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Direct Tax Laws & International Taxation · Taxation of Digital Transactions

Taxation of Digital Transactions: Overview

Updated 5 October 2026 · Fact-checked

Digital transactions are taxed in India by treating income of non-residents from Indian customers and users as income deemed to accrue or arise in India. A business connection, including significant economic presence (SEP), creates the nexus. To solve a question, test the SEP thresholds, apply any treaty, then tax only the attributable income.

Understand Taxation of Digital Transactions: Overview

A foreign company can sell software, run an app or show ads to Indian users without any office in India. Old tax rules needed a physical link, such as an office or an agent. Digital businesses do not need one. So the law widens the idea of nexus.

The starting point is the rule on income deemed to accrue or arise in India. Income of a non-resident through or from a business connection in India is taxable in India. A business connection normally means a close, continuing link, such as a dependent agent who habitually concludes contracts or secures orders for the non-resident.

To capture digital businesses, the law adds significant economic presence (SEP) as a business connection. The Income-tax Act, 2025 carries forward this SEP provision. SEP has two limbs. First, a transaction in respect of any goods, services or property with a person in India, including download of data or software, where the aggregate payments in the year exceed the prescribed amount. Second, systematic and continuous soliciting of business activities, or engaging in interaction with users in India through digital means, where the number of such users exceeds the prescribed number.

The figures you will see quoted are ₹2 crore of payments and 3 lakh users. These were notified under the Income-tax Act, 1961 (Notification 41/2021, under Explanation 2A to section 9 of that Act). Payments carry the ₹2 crore limit and users carry the 3 lakh limit. The 2025 Act's equivalent notification is not confirmed here, so check the prescribed limits against the current notification before you rely on them in an answer or a case.

SEP applies whether or not the non-resident has a place of business in India, has an agreement made in India, or renders services in India. Only the income attributable to the Indian transactions or user activity is taxed in India, not the whole global profit.

Two more points matter. If the non-resident is from a treaty country, the non-resident may be governed by the provisions of the Act or the treaty, whichever is more beneficial, subject to the conditions for claiming treaty benefit. The treaty's permanent establishment (PE) definition has not been widened for SEP, so SEP is often neutralised by treaties and relief is often available.

The equalisation levy is now historical. The 2% levy on e-commerce supply or services was abolished by the Finance Act 2024 with effect from 1 August 2024. The 6% levy on online advertisement and specified services was abolished by the Finance Act 2025 with effect from 1 April 2025. Treat the levy as relevant only to earlier periods. For current periods, taxation of such income relies on the domestic business connection/SEP rules, withholding and treaty positions.

Key rules to remember

SEP limb 1: payments test
Aggregate payments from transactions in India in the year > prescribed amount (₹2 crore as notified under the 1961 Act, Notification 41/2021)
Covers goods, services, property and download of data or software. The test is on payments, not on profit. Check the figure against the current notification.
SEP limb 2: users test
Systematic and continuous soliciting of business activities, or interaction with users in India through digital means, with users > prescribed number (3 lakh as notified under the 1961 Act, Notification 41/2021)
Either limb is enough. The limbs are alternatives, not cumulative. Check the number against the current notification.
Extent of taxable income
Taxable in India = income attributable to the Indian transactions or user activities
Only attributable income is deemed to accrue in India, not global profit.
Physical presence not needed
SEP exists whether or not the non-resident has a place of business, agreement in India or services rendered in India
Use this line to answer arguments that the foreign firm has no office in India.
Treaty choice
For a treaty-country non-resident: governed by the provisions of the Act or the treaty, whichever is more beneficial, subject to the conditions for claiming treaty benefit
This is not an automatic arithmetic minimum of two tax figures. If the treaty gives no PE or business-profits taxing right, treaty relief can apply, but only if the treaty conditions are met and documents such as a tax residency certificate are held.

How to solve Taxation of Digital Transactions: Overview questions

Use this order for any case on digital or e-commerce income of a non-resident.

  1. 1Identify the parties. Is the earner a non-resident? Where are the customers or users located? If the earner is a resident, SEP is not relevant.
  2. 2Classify the income. Is it business income, royalty or fees for technical services? Each may have its own deeming and rate rule.
  3. 3Test for a traditional business connection first, such as a dependent agent in India.
  4. 4Apply the SEP payments test: add all payments from Indian transactions in the year, including downloads of data or software. Compare with the prescribed limit.
  5. 5Apply the SEP users test separately: count Indian users with whom there is systematic and continuous soliciting or interaction through digital means. Compare with the prescribed number.
  6. 6If either test is met, SEP is a business connection. Income attributable to those Indian activities is deemed to accrue or arise in India.
  7. 7Check the treaty. If the country has a DTAA and the treaty PE or business-profits article does not tax the income, state that treaty relief may apply.
  8. 8Conclude in provision-facts-conclusion form and add compliance such as withholding by the payer.

Quickest way: Two thresholds, one attribution, one treaty check

When to use it: For MCQs and short case scenarios where the facts give payments, user counts and the country of the foreign entity.

  1. Underline the payment total and the user count in the facts.
  2. Compare each with ₹2 crore and 3 lakh. Meeting either one gives SEP.
  3. Ignore irrelevant facts such as no office, no agent or server abroad.
  4. Write that only attributable income is taxable.
  5. Add one line: treaty may give relief if the country has a DTAA.

Common mistakes in Taxation of Digital Transactions: Overview

  • Saying SEP exists only if both the payments and users tests are met.

    Students read the two limbs as a single combined condition.

    Fix: The limbs are alternatives. Meeting either one is enough.

  • Taxing the entire global profit of the foreign company in India.

    Students focus on the nexus and forget the limit on the amount.

    Fix: Only income attributable to the Indian transactions or user activity is deemed to accrue in India.

  • Denying taxability because the foreign company has no office, agent or server in India.

    Students apply the old physical-presence logic.

    Fix: SEP applies whether or not there is a place of business, an Indian agreement or services rendered in India.

  • Ignoring the treaty.

    Students stop once the domestic rule applies.

    Fix: For a treaty-country non-resident, check whether the treaty gives India the right to tax. The assessee may follow the Act or the treaty, whichever is more beneficial, subject to treaty conditions and a tax residency certificate. The treaty PE definition has not been widened by SEP.

  • Testing SEP on profit or receipts of the whole company instead of Indian transactions.

    Students use the wrong base for the threshold.

    Fix: Use aggregate payments arising from transactions with persons in India in the year. Do not use global revenue.

  • Still computing 2% equalisation levy on e-commerce supplies or 6% on advertisements for current periods.

    Old notes are still in circulation.

    Fix: The 2% levy was abolished by the Finance Act 2024 from 1 August 2024. The 6% levy was abolished by the Finance Act 2025 from 1 April 2025. Treat both as historical. Rely on the business connection/SEP rules, withholding and treaty positions, and remember that treaties often neutralise SEP.

Worked examples

Example 1

Streamline Inc., a non-resident company of a country with no DTAA with India, runs a video platform. In the year it receives ₹3.5 crore of subscription payments from persons in India. It has no office, employee or agent in India and its servers are abroad. It has about 1.8 lakh Indian users. Is its income taxable in India?

Show the solution
  1. Provision: income of a non-resident through a business connection in India is deemed to accrue or arise in India. SEP is a business connection.
  2. SEP payments test: payments from Indian transactions are ₹3.5 crore, which exceed ₹2 crore. The test is met.
  3. SEP users test: 1.8 lakh users is below 3 lakh, so this limb is not met. This does not matter, because one limb is enough.
  4. Absence of office, agent or servers is irrelevant under the SEP rule.
  5. No DTAA exists, so there is no treaty relief.

Answer: Streamline Inc. has SEP in India through the payments limb. The income attributable to its Indian subscription activities is deemed to accrue or arise in India and is taxable. Global profit is not taxed.

Example 2

Bright Apps LLC, a non-resident from a treaty country, has 2.6 lakh Indian users and receives ₹1.7 crore from Indian customers in the year. It has no office or agent in India. Examine whether SEP arises.

Show the solution
  1. Payments test: ₹1.7 crore is below ₹2 crore, so limb 1 is not met.
  2. Users test: 2.6 lakh is below 3 lakh, so limb 2 is not met.
  3. No dependent agent or other traditional business connection is present in the facts.
  4. Neither limb is met, so SEP does not arise, even though the user base is large.
  5. Separately, if any receipts are in the nature of royalty or fees for technical services, they are examined under their own provisions and the treaty, independent of SEP.

Answer: SEP does not arise because both thresholds are not exceeded, so no business connection is created through SEP. Any royalty or fees for technical services receipts would be examined separately under their own provisions and the treaty. The SEP position changes if payments exceed ₹2 crore or users exceed 3 lakh in a later year.

Exam tips

  • Always state both SEP limbs and say that either limb is enough.
  • Quote the thresholds as ₹2 crore of payments and 3 lakh users, say they were notified under the 1961 Act (Notification 41/2021), and add that the current notification should be checked. Then compare them with the numbers given in the case.
  • Write the answer as provision, facts, conclusion. Examiners reward the nexus logic and the attribution limit.
  • In MCQs, watch for distractors such as no office, no agent or servers abroad. These do not defeat SEP.
  • Link this topic with the treaty PE rules and the abolition of the equalisation levy. Mention both in a long answer, and describe the levy as historical.

Practice questions from Taxation of Digital Transactions

Taxation of Digital Transactions: Overview: frequently asked questions

What is significant economic presence under the Income-tax Act, 2025?

It is a deemed business connection for a non-resident with sufficient digital or transaction-based dealings with India. It arises if payments from Indian transactions exceed the prescribed amount, or if there is systematic and continuous soliciting of business activities or interaction with more than the prescribed number of users in India through digital means. Either test is enough.

What are the SEP thresholds?

The figures commonly used are aggregate payments above ₹2 crore or more than 3 lakh users in India. These were notified under the Income-tax Act, 1961 (Notification 41/2021), and the 2025 Act carries forward the SEP provision. Check the prescribed limits against the current notification. Meeting either limb creates SEP.

Is the whole income of the foreign company taxed if SEP exists?

No. Only the income attributable to the Indian transactions or user activities is deemed to accrue or arise in India.

Does a tax treaty override SEP?

For a non-resident from a treaty country, the assessee may be governed by the Act or the treaty, whichever is more beneficial. The treaty can give relief because the treaty PE definition has not been widened for SEP. The non-resident must meet the treaty conditions and keep the required documents, such as a tax residency certificate.