Royalty Tax Rate Between India and Israel Under DTAA

Royalty Tax Rate Between India and Israel

The Double Taxation Avoidance Agreement (DTAA) between India and Israel, originally signed on 29 January 1996 and subsequently amended by a Protocol signed on 14 October 2015, provides significant relief on the taxation of cross-border royalty payments. Under Article 12(2) of the treaty, royalties arising in one Contracting State and paid to a beneficial owner resident in the other State are subject to a maximum withholding tax rate of 10% of the gross amount. This represents a substantial reduction from India's current domestic withholding rate of 20% (plus applicable surcharge and health and education cess) under Section 115A of the Income Tax Act, 1961.

The India-Israel DTAA addresses royalties (Article 12) and fees for technical services (FTS) (Article 13) in separate but closely parallel articles, applying an identical 10% cap to both income categories. This consistent treatment simplifies compliance for cross-border intellectual property licensing and technology transfer arrangements between the two countries.

Given the strong technology and innovation partnership between India and Israel — with Israeli companies frequently licensing patents, software, agricultural technology, defence systems, and cybersecurity solutions to Indian counterparts — the royalty rate under this DTAA has significant practical importance for bilateral commerce.

Treaty Rate vs Domestic Rate: Detailed Comparison

Understanding the gap between the treaty rate and India's domestic rate is essential for tax planning:

Under Indian domestic law, royalties paid to a non-resident are taxable at 20% under Section 115A of the Income Tax Act (increased from 10% to 20% by the Finance Act 2023, effective 1 April 2023). When surcharge and health and education cess of 4% are added, the effective domestic rate reaches approximately 21.84% for foreign companies. The DTAA rate of 10% therefore offers a saving of approximately 11-12 percentage points on every royalty payment from India to Israel.

This saving is particularly significant following the Finance Act 2023 amendment that doubled the domestic withholding rate on royalties from 10% to 20%. Before this change, the DTAA rate and the domestic rate were identical at 10%, offering no incremental benefit. The 2023 amendment has made DTAA treaty relief critically important for Israeli licensors receiving royalties from India.

The definition of "royalties" under Article 12(3) of the India-Israel DTAA includes payments for the use of, or the right to use, any copyright of literary, artistic or scientific work (including cinematograph films), any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience.

Who Qualifies for the Reduced Rate

To avail the reduced 10% royalty rate under the India-Israel DTAA, the recipient must satisfy several conditions:

Beneficial Ownership Requirement

The most critical condition under Article 12(2) is that the recipient must be the beneficial owner of the royalties. This means the Israeli entity receiving the payment must have the genuine right to use and enjoy the royalty income unconstrained by any contractual or legal obligation to pass it to another person. Mere nominees, agents, back-to-back licensing intermediaries, and conduit entities do not qualify for the reduced rate.

Tax Residency in Israel

The recipient must be a tax resident of Israel as defined under Article 4 of the treaty. A valid Tax Residency Certificate (TRC) issued by the Israeli Tax Authority (Rashut HaMisim) is mandatory. Dual residents are resolved through tie-breaker rules in Article 4(2), which consider factors such as permanent home, centre of vital interests, habitual abode, and nationality.

Limitation on Benefits and Anti-Avoidance

The 2015 Protocol inserted a Limitation on Benefits (LOB) article, restricting treaty benefits if the principal purpose of setting up an entity in Israel was to obtain DTAA benefits. Additionally, following India's ratification of the Multilateral Instrument (MLI), the Principal Purpose Test (PPT) now applies to the India-Israel treaty. Under the PPT, treaty benefits can be denied if one of the principal purposes of an arrangement was to obtain the reduced royalty rate. India's General Anti-Avoidance Rules (GAAR) under Chapter X-A of the Income Tax Act provide a further layer of anti-avoidance protection.

Permanent Establishment Exception

The reduced rate under Article 12 does not apply if the beneficial owner carries on business in India through a Permanent Establishment (PE) and the right or property generating the royalties is effectively connected with such PE. In that case, the royalties are taxed as business profits under Article 7 of the treaty.

Royalty-Specific Treaty Provisions

Article 12 of the India-Israel DTAA contains detailed provisions governing the taxation of royalties:

Definition of Royalties (Article 12(3))

The term "royalties" is defined broadly to include 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
• The use of, or the right to use, any patent, trademark, design or model, plan, secret formula or process
• Information concerning industrial, commercial or scientific experience (know-how)

This definition is broadly aligned with the OECD Model Tax Convention and covers most forms of intellectual property licensing common in India-Israel trade, including software licensing (subject to interpretation), pharmaceutical patents, agricultural biotechnology IP, and defence technology transfers.

Source Rule (Article 12(5))

Royalties are deemed to arise in a Contracting State when the payer is that State itself, a political sub-division, a local authority, or a resident of that State. Alternatively, if the payer has a PE or fixed base in a State and the royalty obligation was incurred in connection with that PE, the royalties are deemed to arise in the State where the PE is situated.

2015 Protocol Amendments

The Protocol signed on 14 October 2015 (effective 19 December 2016) introduced important changes. Most notably, it removed the Most Favoured Nation (MFN) clause that was present in the original 1996 Protocol. Under the original treaty, if India entered into a DTAA with another country providing a lower rate or more restrictive scope for royalties, that lower rate would automatically apply to the India-Israel treaty. This MFN clause was eliminated by the 2015 Protocol. The Protocol also removed the deemed tax credit (tax sparing) provisions.

Documentation Required

To claim the reduced 10% withholding rate on royalties, the Israeli beneficial owner must provide the following documents to the Indian payer:

Tax Residency Certificate (TRC)

A valid TRC issued by the Israeli Tax Authority for the relevant financial year. This is the primary document establishing treaty eligibility under Section 90(4) of the Indian Income Tax Act. Without a TRC, the Indian payer is obligated to withhold tax at the full domestic rate.

Form 10F

A self-declaration in Form 10F providing additional details such as the taxpayer's status, nationality, Israeli tax identification number, and period of residential status. Since 2022, Form 10F must be filed electronically on the Indian income tax e-filing portal.

No Permanent Establishment Declaration

A self-declaration confirming that the recipient does not have a PE in India, or that the right or property generating the royalties is not effectively connected with any PE in India.

Beneficial Ownership Declaration

A declaration confirming that the recipient is the beneficial owner of the royalties and is not acting as an agent, nominee, or conduit entity in a back-to-back licensing arrangement.

Withholding Procedure for Indian Payers

Indian entities making royalty payments to Israeli residents must follow a specific compliance procedure:

Section 195 Compliance

Under Section 195 of the Income Tax Act, any person responsible for paying income (including royalties) to a non-resident must deduct tax at source at the applicable rate. When the DTAA rate of 10% is lower than the domestic rate of 20% and the payee has furnished valid documentation (TRC, Form 10F, declarations), the payer may apply the treaty rate.

Form 15CA and Form 15CB

For remittances exceeding specified thresholds, the Indian payer must furnish Form 15CA (an online declaration to the Income Tax Department) and obtain a certificate from a Chartered Accountant in Form 15CB. Form 15CB certifies the nature of the remittance, the applicable DTAA provisions, the article under which the reduced rate is claimed, and the rate of tax deducted. These forms must be uploaded to the Income Tax portal before the remittance is processed through an authorized dealer bank.

Lower Withholding Certificate (Section 197)

If the Israeli licensor anticipates that the actual tax liability will be lower than the statutory rate (for instance, where expenses are to be allowed), they may apply to the Assessing Officer under Section 197 for a lower or nil withholding certificate. This requires providing the DTAA details, TRC, and Form 10F.

Common Disputes and Judicial Precedents

Several issues have arisen in the interpretation and application of royalty taxation under the India-Israel DTAA:

Software Payments: Royalty or Business Profits?

One of the most contested issues across Indian DTAAs is whether payments for the use of software constitute "royalties" under Article 12 or business profits under Article 7. The Supreme Court of India in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT (2021) held that payments for the purchase of off-the-shelf software (copyrighted articles) do not constitute royalties, as the end user does not acquire any rights in the copyright itself. This ruling applies to the India-Israel DTAA and has significant implications for the large volume of software licensing transactions between Indian companies and Israeli technology firms.

Royalty vs FTS Distinction

Royalties (Article 12) and FTS (Article 13) are governed by separate articles in the India-Israel treaty but carry the same 10% rate cap, so the classification issue is less contentious in the India-Israel context compared to treaties where different rates apply. However, the distinction still matters for determining the source of income and for computing credits in Israel.

Royalty Accrual vs Payment Timing

The Mumbai ITAT in the Sophos Technologies Pvt. Ltd. v. DCIT case (2018) held that under Article 12(1) of the India-Israel DTAA, since the charge of tax on royalty arises only at the time of payment, tax is not required to be withheld when mere provisions for payment of royalty are made in the books of the Indian company. This is an important precedent for Indian companies that accrue royalty liabilities to Israeli licensors but remit payments in subsequent periods.

Equipment Royalties

The India-Israel DTAA definition of royalties includes payments for "information concerning industrial, commercial or scientific experience" (know-how) but notably does not include "equipment rentals" in the royalty definition, unlike some other Indian DTAAs (such as with Saudi Arabia or UAE). Payments for the use of industrial, commercial, or scientific equipment may therefore fall under Article 7 (business profits) rather than Article 12, depending on the specific arrangement.

Practical Examples and Calculations

Example 1: Israeli Software Company Licensing Technology to an Indian Company

An Israeli cybersecurity company licenses its proprietary software platform to an Indian bank. The annual licence fee is INR 50,00,000 (approximately USD 60,000).

• Without DTAA: Tax at domestic rate = 20% + 4% cess = 20.80% = INR 10,40,000
• With DTAA: Tax at treaty rate = 10% = INR 5,00,000
• Net saving: INR 5,40,000 (approximately USD 6,500)

Note: If the software licence is for the use of a copyrighted article (off-the-shelf software) rather than copyright rights, it may not qualify as a royalty at all following the Supreme Court's Engineering Analysis ruling, potentially resulting in zero Indian tax if the Israeli company has no PE in India.

Example 2: Patent Licensing for Agricultural Technology

An Israeli agri-tech company licenses its drip irrigation patent to an Indian agricultural equipment manufacturer for a royalty of INR 2,00,00,000 (approximately USD 240,000) per year.

• Without DTAA: Tax at domestic rate = 20% + surcharge (2%) + 4% cess = approximately 21.22% = INR 42,44,000
• With DTAA: Tax at treaty rate = 10% = INR 20,00,000
• Net saving: INR 22,44,000 (approximately USD 27,000)

The Israeli company can then claim a foreign tax credit of INR 20,00,000 against its Israeli corporate tax liability on the same royalty income.

Example 3: Know-How Transfer for Defence Technology

An Israeli defence contractor provides classified know-how relating to missile defence systems to an Indian defence PSU under a government-to-government agreement. The know-how fee is INR 100,00,00,000 (approximately USD 12 million).

• Without DTAA: Tax at domestic rate ≈ 21.84% = INR 21,84,00,000
• With DTAA: Tax at treaty rate = 10% = INR 10,00,00,000
• Net saving: INR 11,84,00,000 (approximately USD 1.42 million)

Know-how transfers involving information concerning industrial, commercial, or scientific experience clearly fall within the royalty definition under Article 12(3) and are eligible for the 10% treaty rate.

Frequently Asked Questions

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

Under Article 12(2) of the India-Israel DTAA, the maximum withholding tax rate on royalties is 10% of the gross amount, provided the recipient is the beneficial owner and a tax resident of Israel. This compares favourably with the domestic Indian rate of 20% plus surcharge and cess (approximately 21.84% effective rate).

What types of payments qualify as royalties under the India-Israel DTAA?

Article 12(3) defines royalties as payments for the use of, or the right to use, any copyright of literary, artistic or scientific work (including films), any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience (know-how). Payments for the use of equipment are not included in the definition.

Has the 2023 increase in India's domestic royalty rate affected the DTAA benefit?

Yes, significantly. Before the Finance Act 2023, India's domestic withholding rate on royalties was 10% — the same as the DTAA rate, offering no incremental benefit. The doubling of the domestic rate to 20% (plus surcharge and cess) has made the DTAA rate critically important, providing savings of approximately 11-12 percentage points on every royalty payment.

Do software licence payments qualify for the 10% royalty rate?

It depends on the nature of the licence. Following the Supreme Court's ruling in Engineering Analysis Centre of Excellence (2021), payments for off-the-shelf software (copyrighted articles) do not constitute royalties. However, payments for the right to reproduce, modify, or distribute software (copyright rights) may still qualify as royalties under the treaty.

What happens if the Israeli licensor has a PE in India?

If the royalty income is effectively connected with a PE that the Israeli beneficial owner maintains in India, the reduced 10% rate under Article 12 does not apply. Instead, the royalties are taxed as business profits under Article 7, and the Israeli entity must file an Indian tax return and pay tax on the net income attributable to the PE.

What documentation must an Israeli entity provide to claim the reduced rate?

The Israeli entity must provide a valid Tax Residency Certificate from the Israeli Tax Authority, Form 10F (filed electronically since 2022), a no-PE declaration, and a beneficial ownership declaration. The Indian payer must file Form 15CA and obtain Form 15CB from a Chartered Accountant before remitting the royalty.

Did the 2015 Protocol change the royalty provisions?

The 2015 Protocol (effective 19 December 2016) removed the Most Favoured Nation (MFN) clause from the original treaty, meaning Israel can no longer automatically claim lower royalty rates that India may negotiate with other countries. It also removed the deemed tax credit (tax sparing) provisions and introduced a Limitation on Benefits article.