What Is Withholding Tax?
Withholding tax is tax collected at source when an Indian entity makes a payment to a non-resident. Instead of the non-resident filing an Indian tax return and paying tax later, the payer deducts the tax before releasing the payment. The deducted amount is deposited with the Indian government, and the non-resident receives a certificate for claiming credit in their home country.
In Indian tax law, withholding tax on cross-border payments is governed by section 393(2) of the Income-tax Act, 2025 (Table, Sl. No. 17; section 195 of the Income-tax Act, 1961). It is essentially TDS applied to payments leaving India.
Withholding tax is not a separate tax — it is a collection mechanism. The non-resident's actual tax liability is determined by the Income-tax Act, 2025 or the applicable Double Taxation Avoidance Agreement (DTAA), and the withholding approximates that liability.
Legal Framework
- Section 393(2) (Table, Sl. No. 17) — Any person making a payment to a non-resident that is chargeable to tax in India must deduct tax at source at the rates in force
- Section 207(1) (Table, Sl. Nos. 1-3) of the Income-tax Act, 2025 (section 115A of the Income-tax Act, 1961) — Tax rates for non-residents on dividends and interest. Royalty and fees for technical services are charged under section 207(2) (Table, Sl. Nos. 1 and 2) of the Income-tax Act, 2025 (section 115A of the Income-tax Act, 1961)
- Section 395(2) of the Income-tax Act, 2025 (section 195(2) of the Income-tax Act, 1961) — Application to the Assessing Officer for a lower or nil withholding determination
- Section 397(3)(d) of the Income-tax Act, 2025 (section 195(6) of the Income-tax Act, 1961) — Furnishing of information in Form 145 (formerly Form 15CA) and Form 146 (formerly Form 15CB). The 2025 text carries the words "not being a company or a foreign company", which is understood to be a drafting slip: do not read it as putting remittances involving companies or foreign companies outside the Form 145/146 requirement
- Sections 159 and 160 of the Income-tax Act, 2025 (sections 90 and 91 of the Income-tax Act, 1961) — DTAA benefit and unilateral relief. The treaty-more-beneficial rule is in section 159(4) and the tax residency certificate requirement in section 159(8)
- Section 397(2) of the Income-tax Act, 2025 (section 206AA of the Income-tax Act, 1961) — Higher withholding if the non-resident does not provide PAN; the 20% floor survives at section 397(2)(b)(i)(C)
- Section 206AB of the Income-tax Act, 1961 — Higher withholding for non-filers (never applicable to non-residents without PAN). It has no counterpart in the Income-tax Act, 2025
Withholding Tax Rates Under Domestic Law
| Nature of Income | Section | Domestic Rate (excl. surcharge/cess) |
|---|---|---|
| Interest on foreign currency borrowings | 207(1) (Table, Sl. Nos. 1-3) | 20% |
| Interest on ECB (infrastructure debt fund) | 194LC of the Income-tax Act, 1961 | 5% |
| Royalties | 207(2) (Table, Sl. Nos. 1 and 2) | 20% |
| Fees for Technical Services (FTS) | 207(2) (Table, Sl. Nos. 1 and 2) | 20% |
| Dividends | 207(1) (Table, Sl. Nos. 1-3) | 20% |
| Long-term capital gains (unlisted shares) | 197 (section 112(1)(c) of the Income-tax Act, 1961) | 12.5% |
| Short-term capital gains (listed equity) | 196 (section 111A of the Income-tax Act, 1961) | 20% |
| Other income | 393(2) (Table, Sl. No. 17) | Rates in force (30% / 35%) |
Add surcharge (2-5% for foreign companies depending on income) and Health & Education Cess (4%) to get the effective rate.
DTAA Rates — How They Override Domestic Rates
India has DTAAs with over 90 countries. When a DTAA provides a lower rate than domestic law, the lower rate applies. The non-resident must provide:
- A Tax Residency Certificate from their home country's tax authority
- A self-declaration in Form 41 (formerly Form 10F) (available on the e-filing portal)
- No Permanent Establishment (PE) declaration, if relevant
Common DTAA Withholding Rates
| Country | Interest | Royalties | FTS | Dividends |
|---|---|---|---|---|
| USA | 15% | 15% | 15% | 15% / 25% |
| UK | 15% | 15% | 15% | 10% / 15% |
| Singapore | 15% | 10% | 10% (Protocol) | 10% / 15% |
| Germany | 10% | 10% | 10% | 10% |
| Japan | 10% | 10% | 10% (Protocol) | 10% |
| Netherlands | 10% | 10% | Not in DTAA | 10% |
| UAE | 12.5% | 10% | Not in DTAA | 10% |
| Canada | 15% | 10% / 15% | 15% | 15% / 25% |
"Not in DTAA" means the treaty does not have a separate article for FTS. In such cases, FTS may be taxed as business profits (Article 7) — which is taxable in India only if the non-resident has a PE here. For more detail, see Singapore's 10% treaty rate for fees for technical services, or the USA treaty rate for fees for included services.
Why Withholding Tax Matters for Foreign-Owned Companies
- Every payment to the foreign parent is subject to withholding — Management fees, royalties, interest on inter-company loans, service charges, reimbursements with markup — all attract section 393(2) withholding.
- Reimbursements are not automatically exempt — Indian tax authorities often argue that reimbursements from the Indian subsidiary to the foreign parent include a profit element and should be subject to withholding. The CBDT's Circular No. 715/1995 provides some guidance, but disputes are common.
- Grossing-up obligation (section 393(10) of the Income-tax Act, 2025; section 195A of the Income-tax Act, 1961) — If the contract states the foreign company receives payment "net of taxes" (tax-borne-by-payer), the Indian company must gross up the payment and deposit the higher withholding amount. This increases the effective cost significantly.
- Certificate for lower withholding — Under section 395(1) of the Income-tax Act, 2025 (section 197 of the Income-tax Act, 1961), the non-resident can apply to the Assessing Officer for a certificate allowing withholding at a rate lower than the statutory rate. Under section 395(2) (section 195(2) of the Income-tax Act, 1961), the payer can apply for a determination of the appropriate withholding amount.
Withholding Tax Compliance Process
- Determine the nature of payment — Is it royalty, FTS, interest, dividend, or business income?
- Check the domestic rate — Look up the applicable section and rate
- Check the DTAA rate — If a DTAA exists with the recipient's country, compare rates. Apply the lower of the two.
- Collect TRC and Form 41 from the non-resident
- Deduct withholding tax at the time of payment or credit (whichever is earlier)
- Deposit with government — By the 7th of the following month
- File Forms 145 and 146 — Before making the remittance through the bank
- File Form 144 (formerly Form 27Q) — Quarterly TDS return for payments to non-residents
- Issue Form 16A — TDS certificate to the non-resident
Penalties
- Non-deduction of withholding tax — The payer becomes an assessee in default under section 398 of the Income-tax Act, 2025 (section 201 of the Income-tax Act, 1961). Must pay the tax amount plus interest at 1% per month under section 398(3)(a) from the date it should have been deducted.
- Late deposit — Interest at 1.5% per month under section 398(3)(a) from date of deduction to date of deposit
- Disallowance under section 35(b)(ii) of the Income-tax Act, 2025 (section 40(a)(i) of the Income-tax Act, 1961) — 100% of the expense is disallowed if TDS is not deducted on payments to non-residents. This is the harshest penalty — the full payment amount becomes non-deductible, increasing taxable income.
- Late filing of Form 144 — a late fee under section 427(1) of the Income-tax Act, 2025 (section 234E of the Income-tax Act, 1961). The fee was INR 200 per day under the 1961 provision; section 427 was substituted by the Finance Act, 2026, so confirm the current rate before relying on it
- Penalty under section 448 of the Income-tax Act, 2025 (section 271C of the Income-tax Act, 1961) — Equal to the amount of TDS not deducted
Common Mistakes
- Not withholding on software license payments — The Supreme Court in Engineering Analysis Centre of Excellence (2021) held that payments for software use rights are not "royalty" under most DTAAs. However, some DTAAs define royalties broadly. Companies must check the specific treaty.
- Applying DTAA rate without TRC — Without a valid TRC from the non-resident, the domestic rate (not the DTAA rate) must be applied. Applying the DTAA rate and then failing to produce the TRC during audit results in the payer being treated as in default.
- Ignoring the surcharge and cess on withholding — The treaty rate is the base rate. Surcharge and cess still apply. A 10% treaty rate becomes approximately 10.4% after cess (CBDT Circular No. 728/1996 clarifies this for some treaties, but practice varies).
- Not considering section 397(2) — If the non-resident does not provide a PAN, section 397(2) of the Income-tax Act, 2025 (section 206AA of the Income-tax Act, 1961) mandates withholding at 20% (section 397(2)(b)(i)(C)) or the applicable rate, whichever is higher. Under the 1961 Act, CBDT Notification 53/2016 relieved non-residents who furnished specified details (name, email, contact, address, TRC) even without PAN. Under section 397(2) that relief is available only as may be prescribed, so do not assume the old relief continues until the rules under the 2025 Act are checked.
- Confusing business profits with FTS — If a foreign company provides services that do not "make available" technical knowledge (the MFN test under many DTAAs), the payment may be business profits taxable only if the non-resident has a PE in India. Incorrectly classifying it as FTS and withholding at 10% when it should be 0% (no PE) creates refund complications.
Practical Example
An Indian subsidiary in Delhi pays its UK parent company GBP 100,000 per quarter for technology licensing (royalty) and GBP 25,000 per quarter for management oversight (FTS). Under the India-UK DTAA: royalties are taxed at 15%, FTS at 15%. The Indian company deducts 15% + applicable cess on each payment. Before remitting through its Delhi bank branch, the company files Form 146 (signed by a CA certifying the nature of payment, applicable treaty, and tax deducted) and Form 145 (online information form on the e-filing portal). The bank processes the remittance only after receiving the Form 145 acknowledgment. Form 144 is filed quarterly reporting both payments.
Related Terms
- TDS — The domestic counterpart of withholding tax
- Tax Residency Certificate — Required to claim treaty rates
- Forms 145 and 146 — Mandatory for all foreign remittances
- Dividend Tax — Withholding on profit distributions
- Transfer Pricing — Arm's length pricing affects the withholding base
Cross-border withholding tax is one of the most error-prone areas of Indian tax compliance. Beacon Filing ensures correct treaty application and filing for every remittance.