Section 195 TDS on Foreign AI Vendors — India Compliance Guide
Section 195 TDS on foreign AI vendor payments (OpenAI, Anthropic, AWS). Post EL 2.0 abolition (1 Aug 2024). Engineering Analysis SC, DTAA rates, Form 15CB ≥₹5L.
Definition
Section 195 of the Income Tax Act 1961 governs Tax Deducted at Source (TDS) on payments made by Indian residents to non-residents — including payments to foreign AI vendors such as OpenAI, Anthropic, Google (for Gemini API), AWS (for Bedrock / Anthropic via Azure), Microsoft (Azure OpenAI), and any other non-Indian provider of AI / cloud / SaaS services.
The fundamental rule: TDS under Section 195 applies whenever the payment is chargeable to tax in India under the Income Tax Act. There is no monetary threshold under Section 195 itself — TDS applies from the first rupee paid, subject only to DTAA relief and the Engineering Analysis Supreme Court position on software classification.
The Engineering Analysis Supreme Court ruling
The defining case for TDS on foreign software / AI vendor payments is Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT — Supreme Court Civil Appeal Nos. 8733-8734 of 2018, judgment dated 2 March 2021.
The Court held that payments for standard end-user software licences (off-the-shelf, shrink-wrapped, or subscription-based with no transfer of copyright) do not constitute royalty under Section 9(1)(vi) of the Income Tax Act. The buyer receives only a right to use the software, not the underlying copyright. Consequently:
- No TDS under Section 195 for standard end-user software / AI service subscriptions (under domestic law)
- The position is absolute under domestic law — a May 2026 review petition by the Revenue Department was dismissed by the Supreme Court
However, the DTAA position may differ. Some older Double Taxation Avoidance Agreements define “royalty” more broadly than domestic Indian law. For payments under those treaties, royalty TDS may still apply at the DTAA rate even where domestic law would not require TDS. The Indian payer can invoke Section 90(2) to apply whichever is more beneficial — domestic law or treaty.
The post EL 2.0 picture
The Equalisation Levy 2.0 — the 2% levy on consideration received by non-resident e-commerce operators from Indian residents — was abolished by Finance Act (No. 2) 2024 effective 1 August 2024.
Before abolition: payments to foreign e-commerce operators (including foreign SaaS providers in many configurations) were covered by EL 2.0 and were typically exempt from Section 195 TDS to avoid double taxation.
After abolition: Section 195 again applies where the underlying income is chargeable under the Income Tax Act, subject to the Engineering Analysis position and DTAA provisions.
The transition created a real classification problem for FY 2024-25 returns — payments made before 1 August 2024 vs after 1 August 2024 have different TDS treatment. Many mid-market entities are still reconciling this for FY 2024-25 and FY 2025-26 returns. See the Equalisation Levy 2.0 abolition glossary entry for the transition mechanics.
DTAA rate caps — India-US example
For Indian payers transacting with US-resident foreign AI vendors (OpenAI, Anthropic, Microsoft Azure OpenAI, AWS Bedrock with US-resident counterparty), the India-USA DTAA Article 12 caps royalty + Fees for Included Services (FIS) at 10-15% depending on the specific nature of the rights / services.
The Indian payer must:
- Establish the tax residency of the foreign counterparty (Tax Residency Certificate / Form 10F is required for treaty benefits)
- Classify the payment under domestic law: royalty (Section 9(1)(vi)) vs FTS (Section 9(1)(vii)) vs business income (Section 9(1)(i))
- Apply the lower of domestic rate or DTAA rate per Section 90(2)
- Deduct TDS at the applicable rate before remittance
- Issue Form 15CA / Form 15CB per the threshold rules
Form 15CA / Form 15CB requirements
For aggregate taxable remittances to a single non-resident payee:
| Aggregate amount per FY per payee | Form 15CA | Form 15CB |
|---|---|---|
| ≤ ₹5 lakh | Form 15CA Part A | Not required |
| > ₹5 lakh | Form 15CA Part C | Required (Chartered Accountant certificate) |
| Non-taxable payment (e.g., towards remittance of own funds) | Form 15CA Part D | Not required |
Form 15CB certifies the nature of payment, applicable TDS rate, and DTAA position — making the CA professionally responsible for the classification.
Common patterns for foreign AI vendor payments
| Vendor / Service | Typical classification | TDS treatment (domestic) | TDS treatment (DTAA, where applicable) |
|---|---|---|---|
| OpenAI (direct API subscription, end-user use) | End-user software / service under Engineering Analysis | Nil under domestic law | India-US DTAA Article 12: 10-15% if classified as royalty/FIS under treaty; nil if business income with no India PE |
| Anthropic (Claude API subscription) | Same as above | Nil under domestic law | Same as above |
| Microsoft Azure OpenAI Service | Cloud + AI bundle | Typically nil under domestic law for SaaS access | Same as above |
| AWS Bedrock (foundation model API) | Cloud + AI bundle | Same as above | Same as above |
| Google Cloud (Gemini API) | Same as above | Same as above | Same as above |
| Foreign AI consultant / fine-tuning service provider (FTS character) | Fees for Technical Services under Section 9(1)(vii) | TDS applies at rate per IT Act + cess | DTAA-beneficial rate if treaty applies |
| Foreign AI infrastructure with India PE | Business income via PE | Subject to India tax on PE-attributable income | Treaty does not override domestic taxation of PE-attributable income |
The common compliance gap
The recurring pattern across Indian mid-market AI Spend reviews:
- Pre-1 Aug 2024 payments — EL 2.0 was paid; Section 195 was correctly not deducted. Documentation may be incomplete.
- Post-1 Aug 2024 payments — entity continued treating payments as exempt without re-classifying under Engineering Analysis + DTAA. Section 195 risk depends on classification.
- Form 15CA/15CB — historically incomplete on payments above ₹5L per payee per FY; reconciliation against Form 26AS is the recovery / risk-quantification exercise.
- Conservative over-deduction — some entities deducted TDS at flat 10% on all foreign software payments, missing DTAA-beneficial rates or Engineering Analysis nil treatment. Refund claim possible subject to time limits.
The AI Spend & Tax Optimisation methodology sub-domain 2 walks through the reconciliation discipline.
Related concepts
- Equalisation Levy 2.0 — see glossary entry; abolished 1 August 2024
- RCM on foreign SaaS — see glossary entry; 18% IGST under Section 5(3) IGST Act, separate from Section 195
- Engineering Analysis — the SC ruling that defined the no-royalty position for end-user software
- DTAA Article 12 — royalty + FTS provisions in most Indian tax treaties; rate caps typically 10-15%
- Form 15CA / 15CB — procedural compliance for foreign remittances
- Section 90(2) — beneficial-treatment selection between domestic law and DTAA
Practitioner reading
- Income Tax Act Section 195: https://incometaxindia.gov.in/Pages/acts/income-tax-act.aspx
- Engineering Analysis SC judgment (2 March 2021): https://www.indialawoffices.com/legal-articles/no-tds-on-use-of-foreign-software
- India-USA DTAA Article 12 (Royalties + FIS): https://incometaxindia.gov.in/Pages/international-taxation/dtaa.aspx