Pharmaceutical innovators developing and registering patents in India are eligible for a highly concessional tax regime under Section 194(1) of the Direct Tax Code (DTC) 2025. The provision allows eligible resident taxpayers to opt for a flat 10% tax rate on gross royalty income from patents developed and registered in India. This guide analyses the patent royalty taxation election and its application to pharmaceutical innovators.
The Statutory Framework
Section 194(1) (Table: Sl. No. 2) — Concessional Taxation
Under the DTC, any person who is a resident in India and a patentee (referred to as an "eligible assessee") may opt for taxation of royalty income in respect of a patent developed and registered in India at a concessional rate of 10%.
The key features of this regime are:
- Flat Rate: 10% tax on gross royalty income
- No Deductions: No deduction in respect of any expenditure or allowance shall be allowed in computing the royalty income
- Option-Based: The concessional regime applies only if the eligible assessee exercises the option in the prescribed manner
- Lock-In: Once the option is exercised, the assessee is generally required to remain in this regime for the subsequent five tax years
Scope of "Royalty"
For the purposes of this provision, "royalty" in respect of a patent means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head "Capital gains" or consideration for sale of product manufactured with the use of patented process or the patented article for commercial use) for:
- Transfer of all or any rights (including the granting of a licence) in respect of a patent
- Imparting of any information concerning the working of, or the use of, a patent
- Use of any patent
- Rendering of any services in connection with the above activities
Eligibility Criteria
Who is an "Eligible Assessee"?
An eligible assessee must satisfy the following conditions:
- Resident in India: The person must be a resident in India
- Patentee: The person must be a patentee, meaning the true and first inventor of the invention whose name is entered in the patent register as the patentee under the Patents Act, 1970
- Development in India: The patent must be developed and registered in India
- 75% Expenditure Test: At least 75% of the expenditure incurred for any invention in respect of which patent is granted must be incurred in India by the eligible assessee
What Constitutes "Developed"?
The term "developed" means at least 75% of the expenditure incurred in India by the eligible assessee for any invention in respect of which patent is granted under the Patents Act, 1970.
Form 65 — The Election Mechanism
Purpose of Form 65
Form 65 is the prescribed form used to opt for concessional taxation on royalty income from eligible patents. Under the previous Income-tax Act, 1961, this benefit existed under Section 115BBF and Form 3CFA. The updated tax framework now places it under Section 194(1), Table Sl. No. 2 and Rule 134 of the Income-tax Act, 2025.
Filing Requirements
Rule 134 of the Income-tax Rules, 2026 prescribes the procedure for exercising the option:
- Form: Eligible assessees must furnish Form No. 65
- Due Date: The form must be furnished on or before the due date specified under section 263(1)(c) for filing the return of income for the relevant tax year
- First Return: The option must be exercised for the first of the returns of income which the person is required to furnish
Verification
Form 65 must be verified by the person who is authorised to verify the return of income of the assessee under Section 265.
The Five-Year Lock-In
Continuity Requirement
Once a taxpayer files Form 65 and opts for Section 194(1), they are generally required to remain in this concessional regime for the subsequent five tax years.
Consequences of Opting Out
If the eligible assessee does not offer its income for taxation as per the provisions of Section 194(1) (Table: Sl. No. 2) for any of the five tax years succeeding the tax year in which the option was exercised, then:
- Such assessee shall not be eligible to claim the benefit of the provisions for five tax years subsequent to the tax year in which such income has not been offered to tax as per such provisions
Tax Implications for Pharma Innovators
Rate of Tax
The income by way of royalty is taxed at 10% (plus applicable surcharge and cess).
No Deductions
No deduction in respect of any expenditure or allowance shall be allowed to the eligible assessee under any provision of the DTC in computing his income by way of royalty. This means the tax is computed on the gross royalty income, without any deductions for expenses incurred in earning the royalty.
Surcharge and Cess
The 10% rate is exclusive of surcharge and cess, which shall be levied as applicable.
Practical Compliance for Pharma Innovators
1. Determine Eligibility
- Verify that the patent is developed and registered in India
- Verify that at least 75% of the expenditure was incurred in India
- Verify that the person is the true and first inventor
2. File Form 65
- File Form 65 on or before the due date for filing the return of income
- Ensure the form is complete and accurate
- Verify the form as required
3. Maintain Documentation
- Patent registration certificate
- Evidence of development in India
- Details of expenditure incurred in India
- Royalty agreements
- Proof of royalty receipts
4. Consider Lock-In Period
- Plan for the five-year lock-in period
- Consider the implications of opting out
- Seek expert advice on the decision
Interaction with Tax Treaties
Where a Double Taxation Avoidance Agreement (DTAA) applies, the pharma innovator may need to consider whether the concessional rate under the DTC or the treaty rate is more beneficial. However, once the option under Section 194(1) is exercised, the concessional regime applies.
Consequences of Non-Compliance
Disallowance of Concessional Rate
If the conditions are not fulfilled or the option is not properly exercised:
- The concessional 10% rate may not apply
- Royalty income may be taxed at the normal rate
- Interest and penalty may be levied
Penalty
Non-compliance may result in:
- Penalty for incorrect claim
- Prosecution in cases of wilful default
Expert Legal Guidance
Anuj Desai & Associates provides comprehensive legal advisory services on patent royalty taxation for pharmaceutical innovators. Our direct tax experts help pharma innovators understand the concessional regime, file Form 65 correctly, and navigate the regulatory framework. We assist in eligibility assessment, documentation, and representation before income-tax authorities.
Disclaimer: This article provides general information and does not constitute legal advice. For specific guidance on patent royalty taxation or any other direct tax matter, please consult qualified legal professionals.
Need Expert Legal Guidance?
Navigating the patent royalty taxation framework for pharmaceutical innovators requires experienced legal counsel. At Anuj Desai & Associates, we provide comprehensive direct tax advisory services, including:
- Form 65 Filing: Assistance with Form 65 preparation and filing
- Eligibility Assessment: Evaluation of eligibility for concessional taxation
- Documentation: Assistance with documentation and record keeping
- Representation: Representation before income-tax authorities
Contact us for expert legal guidance on your patent royalty taxation matters.