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DTAA Prevails Over Income Tax Act: Supreme Court Caps TDS on Foreign Payments

Background

The Supreme Court of India (2025 ruling) reaffirmed that DTAA provisions override domestic law, including Section 206AA of the Income Tax Act. When DTAA rates are more beneficial, withholding tax (TDS) must be applied at the treaty rate, even if the non-resident does not have a PAN.

Key Judicial Observation

The ruling came after the Income Tax Department sought to impose a 20% TDS on IT companies like Mphasis, Wipro and Manthan Software Services, citing non-furnishing of PAN under Section 206AA. These companies had made remittances for technical services to foreign recipients eligible for DTAA benefits.

Upholding the Karnataka High Court’s 2022 judgment, the Supreme Court reiterated that DTAA rates (in this case, 10%) prevail over domestic tax provisions like Section 206AA and any interpretation allowing higher TDS would contradict treaty obligations.

Transactions Covered & Compliance Steps

Cost Reimbursement (No Markup)

  • Nature: Actual cost recovery (travel, man-hour costs) by parent/group company for services rendered to Indian entity.
  • Tax Treatment: If reimbursement is pure and not income, generally no TDS. If linked to services, it may qualify as Fees for Technical Services (FTS) under DTAA in certain cases.

Cost Allocation (With or Without Markup)

  • Nature: Management fees, IT support, head office allocation, trademark/logo usage.
  • Tax Treatment: Taxable as FTS or Royalty under DTAA.

Dividend

  • Nature: Dividend declared by an Indian company (interim/final).
  • Tax Treatment: Taxable in the hands of a non-resident shareholder; DTAA rate often applies.

Interest on ECB

  • Nature: Interest paid on External Commercial Borrowings.
  • Tax Treatment: Domestic rate 20%; DTAA rate or whichever is lower.

Client Action Required to Avail DTAA Benefit

To apply the beneficial DTAA rate for the following transactions—Cost Reimbursement, Cost Allocation, Dividend and Interest on ECB—the client must ensure:

Mandatory Documentation:

  • Tax Residency Certificate (TRC) from the foreign recipient.
  • Form 10F duly filled in India and signed by the foreign entity.
  • Supporting Agreements & Invoices to substantiate the nature of payment (e.g., cost allocation workings, service agreements).

Compliance Steps:

  • Verify DTAA Applicability
    • Check if the foreign recipient’s country has a DTAA with India.
    • Confirm the relevant article (Dividend, Interest, Royalty/FTS) and applicable rate.
  • Apply DTAA Rate under Section 90(2)
    • Deduct TDS at the treaty rate instead of the domestic rate.
  • File Statutory Forms
    • Form 15CA/CB before remittance.
    • Ensure correct reporting in quarterly TDS returns.
  • Maintain Documentation for Audit
    • Agreements, invoices, TRC, Form 10F and declarations.
    • Proof of characterization (e.g., pure reimbursement vs. FTS).
  • PAN Requirement
    • Supreme Court ruling confirms Section 206AA does not override DTAA; PAN of non-resident is not mandatory if DTAA benefit is claimed.