Withholding Tax / TDS on Import of Goods by Indian Businesses under the Significant Economic Presence (SEP) Framework

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 Overview: Significant Economic Presence (SEP)

The concept of Significant Economic Presence (SEP) was introduced in Indian tax law to ensure taxation of foreign businesses that derive substantial income from the Indian market, even if they do not have a physical presence in the country.

Under Explanation 2A to Section 9(1)(i) of the Income Tax Act, 1961, a foreign company is deemed to have a SEP in India if:

  • It enters into transactions involving goods, services, or property—including downloading of data or software—with any person in India, and the aggregate payments exceed INR 2 crore during the relevant financial year; or
  • It engages in continuous solicitation of business or interacts with at least 300,000 users in India.

However, transactions solely for the purchase of goods for export are excluded from SEP classification.

Implications of SEP

The SEP provisions expand India’s tax reach to include digital and non-digital transactions by foreign entities. Notably:

  • SEP is treated as a form of “business connection”, enabling India to tax the income attributable to such presence.
  • Even a single high-value transaction (e.g., a one-time export exceeding INR 2 crore) may trigger SEP.
  • Foreign companies with SEP are subject to Indian tax compliance obligations: maintaining books of accounts, getting audited, paying tax, and filing returns.

SEP vs. Tax Treaties (DTAA)

Most Indian tax treaties use the term Permanent Establishment (PE)—a narrower concept than SEP. Where a Double Taxation Avoidance Agreement (DTAA) exists:

  • Treaty provisions override SEP rules if more favorable.
  • A foreign company must provide:
    • Tax Residency Certificate (TRC)
    • Form 10F
    • Declaration of no PE in India
    • Principal Purpose Test (PPT) declaration (where applicable under the treaty via MLI)

If these documents are in place, the Indian importer can apply the treaty benefits, including lower or nil withholding tax.

However, where no DTAA exists, the SEP provisions apply fully, and foreign suppliers may become taxable in India solely based on their economic activity.

Key Changes Introduced by SEP

  • Earlier: Tax applied only if a foreign company had a physical presence or agent in India.
  • Now: Digital or remote economic activity alone can create a taxable presence.
  • SEP adds to the existing types of “business connection” under Indian tax law:
    1. Fixed place of business (e.g., branch or office)
    2. Dependent agent
    3. SEP (new category)

Impact on Indian Importers

Indian businesses importing goods or services must now assess whether their foreign suppliers fall under SEP, particularly when withholding tax provisions do not otherwise apply. Key points to consider:

  • Due Diligence Requirement:
    • Verify whether the foreign supplier meets the SEP thresholds.
    • Obtain the following documentation to claim treaty benefits:
      • Tax Residency Certificate (TRC)
      • Form 10F
      • No-PE declaration
      • PPT confirmation (if applicable)
  • Consequences of Non-Compliance:
    • If documents are not furnished, the Indian importer may have to:
      • Deduct TDS at the maximum rate (35% plus surcharge and cess); or
      • Seek a lower deduction certificate from the tax authorities.
    • Non-compliance can lead to:
      • Disallowance of expenses under Section 40(a)(i)
      • Penalties and interest
  • Form 15CA/15CB Filing:
    • 15CA is not required to be filed in case of import of goods, being generally not taxable supply in India, in view of the exceptions provided under Rule 37BB. However, with the introduction of SEP concept in the definition of Business Connection, import of goods being taxable supply under the income tax act, it can be argued that 15CA is required to be filed even in the case of import of goods if SEP conditions are fulfilled.

Conclusion

With the SEP provisions now in force, Indian importers must take a proactive approach in assessing the tax status of their foreign suppliers. Ensuring compliance through documentation and appropriate TDS deduction is essential to avoid disallowances, penalties, and increased scrutiny from tax authorities.