Can India Tax Capital Gains from Foreign Share Buybacks? A Non-Resident’s Dilemma
Question:
Whether capital gains arising to a non-resident from the buyback or repurchase of shares by a foreign company (i.e. not an Indian company) are taxable in India under the Indian Income-tax Act, 1961?
Legal Framework:
To determine taxability in India, we examine:
1. Section 5(2) – Income deemed to accrue or arise in India for non-residents.
2. Section 9(1)(i) – Income accruing/arising through a business connection or transfer of a capital asset situated in India.
3. Explanation 5 to Section 9(1)(i) – Deems shares in a foreign company to be a capital asset situated in India if they derive substantial value (≥50%) from Indian assets.
4. Double Taxation Avoidance Agreement (DTAA) – Taxability also depends on the provisions of the DTAA between India and the country of residence of the non-resident.
Scenarios:
1. Case 1: Foreign Company Shares DO NOT Derive Substantial Value from Indian Assets
No capital asset situated in India.
Hence, not taxable in India under Section 9(1)(i).
The transaction is entirely offshore – non-resident selling shares of a foreign company to that same foreign company.
Not Taxable in India, subject to GAAR or other anti-avoidance rules not being triggered.
2. Case 2: Foreign Company Shares Derive Substantial Value from Indian Assets
Explanation 5 to Section 9(1)(i) applies.
Then, gain may be deemed to arise in India and subject to Indian capital gains tax.
CBDT Rule 11UB and 11UC: Prescribe methods to compute the FMV and test the 50% threshold.
However, even if Explanation 5 applies, relief may be available under DTAA, particularly:
Article 13 of the India-Mauritius / India-Singapore / India-Cyprus DTAA: Taxation rights generally given to the country of residence of the seller.
However, Limitation of Benefit (LOB) clauses and GAAR may override.
Judicial Guidance:
Vodafone International Holdings BV v. UOI (2012) 341 ITR 1 (SC): If the transfer is offshore and not involving transfer of Indian assets directly or indirectly (before Explanation 5 was inserted), such gains are not taxable.
Post-Explanation 5, taxability is triggered only if substantial value is derived from Indian assets.
