How to Calculate TDS on Cross-Border Payments

Section 195: The Foundation of Cross-Border TDS

Section 195 of the Income Tax Act, 1961 requires any person making a payment to a non-resident (other than salary) to deduct tax at source if the income is taxable in India. This applies to payments made by Indian subsidiaries, branch offices, liaison offices, and even individuals or HUFs making business payments to non-residents.

The critical principle: TDS under Section 195 must be deducted on the gross amount of payment, not the net income component. If you pay INR 50 lakhs as royalty to a US parent company, TDS applies on the full INR 50 lakhs -- not on the "profit element" of the royalty.

Payments Covered Under Section 195

• Interest on loans, ECBs, and deferred payments
• Royalties for use of intellectual property, trademarks, and patents
• Fees for technical services (FTS) and management fees
• Dividends paid to non-resident shareholders
• Capital gains on sale of Indian assets by non-residents
• Rent, commission, and professional fees paid to non-residents
• Payments for software licences (treated as royalty under Indian law since 2012)

Step 1: Identify the Applicable Domestic TDS Rate

The starting point is always the domestic rate under the Income Tax Act. Here are the key rates for FY 2026-27:

Important: Non-Furnishing of PAN

If the non-resident payee does not have an Indian PAN, the payer must deduct TDS at the higher of:

• The rate prescribed in the Act
• The rate in the applicable DTAA
• 20%

However, following the Supreme Court ruling in November 2025 (Engineering Analysis Centre of Excellence Pvt Ltd), when a valid DTAA applies and the payee provides a Tax Residency Certificate (TRC), the DTAA rate prevails even without a PAN. This landmark judgment clarified that Section 206AA (higher TDS for no PAN) cannot override DTAA rates.

Step 2: Check the Applicable DTAA Rate

India has Double Taxation Avoidance Agreements with over 95 countries. The DTAA rate often provides a lower withholding rate than the domestic rate. You are legally required to apply the lower of the domestic rate or the DTAA rate.

Key DTAA Rates for Common Countries

Note: Some DTAAs do not have a separate article for Fees for Technical Services. In those cases, FTS may be taxed as business income (exempt if no permanent establishment in India) or as royalty, depending on the treaty language.

Documents Required to Claim DTAA Benefits

• Tax Residency Certificate (TRC): Issued by the tax authority of the non-resident's home country for the relevant year
• Form 10F: Self-declaration by the non-resident providing details like address, TIN, and period of residential status
• No PE declaration: A declaration that the non-resident does not have a permanent establishment in India (where relevant)

Step 3: Apply Surcharge and Cess (Domestic Rate Only)

This is where most companies make errors. The rules differ depending on whether you apply the domestic rate or the DTAA rate:

If Using Domestic Rate

Add surcharge and cess on top of the base rate:

Health and Education Cess of 4% is always applicable on (TDS + surcharge).

If Using DTAA Rate

No surcharge and no cess. The DTAA rate is applied as a flat rate. A 15% DTAA rate means exactly 15% withholding -- not 15% plus surcharge and cess.

This is one of the most common errors in cross-border TDS compliance. Applying surcharge and cess on top of a DTAA rate results in excess withholding, requiring the non-resident to file an Indian tax return to claim a refund -- a process that can take 12-24 months.

Step 4: Calculate the TDS Amount

Here are three worked examples covering common scenarios:

Example 1: Royalty Payment to UK Company

Example 2: Interest on ECB from Singapore Bank

Example 3: FTS to German Consultant (No DTAA Article)

Step 5: Gross-Up if Company Bears the Tax

Many intercompany agreements specify that the Indian subsidiary bears the withholding tax, meaning the parent receives the full invoice amount. In this case, you must gross up the payment to calculate the correct TDS.

Gross-Up Formula

Gross-up amount = Net payment / (1 - TDS rate)

TDS on grossed-up amount = Gross-up amount x TDS rate

Worked Example

Your subsidiary must pay INR 25,00,000 net to a UK parent as royalty, with the subsidiary bearing the tax:

This gross-up cost must be factored into transfer pricing documentation. The arm's length price includes the grossed-up amount, not just the net payment.

Step 6: Deposit TDS and File Returns

TDS Deposit Deadlines

Use Challan No. 281 to deposit TDS electronically through the NSDL/TIN website. Select the correct section code (195) and nature of payment code.

Quarterly TDS Returns

File Form 27Q (TDS return for payments to non-residents) quarterly:

TDS Certificate

Issue Form 16A to the non-resident payee within 15 days from the due date of filing the quarterly TDS return. Download Form 16A from the TRACES portal after filing Form 27Q.

Form 15CA and 15CB: Mandatory Compliance

Before making any foreign remittance, the payer must file Form 15CA electronically on the Income Tax e-filing portal. Depending on the remittance amount and taxability, different parts of Form 15CA apply:

Form 15CB: CA Certificate

When Part C applies, a Chartered Accountant must issue Form 15CB certifying:

• Nature of the remittance and applicable tax rate
• Whether DTAA benefits are being claimed
• TRC and Form 10F details of the non-resident
• Amount of TDS deducted and deposited

The CA uploads Form 15CB to the IT portal, generating a certificate number that you enter in Part C of Form 15CA. The bank will not process the remittance without a valid Form 15CA acknowledgement.

Exemptions from Form 15CA/15CB

33 categories of payments listed in Rule 37BB are exempt, including:

• Imports of goods (covered under customs)
• Payments for travel, education, and medical treatment (within RBI limits)
• Payments by diplomatic missions
• Interest on NRE/FCNR deposits

Penalties for Non-Compliance

The consequences of getting cross-border TDS wrong are severe:

The most expensive penalty is the Section 40(a)(i) disallowance. If you fail to deduct TDS on a USD 100,000 royalty payment, 30% (USD 30,000) is disallowed as a business expense, increasing your taxable income and resulting in additional corporate tax of approximately USD 7,500 at the 25.17% effective rate.

Lower or Nil Deduction Certificate Under Section 197

If a non-resident expects their total Indian tax liability to be lower than the TDS that would be deducted, they can apply for a lower or nil deduction certificate from the Assessing Officer under Section 197. This is common in situations where:

• The non-resident has significant expenses attributable to the Indian income, reducing net taxable income
• The payment falls under a DTAA article that exempts it as business income (no PE)
• The non-resident has brought-forward losses from prior Indian assessments

Application Process

1. The non-resident files Form 13 electronically on the TRACES portal
2. The Assessing Officer examines the application and issues a certificate specifying the rate (which can be as low as nil)
3. The certificate number is quoted in Part B of Form 15CA
4. Processing typically takes 30-45 days from submission

This route is particularly useful for recurring payments where the standard or DTAA rate would result in systematic over-withholding. For example, a US technology company providing cloud infrastructure to its Indian subsidiary may obtain a nil certificate if the DTAA classifies the payment as business income and the US company has no PE in India.

Section 195(2) and 195(3) Orders

Alternatively, the payer can apply to the Assessing Officer under Section 195(2) for a determination of the appropriate portion of the payment that is chargeable to tax. This is useful when only part of a composite payment (e.g., a lump-sum contract covering both goods and services) is taxable in India. The AO's order specifies what proportion of the payment requires TDS and at what rate.

Special Situations

Software Payments

Following the Supreme Court's 2021 ruling in Engineering Analysis Centre of Excellence Pvt Ltd v CIT, payments for software licences (without transfer of copyright) are not royalties and are not subject to TDS under Section 195. However, if the payment involves customisation, support services, or transfer of copyright, TDS may apply. Analyse each software payment on its facts.

Cloud Services (SaaS/IaaS)

Payments for standard cloud services (AWS, Azure, Google Cloud) are generally treated as business income of the foreign provider, not royalty or FTS. If the provider has no permanent establishment in India, no TDS applies under the applicable DTAA. However, the payer must still file Form 15CA (Part D) to confirm non-taxability.

Reimbursement of Expenses

If the non-resident incurs expenses on behalf of the Indian entity (travel, marketing, legal), and the payment is a pure reimbursement at cost with no income element, TDS is not required. However, the burden of proof is on the payer to demonstrate that the payment is indeed a reimbursement and not disguised income. Maintain supporting documentation (third-party invoices, expense breakdowns).

Key Takeaways

• Always compare the domestic TDS rate with the applicable DTAA rate and apply the lower of the two
• Never add surcharge and cess to DTAA rates -- this is the most common error and results in excess withholding
• Deposit TDS by the 7th of the following month and file Form 27Q quarterly to avoid penalties
• File Form 15CA before every foreign remittance; obtain Form 15CB from a CA when aggregate payments to the payee exceed INR 5 lakh
• Non-deduction of TDS triggers a 30% expense disallowance under Section 40(a)(i), which is far more costly than the TDS itself