When an Indian business pays royalty to a foreign company for the use of trademarks, patents, software or technical know-how, GST implications arise. Such payments are treated as import of services under the Integrated Goods and Services Tax (IGST) Act, 2017, and are generally taxable under the reverse charge mechanism (RCM).
Understanding when GST applies, how it is calculated and how it should be reported is essential to avoid interest, penalties and input tax credit (ITC) mismatches. This guide explains the applicability, compliance requirements and key practical considerations businesses must evaluate while dealing with cross-border royalty transactions.
What transactions are considered royalty payments?
There are no separate provisions in the GST framework for royalty separately in a detailed manner. However, it is covered through the concept of ‘supply’ and ‘services’.
As per Schedule II of the Central Goods and Services Tax (CGST) Act, the following are treated as supply of services:
- Temporary transfer or permitting the use or enjoyment of any intellectual property right (IPR)
- Licensing of intangible assets
Since royalty is typically paid for the use of intellectual property such as trademarks, patents, copyrights or technical know-how, it is treated as consideration for a supply of services.
How does the RCM apply?
Under the RCM, the liability to pay GST shifts from the supplier to the recipient of goods or services. RCM applies to notified supplies under Section 9(3) and 9(4) of the CGST Act, 2017, and Section 5(3) of the IGST Act, 2017.
In royalty transactions, RCM typically applies when the supplier is the government or a foreign entity.
For example:
- If royalty is paid to the government for mining rights, the business entity paying the royalty must discharge GST under RCM.
- If royalty is paid to a foreign company, the Indian recipient must pay IGST under RCM.
The tax must be paid in cash and cannot be set off against ITC at the time of payment. However, credit may be claimed later, subject to eligibility.
Time of supply under RCM
The time of supply under RCM is generally the earliest of:
- Date of payment, or
- Sixty days from the issuing date of the invoice by the supplier
If the invoice date cannot be determined, the date of entry in the recipient’s books of account becomes relevant.
How to calculate GST on royalty payments
To calculate GST on royalty payments, first determine the taxable value as per the royalty agreement. This includes the agreed percentage or fixed fee payable for the use of intellectual property, excluding GST.
Next, apply the applicable GST rate. Royalty for licensing of intellectual property is generally taxed at 18% under the GST framework.
The calculation formula is: GST = Taxable Royalty Amount × 18%
For example, if royalty payable is ₹5,00,000, GST will be ₹90,000. The total payable amount after tax becomes ₹5,90,000, subject to valuation and contractual terms.
How to report GST on royalty payments to foreign companies
Royalty paid to a foreign company is treated as an import of services and must be reported carefully in GST returns.
1. GSTR-3B
Report the taxable value and IGST under Table 3.1(d): “Inward supplies liable to reverse charge.” After payment, an eligible ITC can be claimed in Table 4(A)(3).
2. GSTR-1
Import of services under reverse charge is generally not reported as an outward supply. However, records must align for reconciliation.
3. GSTR-2B reconciliation
Since this is a reverse charge, credit will not auto-populate. Manual reconciliation with books is necessary.
Can a business claim ITC for the royalty payments?
A business can claim ITC on GST paid on royalty payments, subject to certain conditions. ITC is available when the royalty is paid for the use of intellectual property in the course or furtherance of business. This includes trademarks, patents, technical know-how or brand licensing arrangements used for taxable supplies.
The following conditions must be satisfied:
- GST must have actually been paid to the government
- A valid tax invoice or self-invoice must be available
- The recipient must have received the service
- The tax must be reflected in returns and properly reported
Special cases: mining royalty and government permissions
Certain royalty payments involve unique regulatory and judicial considerations, some of these are:
Mining and operations
Royalty paid for mineral extraction is treated as a licensing service provided by the government. GST is generally payable at 18% under the RCM. The business entity holding the mining lease must discharge the tax in cash. ITC may be claimed, subject to eligibility and proper documentation.
Government permissions
Payments made for business rights, spectrum allocation or natural resource usage may also be subject to GST under reverse charge.
However, statutory fees in the case of fines or penalties are typically not treated as supply. The taxability depends on whether the payment grants a commercial right or is purely regulatory in nature.
Common GST mistakes in royalty payments
Most issues in royalty transactions arise from how they are recorded and tracked rather than from tax calculation itself. Some of the common mistakes include:
- Recording royalty payments under generic expense heads such as professional fees or subscriptions without reviewing their GST implications.
- Treating all foreign payments in the same manner without separately classifying and documenting royalty agreements.
- Failing to link royalty agreements with accounting records, making it difficult to substantiate the tax treatment during audits.
- Delaying the recording of royalty expenses in the books, resulting in GST being reported in the incorrect return period.
- Creating mismatches between payment dates and accounting entries, which leads to confusion in determining the correct reporting timeline.
- Allowing royalty expenses to appear in financial statements without properly reconciling them with GST return disclosures.
- Operating without a structured review process for foreign payments, causing GST-sensitive transactions to be treated as routine entries.
Way forward
Managing GST on royalty payments to foreign companies is not merely a return-filing exercise. It requires alignment between legal agreements, finance teams and tax reporting systems. Businesses must focus on building a proactive compliance framework supported by robust accounting systems, such as TallyPrime, can help streamline reverse charge tracking, ensure accurate tax computation and maintain audit-ready records.
