Indirect Transfer Taxation Rules 2026: When Foreign Share Sales Are Taxed in India

A company in Singapore sells shares of a holding company in Mauritius. The Mauritius company owns 100% of an Indian subsidiary worth Rs 500 crore. No asset in India was directly transferred - yet India claims the right to tax the capital gains. This is indirect transfer taxation, and it has been one of the most contentious areas of Indian tax law since the landmark Vodafone case.

This guide explains when foreign share sales trigger Indian tax liability under Section 9(1)(i), how the two-threshold test works, who qualifies for the small shareholder exemption, how gains are attributed to Indian assets, what the Draft IT Rules 2026 change, and how DTAA treaties interact with these provisions.

What Is Indirect Transfer Taxation and Why Does It Matter?

Indirect transfer taxation under Section 9(1)(i) of the Income Tax Act, 1961, read with Explanation 5, deems shares or interests in a foreign company or entity to be situated in India if they derive, directly or indirectly, their value substantially from assets located in India. This means that even though the shares being sold belong to a company incorporated outside India, the capital gains are deemed to accrue in India and are taxable here.

This provision was introduced by the Finance Act, 2012 after the Supreme Court’s ruling in Vodafone International Holdings BV v. Union of India (2012), which held that India could not tax such offshore transactions under the then-existing law. For anyone involved in cross-border transactions, understanding these provisions is critical. For domestic capital gains computation, refer to our ITR filing for capital gains guide.

The provision applies to all non-residents - individuals, companies, funds, and trusts - who transfer shares or interests in foreign entities that substantially derive value from Indian assets. The tax is not on the entire gain but only on the portion attributable to Indian assets, computed using the Rule 11UC attribution formula.

Key Terms You Should Know

• Indirect Transfer: Transfer of shares or interests in a foreign company/entity where the value of those shares is substantially derived from assets located in India. Taxable under Section 9(1)(i) read with Explanation 5.
• Substantial Value Test (Explanation 6): The share or interest is deemed to derive substantial value from Indian assets if, on the specified date, the FMV of Indian assets exceeds Rs 10 crore AND represents at least 50% of the FMV of all assets owned by the foreign entity. Both conditions must be met.
• Small Shareholder Exemption (Explanation 7): Indirect transfer provisions do not apply if the non-resident transferor holds less than 5% of the total voting power/share capital/interest and has not participated in management or control of the entity at any time in the 12 months preceding the transfer date.
• Specified Date (Explanation 6(d)): The date used for applying the substantial value test: either (i) the end of the last accounting period preceding the transfer date, or (ii) the transfer date itself if book value of assets on that date exceeds the last accounting period’s book value by 15% or more.
• Attribution Formula (Rule 11UC): The formula to determine the proportion of capital gains taxable in India: Income attributable to India = Total Gain × (FMV of Indian assets ÷ FMV of total assets of the foreign entity).
• Section 285A: A reporting obligation on Indian companies (whose shares are substantially held by foreign entities) to furnish information about the foreign entity, its shareholding pattern, and the indirect transfer to the Income Tax Department.
• Taxation Laws (Amendment) Act, 2021: Withdrew the retrospective application of indirect transfer provisions for transactions before 28 May 2012 (the date the Finance Bill 2012 received Presidential assent). Part of the resolution of the Vodafone and Cairn tax disputes.

Who Is Subject to Indirect Transfer Tax in India?

Indirect transfer provisions apply broadly to any non-resident transferring shares or interests in a foreign entity that meets the substantial value test. The following entities and scenarios are most commonly affected:

• Non-resident companies selling shares in foreign holding companies that own Indian subsidiaries (e.g., Vodafone-type multi-tier structures)
• Private equity and venture capital funds exiting Indian portfolio investments through offshore holding vehicles
• Foreign funds registered as FPIs - Category I FPIs are exempt, but investors in other FPI categories may be covered
• Non-resident individuals selling interests in foreign partnerships, trusts, or LLPs that hold Indian assets
• Multinational groups undertaking cross-border mergers, demergers, or internal restructurings involving intermediate holding companies with Indian subsidiaries
• Foreign startup founders selling shares in a foreign parent company that wholly owns an Indian operating company

Cross-border investors with Indian exposure should ensure FDI compliance services are in place before structuring any exit or reorganisation.

Legal Framework: Explanations 5, 6 and 7 to Section 9(1)(i)

The indirect transfer framework operates through a series of Explanations added to Section 9(1)(i). The following table maps each provision. For the broader capital gains framework, see our capital gains rules for FY 2026-27 guide.

How to Determine If a Foreign Share Sale Is Taxed in India: Step-by-Step

1. Step 1: Identify if the transaction involves shares/interests in a foreign entity. The provision applies only to transfers of shares or interests in companies or entities registered/incorporated outside India. Direct sale of Indian company shares by a non-resident is taxed under regular capital gains provisions, not indirect transfer.
2. Step 2: Apply the Substantial Value Test (Explanation 6). On the specified date, determine: (a) Does the FMV of assets located in India (held directly or indirectly by the foreign entity) exceed Rs 10 crore? (b) Does the FMV of Indian assets represent at least 50% of the FMV of all assets owned by the foreign entity? Both conditions must be satisfied. If either fails, indirect transfer provisions do not apply.
3. Step 3: Check the Small Shareholder Exemption (Explanation 7). Even if the substantial value test is met, the provision does not apply if the non-resident transferor (individually or with associated enterprises) holds less than 5% voting power/share capital/interest AND has not participated in management or control at any time in the 12 months preceding transfer.
4. Step 4: Check FPI exemption. Category I FPIs under SEBI (FPI) Regulations, 2019 are explicitly exempted from indirect transfer provisions. Investments held through Category I FPIs are not deemed situated in India even if the FMV thresholds are met.
5. Step 5: Compute attributable income using Rule 11UC. If the indirect transfer is taxable, apply: Taxable Income = Total Gain × (FMV of Indian assets ÷ FMV of total assets). FMV of unlisted Indian company shares is determined under Rule 11UB. For FMV methodology, see our Rule 11UA valuation of unlisted shares guide.
6. Step 6: Check DTAA treaty protection. Most Indian DTAAs provide that gains from alienation of shares (other than shares in an Indian company deriving value from immovable property) are taxable only in the state of residence of the alienator. If a favourable DTAA applies, the treaty may override the domestic law indirect transfer provisions. However, the India-US DTAA (Article 13) allows each state to tax as per domestic law.
7. Step 7: Comply with TDS and reporting obligations. Under Section 195, the buyer must deduct TDS on payments to non-residents. Under Section 285A, the Indian company must report the indirect transfer. Non-compliance attracts penalties under Section 271FA.

Documents and Records Needed for Indirect Transfer Compliance

• Shareholding pattern of the foreign entity (showing direct and indirect ownership of Indian assets)
• Audited financial statements of the foreign entity showing total assets and Indian asset breakdown
• FMV computation of Indian assets (shares of Indian subsidiary valued per Rule 11UB by SEBI Category I merchant banker or accountant)
• FMV computation of total assets of the foreign entity (including global assets)
• Share purchase/sale agreement for the offshore transaction
• Certification of the specified date used for applying the substantial value test (Explanation 6(d))
• Declaration by the non-resident transferor regarding shareholding percentage and management/control status (for small shareholder exemption under Explanation 7)
• DTAA residency certificate (Tax Residency Certificate / Form 10F) if claiming treaty benefit
• Section 285A report filed by the Indian company
• TDS challan and certificate (Form 16A) for tax deducted under Section 195
• Attribution computation workings under Rule 11UC
• Board resolution of the foreign entity authorising the share transfer

Indirect Transfer Thresholds and Exemptions: Quick Reference

The following table summarises when indirect transfer provisions apply and when they don’t:

Note: The substantial value test must be applied on the specified date. If the foreign entity’s asset composition changes significantly between the last accounting period end and the transfer date (book value increases by 15%+), the transfer date itself becomes the specified date. This prevents manipulation of the test date.

Common Mistakes to Avoid in Indirect Transfer Transactions

Mistake 1: Ignoring multi-tier structures. Indirect transfer provisions apply at every level of a holding structure. If Company A (Singapore) owns Company B (Mauritius) which owns Company C (India), selling shares of Company A can trigger Indian indirect transfer tax if Company A’s value substantially derives from Company C. Taxpayers often analyse only the immediate foreign parent, not the ultimate holding entity. Consult income tax return filing services for complex multi-tier structures.

Mistake 2: Assuming DTAA automatically protects against indirect transfer tax. While most Indian DTAAs allocate share-sale taxing rights to the residence state, some treaties (notably India-US) allow both states to tax. Additionally, India’s domestic law deems the shares to be situated in India, which may trigger the immovable property exception in some DTAAs (where shares deriving value from immovable property can be taxed by the source state). Treaty analysis must be done case by case.

Mistake 3: Forgetting the Section 285A reporting obligation. The Indian company whose shares are substantially held by the foreign entity must report the indirect transfer to the Income Tax Department. Non-compliance attracts a penalty of Rs 500 per day of default under Section 271FA. Many Indian subsidiaries are unaware of this obligation until an assessment notice arrives.

Mistake 4: Relying on the 2021 retrospective withdrawal for post-2012 transactions. The Taxation Laws (Amendment) Act, 2021 withdrew retrospective application only for transactions before 28 May 2012. For all transactions from 28 May 2012 onwards, the indirect transfer provisions apply fully. Some taxpayers mistakenly believe the 2021 amendment provided blanket relief.

Mistake 5: Not obtaining a SEBI Category I merchant banker valuation for Indian assets. Rule 11UB requires that the FMV of unlisted Indian company shares (for the substantial value test and attribution) be determined by a SEBI Category I merchant banker or accountant using internationally accepted valuation methods. Using an internal or non-compliant valuation exposes the transaction to reassessment.

Penalties for Non-Compliance with Indirect Transfer Provisions

Non-compliance with indirect transfer taxation can trigger penalties from multiple angles.

Under Section 271(1)(c), if the non-resident transferor fails to disclose the indirect transfer income or furnishes inaccurate particulars, a penalty of 100% to 300% of the tax sought to be evaded may be levied. Given the large transaction values involved (typically Rs 10 crore+), penalties can run into crores.

Under Section 271FA, if the Indian company fails to file the Section 285A report, a penalty of Rs 500 per day of default is levied. For a two-year delay, this amounts to Rs 3.65 lakh - a modest but avoidable cost.

Under Section 201(1)/(1A), if the buyer fails to deduct TDS under Section 195 on the payment to the non-resident transferor, the buyer is deemed to be an assessee-in-default. The buyer becomes liable to pay the TDS amount plus interest at 1% per month from the date of deductibility to the date of actual payment.

Additionally, failure to comply with indirect transfer provisions may trigger prosecution proceedings under Section 276B (failure to deduct/pay TDS) for amounts exceeding Rs 25 lakh, with imprisonment up to 7 years.

How Indirect Transfer Provisions Connect with Other Tax Laws

Indirect transfer taxation under Section 9(1)(i) interacts with multiple provisions of the Income Tax Act and international treaty law. The deeming fiction in Explanation 5 expands the definition of “capital asset situate in India” to include foreign shares deriving value from Indian assets. Section 48 then prescribes the computation of capital gains, with Rule 11UC providing the attribution formula. Section 195 requires TDS on payments to non-residents, and Section 285A imposes reporting on the Indian subsidiary.

The exemptions under Section 47(viab) and 47(vicc) for amalgamations and demergers operate as carve-outs from the indirect transfer provisions, subject to stringent conditions (25%/75% shareholder continuity and no capital gains tax in the country of incorporation). These exemptions do not extend to the shareholders of the amalgamating/demerging foreign company - only the company-level transfer is exempt.

The Income Tax Act, 2025 (effective 1 April 2026) retains the indirect transfer framework with restructured section numbers. Draft IT Rules 2026 (Rules 11 and 12) introduce formula-based FMV computation and attribution mechanisms, replacing the earlier principles-based approach. The core two-threshold test and small shareholder exemption remain unchanged. Tax professionals should closely monitor the final notification of these rules.

Direct Transfer vs Indirect Transfer: Key Differences

Key Takeaways

Under Section 9(1)(i) read with Explanation 5, shares of a foreign company are deemed to be situated in India if they derive their value substantially from Indian assets - meaning gains from transferring such shares are taxable in India even though the transfer occurs entirely offshore.

The substantial value test requires both conditions to be met simultaneously: FMV of Indian assets exceeding Rs 10 crore AND representing at least 50% of the foreign entity’s total assets. If either threshold is not met, the indirect transfer provisions do not apply.

The small shareholder exemption under Explanation 7 carves out non-residents holding less than 5% with no management or control rights, and Category I FPIs are explicitly exempt - these are the two most common safe harbours.

The Taxation Laws (Amendment) Act, 2021 withdrew retrospective application of indirect transfer provisions for transactions before 28 May 2012, resolving the Vodafone and Cairn disputes. For all transactions from 28 May 2012 onwards, the provisions apply prospectively.

Only the income attributable to Indian assets is taxable under Rule 11UC, not the entire capital gain. DTAA treaty protection may further reduce or eliminate the Indian tax liability, but treaty analysis must be done on a case-by-case basis, especially for DTAAs with immovable property exceptions.

Need Help with Indirect Transfer Taxation?

Indirect transfer transactions involve complex multi-jurisdictional analysis - from the substantial value test and FMV computation to the attribution formula, DTAA treaty benefits, and Section 285A reporting. A single misstep in the threshold test or attribution calculation can result in crores of unexpected tax liability, penalties, and even prosecution.

Explore our tax planning services for expert indirect transfer analysis, FMV computation, DTAA treaty structuring, and compliant ITR filing for cross-border transactions.

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