By Sumeet Hemkar and Shruti Goyal
Advancements in technology and digitisation now permit goods and services to be remotely ordered from anywhere in the world, blurring the concept of territorial jurisdiction, and exposing the static nature of some international tax concepts. The OECD’s Base Erosion and Profit Shifting (‘BEPS’) project provides for a consensus-based solution through Action Plan 1, to address the above static by proposing three alternatives to address the challenges of digital economy, viz., (i) nexus based on significant economic presence (‘SEP’) (ii) withholding taxes on digital transaction and (iii) introducing equalisation levy (‘EL’). Action Plan 1 left each country the choice to further calibrate on the option.
The Indian version of SEP provides that SEP of a non-resident will constitute a ‘business connection’ (a domestic law concept for business nexus) as per section 9 of the Income-tax Act, 1961 (‘IT Act’) in situations as noted below:
Transaction in respect of any goods, services or property carried out by a non-resident with any person in India including provision of download of data or software in India, if the aggregate of payments arising from such transaction or transactions during the previous year exceeds INR 2 crores during a financial year; or
Systematic and continuous soliciting of business activities or engaging in interaction with 3 lakh or more users in India.
India also introduced EL as a separate levy outside of the IT Act – (i) a 6% EL in 2016 as a withholding tax on online advertising related services; and (ii) a 2% EL in 2020 on non-resident e-commerce operators engaged in online supply of or facilitation of goods or services above a threshold of Rs 2 crores. This 2% EL also applies to on amounts received from another non-resident under specified circumstances such as sale of advertisement or data targeted for Indian residents or accessed through Indian IP. However, any income which is chargeable to EL, is exempt from income-tax as per section 10(50) of the IT Act.
Interplay between SEP, EL and withholding tax
While SEP is introduced in the IT Act, no corresponding changes were made to Indian tax treaties. Since India has a wide network of tax treaties, the scope of practical application of SEP is in a very limited number of cases not covered by a tax treaty. Theoretically, both SEP and EL could apply to a transaction. However, as EL takes precedence exempting the application of SEP, the creditability of the EL paid in India becomes a difficult proposition and it directly impinges the scope of taxation as agreed between sovereign governments under the tax treaty frameworks. This misalignment requires immediate attention as it has led to an increased cost of business which is ultimately passed on to end customers in India through higher pricing or through tax protected arrangements.
Aligning SEP with the two-pillar solution of the OECD
India along with 135 other member countries of OECD/G20 Inclusive Framework (‘IF’) has agreed to the global consensus on the two-pillar solution. Since this is a sovereign understanding being agreed between the involved countries, it is critical for India to align with the global consensus-based approach.
Pillar One provides the new profit allocation mechanisms and nexus rules to expand the taxing authority of market jurisdictions. It applies generally to all businesses above the prescribed thresholds. The new taxing right allows reallocation of 25% of the residual profits of in-scope companies (i.e. MNEs with global turnover of 20 billion Euros or more - to be reviewed after 7 years and reduced to 10 billion Euros) over and above a set profit margin (i.e.10%). The reallocation will be made to market jurisdictions where in-scope MNEs have at least 1 million Euros in revenue (2,50,000 Euros for smaller jurisdictions).
As can be noted, these thresholds are higher than the thresholds prescribed for applicability of SEP provisions. As part of the global consensus, unilateral measures by countries would need to be phased out. Following this, SEP provisions and EL provisions, being unilateral measures taken by India, should be rolled back.
The predominant concern expressed by businesses is on the wide scope of SEP and EL provisions. The ambit is further widnened with the removal of ‘digital means’, covering all modes of business physical and digital, as against the intended coverage of only digital economy. Various key terms such as ‘systematic’, ‘continuous’, or ‘soliciting’ have also not been defined, potentially leading to litigation in the future. Stakeholders have also raised concerns on how to determine the number of users as SEP provisions do not restrict the number of users to include only the Indian residents.
The threshholds having been set at low levels without complimenting requirements on turnover and users, further exacerbate the unilateral impact leading to escalated tax and administrative costs. While creditability of such unilateral taxes is somewhat addressed through sovereign agreements that India has (like with the United States) or would sign, this arrangement has limited applicability to only some countries, only to some taxes (i.e. those after October 8, 2021), leading to materially complicated calculations. These elements require businesses to invest significant, in some cases, almost disproportionate resources in making compliance.
Given the emerging difficulties and complexities that would apply to international cross border transactions, there is need for close adherence to global consensus being reached by countries, to ensure consistent and seamless implementation of global tax rules. There is therefore a need for the government to carefully align existing SEP and EL provisions with emerging global consensus and provide much required clarifications, and to also consider the introduction of the GLOBE rules as part of the IT Act, to assure businesses of consistency.
Sumeet Hemkar is partner and Shruti Goyal is manager at Deloitte India. The views expressed are their own views.
