When a foreign company invests in India, they have to chose, which instrument should be used to invest. It could be either shares (Equity, Preference, Convertible or Non convertible), Debentures or Loans. Equity Shares, are the most commonly used instrument , by various foreign companies to invest into an Indian Company, or in case of acquisition of controlling stakes in existing companies.
FDI Guidelines on issue of Equity shares : –
Under the existing FDI guidelines, the price at which fresh shares are issued by the Indian Company to a non resident, should not be less than the price determined as per any internationally accepted pricing methodology for valuation of shares . Generally, discounted cash flow method is the most commonly used method for arriving at the fair value of shares.
However, in case of issue of equity shares on rights basis , the above pricing guidelines are not applicable, but the law provides that the price at which the shares are issued to the non resident, should not be less than the price at which the same shares are issued to the resident.
Tax implications associated with equity shares : –
- Tax Deduction of Dividend in computing taxable income – Dividend paid by the Indian Company is not allowed as a tax deduction in computing taxable income of the Indian company. On the contrary, such dividend is liable to Dividend Distribution Tax (“DDT”) at an effective tax rate of 20.36 percent of the amount of dividend.
- Taxation of dividend income in the hands of the non-resident investor in India : – Dividend income , on which the Indian company has paid Dividend Distribution Tax, is not taxable in the hands of the non-resident investor in India. However such dividend may be taxable in the country of residence of the non-resident investor, depending on the local tax laws of those countries. In many cases, it has been observed that where such dividend is taxable in country of residence, the credit for DDT paid by Indian entity may or may not be available.
- Cost of acquisition of equity shares acquired on Conversion of CCD /Preference Shares – Where equity shares were acquired by the non resident, on conversion of CCD /Preference Shares, the cost of acquisition of such shares for the purpose of calculating capital gains, shall be considered as the proportionate cost of respective CCD /Preference Shares.
- Tax on Conversion of CCD into equity shares : – Conversion of compulsorily convertible debentures into equity shares is not liable to tax in India , under the Indian domestic tax law provision.
- Tax on Sale of Equity Shares
Transfer of Equity Shares, is liable to Capital Gains tax in India. There is a special mechanism for taxation of shares of an Indian company, which are subscribed to in foreign currency by non- resident, whereby the effect of foreign currency fluctuation on capital gains is eliminated, but no benefit is provided in respect of indexation of cost of acquisition of such shares.
Given that the provisions relating to capital gain in various Tax Treaty may be different for transfer of shares and debentures, one should evaluate whether any additional benefit in terms of capital gains would be available post conversion of debentures into shares, and act accordingly.
- Gift of shares/ Transfer between two foreign companies under Corporate reorganization
Where shares of an Indian company are transferred by way of gift under a Corporate reorganization of the MNC group, or transferred at less than fair value (specified under the IT Act), it may trigger tax implications under the Indian domestic law in certain specified circumstances in the hands of the recipient. Further, any transfer of shares under a merger of one foreign company into another/demerger of an undertaking of one foreign company into another, may be tax neutral, provided certain specified conditions are satisfied.
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