Introduction
Every foreign investment into India carries both an opportunity and a compliance responsibility. When a non-resident invests in an Indian company, three parallel frameworks immediately come into play — FEMA (for regulatory filings and inflow permissions), Income Tax Act, 1961 (for taxation on returns or exits), and the Double Taxation Avoidance Agreement (DTAA) between India and the investor’s country.
Ignoring any one of these can derail a clean transaction — from rejection of the FC-GPR filing to double taxation of the same income. This article explains, in simple and practical terms, how FDI is taxed and regulated under Indian law and how businesses can structure their investments to remain compliant and tax-efficient.
What is Foreign Direct Investment (FDI) under Indian law?
Foreign Direct Investment (FDI) in India means any investment by a person resident outside India in the equity or convertible instruments of an Indian company, made under the Foreign Exchange Management Act (FEMA) and reported through RBI filings like FC-GPR or FC-TRS.
Understanding FDI in the Indian context
Under FEMA, 1999, all cross-border capital transactions are regulated. Any non-resident can invest in India either through the Automatic Route (where no prior approval is needed) or the Government Route (where prior approval from the relevant ministry or DPIIT is required).
Once the funds are received, the Indian company must:
- Issue shares or convertible instruments within 60 days,
- Obtain valuation as per prescribed norms, and
- File Form FC-GPR with the Reserve Bank of India through the FIRMS portal within 30 days of share allotment.
These timelines and filings are not mere formalities — they determine whether the investment remains legally valid under FEMA.
For context, see related post:
👉 FEMA & FDI Compliance in India: Key Filings and Approvals Every Company Must Know
How is FDI taxed under the Income Tax Act, 1961?
Tax on foreign investment in India depends on the type of income — dividends, capital gains, or interest. While dividends and gains are taxable in India, rates may vary based on the investor’s country of residence and applicable treaty benefits.
1. Dividend Taxation
When an Indian company declares dividends to a foreign shareholder, the dividend is taxable in India. The company must deduct tax at source (TDS) before remittance. The base rate for dividends paid to non-residents is 20%, but this can reduce under a DTAA.
The earlier Dividend Distribution Tax (DDT) has been abolished. Hence, the liability now falls directly on the investor, not the Indian company.
2. Capital Gains on Exit
When a foreign investor sells shares of an Indian company, the gain is taxed in India because the underlying asset (the company) is Indian. The applicable tax rate depends on:
- Nature of shares (listed/unlisted),
- Holding period (short-term or long-term), and
- Treaty benefits, if the investor is resident in a DTAA country.
Long-term capital gains on unlisted shares held for more than 24 months are generally taxed at 10%, while short-term gains may attract up to 40% for foreign companies.
3. Interest and Other Income
If the foreign investor provides a loan, royalty, or technical service to the Indian entity, the payment will attract withholding tax under sections like 115A or 195.
For example, interest on foreign currency loans to Indian companies is typically taxable at 20%, unless the DTAA specifies a lower rate.
How does the DTAA protect foreign investors from double taxation?
A Double Taxation Avoidance Agreement (DTAA) ensures that income earned by a foreign investor in India is not taxed twice — once in India and again in the investor’s home country. It does this by allocating taxing rights and allowing tax credits or exemptions.
Role of DTAAs in FDI transactions
India has signed DTAAs with more than 90 countries. For FDI, these treaties help in:
- Lowering withholding tax on dividends, interest, and royalties,
- Avoiding dual taxation through credit or exemption methods, and
- Providing clarity on whether capital gains will be taxed in India or the home country.
For example, under certain DTAAs (like India–Singapore or India–Mauritius, subject to conditions), capital gains on sale of Indian shares may be taxable only in the investor’s home country — saving significant tax at exit.
However, to claim treaty benefits, the investor must provide:
- A valid Tax Residency Certificate (TRC), and
- Proof of beneficial ownership of the income.
This ensures that only genuine foreign investors — not conduit entities — enjoy treaty protection.
You can also refer to your related post:
👉 Repatriation of Profits and Dividends by Foreign Shareholders in India
How does FEMA regulate repatriation and reporting of FDI?
FEMA regulates how foreign investment money comes into India and how profits or capital can be repatriated out. It mandates valuation norms, RBI filings (like FC-GPR/FC-TRS), and prior approvals where applicable.
Key Regulatory Points
- Investment inflow: Must be through proper banking channels in foreign currency.
- Reporting: FC-GPR (for fresh issue) and FC-TRS (for share transfer) must be filed within prescribed timelines.
- Valuation: Must follow RBI-approved methods (like DCF or NAV).
- Repatriation: Dividends and sale proceeds can be freely repatriated after payment of applicable taxes and submission of necessary certificates (Form 15CA/CB).
- Annual Filing: Companies with foreign shareholding must file the FLA Return every year by July 15.
Any delay or omission can attract compounding proceedings under FEMA, and can also raise red flags during future FDI audits or due diligence.
Common Mistakes in FDI Structuring (and How to Avoid Them)
Typical mistakes include delayed RBI filings, incorrect valuation, assuming DTAA relief without documentation, or misclassifying equity as debt. These errors can lead to tax disputes and FEMA violations.
Key Lessons from Practice
- Delay in FC-GPR filing is the most frequent cause of penalty under FEMA.
- Incorrect classification of instruments (for example, treating optionally convertible preference shares as FDI) can change tax outcomes.
- Ignoring beneficial ownership can nullify DTAA benefits.
- Repatriation without Form 15CB can be flagged as FEMA non-compliance.
- Treaty shopping structures often trigger GAAR scrutiny.
Each of these can be avoided with proper pre-investment legal vetting and post-investment compliance tracking.
Illustration: UAE Investor in an Indian Private Limited Company
Let’s take a real-world example.
A UAE-based NRI invests ₹8 crore into an Indian private limited company under the Automatic Route. The company issues shares, values them per FEMA norms, and files Form FC-GPR.
Later, when the company distributes dividends, it deducts TDS at 10% as per the India–UAE DTAA (instead of 20% under domestic law).
If the investor sells shares after 36 months, long-term capital gains apply at 10%, but since the India–UAE treaty exempts such gains, India forgoes tax. The UAE investor then remits proceeds through a banking channel with a chartered accountant’s certificate under FEMA.
This illustrates how a clean, compliant structure can achieve both regulatory clarity and tax efficiency.
Strategic Takeaways for Investors and Companies
- Align legal route, tax structure, and regulatory filings from Day 1.
- Obtain valuation reports and maintain supporting documentation for every foreign inflow.
- Ensure FC-GPR and FLA filings are submitted on time.
- Secure TRC and beneficial ownership declarations to avail DTAA benefits.
- Engage both company secretary and tax advisor jointly — FEMA and Income Tax operate in parallel, not sequence.
Related Articles
- FEMA & FDI Compliance in India: Key Filings and Approvals
- Post-Incorporation Compliance Checklist for Indian Companies
- Repatriation of Profits and Dividends by Foreign Investors in India
Conclusion
FDI taxation in India is not just about rates — it’s about the alignment of law, timing, and documentation. FEMA governs the entry and exit, the Income-tax Act governs the levy, and DTAAs decide where tax should ultimately reside.
A carefully structured FDI transaction not only saves tax but also ensures smooth future exits, dividend repatriation, and regulatory confidence — all vital for long-term investor trust.
FAQs: Taxation of Foreign Investment (FDI) in India
1. How is foreign investment (FDI) taxed in India?
Foreign investment in India is taxed under the Income Tax Act, 1961, depending on the nature of income — dividends, capital gains, or interest. Dividends and gains arising from Indian shares are taxable in India, but investors may claim relief under a Double Taxation Avoidance Agreement (DTAA) if applicable.
2. Is FDI subject to both FEMA and Income Tax laws in India?
Yes. FEMA regulates how the investment enters and exits India, ensuring that valuation, sectoral caps, and RBI filings (like FC-GPR/FC-TRS) are properly followed. The Income Tax Act governs how the investment is taxed, including withholding tax, capital gains, and repatriation. Both frameworks apply simultaneously and must be complied with together.
3. What is the tax on dividends paid to foreign shareholders?
Dividends paid by Indian companies to non-resident shareholders are taxable in India at 20% (plus surcharge and cess)under domestic law. However, under many DTAAs, the rate can be reduced to 5–15%. To claim the lower rate, the foreign investor must furnish a Tax Residency Certificate (TRC) and proof of beneficial ownership.
4. How is capital gains tax calculated when a foreign investor sells shares of an Indian company?
When a foreign investor sells shares in an Indian company, capital gains tax applies in India.
- Long-term capital gains (LTCG): If held for more than 24 months, taxed at 10% (for unlisted shares).
- Short-term capital gains (STCG): If held for less than 24 months, taxed at 40% for foreign companies.
However, DTAA provisions may override these rates if the treaty grants exemption or lower taxation.
5. Does India’s DTAA with other countries eliminate double taxation completely?
Not always, but it ensures relief. A DTAA either allows the home country to give tax credit for tax paid in India, or allocates taxing rights so only one country can tax a particular income. The exact benefit depends on the specific treaty — for instance, India–Singapore and India–UAE DTAAs offer capital gains exemptions under certain conditions.
6. What are the mandatory filings under FEMA for FDI transactions?
The key FEMA filings include:
- Form FC-GPR: When new shares are issued to a non-resident.
- Form FC-TRS: When existing shares are transferred between a resident and non-resident.
- FLA Return: Annual reporting of foreign liabilities and assets.
Failure to file within prescribed timelines can attract penalties and compounding proceedings under FEMA.
7. Can a foreign investor repatriate profits and capital freely from India?
Yes, repatriation is freely permitted under FEMA once applicable taxes are paid. Dividends, sale proceeds, or liquidation amounts can be remitted through an Authorised Dealer (AD) bank, supported by Form 15CA/CB from a chartered accountant. The company must also ensure that no regulatory or tax liabilities are pending at the time of remittance.
8. What are the most common mistakes companies make in FDI compliance?
Common mistakes include:
- Delayed FC-GPR or FLA filings;
- Incorrect share valuation or route selection;
- Ignoring TRC/beneficial ownership requirements for DTAA claims;
- Repatriation without proper CA certification;
- Using hybrid instruments that confuse debt vs equity classification.
Each of these can invite penalties or lead to denial of treaty benefits.
9. Does an NRI investment in an Indian private company count as FDI?
Yes. Any investment made by a non-resident individual or entity (including NRIs and OCIs) in an Indian company’s shares or convertible instruments qualifies as FDI. The only distinction is that NRI investments under Schedule 4 of FEMA may have additional relaxations, such as sectoral caps and repatriation benefits.
10. What professional help is needed for FDI transactions in India?
Both legal and tax expertise are essential. A Company Secretary or FEMA specialist ensures regulatory compliance — FC-GPR/FC-TRS filings, route evaluation, valuation certification — while a tax advisor structures withholding, capital gains, and DTAA planning. Engaging both from the start ensures clean, audit-proof, and tax-efficient transactions.
11. Can an investor regularize missed FEMA filings or delays?
Yes. Delays in filings like FC-GPR or FC-TRS can be compounded under FEMA. The company must approach the RBI or the regional office with a compounding application and penalty payment. Timely rectification helps restore compliance and maintain a clean regulatory record for future FDI inflows or exits.
12. How can foreign investors ensure tax efficiency while remaining compliant?
The best approach is to align legal structuring with tax planning from day one. Choose the correct investment route (Automatic vs Government), evaluate DTAA benefits, maintain documentation (TRC, valuation, board resolutions), and ensure all RBI filings are timely. Tax efficiency follows naturally when compliance is proactive, not reactive.
13. Are gains from sale of Indian shares by a foreign investor always taxable in India?
Not necessarily. Under domestic law, such gains are taxable in India, but specific DTAAs (like India–Singapore or India–Mauritius, subject to limitation of benefits clauses) allocate taxing rights to the investor’s home country. Therefore, depending on the treaty and documentation, such gains may be exempt from Indian tax.
14. What are the implications of non-compliance under FEMA for FDI?
Non-compliance — such as late FC-GPR filing, incorrect valuation, or non-reporting — is treated as a contravention under FEMA and can attract monetary penalties up to three times the amount involved. RBI allows voluntary compounding, but persistent default can affect future funding rounds, due diligence, and investor confidence.
15. How can Eclectic Legal assist in FDI and FEMA compliance?
Eclectic Legal advises both Indian companies and foreign investors on end-to-end FDI transactions — from structuring and valuation to FEMA filings, DTAA analysis, and repatriation planning. The firm ensures transactions are tax-efficient, RBI-compliant, and defensible during audits or due diligence. For consultation, reach out at prashant@eclecticlegal.com or +91-9821008011.
About the Author
Prashant Kumar is a Company Secretary, Published Author, and Partner at Eclectic Legal, a full-service Indian law firm advising on foreign investment (FDI), FEMA compliance, and cross-border corporate structuring. He regularly assists Indian companies and overseas investors in designing compliant, tax-efficient inbound and outbound investment strategies — including FC-GPR/FC-TRS filings, ODI transactions, and RBI liaison office setups.He can be reached for consultations on FEMA, FDI, and cross-border regulatory matters at prashant@eclecticlegal.com or +91-9821008011.
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