While Finance Act 2016 had introduced Equalisation levy to tax India sourced online advertisement revenue, the Finance Bill 2018 proposes to bring in a new nexus rule by amending the definition of ‘business connection’ to include “significant economic presence” based on threshold for “revenue” and “users” in India.
While the Finance Bill, 2018 has proposed number of amendments which could have far reaching implications, many of them are introduced to align the tax provisions with recent global developments. Some of the key ones are discussed below.
Taxation of MSMEs & Start-Ups:
Against the backdrop of the US reducing the base corporate tax rate from 35% to 21% with introduction of Base Erosion Avoidance Tax @ 10% on payments made to related party for outsourcing services, it was expected that the government would address apprehensions about India’s competitiveness as a tax efficient investment/ outsourcing destination.
The Finance Bill 2018 has taken a small step towards this by proposing a reduction in the maximum marginal tax rate for MSMEs (having a total turnover/ gross receipts in FY 2016-17 not exceeding INR 2.5 billion) from 34.608% to 29.12%. While the benefit of reduced tax rate is linked to FY 2016-17 turnover, it’s a positive move nonetheless. Also, more Startups (with turnover less then INR 250 Mn) would be eligible to avail income-tax holidays for 3 years in a block of 7 years, with the sunset period for incorporating a start-up proposed to be extended from 1 April 2019 to 1 April 2021 and coverage of ‘eligible business’ extended to any scalable business model with a potential of employment generation or wealth creation. Proposal of a separate policy to be introduced for hybrid instruments would allow flexibility to Start-ups to source foreign investments.
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Taxation of Non-residents
Currently, business profits of foreign companies/nonresidents only if there is ‘business connection’ in India, which essentially provides for physical presence based nexus. The continual increase in digital technologies and reduced need of actual physical presence for carrying on business had triggered discussions around whether the principle of ‘nexus with source country’ based on physical presence is inappropriate to tax transactions in the digital economy?
Watch: Union Budget 2018: Jaitley Recognises MSMEs As ‘Engine Of Growth, Employment’
While Finance Act 2016 had introduced Equalisation levy to tax India sourced online advertisement revenue, the Finance Bill 2018 proposes to bring in a new nexus rule by amending the definition of ‘business connection’ to include “significant economic presence” based on threshold for “revenue” and “users” in India. The threshold of “revenue” and the “users” in India will be decided after consultation with stakeholders. The concept of ‘significant economic presence’ to tax digital transaction has been discussed in the BEPS Action Plan of the Organisation for Economic Cooperation and Development (OECD). Also, some countries have already intimated this concept in its domestic tax laws.
This is an important development for foreign companies operating in online space, e-commerce, etc. which do not require physical presence to carry out India operations. However, clarification by the Government that business profits will continue to be taxed as per the existing treaty rules until the tax treaties are modified should address some of the concerns.
Another important amendment expanding the scope of the ‘business connection’ definition is the inclusion of business activities carried on by non-residents through agents in India, who habitually plays the principal role leading to conclusion of contracts by the non-resident. Thus, even if such agents are not concluding contracts in India but plays a principal role in concluding the contracts, income of the non-residents from such contracts would be taxable in India. This is again in line with OECD recommendation under BEPS Action Plan 7.
The proposed amendment would extend the tax net to also cover activities which are closely and intimately connected to the conclusion of contracts, viz., negotiation, marketing, information gathering etc. Hence, entities that play a leading role in concluding contracts between a foreign enterprise and Indian customers (although without any authority to conclude contracts) and entities engaging distributors including companies using subsidiaries for marketing functions needs to closely look at implications of this proposal vis-à-vis any applicable tax treaty.
By Milan K. Shah, PwC, Partner, Corporate & International Tax