Capital Gains Tax Between India and Japan Under DTAA

Capital Gains Tax Rate Between India and Japan

The India-Japan Double Taxation Avoidance Agreement (DTAA), originally signed on 7 March 1989 and effective from 29 December 1989, addresses capital gains taxation under Article 13 (Gains from the Alienation of Property). While the India-Japan treaty provides a favourable uniform 10% rate for dividends, interest, royalties, and FTS, capital gains follow a fundamentally different approach: Article 13 allocates taxing rights to the source country for most categories of capital gains, with India applying its full domestic tax rates without any treaty-imposed cap.

This means Japanese investors selling Indian shares, real estate, or business assets pay capital gains tax at India's domestic rates, and Japan provides relief from double taxation through its foreign tax credit mechanism. The treaty has been amended by Protocols in 2006, 2008, and 2015, and is further modified by the Multilateral Instrument (MLI) which entered into force for both countries in 2019. Understanding the interplay between Article 13, India's domestic capital gains regime, and Japan's FTC system is essential for Japanese companies and investors with India exposure.

Japan is one of India's largest FDI sources, with companies like Toyota, Suzuki, Honda, Sony, Mitsubishi, SoftBank, and Daikin maintaining substantial investments across Indian sectors. For personalised structuring advice, consult BeaconFiling's tax advisory team.

Treaty Rate vs Domestic Rate: Detailed Comparison

Article 13 of the India-Japan DTAA does not set a maximum withholding rate for capital gains. Instead, it allocates taxing rights between the two countries based on the type of property being alienated.

Article 13(1) — Immovable Property

Gains from the alienation of immovable property situated in India may be taxed in India at full domestic rates. The term "immovable property" is defined by Indian domestic law and includes land, buildings, and property accessory to immovable property. This gives India full taxing rights over gains from Indian real estate sold by Japanese residents.

Article 13(2) — Movable Property of a PE

Gains from the alienation of movable property forming part of the business property of a permanent establishment which a Japanese enterprise has in India may be taxed in India. This includes gains from the alienation of the PE itself, whether alone or with the entire enterprise.

Article 13(3) — Ships and Aircraft

Gains from the alienation of ships or aircraft operated in international traffic, or movable property pertaining to their operation, are taxable only in the country where the enterprise's place of effective management is situated.

Article 13(4) — Shares Deriving Value from Immovable Property

Following the 2006 Protocol amendments, gains from the alienation of shares or comparable interests (including partnership or trust interests) that derive more than 50% of their value directly or indirectly from immovable property situated in India at any time during the 365 days preceding the alienation may be taxed in India. This "property-rich company" rule prevents circumventing the immovable property gains provision by holding property through corporate structures.

Article 13(5) — Shares of Indian Companies (General)

Gains from the alienation of shares in an Indian company by a Japanese resident may be taxed in India. This is a broad provision that gives India taxing rights over most share disposals, subject to India's domestic capital gains rates.

Article 13(6) — Other Property (Residual)

Gains from the alienation of any property other than those described above are taxable only in the state of residence (Japan). This residual clause provides exclusive Japanese taxation for property not covered by the preceding paragraphs.

Note: Rates reflect post-Budget 2024 amendments (effective 23 July 2024). Previously, LTCG on listed equities was 10% above INR 1 lakh, and STCG was 15%.

Who Qualifies for Relief on Capital Gains

Since Article 13 does not provide reduced rates, the question is how double taxation is eliminated. The relief mechanism depends on which country is the residence state.

Japanese Residents: Foreign Tax Credit in Japan

A Japanese resident (individual or corporation) that pays capital gains tax in India can claim a Foreign Tax Credit (FTC) in Japan under Article 23 of the treaty and Japan's domestic law (Article 95 of the Income Tax Act for individuals, Article 69 of the Corporation Tax Act for companies). The credit offsets Indian tax against Japanese tax liability on the same income, limited to the Japanese tax attributable to the foreign-source income.

Japan taxes capital gains as ordinary income for corporations (at the standard corporate tax rate of approximately 23.2% national plus local taxes totalling ~30%). For individuals, capital gains on listed shares are taxed at a flat 20.315% (including local taxes). The FTC ensures that the combined India-Japan tax burden does not exceed the higher of the two countries' rates.

Indian Residents: Relief Under Section 90

Indian residents selling Japanese assets can claim relief under Section 90 of the Income Tax Act by way of a foreign tax credit for Japanese taxes paid, subject to the provisions of Rule 128. Japan generally does not tax non-resident capital gains on listed shares, but may tax gains on unlisted shares or property-rich companies.

Principal Purpose Test (MLI)

The MLI's Principal Purpose Test (PPT) applies to the India-Japan DTAA from FY 2020-21. While the PPT primarily targets treaty shopping for income types with specific rate benefits, it can also affect capital gains arrangements. Structures designed primarily to achieve favourable capital gains treatment through interposition of Japanese entities could be challenged under the PPT.

Capital Gains-Specific Treaty Provisions

Property-Rich Company Rule (Article 13(4))

This provision, introduced by the 2006 Protocol, is particularly important for Japanese companies holding Indian real estate through corporate structures. If shares of a company (whether Indian or foreign) derive more than 50% of their value from Indian immovable property at any point in the 365 days before alienation, India can tax the gain. This anti-avoidance rule prevents Japanese investors from converting taxable immovable property gains into potentially tax-free share sale gains by holding property through a company.

The 50% value threshold is based on the fair market value of the immovable property relative to the total value of the company's assets. Japanese real estate investors, hotel companies, and infrastructure investors should conduct regular valuations to monitor this threshold.

PE Asset Gains (Article 13(2))

Japanese companies closing or restructuring their India operations should note that gains from the alienation of PE assets (including intangible assets, goodwill, and the PE itself) are taxable in India. This includes scenarios where a Japanese company sells its Indian branch operations or transfers PE assets as part of a global restructuring.

Interaction with India's Indirect Transfer Provisions

India's domestic law (Section 9(1)(i) with Explanation 5) taxes gains from shares or interests that derive their value substantially from Indian assets. This provision operates alongside Article 13(4) and 13(5). For Japanese investors, the treaty's broad share sale taxing right (Article 13(5)) means there is generally no conflict between domestic law and treaty provisions -- India can tax most share sales under both frameworks.

Documentation Required

Japanese investors dealing with Indian capital gains must maintain comprehensive documentation:

Tax Residency Certificate (TRC)

The Japanese resident must obtain a Tax Residency Certificate from the Japanese National Tax Agency (NTA). While the TRC does not reduce the capital gains rate (since Article 13 preserves domestic rates), it is essential for establishing treaty residence for FTC purposes and for any LOB or PPT analysis.

Form 10F

The Japanese resident must furnish Form 10F electronically on India's Income Tax e-filing portal, providing details such as status, nationality, Japanese My Number (for individuals) or corporate number (for companies), and period of residential status.

Form 15CA and Form 15CB

When capital gains proceeds are remitted from India to Japan, Form 15CA (declaration of remittance) and Form 15CB (CA certificate) are required. The CA must confirm that TDS has been deducted at the appropriate domestic capital gains rate and cite the treaty provisions.

Japanese Tax Filing (FTC Claim)

Japanese corporations file the FTC claim as part of their annual corporate tax return. Individuals file using the final tax return (kakutei shinkoku). Documentation of Indian taxes paid, including TDS certificates (Form 16A) and Indian tax return acknowledgements, must be maintained.

Withholding Procedure for Indian Payers

Indian entities or buyers making payments on account of capital gains to Japanese residents must comply with TDS obligations:

TDS on Share Transactions

For listed shares sold through Indian stock exchanges, Securities Transaction Tax (STT) is paid and TDS is typically not deducted at the transaction level. For off-market or unlisted share transactions, the buyer must deduct TDS under Section 195:

• LTCG on listed shares (Section 112A): 12.5% (above INR 1.25 lakh threshold)
• LTCG on unlisted shares (Section 112): 12.5%
• STCG on listed shares (Section 111A): 20%
• STCG on unlisted shares: Applicable slab rate

TDS on Property Transactions

For immovable property sold by Japanese non-residents, the buyer must deduct TDS at the applicable capital gains rate under Section 195. For LTCG, the rate is 12.5%. The buyer files Form 27Q quarterly.

Section 197 Lower Deduction Certificate

If the actual tax liability is lower than the TDS rate (for example, due to cost of acquisition adjustments, indexation benefits, or the INR 1.25 lakh exemption threshold), the Japanese seller can apply for a lower deduction certificate under Section 197 before the transaction.

Common Disputes and Judicial Precedents

Indirect Transfers and Section 9(1)(i)

Following the Vodafone case (2012) and subsequent legislative amendments, India asserts taxing rights over indirect transfers of Indian company shares through offshore transactions. For Japanese investors holding Indian assets through multi-tier structures, this means selling shares of a Japanese or third-country holding company whose value derives substantially from Indian assets could trigger Indian capital gains tax under both the treaty (Article 13(4)/(5)) and domestic law (Section 9(1)(i) Explanation 5).

SoftBank and Startup Investments

Japanese investment firm SoftBank's significant investments in Indian startups and technology companies have highlighted the capital gains implications of the India-Japan DTAA. When SoftBank exits Indian investments (as it has done with several listed companies post-IPO), Article 13(5) gives India taxing rights on the gains. The scale of these investments makes the FTC mechanism and treaty compliance particularly important for institutional Japanese investors.

Grandfathering of Cost (Section 112A)

For listed equity shares, the cost of acquisition is grandfathered to the higher of the actual cost or the fair market value as of 31 January 2018. Japanese investors holding Indian listed shares since before February 2018 benefit from this provision, which reduces the taxable LTCG.

GAAR Implications

India's General Anti-Avoidance Rule (GAAR), effective from 1 April 2017, can override treaty provisions for arrangements whose primary purpose is tax avoidance. Japanese investors using intermediary entities or complex structures to minimise capital gains should ensure their arrangements have genuine commercial substance beyond tax benefits.

MLI and Principal Purpose Test

The MLI's PPT, applicable from FY 2020-21, provides an additional anti-avoidance tool. While Article 13 itself gives broad taxing rights to the source country, the PPT could affect situations where Japanese entities are interposed in multi-tier structures primarily to access Japan's FTC system or to characterise gains as arising under Article 13(6) (residual clause -- taxable only in residence state).

Practical Examples and Calculations

Example 1: Japanese Corporation Selling Indian Listed Shares (LTCG)

A Japanese corporation purchased 50,000 shares of an Indian listed company at INR 200 per share (INR 1,00,00,000 total) on 1 April 2020. They sell the shares on 1 December 2026 at INR 500 per share (INR 2,50,00,000 total). FMV on 31 January 2018 was INR 150 per share.

• Cost of acquisition (grandfathered): Higher of actual cost (INR 200) or FMV on 31/01/2018 (INR 150) = INR 200 per share
• Capital gain: INR 2,50,00,000 - INR 1,00,00,000 = INR 1,50,00,000
• Exempt amount: INR 1,25,000 (Section 112A threshold)
• Taxable LTCG: INR 1,48,75,000
• Tax in India: 12.5% = INR 18,59,375
• Japan treatment: Gain included in Japanese corporate income. FTC of INR 18,59,375 (converted to JPY) claimed against Japanese corporate tax (~30%).

Example 2: Japanese Individual Selling Indian Property (LTCG)

A Japanese individual (former NRI) sells an apartment in Bengaluru purchased in 2019 for INR 80,00,000, selling in 2026 for INR 1,40,00,000.

• Capital gain: INR 1,40,00,000 - INR 80,00,000 = INR 60,00,000
• Classification: Long-term (held more than 24 months)
• Tax in India (Section 112): 12.5% of INR 60,00,000 = INR 7,50,000
• TDS deducted by buyer: 12.5% under Section 195
• Japan treatment: Gain reported on Japanese tax return; FTC claimed for Indian taxes paid.

Example 3: Japanese Company Selling Unlisted Indian Subsidiary Shares (STCG)

A Japanese manufacturing company sells its 100% stake in an Indian private subsidiary 18 months after acquisition. Purchase price: INR 5,00,00,000. Sale price: INR 8,00,00,000.

• Capital gain: INR 8,00,00,000 - INR 5,00,00,000 = INR 3,00,00,000
• Classification: Short-term (held less than 24 months for unlisted shares)
• Tax in India: STCG at slab rate for non-resident corporate (maximum 35% + surcharge + cess)
• Japan treatment: FTC claimed against Japanese corporate tax.
• Key lesson: If the company had held the shares for 24+ months, LTCG at 12.5% would have applied instead of the much higher STCG rate.

Frequently Asked Questions

Does the India-Japan DTAA reduce capital gains tax rates?

No. Article 13 allocates taxing rights but does not cap the rate. India applies its full domestic capital gains tax rates to Japanese residents. Relief from double taxation comes through Japan's foreign tax credit mechanism, not through reduced source-country rates.

How does a Japanese investor avoid double taxation on Indian capital gains?

A Japanese investor pays capital gains tax in India at domestic rates and then claims a Foreign Tax Credit in Japan on their corporate or individual tax return. The FTC offsets the Indian tax against Japanese tax on the same income, ensuring the combined burden does not exceed the higher rate.

What is the LTCG rate on Indian listed shares for Japanese residents?

Japanese residents pay 12.5% LTCG tax on gains from Indian listed equity shares held for more than 12 months, with an exemption threshold of INR 1.25 lakh per financial year under Section 112A. This is the full domestic rate -- the DTAA does not reduce it.

Can India tax indirect transfers of Indian company shares by Japanese entities?

Yes. Article 13(4) allows India to tax gains from shares deriving more than 50% of their value from Indian immovable property. Article 13(5) broadly allows India to tax gains from Indian company shares. Additionally, India's domestic Section 9(1)(i) Explanation 5 taxes indirect transfers through offshore entities.

Does the MLI affect capital gains taxation under the India-Japan DTAA?

The MLI introduced the Principal Purpose Test (PPT) effective from FY 2020-21. While Article 13 broadly preserves source-state taxing rights, the PPT could affect arrangements designed primarily to access Japan's FTC system or to characterise gains under the residual Article 13(6) clause.

Can a Japanese investor apply for a lower TDS certificate?

Yes. Under Section 197 of the Income Tax Act, a non-resident can apply for a lower deduction certificate if the actual tax liability is expected to be lower than the TDS rate. This is useful when cost of acquisition adjustments, indexation benefits, or the exemption threshold reduce the effective tax below the standard rate.

What are Japan's reporting obligations for Indian capital gains?

Japanese corporations include Indian capital gains in their annual corporate tax return and claim the FTC. Individuals report on their final tax return (kakutei shinkoku). Both must maintain documentation of Indian taxes paid (Form 16A, Indian tax return acknowledgements) and the computation of taxable gains.