A non-resident has sold shares of Indian company - Capital gains and treaty benefits simplified.

Capital gains?on the?sale?of?shares?of Indian company by any person?non-resident?in India.

As per Section 9(1) of the Income-tax Act of India (domestic tax law of India/Act), any income accruing or arising to a seller of shares in any place outside India whether directly or indirectly through the transfer of a?capital?asset situated in India would be deemed to accrue or arise in India. Further, Section 5 provides that all assesses, whether?resident?or not, are chargeable to tax in respect of their income accrued, arisen, received, or deemed to accrue, arise or to be received in India during the previous year irrespective of their residential status, and the place of its accrual.

The?shares?of an Indian entity (I co.) is a?capital?asset situated in India. Thus, as per the domestic tax laws of India, transfer of?shares?of I co, would be taxable in India in hands of non-resident seller even if the transfer is made outside India to any person?non-resident?in India or to any foreign company.

Now, let's understand the taxability as per the India-Netherlands tax treaty (India-Netherlands has been taken for the example sake). Paragraph 5 of Article 13 of the treaty reads as follows:

i.?"Gains?from the alienation of any property other than that referred to in paragraphs 1, 2, 3 and 4 shall be taxable only in the State of which the alienator is a?resident."ii.?"However,?gains?from the alienation of?shares?issued by a company?resident?in the other State which?shares?form part of at least a 10 per cent interest in the?capital?stock of that company, may be taxed in that other State if the alienation takes place to a?resident?of that other State. However, such?gains?shall remain taxable only in the State of which the alienator is a?resident?if such?gains?are realised in the course of a corporate organisation, reorganization, amalgamation, division or similar transaction, and the buyer or the seller owns at least 10 per cent of the?capital?of the other."

The above concludes that the?capital gains?arising from the transfer of?shares?of I.co. to any person?non-resident?in India would be taxable in the country in which seller is?resident. Accordingly, on the transfer of?shares?of I.co by the holding company based in Netherlands (H.co) to any person?non-resident?in India, any?capital gains?arising on such transfer would be taxable in the Netherlands as per Netherland's domestic tax laws.

Since the taxability as per the treaty is more beneficial than domestic laws, the tax as per treaty will prevail. Thus, such?capital gains?would be exempt from tax in India and no TDS implications arise in hands of the I.co. Interestingly, the?capital gains?in the Netherlands on aforesaid transfer can also be claimed as exempt under the Participation exemption regime. Hence, the above transaction would result ultimately in H.co paying no taxes on such transfer of?shares.

Alternate Scenario - Investment in India not routed through Netherland but USA

In the instant scenario, the investments were directly made by USA co. (USA Co.) Accordingly, India-USA treaty would be followed. The domestic tax laws of India as explained above shall remain the same.

As per Article 10 of the India-USA treaty, the dividend is taxable at source country at 15% (if at least 10% shareholding is held in the company) and 25% in other cases. As per Article 13 of the India USA treaty, each country may tax?capital gains?as per their domestic tax laws. Thus, the?capital gains?on the transfer of?shares?of I.co. would be taxable in India as per the domestic tax laws of India (Refer Para 3.2). Consequently, TDS implications would arise in hands of the I.co. Additionally, such?capital gains?may be taxed in the USA as per the?residence?rule. However, the tax credit may be allowed for the foreign taxes paid.

Tax Rate to be adopted in case of Non-Resident INDIAN seller in case of unlisted shares:

The unlisted shares (other than debt mutual funds) or securities of an Indian company, if held for more than 24 months, are classified as long term capital gain (LTCG) assets. However, the tax liability of such securities is 10% without indexation benefit.

In the case of debt-oriented mutual funds, if the units are held for more than 36 months by the NRI, then they are termed as long term capital gain assets. The tax liability on such a type of transaction is 20% after indexation.

Tax Rate to be adopted in case of Non-Resident seller in case of unlisted shares:

LTCG?arising?from?transfer?of?unlisted?securities?or?shares?of?a?closely?held?company,?is?chargeable?to?tax?in?India?at?10%,?without?giving?indexation?benefits?and?adjustment?on?account?of?forex?fluctuation.

STCG (shares held for less than 24 months on transfer of unlisted shares are taxable as per the prescribed slab rates for individuals and 40% in case of non-resident companies.