Coupon Accepted Successfully!

Tax issues related to investment transactions and investor exits (i.e. sale of securities)
An investor is typically issued securities (shares or instruments convertible into shares) when he invests in India. Making a profitable exit by sale of securities is one of the motives of investment – this is the most common means of exit. Exits by sale of securities like shares (listed or unlisted) or debentures attract capital gains tax under Indian law – these are a major consideration at the time of exits by investors. Therefore, understanding how capital gains tax applies to various exit transactions is critical. In this chapter the primary focus is on exits.
The policy behind tax laws encourages long term investments and discourages quick investment and sale – therefore, short term investments are in principle taxed at a higher rate.
Capital gains tax may either be long term capital gains (LTCG) or short term capital gains (STCG). Tax on LTCG is lower than STCG. Investors acquire shares, debentures or convertible securities when investing into a company – these qualify as capital assets.
To minimize capital gains tax, foreign investors can hold securities for a longer period so that the asset qualifies as a long-term capital asset. In certain cases, they can also take the benefit of double taxation agreements (explained later). Under which circumstances is an investment considered as a long term capital asset?
All equity shares (irrespective of whether they are listed) or convertible or non-convertible debentures (if they are listed) will be considered Long Term Capital Assets (LTCA) if they are held by an entity for more than 12 months, and Short Term Capital Asset (STCA) if they are held for 12 months or less. As explained before tax liability on sale of a capital asset depends on the period of holding of the asset - sale of a LTCA gives rise to LTCG, while sale of a STCA gives rise to STCG. 
  1. Taxation of sale of securities in India:
  • Securities Transaction Tax:
Sale of securities (whether STCA or LTCA) of an Indian company through a recognized stock exchange in India is subject to securities transaction tax (STT). Such a tax is payable by an entity irrespective of its residential status and is collected by the stock exchange in India on which the sale occurs. The rate of STT has been reduced from 0.125% to 0.1% as per the Finance Act, 2012, and such tax is payable by both buyer and seller.
  • LTCG arising on securities
LTCG realized by a non-resident on sale of listed equity shares (or a unit of an equity oriented fund) is exempt from tax in the event such transaction is chargeable to securities transaction tax, i.e., the transaction is undertaken on a recognized stock exchange. In case of sale of any other listed securities, such as corporate bonds or debentures, LTCG is taxable at the rate of 20% (plus surcharge and cess)
LTCG realized by a non-resident on sale of unlisted securities is taxable at the rate of 10% plus surcharge and cess[1].
  • STCG arising on listed or unlisted securities
STCG realized by a non-resident on sale of securities being listed equity shares or a unit of an equity oriented fund will be subject to tax at 15% plus surcharge (plus securities transaction tax) provided that the transaction is undertaken on a recognized stock exchange.
In case of STCG realized on sale of any other securities (other than described above), it shall be subject to tax at the normal income tax rates applicable to non-residents under the provisions of the Income Tax Act, 1961.
Further, income tax is required to be withheld by the buyer (i.e., the payer) at the time of making the payment to the non-resident seller in case the transaction is chargeable to tax in India[2]. Although the primary tax liability is of the seller who earns the income, the buyer is under an obligation to withhold tax on a portion of the consideration at rates prescribed under the Income Tax Act. This provision will be attracted if a foreigner sells shares of an Indian company whether to a resident or a non-resident
  1. Tax on income of Foreign Institutional Investors (FIIs) with respect to securities
As per Section 115AD of the Income Tax Act, income of a Foreign Institutional Investor is taxed as follows:
Category of Income Rate of Tax
Income from securities (other than from dividends) e.g. interest received on debentures 20 percent
Dividends Dividends are tax-free in the hands of investors. The company must pay a dividend distribution tax at the time of payment.
Short-term capital gains (from transfer of the securities) 30 percent
15 percent if it is a listed equity share on which securities transaction tax has been paid.
Long term capital gains (from transfer of securities)
  1. percent
  1. Taxation of buyback – Sometimes, a company may buy-back its shares to improve – buyback can improve investor confidence in the company, ward off hostile acquirers and improve earnings per share, which is a key metric of financial performance for investors and shareholders. Buybacks usually lead to increase in the stock prices of the company. For example, in 2013, Apple had undertaken a huge buy-back of its shares to reward its shareholders by distributing surplus cash, indicating that the company was doing extremely well. What are the tax implications of such transactions?
If shares held by a non-resident investor are bought back by the company from the investor, then the investor will be liable to income tax in respect of the capital gains arising on such buyback as per the provisions of the Income Tax Act, subject to beneficial provisions under an applicable double taxation avoidance agreement. Capital gains tax arising in respect of a buyback must be withheld at source.
[1] Vide Finance Act, 2012, Section 112(1)(c)(iii)
[2] Refer section 195 of the Income-tax Act, 1961

Test Your Skills Now!
Take a Quiz now
Reviewer Name