Budget 2026: A strategic upgrade to India’s International Tax and Transfer Pricing Laws

The Bill proposes a complete exemption for foreign companies on income arising in India from procuring data centre services from specified Indian data centres. The exemption is available until the tax year ending 31 March 2047, providing long-term fiscal certainty for global cloud and technology players operating in a highly capital-intensive sector.

To qualify for the exemption, the foreign company must:

1. be notified by the central government for this purpose;
2. not own or operate any physical infrastructure or resources of the specified data centre in India;
3. route all sales to users located in India through an Indian reseller entity; and
4. maintain and furnish information in the form and manner as may be prescribed.

Context and background

The exemption addresses long-standing tax uncertainty faced by foreign cloud service providers (CSP) that lease infrastructure from independent Indian data centre operators while serving customers globally, including in India.

Historically, disputes have centred on whether payments from Indian customers should be characterised as equipment royalty or business profits. Where treated as business profits, a further question arises as to whether the presence of data centres in India creates a permanent establishment (PE), triggering profit attribution and taxation. The Revenue has consistently sought to characterise such payments as royalty.

Although courts, including the Delhi High Court in Amazon Web Services Inc.,¹ have held that cloud hosting payments are not royalty and are not taxable in India in the absence of a PE, the PE question has not been conclusively examined. In Amazon Web Services India (P.) Ltd.,² the PE issue was remanded to the Assessing Officer due to insufficient facts, with the Court also questioning the Revenue’s approach to profit attribution.

Despite favourable rulings, tax authorities have continued to assert royalty characterisation and PE exposure. They often rely on arguments around the conduct of “core business activities”, “exclusive use” of servers, the “at disposal” test, or broad interpretations of what constitutes a business connection, taxable presence, or PE in India.

As a result, foreign companies procuring data centre services have faced risks of triggering various forms of PE, including a fixed place PE, a service PE, or an equipment PE. The risk is heightened by factors such as the degree of control exercised by the foreign company over the Indian data centre’s operations, the nature and extent of access its personnel have to the premises, and the duration of its employees’ presence in India for related activities.

Judicial decisions such as Mastercard Asia Pacific Pte. Ltd.,³ have further shaped this debate by recognising that automated equipment located in India, even if remotely controlled and operated from abroad by a foreign entity, can constitute a fixed place PE. The ruling underscored that direct human intervention is not a prerequisite, and that remote access, combined with substantial use of equipment for core business functions, may satisfy the PE threshold.

Against this backdrop, the proposed exemption represents a clear policy intervention to reduce recurring disputes on royalty characterisation, PE exposure, and profit attribution for asset-light foreign CSPs relying on independent Indian data centre providers. A key condition for availing the exemption is that all sales to users located in India must be routed through an Indian reseller entity, ensuring that domestic transactions remain within the Indian tax base. Entities that do not meet these conditions will continue to be governed by the general principles under the Income-tax Act and relevant Double Taxation Avoidance Agreements, including determinations on royalty characterisation, the treatment of profits as business income, and the existence of a PE in India, such as where a data centre is leased without the foreign entity having control or the power of disposal over the premises.

Transfer pricing safe harbour

To reinforce certainty for related-party arrangements, the Finance Minister also proposed the introduction of a safe harbour margin of 15% on cost for Indian entities providing data centre services to their related foreign companies availing this exemption.

Policy impact and strategic rationale

This policy is strategically timed to capitalise on the exponential growth in data consumption and the global push towards data localisation. India’s data centre market is expected to attract significant investment over the coming decades, and a 21-year tax holiday directly addresses one of the most critical concerns for investors: long-term policy stability.

By removing tax friction for foreign CSPs and providing certainty around pricing for Indian data centre operators, the exemption is designed to attract global hyperscalers to establish and scale their infrastructure footprint in India. If implemented effectively, this measure could materially accelerate India’s emergence as a leading data centre hub in the Asia-Pacific region, while also reducing prolonged litigation that has historically characterised this sector.

One of the most impactful announcements in the Budget Speech is the comprehensive overhaul of the safe harbour regime for the IT sector, which has been a key focal point for transfer pricing litigation.

Under the earlier framework, the safe harbour margins for software development services, IT-enabled services, knowledge process outsourcing, and contract R&D relating to software development ranged from 17% to 24%, depending on the aggregate value of international transactions and the cost composition of the service provider. Further, eligibility was capped at INR 300 crore aggregate value per service category. This fragmented structure often led to disputes over classification of services across closely linked segments.

The Finance Minister has proposed consolidating these interconnected service segments into a single category of “Information Technology Services” with a uniform safe harbour margin of 15.5%. This simplification aims to reduce litigation and administrative friction arising from interpretational differences in service classification.

The eligibility threshold is also proposed to be increased significantly from INR 300 crore to INR 2,000 crore of turnover. This enhancement brings a much broader segment of the IT industry, including several mid-sized and large Indian subsidiaries of multinational enterprises, within the ambit of the safe harbour regime. In addition, the framework is proposed to be procedurally simplified through an automated, rule-based approval mechanism, removing the need for examination and acceptance by a tax officer. Taxpayers opting for the safe harbour may continue under the regime for a continuous period of five years, easing recurring compliance and documentation burdens.

These changes will be implemented through amendments to the Income-tax Rules, and their impact will depend on the language of the forthcoming rules.

Complementing the safe harbour reforms, the Finance Bill introduces targeted enhancements to the APA programme, further strengthening it as an effective mechanism for dispute prevention and resolution.

1. Enabling modified returns for associated enterprises

   The Bill proposes to allow an associated enterprise affected by an APA to file a modified return of income. Currently, only the taxpayer that entered the APA may do so, creating procedural constraints for related parties seeking to give effect to corresponding adjustments. The proposed amendment addresses this gap by extending the facility to any associated enterprise whose income is impacted by the APA.

2. Fast-track unilateral APAs for IT Services

   Acknowledging that certain IT services companies may not opt for the safe harbour regime given their business models, the Finance Minister has proposed a fast-track mechanism for unilateral APAs in the IT sector. The government will seek to conclude such APAs within two years, extendable by six months at the taxpayer’s request. This reform addresses longstanding concerns over delays in the APA process, which have often undermined timely tax certainty.

Together, these measures strengthen India’s APA framework, align it more closely with international best practices, and enhance certainty for multinational groups operating complex global value chains.

The Bill proposes a tax exemption for foreign companies supplying capital goods, equipment or tooling (goods) to Indian contract manufacturers engaged in electronic manufacturing. Income arising from such arrangements would be exempt up to 31 March 2031, subject to the following conditions:

1. ownership of the goods remains with the foreign company;
2. the goods are under the control and direction of the contract manufacturer;
3. the contract manufacturer operates from a customs-bonded warehouse under section 65 of the Customs Act, 1962; and
4. the manufacturer produces electronic goods on behalf of the foreign company for consideration.

For instance, where a foreign company leases equipment to its Indian contract manufacturer, lease rentals would ordinarily be taxable in India as equipment royalty under the Income-tax Act or the applicable tax treaty. However, under the proposed exemption, such lease rentals would not be taxable in India for the period from 1 April 2026 to 31 March 2031, provided the manufacturing is undertaken from a customs-bonded warehouse.

The Bill seeks to resolve the long-standing tax controversy regarding the due date for depositing employee contributions to provident fund and other welfare funds for claiming a deduction under Section 36(1)(va) of the Income-tax Act, 1961 (ITA 1961), and the corresponding provision in Section 29(1)(e) of the Income-tax Act, 2025 (ITA 2025).

Prior to the Finance Act, 2021, High Courts had taken divergent views on whether the “due date” referred to the return filing due date under Section 139(1) of the ITA 1961, or the statutory due date prescribed under the relevant welfare legislation.

The Finance Act, 2021, inserted an Explanation to Section 36(1)(va) clarifying that the due date is the statutory due date under the relevant labour law. While the Revenue contended that this amendment was retrospective, the Delhi Income-tax Appellate Tribunal held it to be prospective.

In Checkmate Services Pvt. Ltd. v CIT,⁴ the Supreme Court settled the issue for tax years prior to the insertion of the Explanation by holding that employee contributions must be deposited within the statutory due date under the relevant welfare legislation. The Court adopted a strict interpretation of Section 36(1)(va) and denied deduction for delayed deposits, even if deposited before the return filing due date.

The Supreme Court⁵ has recently issued a notice to the tax department in a matter concerning the interpretation of due date under Section 36(1)(va) of ITA 1961. A challenge to the constitutional validity of the inserted Explanation is also pending before the Delhi High Court.⁶

Against this backdrop, the Bill proposes a significant shift under the ITA 2025: employee contributions will be deductible if deposited on or before the due date for filing the return of income under Section 263(1) for the relevant tax year. This relaxation applies prospectively under the ITA 2025, while earlier years will continue to be governed by the ITA 1961.

The proposed amendment provides much-needed clarity for future years and aligns the treatment of employee contributions more closely with employer contributions, thereby reducing litigation and offering relief to employers who deposit contributions before the return filing due date.