An Indian subsidiary can return surplus capital to its foreign parent by a buy-back under section 68 of the Companies Act, 2013 — up to 25% of paid-up capital and free reserves (10% by board resolution alone, more with a special resolution), with post-buy-back debt not exceeding twice capital and free reserves, funded from free reserves or securities premium, and not more than one buy-back in twelve months — or by a capital reduction under section 66 approved by the National Company Law Tribunal. Under FEMA the price paid to the non-resident may not exceed fair value under the pricing guidelines, and the transaction is reported through the bank. For tax, buy-back consideration paid between 1 October 2024 and 31 March 2026 was taxed as dividend in the shareholder's hands; for tax year 2026-27 onwards the Finance Act, 2026 restored capital gains treatment under the Income-tax Act, 2025, so the treaty's capital gains article governs and the company withholds under section 393(2), usually against a section 395 certificate. A capital reduction is a deemed dividend to the extent of accumulated profits and capital gains for the balance.
Key facts
| Provision | Old reference (to 31 Mar 2026) | New reference (from 1 Apr 2026) | Rate / threshold | Timing | Form |
|---|---|---|---|---|---|
| Buy-back — power and limits | s. 68 Companies Act, 2013; Rule 17, Companies (Share Capital and Debentures) Rules | Unchanged | ≤25% of paid-up capital + free reserves (board alone ≤10%); debt:equity ≤ 2:1 after; fully paid shares | One buy-back per 12 months; complete within 1 year of resolution | SH-8 (letter of offer), SH-9 (solvency), SH-11 (return) |
| Buy-back — sources | s. 68(1) | Unchanged | Free reserves, securities premium, proceeds of a different class of securities | — | — |
| Capital reduction | s. 66 Companies Act; NCLT Rules | Unchanged | Special resolution + NCLT confirmation; creditor notice; ROC filing | Several months | RSC-1 to RSC-7; INC-28 |
| FEMA — pricing | Rule 21 NDI Rules: NR → R / company not above fair value | Unchanged | Valuation by CA / merchant banker / cost accountant | At transaction | Valuation certificate |
| FEMA — reporting | Master Direction on Reporting under FEMA | Unchanged | Through AD bank as prescribed for buy-back / reduction | Per Master Direction | — |
| Tax — buy-back consideration | s. 115QA (company-level 20% tax, to 30 Sept 2024); deemed dividend in shareholder's hands (1 Oct 2024 – 31 Mar 2026) | Capital gains in shareholder's hands from TY 2026-27 (Income-tax Act, 2025 as amended by Finance Act, 2026) | Treaty capital gains article | — | — |
| Tax — capital reduction | s. 2(22)(d): dividend to extent of accumulated profits; capital gains on balance | Corresponding provisions, 2025 Act | Dividend: 20% + or treaty; gains: per treaty | — | — |
| Withholding | s. 195 | s. 393(2), Sl. 17; s. 395 certificate (Form 128) | On the taxable component | At payment | Forms 145/146 |
Buy-back under section 68
The company purchases its own shares from the parent and cancels them. Conditions:
- Authorised by the articles; approved by the board for up to 10% of paid-up capital and free reserves, or by special resolution for up to 25% (and, for equity shares, not more than 25% of paid-up equity in a year).
- After the buy-back, the ratio of debt (secured and unsecured) to paid-up capital and free reserves must not exceed 2:1.
- Shares must be fully paid; funded from free reserves, securities premium or the proceeds of a different class of securities; no fresh issue of the same kind of shares for six months thereafter (except ESOPs, conversions and similar).
- Declaration of solvency (SH-9), letter of offer (SH-8) filed with the ROC, completion within one year of the resolution, return in SH-11 within 30 days of completion, destruction of certificates within seven days, and a gap of at least one year between buy-backs.
- Because the subsidiary is wholly owned, the offer is to a single shareholder (plus the nominee); the process is mechanical but every filing is still required.
Capital reduction under section 66
Used where the amount exceeds buy-back limits, where accumulated losses are to be written off, or where selective reduction is intended. Requires a special resolution, an application to the NCLT, notice to the Central Government, the ROC, SEBI (if listed) and creditors, an auditor's certificate on the accounting treatment, and the Tribunal's confirmation order filed with the ROC. Timelines run several months. The reduction can be with or without payment to shareholders.
FEMA
Payment to the non-resident parent on a buy-back or reduction is a capital-account remittance. The price may not exceed fair value under the NDI pricing guidelines (the non-resident-to-resident ceiling), certified by a Chartered Accountant, merchant banker or cost accountant. The bank processes the remittance against the board or Tribunal documents, the valuation, the CA certificate on tax, and Forms 145/146, and reports the reduction in foreign investment as the RBI's Reporting Master Direction prescribes. The subsequent FLA return reflects the reduced foreign liability.
Tax
Buy-back
Three regimes in three years. Until 30 September 2024, the company paid buy-back tax under old section 115QA and the shareholder was exempt. From 1 October 2024 to 31 March 2026, the entire consideration was taxed as dividend in the shareholder's hands (with the cost of the shares becoming a capital loss). For tax year 2026-27 onwards, the Finance Act, 2026 amended the Income-tax Act, 2025 to tax buy-back consideration as capital gains in the shareholder's hands — consideration less cost of acquisition, long-term if held more than 24 months (unlisted shares). For a foreign parent the treaty capital gains article then applies: many Indian treaties (US, UK, Germany, Japan) give India the right to tax gains on Indian shares; the Mauritius and Singapore treaties grandfather shares acquired before 1 April 2017 and tax later acquisitions in India. The company withholds under section 393(2) on the taxable gain, which is why a section 395 lower-deduction certificate in Form 128, fixing the gain and the rate, is obtained before payment.
Capital reduction
A distribution on reduction of capital is a deemed dividend to the extent of the company's accumulated profits (whether capitalised or not), taxed at 20% plus surcharge and cess or the treaty dividend rate, with the balance treated as consideration for the extinguishment of shares and taxed as capital gains. Where the company has no accumulated profits — the typical loss-making subsidiary returning surplus capital — the whole distribution is capital gains computation, often producing no gain or a loss.
Choosing between them
For a profitable subsidiary with modest reserves, a dividend is simpler. For returning a large amount of surplus capital in a loss-making or thinly profitable subsidiary, capital reduction (no deemed dividend absent accumulated profits) is usually cheaper than buy-back but slower. Buy-back suits amounts within the 25% limit where the company has free reserves and wants to avoid the Tribunal.
Worked example
A US parent invested ₹40 crore in its Indian subsidiary in 2019 (4 crore shares at ₹10). The subsidiary now has paid-up capital ₹40 crore, free reserves ₹8 crore, no debt, and ₹20 crore of surplus cash. Fair value per share: ₹13.
| Route | Mechanics | Tax for the US parent (tax year 2026-27) |
|---|---|---|
| Buy-back | Limit 25% × ₹48 crore = ₹12 crore; special resolution; 92.3 lakh shares at ₹13; debt-equity test met; SH-8/9/11 | Capital gains: ₹12 crore − cost ₹9.23 crore = ₹2.77 crore long-term gain; taxable in India under Art. 13 India–US; withholding on the gain per section 395 certificate |
| Capital reduction | Reduce capital by ₹20 crore via NCLT (e.g. cancel 1.54 crore shares at ₹13); 6–9 months | Accumulated profits ₹8 crore → deemed dividend ₹8 crore at 15% (Art. 10) = ₹1.2 crore withheld; balance ₹12 crore vs cost ₹15.4 crore → capital loss |
| Dividend | Limited to distributable profits ₹8 crore | 15% withholding = ₹1.2 crore; cannot return the other ₹12 crore |
The buy-back returns ₹12 crore now with a modest gain; the reduction returns the full ₹20 crore but carries the ₹8 crore deemed dividend. Many groups do both in sequence: dividend the ₹8 crore of profits, then reduce capital with no accumulated profits remaining.
Common mistakes we see
- Buying back more than 25% in a year, or within twelve months of the last buy-back.
- Paying the parent more than fair value on a buy-back, in breach of the non-resident-to-resident pricing ceiling.
- Applying the 2024–26 deemed-dividend treatment to a buy-back in tax year 2026-27, or the capital gains treatment to one completed in March 2026.
- Withholding on the gross buy-back consideration instead of the gain because no section 395 certificate was obtained.
- Ignoring accumulated profits when computing the deemed dividend on a capital reduction.
- Filing the Companies Act forms but never reporting the reduction in foreign investment to the RBI through the bank.
Frequently asked questions
How much can an Indian company buy back from its parent?
Up to 25% of paid-up capital and free reserves (by special resolution; 10% by board resolution alone), with debt not exceeding twice capital and free reserves after the buy-back, and not more than one buy-back in twelve months — section 68 of the Companies Act, 2013.
How is a buy-back taxed for a foreign shareholder in 2026?
For tax year 2026-27 onwards, as capital gains in the shareholder's hands (consideration less cost), under the Income-tax Act, 2025 as amended by the Finance Act, 2026. The treaty capital gains article governs India's right to tax; the company withholds under section 393(2), normally against a section 395 certificate. Buy-backs between 1 October 2024 and 31 March 2026 were taxed as dividend.
Is a capital reduction taxable?
To the extent of the company's accumulated profits the distribution is a deemed dividend (20% plus surcharge and cess, or the treaty dividend rate). The balance is consideration for extinguishment of shares and is subject to capital gains computation.
Does a buy-back from a foreign parent need RBI approval?
No prior approval under the automatic route, but the price may not exceed fair value under the FEMA pricing guidelines and the transaction is reported through the bank.
How long does a capital reduction take?
Typically several months, as it requires a special resolution, NCLT application, notices to the Central Government, ROC and creditors, and the Tribunal's confirmation order.
Can a subsidiary with accumulated losses buy back shares?
Only from free reserves or securities premium. A company with no free reserves cannot fund a buy-back and would use a capital reduction instead.
Sources
Primary sources only. Statutory text is read from the official publication; where a provision has been renumbered, the pre-2026 reference is given alongside so older material can be reconciled.
- Companies Act, 2013 and rules — Ministry of Corporate Affairs
- Income-tax Act, 2025 and Income-tax Rules, 2026 — Income Tax Department, Tax Laws & Rules
- Double Taxation Avoidance Agreements — Income Tax Department
- FEMA notifications — Reserve Bank of India
- RBI Master Directions — Reporting under FEMA; External Commercial Borrowings; Overseas Investment; Export of Goods and Services; LRS
- e-Gazette of India — Finance Act, 2026; Income-tax Rules, 2026; FEMA notifications
Last reviewed on 1 November 2026 by Suchit Jhunjhunwala, FCA, VMS Jhunjhunwala & Co. Law stated as at that date; the Income-tax Act, 2025 and Income-tax Rules, 2026 apply from 1 April 2026.
