Centre moves to impose MDR on UPI, extend tax breaks for contract manufacturers
A proposal under consideration would reintroduce a Merchant Discount Rate (MDR) on Unified Payments Interface (UPI) transactions for large merchants, ending a six-year period of zero-MDR on UPI payments.
Under the proposal, businesses with annual turnover above roughly ₹1 crore to ₹1.5 crore would attract an MDR of about 0.05% to 0.07%, applicable only on UPI transactions above ₹2,000; small and micro merchants (roughly 90% of UPI-accepting merchants) would remain unaffected.
Separately, draft tax amendments propose extending an income-tax exemption for foreign companies supplying manufacturing equipment and components to India-based contract manufacturers, from the current expiry of 31 March 2031 to 31 March 2041.
The extended exemption would also cover income earned by foreign companies from storing and supplying components for mobile phones, tablets, laptops, hearing devices, and wearables to contract manufacturers, and from operations in customs-bonded areas.
Both proposals require Parliamentary approval before taking effect.
Merchant Discount Rate (MDR) and the Zero-MDR Policy on UPI
MDR is the fee a merchant pays to banks/payment service providers for processing a digital payment transaction, typically a small percentage of the transaction value. India moved to a zero-MDR regime on UPI and RuPay debit card transactions to encourage adoption of digital payments among merchants.
Key Details
- Zero-MDR on UPI and RuPay was made effective from 1 January 2020, under Section 10A of the Payment and Settlement Systems Act, 2007, read with Section 269SU of the Income-tax Act, 1961.
- Section 269SU mandates that specified businesses with annual turnover exceeding ₹50 crore must offer prescribed low-cost/zero-cost digital payment modes (UPI, UPI QR, RuPay debit cards) to customers.
- Non-compliance with Section 269SU can attract a penalty of ₹5,000 per day under Section 271DB of the Income-tax Act.
- Since banks and payment service providers earn no MDR revenue on UPI, the government separately runs an incentive scheme reimbursing banks for low-value UPI transactions (a Cabinet-approved outlay in the thousands of crores annually).
The proposal to reintroduce a tiered MDR for large merchants directly modifies this zero-MDR framework built around Section 269SU and the PSS Act — a Parliamentary Standing Committee on Finance has recommended this reintroduction to make the UPI payments ecosystem financially sustainable for banks and PSPs.
Tax Exemption for Contract Manufacturing under the Income-tax Act
To attract global electronics manufacturers (notably smartphone assembly) to India without exposing their foreign principals to Indian tax liability, the government introduced targeted exemptions addressing the concept of "business connection" — the trigger for a foreign company's income becoming taxable in India.
Key Details
- Ordinarily, a foreign company providing high-value equipment to an India-based contract manufacturer risks being deemed to have a "business connection" in India (a taxable presence, broader than but related to the "permanent establishment" concept under India's tax treaties), exposing its profits to Indian tax.
- The exemption, first introduced in 2026, was valid until 31 March 2031; the current proposal extends it to 31 March 2041.
- The expanded scope also exempts income from storage and supply of components used in manufacturing mobile phones, tablets, laptops, hearing devices, and wearable electronics.
- This forms part of India's broader electronics manufacturing push (alongside the Production Linked Incentive/PLI scheme for large-scale electronics manufacturing), aimed at deepening India's position in global smartphone assembly supply chains.
The extended exemption is intended to give contract manufacturers and their foreign equipment/component suppliers long-term tax certainty, supporting India's rising share of global smartphone (including iPhone) assembly.
- Zero-MDR on UPI/RuPay effective from 1 January 2020 (Section 10A, PSS Act 2007; Section 269SU, Income-tax Act 1961).
- Section 269SU applies to businesses with annual turnover exceeding ₹50 crore; penalty for non-compliance is ₹5,000/day under Section 271DB.
- Proposed reintroduced MDR: about 0.05%-0.07%, applicable to large merchants (turnover above ~₹1-1.5 crore) on UPI transactions above ₹2,000; roughly 90% of merchants would remain unaffected.
- Contract manufacturing tax exemption: originally valid to 31 March 2031, proposed extension to 31 March 2041.
- India is projected to manufacture about 26% of the world's iPhones in 2026, up from about 6% four years earlier (industry estimate).