-Economic Presence as amended
Article by: CA. Harsh Mathur
In this digital world, taxation of business profits based on economic allegiance is the core logic of international taxation!
Section 9(1)(i) of the Indian Income Tax Act 1961, tax any income earned by a Non Resident from a business connection in India. The term business connection has not been expressly defined in the act per se. The term has been the subject matter of various interpretations of judicial pronouncements
The finance act has widened the scope of the term business connection in line with BEPS action plan 1 by inserting a new explanation 2A to section 9(1)(i)
The background of the loophole
The explanatory notes to finance bill 2018 released by CBDT dated 26.12.2018 states the problem before the amendment as below:
Allocation of taxing rules under Article 7 of DTAAs, business profit of an enterprise is taxable in the country in which the taxpayer is a resident. If an enterprise carries on its business in another country through a 'Permanent Establishment' situated therein, such other country may also tax the business profits attributable to the 'Permanent Establishment'. For this purpose, 'Permanent Establishment' means a 'fixed place of business' through which the business of an enterprise is wholly or partly carried out provided that the business activities are not of preparatory or auxiliary in nature and such business activities are not carried out by a dependent agent.
With the advancement in information and communication technology in the last few decades and a push gave by almost all the governments towards digitization, new business models operating remotely through digital medium have emerged. Under these new business models, the non-resident enterprises interact with customers in another country without having any physical presence in that country resulting in avoidance of taxation in the source country. The existing nexus based on physical presence do not hold good anymore for taxation of business profits in source country. As a result, the rights of the source country to tax business profits that are derived from its economy are unfairly and unreasonably eroded.
Action Plan-1 Addressing the challenges of the digital economy in its recommendations has discussed that, a non-resident enterprise would create a taxable presence in a country if it has a significant economic presence in that country on the basis of factors that have a purposeful and sustained interaction with the economy by the aid of technology and other automated tools. It further recommended that revenue factor may be used in combination with the aforesaid factors to determine 'significant economic presence'.
India's action on BEPS recommendations:
In view of the above, a new Explanation 2A has been inserted in clause (i) of sub-section (1) of section 9 of the Income-tax Act to provide that 'Significant Economic Presence’ in India shall also constitute 'business connection' and that "Significant Economic Presence" for this purpose shall mean-
(i) transaction in respect of any goods, services or property carried out by a non-resident 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 such amount as may be prescribed; or
(ii) systematic and continuous soliciting of business activities or engaging in interaction with such number of users as maybe prescribed, in India through digital means.
6.7 It is further provided that only so much of income as is attributable to such transactions or activities as specified in (i) or (ii) above shall be deemed to accrue or arise in India. It is also provided that the transactions or activities shall constitute significant economic presence in India, whether or not-
Equalization Levy and Significant Economic Presence
- the agreement for such transactions or activities is entered in India;
- the non-resident has a residence or place of business in India; or
- the non-resident renders services in India
EQL was introduced as a separate chapter in Finance bill 2016, to impose tax on e commerce transactions. Once paid, it is not allowed as credit in the country of residence as to get relief as per DTAA tax has to be paid as income tax. This has been a major drawback in implementation of EQL which has not seen any increment in its scope since introduction.
Also, there is no separate article in any of the DTAA for EQL and as per section 90(2) of the Income Tax Act, 1961 DTAA or Provision of Income Tax whichever is more beneficial is applicable and therefore this was deliberately introduced as a separate chapter and not in Income Tax Act.
SEP has been brought in the Income Tax Act, 1961 and therefore any attributable profit will be taxed as per normal tax laws in the source country and the credit shall be allowed for the tax deducted in the country of residence.
However as clarified in the explanatory notes unless corresponding modifications to PE rules are made in the DTAAs, the cross border business profits will continue to be taxed as per the existing treaty rules.
The insertion of this clause has expanded the base of taxation for source countries and once amendment is done in definition of PE it will also be effective in DTAA's.