Government proposes tax relief extension for foreign contract manufacturing

Indian Economy - Taxation & Manufacturing · 4 August 2026 · Based on The Hindu (original report)

2-minute summary

The Indian government has proposed draft tax amendments aimed at enhancing tax certainty for global technology firms and boosting domestic manufacturing. A key proposal extends income tax exemptions until March 31, 2041, for foreign companies providing machinery and equipment to local contract manufacturers. This addresses long-standing industry concerns regarding 'business connection' tax liabilities, wherein foreign firms feared that owning high-end machinery operated by local partners might expose their global profits to Indian tax laws. The exemption covers manufacturers of mobile phones, tablets, laptops, and wearable electronic devices. Additionally, foreign companies storing parts in customs-bonded warehouses for contract manufacturing will be exempt from income tax until 2041, encouraging export-oriented manufacturing. The draft proposals also relax criteria for foreign firms utilizing Indian data centers—allowing Indian partners to lease rather than own data center facilities under tax exemptions valid until 2047. Furthermore, a 15-year tax exemption has been proposed for foreign diamond miners selling rough diamonds through designated Indian trading zones.

Why it's in the news

India proposed updating tax laws to extend income tax exemptions until 2041 for foreign firms supplying equipment and components to local contract manufacturers. The move aims to remove tax liability risks associated with 'business connection' rules, aiding major global players like Apple as India expands its share in global electronics manufacturing.

Background and context

Under the Indian Income Tax Act, non-resident foreign companies are taxed on income that accrues or arises through a 'business connection' in India. Foreign technology firms supplying specialized, high-cost capital machinery to Indian contract manufacturers faced ambiguity over whether owning such machinery in India constituted a business connection, potentially subjecting their global income to Indian taxation. To foster electronics manufacturing under the 'China Plus One' diversification strategy, India introduced targeted tax exemptions. Initially granted until 2031, the government has proposed extending this tax break to 2041 to offer long-term regulatory certainty. This initiative complements schemes like the Production Linked Incentive (PLI), supporting India's rapid rise in smartphone production—with its global iPhone manufacturing share projected to reach 26% in 2026.

Constitutional provisions

• Article 265 — Mandates that no tax shall be levied or collected except by authority of law, governing statutory tax amendments.
• Article 246 (Seventh Schedule - Union List, Entry 82) — Empowers the Central Government to legislate on taxes on income other than agricultural income.

Committees and reports

• Tax Administration Reform Commission (TARC) — Emphasized tax predictability, non-adversarial tax administration, and clear statutory guidelines to attract Foreign Direct Investment.

Government schemes

• Production Linked Incentive (PLI) Scheme for Large Scale Electronics Manufacturing — Offers financial incentives to boost domestic manufacturing and attract large-scale investments in mobile phones and specified electronic components.
• Manufacturing and Other Operations in Warehouse Regulations (MOOWR) — Allows duty-free import of raw materials and capital goods for manufacturing and warehousing in customs-bonded areas, deferring customs duties until goods enter the domestic market.

Mains practice: Tax policy certainty is a cornerstone for attracting Foreign Direct Investment and integrating domestic industry into Global Value Chains. Discuss in the context of recent tax policy proposals in India's electronics and manufacturing sectors.

Predictable tax policy is essential for creating a stable business environment, encouraging long-term capital investments, and positioning India as a global manufacturing hub.

Key Aspects of Recent Tax Proposals:

• Addressing 'Business Connection' Risks: By extending income tax exemptions until 2041 for foreign companies providing equipment to Indian contract manufacturers, the government alleviates fears that owning machinery in India could trigger business connection liabilities on global income.

• Boosting Export-Oriented Manufacturing: Tax exemptions on storing components within customs-bonded facilities incentivize foreign OEMs to build localized supply networks dedicated to exports.

• Facilitating Digital & Infrastructure Growth: Amending data center tax rules to allow leasing (rather than requiring capital-intensive ownership) reduces entry barriers for mid-sized logistics and infrastructure providers.

• Strengthening Niche Clusters: A 15-year tax holiday for rough diamond sales in designated trading zones reinforces India's dominance in diamond cutting and polishing.

Significance for India’s Growth Engine:

• Integrates Indian contract manufacturers deeper into Global Value Chains (GVCs) by capitalizing on the 'China Plus One' strategy.

• Encourages technological spillover through high-end equipment deployment in mobile, tablet, and wearable technology segments.

• Complements industrial push schemes such as the Production Linked Incentive (PLI).

Conclusion:

Eliminating tax ambiguities signals regulatory maturity and administrative consistency. To maximize these gains, India must pair targeted direct tax incentives with expedited dispute resolution and streamlined customs clearances.

Prelims practice questions

Q1. With reference to recent draft proposals regarding tax incentives for foreign contract manufacturing in India, consider the following statements: 1. The draft tax proposals extend income tax exemptions until 2041 for foreign companies supplying machinery to local contract manufacturers. 2. Foreign firms storing parts in customs-bonded facilities receive tax relief, but sales from such zones into the domestic Indian market attract import duties. 3. Indian partners of foreign companies using data centers are strictly required to own, rather than lease, data center infrastructure to claim tax benefits. Which of the statements given above is/are correct?

1. 1 and 2 only
2. 2 and 3 only
3. 1 and 3 only
4. 1, 2 and 3

Answer: A. Statements 1 and 2 are correct. The proposal extends tax exemptions until March 31, 2041, for foreign firms supplying machinery and storing parts in customs-bonded areas (domestic sales from which attract import taxes). Statement 3 is incorrect because the draft proposals specifically relax rules to allow Indian partners to LEASE data centers rather than mandating full ownership.

Q2. In the context of Indian direct tax laws, what does the concept of 'Business Connection' primarily refer to?

1. A legal partnership between a Public Sector Undertaking and a private entity.
2. A relation between a non-resident and a resident entity that results in income accruing or arising directly or indirectly from India.
3. An agreement governed strictly under the bilateral Investment Guarantee Treaties.
4. A mandatory corporate social responsibility linkage between foreign firms and local NGOs.

Answer: B. Under Section 9 of the Income Tax Act, a 'business connection' includes any professional or business activity carried out by a non-resident in India through or from which income accrues or arises, subjecting relevant portions of non-resident income to Indian taxation.

Q3. Consider the following sectors affected by the proposed 2026 tax amendment draft: 1. Electronics manufacturing (mobile phones, wearables, laptops) 2. Foreign diamond mining and trading in designated zones 3. Foreign companies utilizing leased data center infrastructure How many of the above sectors have received proposed tax exemptions or compliance relaxations?

1. Only one
2. None
3. All three
4. Only two

Answer: C. All three sectors are included in the draft tax proposals: tax exemptions up to 2041 for electronics contract manufacturing machinery/storage, 15-year exemptions for rough diamond trading zones, and tax exemption relaxations (allowing leasing) for data center usage until 2047.

Revision flashcards

• What is the primary risk foreign OEMs face under Indian tax law when supplying machinery to contract manufacturers? The risk that foreign ownership of capital equipment in India could be classified as a 'business connection', exposing their global profits to Indian income tax.
• Until what year does the proposed Indian tax amendment extend tax breaks for foreign machinery and component storage in contract manufacturing? March 31, 2041 (extended from the previous deadline of 2031).
• How do customs-bonded manufacturing zones treat products sold domestically vs. exported? Components and inputs can be imported and stored duty-free for export production; however, finished goods sold into the domestic market attract standard import duties.
• What key change was proposed regarding data center tax exemptions for foreign companies in India? The draft allows Indian partners to lease (rather than strictly own) data center facilities while retaining tax exemptions valid until 2047, lowering capital entry barriers.
• What tax relief is proposed for the diamond sector in India under the draft policy? A 15-year tax exemption for foreign diamond miners and traders who sell rough diamonds through designated trading zones in India.