An analysis of the transfer of Shares of an Indian Company from one non-resident to another, evaluating the compliances under Indian laws to be followed, the tax liability and the fair market value of the shares for computing Capital gains

1. TRANSFER OF SHARES OF AN INDIAN COMPANY BY ONE NONRESIDENT TO ANOTHER NON-RESIDENT
A. What are the Compliances under Indian Law?
B. What is the tax liability in the aforesaid transaction?
C. How will the “fair market value” of the shares be determined for computing capital gains?
A. What are the compliances under Indian Law?
The Foreign Exchange Management (Transfer of Security by a Person Resident outside
India) Regulation 2000 (hereinafter „Regulation‟), under Regulation 9 states:
Regulation 9 - Transfer of shares and convertible debentures of an Indian company
by a person resident outside India:Transfer of shares and convertible debentures of an Indian company by a person
resident outside India:(1) Subject to the provisions of sub-regulation (2), a person resident outside India
holding the shares or debentures of an Indian company in accordance with these
Regulations, may transfer the shares or debentures so held by him, in compliance with
the conditions specified in the relevant Schedule of these regulations.
(2) (i) A person resident outside India, not being a non-resident Indian or an overseas
corporate body, may transfer by way of sale, the shares or convertible debentures held
by him to any person resident outside India:-

2. (ii) A non-resident Indian may transfer by way of sale or gift, the shares or convertible
debentures held by him or it to another non-resident Indian.
Provided that the person to whom the shares are being transferred, in terms of Clauses
(i) and (ii), has obtained prior permission of Central Government to acquire the shares
if he has previous venture or tie up in India through investment in shares or debentures
or a technical collaboration or a trade mark agreement or investment by whatever
name called in the same field or allied field in which the Indian company whose shares
are being transferred is engaged
Further, Regulation 8B of Master Circular on Foreign Investment in India dated July 1, 2013
(RBI/2013-14/15), issued by Reserve Bank of India (RBI) grants a general permission for
purchasing/acquiring shares from non-resident shareholder. It states as hereunder –
8B. Acquisition by way of transfer of existing shares by person resident outside India
8B.I: Foreign investors can also invest in Indian companies by purchasing /acquiring
existing shares from Indian shareholders or from other non-resident shareholders.
General permission has been granted to non- residents / NRIs for acquisition of shares
by way of transfer in the following manner:
a. Non Resident to Non-Resident (Sale/Gift): A person resident outside India (other
than NRI and OCB) may transfer by way of sale or gift, the shares or convertible
debentures to any person resident outside India (including NRIs).
Thus, from a bare perusal of the above stated provisions of Foreign Exchange Management
(Transfer of Security by a Person Resident outside India) Regulation 2000, read with the
Master Circular on Foreign Direct Investment, it is evident that there is no bar under Indian
laws on the transfer of shares of an Indian Company by a non resident to a non resident. A
general permission has been granted by the RBI for the said transaction. Hence, there is no
need to inform the RBI prior to such transaction, however subject to the applicable FDI cap.
Although, no reporting requirements have been laid down by RBI pursuant to the transfer of
shares of an Indian Company by a non resident to a non resident, however, the Transferee, in
order to effectuate the transfer by getting its name recorded as a member in the shareholder‟s
register of the target Company, has to apply to the target Company along with the Share
transfer deed.
B. What is the tax liability in the aforesaid transaction?
[It is imperative to note if a Double Taxation Avoidance Agreement („DTAA‟) exists between
the Republic of India and the particular non-resident country where the transferor resides. In
this case we would examine the proposition, considering the non-resident country to be
Germany]

3. It is imperative to note a Double Taxation Avoidance Agreement (‘DTAA’)
entered exists between Republic of India and Federal Republic of Germany
for the avoidance of double taxation with respect to taxes on income and
capital, on 26.10.1996, and was notified on 29.11.1996. It reads as follows:
ARTICLE 2 - Taxes covered –
1. This Agreement shall apply to taxes on income and on capital imposed on behalf of a
Contracting State, of a land or a political sub-division or local authority thereof,
irrespective of the procedure in which they are levied.
2. There shall be regarded as taxes on income and on capital all taxes imposed on total
income, on total capital, or on elements of income or of capital, including taxes on
gains from the alienation of movable or immovable property, and the pay roll tax.
3. The existing taxes to which this Agreement shall apply are in particular:
(a)
in the Federal Republic of Germany :
the Einkommensteuer (income-tax),
the Korperschaftsteuer (corporation-tax),
the Vermogensteuer (capital tax), and
the Gewerbesteuer (trade tax)
(hereinafter referred to as German tax);
(b)
in the Republic of India,
the income-tax including any surcharge tax thereon (Einkommensteuer, einschl, darauf
entfallender Zusatzsteuern), and the wealth-tax (Vermogensteuer) (hereinafter referred
to as Indian tax).
4. This Agreement shall apply also to any identical or substantially similar taxes which
are imposed after the date of signature of this Agreement in addition to, or in place of,
the existing taxes. The competent authorities of the Contracting States shall notify each
other of changes of importance which have been made in their respective taxation laws.
From the bare perusal of the abovementioned provision it is discerned that DTAA is
applicable for avoidance of double taxation of income tax, corporation tax, capital tax, and
trade tax in Germany and income tax including any surcharge tax thereon and wealth tax in
India.
Further, Article 13 of the DTAA provides for taxation on capital gains arising out of selling
any immovable or movable properties in the contracting states. It reads as follows:

4. Article 13: Capital gains4. Gains from the alienation of shares in a company which is a resident of a
Contracting State may be taxed in that State.
Further, Article 23 provides for the following:
ARTICLE 23- Relief from Double taxation –
1. Tax shall be determined in the case of a resident of the Federal Republic of Germany
as follows:
(a) Unless foreign tax credit is to be allowed under sub-paragraph (b), there shall be
exempted from German tax any item of income arising in the Republic of India and any
item of capital situated within the Republic of India, which, according to this
Agreement, may be taxed in the Republic of India. The Federal Republic of Germany,
however, retains the right to take into account in the determination of its rate of tax the
items of income and capital so exempted.
In the case of dividends exemption shall apply only to such dividends as are paid to a
company (not including partnerships) being a resident of the Federal Republic of
Germany by a company being a resident of the Republic of India at least 10 per cent of
the capital of which is owned directly by the German company.
There shall be exempted from taxes on capital any shareholdings the dividends of
which are exempted or, if paid, would be exempted, according to the immediately
foregoing sentence.
(b) Subject to the provisions of German tax law regarding credit for foreign tax, there
shall be allowed as a credit against German tax payable in respect of the following
items of income arising in the Republic of India and the items of capital situated there,
the Indian tax paid under the laws of the Republic of India and in accordance with this
Agreement on :
(i)
dividends not dealt with in sub-paragraph (a) ;
(ii)
interest ;
(iii)
royalties and fees for technical services ;
(iv)
income in the meaning of paragraph 4 of Article 13;
(v)
directors fees ;
(vi)
income of artistes and sports persons.
(c) ………………………. .
(2)…………………..

5. (3). The laws in force in either of the Contracting States shall continue to govern the
taxation of income and capital in the respective Contracting States except where
express provision to the contrary is made in this Agreement.
Further, Section 9 of the Income Tax Act, 1961 provides as follows:
Income deemed to accrue or arise in India.
Section 9(1): The following incomes shall be deemed to accrue or arise in India:— all
income accruing or arising, whether directly or indirectly, through or from any
business connection in India, or through or from any property in India, or through or
from any asset or source of income in India, or through the transfer of a capital asset
situate in India.
Further Section 2(14) of the Income Tax Act, 1961 defined the term “capital assets” as
follows:
“Capital assets means property of any kind held by an assessee, whether or not
connected with his business or professions, but does not include-………”.
Further, in the matter of Triniti Corporation v. Commissioner of Income Tax decided by
Authority for Advance Rulings New Delhi, (A.A.R. No. 740 of 2006, on 16.11.2007), held
that:
“In simple words, even if the transaction relating to a capital assets takes place outside
India but if the capital asset is situated in India, the profits or gains thereon, is
accruing or arising in India in consonance with the provisions of Section 9(1)(i) of the
Act and is thus assessable under the head 'Capital gains' under the relevant provisions
of IT Act”.
Thus, if we examine the issue on the touchstone of the above judgment, it emerges that in the
instant case, the capital asset i.e. shares of an Indian company (which has to be transferred,
are situated in India and income will directly or indirectly accrued/arisen to the non-resident
through the transfer of the said capital asset. In fact, the above stated Section 9 of the Income
Tax Act, 1961 is designed to catch any capital gains that a non-resident may make by transfer
of any capital asset situated in India. Further, the expression 'capital asset' is defined in
Section 2(14) of the Act and the phraseology 'transfer' is defined in Section 2(47) of the Act.
Nevertheless, as per the existing provision of the Act, the capital gains becomes chargeable
on an alternative basis viz. accrual or arisal basis in India, as the capital asset is or happens to
be situated in India.
In arriving at the conclusion, on the basis of perusal of the above referred provisions of
DTAA read in consonance with the provision of Income Tax Act, 1961 and the decided
cases, it can be concluded that the said capital gain arising out of transfer of shares of an
Indian Company by the non-resident transferor, resident in Germany, to the non-resident

6. Transferee, shall be taxed in India as the income arises out of such transfer deemed to
accrued in India. However, the Transferor Company is eligible for credit of tax in its resident
country i.e. Germany on account of taxes paid in India.
Further, the following taxes would be applicable on the transaction as per the laws of India:
1. In accordance with, section 45 of Income Tax Act, 1961 any profits or gain arising from
the transfer of capital assets shall be chargeable to Income tax under the head “Capital Gains”
and shall be deemed to be income of the previous year of which the transfer took place.
Further the capital gain tax will be applicable upon the transferor irrespective of the place of
transfer.
2. As per Part II of Schedule 1 of Finance Act, 2013, Clause 2(b) (viii) the long term capital
gain tax is leviable at the rate of twenty percent (20%) and the same needs to be deducted on
account of deduction of tax at source by the remitter. Further, it is provided that if the income
exceeds Rs. 1 Crore than a surcharge at the rate of two percent (2%) of such income tax is
chargeable.
Hence, upon consideration of the above, in the instant transaction Capital gain tax shall be
payable by the Transferor Company and, and a certificate should be taken from the Income
Tax Department.
C. How will the “fair market value” of the shares be determined for computing capital
gains?
Section 45 of the Income Tax Act, 1961 states as under:
Section 45: Capital gains:
“[(1)] Any profits or gains arising from the transfer of a capital asset effected in the
previous year shall, save as otherwise provided in sections [54, 54B, [54D, [54E,
[54EA, 54EB,] 54F [, 54G and 54H ]]]]], be chargeable to income-tax under the head
“Capital gains”, and shall be deemed to be the income of the previous year in which
the transfer took place.
[(2) Notwithstanding anything contained in sub-section (1), the profits or gains arising
from the transfer by way of conversion by the owner of a capital asset into, or its
treatment by him as stock-in-trade of a business carried on by him shall be chargeable
to income-tax as his income of the previous year in which such stock-in-trade is sold or
otherwise transferred by him and, for the purposes of section 48, the fair market value
of the asset on the date of such conversion or treatment shall be deemed to be the full
value of the consideration received or accruing as a result of the transfer of the capital
asset.]
Further, Section 2(22B) “fair market value”, in relation to a capital asset, means:

7. (i) the price that the capital asset would ordinarily fetch on sale in the open market on
the relevant date ; and
(ii) where the price referred to in sub-clause (i) is not ascertainable, such price as may
be determined in accordance with the rules made under this Act;
Further, Section 51 states that:
“where any capital asset was on any previous occasion the subject of the negotiations
for its transfer, any advance or other money received and retained by the assessee in
respect of such negotiations shall be deducted from the cost for which the asset was
acquired or the written down value or the fair market value, as the case may be, in
computing the cost of acquisition”.
From the perusal of the above provisions of the Act it discerns that sub-clause (i) of section
2(22B) envisages the price which the asset would fetch in the open market on the relevant
date. The relevant date will be decided in accordance with the provisions in section 51. Sub
clause (ii) of the definition is attracted when the price of the asset in the open market as
contemplated in (i) cannot be ascertained.
Further, for a similar concept of market value, reference may be made to section 7(1) of the
Wealth Tax Act, 1957. In this regard, the Supreme Court in the matter of Bharat Hari
Singhania and others etc. v. Commissioner of Wealth-tax (Central) and others
(AIR1994SC1355), held that:
“For the purpose of determining the market value, the sub-section says that the WTO
shall make an estimate of the price which the asset would fetch if sold in the open
market on the valuation date. The sub-section speaks of the market value of the asset
and not the net income or the net price received by the assessee. This is not a case
where a fiction is created by the Parliament. It is only a case of prescribing the basis of
determination of market value… The contention is that the sub-section created a fiction
of sale of such asset on the valuation date for the purpose determining its market value.
Once a fiction is created, it must be carried to its logical extent and the court should
not allow its imagination to be boggled by any other considerations. If an asset is sold,
it would be subject to capital gains tax. For finding out the net wealth received in the
hands of assessee, one must necessarily deduct the capital gains tax and, therefore,
wholly unacceptable”.
Further, in the case of Commissioner of Wealth Tax v. Mahadeo Prasad Jalan & ors etc.
(AIR 1973SC1023), the Supreme Court made an important observation regarding „market
value‟ of the shares of private company and held that:
“It is proved that at relevant date business cannot have been sold for more than value
of its tangible assets, then that must be taken to be its value as a going concern”.

8. Further, under paragraph 4 and 13 of the aforesaid judgment, the Court observed that,
Paragraph 4: the question which has to be determined in this case is, what is the basis
of valuation of shares in private limited companies for the purpose of section 7 of the
Wealth Tax Act, 1957. Sub section (1) of the section 7 provides that “the value of any
asset, other than cash, for the purposes of this Act shall be estimated to be the price
which in the opinion of the Wealth Tax officer it would fetch if sold in the open market
on the valuation date”………………... On that date the Wealth Tax Officer will have to
ascertain what the shares will fetch if sold in the open market which would be the price
which a willing seller will accept and a willing buyer will pay.
Para 13(2): where the shares are of a public limited company which are not quoted on
stock exchange or a private company the values is determined by reference to the
dividends if any reflecting the profit earning capacity on a reasonable commercial
bases. But where they do not then the amount of yield on basis will determine the value
of the shares…………….The dividend and earning will ordinarily determine the value.
The dividend and earning method or yield method are not mutually exclusive; both
should help in ascertaining the profit earning capacity as indicated above. If the results
of two methods differ, an intermediate figure may have to be computed by adjustment of
reasonable expenses and adopting a reasonable proportion of profits.
From the perusal of the above said provision of law in consonance with the above stated
cases, it is discerned that the transfer of shares by the transferor to the transferee can attract
the capital gain tax liability computed at the fair market value. In accordance with, section 45
of Income Tax Act, 1961 any profits or gain arising from the transfer of capital assets shall be
chargeable to Income tax under the head “Capital Gains” and shall be deemed to be income
of the previous year of which the transfer took place.
Further on the basis of above discussion it may be concluded that the „fair market value‟ is
the value which could be fetch by the seller if the shares are sold in the open market on such
valuation date.