International Tax: India's Share Buyback - Dividend or Capital Gain?

A recent discussion with a colleague highlighted a key international tax dilemma: when an Indian company buys back shares from a non-resident individual, is it taxed as a dividend or as a capital gain? The answer determines the applicable tax treaty article and the final tax burden.

The Indian Law Change

Since October 1, 2024, Indian tax law treats the buyback of shares as a dividend in the hands of the shareholder. This means the Indian company must withhold taxes on the payment to a non-resident, just like it would for a regular dividend.

The Treaty Conflict: Article 10 vs. Article 13

This is where it gets tricky. Tax treaties have two key articles that could apply:

• Article 10 (Dividends): This governs how dividends are taxed. Since Indian law calls the buyback a dividend, this article seems to be the natural fit. It typically gives India the right to tax the payment, often at a reduced rate (e.g., 10% or 15%).

• Article 13 (Capital Gains): This governs profits from the sale or "alienation" of property, like shares. Some of India's treaties state that gains from selling shares are taxable only in the shareholder's home country. A non-resident would naturally prefer this article, as it could mean zero tax in India.

This creates a direct conflict. If both articles could apply, which one wins?

The Prevailing View: Article 10 Applies

Based on global guidance, the stronger argument is that Article 10 (Dividends) takes priority in this specific case.

Our Research & Analysis (R&D):

1. OECD/UN Commentary: The official explanations (commentaries) to the OECD and UN Model Tax Conventions are clear. If a country's domestic law treats a share redemption as a dividend, then it should be taxed under the Dividend Article (Article 10), not the Capital Gains Article (Article 13). The legal logic is that the specific rule for dividends overrides the general rule for capital gains when the payment is characterized as a dividend.

2. Substance over Form: The Indian government has explicitly chosen to reclassify buybacks as dividends to prevent tax avoidance. Applying Article 13 would defeat this very purpose. Tax authorities and most courts are likely to look at the economic substance (a distribution of company profits) rather than the legal form (a share transfer).

A Counter-Argument and Word of Caution

It is important to note a recent and contrasting development. In October 2025, a Netherlands Court of Appeal ruled in a different case that if a transaction fits two treaty articles, the one more favorable to the taxpayer should apply.

However, in the context of Indian buybacks, relying on this foreign ruling is highly risky. The direct guidance from the OECD commentaries is a powerful counter-argument that Indian authorities will certainly use.

Conclusion and Practical Advice

For now, the safest and most defensible path is to treat buybacks by an Indian company as a dividend taxable under Article 10 of the relevant tax treaty.

• For Companies: Withhold tax accordingly based on the treaty's dividend rate.

• For Non-Resident Investors: While the argument for Article 13 is appealing, it is likely to lead to prolonged litigation with a low chance of success under current interpretations. The potential benefit of zero tax must be weighed against the near-certainty of a dispute.

Until Indian courts or a specific circular provide further clarity, prudence lies in applying Article 10, ensuring compliance, and avoiding costly tax disputes.