Generally, transactions involving sale of shares by non-resident shareholders are subject to withholding tax at applicable rates under the Income-tax Act, 1961 (“IT Act”), provided the gains arising from such sales are taxable in India. However, there was no requirement to withhold/ deduct any tax on gains arising to resident sellers from sale of shares/ securities.
Recently, the IT Act has been amended to introduce section 194Q, which obligates certain buyers to withhold tax on purchase of ‘goods’ from resident sellers w.e.f. July 1, 2021. It provides that a buyer responsible for paying a sum to a resident seller for purchase of ‘goods’ exceeding INR 5 million in a financial year is required to withhold tax at 0.1% of such sum exceeding INR 5 million.
Since the introduction of this provision, there have been debates/ discussions on whether the provisions of section 194Q would be applicable to sale of shares by resident shareholders? In this blog, we propose to discuss certain issues surrounding the applicability of section 194Q to sale of securities/ shares by resident shareholders.
1. Whether ‘goods’ under section 194Q includes ‘shares and securities’?
The term ‘goods’ has not been defined under the IT Act. Having said that, the term ‘goods’ has been defined under the Sales of Goods Act, 1930, to include shares. However, ‘goods’ for the purposes of Goods and Service Tax, has been defined to exclude shares and securities.
The CBDT vide circular no. 13/2021, dated June 30, 2021 (“Circular”), has clarified that tax under section 194Q would not be required to be deducted in cases where securities and commodities are traded through recognised stock exchanges or cleared and settled by a recognised clearing corporation, including recognised stock exchanges or recognised clearing corporation located in the International Financial Service Centre.
Thus, as per the Circular, though tax would not be required to be deducted for on market sale of shares and securities, by implication, it would seem that all other transactions pertaining to off-market sale/ purchase of shares and securities, including shares of private and unlisted public companies, would be covered within the ambit of section 194Q.
Though, there is no clarity on whether the term ‘goods’ under section 194Q, includes securities or not, the Circular suggests that the tax department may require buyers to withhold tax on off market sale of shares and securities by resident sellers, subject to provisions of section 194Q.
2. Who is required to deduct tax under section 194Q?
As mentioned above, the obligation to deduct tax under section 194Q is on the buyer. The term “buyer”, for the purposes of section 194Q, has been defined to mean a person whose total sales, gross receipts or turnover from his/ her business exceeds INR 100 million during the financial year immediately preceding the financial year in which the purchase of goods is carried out. Thus, for the provisions of section 194Q to be applicable, the buyer should have gross receipts or turnover from business carried out by him/ her, exceeding INR 100 million, in the financial year preceding the year in which goods are purchased. The Circular has clarified that only the receipts from business activity (and not receipts from non-business activities) have to be included to determine the threshold limit. Further, since the buyer is required to have a prescribed amount of turnover in the financial year preceding the year of purchase, such provisions would not apply to buyers incorporated in the year of purchase.
3. Whether tax is required to be deducted by both resident and non-resident buyers
The definition of ‘buyer’ under section 194Q, does not specify whether the buyer should be a resident or a non-resident. However, the Circular has clarified that the provisions of section 194Q, would be applicable only to resident buyers, unless the purchase is connected with the permanent establishment of a non-resident buyer in India.
Accordingly, non-resident buyers would not be required to deduct tax under section 194Q, in case of purchase of shares and securities from a resident seller (unless the purchase relates to the permanent establishment). However, share sale between two resident taxpayers may be subject to tax deduction under section 194Q of the IT Act.
4. Whether tax is required to be deducted in case of a loss arising on sale of shares and/ or securities?
Unlike section 195 of the IT Act, which requires tax to be withheld on income chargeable to tax under the IT Act, section 194Q requires that the tax should be deducted from the sale consideration. Thus, in the absence of any specific exemption, the literal reading of the provision suggests that tax would be required to be deducted, irrespective of whether such sale of securities results in gain or loss.
The Circular has also clarified that section 194Q will not apply if the seller is a person who is exempt from tax under the IT Act or any other law (like RBI Act, etc.). However, such exemption would not extend to cases where only partial income of the seller is exempt.
5. Whether tax would be required to be collected at source if tax is deducted under section 194Q?
Section 206C(1H) was introduced in the IT Act last year, which requires a seller of goods to collect 0.1% of the sale consideration from the buyer where (a) the consideration received by the seller is more than INR 5 million in a financial year from each buyer; and (b) the seller’s turnover from his/ her business in the financial year preceding the year in which the transactions take place exceeds INR 10 crore. Thus, under the said provisions, sellers are obligated to collect tax from buyers on sale of goods.
However, the IT Act provides that no tax would be required to be collected under the said provisions if tax has been deducted under the IT Act. Thus, if both section 194Q and 206C(1H) are applicable, then section 194Q will supersede and no tax would be required to be collected under section 206C(1H), even if all the conditions therein are satisfied. However, if the provisions of section 194Q do not apply to a particular transaction involving the sale of shares or securities, then section 206C(1H) may apply. Thus, it would be pertinent to analyse its applicability to the said transaction.
The Circular also provides that if, for any reason, tax has been collected by the seller under section 206C(1H) of the IT Act, before the buyer could deduct tax under section 194Q on the same transaction, then such transaction would not be subject to tax deduction again by the buyer. CBDT has provided this concession to remove difficulty, since tax rate of deduction and collection are the same in the aforementioned sections.
In light of the above discussion, it may be advisable to analyse the applicability of provisions of section 194Q (and/or 206C(1H), to the sale of shares and securities by resident shareholders. The application of such provisions will not only have a bearing on the tax cost/ cash flow, but also the way share purchase agreements may be drafted, as appropriate clauses, such as tax indemnity clauses, tax representations, etc., may be required to be incorporated in the share purchase agreements, which were not required to be included earlier.