Effective connection comes before expense arithmetic
Section 59 of the Income-tax Act, 2025 addresses the specified royalty and technical-fee income of a non-resident other than a company, or a foreign company. The receipt must meet the Government/Indian-concern agreement conditions and the right, property or contract must be effectively connected with the Indian permanent establishment or fixed professional place. This guide applies to tax year 2026–27, checked on 28 October 2026; it does not renumber an AY 2026–27 return or determine treaty entitlement merely from domestic wording. Income Tax Department: Income-tax Act, 2025 as amended by Finance Act, 2026, section 59.
Build a contract-to-PE evidence chain
Keep the underlying agreement, payer identity, rights granted, service obligations, Indian operations and effective-connection analysis together. Having an Indian office does not by itself establish that every royalty contract belongs to it. Conversely, a headquarters invoice does not settle the substantive connection question. Determine receipt classification and treaty interaction independently before accepting the numerical models as the applicable computation route. Income Tax Department: Income-tax Act, 2025 as amended by Finance Act, 2026, section 59.
Screen direct expenses for the Indian activity
Section 59(2)(a) denies expenditure or allowance not wholly and exclusively incurred for the Indian PE or fixed professional place's business. Tag costs by contract and actual activity. Preserve employee records, third-party invoices and allocation evidence rather than using a revenue percentage without justification. An accounting debit can require a tax adjustment; an expense passing this particular screen still needs all other applicable deduction conditions. Income Tax Department: Income-tax Act, 2025 as amended by Finance Act, 2026, section 59.
Distinguish reimbursement from internal remuneration
Subsection (2)(b) denies amounts paid by the PE to its head office or other offices otherwise than towards reimbursement of actual expenses. A markup, internal service charge or royalty must not be relabelled reimbursement merely because it is invoiced at group level. Trace actual underlying costs, the Indian activity's share and any duplicated claim. The reimbursement exception only removes this specific prohibition; it does not automatically establish deductibility under every provision. Income Tax Department: Income-tax Act, 2025 as amended by Finance Act, 2026, section 59.
Prepare a single book-to-tax bridge
Start with the stipulated income and expense population, then separately identify unrelated costs, prohibited office charges and other adjustments. If an expense fails two tests, add the same amount back once. Where books already excluded it, do not add it again. Reconcile the bridge to ledgers and retain a separate conclusion on any amount outside section 59. None of the illustrations fixes a tax rate, withholding rate or treaty tax liability. Income Tax Department: Income-tax Act, 2025 as amended by Finance Act, 2026, section 59.
Close statutory documentation separately
Subsection (4) requires the stated books, audit and prescribed report; verify the operative rules, date and report for the actual filing rather than inventing a form number from the old Act. Subsection (3) displaces the specified section 61 mineral-oil-services presumptive limb for income covered here. Maintain an eligibility conclusion, expense matrix, actual-cost support and duplicate-adjustment check before completing the separate tax and filing review. Income Tax Department: Income-tax Act, 2025 as amended by Finance Act, 2026, section 59.
Applicable primary references
Income Tax Department: Income-tax Act, 2025 as amended by Finance Act, 2026, section 59
Six worked illustrations
All facts and amounts below are fictional. Assumptions describe the model, not additional statutory rules.
Illustrative example 1: Exclude an unrelated activity
Assume covered receipts ₹100 lakh and book expenses ₹30 lakh, including ₹5 lakh wholly unrelated to the Indian PE. Other expenses are independently allowable. Book profit ₹70 lakh becomes ₹75 lakh after one ₹5 lakh add-back.
Illustrative example 2: Separate actual cost and markup
Assume covered income ₹80 lakh, allowable local costs ₹20 lakh and a ₹12 lakh head-office debit comprising actual qualifying reimbursement ₹10 lakh and markup ₹2 lakh. Book profit ₹48 lakh becomes ₹50 lakh after the prohibited ₹2 lakh is added back.
Illustrative example 3: Remove a duplicated reimbursement
Assume income ₹60 lakh and book expenses ₹18 lakh, including a ₹4 lakh actual-cost claim already included in another ₹4 lakh direct-expense entry. With all remaining ₹14 lakh independently allowable, book profit ₹42 lakh becomes ₹46 lakh after removing the duplicate once.
Illustrative example 4: Apply the actual supported allocation
Assume a ₹15 lakh third-party cost paid centrally, with ₹9 lakh proved wholly and exclusively attributable to the Indian PE and ₹6 lakh unrelated. If the PE booked all ₹15 lakh against income ₹50 lakh and no other expenses, book profit ₹35 lakh becomes ₹41 lakh. Reimbursement labelling does not support the unrelated ₹6 lakh.
Illustrative example 5: Do not add back an excluded expense twice
Assume income ₹70 lakh, allowable costs ₹25 lakh and a prohibited internal charge ₹3 lakh already excluded from the computation. Tax-computation profit is ₹45 lakh. Adding the same ₹3 lakh again would wrongly produce ₹48 lakh.
Illustrative example 6: Two failed tests, one adjustment
Assume income ₹90 lakh, book expenses ₹40 lakh and an ₹8 lakh office charge within those expenses that is both unrelated and not actual reimbursement. With the rest independently allowable, book profit ₹50 lakh becomes ₹58 lakh, not ₹66 lakh.
Ten-step verification table
| Step | Action | Evidence |
|---|---|---|
| 1 | Confirm taxpayer status | Non-resident non-company or foreign-company evidence |
| 2 | Identify covered receipts | Royalty/technical fees and actual payer |
| 3 | Read the agreement | Government or Indian-concern contract |
| 4 | Establish Indian presence | PE or fixed professional place analysis |
| 5 | Prove effective connection | Rights/property/contract linked to the presence |
| 6 | Screen expense purpose | Wholly and exclusively attributable activity |
| 7 | Test inter-office amounts | Underlying actual costs, allocations and markups |
| 8 | Remove duplicate claims | Single cost population and prior computation treatment |
| 9 | Reconcile the tax bridge | Book profit, individual adjustments and independent allowances |
| 10 | Complete separate filing review | Applicable treaty, rate, books, audit and prescribed report |
Sixteen practitioner FAQs
1. Does every non-resident royalty receipt fall under section 59?
No. Establish all payer, agreement, Indian-presence and effective-connection conditions.
2. Can a foreign company be a specified assessee?
Yes. The definition also includes the stated non-resident non-company population.
3. Does an Indian office alone prove effective connection?
No. Analyse the right, property or contract producing the particular receipt.
4. Does this guide determine a treaty PE?
No. Treaty entitlement and its applicable tests require a separate supported analysis.
5. Is every book expense deductible?
No. Apply the specific prohibitions and other applicable deduction conditions.
6. What happens to unrelated costs?
The wholly-and-exclusively screen prevents deducting costs outside the stated Indian business purpose.
7. Are all head-office payments automatically deductible?
No. Distinguish actual reimbursement from the amounts prohibited by subsection (2)(b).
8. Is a markup an actual expense reimbursement merely because invoiced?
No. Trace the underlying costs and distinguish the additional charge.
9. Does genuine reimbursement settle every deduction test?
No. It must also satisfy the applicable purpose and other deduction requirements.
10. Can the same invoice support two claims?
No. Reconcile centrally paid and locally recorded costs to prevent duplication.
11. Does one expense failing two tests require two add-backs?
No. Adjust the same disallowed amount once.
12. Should a charge already excluded be added again?
No. The bridge must reflect its existing computation treatment.
13. Does section 59 prescribe a flat rate in these models?
No rate is asserted here; the examples isolate income and expense arithmetic.
14. Can the specified mineral-oil-services presumptive limb be applied automatically?
Subsection (3) displaces that stated section 61 limb for income covered by section 59.
15. Are books and audit irrelevant once expenses are reconciled?
No. Subsection (4)'s requirements need a separate current-rule and filing review.
16. Which period does this guide concern?
Current tax year 2026–27 under the 2025 Act, rather than mechanical changes to earlier-period return references.
Conclusion
Test effective connection before computing non-resident royalty or technical-fee business income, and distinguish actual reimbursements from prohibited internal charges.