Section 393(2) — TDS on Payments to Non-Residents

What Is Section 393(2)?

Section 393(2) of the Income-tax Act, 2025 (Table, Sl. No. 17; section 195 of the Income-tax Act, 1961) is the principal withholding tax provision governing payments from India to non-residents. It requires any person making a payment to a non-resident — other than salary, which is covered by section 392 of the Income-tax Act, 2025 (section 192 of the Income-tax Act, 1961) — to deduct tax at source, at the rates in force, if that payment is chargeable to tax in India. The deduction must be made at the time of credit to the non-resident's account or at the time of payment, whichever is earlier. The Income-tax Act, 2025 came into force on 1 April 2026; under its section 536(2)(c) the Income-tax Act, 1961 continues to apply to any tax year beginning before that date, so section 195 of the 1961 Act still governs FY 2025-26 and earlier years.

For foreign companies operating in India through subsidiaries, branch offices, or liaison offices, section 393(2) is the single most frequently encountered tax provision. Every royalty payment, technology licence fee, interest on intercompany loans, management service charge, or capital gains distribution flowing out of India triggers a section 393(2) obligation. Getting this wrong does not just cost the non-resident recipient extra tax — it costs the Indian payer a 100% disallowance of the expense under section 35(b)(ii) of the Income-tax Act, 2025 (section 40(a)(i) of the Income-tax Act, 1961), effectively doubling the economic impact.

There is no threshold limit for section 393(2). Unlike TDS provisions for payments to residents, which carry monetary thresholds, section 393(2) applies to every rupee of a taxable payment to a non-resident, regardless of the amount.

Legal Basis

• Section 393(2) of the Income-tax Act, 2025 (Table, Sl. No. 17; section 195 of the Income-tax Act, 1961) — Core provision requiring any person responsible for paying a non-resident any sum chargeable to tax to deduct income-tax at the rates in force; section 400(3) names the provision.
• Section 395(2) of the Income-tax Act, 2025 (section 195(2) and (3) of the Income-tax Act, 1961) — Allows the payer to apply to the Assessing Officer (AO) for a determination of the portion of the payment that is chargeable to tax (useful for composite payments mixing taxable and non-taxable components), and allows a recipient of interest or other sums to apply to receive them without deduction.
• Section 395(1) of the Income-tax Act, 2025 (section 197 of the Income-tax Act, 1961) — Authorises the non-resident (the payee) to apply for a lower or nil withholding certificate if actual tax liability is expected to be less than the standard TDS rate; the payer's equivalent route to determine the taxable portion of a payment is section 395(2).
• Section 397(2) of the Income-tax Act, 2025 (section 206AA of the Income-tax Act, 1961) — Mandates a higher TDS rate of 20% (or the applicable rate, whichever is higher) where the non-resident does not furnish a PAN; the 20% floor sits at section 397(2)(b)(i)(C). The relief that let non-residents avoid it by furnishing prescribed details (name, email, address, TRC, TIN) is now framed as documents and information "as may be prescribed" — treat it as subject to rules to be prescribed rather than assuming the earlier relief continues on the same terms.
• Section 397(3)(d) of the Income-tax Act, 2025 (section 195(6) of the Income-tax Act, 1961) — The remittance-reporting obligation behind Forms 145 and 146. The provision as enacted describes the payer of a non-resident "not being a company or a foreign company"; that wording is quoted as it stands and must not be read as taking remittances to foreign companies outside the Forms 145 and 146 regime.
• Section 35(b)(ii) of the Income-tax Act, 2025 (section 40(a)(i) of the Income-tax Act, 1961) — Disallows 100% of the expenditure if tax under section 393(2) is not deducted or not deposited by the due date of filing the payer's income tax return.
• Rule 37BB — Prescribes Forms 145 and 146 (formerly Forms 15CA and 15CB) compliance for foreign remittances, amended by Notification No. 93/2015 dated December 16, 2015.

TDS Rates on Payments to Non-Residents

Section 393(2) requires deduction at the "rates in force", so the operative rate comes from the annual Finance Act read with the charging provisions below. Rates depend on the nature of the income and on whether the recipient is a non-resident individual or a foreign company. Where a DTAA applies, the treaty rate may be lower. Confirm the rate in force for the tax year before deducting.

All rates above are exclusive of applicable surcharge and health & education cess (4%). Surcharge rates are: 10% (income INR 50 lakh–INR 1 crore), 15% (INR 1 crore–INR 2 crore), 25% (INR 2 crore–INR 5 crore), and 37% (above INR 5 crore) for non-resident individuals. For foreign companies, surcharge is 2% (income INR 1 crore–INR 10 crore) or 5% (above INR 10 crore). Note that surcharge and cess do not apply when using DTAA treaty rates.

DTAA Treaty Rates vs. Domestic Rates

Section 159(4) of the Income-tax Act, 2025 (section 90(2) of the Income-tax Act, 1961) provides that a non-resident can apply whichever rate is more beneficial — the domestic rate or the DTAA treaty rate. This is a critical advantage. Many treaties significantly reduce withholding rates on royalty, FTS, and interest payments.

For the United States specifically, see the India-USA DTAA Article 12 rate for fees for included services.

To claim treaty rates, the non-resident must provide a valid Tax Residency Certificate (TRC) from their home country, a completed Form 41 (formerly Form 10F), and a declaration of beneficial ownership. Without these documents, the payer must apply the higher domestic rate. Some treaties also contain Limitation of Benefits (LOB) clauses requiring the non-resident to demonstrate substance in the treaty jurisdiction.

Forms 145 and 146 Compliance

Every foreign remittance subject to TDS under section 393(2) requires the payer to furnish information to the income tax department through Form 145, filed electronically on the income tax e-filing portal. Depending on the transaction, an accompanying chartered accountant's certificate in Form 146 may be required.

Which Part of Form 145 Applies?

• Part A: Remittance (or aggregate remittances) does not exceed INR 5 lakh during the financial year — no Form 146 required.
• Part B: Remittance exceeds INR 5 lakh and the payer holds an order or certificate under section 395(1) or section 395(2) — no Form 146 required.
• Part C: Remittance exceeds INR 5 lakh and no order/certificate exists — Form 146 from a chartered accountant is mandatory before filing Part C of Form 145.
• Part D: Remittance is not chargeable to tax (e.g., listed in the 33 specified exempted categories under Rule 37BB) — no Form 146 required.

The authorised dealer bank will not process the foreign remittance without a valid Form 145. Failure to file Forms 145 and 146 attracts a penalty of INR 1 lakh under section 462 of the Income-tax Act, 2025 (section 271-I of the Income-tax Act, 1961).

Exempted Payments (No Forms 145 and 146 Required)

Rule 37BB lists 33 categories of payments exempted from Forms 145 and 146 filing. These include imports of goods (with customs bill of entry), personal remittances under the Liberalised Remittance Scheme (LRS) up to USD 250,000, travel expenses, medical expenses, education expenses, and gifts to close relatives. However, all payments for services (royalty, FTS, interest, management fees) require Form 145 filing.

Lower or Nil Withholding Certificate (Section 395(1))

If the non-resident's actual tax liability on the income is lower than the TDS otherwise deductible, the non-resident (the payee) can apply to the Assessing Officer for a certificate under section 395(1) authorising deduction at a lower or nil rate. The application must be filed in Form 13 on the income tax e-filing portal (TRACES).

Common scenarios where a section 395(1) certificate is beneficial:

• The non-resident has losses or deductions that reduce taxable income below the TDS amount
• The payment includes both taxable and non-taxable components, and TDS on the full amount would be excessive
• The non-resident has already paid advance tax covering the liability
• A treaty rate lower than the domestic rate applies, but the payer is uncertain about applying it without AO confirmation

Processing typically takes 30 days. The certificate is valid for the financial year specified and for the particular payer named in it. The payer can alternatively use section 395(2) to ask the AO to determine the taxable portion of a composite payment.

Interaction with Equalization Levy

The Equalization Levy (EL) was introduced as an alternative mechanism to tax digital transactions involving non-residents. Originally, a 6% EL applied to payments for online advertising services to non-residents (Finance Act, 2016), and a 2% EL applied to e-commerce operators (expanded from April 1, 2020).

The critical interaction: under section 10(50) of the Income-tax Act, 1961, income that was subject to Equalization Levy was exempt from income tax, so TDS on payments to non-residents did not apply to payments covered by EL. Both EL 1.0 and EL 2.0 have since been abolished (the last of them from April 2025), so where the payment qualifies as royalty or FTS and is taxable under the Act read with an applicable DTAA, TDS under section 393(2) applies instead.

As of FY 2025–26, the 2% Equalization Levy on e-commerce was discontinued effective August 1, 2024. The 6% levy on online advertising services has been abolished from April 1, 2025 (Finance Act, 2025). Going forward, digital payments to non-residents that were previously subject to EL may now fall back under regular section 393(2) withholding if they constitute royalty or FTS under the Act or applicable treaty.

Penalties for Non-Deduction or Short Deduction

The consequences of failing to deduct TDS under section 393(2) are severe and multi-layered:

The section 35(b)(ii) disallowance is the most devastating consequence for businesses. If an Indian subsidiary pays INR 2 crore in management fees to its foreign parent and fails to deduct TDS, the entire INR 2 crore is disallowed as a deduction, increasing the subsidiary's taxable income by INR 2 crore and creating a corporate tax liability of approximately INR 50 lakh (at the 25.17% effective rate) — on top of the TDS shortfall itself.

How This Affects Foreign Investors in India

For a foreign company with an Indian subsidiary or presence, section 393(2) governs the tax cost on virtually every payment flowing out of India:

• Technology licence fees and royalties: Payments from an Indian subsidiary to its foreign parent for software licences, brand usage, or technology access are subject to TDS. The domestic rate is 20% (plus surcharge and cess), but most DTAAs reduce this to 10–15%.
• Intercompany loan interest: Interest on loans from a foreign parent to an Indian subsidiary attracts 20% TDS under domestic law. Treaty rates (typically 10–15%) apply if properly documented. The interest rate itself must meet transfer pricing requirements.
• Management and shared service fees: If categorised as FTS, these attract 20% TDS. Many foreign companies structure these as cost reimbursements to argue non-taxability — but the tax department frequently challenges such characterisation.
• Exit proceeds: When a foreign investor sells shares in an Indian company, the buyer must deduct TDS on the capital gains portion. For long-term capital gains on unlisted shares, the rate is 12.5% (post-July 2024 budget amendment).
• Dividend repatriation: Dividends paid by an Indian company to foreign shareholders attract 20% TDS under domestic law. Treaty rates are typically 10–15%.

A common frustration for foreign investors: the TDS is deducted on the gross payment, not the net income. A non-resident earning INR 10 lakh in royalty but incurring INR 3 lakh in costs still faces TDS on the full INR 10 lakh. The non-resident must then file an Indian income tax return to claim a refund of any excess TDS — a process that can take 12–24 months.

Common Mistakes

• Applying the DTAA rate without collecting a valid Tax Residency Certificate first. The payer deducts TDS at the treaty rate (say 10% on royalty under the India-Singapore DTAA), but the Singaporean company never provides a TRC. The AO treats it as short deduction, raises a demand for the difference (20% minus 10%), plus interest at 1% per month under section 398(3)(a). Always collect the TRC, Form 41, and beneficial ownership declaration before making the payment.
• Treating all payments to non-residents as requiring TDS. Section 393(2) only applies to sums "chargeable under the provisions of this Act." Payments for import of goods, reimbursement of out-of-pocket expenses at cost (with no income element), and payments that are exempt from tax do not attract TDS. Wrongly deducting TDS on imports ties up the non-resident's funds unnecessarily.
• Ignoring the gross-up obligation when TDS is borne by the payer. Many contracts state the foreign party receives payments "net of taxes" or "tax-free." This means the Indian payer bears the TDS. The payer must gross up the payment to compute the correct TDS amount. For example, if the net payment is INR 80 lakh and TDS is 20%, the gross amount is INR 1 crore (not INR 80 lakh), and TDS is INR 20 lakh (not INR 16 lakh).
• Filing Form 145 Part A for aggregate remittances exceeding INR 5 lakh. Part A is only valid when the total remittances to the non-resident during the financial year are below INR 5 lakh. Once cumulative payments cross INR 5 lakh, the payer must obtain a Form 146 certificate from a chartered accountant and file Part C. Incorrect Part A filings trigger penalties under section 462.
• Not applying for a lower withholding certificate when the non-resident has offsetting losses. A foreign company with an Indian permanent establishment that has carried-forward losses may owe zero tax on royalty income. Without a section 395(1) certificate, TDS is still deducted at 20%, locking up cash for 12–24 months until a refund is processed.

Practical Example

Meridian Analytics GmbH, a German data analytics firm, licenses its proprietary software platform to its Indian subsidiary, Meridian India Pvt Ltd, under a technology licence agreement. The annual licence fee is EUR 150,000 (approximately INR 1.38 crore at EUR 1 = INR 92).

Step 1: Determine the nature of the payment. The licence fee is classified as royalty under section 9(6) of the Income-tax Act, 2025 (section 9(1)(vi) of the Income-tax Act, 1961) (payment for use of copyright in software). It is also royalty under Article 12 of the India-Germany DTAA.

Step 2: Determine the applicable rate.

• Domestic rate: 20% plus surcharge (2% for foreign company income above INR 1 crore) plus 4% cess = 20.8% effective. On INR 1.38 crore, TDS = INR 28.70 lakh.
• DTAA rate (India-Germany): 10% on royalty. No surcharge or cess on treaty rates. On INR 1.38 crore, TDS = INR 13.80 lakh.
• Beneficial rate: DTAA rate of 10% (saving INR 14.90 lakh compared to domestic law).

Step 3: Collect documentation. Meridian India collects from GmbH: (a) Tax Residency Certificate issued by the German tax authority (Finanzamt), (b) Form 41 (self-declaration of treaty eligibility), (c) Beneficial ownership declaration, and (d) No PE declaration.

Step 4: Deduct and deposit TDS. Meridian India deducts INR 13.80 lakh, deposits it with the government using Challan 281 by the 7th of the following month, and issues a Form 16A (TDS certificate) to GmbH.

Step 5: File Forms 145 and 146. Since the remittance exceeds INR 5 lakh, Meridian India obtains a Form 146 certificate from its chartered accountant, then files Part C of Form 145 on the income tax e-filing portal. The authorised dealer bank processes the remittance of EUR 150,000 minus the TDS equivalent.

Step 6: German side. GmbH claims credit for the INR 13.80 lakh (approximately EUR 15,000) Indian tax against its German corporate tax liability under Article 23 of the India-Germany DTAA (double taxation relief). No double taxation arises.

If Meridian India had failed to deduct TDS: The entire INR 1.38 crore licence fee would be disallowed under section 35(b)(ii), increasing Meridian India's taxable income by INR 1.38 crore and creating an additional corporate tax liability of approximately INR 34.72 lakh. Plus, Meridian India would become an assessee-in-default liable for INR 13.80 lakh TDS, interest at 1% per month, and a penalty of INR 13.80 lakh under section 448. Total exposure: over INR 62 lakh.

Key Takeaways

• Section 393(2) applies to every payment to a non-resident that is chargeable to tax in India — with no minimum threshold. The payer bears the primary compliance burden.
• Domestic TDS rates vary with the nature of the income, but DTAA treaty rates (typically 10–15%) apply where proper documentation (TRC, Form 41, beneficial ownership declaration) is collected beforehand.
• Form 145 must be filed electronically for every foreign remittance, and Form 146 (CA certificate) is mandatory when aggregate remittances exceed INR 5 lakh and no AO certificate exists.
• Failure to deduct TDS results in a triple penalty: the TDS amount becomes payable with 1%–1.5% monthly interest, the entire expense is disallowed under section 35(b)(ii), and penalties under sections 448 and 462 apply.
• A lower or nil withholding certificate under section 395(1) (filed via Form 13) can reduce the cash flow burden when the non-resident's actual tax liability is lower than the default TDS rate.
• The abolition of the Equalization Levy from April 2025 means certain digital payments may now fall back under section 393(2) withholding if they constitute royalty or FTS.

Managing withholding tax on cross-border payments from India? Beacon Filing provides end-to-end section 393(2) compliance, DTAA rate application, Forms 145 and 146 filing, and lower withholding certificate assistance.