The Beginning: An Exciting Opportunity
Rohit Agarwal, a successful entrepreneur in India, had been eyeing an exciting investment opportunity. He wanted to acquire 40% equity shares in Investee Company Pvt. Ltd., a tech-based startup incorporated in India. However, these shares were currently held by UK-based Shareholder Ltd., which had invested in InnovaTech three years ago.
Rohit was excited about the prospects, but as a seasoned businessman, he knew that cross-border transactions involving shares were not simple. He had to navigate through multiple legal, tax, and regulatory requirements, ensuring compliance with the Companies Act, RBI, FEMA, Income Tax Act, DTAA, and valuation norms.
Step 1: Understanding the Companies Act, 2013
Before making any commitments, Rohit needed to understand whether this transaction was even permissible. As per the Companies Act, 2013, private limited companies have restrictions on share transfers.
Checking the Articles of Association (AOA)
The first thing Rohit did was review the Articles of Association (AOA) of Investee Company Pvt. Ltd. to see if any restrictions were imposed on share transfers.
- Clause on Right of First Refusal (ROFR): The AOA stated that if any shareholder wanted to sell shares, they must first offer them to existing shareholders before selling them to an outsider.
- Board Approval Required: The transfer would be valid only after the approval of the Board of Directors.
Fortunately, the existing Indian shareholders had no objection to Rohit’s purchase, and the board was willing to approve the transaction.
Step 2: The FEMA and RBI Compliance Check
Since Rohit was purchasing shares from a foreign company (Shareholder Ltd., UK), he had to comply with Foreign Exchange Management Act (FEMA) rules and Reserve Bank of India (RBI) regulations.
1. FDI Policy and Sectoral Cap Verification
Rohit needed to check if InnovaTech operated in a sector with FDI restrictions.
- Since technology-based services fall under the automatic route, no prior government approval was needed.
- However, he had to ensure pricing guidelines and reporting compliance.
2. Pricing Guidelines – Ensuring Fair Valuation
The RBI mandates that the purchase price must not be lower than the Fair Market Value (FMV), determined through an internationally accepted valuation method.
- Rohit hired a SEBI-registered merchant banker to conduct a Discounted Cash Flow (DCF) valuation.
- The fair value was determined as ₹1,200 per share, and Rohit agreed to purchase them at this price.
3. FC-TRS Reporting Requirement
- Since this was a foreign entity selling shares to an Indian resident, an FC-TRS (Foreign Currency-Transfer of Shares) form had to be filed with the RBI through an Authorized Dealer (AD) Bank within 60 days of the transaction.
- Rohit’s banker advised him on the correct documentation required:
- Share Purchase Agreement (SPA)
- Valuation Report
- Form FC-TRS
- Board Resolution from Investee Company Pvt. Ltd.
Step 3: The Tax Implications – Income Tax Act & DTAA
As a meticulous investor, Rohit wanted to ensure that he and Shareholder Ltd. complied with all Income Tax laws.
1. Capital Gains Tax on the UK Seller
Since Shareholder Ltd. (UK) was making a capital gain on its sale of shares, it had tax obligations in India.
- Under Section 45 of the Income Tax Act, any capital gains arising from the transfer of shares of an Indian company is taxable in India.
- As these shares were held for more than 24 months, it was considered Long-Term Capital Gains (LTCG).
- Updated Tax Rate (as per Finance (No. 2) Act, 2024):
- The LTCG tax rate on unlisted shares has been reduced to 12.5%.
- Indexation benefits have been removed, meaning the tax is calculated on the actual capital gains (Sale Price – Purchase Price) without adjusting for inflation.
2. TDS Deduction Under Section 195
Before making the payment, Rohit was legally required to deduct TDS under Section 195.
- Standard TDS rate: 12.5% on the capital gains amount.
- DTAA Rate: If Shareholder Ltd. provides a Tax Residency Certificate (TRC), it can claim relief under the India-UK DTAA.
- Rohit ensured compliance by remitting the TDS to the Income Tax Department before making the payment.
Step 4: Execution of the Share Transfer Agreement
Now that the regulatory and tax matters were sorted, it was time to execute the transaction.
1. Signing of the Share Transfer Form (SH-4)
- Both parties signed Form SH-4 (Securities Transfer Form) as per the Companies Act, 2013.
- Stamp Duty Paid: Rohit paid 0.25% of the transaction value as stamp duty.
2. Payment through Banking Channels
- Rohit transferred the payment via SWIFT through his AD Bank, ensuring no cash transactions to remain FEMA-compliant.
3. Filing with ROC
Once the transaction was completed, Investee Company Pvt. Ltd. updated its Register of Members and reported the shareholding change in its MGT-7 filing.
Step 5: Post-Transaction Compliance and Reporting
With the deal finalized, there were a few compliance formalities left:
- Filing FC-TRS with RBI within 60 days ✅
- Updating Income Tax records to reflect TDS payment ✅
- Updating ROC annual filings ✅
- Filing Form FLA (Foreign Liabilities and Assets) in the next financial year ✅
Conclusion: A Smooth Cross-Border Investment
Through proper legal, tax, and regulatory planning, Rohit successfully acquired 40% shares in Investee Company Pvt. Ltd. from UK-based Shareholder Ltd..
This journey taught him several key lessons:
- Always check the company’s AOA before initiating a share transfer.
- Comply with FEMA’s pricing guidelines and reporting requirements.
- TDS under Section 195 is mandatory when purchasing shares from a foreign company.
- DTAA benefits can significantly reduce tax liabilities.
- Proper valuation ensures the transaction meets RBI norms.
This structured approach ensured that the cross-border share transfer was completed without any legal hurdles, paving the way for Rohit’s new venture into the world of tech startups.