BUDGET 2018 OF INDIA AND BUSINESS CONNECTION- SOME THOUGHTS….

By Gayatri Sridharan, Tarkaanveshan

The Finance Bill, 2018, has sought to expand the definition of the term "Business Connection" as it appears in clause (i) of sub-section (1) of section 9 of the Income Tax Act , 1961 to include in its scope a “significant economic presence”.

OECD under its BEPS Action Plan 1 addressed the tax challenges in a digital economy wherein it has discussed several options to tackle the direct tax challenges arising in digital businesses. One such option is a new nexus rule based on “significant economic presence”. As per the Action Plan 1 Report, a non-resident enterprise would create a taxable presence in a country if it has 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 'significance economic presence'.

The existing provisions of clause (i) of sub-section (1) of section 9 of the Income Tax Act , 1961 of India essentially provides for physical presence based nexus rule for taxation of business income of the non-resident in India.

Explanation 2 to the said section which defines ‘business connection’ is also narrow in its scope since it limits the taxability of certain activities or transactions of non-resident to those carried out through a dependent agent. Emerging business models such as digitized businesses, which do not require physical presence of itself or any agent in India, are not covered within the scope of clause (i) of sub-section (1) of section 9 of the Act.

In view of the above, the 2018 Budget proposes to amend clause (i) of sub-section (1) of section 9 of the Act to provide that’ significant economic presence' in India shall also constitute 'business connection'.

“Significant economic presence” for this purpose, has been defined as -

(i) any 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 the amount as may be prescribed; or

(ii) systematic and continuous soliciting of its business activities or engaging in interaction with such number of users as may be prescribed, in India through digital means.

It is further proposed to provide that only so much of income as is attributable to such transactions or activities shall be deemed to accrue or arise in India. It is further proposed to provide that the transactions or activities shall constitute significant economic presence in India, whether or not the non-resident has a residence or place of business in India or renders services in India.

The proposed amendment in the domestic law will enable India to negotiate for inclusion of the new nexus rule in the form of 'significant economic presence' in the Double Taxation Avoidance Agreements. It has been clarified that the aforesaid conditions stated above are mutually exclusive. The threshold of “revenue” and the “users” in India will be decided after consultation with the stakeholders. This development is in line with the decision of the Apex Court of India in the case of Jolly George Varghese and Others vs. Bank of Cochin[AIR 1980 SC 470]. In this case, the Honorable Supreme Court of India, in the words of Justice Krishna Iyer had opined that “The positive commitment of the State Parties ignites legislative action at home but does not automatically make the covenant as enforceable part of the corpus juris of India “.

Further, it has been also clarified that 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. This amendment will take effect from 1st April, 2019 and will apply in relation to assessment year 2019-20 and subsequent assessment years. 

This amendment has come in the wake of a series of judgments of the Apex Court of India whereby even the holding of a grand prix or a limited presence within India was held to constitute a permanent establishment within India. As per the Supreme Court of India as laid down in a series of recent judgments certain amount of space at the disposal of the enterprise which is used for business activities is sufficient to constitute a place of business. No formal legal right to use that place is required. Thus, where an enterprise illegally occupies a certain location where it carries on its business that would also constitute a PE. Some of the examples where premises are treated at the disposal of the enterprise and, therefore, constitute PE are: a pitch in a market place, or by a certain permanently used area in a customs depot (e.g. for the storage of dutiable goods). Again the place of business may be situated in the business facilities of another enterprise. This may be the case for instance where the foreign enterprise has at its constant disposal certain premises or a part thereof owned by the other enterprise

What about Equalization Levy?

In 2016 the India Legislature enacted a levy to plug the loopholes in the outdated definition of the "permanent establishment" in the Double Taxation Avoidance Treaties entered into by India and also in keeping with the recommendations of the G-20 Action plan to regulate and contain Base Erosion and Profit Shifting in the case of multinational entities.

To attract the new Equalization Levy, there is no need to determine if there exists a Permanent Establishment or any other nexus to India. Merely earning of revenue from India from specified services makes a nonresident liable to Equalization Levy. Revenue is the source. When in excess of the threshold, it is the nexus adequate for India’s tax jurisdiction..

The introduction the Equalization Levy which is nothing but what in the UK is called the Google Tax also addressed the issue of Double Taxation on such levy and mandated that such income on which the levy is paid or deducted at source would not attract Income Tax. Simultaneously it was enacted that if a particular income/receipt was subject to Income Tax , such income could not again be subject to an Equalization Levy..

The levy was also restricted to income from specified services rendered by the foreign entity only and not to sale/purchase of goods.

Some questions that need to be answered......

• The new definition of business connection invoking the existence of a significant economic presence would hence lead to a taxation of the same receipt twice over at least in respect of the specified services.
• Further in the wake of India's high tax rate in comparison with those of US and other nations how helpful is this source based taxation in attracting Foreign Investments?
• How will it affect the taxpayer given the high rate of taxation in India?
• What about the countries who have a right to tax such profits on the basis of residence? will they have to give up their rights?