US-India IP Transfer: Royalty, License, and Tax Traps

Why IP Transactions Are the Most Dangerous Tax Area in US-India Structures

Intellectual property is the backbone of most US-India corporate structures. Whether it is a trademark licence, a technology transfer agreement, a patent licence, a software licence, or a cost-sharing arrangement for R&D, the flow of IP between a US parent and its Indian subsidiary triggers a web of overlapping tax provisions in both countries — and the traps are everywhere.

On the Indian side, every IP-related payment from the Indian subsidiary to the US parent is subject to: (a) withholding tax under Section 195 of the Income Tax Act; (b) royalty classification under Section 9(1)(vi), which has one of the broadest definitions of "royalty" in global tax law; (c) transfer pricing scrutiny under Sections 92A-92F; and (d) FEMA regulations that cap royalty payments under the automatic route.

On the US side, the One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, has fundamentally changed how IP income from Indian subsidiaries is taxed through the revised NCTI (formerly GILTI) and FDDEI (formerly FDII) provisions, while also excluding gains from intangible property dispositions from the FDDEI calculation.

The India-US DTAA provides some relief through capped withholding rates under Article 12, but the treaty's unique "fees for included services" concept and "make-available" clause add complexity that exists in very few other Indian tax treaties. Getting any of these elements wrong can result in double taxation, penalties, or blocked payments.

Article 12 of the India-US DTAA: Royalty and Fees for Included Services

Article 12 is the primary treaty provision governing IP-related payments between the US and India. It covers both "royalties" and "fees for included services" (FIS) — a concept unique to the India-US DTAA that does not appear in the OECD Model Convention.

Treaty Definition of Royalty (Article 12(3))

Under Article 12(3), royalties include payments for:

• The use of, or the right to use, any copyright of literary, artistic, or scientific work (including cinematographic films and recordings)
• Any patent, trademark, design or model, plan, secret formula or process
• Information concerning industrial, commercial, or scientific experience
• The use of, or the right to use, industrial, commercial, or scientific equipment

Withholding Tax Rates Under Article 12

The India-US DTAA prescribes the following withholding tax rates on royalties:

To claim the beneficial DTAA rate, the US company must: (a) hold a valid Tax Residency Certificate (TRC) from the IRS; (b) furnish Form 10F with Indian tax details; and (c) not have a permanent establishment in India to which the royalty is effectively connected (Article 12(5)). If the royalty is connected to a PE, it is taxed as business profits under Article 7 at the much higher effective rate of ~38.22%.

The "Make-Available" Clause (Article 12(4)(b))

The "make-available" clause is unique to the India-US DTAA and a few other Indian treaties (India-UK, India-Canada). It provides that "fees for included services" are only taxable in India if the services "make available" technical knowledge, experience, skill, know-how, or processes to the recipient, or consist of the development and transfer of a technical plan or design.

The critical test: technology is considered "made available" when the person acquiring the service is enabled to apply the technology independently, without further assistance from the service provider. If the service provider retains the know-how and the Indian entity cannot replicate the service independently afterward, the payment does not qualify as FIS and may not be taxable in India at all.

Practical impact: This clause is a powerful planning tool. Many US companies providing consulting services, market research, data analytics, or technical support to their Indian subsidiaries can argue that these services do not "make available" any technology — the Indian subsidiary receives a deliverable but not the underlying methodology or know-how. However, Indian tax authorities aggressively challenge this position, and significant litigation has resulted. Recent ITAT rulings have generally upheld a strict interpretation of "make available," providing relief to many US companies.

India's Domestic Royalty Definition: Section 9(1)(vi) — The Trap

Here is where US companies frequently fall into a trap. India's domestic definition of "royalty" under Section 9(1)(vi), Explanation 2, is significantly broader than the treaty definition under Article 12(3) of the DTAA. The domestic definition includes:

• Transfer of all or any rights (including the granting of a licence) in respect of any patent, invention, model, design, secret formula or process, or trademark
• Imparting of information concerning the working of, or the use of, a patent, invention, model, design, secret formula, or trademark
• Use of, or right to use, any industrial, commercial, or scientific equipment (other than aircraft, ships, or specified inland waterway vessels)
• Transfer of all or any rights in respect of any copyright, literary, artistic, or scientific work (including films and recordings)
• Rendering of any services in connection with the above activities
• The use of, or right to use, any process (added by Explanation 6)

The last item — "any process" — is the broadest category. After the retrospective amendments introduced by Finance Act 2012 (Explanations 4, 5, and 6), India's domestic definition of royalty now encompasses virtually any payment for the use of a process, including software licenses, algorithms, and automated systems. The Supreme Court in the Engineering Analysis Centre of Excellence case (2021) ruled that Explanation 4 was prospective (effective from AY 2013-14), not clarificatory, which limits the retrospective impact. However, from AY 2013-14 onward, the expanded definition applies in full.

DTAA Override: The Saving Grace

The critical protection for US companies is that the DTAA definition prevails over the domestic definition when the treaty provides a more beneficial treatment. Under Section 90(2) of the Income Tax Act, the provisions of the DTAA apply to the extent they are more beneficial to the taxpayer. This means:

• For US companies with a valid TRC, the narrower Article 12(3) treaty definition of royalty applies, not the broader Section 9(1)(vi) domestic definition
• The 15% DTAA rate applies instead of the 20% domestic rate
• Payments that do not fall within the treaty definition of royalty may not be taxable in India at all (subject to business profit rules under Article 7)

However, claiming treaty benefits requires rigorous documentation. If the Indian subsidiary fails to deduct tax at the treaty rate without proper TRC and Form 10F documentation, it can be held liable as an assessee-in-default under Section 201.

FEMA Regulations: The Regulatory Cap on IP Payments

Beyond tax considerations, every IP payment from an Indian subsidiary to a US parent must comply with FEMA regulations governing cross-border current account transactions. The Reserve Bank of India imposes caps on royalty payments under the automatic route:

These FEMA caps create a practical ceiling on how much royalty the Indian subsidiary can pay, regardless of what the transfer pricing analysis determines as arm's length. If your benchmarking study shows that a 7% trademark royalty is arm's length, but FEMA permits only 5% on domestic sales under the automatic route, you either need to: (a) cap the royalty at 5%; (b) apply for RBI approval for the higher rate (a process that can take 3-6 months with no guarantee of approval); or (c) restructure the payment as a different category (such as a management fee) that is not subject to the same cap — but this carries its own transfer pricing risks.

The Five Most Common IP Tax Traps for US-India Structures

Trap 1: Software Licence Payments Treated as Royalty

When a US parent licenses proprietary software to its Indian subsidiary (ERP systems, internal tools, development platforms), India may classify the payment as royalty under Section 9(1)(vi). However, the Supreme Court's 2021 ruling in Engineering Analysis Centre of Excellence clarified that payments for the use of copyrighted software — where no copyright is transferred, and the recipient merely uses the software under licence — do not constitute royalty under most DTAAs. The key distinction is between a "copyright" transfer (royalty) and a "copyrighted article" licence (not royalty).

How to avoid this trap: Structure software licence agreements to clearly state that no copyright is being transferred — only a right to use the software. Ensure the agreement specifies that the licensee has no right to modify, reproduce, distribute, or sublicence the software. With this structuring, the payment should not be classified as royalty under the India-US DTAA, and may not be taxable in India at all (absent a PE). However, under the domestic law post-Explanation 6, a "process" argument may still be raised for payments post-AY 2013-14.

Trap 2: Failing to Withhold at the Correct Rate

The Indian subsidiary (as payer) must deduct withholding tax on every royalty payment to the US parent. The rate depends on whether DTAA benefits are claimed:

• With DTAA: 15% of gross royalty amount (10% for equipment-ancillary royalties)
• Without DTAA: 20% plus applicable surcharge and cess (effective rate approximately 21.84% for FY 2026-27)

If the Indian subsidiary withholds at the wrong rate (or fails to withhold entirely), it faces: (a) liability to pay the shortfall from its own funds; (b) interest at 1% per month under Section 201(1A); (c) disallowance of the royalty expense in computing the subsidiary's taxable income under Section 40(a)(i); and (d) penalty proceedings.

How to avoid this trap: Before making any royalty payment, ensure the US parent has provided a valid TRC from the IRS, completed Form 10F, and furnished a declaration of beneficial ownership. File Form 15CA/15CB with every outward remittance. Engage a chartered accountant to certify the applicable rate under the DTAA.

Trap 3: Transfer Pricing Challenge on Royalty Rate

Even if the withholding is correct, the royalty rate itself may be challenged by the Transfer Pricing Officer (TPO) as not being at arm's length. Indian TPOs routinely challenge royalty rates above 3% for trademark licences and 5% for technology licences.

The TPO will examine: (a) whether the IP generates measurable economic benefit for the Indian subsidiary (brand recognition, technology advantage, cost savings); (b) whether comparable third-party licence agreements exist at similar rates; (c) whether the Indian subsidiary contributes to the development, enhancement, maintenance, protection, or exploitation (DEMPE) of the IP — if so, the royalty rate should be reduced to reflect the Indian entity's contribution.

How to avoid this trap: Maintain a transfer pricing benchmarking study specifically for the royalty transaction, using comparable licence agreements from databases like RoyaltyStat, ktMINE, or Prowess. Document the economic benefit the IP provides to the Indian entity through market surveys, brand valuation reports, or technology impact assessments. For a deeper analysis of transfer pricing methods, see our guide on transfer pricing basics for foreign subsidiaries.

Trap 4: Ignoring DEMPE Functions

The OECD's BEPS framework (Actions 8-10) introduced the concept of DEMPE — Development, Enhancement, Maintenance, Protection, and Exploitation of intangibles. If the Indian subsidiary performs significant DEMPE functions, it should be entitled to a share of the IP income, which reduces the arm's length royalty payable to the US parent.

Common DEMPE activities performed by Indian subsidiaries:

• Development: Software development, product engineering, R&D conducted in India that enhances the parent's IP
• Enhancement: Localisation of products for the Indian market, adaptation of technology
• Maintenance: Ongoing support, bug fixes, quality assurance of the parent's IP portfolio
• Protection: Filing and prosecuting trademark and patent applications in India
• Exploitation: Marketing and selling IP-based products in India, building brand recognition

If your Indian subsidiary performs any of these functions, the transfer pricing officer may argue that the Indian entity is a co-developer or co-owner of the IP (in economic terms), and that the royalty should be reduced — or that the Indian entity should receive a separate compensation for its DEMPE contributions. Ignoring this analysis leaves money on the table and creates audit vulnerability. For common mistakes in this area, see our article on 7 transfer pricing mistakes that trigger an audit.

Trap 5: US-Side Tax on IP Income — NCTI and FDDEI

US founders often optimise IP structures to minimise Indian tax without considering the US-side consequences. The OBBBA (July 2025) introduces critical changes effective for tax years beginning after December 31, 2025:

• NCTI (formerly GILTI): Royalty income received by the US parent from the Indian subsidiary is included in the US parent's gross income. However, to the extent the Indian subsidiary pays tax on its profits (including the effective tax after the royalty deduction), foreign tax credits may be available. The NCTI effective tax rate is 12.6% (21% statutory rate minus the 40% deduction). The interaction is complex: reducing the Indian royalty deduction increases the Indian subsidiary's taxable income and Indian corporate tax, which generates more foreign tax credits but also increases NCTI.
• FDDEI (formerly FDII): Royalty income from the Indian subsidiary may qualify for the FDDEI deduction (33.34%, resulting in a 14% effective rate) if it is foreign-derived. However, the OBBBA excludes from DEI any income or gain from the sale or deemed disposition of intangible property occurring after June 16, 2025. This means outright IP transfers to the Indian subsidiary no longer benefit from FDDEI treatment — only ongoing licensing income qualifies.
• BEAT: For large US corporations (annual gross receipts exceeding $500 million), royalty payments from the Indian subsidiary that flow back to the US parent can ironically trigger the Base Erosion and Anti-Abuse Tax on the US parent's other deductible payments to foreign affiliates. The BEAT effectively creates a minimum tax floor.

How to avoid this trap: Model the total tax cost (India + US) of any IP arrangement before implementing it. An IP structure that minimises Indian withholding may increase the US tax burden through NCTI or reduce FDDEI benefits. Work with advisors who understand both jurisdictions.

IP Transfer vs. IP Licence: Choosing the Right Structure

US companies transferring IP to Indian subsidiaries must choose between an outright transfer (assignment of IP rights) and an ongoing licence. Each has distinct tax implications:

Outright IP Transfer

• Indian tax: The transfer price must be at arm's length (valuation required under Section 92). India may characterise the payment as a capital gains transaction or as royalty depending on the nature of the IP and the structuring
• FEMA: Outright transfers of IP require compliance with FEMA pricing guidelines, including valuation by a Category I Merchant Banker for transfers above certain thresholds
• US tax: Post-OBBBA, gains from deemed dispositions of intangible property (including Section 367(d) deemed sales) are excluded from DEI, meaning no FDDEI deduction. The US parent may face immediate or deferred recognition of gain.
• Transfer pricing: The valuation must satisfy both India (Section 92) and the US (Section 482 commensurate with income standard)

Ongoing IP Licence

• Indian tax: Annual royalty payments subject to 15% withholding under DTAA Article 12. Transfer pricing applies to the royalty rate.
• FEMA: Subject to automatic route caps (5% domestic / 8% export). Annual payments, not lump-sum.
• US tax: Royalty income may qualify for FDDEI deduction (14% effective rate). Creates ongoing taxable income in the US.
• Transfer pricing: Annual benchmarking required (or safe harbour / APA election).

For most US-India structures, an ongoing licence is preferred over an outright transfer because: (a) it avoids the lump-sum FEMA complications; (b) royalty income qualifies for FDDEI treatment in the US; (c) the US parent retains legal ownership of the IP (critical for future transactions or exits); and (d) the annual royalty creates a tax-deductible expense for the Indian subsidiary, reducing its effective tax rate. For a comprehensive analysis, see our article on IP licensing to Indian subsidiaries under tax and FEMA.

Withholding Compliance: The Step-by-Step Process

Every royalty or licence fee payment from an Indian subsidiary to a US parent requires the following compliance steps:

1. Obtain TRC: The US parent obtains a Tax Residency Certificate from the IRS (Form 6166) confirming US tax residency
2. Furnish Form 10F: The US parent completes Form 10F (available on the Indian Income Tax e-filing portal) with details of residency, status, and tax identification
3. Determine applicable rate: Apply the lower of the domestic rate or DTAA rate. For royalties, this is typically 15% under the DTAA vs. ~21.84% under domestic law
4. Deduct TDS: The Indian subsidiary deducts withholding tax at the applicable rate before making the remittance
5. Deposit TDS: Deposit the withheld amount with the Indian government within 7 days of the month-end in which the tax was deducted (Challan 281)
6. File Form 15CA/15CB: Before the remittance, the Indian subsidiary must obtain a CA certificate in Form 15CB certifying the applicable tax rate and DTAA provisions, and file Form 15CA electronically with the Income Tax Department
7. Issue Form 16A: The Indian subsidiary must issue a TDS certificate (Form 16A) to the US parent within 15 days from the due date of filing TDS returns
8. File quarterly TDS returns: The Indian subsidiary files quarterly TDS returns (Form 27Q for payments to non-residents) by the prescribed due dates

Beacon Filing's FEMA-RBI compliance service handles the entire 15CA/15CB process, and our tax advisory service ensures the correct DTAA rate is applied to every cross-border IP payment.

Cost-Sharing Arrangements: The Alternative to Royalties

Instead of a royalty-based model, some US-India structures use a cost-sharing arrangement (CSA), also known as a cost contribution arrangement (CCA). Under a CSA, the US parent and the Indian subsidiary share the costs of developing new IP, and each party owns the IP for their respective territories.

Key Features

• Each participant contributes to the costs of IP development in proportion to its anticipated share of benefits
• Each participant owns the IP rights for its assigned territory (e.g., the Indian subsidiary owns the IP for India, the US parent owns it for the rest of the world)
• No royalty payments are needed because each party uses its own IP

Tax Implications

• India: The cost contributions are subject to transfer pricing under Section 92. The contribution must be at arm's length, and the sharing ratio must reflect each party's anticipated benefits
• US: IRC Section 482 has specific rules for cost-sharing arrangements, including buy-in payments for pre-existing IP and periodic adjustment requirements
• No withholding: Since no royalty is paid, there is no withholding tax obligation — but cost contributions themselves may still be subject to Section 195 withholding if they are characterised as payments for services

When CSAs Make Sense

CSAs are most effective when: (a) the Indian subsidiary performs significant R&D or product development; (b) the Indian market is large enough to justify territorial IP ownership; (c) both parties make genuine, proportionate contributions to IP development. CSAs are not appropriate as mere tax planning devices — Indian tax authorities scrutinise CSAs aggressively and will re-characterise them as royalty arrangements if the substance does not support the form.

Equalisation Levy: The Tax That Was

US companies should be aware that India's equalisation levy — a digital services tax that applied to online advertising payments (6%) and e-commerce transactions (2%) — has been fully abolished. The 2% levy was removed on August 1, 2024, and the 6% levy was scrapped effective April 1, 2025, as announced in the FY26 Budget. This removal was part of the broader India-US trade agreement under which the US reduced tariffs on Indian goods to 18% from 25%. US companies making digital payments to or from India no longer need to account for the equalisation levy.

Key Takeaways

• Treaty protection is essential: The India-US DTAA caps royalty withholding at 15% (vs. ~21.84% domestic rate) and provides the narrower Article 12(3) definition of royalty. Always obtain a TRC from the IRS and file Form 10F before making any IP payment.
• The "make-available" clause is your best defence: For service payments that do not transfer technology to the Indian entity, the make-available test under Article 12(4)(b) may exempt the payment from Indian tax entirely. Document carefully that the Indian subsidiary cannot independently apply the methodology after the service is delivered.
• FEMA caps create a ceiling: Royalties are capped at 5% of domestic sales and 8% of exports under FEMA's automatic route. Plan your IP licensing structure within these constraints or apply for RBI approval early.
• DEMPE analysis is mandatory: If the Indian subsidiary contributes to developing, enhancing, maintaining, protecting, or exploiting the IP, the royalty should reflect that contribution. Ignoring DEMPE creates audit risk on both sides.
• US tax reform changes the economics: The OBBBA's exclusion of intangible property gains from FDDEI makes ongoing licensing (not outright transfers) the tax-preferred structure for most US-India IP arrangements. Model the combined India-US tax cost before implementing any structure.
• Withholding compliance is procedural but critical: Every royalty payment requires TRC, Form 10F, Section 195 TDS, Form 15CA/15CB, and quarterly return filing. Missing any step exposes the Indian subsidiary to penalties and expense disallowance.