TDS Compliance of IFSC Companies

Introduction: Understanding TDS in the IFSC Context

International Financial Services Centres (IFSCs), particularly GIFT City IFSC, have been positioned by the Government of India as globally competitive financial hubs offering tax efficiency, regulatory flexibility, and ease of doing cross-border business. While IFSC entities enjoy several direct and indirect tax incentives, Tax Deducted at Source (TDS) compliance continues to be a critical and often misunderstood obligation.

A common misconception among IFSC entities is that tax exemptions available to IFSC units automatically translate into blanket relief from TDS obligations. In practice, TDS compliance for IFSC companies is transaction-specific, recipient-specific, and condition-based, requiring careful evaluation under the Income-tax Act, 1961, read with IFSC-specific notifications and Double Taxation Avoidance Agreements (DTAAs).

This article provides a comprehensive and practical guide to TDS compliance for IFSC companies, with particular emphasis on IFSC-specific exemptions and CBDT notifications, which are most relevant for directors and compliance professionals overseeing governance and regulatory risk.

Legal Framework Governing TDS for IFSC Companies

IFSC entities are incorporated in India and are generally treated as resident taxpayers under the Income-tax Act, 1961. Accordingly, Chapter XVII-B (TDS provisions) applies to IFSC companies unless specifically exempted.

The TDS framework applicable to IFSC entities is shaped by the interaction of the following:

• Income-tax Act, 1961
• IFSC-specific provisions introduced through Finance Acts
• CBDT notifications and circulars
• DTAAs for cross-border payments
• IFSCA regulatory approvals and licensing conditions

A fundamental principle to note is that IFSC tax incentives do not override TDS provisions unless expressly stated. Relief from TDS is granted only where:

• The income itself is exempt, or
• A specific notification provides for nil or lower deduction

TDS on Payments to Non-Residents by IFSC Companies

General Rule – Section 195

Under Section 195, any payment to a non-resident which is chargeable to tax in India is subject to TDS. IFSC status does not, by itself, negate this obligation.

Typical payments by IFSC companies to non-residents include:

• Interest on foreign borrowings
• Management and advisory fees
• Technical and professional services
• IT and software services
• Royalty and licensing fees

For most of these payments, TDS must be deducted at rates prescribed under the Income-tax Act or the applicable DTAA, whichever is more beneficial to the payee.

Interest Payments – A Key IFSC Exception

One of the most significant TDS relaxations for IFSC companies relates to interest payments to non-residents.

Under Section 10(15)(iv)(fa), interest income earned by a non-resident from monies borrowed by an IFSC unit is exempt, subject to prescribed conditions.

Implication for TDS compliance:

• Where interest income is exempt in the hands of the recipient, no TDS is required to be deducted
• This benefit is widely used by IFSC banks, NBFCs, treasury centres, and fund entities raising offshore debt

However, the exemption is not automatic. IFSC entities must ensure:

• The borrowing qualifies under the notified category
• The lender is a non-resident
• Documentation and approvals are in place

TDS on Payments to Resident Vendors and Service Providers

For payments made to Indian resident entities or individuals, no special TDS relaxation is available merely because the payer is an IFSC company.

Accordingly, standard TDS provisions apply, including:

Common IFSC scenarios include payments to:

• Indian consulting firms
• Compliance advisors and auditors
• IT vendors and managed service providers
• Facility and infrastructure providers

Non-deduction or short deduction of TDS in such cases often results in disallowance of expenditure, interest, and penalty exposure, making this a key risk area for IFSC compliance officers.

Salary TDS Obligations for IFSC Companies

Applicability of Section 192

Salaries paid by IFSC companies to employees are subject to TDS under Section 192, without any general exemption.

This applies to:

• Indian employees
• Senior management
• Compliance and principal officers

IFSC employees do not enjoy automatic income-tax exemption merely due to the location of employment.

Expatriate Employees

For foreign employees working in IFSC entities:

• Residential status determination is critical
• DTAA provisions must be analysed
• Salary allocation between India and overseas duties may be required

Improper handling of salary TDS for expatriates is a frequent audit observation in IFSC entities.

TDS on Dividend, Royalty, and Other Payments

Dividend Payments

Post abolition of Dividend Distribution Tax (DDT), dividends are taxable in the hands of shareholders. Accordingly:

• TDS applies on dividend payments under Section 194 (resident) or Section 195 (non-resident)
• IFSC companies are not exempt from this obligation

Royalty and Software Payments

Royalty and software payments made by IFSC entities to overseas group companies or vendors often attract scrutiny due to:

• Characterisation issues (royalty vs service)
• PE exposure concerns
• DTAA interpretation differences

In most cases, TDS compliance is mandatory, unless a specific treaty exemption applies.

IFSC-Specific TDS Exemptions and CBDT Notifications

Evolution of IFSC-Focused TDS Relief

Recognising the need to make IFSC operations competitive with offshore financial centres, the Government has progressively introduced targeted TDS exemptions through CBDT notifications.

These exemptions are not general in nature and apply only to specified payments, specified recipients, and specified IFSC units.

TDS Exemption on Payments to IFSC Units

Recent CBDT notifications provide that specified payments made to IFSC units shall not be subject to TDS, subject to conditions.

Key features include:

• Applicable only to IFSC units that have opted for benefits under Section 80LA
• Covers specified nature of payments notified by CBDT
• Requires compliance with prescribed declarations and reporting

This is particularly relevant where:

• A domestic entity makes payments to an IFSC unit
• Inter-unit transactions occur within group structures

Strategic Importance for IFSC Entities

From an IFSC perspective, these exemptions:

• Reduce cash-flow blockage due to withholding
• Improve treasury efficiency
• Enhance attractiveness of IFSC as a booking and operational centre

However, incorrect application of these exemptions can result in severe downstream exposure, including:

• TDS demand on the payer
• Disallowance of expenditure
• Interest under Section 201(1A)

Documentation and Governance Expectations

To legitimately claim IFSC-specific TDS exemptions, entities must maintain:

• Proof of IFSC registration and licensing
• Evidence of eligibility under the relevant CBDT notification
• Contractual clarity on nature of payment
• Audit-ready documentation

Compliance officers and principal officers play a crucial role in ensuring that commercial arrangements align with tax positions.

TDS Compliance, Reporting, and Audit Readiness

Even where no TDS is deductible due to exemption, procedural compliance continues to apply.

IFSC companies are expected to:

• File TDS returns (Forms 24Q, 26Q, 27Q)
• Ensure reconciliation with Form 26AS / AIS
• Report appropriately in tax audit (Form 3CD)
• Maintain robust internal controls and SOPs

In practice, TDS compliance is one of the first areas examined during tax audits and regulatory reviews of IFSC entities.

Conclusion

TDS compliance for IFSC companies is not merely a tax calculation exercise—it is a governance, documentation, and risk management function. While IFSC entities benefit from progressive tax incentives, particularly through targeted CBDT notifications, these benefits demand a higher standard of compliance discipline.

For directors, compliance officers, and principal officers, the focus should be on:

• Correct interpretation of IFSC-specific exemptions
• Strong documentation and internal controls
• Alignment between commercial structuring and tax compliance

A well-governed TDS framework not only mitigates regulatory risk but also strengthens the credibility and sustainability of IFSC operations.