Cross-Border Royalty & FTS Payments: Tax Optimization Under DTAA And GST Implications

If your business makes payments to foreign entities for technical know-how, software licenses, consulting fees, or brand usage rights then you're already dealing with royalty and fees for technical services (FTS) taxation whether you realize it or not. The tricky part? These payments sit right at the intersection of Indian income tax, Double Taxation Avoidance Agreements (DTAAs), and GST which means one wrong move can cost you lakhs in unnecessary tax outflow or penalties. At DSRV and Co LLP, the leading tax consultant in Gurgaon with over three decades of cross-border tax expertise, we deal with these situations every single day. So let's break this down together what exactly qualifies as royalty and FTS, how DTAAs can save you money, and where GST fits into the picture.

What Exactly Counts As Royalty And FTS Under Indian Tax Law?

Before we jump into optimization strategies, we need to get the basics right. Because honestly, this is where most businesses trip up. They assume a payment is straightforward say, for some software or a consulting engagement abroad and then get hit with a tax demand they never saw coming.

Under Section 9(1)(vi) of the Income Tax Act, 1961, royalty covers a pretty wide range of payments. We're talking about consideration paid for using or getting the right to use any copyright, patent, invention, design, secret formula, trademark, or similar property. It also includes payments for the use of industrial, commercial, or scientific equipment. And here's what catches people off guard the definition under Indian domestic law is significantly broader than what you'll find in most DTAAs.

Now, Fees for Technical Services under Section 9(1)(vii) covers payments made to a non-resident for managerial, technical, or consultancy services. The keyword here is "technical." Not every service your overseas vendor provides qualifies as FTS. But the Indian tax department has historically taken an aggressive stance on this, trying to bring as many payments as possible under the FTS umbrella.

Here's where it gets interesting. The Supreme Court and various High Courts have repeatedly stepped in to narrow down these definitions. Remember the landmark ruling where the court held that "make available" is a critical test for FTS under most DTAAs? That single interpretation has saved Indian businesses crores in unnecessary withholding tax. More on that shortly.

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How DTAAs Actually Help You Reduce Tax On These Payments

This is the part where things get really practical and really valuable for your business.

India has signed DTAAs with over 90 countries. Each of these treaties has specific articles dealing with royalty (usually Article 12) and FTS. And here's the golden rule that every business making cross-border payments must understand Section 90(2) of the Income Tax Act allows you to apply whichever is more beneficial: the domestic tax rate or the DTAA rate.

Let's put this in real terms. Under domestic law, royalty and FTS payments to non-residents are taxed at 20% (plus applicable surcharge and cess). But under the India-Singapore DTAA, for instance, the rate could be as low as 10%. Under the India-UK treaty, similar beneficial rates apply depending on the nature of payment. That's a straight 10% saving on every payment which adds up to serious money over a financial year.

But wait it's not as simple as just picking the lower rate and running with it. There are conditions you need to meet.

The "Make Available" Clause - Your Most Powerful Tool

Several of India's DTAAs - particularly with the US, UK, and Singapore contain what's called the "make available" test for FTS. What this means is that a payment qualifies as FTS under the treaty ONLY if the service provider makes technical knowledge, experience, skill, or know-how available to the recipient in a way that the recipient can independently use that knowledge going forward.

So if you hire a foreign consultant who comes in, does the work, delivers a report, and leaves without actually transferring any lasting technical capability to your team that payment may NOT qualify as FTS under the DTAA at all. Which means? India may have no right to tax it at source.

This distinction has been upheld in numerous tribunal and High Court decisions. And it's one of the most powerful optimization strategies available to Indian businesses today.

Beneficial Ownership And Treaty Shopping Concerns

Now here's a word of caution. Tax authorities have become increasingly vigilant about treaty shopping where payments are routed through a country with a favorable DTAA purely to get the lower rate without any genuine business substance in that jurisdiction.

The introduction of the Principal Purpose Test (PPT) and Limitation of Benefits (LOB) clauses in updated treaties means you can't just set up a shell entity in Singapore or Netherlands and claim treaty benefits. There needs to be real economic substance. We've seen several cases in 2025 and 2026 where the tax department successfully challenged such arrangements. So optimization? Absolutely. But it must be backed by genuine commercial rationale.

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TDS Obligations - Getting The Withholding Right

Every time an Indian entity makes a royalty or FTS payment to a non-resident, TDS obligations kick in under Section 195. And this is non-negotiable. If you fail to deduct TDS or deduct it at the wrong rate, you're looking at disallowance of the expense under Section 40(a)(i), interest under Section 201(1A), and potential penalty proceedings.

Here's what you need to keep in mind:

• Domestic rate without DTAA: 20% plus surcharge and cess on royalty and FTS payments to non-residents.
• With applicable DTAA: The rate specified in the treaty, provided the non-resident furnishes a valid Tax Residency Certificate (TRC) and Form 10F.
• Lower deduction certificate: If the effective tax liability is lower than the standard TDS rate, the non-resident can apply for a lower deduction certificate under Section 197, and the payer can apply under Section 195(2) for a determination of the appropriate portion of payment chargeable to tax.

One thing we keep telling our clients at DSRV never treat TDS as a back-office afterthought. The documentation you maintain today TRC, Form 10F, PE declarations, board resolutions these are your shields in an assessment proceeding three years down the line.

The GST Layer - Because One Tax Was Never Enough

Now let's add another layer to this puzzle. When an Indian company pays royalty or FTS to a foreign entity, it's not just income tax you need to worry about. GST enters the picture through the reverse charge mechanism.

Under Section 5(3) of the IGST Act read with the relevant notification, import of services is taxable. So when your foreign licensor or consultant provides services from outside India, and the place of supply falls in India, you the Indian recipient are liable to pay GST under reverse charge at the applicable rate (typically 18%).

Here's the practical side of this:

• You pay GST on the gross amount of the royalty or FTS, including the TDS component. Yes, you read that right. GST is calculated on the whole payment, not just the net amount after TDS.
• Input Tax Credit (ITC) is available on this reverse charge GST, provided the services are used for making taxable outward supplies. So it's not dead money but you need proper documentation and compliance to claim it.
• The timing matters. GST under reverse charge must be paid on the date of payment to the foreign entity or the date of entry in the books whichever is earlier. Late payment means interest liability.

One common mistake we see? Businesses treating TDS and GST as either-or. They're not. Both apply simultaneously on the same cross-border payment. TDS under the Income Tax Act on the income component, and GST under reverse charge on the service component. Understanding this dual compliance is absolutely critical.

Also Read: MUST HAVE DOCUMENTS WHILE FILING FOR INCOME TAX RETURN

Practical Optimization Strategies That Actually Work

After helping hundreds of businesses with cross-border tax structuring over the past 30+ years, here are the strategies we at DSRV and Co LLP recommend most often:

1. Classify Payments Correctly From Day One

The difference between royalty, FTS, and business income under a DTAA can mean the difference between 20% tax and zero tax at source. Get the classification right before you sign the contract not after the tax notice arrives.

2. Structure Contracts With Tax Efficiency In Mind

A single composite contract covering software, implementation, training, and support can create unnecessary tax exposure. Splitting these into separate, clearly defined deliverables each with distinct pricing allows for more precise treaty application.

3. Maintain Bulletproof Documentation

TRC, Form 10F, PE declaration letters, board resolutions confirming the nature of services, invoices clearly describing deliverables keep everything ready. The assessment officer will ask for all of it.

4. Use The "Make Available" Test Proactively

If your DTAA contains the make available clause, structure your engagements so that technical knowledge is NOT transferred permanently. Document this in your service agreements explicitly.

5. Leverage Advance Rulings For High-Value Transactions

For significant recurring payments, consider approaching the Board for Advance Rulings (BAR) for certainty on the tax treatment. It costs some time upfront but saves enormous headaches later.

6. Don't Forget Equalisation Levy Implications

For certain digital services and e-commerce transactions, the Equalisation Levy may apply instead of or in addition to regular income tax provisions. Make sure your tax advisor evaluates this angle too.

Conclusion

Cross-border royalty and FTS payments are not just accounting entries they carry real tax consequences across multiple statutes. The interplay between the Income Tax Act, DTAAs, and GST creates a compliance maze that can either cost your business significantly or, with the right approach, be optimized legally and efficiently.

At DSRV and Co LLP, a trusted chartered accountant firm in India since 1987, we believe that informed decisions today prevent costly disputes tomorrow. Whether you're a multinational making technology payments, an Indian subsidiary paying management fees abroad, or an NRI dealing with cross-border income flows we've got the expertise and the experience to guide you through every single layer of this.

Need help structuring your cross-border payments for maximum tax efficiency? Get in touch with our team today.