income tax
The concept of Significant Economic Presence (SEP) was introduced into the Income Tax Act of 1961 effective April 1, 2018. This provision broadens the definition of income accrued to non-residents in India, establishing that income resulting from a 'business connection' within India is subject to taxation.
Per Explanation 2A of Section 9 of the Income Tax Act, 1961, SEP is defined as follows:
a) Transactions involving goods, services, or property carried out by a non-resident in India, including the downloading of data or software, if the total payments during the previous year exceed a specified threshold.
b) Systematic and continuous solicitation of business activities while interacting with a defined number of users in India.
The Finance Act of 2018 expanded the domestic law’s interpretation of 'Business Connection' to facilitate taxation on non-residents with a SEP in India.
According to Rule 11UD, the thresholds for SEP are established as follows:
Significant Economic Presence pertains to transactions and activities that generate a SEP, regardless of whether the non-resident has physical presence or conducts services in India. Only the income attributable to operations or transactions in India will be taxable.
Several categories of non-residents conducting specified activities above the thresholds may be affected by SEP:
SEP provisions cover a variety of transactions including but not limited to:
The low thresholds set for SEP may encompass many non-residents. Additionally, the broad definition could mean that transactions executed outside India may still result in a SEP if the revenue or user thresholds are met. The current provisions could mistakenly capture isolated transactions, disregarding the continuity and regularity typically associated with a business connection. When a SEP is established, non-residents will have their income from operations in India subjected to Indian taxation, necessitating compliance regarding bookkeeping, audits, and other regulatory requirements.
The SEP provisions do not fundamentally alter the tax liabilities for non-residents covered by tax treaties with India that offer favorable terms. Non-residents that qualify for tax treaty benefits—based on residency status, TRC, and beneficial ownership—will find that tax treaty provisions typically supersede SEP regulations. Income is taxed in India under tax treaties only when a Permanent Establishment (PE) is determined, according to the defined criteria of each treaty.
Non-residents from jurisdictions without a tax treaty with India should carefully evaluate the applicability of SEP provisions.
Non-residents must assess whether SEP provisions apply to them, particularly as those required to file Income Tax Returns must declare any SEP presence in India starting from FY 2021-22 (AY 2022-23). This new requirement imposes significant burdens on non-residents to collect and report the necessary transactional data accordingly.
Additionally, withholding tax may apply to payments made to non-residents for certain income types (interest, dividends, royalties, fees for technical services, etc.). Remitters will require non-residents to verify their SEP status in India and to provide relevant documentation such as TRC and declarations regarding no PE.
The introduction of SEP provisions reflects India's approach to taxing non-resident profits derived from business operations within the country. The complexities surrounding these provisions necessitate a thorough impact analysis for entities engaged in cross-border transactions with India, whether digitally or through traditional means.