Indian Budget 2026-27: Tax Incentives for Data Centres

India’s Union Budget 2026-27 has promised targeted tax incentives, including a tax holiday until 2047 and a safe harbor, to attract foreign investment in India’s data centre industry and establish the country as a hub for AI and cloud infrastructure. Global cloud services providers will need to carefully structure their customer agreements with data centres to benefit from such tax incentives outlined in the Union Budget 2026-27.

This note explores the impact of these tax reforms on the existing business models and ownership structures for data centres in India.

UNDERSTANDING EXISTING DATA CENTRE MODELS

Data centres are specialized facilities designed to house and protect computing and networking equipment for the purpose of collecting, storing, processing, distributing or allowing access to large amounts of data to users and businesses around the clock. Based on ownership and operational models, data centres in India can be categorized into the following types:

Captive or in-house data centres

This includes data centres that are privately owned, built, and/or managed by an organization/corporate group, offering greater control and security. In India, 100% foreign investment in data centres is permitted under the “automatic” route, subject to the condition that the investing entity does not fall under the category of restricted countries (i.e., Pakistan, Afghanistan, Nepal, Bhutan, China (including Hong Kong), Bangladesh and Myanmar), in which case prior government approval shall be required for such investment.¹ Such favorable foreign direct investment policy along with various other government schemes allows foreign investors to establish wholly owned subsidiaries or enter joint ventures with Indian partners to set up data centres for captive use.

Outsourced data centres

This includes third-party owned facilities where businesses rent space, power, and cooling to house their hardware, offering lower costs, high reliability, and easier scalability. Businesses often depend on these facilities for equipment hosting and services. This model can be further categorized into: (i) co-location data centres, where the data centres lease space and provide infrastructure services to multiple users managing their own servers, (ii) hosting data centres, where customers lease servers and equipment, and (iii) hybrid models, offering a mix of co-location and hosting services.

In all such cases, the contracts executed by customers/tenants with the data centre service providers generally follow one of two key contracting structures, that is, a lease or a services agreement, which have further been described below.

DECIDING BETWEEN THE “LEASE” AND “SERVICE” MODEL FOR DATA CENTRE CONTRACTS

Data centre leases and services agreements often provide comparable rights and obligations. However, there exist notable differences between the two structures, as well as a range of factors that are important for any data centre service provider and tenant to consider while selecting the form of agreement to use. No single criterion decides the choice, and the tenants and data centre service providers are recommended to assess all elements on a case-by-case basis.

A brief overview of the key factors for consideration are set out below:

Space exclusivity

A lease agreement grants an exclusive right to use certain space at the data centre premises and suits scenarios requiring dedicated possession of infrastructure facilities, for example, full racks, halls with restricted access to the provider, etc. In contrast, a services agreement only grants a license to the tenant to use the data centre space and is preferred in cases where flexibility with respect to shared spaces matters.

Statutory protections

Data centre leases mirror traditional real estate leases and include details such as the lease duration, rental obligations, and description of the leased space. Such lease arrangements afford more legal protections to data centres tenants with respect to eviction, right to quiet enjoyment, rent control, etc.² On the other hand, services agreements are generally structured as license arrangements. While service agreements may provide more flexibility with respect to termination, customers in a services arrangement have lesser statutory protections with respect to use of the data centre space. A lease would have priority over any future rights or charges created by the facility owner in favor of any third party. However, no such right inheres in a licensee. Parties may also consider stamp duty and registration implications while determining a suitable model.

Scale of services

Customers with large deployments, whether in terms of power (i.e., in terms of megawatts) or physical space (i.e., need for entire data halls or buildings), may prefer a lease over services agreement in order to have an exclusive right of possession over the data centre space. However, this may not be a definitive factor, and large-scale deployments may also take form of a services arrangement depending on the customer’s requirements and nature of business. For example, services agreements allow customers to negotiate a right of first refusal for adjacent space and certain additional rights vis-a-vis a lease, which may in addition to such right allow tenants priority in purchasing the property in case of sale by the data centre service provider.

Scope of services

When data centre service providers offer only basic infrastructure, leases may prove more suitable for tenants. However, this factor alone does not dictate choice, and leases are also seen to bundle services identical to those under services agreements. For key operations relating to power, cooling and security, both structures commonly incorporate service level agreements (“SLAs”) that define the performance metrics for the data centre service providers and incorporate remedies for customers when the provider fails to meet the defined metrics. Remedies typically include service fee credit against future invoices, and in case of chronic failure, such as repeated power outages, SLAs may also allow for termination rights. Further, leases are site-specific in nature whereas services agreements are more flexible and may provide site-specific as well as global coverage. For example, customers may opt for a master services structure to establish their rights and obligations with the data centre service provider in multiple geographies. Such an arrangement helps avoid the need for negotiations with respect to deployments made at each data centre while permitting flexibility regarding commercial and operational terms.

Notwithstanding the above, it is important that service agreements, particularly those involving the provision of physical space or access within a data centre facility, be carefully drafted to establish the arrangement as a license for services rather than a lease of immovable property. Failure to do so carries a risk that judicial authorities may recharacterize the agreement as a lease, irrespective of its title.³

POTENTIAL IMPACT OF THE 2026-27 INDIAN BUDGET ON THE DATA CENTRE INDUSTRY

In November 2020, the Ministry of Electronics and Information Technology, Government of India, issued a Draft Data Centre Policy, 2020⁴ applicable to data centre park developers, data centre operators as well as the allied ecosystem of the data centre sector and took feedback from all stakeholders. However, this policy was not notified by the government and never came into effect.

Notwithstanding this, several states in India, including Rajasthan, Karnataka, Telangana, Tamil Nadu, Maharashtra, Odisha, Uttar Pradesh and Haryana, have formulated their own state-specific data centre policies and have granted certain exemptions and incentives to set up data centres in the respective states.

Against this backdrop, the Indian Budget 2026-27 has proposed the following tax reforms in relation to data centres in India:

Tax holiday up to 2047

Any foreign company, which provides services to any part of the world outside India by procuring data centre services in India, will be granted a tax holiday up to the tax year ending March 31, 2047. However, in order to qualify for this tax holiday, the foreign company is required to provide services to Indian customers only through an Indian reseller entity (which shall be taxed appropriately under Indian tax laws).

In this regard, the Finance Act, 2026, as notified in the official gazette on March 30, 2026 (“Finance Act”),⁵ has clarified that a foreign company will be eligible to avail the tax holiday on “any income accruing or arising in India deemed in or to accrue or arise in India by way of procuring data centre services⁶ from a specified data centre”, subject to satisfaction of the following conditions–

1. the foreign company is notified by the Central Government;

2. the foreign company does not own or operate any of the physical infrastructure or any resources of the specified data centre;

3. all sales by the foreign company to users located in India are made through an Indian reseller company; and

4. the foreign company maintains and furnishes prescribed information.

The term “specified data centre” has been defined under the Finance Act as a data centre that has been, “(i) set up under an approved scheme and is notified in this behalf by the Central Government in the Ministry of Electronics and Information Technology; and (ii) owned and operated by an Indian company.”

Further, the term “data centre” has been defined as “a dedicated secure space within a building or centralised location where computing and networking equipment is concentrated for the purpose of collecting, storing, processing, distributing or allowing access to large amounts of data.”

Safe harbor

A resident entity providing data centre services to a related foreign company (which is providing cloud services to any part of the world outside India) is proposed to be included in a safe harbor regime with a margin of 15%. That is, a domestic data centre that provide services to foreign companies within the same corporate group can apply a fixed 15% margin on their costs for tax purposes. This proposal is aimed at reducing transfer pricing disputes and providing tax certainty.

IMPLICATIONS ON EXISTING DATA CENTRE MODELS AND OWNERSHIP STRUCTURES

The policy changes introduced by the Indian Budget 2026-27 are expected to have a significant effect on the data centre sector in India. Set out below are certain key implications:

Eligibility criteria for “Specified Data Centre”

On October 11, 2022, the Department of Economic Affairs, Government of India, notified an updated Harmonized Master List of Infrastructure sub-sectors (“HML”),⁷ which incorporated “data centres” as a new item in the category of “Communication” and included the following definition for data centres:

“Data Centre housed in a dedicated/centralized building for storage and processing of digital data applications with a minimum capacity of 5 MW of IT load.”

This definition places data centres under the “Communication” category, emphasizing physical infrastructure with a minimum IT power threshold for infrastructure status benefits, such as financing eligibility. In contrast, the Finance Act has included a broader definition for “data centres” and the linkage to the five MW IT load and dedicated building criteria in the HML has been dropped.

However, to qualify for the tax holiday proposed under the Indian Budget 2026-27, data centres are required to meet additional eligibility conditions specified for qualifying as a “specified data centre,” i.e., such data centre: (i) shall have been set up under an approved scheme notified by the Central Government in this regard; and (ii) is owned and operated by an India company. While no separate scheme or guidelines have been issued in this regard, it is recommended that existing data centres assess their eligibility as “specified data centres” once the relevant scheme / guidelines are issued by the Central Government.

Impact on captive or in-house data centres

The safe harbor is likely to incentivize the establishment of captive or in-house data centres, as it provides both operational flexibility and tax certainty for foreign companies while transacting with their Indian group entities. However, to qualify for the tax holiday, foreign companies are required to ensure that: (i) they do not own or operate any of the physical infrastructure or any resources of the specified data centre; and (ii) the data centre meets the criteria for qualifying as a “specified data centre.”

As a result, any foreign company seeking to invest in existing data centre companies in India and benefit from the tax holiday under a captive structure, should structure their investment in a manner such that they do not own or operate the data centre infrastructure themselves. Further, foreign companies will need to ensure that the data centre qualifies as a “specified data centre.”

However, we note that the Finance Act has not clarified whether the condition in relation to the foreign company not owning or operating any of the physical infrastructure or resources of the specified data centre also extends to indirect ownership or operation, i.e., through an Indian subsidiary or wholly owned subsidiary of the foreign company. In the event this condition is extended to indirect ownership and operation, it could create a challenge for existing captive or in-house data centre structures operating through their Indian subsidiaries, and internal restructuring may be required to claim benefits from the tax holiday in addition to the safe harbor.

Impact on outsourced data centres

The tax holiday is likely to incentivize foreign hyperscalers to obtain data centre services from domestic data centres since the risk in relation to their overseas income being taxed in India has now been eliminated. This is likely to incentivize higher utilization levels in existing data centres and may also catalyze development of new data centres in India.

Consequently, Indian data centre companies that own and operate such specified data centres could see increased investment interest from financial investors (both, domestic and foreign). However, since the tax holiday is contingent upon the relevant data centre qualifying as a “specified data centre,” only such limited category of Indian data centre companies may benefit from higher investments pursuant to the tax incentives that have been announced.

Lease versus service model for data centres

The safe harbor provision is expected to make both the lease and service model simpler and more tax efficient in relation to related party transactions.

Under the previous tax framework, leases between foreign companies (as customers) and Indian data centre companies presented a risk of creating a permanent establishment for the foreign company in India thereby resulting in them having a taxable presence in India. However, the proposed tax holiday has addressed this uncertainty. However, such lease agreements will need to be structured keeping in mind the condition for such foreign company to not own or operate any of the physical infrastructure or resources of the specified data centre in order to be eligible for the tax holiday.

The service agreement model will also require compliance with the requirement that foreign companies do not own or operate the infrastructure of the data centre. Additionally, since the further condition for availing the tax holiday requires that all sales by the foreign company to users located in India are made through an Indian reseller company, a single master service agreement, with service orders issued for specific projects or capacity, may be beneficial in such cases. Such an arrangement will allow parties to clearly define their rights and obligations in relation to the data centre services across multiple geographies and avoid the need for having separate contracts or documentation for each jurisdiction.

CONCLUSION

Data centres are critical infrastructure for the modern digital economy and their importance grows as the world is moving towards data-driven technologies. The tax reforms in the Indian Budget 2026-27 propose to create a more predictable and attractive environment for long term investment in the AI and cloud services driven sectors in India. In particular, the tax reforms are expected to influence the way foreign companies procure data centre services in India and how the domestic data centre service providers structure their operations and ownership structures. This shift in business models could lead to greater integration with global players, fostering collaboration and innovation within the sector.