Capital Gains Tax Between India and Israel Under DTAA

Capital Gains Tax Rate Between India and Israel

The India-Israel Double Taxation Avoidance Agreement (DTAA), signed on 29 January 1996 and substantially amended by the 2015 Protocol (effective 1 January 2017), contains specific provisions governing the taxation of capital gains under Article 14. Unlike dividends, interest, royalties, and fees for technical services -- which attract a uniform 10% withholding rate -- capital gains under the India-Israel DTAA are taxed based on the nature of the underlying asset rather than a single flat rate.

The 2015 Protocol introduced the most significant change to the capital gains provisions by expanding India's right to tax gains from shares that derive their value from Indian immovable property. This amendment aligned the treaty with the OECD's BEPS recommendations and India's broader treaty policy of ensuring source-country taxation on property-rich entities.

For Israeli investors holding shares in Indian companies, the capital gains treatment depends on three critical factors: (1) whether the shares derive more than 50% of their value from Indian immovable property, (2) whether the gains relate to movable property connected with a Permanent Establishment in India, and (3) whether the transaction falls under the residual clause that allocates taxing rights exclusively to the country of residence.

Treaty Rate vs Domestic Rate: Detailed Comparison

India's domestic tax rates on capital gains depend on the type of asset and the holding period. The interaction with the treaty creates different outcomes depending on the category of capital gains:

The most significant benefit for Israeli investors lies in Article 14(5) -- the residual clause. For shares that do not derive more than 50% of their value from Indian immovable property (which covers the vast majority of listed Indian shares), capital gains are taxable only in Israel. This means an Israeli resident selling shares in Infosys, TCS, or Reliance Industries would pay zero Indian capital gains tax, provided the shares are not connected with a PE in India.

Under India's domestic law (post the Finance Act 2024 amendments), long-term capital gains on listed securities exceeding INR 1.25 lakh are taxed at 12.5% without indexation, and short-term capital gains on listed shares are taxed at 20%. The treaty exemption therefore provides a saving of 12.5-20% depending on the holding period.

Who Qualifies for the Reduced Rate

The capital gains provisions under the India-Israel DTAA apply differently depending on the nature of the asset. The key eligibility criteria for the most beneficial treatment (exemption from Indian tax under Article 14(5)) are:

Tax Residency in Israel

The alienator must be a tax resident of Israel as determined under Article 4 of the treaty. A valid Tax Residency Certificate (TRC) from the Israeli Tax Authority (Rashut HaMisim) is mandatory. Israeli residency is determined based on the centre-of-life test, considering factors such as permanent home, family ties, economic connections, and habitual abode.

No PE Connection

The shares being sold must not form part of the business property of a Permanent Establishment that the Israeli enterprise has in India. If the shares are effectively connected with a PE, the gains are taxable in India under Article 14(2) as PE-related property.

Immovable Property Value Test (Post-2015 Protocol)

The shares must not derive more than 50% of their value, directly or indirectly, from immovable property situated in India. This test is applied at the time of alienation or at any time during the 12 months preceding the alienation. The 2015 Protocol specifically extended this provision to interests in partnerships, trusts, and other entities, closing a structuring loophole that previously existed.

Beneficial Ownership and Anti-Avoidance

Following the MLI's Principal Purpose Test (PPT), treaty benefits on capital gains can be denied if one of the principal purposes of an arrangement or transaction was to obtain the exemption. India's GAAR provisions under Chapter X-A of the Income Tax Act provide an additional layer of anti-avoidance scrutiny, particularly for arrangements involving interposed entities.

Capital Gains-Specific Treaty Provisions

Article 14 of the India-Israel DTAA (as amended by the 2015 Protocol) allocates taxing rights on capital gains through a layered structure:

Article 14(1): Immovable Property

Gains from the alienation of immovable property situated in India may be taxed in India. "Immovable property" has the meaning defined under Article 6 and includes property accessory to immovable property, rights to which the provisions of general law respecting landed property apply, and usufruct of immovable property.

Article 14(2): PE-Related Movable Property

Gains from the alienation of movable property forming part of the business property of a PE that an Israeli enterprise has in India may be taxed in India. This includes gains from the alienation of the PE itself (alone or with the whole enterprise). Similarly, gains from movable property pertaining to a fixed base available for independent personal services may be taxed in India.

Article 14(3): Ships and Aircraft

Gains from the alienation of ships or aircraft operated in international traffic, or movable property pertaining to the operation of such ships or aircraft, are taxable only in the Contracting State of which the enterprise is a resident. This gives exclusive taxing rights to Israel for Israeli shipping and aviation companies.

Article 14(4): Shares Deriving Value from Immovable Property (2015 Protocol Amendment)

This is the most significant post-amendment provision. Gains from the alienation of shares (or comparable interests such as partnership or trust interests) deriving more than 50% of their value directly or indirectly from immovable property situated in India may be taxed in India. The value test is applied at the time of alienation or at any time during the preceding 12 months.

This provision was inserted by the 2015 Protocol to prevent indirect transfers of Indian real estate through share transactions. It is modelled on Action 6 of the OECD BEPS project and is consistent with Article 9 of the MLI. Before this amendment, the original 1996 treaty required the company's property to "consist wholly or principally" of immovable property -- the 2015 Protocol replaced this with a clearer 50% threshold.

Article 14(5): Residual Clause -- Other Property

Gains from the alienation of any property other than that referred to in paragraphs (1) through (4) are taxable only in the Contracting State of which the alienator is a resident. This is the provision that exempts Israeli residents from Indian capital gains tax on most share transactions, including listed and unlisted shares in Indian companies (provided they do not derive more than 50% of their value from Indian immovable property).

Documentation Required

Israeli investors claiming capital gains exemption or reduced taxation under the India-Israel DTAA must provide comprehensive documentation:

Tax Residency Certificate (TRC)

A valid TRC from the Israeli Tax Authority (Rashut HaMisim) for the relevant financial year. The TRC is the primary document for establishing treaty eligibility under Section 90(4) of the Indian Income Tax Act. It must cover the period during which the capital gain was realized.

Form 10F

Form 10F must be filed electronically on the Indian Income Tax portal. Since 2022, electronic filing is mandatory. The form requires details including the taxpayer's status, nationality, Israeli tax identification number, period of residential status, and address in Israel.

Valuation Report (for Article 14(4) Assessment)

If there is any question about whether the shares derive more than 50% of their value from Indian immovable property, a valuation report from a registered valuer may be required to demonstrate compliance. The valuation should assess the fair market value of the company's assets, including immovable property, at the time of alienation and during the preceding 12 months.

Capital Gains Computation Statement

A detailed computation showing the acquisition cost, period of holding, sale consideration, and the resulting capital gain. For listed securities, exchange records and contract notes suffice. For unlisted shares, the computation must follow the provisions of Section 48 of the Income Tax Act, including any indexation benefits where applicable.

No PE Declaration

A self-declaration confirming that the shares sold are not effectively connected with a Permanent Establishment in India. This is critical for claiming the Article 14(5) exemption.

Withholding Procedure for Indian Payers

When an Israeli resident sells shares or other assets in India, the withholding and compliance requirements depend on the nature of the transaction:

Sale of Listed Securities Through Stock Exchange

For sales of listed shares through recognized Indian stock exchanges, STT (Securities Transaction Tax) is levied at the point of sale. If the treaty exempts the capital gain from Indian tax (under Article 14(5)), the Israeli investor can file a return in India claiming the treaty exemption and obtain a refund of any tax deducted. Alternatively, a nil or lower withholding certificate under Section 197 can be obtained in advance.

Off-Market Sales and Unlisted Shares

For off-market transactions or sales of unlisted shares, the buyer (if an Indian resident) is required to deduct tax at source under Section 195. Where the treaty exempts the gain, the buyer may apply the treaty provisions and deduct nil tax, provided the Israeli seller has furnished the TRC, Form 10F, and the no-PE declaration.

Form 15CA and Form 15CB

For remittance of sale proceeds to Israel, the buyer or the authorized dealer bank requires Form 15CA (online declaration) and Form 15CB (Chartered Accountant certificate). The CA certificate must reference the specific DTAA article under which the capital gain is exempt (Article 14(5)) and confirm that all documentation requirements are met.

Advance Ruling Option

For high-value transactions, Israeli investors may consider applying for an advance ruling from the Board for Advance Rulings under Section 245Q of the Income Tax Act. This provides certainty on the tax treatment before the transaction is completed, which is particularly valuable for private equity exits and large block deals.

Common Disputes and Judicial Precedents

Capital gains taxation under Indian DTAAs has generated significant litigation. While there are no widely reported India-Israel specific rulings on capital gains, the principles established in other treaty contexts are directly applicable:

The Immovable Property Value Test

Disputes frequently arise over whether shares "derive more than 50% of their value" from Indian immovable property. The key contested issues include: (a) whether the test should use book value or fair market value, (b) how to treat intangible assets like goodwill and brand value in the computation, and (c) whether temporary fluctuations in property values during the 12-month look-back period can trigger the provision. Indian tax authorities tend to apply the test aggressively, while taxpayers argue for a narrow interpretation.

Indirect Transfer Provisions (Section 9(1)(i))

India's domestic law under Section 9(1)(i) (introduced in 2012 following the Vodafone case) deems capital gains from the transfer of shares of a foreign company to be Indian-sourced income if the shares derive substantial value from Indian assets. The interplay between this domestic provision and the treaty's Article 14 is complex. The treaty's Article 14(5) residual clause generally overrides Section 9(1)(i) for Israeli residents, but tax authorities may challenge this in cases involving interposed entities.

PE Connection and Capital Gains

If an Israeli enterprise has a PE in India, the question of whether specific shares are "effectively connected" with that PE determines whether Article 14(2) or 14(5) applies. Indian tribunals have examined the nature of the connection -- mere ownership of shares by the same entity is generally insufficient; the shares must be functionally connected with the PE's business activities.

Treaty Shopping and Capital Gains

The 2015 Protocol's Limitation of Benefits (LOB) article and the MLI's PPT are particularly relevant in the capital gains context. Arrangements where Israeli entities are interposed solely to access the Article 14(5) exemption are vulnerable to challenge. The landmark cases involving Mauritius and Singapore (Vodafone, Tiger Global) provide cautionary precedents, though the India-Israel treaty's LOB provision operates differently from those treaties.

Practical Examples and Calculations

Example 1: Israeli VC Fund Selling Listed Indian Shares

An Israeli venture capital fund holds shares in an Indian listed technology company acquired for INR 5,00,00,000. After 3 years, the fund sells the shares for INR 12,00,00,000, realizing a long-term capital gain of INR 7,00,00,000.

• Without DTAA: LTCG tax at domestic rate = 12.5% on gains exceeding INR 1.25 lakh = INR 87,34,375 (approximately USD 105,000)
• With DTAA (Article 14(5)): Capital gains taxable only in Israel = INR 0 Indian tax
• Net saving: INR 87,34,375 (approximately USD 105,000)

The fund pays Israeli capital gains tax on the gains at Israel's domestic rates (25% for companies, with potential participation exemption for qualifying holdings), but the Indian tax of INR 87.34 lakh is entirely eliminated under the treaty.

Example 2: Israeli Individual Selling Unlisted Shares in an Indian Company

An Israeli angel investor holds 5% shares in an Indian unlisted startup acquired for INR 20,00,000. The startup is valued at INR 50,00,00,000, but less than 10% of its assets consist of immovable property. After 30 months, the investor sells for INR 1,50,00,000.

• Without DTAA: LTCG tax at 12.5% = INR 16,25,000
• With DTAA (Article 14(5)): Since immovable property constitutes less than 50% of the company's value, gains are taxable only in Israel = INR 0 Indian tax
• Net saving: INR 16,25,000 (approximately USD 19,500)

Example 3: Israeli Company Selling Shares in an Indian Real Estate Company

An Israeli real estate investment company holds shares in an Indian company whose assets consist of 70% immovable property in India. The shares are sold for INR 25,00,00,000, resulting in LTCG of INR 10,00,00,000.

• Without DTAA: LTCG at 12.5% = INR 1,25,00,000
• With DTAA: Since immovable property exceeds 50%, Article 14(4) applies -- India retains taxing rights. LTCG at domestic rate of 12.5% = INR 1,25,00,000
• Net saving: INR 0 -- the treaty does not provide relief for property-rich companies

This example illustrates the critical importance of the 50% immovable property value test introduced by the 2015 Protocol.

Frequently Asked Questions

Are capital gains from selling Indian listed shares exempt from Indian tax for Israeli residents?

Yes, under Article 14(5) of the India-Israel DTAA, capital gains from the alienation of shares that do not derive more than 50% of their value from Indian immovable property are taxable only in Israel. Most listed shares in Indian companies (IT, pharma, banking, manufacturing) fall under this exemption, meaning Israeli residents pay zero Indian capital gains tax on such transactions.

What changed in the 2015 Protocol regarding capital gains?

The 2015 Protocol amended Article 14 to allow India to tax capital gains on shares that derive more than 50% of their value from Indian immovable property, at the time of alienation or during the preceding 12 months. It also extended this provision to interests in partnerships, trusts, and other entities, closing a structuring loophole.

How is the 50% immovable property test applied?

The test examines whether the shares being sold derive more than 50% of their value, directly or indirectly, from immovable property situated in India. The assessment is made at the time of the share sale or at any point during the 12 months preceding the sale. If the threshold is exceeded at any point during this period, India retains the right to tax the capital gain.

Do Israeli investors need to file an Indian tax return for capital gains?

Yes, even if the capital gain is exempt under the treaty, it is advisable to file an Indian tax return (ITR-2 or ITR-3) to establish the treaty claim on record. This is particularly important for off-market transactions where the buyer has deducted tax at source. A return is mandatory if the gross total income (before treaty exemption) exceeds the basic exemption limit.

What documents does an Israeli investor need to claim capital gains exemption?

A valid Tax Residency Certificate from the Israeli Tax Authority, Form 10F filed electronically on the Indian portal, a no-PE declaration, the capital gains computation statement, and (for Article 14(4) assessment) a valuation report confirming that the shares do not derive more than 50% of their value from Indian immovable property.

Does the MLI Principal Purpose Test affect capital gains exemption?

Yes. The MLI's PPT, applicable to the India-Israel treaty from October 2019, allows Indian tax authorities to deny the capital gains exemption if one of the principal purposes of the transaction or arrangement was to obtain the treaty benefit. Genuine commercial transactions with bona fide business purposes are protected, but back-to-back arrangements designed purely for treaty access are vulnerable.

Can an Israeli PE in India sell shares and claim capital gains exemption?

No. If the shares form part of the business property of a Permanent Establishment that the Israeli enterprise maintains in India, the capital gains are taxable in India under Article 14(2), not under the residual Article 14(5). The shares must be functionally disconnected from the PE's business activities to qualify for the exemption.