Budget amendments 2018
The Union Budget,2018 of India was presented to the Parliament on 1 February 2018. This was the last full budget of the “Modi Sarkar” (PM Modi Government). Amongst the various reforms brought into force by the Finance Act, 2018, in this article we will be focusing on two significant amendments that have been carried out in the Indian Income-tax Act, 1961. These amendments will not only have an impact on the Indian tax payers but will also have far-reaching implications on those non-residents having business allies in India or are investing in India. The said amendments are:
1. Introduction of the concept of Significant Economic Presence (SEP)
2. Taxation on Long-term Capital Gains arising on specified assets.
Introduction of Significant Economic Presence (SEP)
According to the erstwhile provisions in the domestic tax law, a non-resident assessee is not liable to tax in India unless he has “Business Connection” in India. More specifically, Section 9(1)(i) of the Income-tax Act, 1961 provides that “all income accruing or arising, whether directly or indirectly, through or from any business connection in India” shall be deemed to accrue and arise in India. Thus, by virtue of the deeming fiction under section 9(1)(i), India retains the territorial nexus to tax the incomes arising through or from any “business connection” in India. The scope of erstwhile provisions was restrictive as it essentially provided for physical presence based nexus rule for taxation of business income of the non-resident in India.
Modern technology has made it possible for many companies to do business in several countries without business connection or permanent establishment. 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. Realising the need to match the pace of the rapid changes in the business environment and the loss of revenue caused to the government, the amended domestic tax law now contains the provision which brings into play the concept of “Significant Economic Presence”(SEP).
According to the provisions existing as on date, a non-resident 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 non-resident 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.
With the introduction of the concept of SEP many foreign companies having business in India without physical presence may also come under the tax net. Further, as per the provisions prevailing as on date, between the domestic tax law and tax treaties, the more beneficial provisions will prevail. Thus, this appears to be the first roadblock while implementing the concept of SEP, since it is not part of any of the Tax treaties, and hence it is likely that Indian Government may look at renegotiating tax treaties to include this.
This amendment clearly shows that Indian Government is taking note of the changing business environment, digitization of businesses and also finding ways to collect taxes.
Taxation on Long-term Capital Gains arising on specified assets
Under the erstwhile provisions of the domestic tax law, gains arising on the transfer listed equity shares or units of equity oriented fund or units of business trusts, held for a period of more than 12 months were exempt from tax. Such an exemption was brought into picture with a view to foster equity investments amongst the nation. In order to minimize the economic distortions and curb erosion of tax base, such an exemption has now been withdrawn.
As per the law as on date, long term capital gains arising from transfer of an equity share, or a unit of an equity oriented fund or a unit of a business trust shall be taxed at 10% of such capital gains. Such capital gains tax shall be levied in excess of INR 100,000 (USD 1,600 approx). This concessional rate of 10% will be applicable if Securities Transaction Tax (STT) has been paid on both acquisition and transfer of such capital asset, in case of equity shares, and paid at the time of transfer in case of unit of equity oriented fund or a unit of a business trust.
From a domestic tax payer perspective, this amendment was not welcomed well. Moreover, the stock markets in India also saw a correction post proposal of this amendment.
The computation of gains mechanism offers slight relief to the tax payers. When a taxpayer sells securities acquired before 01.02.2018, then the cost of acquisition for such securities shall be higher of:
1. Cost of acquisition or;
Highest trade price of the security on 31.01.2018. Thus, the government has been considerate enough to grandfather the gains of the securities purchased before 01.02.2018 by allowing as a deduction the highest traded price as on 31.01.2018.
With respect to the Foreign Portfolio Investor (FPI) sentiment, such an amendment could adversely impact the revenue for the government since it could lead to significant drop in FPI flows thereby lowering the collections of the STT. Also, there are FPIs who act as an asset manager or pooling vehicle and thus transferring the tax liability to end-beneficiary also becomes complicated going forward.
Manan Mathuria, Chaturvedi & Shah,
T +91 22 4009 0526
Taxation of digital economy – India leads the way!
In the recent past, more and more countries have been voicing their concern on the fact that the current rules are not adequate to tax nexus due to the significant digital presence in a country. While the world is still grappling with devising means to tax the digital economy, India continues to lead the
way in dealing with these emerging tax issues – this time by proposing a new nexus rule to tax digital transactions.
In the Indian Budget presented on 1 February 2018, the government expanded the definition of a Business Connection (Indian version of Permanent Establishment (PE)) by introducing the concept of ‘Significant Economic Presence’ (referred as Digital PE hereafter in the text) to tax digital transactions. The law now provides that significant economic presence of a non-resident in India shall constitute a business connection in India and resultantly, the income attributable to such significant economic presence would be taxable in India. This is in line with India’s recent comments to the revised Organisation for Economic Co-operation and Development’s (OECD’s) model treaty and commentary.
Significant economic presence
Significant Economic Presence (SEP) is defined as:
a. A transaction in respect of any goods, services or property carried out by a non-resident in India including provision for 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
b. Systematic and continuous solicitation of business activities or engaging in interaction with such number of users as may be prescribed in India through digital means.
The law further provides that even where a non-resident does not have a residence or place of business in India or does not provide services in India, a business connection would still be constituted.
The government has announced that it will begin a consultation process with different stakeholders to determine what should be the threshold limits for qualifying as SEP. The above change is a significant departure from the existing rules on PE. Under the existing rules, a PE is generally constituted
based on physical presence in a country.
The above provisions will come into force from 1 April 2018.
OECD – Lack of consensus to tax the digital economy and unilateral measures
The OECD released an interim report in March stating that there is still no consensus among countries on whether changes should be made to international tax rules that apply to multinational digital firms. The report also states that there is no consensus on short-term interim measures to tax the digital economy.
The European Union (EU) in a report released in March, along with OECD’s report, provides for two directives. One of the two proposed directives provides for a temporary EU tax on digital firm revenues at the rate of 3% to serve as a stopgap measure until an international agreement is formed as a longterm fix for corporate income tax rules applicable to digital multinational firms.
The second directive provides for a long-term fix stating that alternative indicators for SEP are required to protect taxing rights in the new digitized business models.
Similarly, the United Kingdom discussion draft on the digital economy highlights the need to consider the active participation of users in determining how the taxable profits of digital businesses are allocated.
Even before these developments, India had already taken the lead by formalizing the concept of digital or virtual PE and taxing digital transactions. Equalization Levy, similar to EU’s first directive, was introduced by India in 2016. It provides for a 6% tax on income earned by a non-resident from digital advertisement. Indian Budget 2018 has now introduced the concept of Digital PE.
India’s transition, along with concerns raised by other countries, highlights that this is an area of interest globally. Until there is a multilaterally agreed and implemented solution on this, countries taking unilateral measures will increase, leading to double taxation and further uncertainty.
No immediate impact – tax treaties remain unaffected
A taxpayer can apply the provisions of the Indian domestic law or the tax treaty, whichever is beneficial to him.
Therefore, while the concept of Digital PE finds a place in the domestic tax law of India, tax treaty’s definition of PE with various countries remains as it is currently. The government has acknowledged this fact and has announced that these changes will enable India to renegotiate its tax treaties to provide for the inclusion of SEP rule in the treaties and unless corresponding modifications are made to the tax treaties, the existing tax law would continue to apply.
The application of the Digital PE rule would largely depend on the cooperation of India’s tax treaty partners by way of amending the respective tax treaties. As such, until the time these tax treaties are re-negotiated, the Digital PE rule remains a domestic tax law concept and may not apply to nonresidents who are eligible for tax treaty benefits.
Impact on non-digital transactions
While the government intends to tax emerging business models, such as digitized businesses, the way the law is drafted, the concept of significant economic presence could apply to brick-and-mortar businesses as well.
One of the parameters of significant economic presence is ‘transaction in respect of any goods, services or property carried out by a non-resident in India.’ This poses a question as to when can one say that the transaction is carried out in India? For instance, for a non-resident taxpayer engaged in
Engineering, Procurement and Construction (EPC) activities, as a general rule, the offshore supply of goods is not taxable in India where the sale concludes outside India. Now, if one goes by the situs of the buyer, such transactions could be taxable in India.
The definition of SEP, therefore, needs suitable modifications.
Enforcement could be a challenge
The present nature of the Digital PE rule raises questions about how it will be enforced. For instance, for the threshold based on the interaction of a number of users, calculating the number of users actually interacting with non-residents could be cumbersome. Among other things, this would require a robust audit trail to arrive at the number of users – especially in cases of business models where the user interaction is on a free-for-all basis.
Determining income attributable to digital PE could be complex
By its very nature and more so in the case of a Digital PE, computing the income attributable to the PE would be a complex and highly subjective exercise. For instance, where a Digital PE is triggered based on the threshold of the number of users the taxpayer interacts with, but the interaction does not result in significant revenue, the income attributable to the PE could be nil. Also, a formulatory approach may not be suitable and the government would need to specify robust guidance on profit attribution.
To summarize, India has taken the lead by carving out tax provisions to tax digital transactions. This provision is at a nascent stage and could evolve through stake-holder consultants. Businesses may not have to worry about Digital PE being created just yet. However, the government could
move swiftly on deciding the coverage of Digital PE to provide stability to the Indian tax environment.
Maulik Doshi, SKP Business Consulting LLP