What Is the Non-Discrimination Clause?
The non-discrimination clause is the article in a Double Taxation Avoidance Agreement (DTAA) that stops India (and the treaty partner) from taxing residents, permanent establishments, and certain payments connected to the other country more heavily than a comparable purely domestic case. In India's treaty with the United States it is Article 26; in the India-UK treaty it is also Article 26. The exact number moves around from treaty to treaty because it sits wherever it falls in that particular convention's sequence of articles, but the substance is consistent: it is not a promise of identical tax treatment in every respect, only a bar on treatment that is less favourable than what a similarly-placed domestic taxpayer receives.
For a foreign company operating in India through a branch office or a permanent establishment, this clause matters because it is the provision a taxpayer would reach for if it believed India's tax authority was singling out foreign-owned business for worse treatment purely because of where the owner or head office is based. It does not, however, block India from applying a different — even higher — tax rate to a foreign company as such, because India's treaties (and India's domestic law) carry an express carve-out for exactly that situation, covered below.
How the Clause Works
The Nationals Test
Article 26(1) of the India-US DTAA states that "Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals [of] that other State in the same circumstances are or may be subjected." This limb compares a US national to an Indian national in the same circumstances — it is about the taxpayer's nationality, not about whether the taxpayer is a resident of India.
The Permanent Establishment Test
Article 26(2) of the India-US DTAA provides that "the taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities." This is the limb that matters most for a foreign company's Indian branch: the profits attributed to the Indian PE cannot be taxed on a basis that is structurally worse than what an equivalent Indian enterprise faces — for example, through disallowed deductions or a different computation method that a domestic enterprise would not suffer.
India's treaty with the United Kingdom carries the equivalent rule at Article 26(2), and adds the reservation explicitly in the treaty text itself: "This provision shall not be construed as preventing a Contracting State from charging the profits of a permanent establishment which an enterprise of the other Contracting State has in the first-mentioned State at a rate of tax which is higher than that imposed on the profits of a similar enterprise of the first-mentioned Contracting State…" In plain terms, the India-UK treaty says outright that a higher tax rate on the PE's profits is not, by itself, a breach of the non-discrimination article.
The Deductibility Test
Article 26(3) of the India-US DTAA adds a third limb: "interest, royalties, and other disbursements paid by a resident of a Contracting State to a resident of the other Contracting State shall, for the purposes of determining the taxable profits of the first-mentioned resident, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned State." This stops India from disallowing an Indian company's deduction for interest, royalty, or other payments simply because the recipient is a US resident rather than an Indian one — the deduction has to be tested under the same conditions either way.
Codified in India's Domestic Law
India does not rely on the treaty text alone. Section 159(5) of the Income-tax Act, 2025 (section 90 of the Income-tax Act, 1961) states directly that the charge of tax "in respect of a foreign company at a rate higher than the rate at which a domestic company is chargeable" — or in respect of a company incorporated in a specified territory at a higher rate than a domestic company — "shall not be regarded as less favourable charge or levy of tax" in respect of that foreign company. This provision sits in the same part of the Act that gives DTAAs domestic effect, so it operates as India's own statutory confirmation of the treaty carve-out: Parliament has told Indian courts and assessing officers, in the Act itself, that a higher statutory rate for foreign companies is not something the non-discrimination article can be used to strike down.
Why the Foreign-Company Rate Carve-Out Matters
India taxes a foreign company's Indian-source business profits — including profits attributable to a permanent establishment — at the foreign-company base rate, while domestic companies are taxed at a lower base rate. This gap is the single most common non-discrimination question foreign investors raise: if my US or UK parent's Indian branch pays a higher rate than an Indian-incorporated competitor doing the identical business, isn't that exactly what Article 26 is meant to stop?
The answer, under both the treaty text and section 159(5), is no. The reservation quoted above from the India-UK treaty, and the equivalent statutory rule in section 159(5), were written precisely to remove that argument: a higher rate applied to a foreign company (or PE) because it is a foreign company, rather than because of some other disadvantageous rule that a domestic company would not face, is carved out of the non-discrimination protection. What the clause continues to police is everything else — computation rules, allowable deductions, and procedural requirements that make the PE's position structurally worse than a domestic enterprise's, independent of the headline rate.
Practical Example
A UK engineering firm operates a project office in India that constitutes a permanent establishment under the India-UK DTAA. The PE's Indian profits are taxed at the foreign-company rate, while an Indian competitor doing the same engineering work as a domestic company is taxed at the lower domestic-company rate. The UK firm's Indian tax adviser confirms this rate gap is not a treaty violation — it falls squarely within the Article 26(2) reservation and section 159(5). What the firm's adviser does check is whether any deduction the PE claims for interest or royalties paid to its UK head office is being disallowed on grounds that would not apply to a purely domestic payment — because that kind of denial, unlike the rate difference itself, is exactly what Article 26(3) and the PE test in Article 26(2) are designed to prevent.
Frequently Asked Questions
Does the non-discrimination clause mean a foreign company's Indian branch must pay the same tax rate as an Indian company?
No. Both India's treaties and section 159(5) of the Income-tax Act, 2025 (section 90 of the Income-tax Act, 1961) state expressly that a higher rate on a foreign company or its permanent establishment is not treated as less favourable treatment. The clause targets discriminatory rules, not the standard rate gap between foreign and domestic companies.
Which article of India's DTAAs contains the non-discrimination clause?
The number varies by treaty rather than following a fixed slot. It is Article 26 in India's treaties with both the United States and the United Kingdom. Always check the specific treaty rather than assuming a fixed article number across all of India's DTAAs.
Can India disallow a deduction for interest or royalties paid to a treaty-country parent?
Under the deductibility limb (Article 26(3) of the India-US DTAA and its equivalents), such payments must be allowed as a deduction under the same conditions that would apply if the payment had been made to an Indian resident. A blanket disallowance based solely on the recipient being a non-resident of the treaty partner would run against this limb.
Does the clause protect a foreign company's permanent establishment from every kind of unfavourable rule?
No. It protects against the PE's taxation being less favourably levied than that of a comparable domestic enterprise carrying on the same activities — for example, in the computation of taxable profits — but it does not extend to a higher statutory tax rate applied because the enterprise is foreign, which both the treaty text and Indian domestic law expressly permit.
Where is this rule codified in Indian domestic law?
Section 159(5) of the Income-tax Act, 2025 (section 90 of the Income-tax Act, 1961) states that charging a foreign company, or a company incorporated in a specified territory, at a higher rate than a domestic company is not to be regarded as a less favourable charge or levy of tax.
See also: Double Taxation Avoidance Agreement (DTAA), Branch Office, and Foreign Company.