India’s startup and unlisted corporate ecosystem have become a strong magnet for Non-Resident Indian (NRI) investors. While deal-making, valuation, and growth prospects dominate conversations at the entry stage, the tax and repatriation consequences of returns often receive far less attention—until investors attempt to exit.
In practice, the real challenge for NRIs is not investing into India, but withdrawing value from India in a tax-efficient and compliant manner.
The Legal Landscape Governing NRI Investments
The taxation and repatriation of NRI investments is not governed by a single statute. Instead, it is shaped by:
- The Income-tax Act, 1961
- FEMA and RBI regulations
- Applicable Double Taxation Avoidance Agreements (DTAAs)
Any misalignment between these frameworks can materially affect net returns.
Tax Treatment of Key Income Streams for NRIs
1. Sale of Unlisted Shares
(Sections 45, 48, 112 & 115F)
When an NRI sells shares of an unlisted Indian company:
- Capital gains are chargeable to tax in India under Section 45
- Shares held for more than 24 months qualify as long-term capital assets
- Long-term capital gains are generally taxed at 20% with indexation under Section 112
For NRIs, a special exemption mechanism exists under Section 115F, but it is strictly conditional. The original investment must have been made in convertible foreign exchange, and sale proceeds must be reinvested in notified assets within the prescribed timeframe. Failure to meet these conditions often results in denial of exemption.
2. Tax Implications on Liquidation
(Sections 2(22)(c) and 46)
Distributions received on liquidation are not treated uniformly. The law mandates a layered approach:
- Amounts representing accumulated profits are deemed to be dividend under Section 2(22)(c)
- Amounts representing return of share capital are not taxable
- Any surplus beyond capital and profits is taxed as capital gains under Section 46
For NRIs, this classification has a direct bearing on withholding taxes, treaty benefits, and repatriation approvals.
3. Share Buybacks by Unlisted Companies
(Sections 115QA and related provisions)
The taxation of buybacks has undergone significant change. Buybacks are no longer automatically tax-efficient:
- Buyback tax may apply at the company level
- Shareholders may lose the ability to set off capital losses
- Income characterisation issues arise for treaty and repatriation purposes
NRIs must therefore evaluate buybacks with caution.
4. Dividend Income
(Sections 56 and 195)
Dividend income earned by NRIs:
- Is taxable in India as income from other sources
- Is subject to tax withholding under Section 195
- May be eligible for DTAA relief, provided procedural conditions are satisfied
Inadequate documentation or incorrect withholding frequently leads to cash flow blockages.
FEMA and Repatriation Constraints
Even where tax liabilities are settled, repatriation remains subject to FEMA compliance. Key considerations include:
- Mode of investment (NRE/FCNR vs NRO)
- Compliance with pricing guidelines for unlisted shares
- Proper reporting under FEMA at both entry and exit stages
Non-compliance at the time of investment often becomes visible only at the repatriation stage—when remedial options are limited.
Common Challenges Faced by NRI Investors
In real-world scenarios, NRIs frequently encounter:
- Double taxation due to timing or character mismatches
- Disallowance of exemptions due to technical non-compliance
- Delays caused by certification and reporting requirements
- Frequent legislative changes impacting exit strategies
These issues are rarely the result of aggressive tax positions, but rather insufficient planning at the structuring stage.
Why Advance Planning Is Essential
For NRIs investing in unlisted Indian companies, taxation and repatriation should be addressed before capital is deployed, not after returns are generated. Entry strategy, holding structure, and exit planning must be aligned across tax and regulatory frameworks.
In cross-border investments, certainty of exit is as valuable as growth potential.
Concluding Note
India continues to offer attractive opportunities for NRI investors. However, without thoughtful tax and regulatory planning, the eventual repatriation of returns can become costly and time-consuming. A well-structured investment preserves value; a poorly structured exit erodes it.