By Manu Rao | Updated March 2026
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 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 or the applicable Double Taxation Avoidance Agreement (DTAA), and the withholding approximates that liability.
Legal Framework
- Section 195 — Any person making a payment to a non-resident that is chargeable to tax in India must deduct tax at source
- Section 115A — Tax rates for non-residents on specified income (dividends, royalties, fees for technical services)
- Section 195(2) — Application to the Assessing Officer for lower or nil withholding certificate
- Section 195(6) — Furnishing of information in Form 15CA and 15CB
- Section 90/91 — DTAA benefit and unilateral relief provisions
- Section 206AA — Higher withholding (20%) if the non-resident does not provide PAN
- Section 206AB — Higher withholding for non-filers (not applicable to non-residents without PAN)
Withholding Tax Rates Under Domestic Law
| Nature of Income | Section | Domestic Rate (excl. surcharge/cess) |
|---|---|---|
| Interest on foreign currency borrowings | 115A(1)(a)(ii) | 20% |
| Interest on ECB (infrastructure debt fund) | 194LC | 5% |
| Royalties | 115A(1)(b) | 10% |
| Fees for Technical Services (FTS) | 115A(1)(b) | 10% |
| Dividends | 115A(1)(a)(i) | 20% |
| Long-term capital gains (unlisted shares) | 112(1)(c) | 10% |
| Short-term capital gains (listed equity) | 111A | 15% |
| Other income | 195 | 30% / 40% |
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 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.
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 195 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 — 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 197, the non-resident can apply to the Assessing Officer for a certificate allowing withholding at a rate lower than the statutory rate. Under Section 195(2), 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 10F 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 Form 15CA/15CB — Before making the remittance through the bank
- File 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 (Section 201). Must pay the tax amount plus interest at 1% per month from the date it should have been deducted.
- Late deposit — Interest at 1.5% per month from date of deduction to date of deposit
- Section 40(a)(i) disallowance — 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 27Q — INR 200/day under Section 234E
- Penalty under Section 271C — 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 206AA — If the non-resident does not provide a PAN, Section 206AA mandates withholding at 20% or the applicable rate, whichever is higher. However, CBDT Notification 53/2016 provides relief for non-residents who furnish specified details (name, email, contact, address, TRC) even without PAN.
- 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 15CB (signed by a CA certifying the nature of payment, applicable treaty, and tax deducted) and Form 15CA (online information form on the e-filing portal). The bank processes the remittance only after receiving the Form 15CA acknowledgment. Form 27Q is filed quarterly reporting both payments.
Related Terms
- TDS — The domestic counterpart of withholding tax
- Tax Residency Certificate — Required to claim treaty rates
- Form 15CA/15CB — 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.