By Vijai Jayaram, and Rohit Lal

These days there is significant change in the way software products are offered. Earlier, purchasing software implied heavy investment in infrastructure, installation, on-boarding, etc. However, the software-as-a-service (‘SaaS’) model, being cost effective and efficient in many ways compared to traditional software products, has fast become quite popular. The ease with which software services/ subscriptions can be provided remotely and the easy maintenance are some of the salient features of SaaS, which have contributed to its growing popularity.

India’s SaaS business too has shown tremendous growth. Growing at a compounded annual growth rate of 30%, revenue from Indian SaaS business reached $ 3.5 billion as of FY 2019-20. Further, even in overseas markets, Indian SaaS products are quite popular, which is evident from the fact that in the past couple of years, 75% of the demand for Indian SaaS products came from overseas.The present talent pool, comprising of both technically skilled engineers and product managers, are the primary drivers for the success of Indian SaaS products. The first generation of Indian SaaS startups has already established a robust presence in the market.

Further, the COVID-19 pandemic, that adversely affected most businesses, seems to have come as a boon for SaaS business. Businesses, which were earlier relying on the traditional software models, realised the importance of cloud based software, and the extended work-from-home practice gave rise to the need for integrating all IT related functions. This has resulted in an increase in the demand for SaaS products and consequently, leading to the growth of already existing SaaS companies while setting up new SaaS start-ups.

However, expansion of SaaS business is also likely to result in an increase in tax challenges / compliances associated with SaaS. Some key tax issues and challenges have been discussed below:

• The recently introduced equalisation levy provisions on non-resident e-commerce operators could impact overseas SaaS players providing services to Indian customers. Further, there are various challenges/ ambiguities associated with the levy such as, taxability of intragroup services considering the wide ambit of definition of ‘e-commerce supply or services’, availability of foreign tax credit as the levy is outside the purview of the Income-tax Act, 1961, inclusion/ exclusion of various components such as taxes, rebates for computing the levy, etc.
• The concept of Significant Economic Presence (‘SEP’) was introduced to bring those non-residents (not having physical presence in India) under the purview of ‘business connection’ who received consideration in excess of prescribed threshold, from Indian customers, in respect of goods or services provided remotely. The thresholds for applicability of SEP provisions have not been notified till date in light of on-going discussions on the subject in the G20-OECD BEPS project. Once the SEP provisions come into force from FY 2021-22, non-resident SaaS players will be required to monitor the sales made to Indian customers.
• Considering the broad coverage of the concept of SEP and equalisation levy, prima facie, it seems that both the above-mentioned regimes would be applicable to non-residents giving rise to double taxation. However, considering that, amounts which have been subjected to equalisation levy are specifically exempt under section 10(50) of the Act and non-applicability of equalisation levy in cases of existence of permanent establishment in India of non-residents, the question of double taxation becomes debatable. It largely seems that the threshold limit for SEP would act as a decisive factor for applicability of either of the above-mentioned provisions.
• In recent times, there has been an ongoing debate on whether sale of software has to be treated as sale of ‘copyright’ or ‘copyrighted article’. While the industry has been treating it as a ‘copyrighted article’ not being ‘royalty’, the tax authorities have been treating sale of software as ‘royalty’ leading to litigation. Increase in SaaS business might cause further logjam before the courts on this matter. The forthcoming judgment by the Hon’ble Supreme Court, in the case of Samsung Electronics, could hopefully help in bringing closure to the debate.
• While the equalisation levy provisions for e-commerce operators are applicable from 1 April 2020, the provisions that exempt such amounts on which equalisation levy has been paid i.e. section 10(50) of the Act will be applicable only from FY 2021-22. This contradiction in the tax provisions could lead to double taxation of amounts for FY 2020-21 and pose challenge for non-resident SaaS players.

To enable the rapidly growing Indian SaaS market to realise its full potential, India would need greater cross-industry collaboration, supportive government policy, clear tax provisions and higher investment.

(Vijai Jayaram is Director and Rohit Lal is Manager with Deloitte Haskins & Sells LLP)