India: Taxation Of An Investment By An Indian Individual In Shares Of A Foreign Company

INTRODUCTION

Sometimes Tax treatment of income arising by an Individual may not be clear from direct provisions of the Income tax act, 1961, an interpretation of various clauses of the Income Tax Act, 1961 along with provisions of Double Taxation Avoidance Agreement may clarify the taxation of income arising from such complex transactions. One such situation, where provisions of Income Tax Act, 1961 are to be read in consonance with the provisions of Double taxation avoidance agreement is in the case of an investment by an Indian Individual (ordinarily resident in India) in the shares of a Foreign Company.

An Investment by an Indian Individual in shares of a Foreign Company may result in following types of Incomes:

  1. on dividend received from such investment made in Spain?
  2. Income, as Capital Gains, by way of transfer of such shareholding in Foreign Company

RELEVANT LEGAL PROVISIONS AND OBSERVATIONS

  1. As per the provisions of Income Tax, taxability of an Individual depends upon his/her days of residence in India.
  2. As per Section 6 of the Indian Income Tax Act, 1961, which defines residence in India for the Taxation purposes, the Indian Individual in present case is ordinarily resident in India.
  3. Section 4 of the Income Tax Act, 1961 provides for Charge of Income Tax on the "Total Income".
  4. Further, Section 5 of the Income Tax Act, 1961 provides for "Scope of Total Income" in case of an individual ordinarily resident in India. As per the said section, all income received or is deemed to receive in India, accrues or arises or is deemed to accrue or arise in India or accrues or arising outside India, during a previous year from all sources in included and hence liable to taxation.
  5. However, Section 10 of the Income Tax Act, 1961 provides for Incomes which do not form part of Total Income. Section 10 (34) of Income Tax Act, 1961 provide exemption to income received by way of dividend only from a domestic company in the hands of the recipient, however all income received by way of dividend from a foreign company is liable to be taxed in India.

    Therefore, Dividend received from foreign Company is taxed under the head "Income from other sources" under the Indian Income Tax Act of 1961.
  6. Relevant provisions of the said DTAA need to be examined to determine taxation of Dividend Income received by an Indian Individual from a Foreign Company. Usually many DTAA's contain a provision of Withholding tax (i.e. tax deducted at source) on dividend incomes. The rate of tax on such dividends in many cases is 15%.
  7. In the above mentioned case, where tax is levied in both the countries, in respect of the same dividend income, DTAA between India and the other country provides relief from effect of such Double taxation. As per the provisions of the DTAA, Indian individual will get a deduction on the Tax already deducted in such other country on such dividend Income. Therefore it can be concluded that though the dividend income received by an Indian Individual from investment of shares in a Foreign Company will be included in his "Total Income" (i.e. Section 5) and is taxable in India, tax already paid in the foreign country on such dividend income will be deducted from tax calculated on such dividend income in India
  8. Income from Sale of shares of a Foreign Company by an Indian Individual is taxable in India. As mentioned above, in case of an ordinarily resident India. All income received from all sources is, which received or is deemed to receive in India, accrues or arises or is deemed to accrue or arise in India or accrues or arising outside India, is taxable in India.
  9. Sale of shares by an Indian Individual, amounts "Transfer" of "Capital Asset" and is taxable as per the provisions of Section 45 of the Income Tax Act, 1961 and will be taxable under the head "Income from Capital Gains" under the Income Act of 1961.
  10. Shares of a Company, the units of Unit Trust of India or any specified Mutual Fund or any security listed in any recognised Stock Exchange are to be considered as short term capital assets if held for twelve months or less and long term capital assets if held for more than twelve months. Therefore, the taxation of sale of shares by the Indian Individual of the Foreign Company maybe treated as short term capital gains or long term capital gains, depending upon the time period within which it is sold after its purchase and its taxation will vary accordingly.
  11. Income from sale of foreign investments would generally be liable to be taxed in India. However, in case India has entered into a DTAA with a foreign country, provisions of such DTAA need to be examined for determining the tax treatment on profits arising from transfer of shares by the Indian Individual of a Foreign Company.
  12. Lets take the example, that an Indian individual invested in shares of a Spanish Company, in such case provisions of India- Spain DTAA need to be determined.

    From the provisions of Article 14 of the said DTAA entered between India and Spain [Point 10 of Annexure attached hereinafter], it is clear that gain from transfer of shares of Spanish company whose immovable property is situated in Spain may be taxed in Spain. It also provides that gain from transfer of 10% shares of a Spanish company, may be taxed in Spain. Profit from transfer of any other asset will be taxed in country of which transferor is resident.
  13. Therefore, income on sale of shares of a Spanish Company by an Indian individual will be taxable in Spain, if:

    1. If immovable property of such Spanish Company is situated in Spain and
    2. If the value of such shares transferred exceeds 10% of participation of such Company. Further, if the income from sale of shares of a Spanish Company is taxable under the head "Capital Gains" in India, as detailed above and a Capital Gain Tax is already paid in Spain, then in such case, in order to avoid double taxation, provisions of Clause 25 of the DTAA between India and Spain will be applicable [Point 7 of Annexure attached hereinafter]. As per the provisions of the said Clause of the DTAA, Indian individual will get a tax credit in India on the Tax already paid in Spain on such Income from sale of shares of Spanish Company.

CONCLUSION

  1. Income by way of Dividend earned by an Indian Individual on investment in shares of a Foreign Company will be included in the "Total income" of such individual and will be taxable in India as per the provisions of the Indian Income Tax Act of 1961. However, a deduction of amount of tax already paid in Spain will be available from tax on such dividend income payable in India
  2. Income from sale of shares of a Foreign Company, example taken above is of Spanish Company will be taxable in India, however, if the underlying value of such shares are Spanish Assets and the shares sold exceed 10% of the total shares of such Spanish Company, then income from such sale will be taxable in Spain as per the provisions of India – Spain DTAA. In case, a tax on income from sale of shares of Spanish Company is already paid in Spain by the Indian individual, then a deduction of the amount already paid in Spain as tax on such income will be available from the tax calculated on Capital gains in India on the aforesaid sale.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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