Introduction
You just received $5,000 from a U.S. client, but only ₹4,00,000 showed up in your account. That missing ₹15,000? Chances are, it’s TDS.
If you’re an Indian service provider, exporter, or startup working with international clients, these hidden deductions can consume your income. In many cases, it’s due to compliance gaps that could’ve been avoided.
When do TDS and TCS apply to foreign payments? What documents do you need? What are the potential penalties? How can modern tools help you stay compliant? Read on!
Key takeaways
- TDS applies when Indian firms pay abroad vendors for services, consultancy, software subscriptions, or licensing payments.
- You can apply for reduced TDS rates under DTAA guidelines by providing documentation such as a Tax Residency Certificate (TRC), Form 10F, and a No PE (Permanent Establishment) statement.
- TCS applies to personal outward remittances under LRS, not regular business payments.
- Outward international payments above ₹5 lakh must be filed using Form 15CA/CB.
- If you don’t follow these rules, you may face fines, interest, and your expenses could be rejected during tax checks.
- Tools like Xflow help automate TDS/TCS compliance, documentation, and eFIRA generation for smoother cross-border payments.
TDS vs TCS
What is TDS?
TDS, or Tax Deducted at Source, is tax withheld before making certain payments. If you’re paying a foreign vendor, consultant, or freelancer, Indian tax law may require you to deduct a portion (under Section 195 or 194J) and deposit it with the government. It ensures taxes are collected early, even before the recipient files their return
What is TCS?
TCS, or Tax Collected at Source, applies when Indian banks collect tax before sending money abroad under the Liberalised Remittance Scheme. Whether it’s for education, medical expenses, gifts, or overseas investments, the bank deducts a percentage and deposits it with the tax department. You can later claim it while filing your income tax return, like an advance tax credit.
Who deducts what?
Here's the key distinction:
- You deduct TDS when paying a foreign entity for services
- Banks collect TCS when you send money overseas for certain personal purposes
But if you're a business making payments for legitimate business purposes (like paying for software tools or hiring foreign consultants), you're typically dealing with TDS, not TCS.
When does TDS apply to foreign payments?
Common scenarios where TDS applies:
- Zoom, Slack, Adobe or tools where human support is involved. Pure plug-and-play software are usually exempted.
- Hiring foreign freelancers, consultants, or agencies.
- Making license or royalty payments for IP, patents, or copyrighted content.
- Using overseas firms for legal, accounting, or consulting services.
But if you’re the one getting paid by foreign clients, you’re likely in the clear. Most won’t deduct TDS, as Indian tax laws don’t apply to them.
- Report the income when you file your Income Tax Return (ITR)
- Keep FIRC or e-FIRA documents as proof of foreign payments
- Follow GST rules if your services fall under taxable categories
- Make sure to maintain accurate invoices and paperwork for audits
Which sections of the Income Tax Act apply?
When paying for technical or professional services, Section 194J comes into play; depending on the service, the rate may be 10% or even more. Section 195 applies to nearly any payment made to a non-resident if it is taxable in India, with a default rate of about 20%.
How DTAA helps reduce your tax burden
India has Double Tax Avoidance Agreements (DTAAs) with over 90 countries, including the US, UK, Singapore, and most major economies. These agreements can significantly reduce your TDS burden.
If your foreign vendor provides the right documentation, you can often deduct TDS at reduced rates:
- Instead of 20%, you might only deduct 10-15%
- For some software subscriptions, the rate might be as low as 0-10%
The key documents you need from your vendor:
- Tax Residency Certificate (TRC) from their home country's tax authority
- Form 10F (a simple declaration form)
- No PE (Permanent Establishment) declaration showing they don't have a taxable presence in India
Recent updates to TDS and TCS rules
The government has made several changes that affect how you handle foreign payments:
TDS threshold increases
Under Section 194J, the TDS threshold has increased from ₹30,000 to ₹50,000 per financial year. If your annual payments to a foreign service provider are below ₹50,000, you might not need to deduct TDS at all.
TCS rate changes
TCS on foreign outward remittances under LRS has been raised to 20% for most purposes, though it remains at 5% for education and medical remittances above ₹7 lakh.
Important for businesses: Business-related remittances under category A1 codes are exempt from TCS. This is crucial for exporters and startups sending money abroad for legitimate business purposes.
Current TDS rates and DTAA benefits
| Payment type | Standard TDS rate | DTAA rate (e.g., US) |
|---|---|---|
| Royalty payments | 20% | 10-15% |
| Technical services | 20% | 10-15% |
| Software subscriptions | 20% (if with human input) | 0-10% |
| Consulting fees | 10% or 20% | Varies |
Required compliance documents
Accurate paperwork is an important step for avoiding penalties and optimizing your tax burden. So you know when and how much TDS applies. So, what paperwork do you actually need to make this work?
For outward payments (when you're paying foreign vendors):
From the vendor:
- Tax Residency Certificate (TRC) from their home country
- Form 10F declaration
- No PE (Permanent Establishment) declaration
You need to file:
- Form 15CA online (for remittances above ₹5 lakh)
- Form 15CB from a chartered accountant (for most payments)
- TDS returns after deducting tax
- Challan showing TDS deposited with the government
For inward receipts (when you're receiving payments):
- eFIRA/FIRC from your bank as proof of foreign currency receipt
- Proper GST invoicing if applicable
- ITR reporting showing foreign income
- Supporting contracts and service agreements
TCS on outward remittances: What businesses need to know
While most business payments don't attract TCS, it's worth understanding when it might apply.
TCS under LRS applies to:
- Education expenses abroad
- Medical treatment overseas
- Personal gifts and investments
- Tourism and travel (above certain limits)
TCS rates:
- 0.5% to 5% for education and medical remittances
- 20% for other purposes above ₹7 lakh annually
TCS typically doesn't apply if you're sending money abroad for legitimate business purposes using proper business remittance codes (A1 category).
Step-by-step TDS/TCS compliance checklist
If you're paying a foreign vendor:
- Always check if TDS is applicable under Section 195 or 194J
- Collect documents: Get the TRC, Form 10F, and No PE declaration from the vendor
- File forms: Submit Form 15CA and 15CB online before payment
- Make payment: Transfer money after deducting the appropriate TDS
- Deposit TDS: Pay the deducted tax to the government within the prescribed time
- File returns: Submit quarterly TDS returns
If you're receiving foreign payments:
- Maintain records: Keep eFIRA/FIRC from your bank for every receipt
- Invoice properly: Ensure GST compliance if applicable
- Report income: Include foreign earnings in your ITR
- Document everything: Maintain contracts, invoices, and remittance proof
Common mistakes and their penalties
| Mistakes | Penalties |
|---|---|
| Not deducting TDS when required or assuming it doesn't apply | Interest charges on delayed TDS payments |
| Deducting TDS at the wrong rates without DTAA documentation | Penalties up to ₹1 lakh for non-filing of TDS returns |
| Missing Form 15CA/15CB filing before remitting funds | Disallowance of expenses during income tax assessments |
| Assuming software subscriptions are always exempt from TDS | Regulatory scrutiny from the RBI or the Income Tax Department |
| Poor record-keeping and missing compliance proofs | Delays in approvals for future outward remittances |
Take control of your international payments
Getting TDS and TCS right means more money in your pocket with fewer compliance headaches.
That's why smart Indian businesses are switching to automation tools that handle the paperwork while they focus on actually growing their business.
How Xflow simplifies compliance
- Automatic eFIRA generation within 24 hours for every transaction
- Auto-generated GST and payment reports formatted for Indian tax requirements
- Transparent FX rates with no hidden markups
- Support for Form 15CA/CB filing with proper documentation
- Compliance guidance tailored to your specific remittance types
- Real-time tracking of all international payments and their tax implications
Sign up with Xflow and start receiving payments faster, cheaper, and with full compliance. Your clients will love the convenience, and you'll love the efficiency.
Frequently asked questions
TDS applies when you're paying foreign service providers. It does not apply when you're receiving payments from foreign clients. The applicability depends on the nature of the payment and whether it's taxable in India.
Yes, for most foreign remittances above ₹5 lakh, unless specifically exempted. Some routine payments, such as software subscriptions, may have simplified procedures.
Only if the foreign client deducts tax under their country's laws and provides proper documentation. This typically requires support under DTAA provisions and reporting.
No. TCS under LRS applies primarily to personal remittances. Business transactions under A1 remittance codes are generally exempt from TCS.
While receiving payments in foreign currency for exported services is typically GST-exempt under the zero-rated supply rule, not everything around the transaction is tax-free.
Services that support or facilitate remittance, like foreign currency conversion, compliance processing, or issuing certificates (like FIRC or BRC), can attract GST, since they're considered domestic taxable services.
