Royalty Tax Rate Between India and Canada Under DTAA

Royalty Tax Rate Between India and Canada

Under Article 12 of the India-Canada Double Taxation Avoidance Agreement (DTAA), royalties arising in one Contracting State and paid to a resident of the other Contracting State are subject to reduced withholding tax rates. The treaty provides two distinct rates: 15% for royalties related to copyrights, patents, trademarks, designs, and secret formulas, and 10% for royalties paid for the use of industrial, commercial, or scientific equipment.

These rates represent a significant reduction from India's current domestic withholding rate of 20% (plus applicable surcharge and health and education cess) under Section 195 read with Section 115A of the Income Tax Act, 1961. The effective domestic rate, inclusive of surcharge and cess, can reach approximately 20.8% to 21.84%, making the treaty rates considerably more favourable for Canadian residents receiving royalty income from India.

The India-Canada DTAA was signed on 11 January 1996 and entered into force on 6 May 1997. It has since been modified through protocols, and both countries have ratified the Multilateral Instrument (MLI), with MLI provisions effective for withholding taxes in India from 1 April 2020. The CBDT has published the synthesised text reflecting the combined effect of the original treaty and MLI provisions.

Treaty Rate vs Domestic Rate: Detailed Comparison

Indian tax law imposes a domestic withholding tax rate of 20% (plus surcharge and cess) on royalty payments to non-residents under Section 195 read with Section 115A. This rate was increased from 10% to 20% effective 1 April 2023 by the Finance Act, 2023. Under Section 90(2), a non-resident can opt for the more beneficial rate available under the applicable DTAA.

For equipment royalties, the treaty rate of 10% provides a saving of approximately 10-12 percentage points compared to the effective domestic rate. For IP royalties at 15%, the saving is approximately 5-7 percentage points. The distinction between these two categories is one of the most important practical considerations when structuring royalty payments between India and Canada.

A key difference between the India-Canada DTAA and many other Indian treaties is that Article 12 also covers fees for included services (FIS) -- a concept similar to fees for technical services but with the critical "make available" requirement. FIS payments are capped at 15% under the same article.

Who Qualifies for the Reduced Rate

To claim the reduced royalty rates under the India-Canada DTAA, the recipient must satisfy several conditions:

Beneficial Ownership Requirement

The recipient must be the beneficial owner of the royalties. This means the recipient must have the right to use and enjoy the royalty income without any obligation to pass it on to another person. Post-MLI, this requirement has been strengthened through the Principal Purpose Test (PPT), which can deny treaty benefits if one of the principal purposes of an arrangement was to obtain the treaty benefit.

Tax Residency Requirement

The recipient must be a tax resident of Canada as defined under Article 4 of the treaty. A valid Tax Residency Certificate (TRC) issued by the Canada Revenue Agency (CRA) is mandatory to establish residency status under Indian law.

No Permanent Establishment Connection

The reduced rates do not apply if the beneficial owner carries on business through a permanent establishment (PE) in India and the royalty-generating right or property is effectively connected with that PE. In such cases, the royalties are taxed as business profits under Article 7 at the applicable corporate tax rate.

Limitation on Benefits

Post-MLI, the India-Canada treaty includes a Principal Purpose Test (PPT). Treaty benefits can be denied if one of the principal purposes of an arrangement or transaction was to obtain benefits under the treaty, unless granting those benefits would be consistent with the object and purpose of the relevant provisions. India's domestic GAAR provisions, effective from April 2017, provide an additional layer of anti-avoidance scrutiny.

Royalty-Specific Treaty Provisions

Article 12 of the India-Canada DTAA contains several important provisions specific to royalty taxation:

Definition of Royalties

Under Article 12(3), the term "royalties" means payments of any kind received as consideration for the use of, or the right to use:

• Any copyright of literary, artistic, or scientific work, including cinematograph films or films and tapes used for radio or television broadcasting
• Any patent, trademark, design or model, plan, secret formula or process
• Any industrial, commercial, or scientific equipment
• Information concerning industrial, commercial, or scientific experience

Fees for Included Services (FIS) Distinction

A unique feature of the India-Canada DTAA is the concept of "fees for included services" (FIS). Unlike the broader FTS concept in some other Indian DTAAs, FIS requires that the technical or consultancy services make available technical knowledge, experience, skill, know-how, or processes to the recipient. The "make available" test means that the recipient must be able to apply the knowledge or skill independently after the services are provided, without further assistance from the service provider.

Equipment Royalties vs IP Royalties

The treaty explicitly provides a lower rate of 10% for royalties paid for the use of industrial, commercial, or scientific equipment, compared to 15% for other types of royalties. This distinction incentivises equipment leasing arrangements between Indian and Canadian companies.

Documentation Required

Canadian residents claiming the reduced royalty rates on payments from India must furnish the following documents:

Tax Residency Certificate (TRC)

A valid TRC from the Canada Revenue Agency (CRA) confirming that the recipient is a tax resident of Canada for the relevant financial year. This is the primary document for claiming treaty benefits under Section 90(4) of the Income Tax Act.

Form 10F

If the TRC does not contain all prescribed particulars (name, status, nationality, tax identification number, period of residency, and address), the recipient must file Form 10F electronically on the Indian Income Tax portal.

Self-Declaration

A self-declaration confirming that the recipient is the beneficial owner of the royalty income, does not have a PE in India to which the income is attributable, and that the arrangement is not primarily motivated by tax avoidance.

PAN Considerations

While having an Indian PAN is not mandatory for claiming treaty benefits, Section 206AA may trigger higher withholding if the recipient does not furnish a PAN. Per CBDT Notification No. 53/2016, treaty rates prevail over Section 206AA rates for non-residents who furnish the prescribed documents.

Withholding Procedure for Indian Payers

Indian companies or individuals paying royalties to Canadian residents must follow specific compliance procedures under Section 195 of the Income Tax Act:

Step 1: Classify the Royalty Payment

Determine whether the payment falls under the IP royalties category (15%) or the equipment royalties category (10%). Payments for software licences, patent use rights, and trademark licences generally fall under IP royalties, while payments for equipment rental or lease fall under equipment royalties.

Step 2: Distinguish Royalties from FIS

If the payment involves technical or consultancy services, determine whether it qualifies as fees for included services (FIS) under the "make available" test. If the services make available technical knowledge to the recipient, the payment is FIS subject to 15%. If the services do not make knowledge available, they may be taxed as business profits under Article 7.

Step 3: Verify Documentation

Before applying the reduced treaty rate, verify the TRC, Form 10F, and beneficial ownership declaration from the Canadian recipient.

Step 4: Deduct TDS at Treaty Rate

Deduct TDS at the applicable treaty rate (10% or 15%) on the gross royalty amount. The TDS must be deposited with the government within 7 days of the following month.

Step 5: File Form 15CA/15CB

For remitting the royalty to Canada, the payer must file Form 15CA electronically. If the remittance exceeds INR 5 lakh in a financial year, a Form 15CB certificate from a Chartered Accountant is also required.

Common Disputes and Judicial Precedents

Several key issues have arisen in the interpretation of royalty taxation provisions under the India-Canada DTAA:

Software Payments as Royalties

The Supreme Court of India in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT (2021) held that payments for shrink-wrapped software licences do not constitute royalties under Indian DTAAs. This ruling directly impacts Canadian software companies selling licences to Indian customers, as such payments would be treated as business profits rather than royalties.

Make Available Test Interpretation

The ITAT has consistently held that the "make available" test requires that the recipient be enabled to apply the technology or knowledge independently after the service engagement ends. The mere use of technical skill by the service provider in delivering a service does not meet the "make available" threshold. Several ITAT decisions have ruled that standard consulting, auditing, and management advisory services do not meet this test.

Equipment vs IP Royalties Classification

Disputes arise over whether certain payments -- such as those for cloud computing services, SaaS subscriptions, or equipment bundled with software -- should be classified as equipment royalties (10%) or IP royalties (15%). The ITAT has applied the dominant purpose test and substance-over-form principle in resolving these disputes.

Characterisation of Mixed Payments

When a single payment covers both the use of IP and equipment, or both royalties and services, the ITAT has required bifurcation of the payment into its component parts, with each part taxed at the applicable rate. Where bifurcation is not possible, the rate applicable to the dominant component has been applied.

Practical Examples and Calculations

Example 1: Patent Licence Fee

A Canadian biotech company licences a patent to an Indian pharmaceutical manufacturer for INR 40,00,000 per annum. Under domestic law, the Indian company would withhold TDS at approximately 20.8% (20% plus surcharge and cess), resulting in a tax of INR 8,32,000. Under the India-Canada DTAA, the withholding is limited to 15%, i.e., INR 6,00,000 -- a saving of INR 2,32,000.

Example 2: Equipment Lease

A Canadian oil and gas company leases specialised extraction equipment to an Indian company for INR 80,00,000. As this qualifies as an equipment royalty, the treaty rate of 10% applies, resulting in a tax of INR 8,00,000 compared to INR 16,64,000 under domestic rates (20.8%). The treaty saves INR 8,64,000.

Example 3: Trademark Licence

A Canadian retail brand licences its trademark and trade dress to an Indian franchisee for INR 25,00,000. Under the treaty, the withholding is capped at 15%, i.e., INR 3,75,000, compared to approximately INR 5,20,000 at the domestic rate. The saving is INR 1,45,000.

Example 4: Software Licence (Post-Supreme Court Ruling)

A Canadian software company sells a standard off-the-shelf software licence to an Indian enterprise for INR 15,00,000. Following the Supreme Court's ruling in Engineering Analysis Centre (2021), this payment does not constitute a royalty. As a business profit under Article 7, no Indian tax applies if the Canadian company has no PE in India -- a saving of the full withholding amount compared to the domestic FTS rate.

Frequently Asked Questions

What is the royalty withholding tax rate under the India-Canada DTAA?

The India-Canada DTAA provides two royalty rates under Article 12: 15% for royalties related to copyrights, patents, trademarks, designs, and secret formulas, and 10% for royalties related to the use of industrial, commercial, or scientific equipment. Both rates are lower than India's domestic rate of 20% plus surcharge and cess.

What is the difference between royalties and fees for included services under the India-Canada DTAA?

Royalties are payments for the use of intellectual property or equipment, while fees for included services (FIS) are payments for technical or consultancy services that make available technical knowledge, skill, or processes to the recipient. Both are covered under Article 12, with FIS also capped at 15%. The key distinction is the "make available" requirement for FIS.

What does the "make available" test mean?

The "make available" test requires that the service recipient be enabled to apply the technical knowledge, skill, or process independently after the service engagement ends, without further assistance from the service provider. If the recipient merely receives the benefit of the service without acquiring the underlying knowledge, the payment does not qualify as FIS.

How did the Finance Act 2023 affect royalty taxation under the DTAA?

The Finance Act 2023 doubled India's domestic withholding rate on royalties from 10% to 20% under Section 115A. This made the DTAA rates (10% and 15%) considerably more valuable for Canadian residents. Prior to this amendment, the domestic rate was equal to the treaty rate for equipment royalties.

What documentation does a Canadian company need to claim the reduced rate?

A Canadian company must provide a valid Tax Residency Certificate from the Canada Revenue Agency, Form 10F (if the TRC does not contain all prescribed particulars), and a self-declaration confirming beneficial ownership and absence of a PE in India.

Are software licence payments treated as royalties under the India-Canada DTAA?

Following the Supreme Court ruling in Engineering Analysis Centre (2021), payments for shrink-wrapped or off-the-shelf software licences are generally not treated as royalties. They are classified as business profits, taxable in India only if the Canadian company has a permanent establishment in India.

Can a Canadian company get a refund if TDS was deducted at the higher domestic rate?

Yes. If the Indian payer deducted TDS at the domestic rate instead of the applicable treaty rate, the Canadian company can file an Indian income tax return to claim a refund of the excess tax deducted. The refund process typically takes 6-12 months.