Selling Foreign Stock Under the US-India Tax Treaty

By: Robert Torres

At a glance

• The main takeaway: Selling stock in a foreign corporation can present many dynamic tax challenges that require expertise and familiarity to handle appropriately.
• Personal impacts: The US-India Tax Treaty reduces tax implications for American investors through foreign tax credits when directly selling stock from Indian companies, whereas indirectly selling such stock does not carry the same benefit.
• Next steps: Connect with Aprio’s Transaction Advisory team to learn how to reduce your tax liabilities and navigate these transactions with confidence.

Background

Selling a corporation’s stock requires careful consideration of the potential tax impacts, such as gains or losses that are subject to specific tax regulations. These tax considerations multiply when involving a cross-border element because certain countries may also impose additional taxes to those levied under US tax law. Some countries enter into tax treaties with the US to determine the taxation of certain transactions, but domestic law prevails in the absence of a treaty.

The US-India Tax Treaty illustrates the complexity of international tax considerations associated with the direct or indirect sale of an international company or stock by a US person (USP).

What is the US-India Income Tax Treaty?

The US and India have agreed to an international tax treaty that aims to avoid double taxation on items taxed in both countries. Since income from the sale of stock is considered gain derived from the sale of a capital asset in both the US and India, the capital gains provision of the US-India Income Tax Treaty applies when selling stocks between countries. However, this provision states that the US and India may tax capital gains in accordance with their domestic law. To avoid double taxation under their independent regulations, the treaty provides that both the US and India shall offer a tax credit for taxes incurred in the other country with respect to the same item of income, as long as the tax levied is a tax covered by the treaty.

Direct Stock Sale of an Indian Company

A direct sale occurs when a USP sells their stock in an Indian company (IndiaCo) to a buyer. In this scenario, the USP would incur capital gains tax in the US because they are a resident of the US, as well as capital gains tax in India, because the property (shares of IndiaCo) from which the income was derived is in India.

The extent to which the USP would incur tax in both the US and India depends on the holding period, or the amount of time the USP held the stock in IndiaCo prior to the sale. The US and India can impose different holding periods as well as differing long- or short-term capital gains tax rates depending on the specifics of the transaction. In both long-term and short-term capital gains cases, the buyer is generally liable for withholding the capital gains tax from the purchase price and remitting it to the taxing authorities in India within seven days from the end of the month the transaction takes place. However, the primary tax liability remains with the seller.

This potential for significant double-taxation in a direct sale underscores the importance of the US-India income tax treaty, which allows a USP to claim a foreign tax credit for income taxes (or taxes in lieu of income taxes) paid, such as a tax on gross receipts from the occurrence an event that may be offset by associated costs. However, the USP may still be expected to pay additional Indian taxes not covered by the foreign tax credit, such as a 2-5% withholding tax on sales by non-residents of India, a 1% registration fee, and stamp duties equivalent to 2-8% of the sale price.

Indirect Stock Sale of Indian Company

An indirect sale occurs when a USP sells stock in a US company (USCO) that owns all of the stock of an Indian company (IndiaSub), thus resulting in the indirect sale of IndiaSub stock.

In an indirect sale, the seller would incur US capital gains tax on the sale if the seller is a US resident and if the USCO is located in the US. If the buyer is a non-US person, the Foreign Investment in Real Property Act (FIRPTA) applies, in which withholding taxes will be incurred at 30% of the purchase price if the USCO is considered a real property holding corporation (USRPHC). However, if USCO is not a USRPHC, the buyer can obtain an exemption from FIRPTA withholding.

Typically, an indirect property sale between two non-residents of a country would not have tax consequences in the country where the property indirectly transferred is situated. However, if such property is situated in India, an indirect transfer tax may be applied on assets that meet a two-pronged “substantial value” threshold test.

Essentially, capital gains will be assessed on an indirect transfer of stock of IndiaSub if the value of assets indirectly transferred:

1. exceed 100 million Indian Rupees (INR) (approximately $1.3 million) and
2. represent at least 50% of the value of all the assets owned by the target company.

Therefore, if the USCO is purchased for $10 million, $5 million of which is attributable to IndiaSub, the transaction would be subject to capital gains tax in India, even though the direct transaction involved a US company and two non-India residents.

Furthermore, India has prescribed thorough valuation rules for determining the value of the assets and the associated capital gain, assuming the seller controls more than 5% of the target company.

Implications of the Indirect Transfer Tax

In a situation where the indirect transfer tax applies, the buyer is still responsible for withholding the capital gains tax and remitting it to the authorities in India. Additionally, the seller is required to file a tax return and a report (Form No. 3CT) that must be certified by a chartered accountant registered in India to confirm the capital gain has been computed correctly.

Perhaps the most significant pitfall of the indirect transfer tax for a US seller is the inability to take advantage of the US foreign tax credits for abating the US capital gains tax incurred. The capital gains tax levied on the indirect transfer would constitute a transfer tax, rather than an eligible income tax; as such, a USP would be unable to avoid double taxation.

Conclusion

The direct or indirect sale of shares of an Indian company held by a US person requires various tax considerations from both a US and Indian tax perspective, as well as the jurisdiction of a potential buyer. The tax laws that govern these transactions can be challenging, with many different variables and tax rates to consider, requiring the assistance of an experienced advisor knowledgeable in all the nuances of international taxation. Aprio’s Transaction Advisory team is equipped to help potential buyers and sellers navigate US and non-US tax implications in order to reach the most efficient results possible.

Related Resources/Assets/Aprio.com articles/pages

Case Study: Securing Tax Savings During a Multinational M&A Transaction

Important Considerations for the US-Chile Tax Treaty

Are you Leveraging Payroll Tax Savings During an M&A Deal?