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Case Study : Withholding Tax on Cloud Services


A US based company, earned income from providing cloud services including cloud hosting and other supporting and ancillary services to its Indian customers.


Whether the Indian resident payer is required to withhold tax on Cloud Services as per Section-195 of ITA on the services as explained in the facts above?


  • As per Section-195 of ITA, Withholding tax is required to be deducted only when the sum payable to non-resident is chargeable to Tax under the provision of the ITA.
  • As per Section-5 of the ITA, Non-resident is taxable in Indian in the following situations:
  • Assuming that the US company is operating from USA and do not have any business connection in India and also received the sum in the US bank account of the Company, the income received by the US company from Indian Company for the services referred in the facts above is neither received or deemed to be received by the US Company in India nor the income is accrue or arise to the US company in India as it do not have any business connect-ion in India.
  • Now, the only option left is to test the income whether it is deemed to accrue or arise in Indian to the US Company as per the provision of Section-9 of the ITA.
  • The relevant clause of Section-9 of the ITA for the nature of income as mention in the facts of this case study is Clause-(vi) Income as Royalty or Clause-(vii) Income as Fee for technical services of sub section-1 of section-9 of ITA. Clause-(i) (Business Income) of sub section-1 of section-9 of ITA is not applicable as we have assumed that the US Company do not have any Business Connection in India.
  • As per Section-9(1)(vi) of the ITA: Income by way of royalty payable by person who is resident in India where the royalty is payable in respect of any right, property or information used or services utilised for the business or profession carried on by such person in India or earning any income from any source in India.
  • Royalty as used in the said clause is defined in Explanation 2 of Section-9(1)(vi) of the ITA and the relevant extract is as under:

Clause-(iva) [Inserted by Finance Act 2001 w.e.f. 1.4.2002] of Explanation 2 of Section-9(1)(vi) of the ITA read as:

“For the purposes of this clause, "royalty" means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head "Capital gains") for: the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB.


Explanation 5 [Inserted by Finance Act 2012 w.e.f. 1.6.1976. However, the Apex Court Ruled that it is effective from 1.4.2013 in Engineering Analysis Case] of Section-9(1)(vi) of the ITA read as:-

Explanation 5.—For the removal of doubts, it is hereby clarified that the royalty includes and has always included consideration in respect of any right, property or information, whether or not

a) the possession or control of such right, property or information is with the payer;

b) such right, property or information is used directly by the payer;

c) the location of such right, property or information is in India.

  • Based on the above, the income covered as per our facts may be considered as Royalty or popularly known as ‘Equipment Royalty’.
  • Let us also test the taxability under the relevant DTAA i.e. India-US DTAA. Article-12 of this DTAA deals with Royalty and fee for included services. The relevant extract is as under:

Article-12(3)(b) of this DTAA read as:

“Payments of any kind received as consideration for the use, or right to use, any industrial, commercial or scientific equipment, other than payments derived by an enterprise described in paragraph 1 of Article 8 (Shipping and Air Transport) from activities described in paragraph 2(c) or 3 of Article 8".

  • The definition of royalty in US India DTAA is exactly similar to the definition as provided in Clause-(iva) of Explanation 2 of Section-9(1)(vi) of the ITA BUT without Explanation 5 of Section-9(1)(vi) of the ITA which was inserted by Finance Act, 2012 w.e.f. 1976, therefore the scope under DTAA is limited as the services failed the essential test as was inserted in the ITA such as:

i) the user exercise any control /physical access over the equipment; or

ii) the user have independent right to use the equipment; or

iii) There is no agreement to hire or lease out any equipment but only a service level agreement

  • In view of Section-90(2) of ITA, DTAA provision is more beneficiary to the US Company and therefore, transaction as mentioned in our facts is not covered under Royalty.
  • If we test the transaction under consideration as per Section-9(1)(vii) of the ITA, whether it was covered under Fee for technical services? As the services covered as per the facts of this case does not require any human intervention to reach to the user, therefore it may not be covered as Fee for Technical Services as help by Delhi High Court in the case of CIT v. Bharti Cellular Ltd. [2009]319 ITR 139.


In view of the above analyses, income as mentioned in the facts of this case study is not chargeable to tax under the provisions of the ITA and no withholding tax on cloud Services is required as per Section-195 of the ITA.

(Disclaimer: This content is meant for our clients or professional friends only for stimulating discussion on the subject matter not to frame any commercial opinion. All efforts are made to compile correctly with no guarantee of extreme accuracy)

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