"Royalty to the parent is just an intercompany invoice": What FEMA and Indian tax law actually require

The first royalty invoice usually gets raised about eighteen months after the Indian subsidiary is incorporated. Someone at the parent notices that the India entity has been using the group's trademark, software and engineering know-how for free, and books a 5% royalty to fix the transfer pricing optics. The invoice goes out, the Indian CFO sends it to the bank, and the remittance stops — because nobody produced an agreement, a Form 15CB, or a withholding tax challan. This is the single most common cross-border payment that foreign groups get structurally wrong in India, and the reason is that it sits at the intersection of three separate regimes that do not talk to each other: FEMA, the Income-tax Act, and transfer pricing.

What the regulation actually says

FEMA treats royalty as a current account transaction, not FDI. Royalty and technical fee payments are governed by Section 5 of the Foreign Exchange Management Act, 1999 read with the Foreign Exchange Management (Current Account Transactions) Rules, 2000. This matters enormously, because current account transactions are presumptively free unless expressly restricted, whereas capital account transactions (equity, convertible instruments) are presumptively restricted unless expressly permitted.

Historically, royalty payments were capped — 5% of domestic sales and 8% of exports for technology transfer, 1% and 2% for trademark use without technology. Those caps were removed in 2009 and the residual approval requirement was abolished by Press Note 8 of 2009. Since then, royalty and technical fee (often labelled "fees for technical services" or FTS) payments to a foreign parent have been permitted under the automatic route with no monetary ceiling and no prior government approval, provided the payment is for a genuine service or right actually supplied.

That freedom on the FEMA side is precisely why the pressure shifted to tax and transfer pricing. There is no longer a regulatory cap telling you what is reasonable. You have to defend the number yourself.

The tax side: Section 195 withholding. Any person paying a sum to a non-resident that is chargeable to tax in India must deduct tax at source under Section 195 of the Income-tax Act, 1961. Royalty and FTS are deemed to accrue in India under Section 9(1)(vi) and 9(1)(vii) respectively when paid by an Indian resident, regardless of where the service was performed.

The domestic rate for royalty and FTS paid to a non-resident is 20% (plus applicable surcharge and cess) following the Finance Act 2023 amendment, which doubled the earlier 10% rate. Most double taxation avoidance agreements (DTAAs) prescribe a lower rate — commonly 10% or 15% — and Section 90(2) allows the payer to apply whichever is more beneficial. But the treaty rate is not automatic. To claim it, the foreign parent must furnish:

• A valid Tax Residency Certificate (TRC) issued by its home tax authority for the relevant year
• Form 10F, now filed electronically on the Indian income tax portal, which requires the non-resident to hold an Indian PAN
• A no-Permanent-Establishment declaration, where the treaty article is conditioned on the income not being attributable to a PE in India

Without these, the AD bank and the Chartered Accountant certifying the remittance will apply the 20% domestic rate.

"Make available" changes the answer for technical fees. Several Indian treaties — notably with the United States, United Kingdom, Singapore, Netherlands and Canada — restrict taxation of FTS to services that "make available" technical knowledge, experience or skill to the Indian recipient, such that the recipient can apply it independently in future. Routine managerial support, recurring engineering assistance or day-to-day helpdesk services often fail the make-available test and are therefore not taxable in India at all under those treaties. Trademark royalty, by contrast, is almost always taxable as royalty regardless.

Getting this distinction right in the agreement — and in how the invoice describes the charge — is worth more than any amount of post-facto argument.

The remittance mechanics: Form 15CA and 15CB. Before the AD Category-I bank will execute the outward remittance, Rule 37BB requires:

• Form 15CB — a certificate from a practising Chartered Accountant stating the nature of the payment, the taxability position, the treaty article relied on, and the rate of withholding applied
• Form 15CA Part C — the remitter's declaration, filed on the income tax portal, referencing the 15CB acknowledgement number

The bank will also ask for the underlying royalty or technical services agreement, the invoice, and the TDS challan evidencing deposit of the withheld tax. No agreement, no remittance — this is the step that catches groups who treated the charge as a bookkeeping entry.

The transfer pricing layer. A payment from an Indian subsidiary to its foreign parent is an international transaction between associated enterprises under Section 92B, so it must satisfy the arm's length standard in Section 92. Practically:

• If aggregate international transactions exceed INR 1 crore, you need contemporaneous TP documentation under Rule 10D
• Form 3CEB, certified by an accountant, is due by 31 October each year, regardless of the value threshold
• The Comparable Uncontrolled Price method is preferred for royalty where external licence comparables exist; the Transactional Net Margin Method is common as a corroborative check on whether the Indian entity retains a reasonable residual return after paying the royalty

Indian transfer pricing officers have historically attacked royalty payments on two fronts: benefit test (did the Indian entity actually receive something of value?) and economic ownership (has the Indian entity built local brand value it is now paying to use?). Both are answerable, but only with evidence assembled before the payment, not after the notice.

Practical implications of getting it wrong

Short-deducted withholding disallows the whole expense. Under Section 40(a)(i), failure to deduct or deposit tax on a payment to a non-resident results in 100% disallowance of that expenditure when computing the Indian entity's taxable income. A ₹4 crore royalty paid without proper TDS is a ₹4 crore addition to taxable profit, plus interest under Section 201(1A) at 1% per month for non-deduction and 1.5% per month for non-payment after deduction.

TP adjustment is an addition, not a refund. If the TPO holds the arm's length royalty to be 2% rather than the 5% charged, the 3% differential is added to the Indian entity's income. The parent does not get to give the money back — the adjustment is one-directional unless you pursue a Mutual Agreement Procedure under the relevant DTAA, which takes years.

Secondary adjustment creates a deemed loan. Where a primary TP adjustment exceeds INR 1 crore and the excess money is not repatriated to India within the prescribed period, Section 92CE deems it an advance to the associated enterprise and imputes notional interest, taxable annually until repatriated. This is how a one-year adjustment becomes a recurring problem.

FEMA contravention on the remittance itself. Remitting without the underlying agreement or without the 15CA/15CB trail is a contravention capable of compounding under Section 15 of FEMA, and it surfaces later — usually during due diligence on an exit, when the acquirer's counsel asks for the royalty agreement and there isn't one.

Step-by-step: what to do

• Execute a written agreement before the first charge accrues. A royalty agreement (for trademark, patent or know-how) and a separate technical services agreement (for engineering, IT or management support) — kept distinct, because they attract different treaty treatment. Specify the licensed rights, territory, term, rate, and the basis of computation (net sales, defined precisely, with exclusions for GST, freight and returns).
• Obtain a PAN for the foreign parent. Without it, Form 10F cannot be filed electronically and Section 206AA can force a 20% floor rate irrespective of the treaty.
• Collect the TRC and file Form 10F on the income tax portal at the start of each Indian financial year (1 April to 31 March), before the first remittance of that year.
• Run a benefit-test file alongside the agreement. Contemporaneous evidence that the Indian entity received something: training records, technical documentation shared, engineer visit logs, software access grants, brand guidelines received. Build it as the year runs, not in response to a notice.
• Deduct tax at the applicable rate and deposit it by the 7th of the following month (30 April for March deductions). File the quarterly Form 27Q TDS return for non-resident payments.
• Get Form 15CB from a Chartered Accountant, then file Form 15CA Part C on the portal, and submit the 15CA/15CB pair with the invoice, agreement and TDS challan to your AD Category-I bank.
• Issue Form 16A to the foreign parent so it can claim foreign tax credit in its home jurisdiction.
• Commission the TP study and file Form 3CEB by 31 October. For the royalty rate specifically, benchmark against third-party licence agreements in the same industry, and document why the Indian entity's residual operating margin after the royalty remains within the arm's length range.
• Consider an Advance Pricing Agreement if the royalty is material and recurring. India's APA programme has a functioning rollback mechanism covering four prior years, which is the only way to buy genuine certainty on a rate.

FAQ

Is there still a cap on royalty payments to a foreign parent?
No. The sectoral caps of 5%/8% for technology and 1%/2% for trademark were removed in December 2009 and the payment moved to the automatic route. The constraint today is the arm's length standard under transfer pricing, not a FEMA ceiling.

Can we backdate a royalty agreement to cover prior years?
No — and attempting it is worse than the original omission. Indian TP documentation must be contemporaneous under Rule 10D, and an agreement executed after the fact will be treated as evidence that no benefit was actually conferred. The correct fix is a prospective agreement from a clean date, with the prior-period exposure assessed separately.

If the treaty says the technical fee is not taxable in India, do we still need Forms 15CA and 15CB?
Yes. Form 15CB is the mechanism by which the non-taxability position is certified — the CA states the treaty article and the reason no tax is deducted. The bank will not process the remittance without it. Non-taxable is not the same as non-reportable.

---

Planning India entry? Start with a free structure review at makeitlegit.in

---

See Also

• "A virtual office is enough for our Indian entity": What MCA actually requires for a registered office
• "We'll just put our CFO on the board": What the Companies Act and FEMA actually require of directors in your Indian subsidiary
• "We'll just appoint our CFO in Singapore as director": what the Companies Act actually requires of an Indian subsidiary's board