Digitization widening the Scope of Business Connection and Tax Implication in India

Rapid digitization has raised many questions regarding the tax implications on income generated through digital mode. What constitutes as Business Connection or Permanent Establishment?

Introduction
 
India with the second largest population in the world have the biggest customer base which encourage many multinational companies to be present in India through physical or virtual mode. The outbreak of coronavirus has opened innovative ways of carrying out business activities and business interaction across the world. Prohibition on travel, lockdown and social distancing has limited the reach of business not only in the domestic market but in the foreign market. This has resulted in changing the conventional manner of doing business and the adoption of more digital technologies to do business such as the internet, videoconference, e-commerce, cloud computing.
 
This rapid digitization has raised many questions regarding the tax implications on income generated through digital mode. India is one of the most proactive countries to take steps to tax digital economy in domestic law and continuing with this effort, the Finance Bill 2020 widen the scope of business connection with insertion of explanation 3A to section 9(1) of the Income Tax Act, 1961.
 
The Act cover that any income accruing or arising, 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 through the transfer of a capital asset situated in India, is deemed to be arising or accrued in India and is subject to the imposition of income tax in India.
 
Therefore, it becomes imperative for MNCs having a business connection in India to analyse their income tax implication in India. In this article, we will deliberate upon the concept of business connection in India and the impact of the recent amendment or rulings on the same.
 
Scope of Business Connection in India
 
The term Business Connection is wider than the concept of Permanent Establishment which prima facie covers the fixed place or physical presence in India. Business Connection includes business activities conducted by agents on behalf of non-residents who habitually conclude contracts in India or play a principal role in their conclusion in the country. The Income Tax Act prescribes that only income that is reasonably attributable to such activity carried out in India will be taxed in the country. But what about the services rendered through virtual mode?
 
The term Business Connection also includes the concept of a significant economic presence which is defined as:
 
  • a transaction carried out by a non-resident in India in respect of goods, services or property and includes provision for downloading of data or software in India, and
  • systematic and continuous soliciting of business activities or interaction with the prescribed number of users in India through digital means.
 
The significant economic presence related thresholds or monetary limits for transactions and the number of users is yet to be prescribed by the Central Board of Direct Taxes and its implementation has been deferred to 1st April 2022. This is to help the multinational companies to understand the compliances and take the necessary steps before the enactment.
 
Further, the Finance Act 2020 (through explanation 3A to section 9(1) of the Income Tax Act, 1961) effective from 1st April 2021 has widened the scope of business connection in India and introduced that any MNC having the income through advertisement, e-commerce activities from a person residing in India or a person using Indian IP address shall constitute business connection in India.
 
Impact of these amendments in a Business Connection
 
a) Multinational Companies (from a country) having the Double Taxation Agreement with India – Any foreign entity covered by Double Taxation Avoidance Agreement, earns any income in India through digital means will be construed as income accrued and arose in India under section 9(1) of the Income Tax Act 1961. Though the Act has been amended to cover specified digital transactions, most of the treaty agreement still construes Permanent Establishment based on physical presence. Therefore, in case the foreign entity having the business connection in India as per the Act, the said entity may have an option under DTAA if they are more beneficial.
 
b) Multinational Companies (from a country) having no Double Taxation Agreement with India – Any foreign entity not covered by Double Taxation Avoidance Agreement, earns any income in India through digital means will be construed as income accrued and arose in India under section 9(1) of the Income Tax Act 1961 and will be required to pay tax in India to the extent such income accrue and arise in India.
 
 
Recent Case Law on Business Connection in India
 
Recently, the Mumbai bench of the Income-tax Appellate Tribunal held that the income earned by an international celebrity for appearance/ participation in a product launch event outside India, for which all the benefits accrued to the payer in India, constituted an intangible business connection of the non-resident in India, and was taxable in India. Thus, the Indian payer (taxpayer) was obligated to withhold taxes on such payment u/s 195 of the Income-tax Act, 1961.
 
The ruling has been rendered considering changing business models for the purpose of interpretation of the term business connection in India (even where activities are not carried out physically in India). The companies may want to assess impact of the same, inter alia, while determining tax liability for activities undertaken outside India but having nexus with India.
 
Conclusion
 
India with introduction of the concept of ‘significant economic presence’ and recent amendment to expand the scope of business connection has clearly shown its intent towards taxing the non-residents who are benefitted from the India economy via e-commerce and related transactions. Therefore, it is important for a multinational company having the business in India through physical or virtual mode to understand the implication of income tax on income earned through business connection in India.