Clause 194 Tax on certain incomes.
Income Tax Bill, 2025
Introduction
Clause 194 of the Income Tax Bill, 2025, introduces a consolidated regime for the taxation of certain specified incomes, including, at S. No. 2 of its Table, a concessional tax rate on royalty arising from patents developed and registered in India. This provision is closely modeled on, and intended to replace or update, the existing Section 115BBF of the Income-tax Act, 1961, which, together with Rule 5G of the Income-tax Rules, 1962, currently governs the concessional tax regime for patent royalty income for resident patentees. The legislative context for these provisions is India's ongoing effort to incentivize domestic innovation and intellectual property development, aligning tax policy with the nation's economic and technological aspirations.
This commentary undertakes a detailed clause-by-clause analysis of Clause 194 (Table: S. No. 2) of the Income Tax Bill, 2025, focusing on its key features, objectives, and practical implications. It then provides a comparative analysis with the existing Section 115BBF of the Income-tax Act, 1961, and Rule 5G of the Income-tax Rules, 1962, highlighting similarities, differences, and potential areas of concern or improvement. The commentary concludes with an assessment of the likely impact of the proposed changes and identifies areas where further legislative or judicial clarification may be warranted.
Objective and Purpose
The legislative intent behind both Clause 194 (S. No. 2) of the 2025 Bill and Section 115BBF of the 1961 Act is to provide a concessional tax regime for royalty income derived from patents that are both developed and registered in India by resident patentees. This regime, often referred to as a "patent box" regime in international tax parlance, is designed to encourage research and development (R&D) within the country, foster innovation, and incentivize the commercialization of intellectual property domestically.
The policy rationale is twofold:
- To reward and encourage Indian innovators and inventors by offering a lower tax rate on royalty income, making India a more attractive jurisdiction for R&D activities.
- To align the Indian tax framework with global best practices, where several developed economies have implemented similar patent box regimes to attract and retain intellectual property and associated economic benefits within their jurisdictions.
The introduction of Clause 194 in the 2025 Bill, with a dedicated item for patent royalty income, signals the legislature's continued commitment to this objective, while also seeking to streamline and update the tax treatment of various special categories of income.
Structure and Scope
Clause 194(1) establishes a special mechanism for determination of tax in respect of specified incomes, overriding other provisions of the Act. The Table appended to this clause lists various categories of income, the applicable tax rates, and specific conditions. S. No. 2 is relevant for royalty income from patents:
| Assessee |
Income |
Rate of Tax |
Conditions |
| A person, resident in India and who is a patentee (eligible assessee) |
Royalty in respect of a patent developed and registered in India |
10% |
(a) No deduction in respect of any expenditure or allowance shall be allowed to the eligible assessee under any provision of this Act in computing his income referred to in column C;
(b) An option for taxation of income by way of royalty in respect of a patent developed and registered in India is exercised in the prescribed manner, on or before the due date specified u/s 263(1) for furnishing the return of income for the relevant tax year;
(c) Where an option is exercised under clause (b) and the eligible assessee does not offer its income for taxation as per the provisions of columns C and D for any of the five tax years succeeding such tax year, then such assessee shall not be eligible to claim the benefit of the provisions of columns C and D for five tax years subsequent to the tax year in which such income has not been offered to tax as per such provisions. |
The provision is further supplemented by definitions in sub-section (2), which closely mirror those in Section 115BBF, covering terms such as "developed," "patentee," "patent," "royalty," and "true and first inventor."
Definitions and Interpretative Aids
Clause 194(2) provides detailed definitions for key terms, many of which are directly borrowed from the Patents Act, 1970, or the existing Section 115BBF. Notably:
- "Developed": At least 75% of the expenditure incurred in India by the eligible assessee for the relevant invention.
- "Patentee": The true and first inventor whose name is entered in the patent register, including joint patentees.
- "Royalty": Consideration for transfer or use of patent rights, excluding capital gains or sale proceeds of products manufactured using the patent.
These definitions ensure that only genuine, substantial R&D activity conducted within India qualifies for the benefit, and that the concessional regime is not extended to mere holders of patents or to those whose connection to the invention is tenuous.
Key Interpretative Elements
- Eligible Assessee: The benefit is restricted to a person resident in India who is a patentee. This echoes the definition u/s 115BBF and ensures that the regime is not available to non-resident patentees, thereby targeting domestic innovation.
- Qualifying Patent: The patent must be both developed (with at least 75% of expenditure incurred in India) and registered in India. This requirement is designed to ensure substantial domestic value addition and prevent mere "paper" patents from availing the benefit.
- Royalty Income: The term "royalty" is defined exhaustively, covering transfer of rights, imparting of information, use of patent, and services related thereto, but excludes capital gains and consideration for sale of products manufactured using the patented process/article.
- Option Mechanism: The assessee must exercise an option for the concessional regime in the prescribed manner and within the prescribed time limit (on or before the due date for filing the return of income). Failure to adhere to the regime for any of the five subsequent years results in a five-year lockout from the regime, serving as an anti-abuse measure.
- No Deduction for Expenditure: The regime is a gross income regime-no deduction for any expenditure or allowance is permitted in computing the royalty income, ensuring simplicity and preventing base erosion.
Notable Features and Issues
- Override Clause: The provision operates "irrespective of anything contained in any other provision," ensuring primacy over other sections.
- Aggregation Mechanism: The total tax payable is the sum of (a) tax on royalty at 10% and (b) tax on other income at the applicable rates, after reducing the royalty income.
- Procedural Reference: The reference to "the prescribed manner" and due date u/s 263(1) (presumably the new equivalent of section 139(1) in the re-codified Act) indicates the need for a formal option, likely to be prescribed via rules analogous to Rule 5G.
- Lockout Provision: The five-year exclusion for failure to comply with the regime is a direct carryover from Section 115BBF(4), serving as a strong deterrent against regime shopping.
Practical Implications
For Resident Patentees
The regime provides a significant incentive for resident inventors and organizations to commercialize their patents in India, as the effective tax rate on royalty income is reduced to 10%, compared to the regular corporate or individual rates, which can be substantially higher. The prohibition on deductions, however, means that careful planning is required to ensure that the benefit of the lower rate is not offset by the inability to claim related expenses.
Compliance Requirements
The requirement to exercise the option in a prescribed form and within a specified timeline introduces an additional compliance burden. The lock-out provision further underscores the importance of consistency and accuracy in tax filings, as a single lapse can result in the loss of the benefit for a decade (five years of ineligibility after a lapse in any of five years).
Administrative and Regulatory Impact
Tax authorities will need robust systems to track the exercise of options, monitor compliance with the consistency requirement, and enforce the lock-out provision. The definitions provided should help minimize disputes over eligibility, but the potential for interpretative challenges remains, especially in relation to the "developed" criterion and the calculation of qualifying expenditure.
Comparative Analysis with Section 115BBF and Rule 5G
Section 115BBF, introduced by the Finance Act, 2016 (effective AY 2017-18), was India's first foray into a patent box regime. Its key features are:
- Scope: Applies to "eligible assessee" (resident patentee) earning royalty from a patent developed and registered in India.
- Rate: 10% on qualifying royalty income.
- No Deductions: No deduction for any expenditure or allowance in computing such income.
- Option Mechanism: Option to be exercised in the prescribed manner, on or before the due date u/s 139(1).
- Lock-out Provision: If the assessee fails to offer income as per the section for any of the five assessment years succeeding the option year, the benefit is denied for the next five assessment years.
- Definitions: Detailed definitions, closely paralleling those in Clause 194.
Rule 5G operationalizes the option mechanism u/s 115BBF. It prescribes:
- Filing of Form 3CFA, verified appropriately.
- Electronic submission, either with digital signature or electronic verification code.
- Submission on or before the due date for filing the return u/s 139(1).
- Responsibility of the Director General of Income-tax (Systems) for procedural and security aspects.
Comparison Table: Clause 194 (S. No. 2) vs. Section 115BBF and Rule 5G
| Feature |
Clause 194 (S. No. 2) - 2025 Bill |
Section 115BBF & Rule 5G - 1961 Act/Rules |
Comments |
| Eligible Assessee |
Resident patentee |
Resident patentee |
No change; both restrict benefit to resident inventors. |
| Qualifying Income |
Royalty from patent developed and registered in India |
Same |
Definitions and scope are identical. |
| Tax Rate |
10% |
10% |
No change. |
| No Deduction for Expenses |
Prohibited |
Prohibited |
Consistent approach; gross income taxed. |
| Option Mechanism |
Option to be exercised in prescribed manner, on or before due date u/s 263(1) |
Option to be exercised in prescribed manner (Form 3CFA), on or before due date u/s 139(1) |
Minor change: reference to Section 263(1) in Bill may reflect a renumbering or new procedural section in the 2025 Bill; functionally similar. |
| Lock-out Provision |
Five-year ineligibility if not offered for any of five years after opting in |
Same |
Identical mechanism. |
| Definitions |
Provided in Clause 194(2), referencing Patents Act |
Provided in Explanation to Section 115BBF, referencing Patents Act |
No substantive difference. |
| Procedural Rules |
To be prescribed |
Prescribed u/r 5G (Form 3CFA, electronic filing) |
Bill leaves details to rules; likely to mirror Rule 5G. |
Key Observations
- Substantive Parity: The core elements of the regime-eligibility, qualifying income, rate, denial of deductions, option mechanism, lock-out provision, and definitions-are virtually identical between the proposed Clause 194 (S. No. 2) and the existing Section 115BBF regime.
- Procedural Nuance: The Bill refers to the due date u/s 263(1) for exercising the option, whereas Section 115BBF refers to Section 139(1). This may reflect a restructuring or renumbering in the 2025 Bill, but the intent is to require timely exercise of the option concurrent with return filing.
- Integration with Broader Special Tax Regimes: The 2025 Bill consolidates various special tax rates for different categories of income (lotteries, online games, carbon credits, virtual digital assets, etc.) into a single clause. This may improve clarity and administrative efficiency.
- Potential for Updated Procedures: The Bill leaves the manner of exercising the option to be "prescribed," likely through future rules, which may update or replace Rule 5G and Form 3CFA.
Ambiguities and Potential Issues
While the regime is, on its face, straightforward, several interpretative and practical issues may arise:
- Determining "Developed" Expenditure: The requirement that at least 75% of the expenditure for the invention be incurred in India may necessitate detailed tracking and documentation, particularly for multinational entities or collaborative R&D projects.
- Nature of Royalty Income: The exclusion of consideration for sale of products manufactured using the patented process or article from the definition of "royalty" may require careful contractual structuring and revenue segregation.
- Lock-out Provision: The rigidity of the five-year lock-out may be harsh in cases of inadvertent or technical non-compliance, and could be subject to challenge or requests for relaxation in genuine hardship cases.
- Procedural Uncertainty: Until the new rules are notified, there may be uncertainty as to the exact form and manner for exercising the option under the 2025 Bill.
- Transitional Issues: For assessees currently availing Section 115BBF, the transition to the new regime under Clause 194 will need to be carefully managed to prevent loss of benefit or unintended consequences.
Comparative Context: International Patent Box Regimes
India's regime, as reflected in both Section 115BBF and Clause 194, is broadly consistent with international practice, particularly in the use of a concessional rate, a requirement for substantial R&D activity within the jurisdiction, and a focus on encouraging domestic innovation. However, some jurisdictions (e.g., the UK, Belgium, Netherlands) offer broader patent box benefits, sometimes extending to other forms of intellectual property or allowing partial deductions for expenses. India's regime is relatively strict in denying all deductions and limiting the benefit to resident patentees.
Conclusion
Clause 194 (S. No. 2) of the Income Tax Bill, 2025, essentially carries forward the policy and structure of the existing Section 115BBF regime, with minor procedural updates and integration into a consolidated special tax rate framework. The regime continues to offer a clear incentive for domestic innovation and the commercialization of Indian-developed patents, while maintaining robust safeguards against abuse. The practical impact for resident patentees is largely unchanged, though attention will need to be paid to procedural compliance and potential transitional issues as the new law comes into effect. Future legislative or judicial clarification may be required on the interpretation of qualifying expenditure, the operation of the lock-out provision, and the procedural requirements for exercising the option.
Full Text:
Clause 194 Tax on certain incomes.
Dated: 3-5-2025
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