The Central Board of Direct Taxes (CBDT), vide its notification dated 3 May 2021[1] has stipulated Rule 11UD to prescribe the ‘revenue’ and ‘users’ threshold for the purpose of determining Significant Economic Presence (SEP) of a non-resident entity in India. It has come into force with effect from 1 April 2022 (i.e., Financial Year 2021-22 or Assessment Year 2022-23 onwards).

The threshold limit notified by CBDT for the purpose of SEP has been tabulated as under:

If either one of the above-mentioned thresholds is met by a non-resident entity, then such entity shall be deemed to have a business connection in India and accordingly would be liable to pay tax on income attributable to transactions or activities mentioned above, subject to the beneficial provisions of tax treaties, as may be applicable.

FM Comments:

It may be noted that this Explanation was inserted primarily with an intention to tax digital transactions which otherwise escapes tax net due to absence of physical presence in India. However, on careful reading of the provisions, it is possible to infer that SEP provisions may even cover the transactions which are carried out through non-digital means (i.e., even on ‘physical’ buying and selling of goods and services).

At this juncture, it is also imperative to mention that UN tax committee has recently approved Article 12B (Income from automated digital services) in the UN Model Tax Convention. It would be interesting to watch whether India renegotiates its tax treaties to include this Article in its tax treaties and its interplay with the SEP provisions.

Further, from a practical perspective, this provision may not have much impact on non-resident entities based out of countries with whom India has executed tax treaties, due to existence of the conventional Permanent Establishment (PE) provisions in the tax treaty, where PE exists based on the physical presence in India. It would be worthwhile to note that the provisions of section 9 of the Act does not override the provisions of tax treaty and hence unless the tax treaty is renegotiated to include provisions that are like SEP, it would not have any impact on entities based out of tax treaty countries.

Having said the above, SEP provisions could have major impact on non-resident entities based out of non-tax treaty countries as well as tax treaty countries to whom benefit under the covered tax treaty may get denied, pursuant to application of, inter alia, Article 7 – Prevention of treaty abuse of Multilateral Instrument (MLI); considering the lower threshold prescribed by CBDT, such entities may then become liable to SEP provisions and may also have to pay incremental tax in India. Additionally, those entities may then also be under obligation to undertake various tax compliances in India (such as withholding tax, filing of return of income, etc.).

The non-resident entities may face various practical challenges in determining the “revenue” and “user” thresholds and in cases where existence of Business Connection is determined based on SEP, the challenges would be in relation to attribution of profits that would be chargeable to tax in India. Accordingly, it is of paramount importance that CBDT provides adequate guidance to determine the thresholds on how the profit would be attributed to such SEP activities in India.

Last but not the least, it would be interesting to examine the interplay and co-existence or otherwise of Equalization Levy (EQL) vis-à-vis the SEP provisions. For instance, in cases where the transaction falls specifically under the EQL provisions, then such income should be exempt from tax under the provisions of the Act and accordingly the expanded scope of business connection should not apply.