Royalty Tax Rate Between India and China Under DTAA

Royalty Tax Rate Between India and China

The India-China Double Taxation Avoidance Agreement (DTAA), signed on 18 July 1994 and updated through a protocol on 26 November 2018, establishes a preferential withholding tax rate on cross-border royalty payments. Under Article 12 of the treaty, royalties arising in one Contracting State and paid to a beneficial owner resident in the other Contracting State are subject to a maximum withholding tax rate of 10% of the gross amount.

This treaty rate is particularly valuable following the Finance Act 2023, which doubled India's domestic withholding tax rate on royalties from 10% to 20% under Section 115A. With surcharge and 4% health & education cess, the effective domestic rate now reaches approximately 20.8% for non-corporate non-residents and 21.84% for foreign companies. The DTAA rate of 10% therefore delivers savings exceeding 10% on every royalty payment between India and China.

The India-China DTAA uniquely combines both royalties and fees for technical services (FTS) within a single Article 12, applying the same 10% ceiling rate to both categories. This simplified structure contrasts with some other Indian DTAAs that treat royalties and FTS in separate articles or apply different rates.

Treaty Rate vs Domestic Rate: Detailed Comparison

The gap between treaty and domestic rates has widened significantly since April 2023:

Before the Finance Act 2023 amendment, the domestic royalty rate under Section 115A was 10%, making the treaty rate only marginally beneficial (the treaty eliminates surcharge and cess). Since 1 April 2023, however, the domestic rate doubled to 20%, making the 10% treaty rate an essential tool for Chinese entities receiving royalties from India and Indian entities paying royalties to Chinese licensors.

On China's side, domestic withholding tax on royalties paid to non-residents is 10% under Chinese Enterprise Income Tax Law. Where the treaty rate matches or exceeds the domestic rate, the lower of the two applies. The DTAA thus provides symmetrical protection for royalty flows in both directions.

For structuring IP licensing arrangements between India and China, consult our tax advisory and transfer pricing services.

Who Qualifies for the Reduced Rate

Access to the 10% treaty rate on royalties requires satisfying several conditions under Article 12 and the treaty's anti-abuse provisions:

Beneficial Ownership Requirement

Article 12(2) restricts the reduced rate to royalties where the beneficial owner is a resident of the other Contracting State. The beneficial owner must have genuine economic ownership of the royalty income — meaning the right to use and enjoy the income without being obligated to pass it through to another entity. Conduit licensing arrangements, where a Chinese entity interposes itself to access the treaty rate on behalf of a third-country entity, will be denied treaty benefits.

No Permanent Establishment Connection

If the beneficial owner carries on business through a permanent establishment (PE) in the source state, and the right or property generating the royalties is effectively connected with that PE, the royalties are taxed as business profits under Article 7 rather than under Article 12. This means a Chinese technology company with a PE in India cannot claim the 10% rate on royalties from IP that is effectively connected to its Indian PE — instead, the royalties would be subject to net-basis taxation at regular corporate rates (up to 35%).

Principal Purpose Test (PPT) — Article 27A

The 2018 Protocol introduced a Principal Purpose Test under Article 27A, aligned with OECD BEPS Action 6. If one of the principal purposes of an IP licensing arrangement is to obtain the treaty benefit (the 10% rate), the benefit may be denied. This targets back-to-back licensing structures and treaty shopping through intermediary IP holding companies.

India's GAAR Provisions

India's General Anti-Avoidance Rules (GAAR) under Chapter X-A of the Income Tax Act, effective from 1 April 2017, provide an independent domestic basis to deny treaty benefits for arrangements lacking commercial substance. A licensing structure designed primarily to access the treaty rate, without genuine business rationale, is vulnerable to GAAR challenge regardless of the treaty's own anti-abuse provisions.

Royalty-Specific Treaty Provisions Under Article 12

Article 12 of the India-China DTAA contains comprehensive provisions governing both royalties and fees for technical services:

Article 12(1): Primary Taxing Right

Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. This establishes the residence state's primary right to tax royalty income.

Article 12(2): Source State Rate Cap

The source state may also tax royalties, but the tax shall not exceed 10% of the gross amount if the beneficial owner is a resident of the other Contracting State. This is a flat rate — there is no tiering based on the type of IP, the industry sector, or the quantum of royalties.

Article 12(3): Definition of Royalties

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 and films or tapes for radio or television broadcasting
• Any patent, trademark, design or model, plan, secret formula, or process
• Industrial, commercial, or scientific equipment (equipment royalties)
• Information concerning industrial, commercial, or scientific experience (know-how)

Notably, the India-China DTAA includes equipment royalties within the definition — payments for the use of industrial, commercial, or scientific equipment. This is broader than some treaties that exclude equipment rentals from the royalty definition. Software licensing payments may also qualify as royalties under this treaty, depending on the nature of the rights transferred.

Article 12(5): PE Exception

If the beneficial owner has a PE in the source state and the right or property generating royalties is effectively connected with that PE, Article 12 does not apply. The royalties are instead taxed as business profits under Article 7.

Article 12(6): Source Rule

Royalties are deemed to arise in a Contracting State when the payer is a resident of that state, or when the right or property was incurred in connection with a PE situated in that state. This prevents sourcing disputes in complex cross-border IP arrangements.

Documentation Required for Claiming the Reduced Rate

Indian entities paying royalties to Chinese residents must maintain complete documentation before applying the 10% treaty rate:

Tax Residency Certificate (TRC)

The Chinese recipient must obtain a valid Tax Residency Certificate (TRC) from China's State Taxation Administration confirming tax residency in China for the relevant financial year. The TRC must cover the period during which the royalty payment is made or credited.

Form 10F

Under Section 90(5) of the Income Tax Act read with Rule 21AB, the non-resident must furnish Form 10F to the Indian payer. Form 10F is a self-declaration providing supplementary information not contained in the TRC, including the assessee's status (individual, company, etc.), nationality, PAN (if applicable), and period of residential status.

Self-Declaration and No-PE Certificate

A self-declaration from the Chinese licensor confirming that: (a) the recipient is the beneficial owner of the royalty income; (b) the IP generating the royalties is not effectively connected with a PE in India; and (c) the licensing arrangement is not part of a conduit or back-to-back structure designed primarily to access the treaty rate.

IP Licensing Agreement

The underlying technology transfer or IP licensing agreement, along with any amendments, must be available. The agreement should clearly identify the type of IP licensed, the territory of use, the royalty rate, and payment terms. For RBI/FEMA compliance, technology transfer agreements may require prior filing with the designated AD bank.

Withholding Procedure for Indian Payers

The withholding compliance process for royalty payments to Chinese residents follows Section 195 of the Income Tax Act:

Step 1: Verify Treaty Eligibility

Confirm the Chinese licensor's tax residency through the TRC, verify beneficial ownership through declarations, and ensure the IP is not PE-connected. Determine whether the payment constitutes "royalties" as defined in Article 12(3) — particularly for software licensing payments where the classification may be disputed.

Step 2: Deduct TDS at the Treaty Rate

Deduct TDS at 10% of the gross royalty amount. No surcharge or cess applies when deducting at the treaty rate. If documentation is incomplete or the recipient fails to provide TRC/Form 10F, deduct at the full domestic rate of 20% plus surcharge and cess (~20.8% to 21.84%).

Step 3: File Form 15CA/15CB

For remittances exceeding INR 5 lakh, file Form 15CA online after uploading the Chartered Accountant's certificate in Form 15CB. The CA must certify the DTAA article applied, rate of TDS, and confirm treaty eligibility. The CA should specifically reference Article 12(2) and the 10% rate in the 15CB certificate.

Step 4: Deposit TDS and File Returns

Deposit TDS within prescribed deadlines (7th of the following month; for March, 30 April). File quarterly TDS returns in Form 27Q. Maintain all documentation for a minimum of six years for potential assessment proceedings. For comprehensive guidance, see our tax advisory and FEMA-RBI compliance services.

Common Disputes and Judicial Precedents

Royalty taxation under the India-China DTAA has generated significant judicial attention:

Software Payments — Royalty or Business Profits

A major area of dispute concerns whether payments for off-the-shelf software licenses constitute "royalties" under Article 12 or business profits under Article 7. The Supreme Court of India, in its landmark Engineering Analysis Centre of Excellence decision (2021), held that payments for shrink-wrapped/off-the-shelf software are not royalties, as they do not involve the transfer of copyright but merely a license to use a copyrighted article. This ruling impacts payments by Indian entities to Chinese software companies — such payments may not attract withholding tax at all if they qualify as business profits and the Chinese entity has no PE in India.

Equipment Royalties and Lease Payments

The inclusion of "industrial, commercial, or scientific equipment" in the royalty definition under Article 12(3) means that equipment lease payments to Chinese entities may be characterised as royalties subject to the 10% rate. However, disputes arise over whether the arrangement constitutes a genuine equipment royalty or a service contract. The characterisation depends on whether the payer acquires a right to use the equipment or merely receives a service.

Transfer Pricing on Royalty Rates

Royalty rates on inter-company IP licenses between Indian and Chinese group entities are subject to transfer pricing scrutiny under Section 92 of the Income Tax Act. The Transfer Pricing Officer may benchmark the royalty rate against arm's length comparables (comparable uncontrolled price method, transactional net margin method) and make adjustments that increase the taxable royalty amount. The Delhi High Court, in several rulings, has held that royalty payments at arm's length rates should not be disturbed merely because the tax authorities consider the rate excessive.

Make Available Test — Not Applicable to India-China DTAA

Unlike some Indian DTAAs (notably India-USA and India-UK), the India-China DTAA does not contain a "make available" requirement for FTS or royalties. This means the scope of taxable royalties under the India-China DTAA is broader — any payment qualifying under the Article 12(3) definition is taxable, without the additional filter of whether the technology is "made available" to the payer.

Practical Examples and Calculations

Example 1: Chinese Technology Company Licensing Software to Indian Firm

A Chinese tech company licenses proprietary enterprise software to an Indian manufacturing company. Annual royalty: USD 500,000 (approximately INR 4,20,00,000 at INR 84/USD).

• Without DTAA: TDS at 20% + surcharge (2%) + cess (4%) = ~20.8% = INR 87,36,000 withheld
• With DTAA (Article 12(2)): TDS at 10% = INR 42,00,000 withheld
• Tax saving: INR 45,36,000 per year

Example 2: Indian Pharma Company Paying Patent Royalties to Chinese Licensor

An Indian pharmaceutical company pays patent royalties at 5% of net sales to a Chinese licensor. Annual royalty on INR 50 crore sales: INR 2,50,00,000.

• Without DTAA: TDS at ~20.8% = INR 52,00,000 withheld
• With DTAA (Article 12(2)): TDS at 10% = INR 25,00,000 withheld
• Tax saving: INR 27,00,000 per year

Example 3: Equipment Royalty Payment

An Indian infrastructure company pays USD 200,000 annually for the use of specialised Chinese construction equipment under a long-term lease. Since equipment royalties are included in the Article 12(3) definition:

• Without DTAA: TDS at ~20.8% = INR 34,94,400 withheld (at INR 84/USD)
• With DTAA (Article 12(2)): TDS at 10% = INR 16,80,000 withheld
• Tax saving: INR 18,14,400 per year

Frequently Asked Questions

What is the royalty tax rate under the India-China DTAA?

Under Article 12(2) of the India-China DTAA, the maximum withholding tax rate on royalties is 10% of the gross amount when the beneficial owner is a resident of the other Contracting State. This compares favourably with India's domestic rate of 20% plus surcharge and cess (effective ~20.8% to 21.84%).

Does the 10% rate apply to software license payments?

It depends on the nature of the software transaction. Payments for customised software or IP licensing may qualify as royalties under Article 12. However, following the Supreme Court's ruling in Engineering Analysis Centre of Excellence (2021), payments for off-the-shelf software may be classified as business profits under Article 7, potentially not taxable in India if the Chinese entity has no PE.

What documentation is required to claim the 10% treaty rate?

The Chinese licensor must provide: (1) a valid Tax Residency Certificate from China's State Taxation Administration, (2) Form 10F self-declaration, and (3) a beneficial ownership and no-PE declaration. The Indian payer must file Form 15CA/15CB for remittances exceeding INR 5 lakh.

Are equipment lease payments considered royalties?

Yes. The India-China DTAA includes payments for the use of industrial, commercial, or scientific equipment within the definition of royalties under Article 12(3). Such payments are subject to the 10% treaty rate, provided the beneficial ownership and other conditions are met.

How does the Finance Act 2023 change affect treaty benefits?

The Finance Act 2023 doubled the domestic royalty withholding rate from 10% to 20% under Section 115A, effective 1 April 2023. This makes the 10% DTAA rate significantly more valuable, as the savings have increased from approximately 0.4% (surcharge and cess only) to over 10.8%.

Is there a "make available" test under the India-China DTAA?

No. Unlike DTAAs with the USA and UK, the India-China DTAA does not include a "make available" clause. All payments qualifying as royalties under Article 12(3) are subject to the 10% rate, without the additional requirement that the technology be made available to the payer for independent use.

Can royalties be taxed as business profits instead?

Yes, if the royalty-generating IP is effectively connected with a permanent establishment of the beneficial owner in the source state, the royalties are taxed as business profits under Article 7. This results in net-basis taxation at corporate rates (up to 35%) rather than the 10% gross rate under Article 12.