Royalty Tax Rate Between India and USA Under DTAA

Royalty Tax Rate Between India and USA

The India-USA Double Taxation Avoidance Agreement (DTAA), signed on September 12, 1989, and effective from December 18, 1990, establishes specific withholding tax rates on royalty income under Article 12. The treaty distinguishes between two categories of royalties -- intellectual property royalties taxed at 15% and equipment royalties taxed at 10% -- both significantly lower than India's domestic withholding tax rate of 20% (plus applicable surcharge and 4% health and education cess) under Section 115A read with Section 195 of the Income Tax Act, 1961.

The India-USA DTAA is unique among India's tax treaties in several respects. First, it uses the term "fees for included services" (FIS) rather than the more common "fees for technical services" (FTS) found in most other Indian DTAAs. Second, it contains a strict "make available" clause that narrows the scope of taxable technical services. Third, the treaty is not covered by the Multilateral Instrument (MLI) because the United States has not signed the MLI, meaning the original 1989 treaty provisions (as amended by the 2000 Protocol) remain in force without PPT or other MLI modifications.

Treaty Rate vs Domestic Rate: Detailed Comparison

Article 12 of the India-USA DTAA establishes two tiers of withholding tax rates on royalties, based on the nature of the underlying right or property:

15% Rate for Intellectual Property Royalties (Article 12(2)(a))

Under Article 12(2)(a), royalties paid for the use of, or the right to use, intellectual property are taxed at a maximum rate of 15% of the gross amount. This category covers:

• Copyright of literary, artistic, or scientific works (including films and broadcasting)
• Patents and patent applications
• Trademarks and trade names
• Designs, models, plans, and secret formulas
• Industrial, commercial, or scientific know-how and experience
• Software licensing fees (where they constitute royalties)

Since India's domestic rate for royalties paid to non-residents was increased from 10% to 20% (plus surcharge and cess) by the Finance Act 2023 (effective April 1, 2023), the 15% treaty rate now provides a meaningful saving of at least 5 percentage points on IP royalties.

10% Rate for Equipment Royalties (Article 12(2)(b))

Under Article 12(2)(b), royalties paid for the use of, or the right to use, industrial, commercial, or scientific equipment are taxed at a lower rate of 10% of the gross amount. This category covers lease rentals and hire charges for tangible equipment used in manufacturing, scientific research, commercial operations, and similar activities.

The 10% equipment royalty rate represents a 10 percentage point saving compared to the domestic rate of 20% (plus surcharge and cess), making it one of the most beneficial provisions of the treaty for companies leasing equipment across borders.

Who Qualifies for the Reduced Rate

Claiming the reduced DTAA rates on royalties requires satisfying several conditions under the India-USA treaty:

Beneficial Ownership Test

The recipient must be the beneficial owner of the royalty income. This means the recipient must have the right to use, enjoy, and dispose of the royalty income without being a mere agent, nominee, or conduit. The beneficial ownership requirement prevents interposing shell entities to access treaty rates.

Limitation of Benefits (LOB) under Article 24

The India-USA DTAA contains one of the most robust Limitation of Benefits clauses among India's tax treaties. Under Article 24, a US resident claiming treaty benefits must satisfy at least one of the following tests:

• Active trade or business test: The US resident is engaged in an active trade or business in the USA (other than making or managing investments), and the royalty income from India is derived in connection with or incidental to that business.
• Ownership/base-erosion test: More than 50% of the beneficial interest is owned directly or indirectly by US residents or citizens, and the income is not substantially used to meet liabilities to non-US residents.
• Competent authority determination: If neither test is met, the competent authority of India may grant benefits at its discretion.

A US holding company that merely owns IP and licenses it to India without conducting substantial business activities in the USA would likely fail the LOB test and be denied the reduced treaty rate on royalties.

No Permanent Establishment Attribution

Under Article 12(5), if the beneficial owner carries on business through a permanent establishment in the source country and the royalty-generating right or property is effectively connected with that PE, the royalties are taxed as business profits under Article 7 at the applicable corporate tax rate (currently 35% for foreign companies in India), not under the reduced Article 12 rates.

Royalty-Specific Treaty Provisions

Definition of Royalties (Article 12(3))

Article 12(3) defines "royalties" 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, tapes, or other means of reproduction for radio or television broadcasting)
• 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, any industrial, commercial, or scientific equipment

Source Country Taxation

Article 12(1) allows royalties arising in one contracting state and paid to a resident of the other state to be taxed in the state of residence. However, Article 12(2) preserves the source country's right to tax, subject to the rate limitations above. This means India retains the right to withhold tax on royalties paid by Indian entities to US residents, but the rate is capped at 15% or 10% depending on the category.

Deemed Source Rule (Article 12(7))

Royalties are deemed to arise in a contracting state when the payer is a resident of that state, or when the obligation to pay royalties is incurred in connection with a PE or fixed base situated in that state. This is important for determining when Indian withholding tax obligations are triggered.

Documentation Required

To claim the reduced DTAA rate on royalties, the following documentation is mandatory:

Tax Residency Certificate (TRC)

The US recipient must obtain a Tax Residency Certificate from the US Internal Revenue Service (IRS) using IRS Form 8802 (Application for United States Residency Certification). The IRS issues Form 6166 as the TRC, which serves as the primary document proving US tax residency under the treaty. The processing time is typically 4-6 weeks, and the fee is USD 85 per application.

Form 10F

The non-resident must furnish Form 10F to the Indian payer, providing details such as status (individual, company, etc.), nationality, US taxpayer identification number (EIN or SSN), and period of residential status. Form 10F must be filed electronically on India's income tax e-filing portal.

Self-Declaration and No-PE Certificate

A self-declaration confirming that the recipient is the beneficial owner of the royalty income and does not have a permanent establishment in India to which the royalty is attributable. This is typically provided as a combined beneficial ownership and no-PE declaration.

Withholding Procedure for Indian Payers

Indian entities paying royalties to US residents must follow specific withholding procedures under Section 195 of the Income Tax Act:

Section 195 TDS Deduction

The Indian payer must deduct TDS at the applicable treaty rate (15% for IP royalties or 10% for equipment royalties) at the time of credit or payment, whichever is earlier. Importantly, when applying DTAA rates, surcharge and health and education cess are not added to the treaty rate -- a significant advantage over the domestic rate, where the effective rate including surcharge and cess can reach approximately 21.84%.

Form 15CA and Form 15CB

For royalty remittances exceeding INR 5 lakh in a financial year, the remitter must comply with Form 15CA/15CB requirements:

• Form 15CB: A Chartered Accountant must issue Form 15CB certifying that TDS has been deducted at the correct rate and that treaty conditions are met.
• Form 15CA Part C: The remitter files Form 15CA Part C online, referencing the Form 15CB acknowledgement number.
• Lower deduction certificate: If the payer has obtained a certificate under Section 197, Form 15CA Part B is filed instead.

Quarterly TDS Return (Form 27Q)

The Indian payer must file quarterly TDS returns in Form 27Q, correctly reflecting the treaty rate applied (15% or 10%) and the relevant DTAA article number (Article 12). TDS must be deposited with the government by the 7th of the month following the month of deduction.

Common Disputes and Judicial Precedents

Software Payments: Royalty or Business Profits?

One of the most litigated issues under the India-USA DTAA is whether payments for software constitute royalties under Article 12 or business profits under Article 7. The Supreme Court of India, in its landmark 2021 ruling in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT, held that payments for shrink-wrapped or off-the-shelf software do not constitute royalties because the end-user acquires only a licence to use the software, not rights in the underlying copyright. However, customised software development, where the copyright is transferred or the software is specifically designed for the payer, may still qualify as royalties.

Cloud Computing and SaaS Payments

Recent ITAT rulings have addressed whether payments for cloud computing and SaaS services constitute royalties or fees for included services under the India-USA DTAA. In several cases, tribunals have held that cloud service payments do not constitute royalties because no copyright, patent, or equipment is transferred to the user -- the user merely accesses the service provider's infrastructure remotely. A 2023 PwC analysis noted that receipts from cloud computing services were held not taxable as royalty, FTS, or FIS under the India-USA DTAA.

Make Available Clause and Royalties

While the "make available" clause primarily applies to fees for included services (FIS), it has implications for royalty characterisation. If a payment is recharacterised from royalty to FIS, the make-available test must be satisfied for the payment to be taxable. In the Invesco Holding Company case (2024-2025), the ITAT held that cost-to-cost reimbursements for IT support services did not qualify as FIS because no technical knowledge was "made available" to the Indian affiliate.

Distinction Between Royalties and Business Profits

Courts have consistently held that the characterisation of a payment as royalty depends on the nature of the right transferred, not the label given by the parties. If the payer acquires ownership of the IP (an outright sale), the payment is a capital gain, not a royalty. If the payer merely gets a licence to use the IP without acquiring ownership, the payment is a royalty.

Practical Examples and Calculations

Example 1: US Company Licensing Patent to Indian Subsidiary

A US corporation licenses a patented manufacturing process to its Indian subsidiary. The annual royalty payment is INR 5,00,00,000 (INR 5 crores).

• Domestic rate: 20% = INR 1,00,00,000 (plus surcharge and cess, effective ~INR 1,09,20,000)
• DTAA rate (Article 12(2)(a)): 15% = INR 75,00,000
• Tax saving under DTAA: INR 34,20,000 per year (including surcharge and cess savings)

The US corporation provides a valid IRS Form 6166 (TRC), Form 10F, and beneficial ownership declaration. The Indian subsidiary deducts TDS at 15% and remits INR 4,25,00,000.

Example 2: US Company Leasing Scientific Equipment to Indian Entity

A US manufacturer leases specialised laboratory equipment to an Indian pharmaceutical company. The annual lease rental is INR 2,00,00,000 (INR 2 crores).

• Domestic rate: 20% = INR 40,00,000 (plus surcharge and cess, effective ~INR 43,68,000)
• DTAA rate (Article 12(2)(b)): 10% = INR 20,00,000
• Tax saving under DTAA: INR 23,68,000 per year (including surcharge and cess savings)

The 10% equipment royalty rate makes cross-border equipment leasing significantly more tax-efficient under the DTAA.

Example 3: Software Licensing Fee -- Domestic Rate May Be Lower Pre-2023

Prior to the Finance Act 2023, the domestic withholding rate on royalties was 10% (plus surcharge and cess). In that era, the domestic rate was actually lower than the 15% treaty rate for IP royalties. Section 90(2) of the Income Tax Act ensures that the taxpayer always gets the benefit of the lower rate. However, since April 1, 2023, with the domestic rate at 20%, the 15% treaty rate is now clearly beneficial for IP royalties.

Frequently Asked Questions

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

The DTAA provides two rates: 15% for intellectual property royalties (copyright, patent, trademark, know-how) under Article 12(2)(a), and 10% for equipment royalties (industrial, commercial, or scientific equipment) under Article 12(2)(b). Both are lower than the domestic rate of 20% plus surcharge and cess.

How is the India-USA DTAA different from other Indian DTAAs on royalties?

The India-USA DTAA is unique in several ways: it distinguishes between IP royalties (15%) and equipment royalties (10%) with different rates; it uses the term "fees for included services" instead of "fees for technical services"; it contains a strict "make available" clause; and it includes a robust Limitation of Benefits (LOB) clause under Article 24. The treaty is also not covered by the MLI since the USA has not signed it.

Are software licensing fees considered royalties under the India-USA DTAA?

It depends on the nature of the licence. The Supreme Court ruled in 2021 that payments for off-the-shelf or shrink-wrapped software are not royalties because only a user licence is granted, not rights in the copyright itself. However, customised software, source code transfers, or copyright assignments may still be classified as royalties under Article 12.

What documents does a US company need to claim the reduced royalty rate?

A US company needs: (1) IRS Form 6166 as the Tax Residency Certificate, obtained by filing Form 8802 with the IRS; (2) Form 10F filed on India's e-filing portal; (3) a self-declaration of beneficial ownership; and (4) a no-PE declaration confirming no permanent establishment in India.

Does the Limitation of Benefits clause affect royalty claims?

Yes. Under Article 24, a US entity must pass either the active trade or business test or the ownership/base-erosion test to claim treaty benefits on royalties. A US shell company that merely holds IP without substantial US business activities would likely be denied the reduced rate.

How did the Finance Act 2023 change the domestic royalty rate?

The Finance Act 2023 doubled the domestic withholding tax rate on royalties and FTS paid to non-residents from 10% to 20% (plus surcharge and cess), effective April 1, 2023. This change made the DTAA rates of 15% and 10% significantly more beneficial than before, when the domestic rate was often lower than or equal to the treaty rate.

Can an Indian company apply the treaty rate without a TRC from the US recipient?

No. Without a valid TRC (IRS Form 6166), the Indian payer must deduct TDS at the higher domestic rate of 20% plus surcharge and cess. The TRC is a mandatory prerequisite for applying DTAA rates, as established by Section 90(4) of the Income Tax Act.