By Ritwik Tandon
How will a change in the domestic law affect the taxable position under these Double Taxation Treaties?
The CBDT inserted Rule 11UD under Income Tax Rule, 1962 vide Notification No. 41/2021[1] on May 3, 2021 for the purposes of Significant Economic Presence. Under powers of section 295 of the Income Tax Act, 1961, the CBDT inserted the Rule 11UD after Rule 11UC which come into force with effect from April 1, 2022 (a year from now).
Rule 11UD sets the threshold limit of Significant Economic Presence, For Section 9 (1) (i) Explanation 2A (a) and (b), below mentioned are the two threshold categories:
- Transaction threshold: If the amount of aggregate of payments arising from transaction or transactions 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 during the previous year, shall be two crore rupees.
- User threshold: If the number of users with whom systematic and continuous business activities are solicited or who are engaged in interaction shall be three lakhs in India.
It appears a low threshold without a reasonable mark, since this implies even smaller players will have more users than mentioned in the notification.
Upon either, reaching the transaction threshold or the users threshold- the entity will be seen as having business presence in India.
This provision is likely to create a conflict in India which is currently in a Double Taxation Avoidance Agreement with 130 countries- thus, entities from non DTAA locations will get impacted by the SEP provisions, since the DTAA specifies that NR entities will come under the tax net only if they have a PE in India.
This calls for clarification on what will be the status of entities not classifying under the PE category.
The NR hitting the above threshold shall be considered as Significant Economic Presence, equivalent to Business Connection under Section 9(1)(i) of the Income Tax Act and all income accruing or arising, whether directly or indirectly, through or from such SEP in India shall be deemed to accrue or arise in India. Irrespective of the following factors:
- Whether the agreement for such transactions or activities is entered in India or not; or
- Whether the non-resident has a residence or place of business in India or not; or
- Whether the non-resident renders services in India or not:
Digital advertising on foreign platforms are already under tax net- also known as the equalisation levy (EQ). What is the treatment to digital companies selling user data for targeted advertising?
For a better understanding, this move of the government will run into two problems:
- Attribution of profits among countries- who can tax how much.
- Treaty troubles.
So, how should the governments determine the revenue attributable to digital activities in their respective country?
‘The conventional principle of permanent establishment will not apply to digital businesses’ this is going to be a task on the Indian government or regulators to ascertain as it is going to get complex – revenues collected in other countries arising from the user data is not easy to get hold on despite the exchange of information arrangements.
Sudhir K, Partner, EY India explained the profit attribution is the sense that, currently, India has two provisions for attribution-
first: Rule 10[2] of the Income Tax rules which essentially is –
- revenues from India divided by global revenues multiplied by global profits should be the taxable base in India.
This, in a brick-and-mortar space, poses enough challenges. It will be impossible to apply this principle in a digital business.
Second:
- the Arm’s length principle under transfer pricing, may not work since the relevant arm’s length pricing is based outside of India in the digital business context.
Treaty trouble
Budget passed in 2018, clearly said that India is proposing this law in order to be prepared for the changes that occur in double-tax treaties. This subordinate legislation that the department is proposing will fail to be useful in situations where the NR tax payer is from a country that has a tax treaty with India.
There is no inclusion of digital transaction under the definition of PE under the tax treaties. The only way to amend the treaties using the multilateral instrument tool proposed by OECD- which will be null if the treaty partner has not signed up to MLI, even the provisions under the domestic law will not be of any help.
The SEP provision was deferred till 2022-23 on grounds that a multilateral solution under OECD is being deliberated where all tax treaties will get amended automatically. Around 130 countries are striving to arrive at a consensus-based solution by mid of the year to tax digital entities that end up not paying taxes in countries from where they earn income as traditional taxation rules require a physical presence.
However, India has, in the meantime, expanded the scope of the equalisation levy over the last few years, to tax NR digital entities. While the levy applied only to digital advertising services till 2019-20 at the rate of 6 per cent, the government widened the scope further in the Finance Act 2021-22 through a clarification to cover e-commerce supply or service when any activity, including acceptance of the offer for sale, placing the purchase order, acceptance of the purchase order, supply of goods or provision of services, partly or wholly payment of consideration, takes place online.
The blog on Rules to levy digital tax is only for information purposes. Nothing contained herein is, purports to be, or is intended as legal advice and you should seek legal advice before you act on any information or view expressed herein. Endeavoured to accurately reflect the subject matter of this alert, without any representation or warranty, express or implied, in any manner whatsoever in connection with the contents of this. This isn’t an attempt to solicit business in any manner.
[1] Official CBDT notification- https://www.incometaxindia.gov.in/communications/notification/notification_41_2021.pdf
[2] Determination of income in the case of non-residents.
10. In any case in which the [Assessing Officer] is of opinion that the actual amount of the income accruing or arising to any non-resident person whether directly or indirectly, through or from any business connection in India or through or from any property in India or through or from any asset or source of income in India or through or from any money lent at interest and brought into India in cash or in kind cannot be definitely ascertained, the amount of such income for the purposes of assessment to income-tax [* * *] may be calculated: (i) at such percentage of the turnover so accruing or arising as the [Assessing Officer] may consider to be reasonable, or
(ii) on any amount which bears the same proportion to the total profits and gains of the business of such person (such profits and gains being computed in accordance with the provisions of the Act), as the receipts so accruing or arising bear to the total receipts of the business, or
(iii) in such other manner as the [Assessing Officer] may deem suitable.