New Indian tax rules: Watch out for implications of Significant Economic Presence

Since 2021, the Organization for Economic Co-operation and Development (OECD) has been tackling tax evasion globally by companies -who shift their profits to low-tax jurisdictions. This so-called BEPS (Base Erosion and Profit Shifting) project focuses specifically on tax challenges of the new, digital economy. India has incorporated the measures from BEPS into its tax code, which may affect your company if you do business in India. 

The key concept that India has adopted from the BEPS project is "Significant Economic Presence" (SEP). We explain the implications of this addition for Indian tax law in this article. 

Significant Economic Presence (SEP).

Significant Economic Presence means that tax should be levied if a company has significant involvement in the market where it will pay the tax, even if it has no physical presence in the country. Under current law, a foreign company in India constitutes an SEP if:

• it enters into a transaction involving goods, services or property with a legal entity in India, including downloading data or software, and the total payments resulting from such transaction(s) exceed 20 million rupees (220,000 euros) in the previous year.

or

• it engages in continuous business recruitment or is in contact with at least 300,000 users.

The implications of SEP for foreign companies in India

The idea behind the SEP provision is to ensure that no one who makes profits in a country avoids taxation there and that all players are valued the same way. Despite the OECD's regulatory focus on the digital economy, the current implementation of SEP in India has a broad scope. Indeed, it covers all transactions involving goods, services or property conducted by foreign companies with a legal entity in India, whether online or offline.  

The SEP has been implemented in a very broad sense in India, with the result that even foreign companies that have no entity in India are already considered SEP by their activities. For example, the one-time export of goods to India by a foreign company, which is not otherwise active in India, can already trigger the SEP provision if it exceeds 20 million rupees (€220,000). 

Thus, Indian law looks at both the regularity with which you as a foreign company operate in India and the income involved. Once the provision takes effect, the foreign company must keep accounts, undergo audits, pay taxes and file tax returns in India.

SEP and the European tax treaties with India

Companies with operations in India that are located in countries with which India has a tax treaty will obviously not be double valued because they are classified as SEP. Indian laws also dictate that for foreign companies, the most favorable provisions of either the Indian tax code or the tax treaty will govern. 

India's tax treaties with Europe do not use the term SEP but the term Permanent Establishment, which has a narrower scope. As long as foreign companies can prove that they do not have a "permanent establishment" in India, they remain outside the scope of the SEP provisions. For this, however, the company must be able to provide documentation, including a certificate of tax residency, a statement that they do not have a 'permanent establishment' and Form 10F.

However, the SEP provisions will always apply to companies coming from countries that do not have a tax treaty with India (all European Union member states have a tax treaty with India). For companies from these countries, it is important to constantly check whether the transactions trigger the SEP provisions. 

Everything you need to know about the tax side of doing business in India

SEP and Permanent Establishment are not the only insidious, tax issues European companies encounter in India. IndiaConnected has been active in India for ten years and annually helps hundreds of companies with their questions about the Indian tax system and other tax issues. To help companies get started, we have therefore compiled all our knowledge and tips into a free guide for CFOs with operations in India.

Differences in the way of doing business among Indian states

India is almost as large as the European Union and has more than twice as many inhabitants. No wonder, then, that there are major differences between the various Indian states in terms of language, demographics, politics and economic growth. For a successful start-up in India, it is therefore important to take these differences into account when drawing up a business plan. Because what works in Gujarat does not automatically work in West Bengal.

Image via Harvard Business Review

The regional differences among Indian states

For a European company to succeed in India, you must be aware of the country's vast regional differences. India is a fragmented market with large, and often underestimated, regional differences in language, culture, infrastructure and wealth, all of which affect the regional business culture.

Indian states are therefore better compared to individual countries than to, say, the Dutch provinces. Indeed, India's most populous state, Uttar Pradesh, has as many inhabitants as Brazil, and the southern state of Tamil Nadu has an economy as large as that of Hungary. 

There are also large demographic differences between Indian states. For example, southern India is older, has more to spend and is more educated than the rest of the country. Northern India, on the other hand, is younger and relatively poor.

North Indians primarily speak Hindi, while South Indians prefer to communicate in English or in their regional state language, such as Kannada or Malayalam. The German wholesaler METRO, better known in the Netherlands as Makro, found out after their start in India that there are big differences between the groceries that customers in a certain region put in their shopping cart and adjusted the assortment accordingly by adding more local products. Logical really, Finns also have different preferences than Spaniards.

"METRO found out that there are big differences between the groceries that customers in different regions in India put in their shopping cart."

- Mark Alexander Friedrich, Head of International Affairs for METRO

Do not make one business plan for all of India

For a successful start in India, thorough market research is a must. Regional differences are not only obstacles, but can also work in your favor depending on your sector and product.

The southwestern states, such as Maharashtra and Karnataka, are a suitable base for technical sectors such as automotive, engineering, as well as outsourcing IT and Research & Development teams.

Northern states such as Punjab and Haryana, among others, have thriving agricultural sectors, creating opportunities for food processing and renewable energy industries.

Starting in the right regions is also essential for selling your product in India. European products almost always fall in the highest market segment in India, so it is smart to start in the regions where people have sufficient income and there is real demand for a more exclusive, expensive product.

"Approaching India as one country by working with only one distributor or partner is one of the most common mistakes European companies make in India," says Klaus Maier, CEO of Maier + Vidorno, IndiaConnected's partner in India.

"In Europe, you wouldn't ask an Italian distributor to set up your network in Norway either. An Indian partner or distributor operating in a specific state has a good network only there and will not succeed in successfully expanding sales to other states. Therefore, those who take India seriously start with about four dedicated, local managers or distributors who understand your product and the regional market well. With them, the market can be mapped and the logistics network set up, one of the biggest challenges for international companies in India. In this way, the Indian market can be conquered step by step, successfully." 

Selling successfully in India with the right strategy

For anyone looking to conquer the Indian market, IndiaConnected has put together a special guide in which we offer you insight into the steps to take to successfully start and grow your sales in India.

From preparing your first export shipment to India to setting up a solid after sales service, we guide and advise throughout your India journey.

How does a foreign company deal with corruption in India?

Any foreign company doing business in India will eventually have to deal with corruption. Prime Minister Modi has made many changes in recent years to improve the situation in the country, but India still ranks 80th in Transparency International's corruption index. As an international company, you want to stay as far away as possible from paying bribes, because this can have serious consequences not only in India, but also in your own country.

Every year, Transparency International ranks 176 countries worldwide on corruption. India is ranked 80.

Clean business takes time

It is still not uncommon in India to be asked for 'speed money', an amount paid under the table to get a permit approved more quickly, for example. Despite the fact that in some cases it seems as if there is no other solution than to pay, we strongly advise international companies against this. Firstly, it is of course forbidden and secondly, it is perfectly possible to do clean business in India. 

For instance, the German IT company Optanium went to India to look for an accounting firm that could set up their entity in India without paying bribes. The process of setting up the company took longer, thirteen months instead of six, but it allowed Optanium India to get off to a flying start. An important tip is therefore to plan enough time for dealing with issues such as applying for licences or the release of your products from customs. 

It is easier for foreign companies not to cooperate with corruption'.

In an interview with Quartz, Ravi Venkatesan, former chairman of Microsoft India and author of the book 'Conquering the Chaos: Win in India, Win Everywhere', explains how companies should deal with corrupt situations. "It is easier for a foreign company not to participate in corruption. The local management can stand firm and say that paying bribes is against their company policy. If a hard line is taken, the bribe-takers will drop out." 

In addition, having a very strong administrative department is essential, according to Venkatesan. "Manage your business with competent, long-term administrative staff who can hold their own in discussions with officials. Many companies do not invest enough in these functions because they do not see them as the core of the business. Instead, they outsource these administrative tasks to local agents, who do pay the 'speed money' and simply bury it in their other expenses."

"Many companies in India do not invest enough in administrative staff. That makes them vulnerable to corruption."

- Ravi Venkatesan

Always your papers in order

Fortunately, there are more and more situations in India where corruption has been completely eliminated because those processes are now automated or better controlled, such as filing your taxes or getting your identification. If you make sure you always have all your paperwork in order and therefore never need special assistance, you can avoid corruption with ease.

Of course, the experts at IndiaConnected can help you ensure that your business is always and in every area compliant.