Royalty Tax Rate Between India and Japan Under DTAA

Royalty Tax Rate Between India and Japan

Under Article 12 of the India-Japan Double Taxation Avoidance Agreement (DTAA), royalties arising in one Contracting State and paid to a resident of the other Contracting State may be taxed in the state of source, but the tax is capped at 10% of the gross amount if the recipient is the beneficial owner. This represents a significant reduction from India's 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 India-Japan DTAA was originally signed at New Delhi on 7 March 1989 and entered into force on 29 December 1989. The treaty has been amended by multiple protocols, most notably the protocol signed at Tokyo on 24 February 2006. Both countries have also signed and ratified the Multilateral Instrument (MLI), with the CBDT publishing the synthesised text reflecting the combined effect of the original treaty, protocols, and MLI provisions.

A distinctive feature of the India-Japan DTAA is that Article 12 covers both royalties and fees for technical services (FTS) under a single article with a uniform rate of 10%. This combined treatment differs from DTAAs like the India-USA treaty, which has separate articles for royalties and FTS. The 10% rate under Article 12 is inclusive of all surcharges and cess -- no additional levy can be imposed beyond the 10% treaty cap.

Treaty Rate vs Domestic Rate: Detailed Comparison

Indian tax law imposes a domestic withholding rate of 20% (plus surcharge and health and education cess) on royalty payments to non-residents under Section 195 read with Section 115A of the Income Tax Act. 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 under the applicable DTAA.

The India-Japan DTAA applies a uniform 10% rate across all categories of royalties. The effective domestic rate, inclusive of surcharge and cess, can reach approximately 20.8% to 21.84%, making the treaty rate a saving of roughly 10-12 percentage points. Critically, the ITAT Delhi Bench has confirmed that the 10% rate under Article 12 is the total withholding rate inclusive of surcharge and cess, so the effective saving is even greater than it appears.

Prior to the Finance Act 2023, when the domestic rate was 10%, the treaty provided no additional benefit. The doubling of the domestic rate has made the treaty significantly more valuable for Japanese companies receiving royalty income from India.

Who Qualifies for the Reduced Rate

To claim the reduced 10% royalty rate under the India-Japan 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 contractual or legal obligation to pass it on to another person. Post-MLI, the Principal Purpose Test (PPT) 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 Japan as defined under Article 4 of the treaty. A valid Tax Residency Certificate (TRC) issued by the Japanese National Tax Agency (NTA) is mandatory to establish residency status.

No Permanent Establishment Connection

The reduced rate does 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. Under the India-Japan DTAA, building sites and supervisory activities constitute a PE only if they exceed 6 months -- a shorter threshold than many other Indian DTAAs.

GAAR Considerations

India's domestic General Anti-Avoidance Rules (GAAR), effective from April 2017, can override treaty benefits if the tax authority determines that the arrangement lacks commercial substance and was entered into primarily for obtaining a tax benefit.

Royalty-Specific Treaty Provisions

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

Broad Definition of Royalties

Under the treaty, 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
• The use of, or the right to use, any patent, trademark, design or model, plan, secret formula or process
• The use of, or the right to use, industrial, commercial, or scientific equipment
• The supply of information concerning industrial, commercial, or scientific experience (know-how)

Combined Royalty and FTS Article

Unlike many other Indian DTAAs, the India-Japan treaty addresses both royalties and fees for technical services under Article 12 with the same 10% rate. The term "fees for technical services" means payments for services of a managerial, technical, or consultancy nature, including the provision of services by technical or other personnel. For a detailed analysis of FTS provisions, see our FTS tax rate page for India-Japan.

Inclusive Rate (No Surcharge/Cess)

A critical distinction upheld by the ITAT Delhi Bench is that the 10% rate under Article 12 is the total withholding rate. Indian tax authorities cannot levy surcharge or health and education cess over and above the 10% treaty rate. This position has been confirmed in the case of Mitsubishi Corporation v. DCIT and other rulings.

Documentation Required

Japanese companies claiming the reduced 10% royalty rate on payments from India must furnish the following documents to the Indian payer:

Tax Residency Certificate (TRC)

A valid TRC from the Japanese National Tax Agency (NTA) confirming that the recipient is a tax resident of Japan 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 at 20% if the recipient does not furnish a PAN. Per CBDT Notification No. 53/2016, treaty rates prevail over Section 206AA rates for non-residents with the prescribed documents (TRC, Form 10F, self-declaration).

Withholding Procedure for Indian Payers

Indian companies paying royalties to Japanese residents must follow compliance procedures under Section 195:

Step 1: Classify the Payment

Determine whether the payment constitutes a royalty under Article 12(3). Payments for technology licences, patent rights, trademark licences, equipment rentals, and know-how all qualify. Importantly, distinguish between royalties (Article 12) and business profits (Article 7) -- the classification determines whether the 10% cap applies or whether full business profit taxation applies.

Step 2: Verify Documentation

Before applying the 10% treaty rate, verify the TRC, Form 10F, and beneficial ownership declaration from the Japanese recipient. The payer bears responsibility for ensuring all conditions are met.

Step 3: Deduct TDS at Treaty Rate

Deduct TDS at 10% on the gross royalty amount. No surcharge or cess should be added above the 10% treaty rate. The TDS must be deposited with the government within 7 days of the following month.

Step 4: File Form 15CA/15CB

For remitting the royalty to Japan, the payer must file Form 15CA electronically. If the remittance exceeds INR 5 lakh, a Chartered Accountant's certificate in Form 15CB is required, certifying the nature of remittance, applicable TDS rate, and treaty provisions relied upon.

Step 5: Issue TDS Certificate

The payer must issue a TDS certificate in Form 16A to the Japanese recipient within 15 days from the due date of furnishing the quarterly TDS return.

Common Disputes and Judicial Precedents

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

Surcharge and Cess on Treaty Rates

A recurring dispute has been whether surcharge and cess can be charged over and above the 10% treaty rate. The ITAT Delhi Bench in Mitsubishi Corporation v. DCIT ruled decisively that the 10% rate under Article 12 is the total tax rate inclusive of surcharge and cess. Article 2 of the India-Japan DTAA specifies that the taxes covered include income tax "including any surcharge thereon," confirming that the treaty rate encompasses all levies.

Secondment of Technical Personnel

In cases involving Japanese companies deputing technical executives to Indian subsidiaries, the ITAT has examined whether the payments constitute FTS under Article 12 or salary reimbursements. In Mitsui & Co. Ltd. and related cases, the tribunal examined whether the technical knowledge was "made available" to determine FTS classification.

Software Payments

Following the Supreme Court's 2021 ruling in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT, payments for standard software licences by Indian companies to Japanese software firms may not constitute royalties. This is particularly relevant for enterprise software licences from major Japanese technology companies.

Equipment Royalties vs Service Fees

Disputes arise over whether payments for sophisticated industrial equipment from Japanese manufacturers should be classified as equipment royalties (Article 12 at 10%) or as business profits (Article 7). The characterisation depends on whether the payment is for the equipment use right or for services associated with the equipment.

Practical Examples and Calculations

Example 1: Technology Licence

A Japanese automobile manufacturer licences its proprietary manufacturing technology to an Indian joint venture partner for INR 5,00,00,000 per annum. Under domestic law, TDS at approximately 20.8% would be INR 1,04,00,000. Under the India-Japan DTAA, the withholding is capped at 10%, i.e., INR 50,00,000 -- a saving of INR 54,00,000. No surcharge or cess applies on top of the 10%.

Example 2: Patent Licence

A Japanese pharmaceutical company licences a drug patent to an Indian manufacturer for INR 1,00,00,000. Under the treaty, TDS is 10% (INR 10,00,000) versus approximately 20.8% domestically (INR 20,80,000). The saving is INR 10,80,000.

Example 3: Industrial Equipment Lease

A Japanese heavy machinery company leases construction equipment to an Indian infrastructure firm for INR 3,00,00,000. Under Article 12, the treaty rate of 10% applies, resulting in tax of INR 30,00,000 compared to INR 62,40,000 at the domestic rate. The saving is INR 32,40,000.

Example 4: Trademark Licence

A Japanese electronics brand licences its trademark to an Indian distributor for INR 40,00,000. Under the treaty, TDS is capped at 10% (INR 4,00,000) versus 20.8% domestically (INR 8,32,000). The saving is INR 4,32,000.

Frequently Asked Questions

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

The royalty withholding tax rate under the India-Japan DTAA is 10% of the gross amount of royalties under Article 12(2). This rate applies uniformly to all categories of royalties, including copyrights, patents, trademarks, equipment use, and know-how payments. The 10% rate is inclusive of surcharge and cess.

Does the 10% rate include surcharge and health and education cess?

Yes. The ITAT Delhi Bench has ruled that the 10% rate under Article 12 is the total withholding tax rate, inclusive of all surcharges and cess. Indian tax authorities cannot impose any additional levy beyond the 10% cap specified in the treaty. This was confirmed in Mitsubishi Corporation v. DCIT and other rulings.

Are royalties and FTS treated under the same article?

Yes. Unlike many other Indian DTAAs, the India-Japan treaty addresses both royalties and fees for technical services under Article 12 with the same 10% rate. This combined treatment simplifies compliance for Japanese companies that provide both IP licences and technical services to Indian clients.

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

A Japanese company must provide: (1) a valid Tax Residency Certificate from the Japanese National Tax Agency, (2) Form 10F filed electronically if the TRC lacks prescribed particulars, and (3) a self-declaration confirming beneficial ownership and absence of PE in India.

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 10% DTAA rate significantly more valuable for Japanese residents. Prior to this amendment, the domestic rate equalled the treaty rate, providing no additional benefit.

What are the PE thresholds under the India-Japan DTAA?

Under Article 5, building sites and supervisory activities constitute a PE if they exceed 6 months -- shorter than the 12-month threshold in the OECD Model Convention. This means Japanese companies with construction or installation projects in India need to monitor their presence carefully to avoid triggering PE status.

Can a Japanese company apply for a lower withholding certificate?

Yes. Under Section 197 of the Income Tax Act, a Japanese company can apply to the Assessing Officer for a certificate authorising the Indian payer to deduct tax at a rate lower than the 10% treaty rate if the actual tax liability is expected to be lower due to deductions, expenses, or available tax credits.