Withholding Tax on FPI — Section 196D
Section 196D of the Income Tax Act governs the withholding tax on income earned by Foreign Portfolio Investors (FPIs) from Indian securities — prescribing a 20% TDS rate on dividend income and specifying the tax treatment of capital gains and interest income — with DTAA treaty benefits available to FPIs from treaty countries that can modify the applicable withholding rate through Form 10F and tax residency certificate submissions.
Foreign Portfolio Investors are a significant driver of Indian capital markets, collectively holding over Rs 60 lakh crore in Indian equities and debt as of 2024. The tax framework for FPIs balances India's sovereign right to tax Indian-source income against the need to maintain a competitive investment environment relative to other emerging markets. Section 196D is the primary withholding tax provision for FPI income, supplemented by Section 115AD which sets the substantive tax rates applicable to FPI income.
Under Section 115AD, FPIs are taxed at 20% on dividends from Indian companies (Section 196D requires the Indian company to withhold at this rate before remitting dividends), at 10% on LTCG from listed equity shares and equity-oriented funds (gains exceeding Rs 1.25 lakh per year), and at 20% on STCG from equity instruments. Interest income from securities is taxed at 20% under Section 115AD. These rates compare favourably with the maximum marginal rate of 30% applicable to domestic individuals, reflecting the policy choice to incentivise FPI participation.
DTAA treaty rates often improve on these statutory rates. The India-Mauritius DTAA, following its 2016 amendment, provides for capital gains sourcing rights to India — meaning capital gains from Indian securities are taxable in India even for Mauritius-registered FPIs. However, the treaty rate on dividends under the Mauritius DTAA is 5% (for substantial holdings) or the domestic rate of 20%, whichever is lower. The India-Singapore DTAA similarly provides for reduced rates on specific income categories. The India-Netherlands and India-France DTAAs contain provisions relevant to European FPIs.
To claim DTAA benefits, FPIs must furnish two key documents: a Tax Residency Certificate (TRC) issued by the competent authority of the country of residence confirming their tax residency status, and Form 10F providing additional information required under Section 90(5) of the Income Tax Act. Without these documents, the custodian or withholding agent must apply the higher of the domestic statutory rate or the treaty rate. SEBI-registered FPIs are required to maintain current TRCs and file them with their custodian banks at the start of each financial year.
The Principal Purpose Test (PPT) introduced by the Multilateral Instrument (MLI) to which India is a signatory adds a new layer of treaty benefit scrutiny. Under the PPT, treaty benefits can be denied if one of the principal purposes of an arrangement was to obtain the treaty benefit. For FPIs structured in Mauritius, Singapore, or Luxembourg primarily for tax reasons rather than genuine commercial reasons, PPT creates treaty shopping risk even for otherwise treaty-eligible structures. CBDT guidelines on treaty application and several recent AAR rulings provide guidance on the PPT's application in the Indian FPI context.