of goods by an Indian resident from a nonresident based in countries with whom India does not have a tax treaty.
  • Certain terms in the SEP rules are not clearly defined, such as, what shall be the meaning of terms “digital mean”, “systematic and continuous soliciting”? Whether the SEP provisions will cover all transactions or only revenue generating transactions?
  • Crossover between SEP and Equalization levy (EL) which may affect the same nature of transactions, such as, download of data or software will be covered under the SEP rules but may also come under the purview of the EL provisions. There could be repercussion as to the fact if EL is levied on the transaction, it would not be reasonable to levy tax again on the income attributable to the SEP.
  • There will be challenges associated with tracking the data and counting the number of users to accurately determine the thresholds. If the same user logs into the account with multiple devices, there will be multiple IP addresses, which would increase the user threshold if the IP address is considered to be the benchmark for counting purposes.
  • Although the current SEP rules provide certain parameters related to the attribution of profits, the guidance seems limited on how profits can be attributed in India in instances where a nonresident has a SEP in India. The Assessing Officer has been provided a discretionary power to compute and attribute profits in the manner he/she deems fit.

Globally active businesses that are considering or are currently doing business in or with customers in India should evaluate how SEP rules will affect them. If you have specific questions about the SEP rules and their applicability to your business, please contact us today

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