Withholding tax is a mechanism where tax is deducted at source by the payer before making certain payments to residents or non-residents. In India, it mainly applies to cross-border transactions involving interest, royalty, technical fees, dividends, and payments to foreign companies or individuals.
This blog explains what withholding tax means, when it applies, applicable rates, and how it differs from TDS.
Introduction
In a globalized economy, payments often flow across borders for services, technology, royalties, or investment returns. To ensure that tax is collected on such income, many countries, including India, use a system known as withholding tax.
Withholding tax in India refers to the amount of tax that an Indian payer must deduct before making certain payments to non-residents or foreign entities. This deduction is made at the time of payment or credit, whichever is earlier, and is deposited with the Indian government. It ensures tax collection at the source itself, even if the income earner is not physically present in India.
Although it is often confused with TDS (Tax Deducted at Source), withholding tax is a broader international concept focused on payments made to non-residents.
What is Withholding Tax?
The withholding tax is the tax deducted by a person (payer) from the amount payable to a foreign company or non-resident individual for specific types of income sourced from India. It applies to payments such as –
- Interest on loans or deposits
- Royalty and technical service fees
- Dividend income
- Software payments
- Contractual or professional services
The purpose is to withhold tax at the time of payment, ensuring the Indian government collects its share of tax revenue before the income leaves the country.
When Does Withholding Tax Apply?
Withholding tax applies when –
- A resident Indian makes specified payments to a non-resident
- The income is earned or deemed to be earned in India under Indian tax law
- The payment is taxable in India either under domestic law or under a Double Taxation Avoidance Agreement (DTAA)
For example, if an Indian company pays license fees to a U.S. software firm, withholding tax must be deducted from that payment as per applicable rules.
Key Rates and Applicability
Withholding tax rates may vary depending on the nature of payment, residency of the recipient, and applicable DTAA between India and the recipient’s country.
Typical rates under Indian domestic law –
- Interest – 20%
- Royalty/Fees for Technical Services – 10%
- Dividends – 20% (unless exempt under amended laws)
- Professional/Contractual services – 10% or more, depending on the nature.
However, if the recipient provides a Tax Residency Certificate (TRC) and qualifies under the DTAA, the rate could be lower (e.g., 10% or even 5% in some treaties).
All payments are subject to surcharge and health & education cess, if applicable.
Difference Between TDS and Withholding Tax
While both TDS and withholding tax involve the deduction of tax at source, they differ in context-
| Aspect | TDS | Withholding Tax |
| Applies To | Resident payees (within India) | Non-resident payees (outside India) |
| Governing Law | Income Tax Act, 1961 | Income Tax Act + DTAA provisions |
| Rates | Fixed as per sections like 192, 194J | Varies with payment type and DTAA |
| Declaration Forms | PAN, Form 15G/15H, etc. | Tax Residency Certificate (TRC), Form 10F |
| Filing | Quarterly TDS returns | Form 27Q for non-resident payments |
Compliance and Filing Requirements
Indian payers making payments subject to withholding tax must –
- Deduct tax at the applicable rate
- Deposit the tax with the government within 7 days of the next month
- File Form 27Q, a quarterly return for non-resident TDS
- Issue Form 16A (TDS certificate) to the foreign party
- Collect TRC, PAN (if available), and Form 10F to avail of lower DTAA rates
Incorrect deduction or non-deduction can lead to interest, penalty, and disallowance of expenses under Section 40(a)(i) of the Income Tax Act.
How Does DTAA Impact Withholding Tax?
India has signed the Double Taxation Avoidance Agreements (DTAAs) with over 90 countries. These agreements –
- Avoid the same income being taxed in both countries
- Prescribe reduced withholding tax rates
- Require submission of the TRC and Form 10F by the foreign recipient
- Offer credit or exemption in the recipient’s home country
For example, under the India–USA DTAA, royalty payments may be taxed at 15% or lower, instead of the domestic rate of 20%.
Conclusion
The withholding tax in India is an important element of international taxation as it ensures that income sourced from India is taxed at the time of payment, where the recipient is not located in India. For businesses and professionals engaged in cross-border transactions, it is important to be aware of and comply with withholding tax provisions if they want to avoid penalties and problems in making international payments.
By keeping proper documentation, knowing DTAA benefits, and following the prescribed filing procedures, Indian payers can manage withholding tax efficiently and maintain smooth business relationships with global partners.
Related Services
Income Tax Return Filing Online
Reference
The Income-Tax Act, 1961 (Act No. 43 of 1961)
https://incometaxindia.gov.in/
https://contents.tdscpc.gov.in/
https://www.icai.org/
