Capital Gains Tax Under DTAA: Planning Share Transfers in India

Introduction: Why Capital Gains Tax Planning Under DTAA Matters

When a foreign company or investor sells shares in an Indian entity, India's domestic law imposes capital gains tax that can reach 12.5% to 20% depending on the holding period and asset class. For cross-border share transfers, Double Taxation Avoidance Agreements (DTAAs) can significantly reduce or even eliminate this burden — but only if the transaction is structured correctly from the outset.

This article is part of our Complete Guide to DTAA for Foreign Companies in India. Here we dive deep into capital gains tax planning for share transfers, covering India's domestic rates, treaty-based relief, country-specific strategies, and the compliance framework that foreign companies must follow to claim benefits.

India's Union Budget 2024-25 introduced a simplified capital gains regime effective from 23 July 2024, replacing the earlier multi-tier structure. Long-term capital gains (LTCG) are now taxed at a uniform 12.5% without indexation across all asset classes, while short-term capital gains (STCG) on listed equity (where Securities Transaction Tax is paid) are taxed at 20%. These changes make DTAA planning more important than ever, because treaty rates may offer substantially lower taxation than these domestic rates.

India's Domestic Capital Gains Tax Framework for Share Transfers

Holding Period and Classification

The classification of capital gains depends on how long the seller held the shares:

• Listed equity shares: Holding period of more than 12 months qualifies as long-term. Less than 12 months is short-term.
• Unlisted shares: Holding period of more than 24 months qualifies as long-term. Less than 24 months is short-term.

Tax Rates Under Domestic Law (FY 2025-26)

For non-residents, the effective rate includes applicable surcharge and health and education cess of 4%, bringing the effective LTCG rate to approximately 13% and STCG rate on listed equity to approximately 20.8%.

Section 195: TDS on Payments to Non-Residents

Under Section 195 of the Income Tax Act, any person paying capital gains to a non-resident must deduct tax at source. The buyer of shares (or the company in case of buyback) is responsible for deducting TDS at the applicable rate before remitting payment. The TDS rate is the lower of the rate prescribed under the Income Tax Act or the applicable DTAA rate — provided the seller furnishes a valid Tax Residency Certificate (TRC).

How Article 13 of DTAAs Governs Capital Gains on Shares

Article 13 of most Indian DTAAs deals with capital gains. However, the specific provisions vary dramatically across treaties. The key question is: does the treaty give India (as the source country) the right to tax capital gains on share transfers, or does it reserve that right exclusively for the country of residence?

Three Categories of Treaty Provisions

Indian DTAAs broadly fall into three categories regarding capital gains on shares:

1. Source-country taxation permitted: India can tax the gains. The treaty may cap the rate (e.g., at 10% or 15%), or it may apply the full domestic rate. This is the most common position in modern Indian treaties.
2. Residence-country exclusive taxation: Only the country where the seller is resident can tax the gains. India cannot impose any tax. This was the historic position under the India-Mauritius and India-Singapore treaties (pre-2017 for investments made before April 2017).
3. Conditional source taxation: India can tax only if certain conditions are met — for example, if the shares derive more than 50% of their value from immovable property in India, or if the seller held more than a certain percentage of the company.

The Immovable Property Exception

Most DTAAs include an exception: gains from shares that derive their value substantially (often more than 50%) from immovable property situated in India can always be taxed in India, regardless of the general capital gains provision. This is a critical consideration for real estate holding companies and companies with significant land holdings.

Country-Specific Capital Gains Treatment Under Key DTAAs

India-Mauritius DTAA

The India-Mauritius DTAA was historically the most favorable for capital gains planning. Prior to the 2016 protocol amendment, capital gains on shares were taxable exclusively in the country of residence (Mauritius), effectively resulting in near-zero taxation due to Mauritius's favorable domestic tax regime.

Post-amendment (effective 1 April 2017):

• Shares acquired before 1 April 2017: Grandfathered — capital gains remain taxable only in Mauritius regardless of when sold.
• Shares acquired on or after 1 April 2017: India has full right to tax capital gains at its domestic rate. The earlier transitional rate of 50% of the applicable rate (for the period April 2017 to March 2019) has expired.

India-Singapore DTAA

Singapore followed a similar trajectory. Post-amendment, India can tax capital gains on shares acquired after 1 April 2017. The Singapore route is no longer a capital gains tax planning vehicle for new investments, though grandfathered investments retain the old benefit.

India-Netherlands DTAA

The India-Netherlands DTAA permits India to tax capital gains on shares. However, there is no specific reduced rate — the domestic rate applies. The Netherlands route is primarily used for its favorable dividend withholding provisions (10%) rather than capital gains planning.

India-USA DTAA

Under the India-US DTAA, capital gains from share transfers are generally taxable in the country of residence of the seller. However, India retains the right to tax if the shares derive value from immovable property. The US Foreign Tax Credit mechanism allows US taxpayers to offset Indian taxes paid against their US tax liability, which is an important planning consideration.

India-UK DTAA

The India-UK treaty allows India to tax capital gains on share transfers. The UK provides double taxation relief through foreign tax credits. For UK companies, the Substantial Shareholding Exemption (SSE) may eliminate UK tax on the gain, making the Indian tax the only effective burden.

India-Japan DTAA

The India-Japan DTAA allows source-country taxation on capital gains from shares. Japan provides a foreign tax credit against its domestic corporate tax. Given Japan's high domestic corporate tax rate (approximately 30%), the Indian capital gains tax of 12.5% can generally be fully credited.

GAAR and the Limitation of Benefits: What Foreign Companies Must Know

India's General Anti-Avoidance Rules (GAAR), codified under Sections 95 to 102 of the Income Tax Act and effective from 1 April 2017, fundamentally changed the capital gains planning landscape. GAAR empowers the tax authorities to deny treaty benefits if an arrangement is found to be an "impermissible avoidance arrangement" — one whose main purpose is to obtain a tax benefit and which either creates rights or obligations not ordinarily created between parties dealing at arm's length, results in misuse or abuse of the provisions of the Act, lacks commercial substance, or is not carried out in a bona fide manner.

Practical Impact on Share Transfer Structures

The most immediate impact is on multi-layered holding structures. A foreign company that holds shares of an Indian company through an intermediary entity in a favorable treaty jurisdiction (such as Mauritius, Singapore, or Cyprus) may find the intermediary entity's treaty benefits denied if the intermediary lacks genuine commercial substance. The tax authorities will examine whether the intermediary has real employees, office space, decision-making authority, and business activities beyond merely holding the Indian shares.

Safe Harbor Considerations

GAAR does not apply where the aggregate tax benefit obtained from an arrangement in a relevant assessment year does not exceed INR 3 crore (approximately USD 360,000). Additionally, Foreign Institutional Investors (FIIs) who do not take any benefit under a DTAA and invest in listed securities through any investment fund, venture capital company, or venture capital fund are excluded from GAAR scrutiny. These carve-outs provide practical safe harbors for smaller transactions and institutional investors.

The MLI Principal Purpose Test

Complementing GAAR, the OECD Multilateral Instrument (MLI), which India has ratified, introduces the Principal Purpose Test (PPT) into most of India's DTAAs. Under the PPT, treaty benefits can be denied if one of the principal purposes of an arrangement was to obtain the benefit. Unlike GAAR, which is a domestic law provision, the PPT operates at the treaty level and can override treaty benefits directly.

Section 90: Choosing the More Beneficial Provision

Section 90(2) of the Income Tax Act provides a critical planning tool: where India has a DTAA with a country, the taxpayer can apply whichever is more beneficial — the DTAA provision or the domestic law provision. This means:

• If the DTAA rate for capital gains is lower than the domestic rate, the taxpayer applies the DTAA rate.
• If domestic law exemptions (such as the INR 1.25 lakh LTCG exemption on listed shares) result in a lower effective rate than the DTAA, the taxpayer can apply domestic law instead.
• The taxpayer can cherry-pick provisions — for example, using the DTAA rate for one type of income and domestic law for another.

To claim treaty benefits, the non-resident must obtain a Tax Residency Certificate (TRC) from the tax authority of their home country and submit it to the Indian payer along with Form 10F (self-declaration of treaty eligibility).

Practical Planning Strategies for Share Transfers

Strategy 1: Timing the Transfer

Converting short-term gains to long-term gains by holding shares beyond the threshold period (12 months for listed, 24 months for unlisted) reduces the tax rate from up to 20% (listed) or slab rates (unlisted) to a flat 12.5%. Combined with treaty benefits, this can result in significant savings.

Strategy 2: Structuring Through Favorable Treaty Jurisdictions

While the India-Mauritius and India-Singapore routes have been curtailed for new investments, other treaty jurisdictions may still offer benefits. However, companies must ensure genuine substance in the intermediary jurisdiction — India's General Anti-Avoidance Rules (GAAR), effective since April 2017, can deny treaty benefits to arrangements that lack commercial substance.

Strategy 3: Utilizing Foreign Tax Credits

For investors from countries with high domestic tax rates (USA, Japan, Germany), the Indian capital gains tax may be fully creditable against home-country tax. In these cases, the effective additional tax burden from India is zero — the investor would have paid the same or higher tax at home anyway. Proper documentation of taxes paid in India (via Form 67 or equivalent home-country filing) is essential.

Strategy 4: Share Valuation and Fair Market Value Reporting

For transfers of unlisted shares, India requires that the transfer price be at or above the fair market value (FMV) determined under Rule 11UA of the Income Tax Rules. If the transfer price is below FMV, the FMV is deemed the sale consideration. Strategic valuation — using a Chartered Accountant-certified Discounted Cash Flow (DCF) method — can optimize the capital gains computation.

Strategy 5: Indirect Transfers and the Vodafone Precedent

Following the Vodafone case and subsequent legislative amendments, India taxes indirect transfers of shares where the underlying assets (shares of an Indian company) exceed INR 10 crore in value and represent at least 5% of the total assets of the foreign entity. Planning the corporate structure to stay below these thresholds — or ensuring the transfer qualifies for an exemption (such as group restructuring) — is critical.

Compliance Framework: Forms and Filing Requirements

Form 15CA and Form 15CB

Any remittance of capital gains proceeds to a non-resident requires filing Form 15CA (an information form filed by the remitter on the income tax e-filing portal) and, where the remittance exceeds INR 5 lakh, Form 15CB (a certificate from a Chartered Accountant certifying the treaty eligibility and applicable rate).

Filing Timeline and Process

1. Obtain TRC from the home country's tax authority.
2. The CA prepares and uploads Form 15CB on the e-filing portal.
3. The remitter files Form 15CA online, referencing the Form 15CB.
4. The bank processes the remittance based on the approved Form 15CA.
5. TDS is deposited with the government within 7 days of the month following the deduction (30 days for March deductions).
6. Quarterly TDS return (Form 27Q) is filed by the buyer/company.

Penalties for Non-Compliance

• Failure to deduct TDS (Section 201): The payer becomes an assessee-in-default and is liable to pay the TDS amount plus interest at 1% per month (for late deduction) or 1.5% per month (for late payment after deduction).
• Failure to file Form 15CA: Penalty of INR 1 lakh under Section 271-I.
• Short deduction: Interest at 1% per month on the shortfall from the date of deduction to the date of actual payment.

Key Takeaways

• India's uniform 12.5% LTCG rate (post-July 2024) applies to all share transfers, but DTAAs can provide lower rates or exclusive residence-country taxation depending on the treaty.
• The India-Mauritius and India-Singapore capital gains exemptions are effectively over for shares acquired after April 2017 — only grandfathered investments retain the old benefit.
• Section 90(2) allows taxpayers to choose the more beneficial provision between domestic law and the DTAA, making treaty analysis essential for every cross-border share transfer.
• GAAR provisions mean that treaty shopping through shell entities without commercial substance will be denied — genuine business operations in the intermediary jurisdiction are mandatory.
• Compliance with Form 15CA/15CB, TRC, and TDS obligations is non-negotiable. Failure to comply results in penalties, interest, and potential prosecution.