Significant Economic Presence for E-Commerce Taxation
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- Last Updated on 1 November, 2022
This is a concept raised in the BEPS Action 1 Report on E-commerce taxation. Of course, it is already being used by some states within USA for their cross-state indirect taxes. It is being strongly promoted by the European Union. However, US Government is strongly opposed to any kind of E-commerce Income-tax under the OECD Model of DTA. Hence so far, there is no provision for E-commerce taxation under the DTA.
An explanation of the concept of SEP:
Article 7 of the DTA provides that the non-resident assessee is not liable to tax in the country of sales unless he has a PE in the Country of sales. Primarily, a PE requires a fixed place of business within the geographical boundaries of the country of sales. Modern technology has made it possible for many companies to do business in several countries without PE. Phrases like “Borderless world” and “Modern technology defies Geography” have become reality for E-Commerce. But governments do want to collect income tax based on geography. Several Governments are now claiming a right to tax a NR’s income based on sale of goods & services within their countries. They need a concept of a PE without fixed place of business. An SEP would be a PE not requiring the fixed place of business.
If there is no fixed place of business, then on what grounds (nexus) a non-resident may be taxed for its business income? Which other nexus may be used to bring the NR in tax net? This is the crucial matter of definition of SEP. BEPS Action 1 Report gives several different criteria which may be considered for considering an SEP. The criteria adopted by Indian Government under SEP definition are discussed below: S.9 (1) (i) Explanation 2A: A NR will be considered to have an SEP in India –
(a) If the non-resident receives revenue exceeding an amount to be prescribed; for transactions carried on by the NR within India,
(b) (i) If the non-resident systematically and continuously solicits business in India through digital means;
(b) (ii) If the non-resident engages in interaction with users in India through digital means. The minimum number of users that would attract the provision of SEP will be prescribed by notification.
Need for SEP:
1. Equalisation Levy (EQL) & Significant Economic Presence (SEP):
Equalisation Levy has been imposed as an E-commerce tax by Chapter VIII, Sections 163 to 180 of The Finance Act, 2016. No change has been proposed under Finance Bill, 2018 on Equalisation Levy.
With introduction of Significant Economic Presence (SEP) in ITA & continuation of EQL under Finance Act, 2016; there will be an overlap. If a NR earns advertising revenue from India, he will be liable to which tax?
(i) Any income which is chargeable to EQL is exempt from Indian Income-tax u/s. 10 (50). Hence there will be no double tax.
Can such an assessee choose to be taxed under ITA instead of EQL? No. Finance Act, 2016 chapter VIII does not give any option to the assessee. If he is liable to tax under EQL, he has to pay tax as EQL & get exemption under ITA.
(ii) Many revenues will be covered under the definition of SEP &are not covered under EQL. Such revenues will not get exemption u/s. 10 (50). What will be their tax exposure?
There can be two possibilities. Such assessee is entitled to DTA relief because he is resident of a country with which India has DTA; and the assessee produces Tax Residency Certificate (TRC). In such a case, under the present DTA, the NR businessman can claim that he does not have a PE in India. Hence his income will not be taxable in India.
(iii) There are NR assessees who are not entitled to DTA relief. Hence they do not get protection of PE. Their incomes will be – after 1st April, 2018 – covered under SEP & hence Business Connection. They will be liable to Indian Income-tax u/s. 9 (1) (i) Explanation (2A). Indian payers will be liable to deduct tax at source u/s. 195.
2. Double Tax Avoidance Agreement (DTAA):
There is a legitimate complaint that E-commerce tax (Equalisation Levy) imposed by Indian Government is not available as a set off under the DTAA in the COR. To explain: If a British company pays Equalisation Levy in India, that tax is not available as set off against the British Income-tax in Britain (COR). How to provide this set off under DTAA? First of all, the set off under DTAA would be available only if the tax is an Income-tax. Equalisation Levy has been deliberately kept out of the Income-tax Act. Hence it can be difficult to claim it as set off under DTA. Though some countries may consider it as a tax similar to Income-tax & give set off under DTAA. The reason for keeping Equalisation Levy out of the Income-tax Act was that in the year 2016,the OECD & UN Model DTA did not provide and there was no DTA providing for E-commerce taxation. This position continues even today. In India, a DTA or ITA whichever is more beneficial to the assessee would be applicable – Section 90(2). Hence the position was that if a tax were imposed under the ITA, assessee would claim exemption under DTAA; and almost no assessee would be paying tax.
3. Dead Lock:
How to break this dead lock?
4. Attribution of Profits to SEP:
Once an SEP is treated as a BC and the non-resident is liable to tax in India under the deeming provision of Section 9(1)(i), it is not that the whole of its net profit is taxable in India. Only that portion of its net profit which is attributed to the Indian SEP will be taxable in India. Thus, the system of SEP will be normal system of taxation of a foreign assessee’s branch /PE in India. It will not be like Equalisation Levy where a flat rate of tax is levied on gross revenue. However, attribution of profits will create serious issues. (i) First of all, OECD ways of attribution of profits are impractical. Assessees as well as IT department find it difficult to come to an objective amount of profit attributable to India. (ii) Now there will be two provisions for attribution of profits. S.9 (1) (i) Explanation 1 (a) and Explanation (2A) for SEP. Which explanation will apply? Both explanations have different languages leading to similar conclusions. I would say that explanation 1 (a) is general & explanation (2A) is specific. Hence as far as SEP is concerned, 2nd proviso within explanation (2A) will apply; and explanation 1 (a) will not apply. (iii) 2nd proviso provides that the income attributable to transactions or activities referred to in clauses (a) & (b) shall be deemed to accrue or arise in India. Both clauses (a) & (b) provide for transactions carried out “in India” or interaction “in India”. This provision creates controversies discussed in paragraph II.6 &II.8 below. In short, the need to “attribute profits” will create several administrative problems & legal controversies.
5. Overall scheme of SEP:
Once the concept of SEP is brought within the concept of Business Connection, Government of India will have a nexus / connection under ITA to tax a non-resident’s business income in India. Thereafter Government of India has to amend the DTA to include E-commerce taxation; or in technical words, to add the concept of SEP to article5of the DTA which defines PE. India has signed around 80 DTAs with 80 different countries / jurisdictions. Hence Indian Government will have to try and negotiate the treaty with each country separately. Only when the other country accepts to add the concept of SEP, it will be added in the bilateral treaty. When it is added in the treaty, Government of India will be able to levy E-commerce taxation. OECD – G20 Multilateral Instrument (MLI) does not have specific article for E-commerce taxation. If the MLI had a specific article on E-commerce taxation, India would not require fresh negotiations with all the 80 countries. In any case, out of 80 countries, many countries would not have assessees providing E-commerce goods or services to IRs. Hence signing a treaty with them is not of any financial significance. Yet, this is an important step in international treaty negotiations. India has taken a leadership in E-commerce taxation. It needs to maintain the leadership in BEPS negotiations to ensure that ultimately Action 1 Report makes a provision for E-commerce taxation.
6. BEPS Recommendations:
BEPS recommendations are of three kinds: (i) Recommendations for amending domestic law, (ii) Recommendations for amending treaties. This action is partly executed through MLI. Other part is to be completed by bilateral negotiations, (iii) International banks, financial institutions & tax departments of Governments share information on automatic basis with the tax departments of other countries. This process has already started. Introduction of SEP in ITA is an amendment in domestic law sought to be carried out by GOI.
For more detailed information on SEP, DTA, BEPS, subscribe to our International Taxation Module.
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