New Tax Exemption Regime: Strengthening India's Electronics Manufacturing Ecosystem

Introduction

The Finance Act, 2026 introduced notable tax exemptions as part of the Government's efforts to enhance India's attractiveness as a global manufacturing and digital infrastructure destination. The exemption, inter alia, apply to foreign companies in respect of income from supply of capital goods, equipment or tooling to resident companies engaged as contract manufacturers.

While the original provisions were aimed at facilitating foreign participation in India's manufacturing and digital infrastructure sectors, the Taxation and Other Laws (Amendment) Act, 2026 (‘TOLA’), enacted on 17.08.2026, introduced certain amendments to provide greater clarity and operational flexibility in their implementation. The significant changes introduced under the TOLA are discussed below. 

Exemption for Foreign Companies Engaged in Electronics Manufacturing

The Finance Act, 2026 introduced Serial No. 13A in Schedule IV to the Income-tax Act, 2025 (‘Act’) to exempt income earned by a foreign company from supplying capital goods, equipment or tooling (‘machinery’) to an Indian contract manufacturer company engaged in electronics manufacturing within a customs bonded warehouse. The rationale underlying the exemption was to provide tax certainty to foreign enterprises by mitigating concerns that the ownership and deployment of machinery in India through a contract manufacturing arrangement could give rise to business connection/Permanent Establishment (PE) in India and the consequent attribution of substantial profits to such PE.

The exemption was available for a period of five years, ending with Tax Year 2030-31, and was subject to the satisfaction of following conditions:

• ownership of the machinery remaining with the foreign company while the control and direction of such machinery rest with the contract manufacturer

• use of such machinery for electronic manufacturing by an Indian contract manufacturer located in a customs bonded area; and

• manufacture of electronic goods by contract manufacturer on behalf of the foreign company for a consideration.

However, the lack of clarity regarding the meaning of "electronic goods" gave rise to potential interpretational issues concerning the scope and availability of the exemption. Further, industry stakeholders viewed the five-year exemption period as relatively short, particularly given the significant capital investments and long-term business commitments associated with electronics manufacturing operations. Consequently, the exemption was perceived as providing limited tax certainty to foreign companies considering or undertaking investments in the sector. 

To address these concerns and providing greater long-term certainty, the TOLA has introduced following changes to the Act with effect from 01.04.2026:

• Extending the sunset date: extending the availability of the exemption by a further ten years, making it applicable up to Tax Year 2040-41. The stated objective of this amendment is to provide greater long-term certainty to industry participants.

• Defining electronic goods: the expression "electronic goods" is now replaced with "specified electronic goods" and an exhaustive statutory definition of specified electronic goods has been introduced. The expression specified electronic goods means: mobile phones; laptops; all-in-one personal computers; tablets; servers; ultra-small form factor (USFF) devices; sub-assemblies relating to these products; and hearables, wearables and related accessories.

Significantly, the proposed definition of specified electronic goods mirrors the definition adopted under the existing safe harbour regime.[1] This alignment is likely to facilitate a consistent interpretation of the term across different tax provisions and mitigate potential disputes arising from divergent interpretations. 

The exemption continues to be subject to the condition that the control over the machinery rests with the contract manufacturer. This may pose some challenges as the foreign company may retain some level of control and access to critical machinery incorporating proprietary technology. Hence, the Government may consider removing this condition. 

Another condition that may prove to be a thorn in the flesh is that the electronic goods must be produced on behalf of the foreign company. Literal reading would mean that the exemption is available only if the foreign company, which is owner and supplier of the machinery, is itself placing the orders for manufacture and supply of the electronic goods by the Indian contract manufacturer. It is not clear if the exemption will continue to apply if the machinery is used by Indian contract manufacturer for manufacturing and supply of electronic goods to some group entities/ affiliates of the foreign company. Moreover, the use of the expression “on behalf of” may also pose other legal challenges if interpreted in a narrower sense to cover only a principal agent relationship, rather than extending to arrangements entered on a principal-to-principal basis. 

New exemption for warehousing of electronic components by Foreign Companies

The TOLA additionally introduces a new exemption clause as Serial No 13G to Schedule IV the Act for income earned by foreign companies on account of storage of electronic components in customs-bonded warehouses for subsequent sale to Indian company engaged as contract manufacturers. Such exemption is proposed to be available for 15 years starting from 01.10.2026 up to tax year 2040-2041 subject to following conditions:

·         Exemption shall be available on sale of components by such foreign company.

·         Such contract manufacturer produces electronic goods on behalf of any foreign company

·         Exemption shall be subject to furnishing of prescribed information.

·         components to be provided to components manufacturer to be used for manufacturing of specified electronic goods as defined in Serial No. 13A.

While Serial No. 13A addressed concerns relating to ownership of capital goods, equipment and tooling in India, it did not cover situations where foreign companies maintain inventories of components in India for use in local manufacturing operations. Electronics manufacturing typically relies on efficient inventory management and uninterrupted availability of components. Requiring components to be imported separately for each production cycle may increase logistics costs and lead times. 

The absence of a specific exemption for inventory-based arrangements also gave rise to concerns regarding the potential constitution of a business connection or Permanent Establishment (PE) in India on account of the storage of components within the country. Judicial precedents have recognised that a fixed place PE may arise where a specifically identified area in a warehouse is earmarked exclusively for the goods of a foreign enterprise, the warehouse service provider is restricted from using such space for other customers, and the foreign enterprise exercises a significant degree of control over the warehousing arrangement[2].

While tax treaties generally provide an exemption from PE exposure in respect of facilities used solely for the storage, display or sometimes delivery of goods, such activities are ordinarily required to be of a preparatory or auxiliary character. Further, following the adoption of the Multilateral Instrument (‘MLI’), the availability of such exemption is subject to the anti-fragmentation rule, which requires the warehousing activity to be evaluated in conjunction with other activities undertaken by the foreign enterprise or its closely related parties in India. Consequently, inventory-holding arrangements in India may, in certain circumstances, continue to present PE-related uncertainty for foreign enterprises.

The legislature presently provides a safe harbour of at least 2% of the gross receipts from the business for a foreign company which stores components in a custom bonded warehouse. However, with the proposed changes, foreign taxpayers would be eligible for complete exemption on income, if any, arising from such activities, for a period of 15 years under the domestic tax law itself. This will substantially reduce the compliance requirement for foreign taxpayers including those required for treaty entitlement. The new exemption thus enables foreign companies to maintain component inventories in India without adverse tax consequences, thereby supporting localisation of supply chains. However, the benefit is proposed to be available only for a period of 15 years, following which taxpayers may need to rely on the safe harbour regime, subject to its continued availability.

Conclusion

The proposed amendments reflect a broader policy shift towards providing long-term certainty, reducing compliance burdens and aligning tax provisions with prevailing business models. Taken together, these reforms represent a targeted effort to make India's tax framework more predictable, commercially aligned and conducive to foreign investment in strategically important sectors.

While the introduction of the exemption is a welcome measure, its effectiveness would largely depend on the nature of the conditions and reporting requirements prescribed. To fully realise the Government's objective of promoting foreign investment and enhancing ease of doing business, it would be desirable that the compliance framework remains simple and streamlined.  

It is pertinent to note that the foreign company’s overall activities in India should be evaluated independently under Section 9 of the Act read with PE provisions of the applicable Double Taxation Avoidance Agreement (‘DTAA’). Particular attention should be given to situations where the foreign company exercises substantial control over or supervision of the infrastructure located in India, or where the Indian contract manufacturer functions beyond the scope by concluding contracts, playing the principal role in securing contracts that are subsequently finalized by the foreign company, or where employees of the foreign company are seconded to the Indian contract manufacturer. The said activities if present are not immune from present exemptions and will require separate evaluation.

[The authors are Senior Partner, Associate Director and Senior Associate, respectively, in Direct Tax practice at Lakshmikumaran & Sridharan Attorneys]

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[1] Rule 99 of the Income-tax Rules 2026

[2] Seagate Singapore International Headquarters (P.) Ltd., In re (2010) 189 Taxman 181 (AAR-New Delhi).